Monday, November 28, 2011

Theil vs Khosla: Apples and Oranges

Last September, during TechCrunch Disrupt 2011, Peter Thiel, 39 year old internet whiz and outspoken venture capitalist, made a statement that made renowned Cleantech VC star Vinod Khosla, 56, rise to defend what he considers to be the best investment strategy that could “change the world”.

Theil’s statement
“Cleantech is an increasingly large disaster that people in Silicon Valley aren’t even talking about any more. The failure in energy and transportation points to a larger failure in clean energy — we aren’t moving any faster, literally, than we were when modern airplanes first came out. […] Cleantech investing has scattered Silicon Valley investors and left the U.S. behind in terms of innovation.”

Khosla’s defense
“Cleantech is not a disaster. During 2010, Khosla generated more than $1 billion in profits from three IPOs and will ‘probably’ see six more IPOs over the next 12 to 18 months, if the markets hold up. That $1 billion in profits over the last year is way more than most venture funds have done in IT in the last ten years cumulatively.”

Theil may have been reacting to recent cleantech bankruptcies (Solyndra’s Sept. 2011 bankruptcy, for $535 million and Khosla’s own Range Fuels Jan. 2011 bankruptcy, for $162 million) that lost millions of taxpayer and investor monies before closing their doors.

Aside from his Libertarian convictions, Theil based his comment specifically on the lack of progress that cleantech has shown so far. Markets for cleantech really have not moved any faster than when modern airplanes first came out in the 1960’s, and alternative energy is still a very small percentage of the US energy mix. But that may have to do more with lack of financing and political and business apathy towards (and ignorance of) needed climate change adaptation and mitigation measures than with the correctness of VC investing in cleantech. It may also have something to do with how the VC industry coped with fast-changing economic forces during the last decade.

Slight Political Support
President Reagan infamously took down President Carter’s solar panels from the White House roof; ‘Political Will’ towards climate change solutions became only slightly less lethargic through the first Bush presidency and the Clinton years, and then nosedived during the two-term Bush Jr. presidency. There has been scant support for cleantech at the federal level (compared to European and Asian government investment) for the last three decades, and it is only recently that politicians have begun to backpedal as they see many other nations embrace and prosper with cleantech.

Theil fails to mention the challenges faced by cleantech: only 10% of the population sees climate change as the biggest challenge our generation faces; the window of opportunity for climate change mitigation does not allow a cleantech sector to do necessary R&D without subsidies and incentives; a nascent industry needs government financial support in order to scale; there are too many pressing crises and fast-approaching closures of “climate windows of opportunity” to avert the worst climate catastrophes; cleantech firms are fighting against a rich and well established fossil fuel industry that collectively spends hundreds of millions of dollars a year to deny or delay any acceptance of climate change and therefore of cleantech solutions; cleantech is fighting an industry that has all its needed infrastructure and has already done much of its R&D, which cleantech has not; so far, economic accomplishment in cleantech has been spotty, there are no breakthrough companies; no one single alternative energy solution can replace petroleum and none has been a breakout success (price too costly, energy too inefficient or too intermittent); and finally, cleantech is by force local and limited by geographical constraints.

A Short History of Venture Capital
A short recapitulation of how venture capital came into existence in needed. VC has existed in America since the trans-continental railway. The industry sprang from a social need for overland and mass transportation, a political need to expand national borders, and the economic need of a small cadre of millionaires (Robber Barons) that needed to place some disposable income in high return investments under the rubric of presaging a bright future for America.

In the ‘60s, venture capital moved into the emerging semiconductor industry. In the ‘70s, computer hardware and software companies were in vogue; in the ‘80s it was biotech, mobility, and networking companies; in the ‘90s investment in the Internet exploded.

But by the late 1990s, “venture portfolios began to reflect a different sort of future. Venture investing shifted away from funding transformational companies and toward companies that solved incremental problems. VC is [no longer] the funder of the future, and instead has become a funder of features, widgets, irrelevances. In large part, it also ceased making money, as the bottom half of venture produced flat to negative return for the past decade. Long-standing investors are now getting squeezed by private equity firms on the high end, and wealthy angel investors on the low end of the investing scale. A bleak market for venture-backed initial public offerings has only increased the pressure.”

So Theil’s last sentence quoted above may also give a clue as to his motivations: investment in cleantech has “scattered Silicon Valley investors,” who are already under stress from various quarters within the industry and a volatile economy. In Theil’s mind, Khosla is squandering his “money pool” on cleantech.

From all that is published about Theil, one can surmise that he believes strongly in his own strategy for investment at the exclusion of all others: helping entrepreneurs and investors create “game-changing” tech businesses and a win-win situation for all involved. To him, investing in cleantech is a waste of money, and diverts possible investors from real investments.

The Differences between them

Although both investors have cited the challenges of climate change and peak oil as a driver of their investment decisions, their chosen investment paths are widely divergent. Libertarian Theil invests solely in internet tech stocks and hedges his climate change bets by funding the Seasteading Institute to create sovereign nations in international waters, free from the laws of any country (hardly a sustainable strategy for everybody).

