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CFI Newsletter #5: Climate SPACs Go Big
+ carbon inequality in India, net-metering rules hamper rooftop solar, carbon capture draws Elon's attention, and wind's collateral damage on balsa wood
The Climate Finance Initiative Newsletter offers quick digests and insights around what is happening in climate finance. While the Climate Finance Initiative’s current focus of work is India-centric, we will capture a global perspective of climate finance in this newsletter on a fortnightly basis.
We, at CFI HQ, like learning about externalities and the unintended consequences of actions. The case of how the Sahara Desert feeding the Amazon rainforest for one is just mind-blowing.
The Economist this week, threw light on a couple of nuggets on the human-made unintended consequence around the growth of wind energy and its impact on balsa forests. The first, it was learning that balsa wood due to their strength, is a key component of wind farms where they are sandwiched between blades. The second was the troubling impact of the boom in wind farms and increased logging in forests, especially in Ecuador (which supplies 75% of the world's balsa wood) where prices have tanked and cut balsa wood is strewn around. We highly recommend you giving this piece a read.
Stories like this are important. They remind us that most impacts around climate change and action, even though intended to be positive, are not localized, and can often have a sort of butterfly effect that is exponential.
And we often gloss over such occurrences to our own detriment.
Climate Finance by the Numbers
India’s average per capita carbon emissions are calculated at between 1.8 and 2.7 tonnes CO2 per year, a quarter of the global average. This is not due to a prudent minimalist lifestyle. It is skewed by the huge numbers of people living in poverty or low-income sections of society - 28.4% of India’s population as identified in the paper.
A flawed approach India takes for measuring climate action is using this one average per capita carbon emission number in its policy to demonstrate India’s action towards climate change. Multi-lateral organizations, development finance institutions, and think-tanks as well repeatedly take this number at its face value with no context. The fact that high-expenditure households in India are responsible for nearly seven times the carbon emissions than low-expenditure households is not taken into account.
This has consequences. We do not talk much about climate inequality within a developing country, like India, more between developed and developing countries. We probably should start talking about it given that we have climate refugees in India today (who come exclusively from the lower-income sectors of society) and this disparity in carbon footprint across different income sectors.
The artificially lower per capita carbon emissions gives India leeway to employ economic growth policies without much regard for climate mitigation approaches, e.g. new coal power plants being introduced as essential for energy security that brings people out of poverty. This is also compounded with a belief that climate-friendly policies are at odds with poverty alleviation, which the paper touches upon is not so. Poverty reduction and climate action do not have to be in conflict.
Climate mitigation approaches have to be defined and differentiated based on different sectors of society, initially targeting the high-income sector, rather than treating Indian society with one average per capita carbon footprint.
When India first announced its solar push in 2016, rooftop solar was expected to contribute 40GW of the expected 100GW capacity addition planned by 2022. The early enthusiasm, combined with falling solar project prices led to some 6GW of installations between 2017-2020. However, the policy tide seems to have turned against rooftop solar now.
Rooftop solar projects make economic sense because of net metering. Say you consume 2,000 units of electricity a month and you set up a rooftop solar plant that generates 1,200 units. What net metering does is let you “net-off” what you generate so you only pay your electricity distribution company (discoms) for the 800 extra units you consumed.
This has caused a lot of angst amongst discoms. Since most of them supply agricultural power for free and charge homeowners a reasonable rate, their profits largely come from selling power at a high tariff to commercial and industrial users. These same industrial users were the ones who mainly opted for rooftop solar projects.
Rather than find a long term solution that encourages rooftop solar while maintaining a viable distribution network, the government has gone into a “Protect Discoms” mode. Recent electricity rules formulated by the Ministry of Power restrict the maximum size of rooftop solar projects eligible for net metering to 10kW, a limit that previously was between 1MW to 2MW depending on the state, reduced by 100 times.
Larger projects above 10kW will now be covered under gross metering. Without going into too much detail on how it works, let us just say that the new rules make distribution companies profitable but rooftop solar projects unviable. The sector already had a set of funding challenges, this may just stop all progress in newly installed capacities going forward.
USD 100 million
Carbon capture from air has a Holy Grail-esque mystique around it for climate action; perhaps justifiably so because it offers the most direct way of tackling carbon emissions by physically removing them from the atmosphere. The technology for carbon capture is not new, and there are at least three startups that have built operational pilot plants to capture carbon dioxide from the air, Climeworks, Global Thermostat, and Carbon Engineering.
But they are just that, pilots. Carbon capture is expensive. The cost of capturing one ton of carbon from air is around USD 600, 15 times more than price of carbon in European carbon trading markets.
Elon Musk’s pledge is intended to go some way towards getting one of these carbon capture technologies towards real-world commercialisation and will be one of the largest investments in the space; likely only exceeded by Microsoft’s USD 1 billion commitment. His interest has been speculated towards a direction of making carbon dioxide the basis for SpaceX rocket fuel. This market-driven funding does open up an interesting path to the other question relating to carbon capture - what do you make with the captured carbon and an effective revenue model around it.
It also leaves a question at CFI HQ around this nature of innovation funding, especially in newer areas of climate innovations, not just carbon capture. The amount is undoubtedly significant, but it is likely to only benefit one organization. It does come at the end of a raft of other challenge competitions around carbon capture, which leaves unanswered what are funding sources towards further commercialisation, that will come after these innovation validation challenges.
SpaceX’ position of being a long-term beneficiary creates that market pull, and that might be the trick to identify backers who have a market demand for such technologies to be effective. A lot is riding on Elon Musk’s star power to throw a spotlight in the space, but if we are to have financing that is sustained and significant, it is going to require a lot more players to back increasingly larger amounts in this area.
