At the recent Square Peg 2023 AGM, Square Peg Partners Amanda Hjorring and James Tynan hosted a deep dive into Climate Tech. James shared his perspective on the role startups play in addressing some of the world's most pressing climate issues, how regulation shapes the industry, the tailwinds generating significant opportunities for startups, and Square Peg’s approach to investing in climate tech companies.

AH: What role does venture capital have to play in the climate space?

JT: I think there is an important role for venture capital. The climate crisis has become so acute that we need to build and scale some of the world’s biggest companies inside the typical lifecycle of a venture fund. Speed and scale are what venture-funded technology companies do really well.

Over $40B venture dollars were invested each year in 2021 and 2022 in climate tech and while we may not see the same quantum of investment dollars in 2023 it’s looking like the actual number of companies funded will be even higher.

However, it’s important to acknowledge that the number of companies capable of the speed and scale required by venture capital is a very narrow sliver of the market. I’m often asked when talking to founders: ‘Can’t Square Peg fund a wider group of climate companies to support the overall ecosystem?’

But I think it’s important for us to focus on helping rapidly scale global winners in climate. This leaves room to collaborate with other forms of capital like project finance, debt and impact investment to support different types of companies at different stages.

AH: What is Square Peg looking for (or not looking for) in the climate space?

At Square Peg we don’t think about climate investment as fundamentally different from how we invest in other areas - we’re always looking for incredible founders and businesses capable of hyperscale and defensibility.

The way this applies in climate is that we gravitate strongly towards startups with products that companies or consumers choose selfishly to drive their core needs. 

This approach has kept us away from some “obvious” areas of climate tech such as carbon accounting tools. As climate businesses with SaaS business models, these companies have generated a lot of investor interest. But when we talked to customers, we couldn’t find much customer love for their products. It felt like they were a bit of a “grudge buy” addressing a need that was not emerging from the core of the business. Of course, this will likely change over time but the large amount of investment in the thematic has also created a red ocean of competitors which has made it difficult to see true differentiation or defensibility.

In contrast, our investment in Tomorrow.io was driven by a focus on core business needs. Tomorrow.io is a weather intelligence platform that helps customers like the NFL know when to roof a particular stadium or rail network Amtrack to know which tracks are too icy or windy for trains.

Recently, Tomorrow.io started launching its own weather satellites. This is enabling new capabilities like tracking hurricanes, monitoring weather over oceans, and making accurate weather predictions in the global south. In addition to opening up new customer segments - it also means their SaaS product is getting better in ways that will be incredibly hard for competitors to match.

AH: How does regulation impact climate investing?

Regulation can cut both ways. Our portfolio company Vow is working closely with regulators to bring a new form of meat to market that will taste better while being far cheaper and less carbon intensive than current farming practices. Negotiating regulations is a significant cost for what we hope will be an early-mover advantage in market access.

As a tailwind, regulation can be hit and miss. For example, there are some amazing startups with technologies that actually and verifiably remove carbon from the atmosphere but, at present, regulators of carbon markets do not force emitters to choose these types of projects over cheaper, lower quality, carbon credits. We’ve found it difficult to predict how and when regulators will impose new costs on businesses or consumers. Unfortunately voluntary corporate behaviour is just as unpredictable - as evidenced by Nestle recently walking away from its carbon offsetting program.

There are regulations creating tailwinds for startups more indirectly. The Inflation Reduction Act (IRA) in the United States has created enormous tax incentives for large corporates to engage in carbon abatement and removal. This value is filtering through to startups with the technology to run a lot of these projects. A couple of months ago Occidental Petroleum bought one of the leading direct air capture companies (Carbon Engineering) for $1.1B - clearly anticipating the ability to deploy their technology and take advantage of the incentives established by the IRA.

Another example is the EU’s Carbon Border Adjustment Mechanism. As of November 2023 this mechanism will begin to force anyone who wants to sell into Europe to buy the equivalent carbon credits that they would need if they were operating under the EU emissions trading scheme. This is expected to drive a lot of companies exporting resources to the EU to look for ways to reduce their carbon footprint and/or contribute to growing the market for carbon credits.

Meanwhile, a couple of months ago, Australia’s mining giants announced they would collaborate to create the world’s largest fully renewable energy network in Western Australia. This includes the Pilbura region which is where a lot of the world’s steel comes from. I wonder if this was a coincidence! Either way this massive project will create many opportunities for startups with the technology to deliver on such a bold vision.

AH: What are the biggest tailwinds in climate tech?

I’m obsessed with energy for two reasons. First - the size of the prize. Energy is responsible for the lion’s share of emissions. If we can electrify everything from transport to heating and cooling then switch to renewable sources of power it’s possible to address well over 50% of the problem.

Second, there are industry-transforming tailwinds. The cost of solar energy has fallen 90% in ten years - and onshore wind has fallen by 70%. In Australia alone, rooftop solar is a $4B per year market that is growing 35% year on year. We now have more rooftop solar capacity in Australia than coal! If we could harness all of it we would be over 50% energy independent right now.

A similar shift has taken place in battery technology. The price per kilowatt hour of lithium ion batteries was over $7500 in 1991 and by 2018 it was $181. Today it’s hovering between $130-150. This has been a critical enabler of the exponential rise in EV registrations.

AH: What does this mean for startups?

These exponential changes have put the energy system into crisis, creating opportunities for startups. On the supply side there are billions of dollars in renewables projects trying to plug into the grid - trying to take advantage of the lower cost of renewables. 

But renewables projects don’t tend to spring up in exactly the same place as coal power plants - and they don’t work exactly the same way. So working out how to plug them in is a huge problem and a massive opportunity for companies like Neara.

Neara takes huge clouds of information from LiDAR and Satellite and uses advanced AI models to create a digital twin of a utility’s physical infrastructure - everything from transmission lines and substations, to underground cables, to power poles and powerlines. These models are so detailed that the utilities can run engineering analysis on them. This can be an enormous help when planning out how to connect renewables projects. 

Recently, Neara was also able to show that they can double the capacity of an enormous electricity network using their software alone. That’s the equivalent of capacity that would otherwise require the construction of two new major transmission lines, which would cost over $10 billion and take 10 years to build.

On the demand side there’s another set of problems. Households need to pull too much power from the grid to charge new EVs and are also sending too much power flowing back into the grid from rooftop solar. Both of these activities cause big problems for existing energy infrastructure.

Companies like Amber enable everyone from governments to utilities to consumers to win. Amber is an energy retailer that can automate household batteries and EVs to sell power back to the grid at the right time and at the right price.

Last winter there were days when Amber customers were not paying for power and were instead making $50-$100 per day by discharging their household battery back to the grid. Soon they'll be able to do the same with EVs which are about 5x the capacity of a household battery. 

These are just two examples but we’re excited to find many more and look forward to meeting founders working in these areas.

If you’re founding a business in the climate space, we’d love to hear from you. Get in touch at james@squarepeg.vc.