Vinod Khosla at Milken Institute: Part II
This is a continuation of the previous post covering Vinod Khosla’s (VK) recent lengthy interview Milken Institute 2009 Global Conference. The interview was conducted by Elizabeth Corcoran (EC) of Forbes and can be viewed here.
In Part I, VK discussed the role of government money, capital intensity of renewable projects, and some of his solar investments. Part II picks up at the 13:40 mark of the 75 minute interview. In this section, VK covers his strategy for cutting poor performers from his portfolio, discusses butanol, suggests that cellulosic ethanol can replace oil, says nuclear power can’t compete without subsidies, says cap and trade is inevitable, talks efficiency and smart grid, and tells us that he is often wrong.
EC (13:40): In the past 90 days we have seen something like a billion dollars being put into solar investments – whether in the form of equity or debt. Is that stupid money?
VK: The people who are putting in gobs of money, behind people chasing First Solar at billion dollar valuations – I won’t say it’s stupid but it’s not something I would do with my money. (EC: That pretty much counts as stupid). A diversity of opinion is good. I am often wrong. (EC: Sometimes you are). You only need to be correct once in a while because in our business you only lose one time your money but you can make 100 times quite easily. I don’t have to be very right.
(RR: I would like to hear that during his next congressional testimony where he is trying to drive the direction of energy policy: “I am often wrong.” But this also gets to the heart of why I often object to what he is saying. If he uses his high level of influence to help put us down the wrong path on energy policy, then what are the consequences of being wrong? They could be severe.)
EC (14:38): How many companies do you currently have in your portfolio?
VK: Our clean tech portfolio has probably about 50 companies.
EC (14:50): And how many companies – again you have been at this 5 years or so – how many companies do you cut off at this point?
VK: Interestingly the companies we have cut off…when we started, we started with a different premise. I decided, you know in most venture capital there are plenty of angels. Angels spend half a million dollars, work with a university professor, develop the idea a little further. There are very few angels in clean tech. First, the start-ups are harder, because they are very science and technology-based. If you made money in real estate, you aren’t going to put new money into a waste heat system, for example. It’s harder to understand. (RR: That’s ironic.) So we decided in 2004 that I would spend a lot of my time on what we would call science experiments. So we have cut off perhaps four or five things.
EC (15:48): Which was the biggest disappointment?
VK: Let me just finish the thought. The ones we have cut off, we cut off relatively early. So, of the 10 science experiments we did, we cut off five of them with a million dollars invested. Who cares? The problem is when you invest $50 million and cut it off. That’s the problem. We have not had any large cut-offs – I am trying to think – in our clean tech portfolio. When we have invested a lot of money, there’s one or two places – well one we wrote off; one called Altra (RR: Altra is a corn ethanol producer that is on the ropes). There’s one place we actually decided to change the plan – Cilion – and made it capital neutral, so they don’t need a lot of cash. Got rid of the debt; the company is going fine, but sort of on the slow boat.
(RR: When Cilion was formed in 2006, they announced they would have 8 plants in operation by 2008 and achieve an energy return of better than twice that of gasoline. Here in 2009 they have zero plants in operation. The formation of the company included much fanfare, such as this quote from VK: “Cilion will be able to single-handedly produce all of the ethanol that the Governor has ordered for 2010 [900 million gallons], based on current consumption.” So far, they have proven to be nothing but a money pit. So what if California had counted on that ethanol? These are the dangers of having someone unduly influencing energy policy and being “often wrong.”)
EC (16:57): How about Hawaii Bio?
VK: Hawaii Bio was a tiny investment. It was sort of like – I don’t even remember – under a million bucks. It’s actually going pretty well. They have only spent, cumulatively, a few hundred thousand dollars in their whole life. The idea there was very simple, and it’s still valid. We teamed up with the three largest landowners in Hawaii; about 640,000 acres and said when the technology comes along – and all they are doing is looking for technology; they aren’t developing any technology of their own – that land will be a strategic asset for the fuels area in Hawaii. And so we have been talking to a lot of technology providers, spending very little money. We’ll tread water until the right technology comes along.
EC (18:03): Last fall you said project finance was not an area you want to be headed into. Talk a little bit about where you see cellulosic ethanol going, and isn’t that an area where you have been involved with project finance?
VK: It depends on what you call project finance. Cellulosic technology is something I am very interested in; I actually think it’s the only thing that can replace the oil; I am fairly confident that within the next 5 years it will be cheaper unsubsidized than oil at $50, $60 a barrel.
(RR: I would like to see the math on this. It’s amazing that someone can believe this, despite there not being a single commercial-sized cellulosic ethanol plant in existence.)
EC (18:48): Let’s look at some of the numbers. You don’t like plain ethanol, right; the kind that comes from corn and soy?
VK: Right. To be fair to the corn guys, they served their purpose. I have said for years that they are a good stepping stone. This is important. I will tell you a funny story that really makes a lot of sense. About two years ago, we said that corn ethanol would be a good stepping stone; they have raised a lot of visibility; there’s a lot of pumps; cars are flex-fuel capable. It helped set up the infrastructure. The economics of corn will not work long-term relative to cellulosic. We had a company called Gevo that were not doing corn ethanol, they were doing butanol. (RR: Butanol is something that was produced commercially via the biological route before the petroleum route displaced it; I have explained the issues with bio-butanol here).
They decided to change – not their science; they have bugs that produce butanol and on to some other things – but they changed their strategy for developing the process; the plants they use – to use corn ethanol plants. They have been doing this for two years now; planning on corn ethanol plants being available at 20 cents on the dollar. (RR: And as we saw recently with the Valero purchase of Verasun’s assets, others are also interested in picking up ethanol plants for pennies on the dollar). And developing a process technology that can use them. And in fact the largest maker of corn ethanol plants in the country – or one of the largest, ICM – about three months ago signed an exclusive agreement with them to convert corn ethanol plants into higher value products. So that’s a great example of how every problem is an opportunity.
