How Many Bridges Does it Take to Cross the Valley of Death? More Than You Might Think
If ever there was a topic on renewable energy that resembled folklore, it is the “commercialization valley of death.” The term describes the difficulties entrepreneurs face in obtaining cash to scale up manufacturing and put more projects (e.g., steel) in the ground (note that this is separate from—and comes after—the “technology valley of death,” or the death of financing available to take a bench-scale model and create a commercial-scale demonstration). However, this challenge of mass scale deployment is a very real and daunting issue facing the renewable energy sector.
Two recent studies conducted by Bloomberg New Energy Finance (BNEF) and the California Clean Energy Fund (CalCEF) explain the nuances of the commercialization valley of death. The problem is that emerging clean energy (CE) technologies have extremely large capital costs and are seen as high-risk investments. Consequently, commercialization financing is difficult to obtain, leaving nearly commercial technologies in the proverbial “valley of death.” Though it would seem logical to conclude that one bridge is sufficient to cross a valley, recent studies suggest that many policy supports will be required to cross the commercialization valley of death.
CalCEF points out that “Venture capital firms seek to fund companies (and manufacturing facilities) through the early growth stages of development, from initial product prototype toward initial commercialization” (see CalCEF report). These firms often fund technologies that are novel and high-risk yet offer potentially high returns. These rounds of financing generally “range from just a few million dollars to as much as $20 million dollars or more” (see CalCEF report). This is sufficient to advance technologies beyond a single, full-size demonstration project and sufficient in many sectors to catapult a new innovation into commercial production. In the energy sector, however, “extensive field testing and trial installations” are necessary to bring an emerging and unproven energy technology to commercial production, according to the BNEF report. This process can require hundreds of millions of dollars or more—greater sums than most venture capital firms are willing to finance.
Debt and equity project finance also support the deployment of CE technologies, but these investors are far more risk averse than their venture capital counterparts. Consequently, project finance is oftentimes available solely for proven technologies that offer a low-risk profile. This means that if developers of emerging CE technologies wish to access traditional project finance, they will have to demonstrate their technologies at commercial scale in order to reduce the perceived risks of the projects.
Therein lays the problem—a funding gap is created when expensive, emerging technologies exhaust the capital of high-risk venture capital but remain unattractive to traditional debt providers with stringent risk requirements, leaving a frequently fatal gap known as the commercialization valley of death (depicted below). Within this valley lay technologies that could prove to be hugely beneficial to our nation's energy infrastructure; a serious and daunting issue to say the least.
Source: UNEP, SEFI. Public Finance Mechanisms to Mobilise Investment in Climate Change Mitigation.
The BNEF and CalCEF studies offer unique strategies for overcoming the commercialization valley of death. They both conclude that a coordinated effort between the public and private sectors will be necessary. As noted in the BNEF study, “the problems posed by this funding valley represent fundamental, structural market shortcomings that cannot be resolved by the private sector acting on its own; no existing class of financing institutions is effectively positioned to address this particular risk/return category.”
This begs the question: What role should the public sector play in addressing this serious issue?
Although there is no clear answer, the BNEF and CalCEF studies provide a roadmap for where to start. The recommendations provided in the two studies are unique and diverge slightly from one another, but there are some common themes that emerge.
First, the public sector could provide “direct funding” or form “novel co-investment partnerships” with the private sector in order to directly address the finance gap (see CalCEF report). There is also a need for government-backed insurance products (think re-insurance), such as “efficacy insurance,” to reduce the perceived risks of emerging CE projects and attract private capital. And, the public sector could pursue several actions to make the procurement process easier on emerging CE projects.
Even if the public sector decides to play a large role in addressing this issue, it should be noted that there is no silver bullet; crossing the commercialization valley of death will require a broad range of policy measures taken in concert. And, as we have seen with other policies aimed at increasing the deployment of CE technologies, the policies deployed to address this issue “must have both perceived and real longevity” in order to be effective (see BNEF report).