Addressing The Innovation Gap in Green Technology

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LAW269H1S Climate Change Law Dennis Mahony & John Terry Ovenbird
Addressing the Innovation Gap: Government Intervention in Early Stage Commercialization of Clean Technologies
Table of Contents
Introduction .................................................................................................................................................. 2 Aligning Climate Change Concerns with Economic Incentives ..................................................................... 3 Why Winner-Neutral? The Difficulty of Picking Winners........................................................................... 6 The Innovation Chain and the Innovation Gap ............................................................................................. 9 A. B. The Innovation Chain Explained ....................................................................................................... 9 The Innovation Gap ......................................................................................................................... 12
Finding the Right Policy Mix to Bridge the Gap .......................................................................................... 15 A. Technology Push Policies ................................................................................................................ 16 (1) (2) (3) B. Government Demonstration Grants ....................................................................................... 16 Incubators ............................................................................................................................... 17 Government Venture Capital Funds and Fund of Funds......................................................... 19
Market Pull Factors ......................................................................................................................... 21 (1) (2) (3) (4) Feed-In Tariffs ......................................................................................................................... 21 Public Procurement................................................................................................................. 23 Grants and Subsidies for Investors ......................................................................................... 23 Carbon Pricing ......................................................................................................................... 24
Conclusions ................................................................................................................................................. 25
Introduction
This paper will look to explore in more detail the idea of governments, in following a low carbon emission energy policy, intervening to support early stage commercialization of clean technology (CleanTech) and related business ideas.1 What would this sort of intervention look like? How much should government intervene and at what point(s)? What are some of the issues that we run into when trying to promote early stage CleanTech energy development? This paper will attempt to frame questions such as these and explore them in more detail, with a particular focus on government policy in the province of Ontario. Ontarios Green Energy Act2 was introduced in 2009 and is one of the most progressive pieces of energy legislation in North America, if not the world. The lynchpin of the Green Energy Act is its Feed-In-Tariff (FIT) program, which has been severely criticized for its arbitrarily determined and overly generous price schedule.3 While the intent of the Ontario government to support carbon mitigation and the alternative energy sector generally is laudable, it is unclear whether this policy mix of direct government intervention, price-setting, and winner-picking will be best suited to achieving net carbon abatements while balancing other competing environmental, economic, and social (e.g. employment) factors. This paper will advocate for more indirect approach to government support for CleanTech in order to encourage sustainable, market-based mechanisms that help achieve government policy objectives over the long run. Underlying the argument for government support of the market
1
See generally Michael J Trebilcock & James SF Wilson, Policy Analysis: The Perils of Picking Technological Winners in Renewable Energy Policy (Probe International, 2010) [Picking Winners]. Clean technology or CleanTech, for the purposes of this paper, includes renewable energies and other products, services, and processes that reduces the use of natural resources and reduces emissions and wastes. 2 Green Energy Act, 2009, SO 2009, c 12. 3 Jatin Nathwani, Does Ontarios Green Energy Act pass the net benefit test?, The Globe and Mail (15 November 2010) online: The Globe and Mail <http://www.theglobeandmail.com/news/opinions/opinion/does-ontariosgreen-energy-act-pass-the-net-benefit-test/article1797190/>.
proliferation of CleanTech ventures is that the job of picking winners among a diverse set of CleanTech alternatives is more likely to be done effectively by the private sector (which is focused on achieving an acceptable return on investment) than the public sector (namely by having governments subsidize CleanTech companies and investors directly).4 In order for low carbon emission solutions to be viable in the private sphere (and consequently, for these solutions to be less costly for taxpayers), ultimately the costs of these alternatives have to be more competitive with traditional, carbon-emitting energy sources. For this to happen, the need to innovate is apparent. A renewed focus must be put on research and development as well as early-stage commercialization. This paper will focus on how to address the Innovation Gap that exists between government-supported R&D and full-scale commercialization of CleanTech ideas. It will attempt to frame the debate, survey policy options and present some recommendations that may prove to be fruitful for policymakers in the future.
Aligning Climate Change Concerns with Economic Incentives

