According to the IPCC’s Sixth Assessment Report (AR6) on climate change, current investment levels would have to increase by 3-6X through 2030 to limit global warming to 2°C or 1.5°C. One barrier to achieving this goal is “the inadequate assessment of climate-related risks and investment opportunities,” says the IPCC report. While total global investment, both public and private, is insufficient to meet climate goals, one interesting area of uptick in investment has been venture capital flowing to climate technology. Global venture investment in climate tech was up 89% year-over-year (YoY) in 2022 according to Holon IQ. This is impressive against a backdrop of consolidating venture capital overall in 2022, with global venture funding down 35% YoY according to Crunchbase. As measured by PWC, climate tech funding represented more than a quarter of all venture funding last year.
Several positive trends in public and private climate finance bode well for investors and climate tech entrepreneurs. Historically, one of the biggest challenges investors faced when looking to fund climate technology is that these investments tend to have relatively long time-horizons and high levels of uncertainty requiring a combination of subject matter expertise and market acumen to understand the commercial potential of technology that may be still in development.
In the public sector, a combination of carrot and stick measures enacted by the US and governments across the globe will help to mitigate some of this risk by providing immediate incentives to reduce the cost of climate technology investment and increase the cost of climate inertia. According to PWC, US federal government spending on climate tech and clean energy will triple in the next 10 years thanks to legislations like the Inflation Reduction Act, Infrastructure Investment and Jobs Act, and the CHIPS and Science Act.
While the US has no national cap-and-trade market for carbon, the notion of a compliance driven carbon credit market is once again gaining steam among state regulators. California has had a cap-and-trade market since 2014. Oregon launched a version of cap-and-trade last year focused on fuel. Washington held its first cap-and-trade auction in February of 2023 with positive results. New York plans to cut emissions by 85% by 2050 by launching its own carbon market. In addition to compliance, rising costs of fossil fuels and the impetus to secure national energy supply in a volatile geopolitical climate has also acted as a catalyst for climate tech investments.
Unique funding vehicles are also emerging to help bridge the gap between short and long-term climate investment. For example, Frontier, founded by Stripe, Alphabet, Shopify, Meta, McKinsey and others, is an advanced market commitment (AMC) “that aims to accelerate the development of carbon removal technologies by guaranteeing future demand for them.” AMCs were first created in 2007 by five countries and the Bill and Melinda Gates Foundation to incentivize pharmaceutical manufacturers to invest in R&D to create a vaccine for pneumococcal disease and to keep the future cost of this vaccine down to maximize impact in the world’s poorest countries. The value of AMCs in clean tech is not only to keep the cost of these solutions down so that they are financially viable – and even financially attractive – for various end markets, but also to mitigate some of the risk of investing in early-stage climate tech companies with a long return window.
While carbon markets and AMCs provide interesting counterweights to the innate risk involved in climate tech investment, arguably, the best strategy for climate tech investors is a diversified climate tech portfolio. Interestingly, some of the largest funds raised in 2022, according to Crunchbase, have gone to startups working on mitigation efforts within established markets. For example, Arcadia, a SaaS and data startup focused on decarbonizing the electric grid, raised $325M in 2022. With shareholder filings related to climate change up 12% YoY in Q1 2022 according to Proxy Preview, in the short term, investors should look for climate tech startups partnering with public companies across energy, manufacturing, transportation, etc. to meet their ESG goals. Climate tech startups focusing on circular economy concepts like eliminating waste and pollution within existing systems and infrastructure and circulating products and materials provide an opportunity for near-term returns that can offset risk and enable the long-term orientation required to invest in more transformational technologies. In short, climate finance is going to need to look across multiple temporal horizons to be successful – at both driving impact and driving returns.