The combined impact of the energy crisis, supply chain disruption and climate change has sparked a surge of interest in Europe’s climate tech sector. Encouraged by the EU’s demanding regulations, investors, corporates and entrepreneurs are working together to give Europe a lead in the sector. Alice Besomi and Mélissa Cohen look at the role of venture capital and infrastructure funds in European decarbonization.
Macro economic tailwinds propel climate tech sector upwards
Climate change awareness has taken off in Europe over the last two years, leading to an influx of private capital deployment in climate tech, and more generally in the energy transition.
Climate tech ranks as the fastest growing start-up category in the region, having doubled in size since 2020 to a total value of over $100 billion today, second only to fintech overall.
Three major factors have accelerated this trend: the impact of the Ukrainian war has prompted renewed calls for energy efficiency, more renewables and clean mobility; widespread supply chain disruption has pushed companies to digitalize their operations more rapidly; and the ever more tangible impact of climate change is focusing attention on the need for change in cities and urban centers, accounting for 60% of carbon emissions.
Consumers and regulators see eye-to-eye in cutting carbon emissions
There is a remarkable alignment of interests across society to pursue investment in all aspects of ecological transition, from cutting carbon emissions to helping adapt to climate change.
This alignment brings together consumers, politicians, regulators, corporations, venture capitalists, infrastructure investors, and entrepreneurs.
At one end of society, individuals – in other words, the consumers, shareholders and voters who each have a small but important voice in the debate – are literally paying a very heavy price for Europe’s reliance on imported oil and gas, as energy prices have spiraled upwards since Russia’s invasion of Ukraine. This gives a powerful economic rationale for the acceleration of renewable energy development and improvement of efficiencies from an energy consumption standpoint.
The push is also from the top down, driven by strong political and regulatory impetus. The EU member states have made a strong commitment to reach net zero by 2050 through the European Green Deal. The EU Renewable Energy Directive has established a 32% target for renewable fuels, and its “Fit for 55” program aims to cut net greenhouse gas emissions by 55% by 2030.
In addition, there is strong European political support for innovation. For example, the REPowerEU program unveiled by the European Commission in May 2022 to reduce reliance also laid out a roadmap to encourage the production of significant amounts of “green” hydrogen by 2030.
Europe’s institutional investors are also helping to propel this virtuous circle, themselves driven by the need to take account of new regulatory requirements. Most important among these are the EU’s Sustainable Finance Disclosure Regulation or SFDR, especially via its so-called “Article 9” funds, which has been designed to ensure private capital dedication to sustainable investments.
VC and infrastructure funds investing in a cleaner future
The need for financing the climate tech revolution has also prompted a beneficial alliance of interests between VC and infrastructure funds. Both investment categories have major roles to play in helping to achieve society’s climate goals.
On the venture side, there has been a wave of innovative young climate tech companies – often created by second or third-time entrepreneurs – springing up across the region in the past few years. These young start-ups themselves represent a variety of approaches. Some, for example, are focusing on software tools and processes to help corporations with their carbon and climate management systems, with ESG implementation, or with energy trading and tracking. Others apply digital technologies to improve operational processes and installation large quantities of new equipment to improve energy efficiency such as heat pumps, solar panels or EV charging posts. A third category includes entrepreneurs focusing on “deep tech”, a more science-driven approach calling for substantial capital investment to develop technologies to support, for example, carbon capture or green hydrogen.
The start-ups’ clients themselves are to be found across a broad range of industries looking to accelerate their decarbonization. Most notably, they are helping to redress the balance in some sectors that have lagged behind in VC funding relative to the proportion of greenhouse gases they contribute. Until now, for example, mobility has attracted the lion’s share of VC funding related to climate tech (an estimated 60% of the total), even though it only contributes 16% of the carbon emissions. However, the situation is inverted in other sectors, opening opportunities for example in industry & manufacturing which contributes a hefty 29% of global emissions but only attracts 9% of VC climate-related funding. Similarly, food & agriculture accounts for 21% of emissions, but only gets 12% of the VC funding, and real estate also accounts for 21% of emissions but receives a mere 4%.
Infrastructure funds are also playing an important role in financing decarbonization because funding will be required not only in innovative start-ups in the space, but will also require large investments in physical assets.
Building the sort of large-scale projects required to decarbonize our economies will require some heavy financial lifting. Because of the scale of the challenge, there is also a substantial need for public money and regulatory framework shall be implemented to foster investments in these projects.
The size of the investments to build full renewable-energy technologies, electric mobility frameworks, zero-carbon residential heating systems, storage, green-hydrogen-based fuels, and industrial decarbonization will require dedication from different pockets of capital, including VC funds that shall allow the emergence of innovative solutions, whilst infrastructure investors will take over once the projects are mature enough and require significant capital expenditure.
Finally, and reassuringly for those investors that are fueling the surge in climate tech, the sector’s rapid growth isn’t coming at the expense of returns. According to the EIP Climate Tech Index, designed to track the performance of publicly-traded companies primarily involved in providing technology to support global decarbonization, climate tech has in fact soundly outperformed the Nasdaq over the last three years, up 86% compared with the broader market’s 26%.