In Roger Pielke Jrs book, The Climate Fix, Pielke offers an explanation for the failures of governments to agree on climate policy: the politicization and polarization of the debate.5 The politicization of this debate stems primarily from the dichotomous positions of environmental and social interests at one end, and economic interests on the other. Climate change concerns and policies are normatively conceptualized by the business world in terms of risks and costs. 6 When shifting to low carbon policies, emphasis is often put on the jobs that would be lost or the
4
James A Brander, et al, Government Sponsored versus Private Venture Capital: Canadian Evidence (2008) NBER Working Paper No 14029 at 5. 5 Roger Pielke Jr, The Climate Fix: What Scientists and Politicians Wont Tell You About Global Warming (New York: Basic Books, 2010). 6 See generally Charles Wankel & James AF Stoner, Managing Climate Change Business Risks and Consequences: Leadership for Global Sustainability (Basingstoke: Palgrave Macmillan, 2012).
costs that would be imposed on businesses and taxpayers directly or indirectly through mechanisms such as electricity bill prices. These concerns bleed their way into the venture capital world as well. A survey distributed to a variety of venture capital firms involved in CleanTech projects show a significant apprehension on the part of firms towards using words such as ecological, environmental, or sustainable to market themselves because they assume it would be more difficult for them to attract investment and funding.7 In the venture world, some view climate change innovations and ventures as fulfilling a moral duty and are thus less profitable relative to traditional venture sectors such as IT, biotech, and software development. However, empirical evidence seems to fly in the face of these normative concerns. In Canada, Energy and Environmental Technologies comprised the 3rd largest venture capital sector in 2011 (behind only life sciences and IT), attracting over $244 million in funding.8 Within this category, CleanTech ventures received the vast majority of investment. While these Canadian investment statistics may be somewhat skewed by preferential policies, such as Ontarios Green Energy Act FIT program, studies have also shown that, since the early 90s, CleanTech venture investments in the US and Europe have generated returns exceeding the venture capital average.9 These statistics show that a shift towards a low carbon emissions policy can in many cases provide opportunities for above-average risk-adjusted market returns, particularly in early-stage
Jelena Randjelovic, Anastasia R ORouke & Renato J Orsato, The Emergence of Green Venture Capital (2003) 12 Business Strategy and the Environment 240 at 241-242. 8 Canadas Venture Capital & Private Equity Association, Total VC Investment Activity, By Sector 2011 (Thomson Reuters, 2012) online: CVCA <http://www.cvca.ca/files/Resources/2011_CVCA_Investment_Activity_by_Sector.pdf>. 9 Roland Pfeuti, Clean Technologies and Venture Capital (2005) 1 JASSA The FINISIA Journal of Applied Finance 15 at 16-17.
CleanTech developments.10 Whether these above-average returns will persist is debatable, but it is clear that there is a discrepancy between reality (in which many VCs are investing in CleanTech projects and generating satisfactory returns) and perception (that any shift towards a low carbon emission policy is detrimental to business and anathema to investors). However, in order to have widespread and sustained political buy-in for low carbon emission policies, economic interests have to be aligned with policy. Furthermore, this alignment must be communicated to businesses and the public in general. Given the nature of carbon and GHG emissions, the impacts (good and bad) will have varying impacts on different stakeholders (for example, automobile manufacturers and mining companies will bear a disproportionately high burden in this shift).11 Therefore, it will not be possible to get across-the-board buy in from all stakeholders. Nevertheless, if it can be shown that a low carbon emission campaign can be beneficial (or at least benign) to the overall economy, the policy discourse can be shifted from whether or not such a policy should be pushed through to how best to align economic, environmental, and social concerns.12 Ultimately, there is a pressing need to remove the stigma associated with phrases like CleanTech, green, sustainability, and climate change in the investing and business world and move towards a more nuance understanding that internalizes relevant opportunities in addition to the risks and costs, particularly if traction is to be maintained through trying economic times. This conceptual shift can also be observed among thought leaders within the investment community itself. CleanTech venture capital is seen by some academic commentators as an indirect result (or
10 11
Ibid at 17-18. See Natural Resources Canada, Energy Use Data Handbook Table (Ottawa: Natural Resources Canada, 2011) online: <http://oee.nrcan.gc.ca/corporate/statistics/neud/dpa/tableshandbook2/aaa_ca_3_e_5.cfm?attr=0>. 12 Measuring economic, environmental, and social concerns, particularly in the context of accounting measures and management structuring is otherwise known as the triple bottom line.
natural extension of) the Socially Responsible Investing (SRI) movement, which has seen a phenomenal proliferation within the past few decades, particularly among pension funds, sovereign wealth funds, mutual funds, and exchange-traded funds (ETFs). Global assets in socially and environmentally screened portfolios climbed to $3.07 trillion in 2010, while nearly one in every eight dollars under professional management in the US involved SRI. 13 SRI principles are operationalized primarily through screens that involve ESG (environmental, social, and governance) criteria, otherwise known as negative screening.14 While on occasion SRI investors may engage in more proactive practices such as shareholder advocacy and community investing, for the most part SRI is limited to ensuring that firms meet social and environmental compliance standards.15 On the other hand, VC firms in sustainability sectors such as CleanTech are concerned with pushing the social and environmental frontiers of business actively seeking entrepreneurs who can present economically sustainable ideas that further social and environmental goals. This shift in investor direction from social and environmental compliance to proactively pushing social and environmental frontiers parallels the shift that needs to occur at the policy discourse level; that is, for public and private actors to align interests in the climate change arena.
Why Winner-Neutral? The Difficulty of Picking Winners