(RR: While they may be able to reuse portions of a corn ethanol plant, the distillation of the butanol is going to be much different. Distillation capacity will need to be added during any conversion of ethanol plants to butanol plants. I have looked into this already at someone’s request, and I did spend years working in a butanol plant.)
EC (20:38): From your point of view, it’s the 2nd generation ethanol (VK: Absolutely) that’s going to make the most sense. What’s had to go into that is a lot of biotech engineering, finding microorganisms that can efficiently convert. (VK: Sometimes, not always) Finding fuel stocks that will be cheap enough, whether you get them from trees or other brush or winter crops and so forth. Take us through the numbers. Where do the prices have to be in order to make that work, and what happens if oil declines in price? What happens if it gets down to $30/bbl?
VK: What I would say is that unless there’s a competitor to oil, I don’t think oil is going to $30/bbl. (EC: Even though John Doerr was in the Middle East, and people told him, “John, it’s going to $30/bbl?) I won’t speak for John. When we plan for unsubsidized market competitiveness, we plan on $50 oil. I suspect the price will be much higher, especially when economic growth resumes. And whether it’s higher in a year or five years doesn’t matter as much. Not only that, the problem isn’t oil anymore, it’s a carbon constrained world. And we are going to have legislation on that. It doesn’t matter whether the science of climate change is right or wrong. Assume for a moment that we discover over the next 10 years that climate change science is wrong, and we don’t have a climate change problem – not something I believe. We will still end up with legislation in the next five years. So, at this point it is fait accompli; it’s going to happen.
EC (22:50): Doesn’t that amount to government subsidies?
VK: No it doesn’t. If you dump your wastewater into the river, is it a government subsidy if they require you to clean it up? In fact the nuclear industry is the one that’s subsidized. They say we’ll take your toxic waste, the government takes responsibility and subsidizes them. There is not a chance that you [nuclear] can compete in the market unsubsidized. Even if it had the toxic waste subsidy where they took waste off, you still couldn’t compete at market interest rates. There’s not a viable nuclear plant at 15% IRR or 15% debt, which is what the solar guys contend with. It’s only because of 5% loan guarantees from the federal government that keeps nuclear in business.
EC (24:30): Come back to the tax on carbon, though, because there will be a tax. Right? (VK: Yeah). What do you predict that legislation is going to be?
VK: I suspect…look it’s hard to predict politics…I suspect it won’t happen this year it will happen next year. Many people are pushing to have it before Copenhagen this year. I hope we do. There is a 50/50 chance the House can pass a bill by summer. The Senate will take longer, and it will get stuck in the Senate. Anyway, my expectation is that next year we will have a carbon cap and trade.
EC (25:30): Do we know enough about how to make cap and trade work? Isn’t that market just an opportunity for fraudsters to come in?
VK: Any market will have fraudsters to begin with. (RR: He went into an explanation of events that have led to stock market regulations). Will it take 10 years to get a system in place where there is not too much fraud? Yes. (RR: And during those 10 years another administration can come in and dismantle the whole thing).
EC (27:20): So you are willing to put up with an ill-defined, highly-regulated system to have cap and trade?
VK: We have to have cap and trade. We don’t have a choice. (RR: VK compares the need for homeowner’s insurance to the risk that climate change is catastrophic). If we buy home insurance, why shouldn’t we buy planet insurance? (RR: VK discusses the risks that climate change will lead to 100 million deaths; also suggests that the growth rate in China is exaggerated by neglecting “off the books” environmental damage).
EC (29:48): What is a cap and trade system going to do in the United States if we enact it without China?
VK: I suspect China will be part of it in some way. (RR: Discusses targets for developing countries, but doesn’t really answer the question of how China will be compelled to participate. He then referred people to this paper on his website that further explains his ideas.).
EC (33:50): Talk about efficiency. We are hearing a lot about the smart grid; a lot of smart grid technology involving more efficient use of power; we are hearing a lot about Silver Spring which is a company that I think you passed on. Why not? That seems like it would fit your strategy; great, low-cost investment; big bang for the buck.
VK: Silver Spring is a good company. (EC: Why did you pass?) I wouldn’t say I passed, what I would say is that what Silver Spring is doing is not what we are investing in. By that I mean we don’t invest at the valuations at which Silver Spring was raising money. It’s a different domain. (RR: EC explains that Silver Spring is doing smart metering). Efficiency is absolutely in our sweet spot. We are reinventing lighting. We are reinventing motors. We are reinventing air conditioners that haven’t been reinvented for 75 years. Every air conditioner still has a compressor; we are trying to do one without a compressor. We are reinventing batteries, pumps; anything that consumes energy, we are interested in improving.
A smart grid is a good thing to do. I would say that it’s very fashionable among environmentalists. (RR: VK says to remind him to rant later about environmentalists, whom he said cause half the damage). But efficiency is important, smart grid is important, but if I was asked, the money that was allocated to the smart grid in the stimulus package – is that the best use of that money? Absolutely not. (RR: VK says he would rather have a smart grid so wind energy in North Dakota can get to New York; then goes into the differences between a smart grid and a transmission grid.) An area of less than 100 miles by 100 miles in Nevada – and there are plenty of those – could replace 100% of U.S. electricity with solar. (RR: I have done calculations consistent with that sort of estimate, but there are some big caveats like intermittency). Why don’t we have it? Because we don’t have a grid.
EC (39:00): Let’s get to those electric cars. You don’t like the Prius.
(RR: This takes us just past the halfway mark of the interview. I will pick up the second half and conclude it in Part III).