Climate tech investing in 2023 — Carbon Equity’s top 12 market and tech trends
2022 was a relatively strong year for private climate tech investing. Against the backdrop of the public market downturn last year, the general venture funding market decreased by 35%. Still, the climate tech VC market managed to grow by about 3%. That means that climate tech investments now represent 10% of total venture funding, compared to 6% in 2021.**
As we look ahead to the rest of 2023, it's clear that both challenges and opportunities await private climate tech investors. Let's first dive into six trends driving climate tech market dynamics and then the top six climate tech trends for 2023.
Top 6 climate tech market drivers
1) The competition to take the lead in climate tech is on
The Inflation Reduction Act (IRA) of the United States has intensified the race between countries to become the leader in climate tech.
The IRA, signed into law last summer, has changed the game. It has committed a formal $369 billion in subsidies and tax breaks for green technologies like electric vehicles, hydrogen, and carbon removal. Since there is no formal cap on the total cost and considering the wide demand, total investments may surpass 1 trillion dollars.
Ursula von der Leyen, President of the European Commission, herself stated that the IRA firmly increases global competition in the clean tech sector.
In addition to fueling investments and demand, the IRA's second major effect is that incentives depend on the technologies being produced on US soil, creating a competitive landscape between countries. China, Japan, and Europe have already responded with similar domestic incentives to ensure that green companies remain competitive and do not relocate to the US. While the details are still being finalized, the European "Green Deal Industrial Plan" is expected to provide around $270 billion (€250 billion) in incentives.*
In 2023, these financial incentives are likely to further accelerate investments in and deployment of climate technologies. This year will begin to reveal whether this is the start of a bidding war between nations or the new playing field will stabilize after major stepups from all sides.
2) Increasing corporate commitments to net zero
Covid-19, the Russia-Ukraine war, macroeconomic turbulence and rising energy prices have accelerated climate commitments. Out of all corporate net zero commitments made since 2015, 39% were made in the months after Russia invaded Ukraine.*
By now, about half of European companies report having 1.5°C climate transition plans.* While many of these plans are not backed with concrete strategies and initiatives, we do believe that they will help the climate tech ecosystem develop further. Particularly, in the exit market.
Corporations were by far the most common acquirer of climate technologies, participating in 63% of all acquisitions tracked since 2020.* As more corporates align themselves with Science-Based Targets that seek ways to reduce their emissions in line with the Paris Agreement, we anticipate that these corporations will continue to lead acquisitions, resulting in more exit opportunities for private climate tech companies.
3) The electricity grid bottlenecks the energy transition
An upgraded and expanded electricity grid is the backbone of our energy transition — and a requirement of any realistic decarbonization pathway. Although renewable energy adoption is accelerating (it saw a record increase in 2022 with capacity up almost 10% globally*), we cannot continue on this growth trajectory without swift and substantial investments in grid improvements.
We’ve already seen grid challenges creating delays. In The Netherlands, fast renewable adoption has left grid operators unable to meet the demand for new connections, resulting in delays in renewable power projects and offerings to new consumers.* So long as the demand far outpaces the industry’s speed and capacity to build, the grid will remain a bottleneck for the energy transition.
While the European Union has committed to reducing permitting times*, global supply chains and shortages of skilled trades are not expected to be resolved in the next 12 months. This creates a significant opportunity for digital climate technologies that can create flexibility in the grid, such as grid-scale batteries or demand-side response solutions like smart scheduling of power consumption (like Arcadia).
4) Biomass in mass demand
Biomass is an important lever to the decarbonization of our economy quickly with many uses, including bioplastics, biofuels, bioenergy and BECCS (bioenergy carbon capture and storage).
Bioenergy is an attractive option for many applications because its technologies are quite mature and can often take advantage of existing infrastructure, which has led to a 7% increase per year between 2010 and 2021.* Plus, there’s a lot of untapped potential. We’re currently only using 5% of all organic waste, including municipal waste, manure and food waste, for biogas and biomethane production.*
However, as policymakers and companies begin to double down on biomass, it is critical that they understand that the supply of waste biomass is and will remain limited.