The major problem with direct public subsidies for CleanTech is that often, the government will have to pick a specific technology or project to subsidize and support. There is real concern that governments are ill-suited to do this, especially considering the quickness which with
13
EUROSIF, 2010 European SRI Study: Revised Edition, (EUROSIF, 2010) at 59 online: ISSUU <http://issuu.com/eurosif/docs/eurosif_2010_sri_study>. 14 Steve Schueth, Socially Responsible Investing in the United States (2003) 43:3 Journal of Business Ethics 189. 15 Ibid.
technologies change, markets change, and perhaps most importantly, political perceptions about climate and other environmental concerns change. As political economy theorists suggest, while it is extremely difficult to pick winners, it is also difficult to avoid trying, for political reasons. Government policy in CleanTech can often involve big money and when processes are not transparent, can easily lead to political capture. An example that is often used in Ontario is George Smithermans untendered multi-billion dollar wind contract that was awarded to Daewoo Industries and his (unfounded and unsupported) claims that the Green Energy Act would create over 50,000 jobs and only cost electricity consumers an incremental one percent a year on their existing bills.16 Sustainably creating new, permanent jobs in CleanTech with direct government subsidies (a type of fiscal stimulus) is also a real challenge. There is a temporary nature to many of these projects (e.g. wind turbine projects) in that a large amount of labour and capital is needed during construction, but only a skeletal crew would be kept on for maintenance and operation. Recent studies in Denmark and Germany reflect this condition, with new jobs in Denmark costing $90,000 to $140,000 per job per year in public subsidies and jobs in Germany costing up to $240,000 per job.17 Furthermore, these new jobs must be netted with the jobs that are either lost or simply transferred from other traditional energy sectors further diminishing the new job creation effect of public subsidies. Picking winners through government subsidies also run two additional risks. First, it often promotes CleanTech for the sake of promoting CleanTech, without focusing on net carbon
16
Michael Trebilcock, Speaking Truth to Wind Power, (Probe International, 22 June 2011) at 2 online: Probe International <http://probeinternational.org/library/wp-content/uploads/2011/07/Speaking-Truth-to-WindPower_22jun11.pdf> [Truth to Wind Power]. 17 See Kenneth Green &Ben Eisen, Green Jobs: The European Experience, (2011) 106 Frontier Centre for Public Policy Series.
abatements. For example, the current generation of corn ethanol has been widely-criticized for not taking into account total lifecycle accounting (including arable land use, fertilizers, carbonbased inputs, machinery, and transportation).18 Total lifecycle accounting significantly reduces the net effect of ethanol of carbon reduction and adds to its ecological footprint. Despite these concerns, policies that heavily subsidize ethanol producers19 as well as quota policies such as the 5% ethanol mandate20 for gasoline leads into our second problem creating vested interests in CleanTech that rely on government subsidies. These vested interests will often lobby hard to keep their subsidies; regardless of whether or not the market introduces a better alternative technology as a solution. Ultimately, this costs taxpayers money while impeding the goal of cost-efficient and effective carbon reduction. A winner-neutral policy approach attempts to avoid these problems by not getting directly involved in picking technological winners, instead leaving those decisions to the experimentation and adaptation of the market. What the government does focus on however, is leveling the playing field. Specifically, carbon must somehow be priced into the market. This means eliminating fossil-fuel subsidies and instituting some sort of carbon tax or a cap-and-trade system that forces market actors to internalize the cost of carbon. There is ample literature on the relative merits of these schemes and therefore a detailed analysis of carbon pricing will not be conducted in this paper. Instead, focus will be put on another key pillar of the winner-neutral
18
See generally Timothy Searchinger, et al, Use of US Croplands for Biofuels Increases Greenhouse Gases Through Emissions from Land-Use Change (2008) 319 Science 1235. 19 See example the Ontario Ethanol Growth Fund, which has made public investments of $520 million and has attracted private investment of over $270 million in developing and promoting the ethanol industry in Canada, online: Ontario Ministry of Agriculture, Food and Rural Affairs <http://www.omafra.gov.on.ca/english/rural/ruralfunding/oegf/index.html>. 20 O Reg 535/05.
policy approach: subsidizing breakthrough innovation that may lead to significant reductions in net carbon emissions.21
The Innovation Chain and the Innovation Gap

Assuming that a winner-neutral approach to low carbon emission policy is taken, what are the components needed to ensure that innovation is successful and the costs of CleanTech alternatives become more economically competitive over time? The answer lies in understanding the Innovation Chain and in particular, identifying Innovation Gaps where government would do well to focus their policy efforts.
A. The Innovation Chain Explained