Khosla, on the other hand, believes that “in order to achieve 80 percent less emissions from 2005 levels, with ten times the number of people living energy rich lifestyles, we would need 10 times energy productivity, and then 5 times energy carbon efficiency on top of that. Not accounting for methane and other greenhouse gases, we need roughly a 50 times ‘carbon productivity’ improvement. Provided we deal with the non-CO2 greenhouse gases separately, our only hope of reaching this goal is with a combination of energy productivity (how efficiently we use the energy we can make/extract/collect) and carbon energy efficiency (how little carbon we emit to make the energy we use) using substantially superior - cleaner, yet economic - technologies.”

Theil is straightforward and does not include climate change in his investment decision-making. He believes that since no single clean energy option can solve the world’s energy problems, cleantech VC is a failure, and he has a point: just because you can raise money for a business or a cleantech fund does not mean that the companies you invest in are going to solve the problem or be profitable.

Khosla’s response does not address the broader implications of Theil’s assertions (where are the scaled up, profitable solutions?), and instead he hides behind his accomplishments as a fundraiser. But that is not the only reason Khosla’s defense sounds a bit hollow. Khosla has embraced risk-based analysis and cost-benefit analysis to bolster his undeniable belief in the urgency and necessity of finding alternative sources of energy and fighting climate change.

Unfortunately, he ignores the broader concepts of Ecological Economics (espoused by Herman Daly , David Pimentel , Donella Meadows and Robert Constanza ), which allow him to make the following statements (all taken from his 2011 Green Investing Strategies by Vinod Khosla ) without a hint of irony:
“[T]he logic of business is to externalize as many costs (like using public roads or not reducing emissions) and maximize profits, as it should be."

"Green’ should be a feature that follows – rather than defies – the ‘laws of economic gravity,’ which in essence declares that economics trump everything when it comes to mass adoption of a technology."

"My basic thesis is that investment in true innovation is the key to reinventing the infrastructure of society and enabling 5+ billion people to sustainably live the energy affluent lifestyle that 500 million enjoy today.”

“The environmentalist solution is often one of “deploy the technologies we have as quickly as possible” combined with idealized hopes that the business community will start to value un-priced environmental and health externalities. These thoughts are noble, and occasionally work, but distract from our best “broad” hope: robust unsubsidized market competitiveness of “green” technologies against their fossil competitors that are affordable to ‘Chindia’ consumers.” [emphasis mine]

Both are missing the point
Global warming is caused by carbon emissions and can only be contained by reducing them, which means a sharp reduction in consumption in developed countries (‘impossible’ according to Columbia Sustainability Management professor Steven Cohen) and a slow increase to relatively low levels in developing countries (improbable, given China’s and India’s growth).

‘No growth’ threatens our capitalist economy because under current business models, very few businesses can survive lower consumption and a steady-state economy. In order to solve the ecological problem (climate change), we must also address the economic problem (a socially just, self-sustaining, ecologically sound, steady-state economy).

Alternative energy sources are all in their development stage, and all must be helped along to see which is best for each geographical region through government and private investments. Technology will not solve the problem of finite resources on this planet; first we have to learn how to live sustainably in it.

Sheikh Rashid bin Saeed Al Maktoum (1912-1990), former Prime Minister of the United Arab Emirates and ruler of Dubai once said: "My grandfather rode on a camel, my father rode in a car, I ride in a jet, my children will ride in cars, my grandchildren will ride on camels." Our grandparents knew how to live with less, and that is what we and our children must re-learn to do.

Lastly, one cannot compare investing in the internet versus localized cleantech investments; the comparison is apples to oranges. Additionallty, setting hi-tech VC cleantech parameters by force excludes possible low-tech solutions that would help local communities survive, but may not fulfill anticipated returns set by VC’s that are used to billion dollar IPO’s and generous ROI’s.

Comparing Theil and Khosla is heartbreaking in that they both manage billions of dollars, and they truly could be game changers; while one is cynically blind and the other is only marginally concerned with ecological reality, they are firmly ensconced in their belief that economy trumps ecology, and neither one of them are willing to embrace ecological limits and truly change the world for the better.

Khosla is by far the more environmentally savvy of the two, but his belief that technology will allow the human race to keep growing and consuming is unrealistic.

Reading about these two titans of finance I feel like I am standing on Easter Island, watching the last trees being felled, while the King and the Prince fight over where to best place the last Moai statue that the last logs will help transport, all in hopes their Gods will be appeased with their sacrifice. Little did the King or Prince know that by felling their trees, Easter Island would never again regenerate, and that they were condemning every living thing on the island to a long, slow decline from which they would not be able to recover.

Peter Thiel: Clean technology is a “disaster” September 12, 2011 | Matthew Lynley as of 11/6/2011

Thiel vs Khosla on Cleantech: Who is Right? Posted by Robert Rapier on Thursday, September 15, 2011 as of 11/5/2011
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What Happened on Easter Island