For example, even if we combine waste streams with virgin biomass production and we use all arable land suitable for producing new biomass within Europe (which has already shown downsides competing with food production), the projected demand for biomass will still be 40-100% higher than the available supply.*
As a result, we anticipate that (waste) biomass prices will rise due to scarcity, leading to a heightened focus and investments into securing biomass supply and improving biomass production and utilization efficiency.
5) Climate tech remains a significant part of VC
Against the backdrop of the public market downturn last year, the general venture capital (VC) funding market decreased by 35%, while the climate tech VC market grew by about 3%. That means that climate tech investments now represent 10% of total venture funding, compared to 6% in 2021.**
With public markets not fully recuperated and persistent high interest rates, we expect general VCs to continue experiencing slow fundraising and a weak exit market, which will lead to constrained growth for the general VC funding market in 2023.
On the climate side, climate tech funds still have $37 billion of investable dry powder ready to deploy across venture capital and growth equity funds.* That means that even if no new funds would be raised this year, the sector would still be able to continue supporting climate tech companies throughout their funding rounds.
Backed by this dry powder, clear demand signals from the energy crisis, increased policy support, and a decline in green premiums for climate solutions, climate tech investing is well positioned in 2023 to continue along its breakout growth trajectory in the turbulent environment.*
6) It's trending toward a buyer’s market
The interest rate hikes and weak public markets over the past year have decreased venture capital valuations and turned the tables from a seller’s market toward a buyer’s market. This trend has also hit public markets, where stock prices of later-stage climate tech companies (more sensitive to interest rates) have come down.*
This means VC funds will be able to dictate financing terms instead of companies, which means they can buy stakes in companies for lower prices and possibly enjoy greater returns once financial markets recuperate.
While this likely won’t be the case for all sectors within climate tech, VC investors will definitely have some opportunities to invest in less-crowded technologies at lower valuations. As such, 2023 could shape up to be one of the better vintage years for venture capital, climate tech included.
Top 6 climate tech trends
1) Precision fermentation becomes a force in food
With the promise of delivering the taste and nutritional value of animal-based foods, the global precision fermentation industry is taking off. By using microbes such as yeast, algae, fungi and bacteria to mimic animal proteins and fats, precision fermentation creates new possibilities for alternative meat, seafood and dairy products.
2022 was a breakthrough year for precision fermentation — companies cracked the cheese code (producing casein without a cow), The Every Co. proved its animal-free egg white protein product,* and Brave Robot, an alternative ice cream company, became one of the 25 fastest-growing direct to consumer brands in the US.* Plus, alliances across a number of startups are being made to help drive the sector forward.*
That said, the precision fermentation industry faces two major bottlenecks to continuing its growth trajectory. Firstly, manufacturing capacity is insufficient, causing a backlog of promising innovations that cannot be commercialized. Secondly, the regulatory environment, especially in Europe, is holding back the genetically modified organism (GMO) industry with a tortuous process to secure regulatory approvals for novel foods.
Therefore, 2023 represents a huge opportunity for governments and other startups (like Planetary) to step in to overcome these obstacles. Whoever helps precision fermentation break through its bottlenecks is set up to win big as the global precision fermentation industry generated $1.3 billion in 2021, and is anticipated to generate $34.9 billion by 2031 — or a 40.5% compound annual growth rate.*
2) Carbon removal takes the stage
Carbon dioxide removal (CDR) is the new kid on the block in the voluntary carbon offset market. There are three types of technologies to do carbon removal at scale: natural climate solutions (NCS), biomass with carbon removal storage (BECCS), and engineered solutions (DACCS).
MORE: Dive into each CDR technology here
The demand for carbon dioxide removal has seen recent signs of acceleration thanks to commitments from big companies like Microsoft and a $925 million commitment to purchasing carbon removal credits from four large tech giants.* Plus, carbon removal saw a boost in government support from the EU Green Deal* and the US’s IRA, which could deliver $100+ billion to carbon capture projects in tax credits.*
With all the funding activity and government support, 2023 is lined up to be a strong year of growth within the carbon removal industry. Keep an eye out this year for another mega deal like Climework’s $650M round last year. 👀
3) Flexibility in demand solutions
As renewable energy sources become more prevalent, the intermittency of wind and solar power combined with limited storage capacity has caused electricity prices to fluctuate significantly. In many cases, such as in the Netherlands, prices have even gone negative when there is an excess of renewable power production. However, this presents an opportunity for technologies that can combine electricity storage with functional use to benefit from the fluctuating prices.