A new CleanTech venture needs support at each stage of its lifecycle in order to get to full commercial capacity and dissemination. The Innovation Chain provides a (somewhat simplified) model in order to understand each step, the relevant actors, and underlying forces that influence this process. At each stage of the Innovation Chain, funding is needed along with specific expertise to increase the chance of commercial success. Figure 1 below outlines the major components of the Innovation Chain:
21
Trebilcock, Truth to Wind Power, supra note 15 at 6.
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Figure 1: The Innovation Chain22 As shown in Figure 1, the stages of innovation are broken down into roughly six segments: basic R&D, applied R&D, demonstration, pre-commercial, niche market & supported commercial, and fully commercial. This corresponds roughly with the lifecycle of the typical (successful) technological startup from lab to market. As shown with the red and blue lines in the middle of the graph, the cost and revenue structure of the venture changes over time. Early on, the venture generates no revenue, but incurs costs such as research and development costs, prototyping costs,
22
Michael Grubb, Technology Innovation and Climate Change Policy: An Overview of Issues and Options (2004) 41:2 Keio Economic Studies 103 at 126.
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and overhead costs. Eventually however, costs per unit go down as the prototyping finishes and production is scaled. At the same time, the product is introduced to the market and customer orders eventually grow, creating a stable revenue stream. In other words, the technological venture moves from highly cash flow negative, to break even, to cash flow positive over time, but only with support at key stages.23 Financial support is obviously one of the biggest hurdles for successful commercialization of new technologies. Different financing sources are represented at the bottom of Figure 1 in rough order of their appearance and specialization in the venture lifecycle. Basic and applied R&D is generally funded by governments through universities and colleges, as well as industry-based research and development labs. As the technology becomes proven, it goes through the development and pre-commercial stage, where its commercial viability must be tested. Generally, angel investors and early-stage VC firms are expected to provide funding at this early stage. Finally, the product/service is commercialized and focus is put on business growth and operational efficiency improvements. Large amounts of capital are generally needed for growth, attracting the attention of private equity firms, project financiers, banks, and eventually public markets through an initial public offering.24 Governments may at times use policies to guide or support the innovation chain towards achieving certain objectives. These policies can be categorized into two general buckets: (1) technology push policies and (2) market pull policies, which will be described individually and in detail later on in the policy mix segment of the paper. Generally, technology push factors
23 24
Ibid at 130. Ibid at 131.
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increase the amount of technology supply, which increases productivity of capital.25 In the climate change context, this could mean finding new ways to manage emissions more efficiently, increasing energy conversion rates of renewables, or identifying new, cost-efficient materials and compounds. On the other hand, market pull policies attempt to increase commercial demand for new technologies and provide firms and consumers with economic incentives to apply them.26 In the climate change context, this could mean implementing a cap-and-trade system or requiring more stringent climate change impact disclosure from corporations, increasing the information available for investors to make decisions upon.
B. The Innovation Gap

As shown in Figure 1, the period where a new venture requires a large amount of cash inflow while having little operating cash inflow occurs between the demonstration stage and the supported commercialization stage. This period of extreme negative net cash outflow is otherwise known as the Technology Valley of Death, as many ventures die during this period because they are not able to secure the financing they need to stay afloat before they reach the breakeven point. Figure 2 details the phenomenon in greater detail, using a slightly different typology than Figure 1:
25
Mary Jean Burer & Rolf Wustenhagen, Which Renewable Energy Policy is a Venture Capitalists Best Friend? Empirical Evidence from a Survey of International Cleantech Investors (2009) 37 Energy Policy 4997 at 4998. 26 Ibid.
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Figure 2: Gaps within the Innovation Chain27 Despite the fact that new ventures most pressingly require financing when trying to bridge the Technology Valley of Death, Figure 2 shows that there is a serious funding gap during this lifecycle period, falling within the demonstration phase when ventures are developing their product/service, demonstrating its commercial feasibility, and iterating on designs. Significant capital is usually required to develop the concept from a pilot project to its full-scale commercial form. Capital requirements are perhaps even more pronounced in the CleanTech sector, where technologies are often intended for large-scale, commercial use and accordingly, require millions of dollars to properly develop.28
27
Sustainable Development Canada, The Funding Gap (Ottawa: SDTC, 2012) online: SDTC <http://www.sdtc.ca/index.php?page=the-funding-gap&hl=en_CA>. 28 Matthew Nordan, The State of CleanTech Venture Capital, Part 1: The Money, GigaOM (28 November 2011) online: GigaOM <http://gigaom.com/cleantech/the-state-of-cleantech-venture-capital-part-1-the-money/>.
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Why is there is an abrupt drop in funding during this period? The major reason is because of the high-risk of investments at this stage of the game. The technology is not yet mature and there is little certainty as to its commercial viability. Given the general risk aversion of financial players (even VC firms generally will not invest until a firm has some customers lined up and the technology has demonstrated its viability), many ventures are starved of cash at this point, frustrating the Innovation Chain entirely.29 Angel investors can sometimes help cash-starved ventures mired in the Valley of Death, but as a group they cannot provide nearly as much capital or provide it as consistently as can venture capital or private equity firms. This Innovation Gap reveals a systemic structural break in the transition between government-supported research and commercialization and dissemination of innovative, potentially breakthrough technologies. The Innovation Gap phenomenon is supported by funding statistics for new technologies across the board. For example, the total amount of funding in Canada for research (both public and private) is estimated to be around $27.2 billion annually. However, VC funding averages $1.8 billion a year, demonstrating that well-funded research gains are often not capitalized on because of a lack of sustained funding.30 This Innovation Gap also costs the government directly in terms of lowering their return on investment for upstream research: the USA spends 14 times more than Canada on fundamental and applied research, but obtains 49 times more revenue from licensing and royalties upon commercialization of this research.31 Efforts therefore should be made by governments in order to bridge this Innovation Gap. This can be done in many possible ways, some options of which will be explored in the next section.
29 30
Sustainable Development Technology Canada, The Funding Gap, supra note 27. Ibid. 31 Ibid.
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Finding the Right Policy Mix to Bridge the Gap

