Optimisation for financial returns is uncorrelated to generating climate benefits

Michael Molitor, Contributor

There has been an explosion of interest in climate tech startups by the venture capital community over the past 18 months. Just about every week I receive an email update of yet another early-stage climate tech fund being launched.

Estimates of investment into climate related startups over the last 12 months now exceed US$60billion.

There is an assumption that most of this capital is being deployed in companies developing technologies and other novel approaches which will have a meaningful effect on improving our chances of avoiding the worst impacts of the climate crisis—unfortunately, nothing could be further from the truth.

The Climate Tech Fund and Impact Divide

There are several important reasons why there is a massive gulf between growing investment into early-stage climate tech companies and making a real dent in the global climate crisis.  The first, and most important, problem is that venture capital funds are optimized to generate outsized financial returns and not necessarily solve giant problems facing humanity.  When I review the people running climate tech funds, I see a lot of financial skills and virtually zero climate science expertise—exactly what you would expect to see if your primary objective is hunting for climate tech unicorns.  

Ironically, if you were hunting for the next climate-related Google or Apple, the best place to look would be startups capable of demonstrating not why they might achieve unicorn valuations but why they can make a meaningful difference to the climate crisis challenge.  I have yet to find a single climate tech fund which understands this—but my search continues, and I still have hope of persuading at least one of them to pursue this pathway.  To understand what a climate tech fund focused on delivering a measurable impact on responding to the climate crisis at scale would look like requires a bit of climate science—which might be a problem if you define excellence by earning a Harvard MBA.

Photo by Rita Morais on Unsplash

What most people who describe themselves as climate change experts don’t understand is that the key underlying challenge is to try and maintain a sufficiently stable climate system.  For reasons which are not completely understood, in the period following the end of the last ice age, approximately the last 10,000 years, the climate system has been incredibly stable.  This is great as it allowed human civilisation to flourish; especially over the last 100 years.  The bad news is that we invested trillions of dollars into infrastructure and other key components of the global economy under the misguided belief that this stable climate system would continue forever.  

By quickly transferring large amounts of carbon in the form of greenhouse gases from long-term underground reservoirs [coal, oil, and gas] into the atmosphere, we have dramatically impacted how the climate system maintains sufficient stability to allow humanity to survive and thrive.  Very small changes in overall climate stability generated by human impacts have already led to consequences with powerful negative outcomes.  Unprecedented forest fires in California, the Pacific Northwest, Russia, Australia, and across much of Europe are the result of very small changes in climate system stability.  Disastrous flooding in Germany, Australia, China, and Southeast Asia is another prominent example of climate stability being undermined by human activities.  Imagine what might happen when we push the climate system further into instability.

The most important driver of climate system instability is the total amount of human-emitted greenhouse gases [carbon dioxide from the use of fossil fuels is the biggest] which currently reside in the atmosphere.  The problem is that we are adding more than 50 billion tonnes of these gases into the atmosphere every year and so most of the focus of climate change policies has been to try and lower these annual emissions.  The UN climate negotiations began in 1991 and have created 3 international agreements which most of the countries of the world have joined—the Paris Agreement in 2015 was the most recent.  In the 30 years since these UN negotiations began, the amount of greenhouse gases emitted into the atmosphere have increased almost every year.


The UN climate negotiations, as seen from a climate stability management perspective, have been absolutely useless. 


How to reach climate system stability: Green Unicorns vs Dinosaurs 

If you want to maintain a sufficient level of climate system stability, the fastest way to achieve this is to lower the total amount of greenhouse gases in the atmosphere as quickly as possible.  This means you need both to lower emissions into the atmosphere as well as remove greenhouse gases from the atmosphere very quickly.  Unfortunately, there is no link between investments into climate tech startups and the absolute requirement of quickly lowering emissions and increasing removals from the atmosphere.  Investors into climate tech startups don’t usually ask the founders how much carbon their company will stop from entering the atmosphere or remove from the atmosphere and by when?  These are the only metrics which determine whether a climate tech startup is capable of being a meaningful part of the climate stability solution.

The second big problem with the climate tech space is that it includes many investment areas which have little or no relevance to helping solve the climate stability challenge.   My favourite area of criticism in this connection is the food tech space and its tangential relationship to climate change.  If you want to hunt for unicorns then the global food system is the best hunting ground on the planet as it is gigantic and so incredibly inefficient—it would be hard to imagine a less efficient system of producing and distributing food to the global human population than what exists today.  Unicorns all share one key common feature—they disrupt large and wildly inefficient sectors where the dinosaur incumbents cannot move due to their legacy investments in their obsolete business models.

The elusive Green Unicorn Photo by Stephen Leonardi on Unsplash

Although the global food system is relatively carbon intensive, the opportunity to invest in food/ag tech unicorns is more a function of the gigantic inefficiencies which exist in this sector.  The difference in efficiency between where the food sector exists today and where it would have to improve to deliver benefits on a scale meaningful to our 21st century modern society is gigantic.  Couple this to the fact that the food sector is the biggest component of the global economy and the chances of finding the next Uber or AfterPay are almost inevitable.  It is very possible to invest in food tech unicorns which will have no meaningful impact on the climate stability challenge and, even worse, do nothing to improve the food sector on a scale meaningful to improving system efficiency at scale.  

I am keen to see a climate stability investment premium emerge which would generate better returns for startups which can demonstrate a focus on reducing/removing carbon as soon as possible. 

Estimates suggest the total amount of unpriced climate risks sitting across capital markets is more than US$50trillion—making climate change the biggest source of systemic risk facing capital markets in history. 

Asset owners are already measuring the embedded climate risks across their portfolios, and this is driving change across the entire financial value chain from venture capital to asset managers and private equity.  Sooner than later capital markets will need to establish a robust link between climate investments and improving climate stability.  The US$900billion invested into climate assets over the past 12 months has done very little to improve climate system stability.

Even if your primary objective is generating gigantic returns for your limited partners, general partners at climate tech venture funds would be better off shifting their investment focus towards improving climate system stability.  The climate stability space will help launch several companies the size of Google and Apple over the next decade—doesn’t this appear to be a better place to invest than in startups offering carbon credits to consumers or carbon trading marketplaces?  My hunt for a venture capital firm interested in pursuing the climate stability investment thesis continues —follow my posts on climatesalad.com and I will let you know when I find one. 

Cover Photo by Stephen Leonardi on Unsplash

Mar 7, 2022

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