Alternative Fuels Attracting Venture Capital

The Wall Street Journal
By Jim Carlton and Rebecca Buckman

February 2, 2006

Even before President Bush called for a push into petroleum alternatives in the State of the Union address, energy start-ups were venture capitalists' latest technology craze.

Some of the same people who helped to finance Silicon Valley's succession of electronics-technology booms see promise in energy technology. One of the valley's best-known venture capitalists, Vinod Khosla — who co-founded Sun Microsystems Inc. in the early 1980s and is now a partner at Kleiner, Perkins, Caufield & Byers — says he has distanced himself from his firm recently in part to focus more on alternative energies.

Through a fund called Khosla Ventures, Mr. Khosla says he has sunk his own money into a half-dozen start-ups over the past four years involved in “clean fuel” technologies, such as making ethanol a viable substitute for much of the petroleum now used to fuel cars. One of those biofuel companies, BC International Corp. of Dedham, Mass., has been around for more than a decade and is developing an ethanol plant in Jennings, La., according to its Web site. Mr. Khosla, who still keeps an office at Kleiner, declines to discuss any of his investments in detail.

Mr. Khosla says he is particularly enamored with technologies that help produce ethanol from sources other than the edible part of corn, the main technique now in use in the U.S. By using cornstalks, grasses and even woodchips — as President Bush suggested in his speech — large-scale ethanol production would pose less of a threat to food supplies, Mr. Khosla says.

From 1999 through 2004, venture capitalists invested an estimated $4.4 billion in the energy-technology sector, including renewable energy and more-traditional energy projects. That compares with just $380 million in venture-capital money invested in the sector from 1993 through 1998. Energy tech got a further $500 million in venture capital during the first half of 2005, according to Nth Power, a San Francisco venture fund, and Clean Edge, a San Francisco market-research firm.

Venture capitalists take stakes in small companies with promising technologies, counting on at least a few of their risky bets to pay off big later when the companies are sold or go public. They have profited hugely from investments in startups like Apple Computer Inc., eBay Inc. and Google Inc. They say even more money is likely to flow into new energy companies after the president's call to reduce the nation's “addiction” to oil imports through the use of alternative fuels.

“Even though Jimmy Carter espoused energy independence, Bush has put a timeline on it,” says Nancy Floyd, managing director at Nth Power, referring to the president's call for developing new ways to produce ethanol within six years. “This means there's going to be a lot more venture activity in this sector,” she adds. Nth Power's $250 million in assets under management are devoted solely to new energy technologies.

The VC money is chasing technologies aimed at increasing the supply of renewable energy, as well as for making existing energy plants and other infrastructure cleaner and more efficient. Venture capitalists sank nearly $181 million into alternative-energy companies last year — nearly double the $103 million invested in that sector in 2004, according to estimates by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association. In 1995, investment in the sector was a scant $2.95 million.

Some high-profile investments in the past two years include Amp Resources, a Draper, Utah, power-generation company with geothermal expertise that is being acquired by Raser Technologies Inc., of Provo, Utah, and solar-power companies Nanosolar Inc. of Palo Alto, Calif., and Energy Innovations Inc. of Pasadena.

The price of traditional fossil-fuel energy is soaring as supplies world-wide have become shaky. As a result, alternative energies that used to be prohibitively expensive are getting new attention from policy makers. For example, more than 20 states have mandated that their energy supplies come from renewable sources. In California, Gov. Arnold Schwarzenegger has set a goal of getting as much as a third of the state's energy in this way.

But great hurdles stand in alternative energy's path to the mainstream, skeptics warn. Billions of dollars have been poured into both solar and wind energies, for example, and both alternatives remain relatively expensive without subsidies, although prices are dropping. Also, fuel-cell engines, once widely regarded as a possible replacement to gasoline-driven engines, haven't yet proved durable, critics say.

While ethanol may address concerns about U.S. dependence on oil imports and cut down on one type of pollution, it raises other environmental questions. Bob Grady, who runs the Carlyle Group's U.S. venture-capital practice and who served as an environmental policy adviser to the first President Bush, says ethanol can, in some cases, increase smog, even as it helps reduce carbon monoxide.

Still, Mr. Grady is on the alternative-energy bandwagon and says Carlyle has looked at possible investments in the solar and fuel-cell areas. “I do think it's a long-term trend to try to reduce emissions from the use of energy, and to develop alternative sources of energy,” he says. “I don't think the pressure to do that is going to yield anytime soon.”

Energy has become more attractive, venture investors say, because new technologies can make alternative sources profitable in ways they weren't before. Recent innovations mean it is easier to make products such as ethanol and solar panels on a large scale, says Erik Straser, a general partner at Mohr Davidow Ventures, of Menlo Park. As a result, venture capitalists can focus “not on how to build a better factory, but on how to build a 'secret sauce,' “ relying on bioengineering or nanotechnology, he says.

Already in Brazil, “flex fuel” cars that burn either ethanol or gasoline are surging in popularity, Mr. Khosla says. There are some five million flex-fuel vehicles on the road in U.S., he notes, although many owners are unaware they have the option. Ethanol production in Brazil relies on sugar-cane crops that largely aren't needed for the local eating supply. “The cars are already here and we know they work,” says Mr. Khosla. “It's a much more economic solution than spending hundreds of billions on security in the Mideast,” he adds.

Mr. Khosla is a major ethanol evangelist, talking up the fuel with the Bush administration and Democratic Party leaders. He says the U.S. could allocate the farmland necessary for growing crops that would be turned into “cellulosic ethanol,” made from prairie grasses, forest clippings and agricultural waste. He says it will probably take several years to overcome limitations on the technology, such as the fact that few U.S. gas stations in the U.S. are equipped to dispense ethanol.

Executives at VantagePoint Venture Partners say they have invested roughly $50 million on energy-infrastructure projects, including three ethanol plants and factories for making fuel from other organic sources, such as biomass, which is waste from animals and other organisms. The San Bruno, Calif., firm has invested about $100 million in energy-technology companies, a small fraction of its $2.8 billion in assets under management, but one of the fastest-growing parts of its portfolio. “If you look out five years,” says Stephan Dolezalek, a VantagePoint managing director, “this is a sector that can be every bit as big as the Internet.”