While this section will outline potential policy tools, it should be noted that regardless of what policy mix governments ultimately choose to bridge the innovation gap between research and commercialization, they must focus on exhibiting two things: (1) intent and (2) consistency. Private investors recognize that government policies may change with the ebb and flow of political realities (what the government can give, it can also take away).32 Because of this, VC firms prefer not having to rely on government intervention to make a venture economically sustainable and instead focus on ensuring that the business fundamentals of a venture make sense independent of external policy influences. However, a show of support for broader goals, such as pro-innovation, pro-sustainable development, and ecologically-sensitive attitudes can generate confidence on the part of the CleanTech investment community. Consistency in government policies is especially important in the climate change arena, where even scientists have become highly politicized and there have been a succession of regulatory starts and stops in the past. Surveys conducted among early stage CleanTech VC firms show that the most important aspect of policy is that it should be consistent.33 For business, regulatory inconsistency just creates an additional risk factor that militates against investing for the medium or long term. Such regulatory inconsistency is one of the reasons why many incumbent carbon emitters do not bother to comply with cap-and-trade systems and why many early-stage financers often shy away from putting serious money into innovative climate change solutions. With those two overarching principles in mind, we move to an evaluation of some individual policy tools:
32 33
Burer & Wustenhagen, supra note 25 at 5003-5004. Ibid at 5005.
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A. Technology Push Policies