Several companies have already started to take advantage of this opportunity. For instance, Blue Frontier makes a cooling technology that utilizes excess energy to charge its system so that it can be used when needed Rondo Energy creates a thermal energy storage system that lets companies take advantage of the variability of renewable power and electricity prices, enabling them to turn (cheap) electricity to heat to be used when needed.
Given the persistent variability in electricity prices, variable demand solutions have the potential to dominate in 2023, enabling companies and consumers to benefit from the best electricity prices. We see immense potential for further advancements in energy demand solutions in 2023. If you have seen any other exciting solutions in this space lately, please share them with us!
4) Grid-scale batteries become more attractive
Grid-scale batteries help balance power grids working with intermittent renewables (solar and wind) and better manage peak electricity demand.
Currently, the most widely used technology for electricity storage is pumped-storage hydropower, which still has significant potential in several regions but is quite saturated in most mature markets. In addition, grid-scale batteries are becoming more attractive and have seen strong growth in recent years. While still much smaller than pumped-storage hydropower, grid-scale batteries are projected to account for the majority of storage growth worldwide.*
Currently, lithium iron phosphate batteries are the most widely used grid-scale batteries due to their favorable cost and energy density. However, there is a growing interest in exploring more innovative technologies, such as the proven Form Energy iron-air solution (which raised $450 million in late 2022) and the emerging Noon Energy carbon-oxygen battery technology (which raised $28 million in January).
These technologies, along with flow batteries, show promise in surpassing lithium-ion in terms of cost and lifetime when deployed at scale.
Alongside the push for renewables, governments worldwide supported this trend with a record amount of policies for energy storage made in 2021, followed by the IRA in 2022. The market for grid-scale batteries is expected to grow rapidly this decade at a compound annual growth rate of 26% from 2022-2031* — and we expect to see this reflected in funding raised by startups in 2023.
5) Clean heating without overheating our planet
Even though high gas prices have increased heat pump sales, the adoption of low-carbon space heating is still low. However, governments motivated by geopolitical, energy affordability and emission reduction concerns are taking action to increase adoption.
In the US, the Inflation Reduction Act earmarks $9 billion to help homeowners switch to electric heating — homeowners may save $8,000 when purchasing a heat pump.* In many European countries, including Germany, France, Sweden, Slovenia, the United Kingdom and the Netherlands, have announced bans or restrictions on oil- and/or gas-fired boilers.
With the increases in gas prices, government policies promoting sustainable heating, consumer demand and declining costs, the market opportunity for sustainable space heating is growing. However, VC funding is lagging behind in this sector — less than 1% of all climate tech VC investments were made here.*
In 2023, I am on the lookout for climate funds that see this potential and especially paying attention to heat pumps, district heating, geothermal energy and waste heat recovery technologies.
MORE: If you want to read my in-depth on space heating, check out our article here.
6) Innovation in raw materials
As we continue to rely on electricity to decarbonize various sectors of our economy (including transportation, sustainable fuels and industry), we’ve run into a fundamental obstacle: the current mining capacity of critical minerals is not enough to get us to net zero.
The demand for lithium is projected to increase sixfold by 2030, requiring the equivalent of 50 new average-sized mines* — and these on average take 10 years to commission.* And while we expect many investments in lithium and other rare earth mines in the coming years, we also expect innovations that can displace virgin critical minerals demand to further accelerate.
Not to mention, mining continues its concerning track record with people and planet, including concerns about deforestation and child labor.
In 2023, you can expect to see more funding directed to companies developing innovation to extract more raw materials and reduce our dependence on certain materials such as virgin lithium. This includes new ways of extracting lithium from lower-density sources (like Lilac Solutions), recycling rare-earth materials we already have (like Redwood Materials), and using less scarce materials (like nickel cobalt manganese batteries*).
Did we miss out on any of the trends you are paying most attention to in 2023? Let us know in the chatbot or connect with Liza, our Co-Founder and Head of Impact, on LinkedIn!
Important notice: This content is for informational purposes only. Carbon Equity does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorized advisor. Past performance is not a reliable guide to future returns. Your capital is at risk.