Energy Markets Confront the Post-Petroleum Era

Michael Butler is chairman and CEO of investment bank Cascadia Capital. He is writing a book titled Financing the Future and the Next Wave of 21st Century Innovation, and is serializing it here at peHUB. What follows is an excerpt from the ninth chapter.

Oil prices have dropped more than 20% from their recent historic highs, but they still remain well above $100 a barrel and there’s little reason to rejoice or relax. In fact, we have every reason to be concerned – because petroleum is rapidly becoming the most critical global market of the early 21st century, and it’s likely to remain crucial to our safety and security for generations to come.

Rich oil flows over the past few years have emboldened harsh, hard-line Petro-Regimes in Russia, Iran and Venezuela, for example. And each of these strident nations has taken a stand against American interests and has the ability to cow oil-dependent countries all over the world.

Petroleum is rapidly becoming a significant drag on the American economy. Rising fuel prices are increasing overhead and constraining industries across the board while adding to the cost-of-living for average families who drive cars and heat or cool their homes. All of this is sending out ominous inflationary ripples that could cut into much-needed GDP growth.

Petroleum is also a leading environmental culprit when it comes to greenhouse gas emissions and the real threat that global warming and climate change present to the billions of people on our planet.

And despite the apparent slowing of the goliath Chinese economy, unprecedented petroleum demand in developing nations is eating into global supplies and renewing calls for even more oil drilling and underground or underseas exploration.

Focusing on the supply side of the petroleum markets isn’t the right way to come at this, at least from my perspective. There are more than 300 million acres of public land now available for oil leasing in the United States. Oil companies are currently sitting idle on nearly 70 million of those acres, so there’s plenty of room for new drilling and exploration – we don’t need to add more acreage to the mix.

And even if we did, would it make much of a difference? Probably not.

The United States consumes nearly 25% of global oil but sits on less than 2% of total world supply.

So, in the end, the petroleum markets must come to grips with the demand side of the equation. And that means energy efficiency, which got a bad name a generation ago, under the Carter Administration, when it was known as energy conservation and required significant personal sacrifices that people in America simply weren’t willing to make.

Energy efficiency has come a long way since then. And it’s now increasingly seen as low-hanging fruit – the cheapest, easiest and quickest way to restore balance to the petroleum markets while patching up the environment.

California, a good case in point, has implemented a wide variety of energy efficiency programs – affecting everything from light bulbs to massive electricity transformers – and the results have been startling and instructive. Over the past 30 or so years, for example, the Golden State has been able to hold energy consumption flat despite double-digit economic growth.

And a recent study from McKinsey indicated that the growth of global energy consumption – which includes petro-guzzlers like China and India – could be halved over the next 15 years with the right set of energy efficiency policies and programs.

Finally, if we are serious about reaping the economic and environmental benefits of a post-petroleum era, countries around the world must trim or curtail their oil subsidies to consumers. These politically motivated government subsidies simply reduce the price of gasoline for drivers and do nothing but encourage increased petroleum demand.
There is a major – and much-needed – role for new capital in the burgeoning worlds of energy efficiency and energy alternatives. And I see this clearly every day as entrepreneurs and executives roll out a series of innovative breakthrough technologies designed to wean us off petroleum while cleaning up the environment.

The emerging clean tech and alternative energy industry is still very young and, unlike information technology or biotechnology, it’s really several industries with very different lifecycles and value drivers under one umbrella.

Solar, wind, bio-fuels, green buildings / energy efficiency, smart grid, energy storage and clean water are each separate subsectors, in my view. Others may categorize these industries a bit differently than I have, but nobody can argue that there are not anywhere from a half dozen to a dozen multi-billion-dollar markets that fall under the clean tech and alternative energy banner.

This is fairly logical if you look at the “traditional” industries that are impacted by clean tech and alternative energy. The utility, oil and auto industries are deeply affected – and all three are mammoth. The sprawling municipal and private water and sewage sector also feels the impact. And so does the multi-hundred-billion-dollar building and construction sector. Even huge construction subsectors like lighting and HVAC are touched.

Like all nascent industries, there’s been a lot of hype around clean tech and alternative energy in the beginning. True to form, this has been followed by increased company formation, increased investment and rising valuations. After the surge, a slide usually takes hold. We have already seen signs of this in clean tech and alternative energy. But the good news is that after the slide, business models normally emerge, technology is refined, costs come down, demand firms up and successful companies emerge.

While version 1.0 is often more exciting and has a “gold rush” feel, it’s version 2.0 where the real money is made.

I think this will be the profit pattern for clean tech and alternative energy.

Clearly, government support is – and will be – a critical profit driver for clean tech and alternative energy. As always with the public sector, visibility, predictability and consistency is in short supply. This adds increased volatility to clean tech and alternative energy and it contributes to the very rapid opening and shutting of capital inflows we’re seeing in these industries today.

Exhibit A is the solar power industry.

The solar market has seen significant new company formation and venture capital investment in early-stage companies. But market demand – in the United States, Germany and Spain – has been driven, to a great extent, by government subsidies (tax credits or feed-in tariffs). In the United States, federal policy makers have thus far refused to renew the Investment Tax Credit (ITC). This has truly whipsawed the market: demand has dramatically slowed, projects are on hold, public solar company stock prices are off considerably, private solar companies are not hitting their revenue targets, and capital inflows into early-stage solar companies have dropped tremendously.

Private sector – as well as public sector – misjudgment is also rattling clean tech and alternative energy.

Exhibit B is the bio-fuels industry.

Bio-fuels were very hot in 2006 and 2007 after the government mandated their use. Anticipating major demand, money poured into the industry. VC funds, private equity funds, hedge funds and debt providers all stampeded into the game to provide capital to bio-fuels companies. But soon it became evident that the technology and business model of the bio-fuels industry was flawed. Companies were using the wrong feedstock as their input to create bio-fuels. This proved uneconomical as the price of the input increased faster than the price of the output. The bio-fuels market collapsed and capital fled the sector.

The New Energy Economy is clearly a work-in-progress, full of trial and error, stops and starts, and twists and turns. And, as a result, the sector rotations for investors will obviously keep changing rapidly as things shake out and evolve. This isn’t surprising, given that the path to prosperity has never been smooth or easy.

What we are seeing today is that the road to a post-petroleum era – to environmental improvement – is no less circuitous. We may be trading cutting-edge ideas and initiatives – in addition to petroleum futures and carbon credits – over the next few years, but the important thing to remember is that capital flows where it needs to go. That’s why I’m confident the volatile energy markets are headed in the right direction, a direction that will ultimately reward everyone.