(1) Government Demonstration Grants The simplest way to address the funding gap at the demonstration and pre-commercial phase is to provide grants to those entrepreneurs who have innovative technologies that require money to demonstrate their commercial viability. Generally these grants would be given to firms that have already laid down the groundwork for their idea, including initial testing and are ready to move on to the pilot stage. Demonstration grants are typically used to purchase specialized equipment, hire expert staff or conduct expert training, as well as to cover development and design costs. Surveys of venture capital firms in the US and Europe have shown that, among potential technology push policies, government demonstration grants were perceived to be the most effective in stimulating the VC firms interest in investing in innovative CleanTech ventures.34 Ontarios most significant government demonstration funding program is the Innovation Demonstration Fund (IDF), a $24 million fund under the Ministry of Economic Development and Innovation, which was launched in 2006 and subsequently topped up in recent years.35 Although the IDF does not offer grants outright (financial assistance is usually offered in the form of a forgivable loan, equity participation, or royalty agreements), it offers financing on very favourable terms and provides significant access to early-stage capital: a minimum of $100,000 and to a maximum of $4 million per project.36 As of January 2012, the IDF has funded 32 different CleanTech pilot projects, some of which have had encouraging commercial success. 37
34 35
Burer & Wustenhagen, supra note 25 at 5001. Office of the Premier, Innovation Demonstration Fund (2 June 2006) online: News Ontario <http://news.ontario.ca/opo/en/2006/06/innovation-demonstration-fund.html>. 36 Ontario Ministry of Economic Development and Innovation, Innovation Demonstration Fund (IDF) Program Guidelines online: MRI Ontario <http://www.mri.gov.on.ca/english/programs/idf/guidelines.asp>. 37 Ontario Ministry of Economic Development and Innovation, Innovation Demonstration Fund Projects (19 January 2012) online: MRI Ontario <http://www.mri.gov.on.ca/english/news/EcoVu022009_bd2.asp>.
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Demonstration bridge-funding programs like the IDF can be expanded and offer a more diverse range of financing options (including small scale grants) to a greater number of potential CleanTech ventures. At the Federal level, there is Sustainable Development Technology Canadas (SDTC) $590 million SD Tech Fund and its $500 million NextGen Biofuels Fund.38 These are not investment funds but rather pools for grant money that identify promising sustainable development ventures (a relatively broad concept) and support them at the development and demonstration phase. Money invested by the SDTC in 228 demonstration projects has attracted an additional $1.4 billion in co-invested private sector funding and some of its former startups, such as Burlingtons Ecosynthetix Adhesives Inc. and Montreals Enerkem Technologies Inc. are preparing to go public.39 The major problem facing the long-term sustainability of SDTC is that because of major demand for its funding, the pool of money has quickly dried up and requires periodic injections from the federal government.40 A consistent source of funding (from carbon tax revenues for example), would be necessary for the SDTC to continue doing its work through subsequent political and economic storms. (2) Incubators Another possible avenue of supporting early stage development would be to invest more money into green technology entrepreneurial incubators, establishing hubs where technological innovation and commercialization are closely linked with each other from the outset. This model takes after US incubators in Silicon Valley and the Boston Area, where VCs set up shop right
38
Sustainable Development Technology Canada, About Our Funds (Ottawa: SDTC, 2012) online: SDTC <http://www.sdtc.ca/index.php?page=about-our-funds&hl=en_CA>. 39 Barrie McKenna, Clean-Tech Fund Awaits Ottawas Budget Cuts, The Globe and Mail (26 March 2012) online: The Globe and Mail <http://www.theglobeandmail.com/report-on-business/clean-tech-fund-awaits-ottawasbudget-cuts/article2381800/>. 40 Ibid.
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next to world-class research institutes such as Cal Tech, Berkeley, and MIT. Arguably, this is already happening with software startups in Canada, with the recent establishment of the MaRS Incubator at the University of Toronto, the Digital Media Zone at Ryerson University, and VeloCity at the University of Waterloo. Investment in green technology specific incubators could have the effect of reducing information and transactions costs, spurring the supply of private venture capital in Canadian markets, thereby bypassing the drawbacks of direct government intervention. Encouragingly, MaRS set up its own privately-run CleanTech venture capital fund, MaRS CleanTech Fund LP, in March of 2012. The $30 million fund, managed by Tom Rand (head of the MaRS CleanTech practice) and Murray McCaig (a serial entrepreneur), is notable because of its partnership with the MaRS incubator.41 The incubator itself can work on de-risking technologies by working directly with entrepreneurs in refining and proving technology, assembling a team, as well as equipping them with basic entrepreneurial skills such as budgeting, management, creating business plans, and pitching ideas.42 By the time the venture is ready for commercialization, the MaRS CleanTech Fund will already have been very familiar with the idea and team, removing some of the informational barriers that normal early-stage VC firms face. The Fund will co-invest with angel investors and other institutional funds so as to leverage this expertise and increase overall access to capital.43
41
Mark Evans, New fund gives clean-tech startups needed boost, The Globe and Mail (2 April 2012) online: The Globe and Mail <http://www.theglobeandmail.com/report-on-business/small-business/sb-money/businessfunding/new-fund-gives-clean-tech-startups-needed-boost/article2387294/>. 42 MaRS Cleantech Fund, About the Fund online: <http://marsvf.com/>. 43 Sustainable Development Technology Canada, About Our Funds, supra note 38.
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(3) Government Venture Capital Funds and Fund of Funds We should note here that the idea of government sponsored venture capital is nothing new in Canada. If we account for Labour-Sponsored Venture Capital Corporations (LSVCCs), provincial subsidies to VCs through an array of different funding programs, as well as crown corporations like the Business Development Bank of Canada (BDC), we find that actually the majority of venture capital under management in Canada is government sponsored in some shape or form. 44 Generally, literature that has overviewed empirical studies of government intervention in venture capital has showed that these programs underperform private venture capital funds not just in terms of pure return on investment, but also on ancillary government objectives such as innovation, competition, and employment measures. Furthermore, there seems to be evidence that government venture capital (GVC) may crowd out certain private competitors by reducing cost of capital below market levels and dissuading purely private entrants.45 These findings
should give policymakers significant pause before going ahead with GVC policies to support the commercialization of CleanTech ventures. This does not necessarily mean that there is no place for government intervention in early stage VC, but rather that there are certain concerns that must first be addressed. The first concern, referred to above, is that of crowding out private entrants. An argument that is frequently levied against LSVCCs is that, because of preferential tax credits, their cost of capital is artificially lowered and that this distortion gives them an unfair competitive advantage in VC deal sourcing
44 45
Brander, supra note 4 at 6. Ibid at 9.
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an advantage that is funded by taxpayers but provide little ancillary benefit.46 A secondary risk is misalignment of incentives. The government clearly wants certain benefits from GVC beyond maximizing rate of return; they are looking for technological innovation, options for decreasing greenhouse gas (GHG) emissions, commercializing renewable alternatives to avoid fossil fuel depletion, and creating new jobs in a politically attractive way. What happens if a VC firm or individual enterprise strays from these objectives? How can the government bring these renegade parties into line? One possible way is that the government could adopt a Fund of Funds (FoF) approach to investing instead of direct tax credits or subsidies which have a significant market distortion effect.47 The idea would be to create a fund with a mandate to invest in other primary VC funds that support early stage CleanTech in Canada (or in a particular province). This model could be similar to the structure of funds and secondary investment departments at large pension funds, like Canada Pension Plan Investment Board (CPPIB) or Ontario teachers Pensions Plan (OTPP).48 The government could create a semi-autonomous green investment board with a specific mandate, which would then be able to hire its own internal staff of investment and green technology professionals to achieve this mandate. Arguably however, we have simply moved the task of picking winners up from the level of specific technology subsidies to picking individual VC firms that (1) can achieve competent returns through selection and ongoing management and (2) have incentives to promote non-financial government
46 47
Ibid at 6. Trebilcock & Wilson, supra note 1 at 23. 48 Canada Pensions Plan Investment Board, Funds & Secondaries online: <http://www.cppib.ca/Investments/Equities/Private_Equities/funds_secondaries.html>; Ontario Teachers Pension Plan, Funds (April 2012) online: <http://www.otpp.com/wps/wcm/connect/otpp_en/home/investments/teachers+private+capital/how+we+invest /funds/funds>.
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objectives. Such incentives would have to exist somewhere in the contract or investment terms between the government-sponsored FoF and private VC firm.
B. Market Pull Factors