THE BIG READ
Climate SPACs Go Big
SPACs are a great way for global climate businesses to go public and raise large amounts of funding, however, regulations will pose a challenge for companies to do SPACs in India, but there can be ways around it
Special Purpose Acquisition Companies (SPACs) had their biggest year ever on the US stock markets in 2020. 2021 is promising to be even bigger. SPACs, also known as blank cheque companies, are not a new concept. They were generally relegated to an obscure corner of the stock markets until Chamath Palihapitiya came along and used a SPAC to take Virgin Galactic public in 2019. Since then, the SPAC frenzy has continued unabated. Before delving into the potential this “new” found financial structure has for climate businesses, it is worth taking a pause to talk about what a SPAC actually is.
So What Is a SPAC?
Taking a company public via an initial public offering (IPO) is a long, arduous process. A company going public through this route would need to have an impeccable track record of revenue growth, profitability and a stable business that investors - both institutions and the general public - could understand. Even with all these criteria ticked off, the IPO process comes with months of uncertainty around whether or not the retail investors would be convinced of the company’s potential and what price they would put on this potential. An IPO is essentially a fundraising transaction being negotiated with thousands of investors at the same time, and a lot of uncertainty on being able to raise the capital you need.
What a SPAC does is bring a lot more certainty to the listing process. Experienced professionals - often fund managers or former public company CEOs - put together an investment team and raise anywhere from USD 50 million - USD 4 billion for a newly incorporated company. These funds go into a trust and the SPAC then has one objective: finding a target business to acquire in the next 18-24 months. For SPAC sponsors, this is akin to setting up a private equity fund that will make only one investment and will give them attractive returns in less than two years.
SPAC deals make sense for potential targets too. They now have the option, via a merger with the already listed SPAC, to become a listed entity and get access to all the funding the SPAC has already raised. Unlike an IPO, the target company is negotiating with a small team of fund managers, making the process shorter and a lot more certain in terms of company valuation and capital raised. Due to negotiating with experienced fund managers who are likely to have a more shared vision, a lot more time on due diligence and the value of the company can be spent on its future potential rather than its past, the capital markets open up for everything considered too risky in the past: space travel, cannabis, gaming, hard to understand health-tech, and of course cleantech innovations have all gone public via SPACs.
While the first SPAC was issued way back in 2013, it took validation from large fund managers and successful targets in 2019 for SPACs to really take off. With a total of USD 83 billion raised from 248 transactions, 2020 was the biggest year ever for SPACs. 2021 promises to be even bigger - we are only one month in and there are already 91 SPAC IPOs in the works.
Why Should the Climate Finance World Care for SPACs?
Anyone with even a casual interest in climate change will tell you that fixing the warming world is going to take a heck of a lot of money. A lot of this funding would come from governments, from venture capitalists and private equity funds that invest in climate startups. But as these ventures grow to billion-dollar businesses, private money starts to hit its limits. Going public is a time-honoured way to raise a lot of capital for high growth companies, but not an easy option for climate businesses that rely on future potential.
SPACs could change that. By one count, 25% of all SPACs that have been announced target climate businesses. That is a whole lot of new capital coming together with the aim of building a cleaner earth.
Electric vehicles, in particular, have been of immense interest to SPAC investors. Nikola, which has hit roadblocks for other issues, was the first big name EV maker to go public in early 2020, raising USD 525 million at a staggering USD 3.3 billion valuation. Since then, several EV companies, battery makers and charging infrastructure owners have gone the SPAC route. Chamath is taking a commercial EV maker public in his latest USD 800 million+ transaction.
SPAC sponsors are looking beyond electric vehicles. Former NRG Energy CEO David Crane is backing a SPAC that will look at the wider cleantech world for targets. And a residential solar company - Sunlight Financial - just went public in a USD 1.3 billion SPAC transaction.
Can There Be An Indian SPAC?
The short answer is ‘it depends’! Regulations do not permit blank cheque companies to list on an Indian stock exchange. An Indian SPAC would therefore require a merger with a US SPAC listed on the NYSE or Nasdaq stock exchange. There is precedent here though, as well as a SPAC pioneer from India. Yatra went public via a SPAC in 2016, when SPACs were not fashionable.
That said, an overseas merger is a tricky business requiring significant regulatory approvals, with the added cost and time of that process taking away most of the benefits companies look for in a quick SPAC listing. (Simmi is facing this first-hand working on a cross-border SPAC and it is not a fun process).
SPACs would still make sense for climate businesses with operations in India and holding companies abroad in US, Europe or Singapore. This is not anything new. It is a trend that we have seen in the VC and PE-backed startup world so it’s not really a big leap.
A bigger challenge for Indian SPACs in our view is simply the lack of businesses large enough to list on global markets. The smallest of SPACs being raised today is at around USD 100 million. Because SPACs take minority stakes in the companies they acquire, the target that goes public via this route would have to be valued at least half a billion dollars.
We combed through our database of cleantech businesses in India and came up with only a handful of potential names - solar companies and EV manufacturers which might not be hard for you to figure out - that would meet the criteria for a potential listing.
Still, SPACs are just starting out as a financing structure for climate action. As other segments of climate businesses grow in the coming years, with the knowledge of SPACs, it can be a powerful tool in this capital hungry sector’s arsenal.
Engaging with CFI
As always, if you are keen to engage or talk to us on our work plans (check out the deck here) or if you have something of your own to collaborate on, reach out to us below!
That’s it for this edition of our newsletter. As always, send all feedback, compliments and brickbats our way. And of course, we do appreciate you spreading the word about this newsletter.
We’re growing to build something collaborative with you and the more the merrier!
Simmi Sareen and Shravan Shankar