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As a climate tech investor, unit economics is the only thing I care about

With climate tech today, as during the clean tech boom, there is more public attention on sectors that resonate with consumers. Plastic alternatives or recycling, for instance, is the go-to thing for people who want to get into sustainability.

This thinking is further supported by the Intergovernmental Panel on Climate Change (IPCC) reports and pundits who suggest that consumers can reduce 40% to 70% of projected 2050 emissions by shifting to locally grown food, avoiding flights, and choosing to walk or bike instead of driving cars. It implies that the responsibility lies with consumers and emphasizes transportation as the main concern.

This is an unrealistic expectation. Significant shifts in consumer behavior can take decades. And it’s poking at the wrong beast. We must focus instead on disruption and innovation in industry sectors with the greatest capacity to make progress on decarbonization.

But you cannot expect big industries to change overnight. You also cannot expect them to trust new technologies, particularly if those increase their capital expenditure (CapEx) and operating expenses (OpEx).

Legacy industry will not pay more for green solutions

There is only one way that brown-field industries will ever adopt green practices and technologies, and that’s through superior unit economics.

We must focus instead on disruption and innovation in industry sectors with the greatest capacity to make progress on decarbonization.

Many consumers might pay a “green premium” for eco-friendly products like clothes or coffee, but businesses are far more price sensitive. And that’s who these climate tech companies are selling to — legacy industries already seeing their margins squeezed by other factors like commodity pricing and supply chain costs.

So, incurring higher costs for green solutions is not an option. This is particularly true in sectors that rely on resource- or energy-intensive processes, like steel, cement, and agriculture, which are sectors with some of the greatest potential for decarbonization:

  • Agriculture and food production will generate a third of carbon emissions in the next 20 years.
  • Steel-making accounts for 7% of carbon emissions and industrial process heat for 9%, and both are using processes that haven’t changed in decades, if not centuries.
  • Buildings and constructions are ripe for disruption, not only for heating and cooling, but also for cement (7% of emissions).

While the long-term benefits of sustainability might be evident, immediate financial pressures take precedence in decision-making. This is why green premium products won’t scale. And this challenge is exacerbated when these solutions clash with fundamental limitations of physics.

Climate tech: What is hype and what is not

What do I mean by that? Let’s talk about the senseless economics of direct air carbon capture (DAC) systems that suck CO2 directly out of the atmosphere.

Investment in carbon capture and storage (CCS) has more than doubled since 2022 to hit a record high of $6.4 billion, with most of the capital going into DAC.

One that got a lot of attention is building a direct air capture plant that will reduce 800 cars’ worth of emissions a year. The cost of the plant is $15 million.

Do the math: There are roughly 1.4 billion cars on the planet. To offset and capture the CO2 emissions from all of those cars, it would cost us $20 quadrillion. Not $20 billion, not $20 trillion. $20 quadrillion.

And, by the way, passenger cars are responsible for just 5% of global carbon emissions. So this will never scale to the point where it can have an actual impact.

Direct air carbon capture might be cool to talk about, and visualize, but it is just not economically viable. CO2 in the air is so diluted that trying to capture it is a fight against entropy.

On the other hand, trees are cheap and self-powered by the sun. Leaning into nature-based solutions, like ecosystem restoration and increasing forest stock, is the wiser choice.

Guided by fundamental laws of physics, not BS economic models

When evaluating early-stage deals in climate tech, we always consider:

  • Matter (e.g., lower feedstock costs).
  • Energy (OpEx savings).
  • Time (higher throughput, faster payback on CapEx).
  • Space (applicable to space-constrained industries).

And we never rely on economic modeling when scientific and physical measurement can be done instead. If the technology is truly disruptive, it solves the problem in a way that is so compelling it wipes out the previous way of doing things. To feel ultra-secure, we test it with potential customers to see how motivating the better unit economics are.

Let’s use this lens on another hyped-up climate technology: green hydrogen. Electrolysers require more energy to produce a molecule of hydrogen than the energy held in this same molecule of hydrogen.

As a result, green hydrogen is 2x to 3x more expensive than “gray” hydrogen. And we’re far from solving this cost issue. Without lower costs, industries and consumers will never adopt hydrogen as a fuel at scale. Yet VC investments in green hydrogen companies have skyrocketed the last few years, from less than $200 million in 2020 to over $3 billion in 2022.

Let’s go back to where we started: plastic. Recycling plastic is a fight against entropy. The reverse logistics cost of collecting plastic waste from dispersed locations (scattered across billions of households) outweighs the cost of virgin plastic.

Recycling metals, on the other hand, does make sense. Companies that can easily collect end-of-life lithium-ion batteries and turn them into new EV batteries are worth their weight in lithium, so to speak.

Investors need to focus on the wide-chain economics for any solution they are considering. And they must focus on those that are at least at cost parity with incumbent technologies to make it a no-brainer for adoption. This is about stacking up financial wins side by side with decarbonization, creating a compelling incentive for widespread adoption by industries. It’s the only way climate tech investments will pay off, provide real returns, and, therefore, have a long-lasting impact.

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