(1) Feed-In Tariffs Of all potential low carbon emission government policies included in Mary Jean Burer and Rolf Wustenhagens comprehensive 2009 survey of VC firms, feed-in tariffs were by far the most preferred policy for VC firms considering CleanTech investments.49 This is not surprising, since feed-in tariff programs typically guarantee grid access and provide long-term guaranteed demand for any electricity produced, usually at a predictable price point.50 These key features create a relatively consistent and predictable economic environment in which to assess commercial feasibility of projects tied to feed-in tariffs. Additionally, it provides a legal mechanism (viz. long-term contracts) for redress should governments renege on their agreements. On the empirical front, a detailed analysis by the European Commission in 2008 concluded that "well-adapted feed-in tariff regimes are generally the most efficient and effective support schemes for promoting renewable electricity".51 Support for feed-in tariff programs was also echoed by Ernst & Young in their 2008 report, finding that the German feed-in tariff program was successful at delivering more power at lower costs than other alternatives.52 These studies
49 50
Burer & Wustenhagen, supra note 25 at 5002. See generally Miguel Mendonca, Feed-In Tariffs: Accelerating the Deployment of Renewable Energy (London: Routledge, 2007). 51 European Commission, The Support of Electricity from Renewable Energy Sources (2008) 57 Commission Staff Working Document online: <http://ec.europa.eu/energy/climate_actions/doc/2008_res_working_document_en.pdf>. 52 Paul Gipe, Ernst & Young Find Feed-in Tariffs Cheaper Than Trading System Wind Works (7 October 2008) online: Wind-Works.org <http://www.wind-works.org/FeedLaws/Great%20Britain/ErnstYoungFindFeedinTariffsCheaperThanTradingSystem.html>.
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provided the technical support for Ontario to push forward with their own feed-in tariff program in the Green Energy Act one year later. However, in the case of Ontarios Green Energy Act, problems surface with the way that prices are set. The main administrative pitfall in the feed-in tariff scheme is that the government must find a way to set the price. In Europe, prices are set based on cost of energy production. Since there is a diverse array of alternative energy technologies, different prices are set for different technologies. Compensation rates are determined based on scientific studies and best-guess estimates a most difficult task, even for experts.53 When technologies change the cost structure of different alternatives rapidly, as is currently the case with the CleanTech industry, the pricing structure must also change to reflect this. This pricing risk, if borne by governments, may add significantly to administrative and economic costs for taxpayers. If this pricing risk is borne by investors instead (e.g. in variable contractual price provisions), it may dissuade them from investing. This puts governments squarely in the difficult situation of picking technological winners. This pricing risk becomes much worse if governments do not base their pricing structure on any rigorous cost analysis at all, as seems to be the case with the Ontario scheme. Some of the pricing, for example its 2010 tariff of 80.2 cents/kWh (base load electricity costs about 4 cents/kWh) on small solar systems under the microFIT program, have no detailed expert research supporting it and seems to have been created out of political expediency (or more pointedly, the numbers seemed to have come out of thin air).54 In addition, the consultation process for the
53
See Judith Lipp, Lessons for effective renewable electricity policy from Denmark, Germany and the United Kingdom 35:11 Energy Policy 5481. 54 Trebilcock & Wilson, supra note 1 at 29.
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Green Energy Act was skeletal: there were no background research papers or policy papers with which to focus discussion.55 Finally, the variable pricing structure of feed-in tariffs, if based on the vague notion of providing a reasonable return, does not let the lowest-cost technology emerge as a winner (as would be the case if the picking winners function was devolved to the private sector). It seems to promote alternative energies investment simply for the sake of doing so, regardless of the economic cost borne by taxpayers or actual impact (or lack thereof) on net carbon abatement.56 (2) Public Procurement Direct public procurement can play an important in generating demand for certain CleanTech projects but, like other areas of public procurement, this only works when processes are transparent and tenders are competitive. Least-cost subsidy contracts for CleanTech projects would balance economic efficiency and transparency concerns and should be encouraged as part of the public procurement process. Another helpful example of public procurement is investment in infrastructural improvements, such as smart grids, that reduce subsequent costs of future CleanTech development projects.57 (3) Grants and Subsidies for Investors Although providing grants and subsidies to investors may spur increased investment in CleanTech, it is not clear whether this would be necessary or efficient. The gap in funding for CleanTech only really exists at the demonstration and development phase of the lifecycle, which
55
Government of Ontario, Go Green: Ontarios Action Plan on Climate Change (August 2007) online: Ministry of the Environment <http://www.ene.gov.on.ca/environment/en/resources/STD01_076573.html>. 56 David G Duff & Andrew J Green, A Comparative Evaluation of Different Policies to Promote the Generation of Electricity from Renewable Sources in Steven Bernstein, Jutta Brune, David G Duff & Andrew J Green, eds, A Globally Integrated Climate Policy for Canada (Toronto: University of Toronto Press, 2008) 222 at 238. 57 Trebilcock & Wilson, supra note 1 at 24-25.
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makes targeting these grants and subsidies a particularly difficult exercise.58 Furthermore, studies on VC returns on capital for CleanTech investments show that they are actually providing above average returns compared to the rest of the venture capital market, which calls into question why these investors should be given even more on top of those returns as an incentive.59 Adding basis points to VC firms return on investment through direct subsidies and grants may also have the market distorting effect of commercializing technologies too early in their life cycle or promoting otherwise unsustainable technologies. In any case, this does not seem to be an efficient use of government funds relative to other policy options. (4) Carbon Pricing Although carbon pricing (either through a carbon tax or a cap-and-trade system) only indirectly affects the Innovation Gap, it is extremely important in terms of evening the competitive playing field for alternative energies. By applying a rough cost to carbon emissions, carbon pricing, among other things, incentivizes the innovation and commercialization of low-emission technologies across the Innovation Chain. The elimination of fossil-fuel subsidies can also be added to this section, since the goal of such a policy would also be to provide a more balanced competitive environment for low-emission technologies.60 The comparative advantage of both fossil-fuel subsidies reduction and carbon taxes is that they provide a relatively predictable pool of money with which governments can dedicate towards promoting low carbon emission policies, such as the other innovation policies detailed in this
58
Devon Sweezy, The Coming Clean Tech Crash Forbes (7 July 2011) online: Forbes <http://www.forbes.com/sites/energysource/2011/07/07/the-coming-clean-tech-crash/>. 59 Pfeuti, supra note 9. 60 In fact, governments currently subsidize fossil fuels by $557 billion per annum, creating a significant market distortion. See Bloomberg New Energy Finance, Fossil Fuel Subsidies Outpace Renewables (29 July 2010) online: Renewable Energy World.com <http://www.renewableenergyworld.com/rea/news/article/2010/07/fossil-fuelsubsidies-outpace-renewables>.
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paper.61 This stability, revenue generation, and relative ease of administration may make these policies preferable over cap-and-trade systems in terms of pricing carbon. However, all three policies are subject to considerable political opposition, potential solutions to which are beyond the scope of this paper.
Conclusions
Too much energy is expended over the question of whether climate change is real or not as well as the conflict between climate change believers and climate change deniers.62 This is a false dichotomy which is largely unhelpful for global society in general. Public and private actors consistently deal with decisions on how to act in the face of uncertainty and incomplete information on a day-to-day basis. This paper suggests that the climate change discourse should instead be shifting towards the question of how to align economic interests with climate change concerns. If that hurdle can be bypassed, much of the current political resistance to climate change policy will be mitigated. Such an alignment requires us to even the playing field by pricing carbon effectively, as well as eliminating subsidies for the fossil fuel industry. It also requires us to figure out ways to reduce the cost of low-emission energy alternatives so that they can be economically competitive with traditional energy sources. A dedicated commitment to CleanTech innovation is the lynchpin of such a policy and therefore attention should be focused on how to overcome problems such as the Innovation Gap, which prevents potentially ground-breaking research from being commercialized and widely
61 62
Pielke Jr, supra note 5. See Andrew J Hoffman, Talking Past Each Other? Cultural Framing of Skeptical and Convinced Logics in the Climate Change Debate (2011) 24:1 Organization Environment 3.
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disseminated. While there are many potential policies that may help bridge this gap, it is likely that a mix of complementary policy tools, such as demonstration grants, incubators, government CleanTech FoFs, carbon pricing, and public investment in supporting infrastructure, is needed to get the job done. The debate should not focus on whether climate change is a substantial and pressing concern, but rather it is how we should balance climate change concerns with other legitimate concerns moving forward.

Addressing The Innovation Gap in Green Technology

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Addressing The Innovation Gap in Green Technology

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Aligning Climate Change Concerns with Economic Incentives

Why Winner-Neutral? The Difficulty of Picking Winners

The Innovation Chain and the Innovation Gap

A. The Innovation Chain Explained

Trebilcock, Truth to Wind Power, supra note 15 at 6.

Ibid at 130. Ibid at 131.

B. The Innovation Gap

Finding the Right Policy Mix to Bridge the Gap

Burer & Wustenhagen, supra note 25 at 5003-5004. Ibid at 5005.

A. Technology Push Policies

Brander, supra note 4 at 6. Ibid at 9.

B. Market Pull Factors

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