Vinod Khosla has a large portfolio of energy investments which I had blogged about yesterday. Since the time I had known his interest in bio-fuels he has moved on. This intrigued me and I wanted to understand his thinking behind the “energy issue” and what could be the possible solutions.

Khosla on his website provides some resources to the issues close to his heart. In one of the essays titled Environmentalists vs Pragmatists (Download: Word Doc) he comes out with a strong case against the ideas of Dr. Hermann Scheer. Dr. Scheer is a Member of the German Parliament and he has introduced a novel solar scheme in Germany which has transformed the solar industry in Germany and makes it a world leader in this area.

Sometime back, Scheer and Khosla had a debate on “how” to solve the energy issue and the related pollution problems. Scheer backs renewable energy; especially solar cells, and wind; he is against the electric grid and prefers a government mandated, higher cost, distributed, solar generation for every home.

In this essay, apart from making a case against Scheer’s ideas; which he calls Scheer nonsense and he provides a good look into his understanding of “the energy issue”, what kinds of solutions will work, his investment philosophy, and thus, leading to his investment decision making.

Recently, I was on a panel with Dr. Herman Scheer, a member of the German parliament and the president of EUROSOLAR (The European Association for Renewable Energy) and a much honored “environmentalist”. Suffice it to say that there was great commonality of goals but significant disagreement about “how”……India, China, and other countries are rapidly industrializing and bringing basic electric power services to their peoples. Their development, like US electric power, follows least-cost options. Our least-cost electric power options – coal-fired power plants – are by far our most destructive and dangerous ones…

…As such, we must address some basic rules: For any energy scheme to be viable, it must be cost effective, and it must be scalable. If solutions don’t get adopted in India and China global warming control efforts are futile. To scale, they must make economic sense in China and India….If we allocate the same carbon emission per person worldwide (an equal right to pollute for every human) we are toast at anywhere near current levels of US emissions or even at levels of carbon emission in Europe…To achieve these goals, we must provide services that consumers want and prefer over their non-sustainable fossil competitors, while at the same time be profitable for business…

…Applications that meet the engineering needs but fail to meet the commercial ones are doomed to failure, which provides one of the key reasons for my disagreements with Dr. Scheer. …

Two things Khosla suggests are important to understand. First, it needs to be a low-cost option; commercially viable and acceptable in India and China; and second, an equal right to pollute for every human; which is the argument of per capita emissions that I have made several times.

…Despite the evidence in its favor, no new nuclear power plant has been approved in almost 30 years in the United States . The reason? Misguided environmentalism…To their credit, some environmentalists have started to come around the issue (Patrick Moore, one of the founders of Greenpeace as well as Stuart Brand of Whole Earth) but many are still hostile… I would guess that had we continued on the nuclear trajectory in the 1970’s we would have made substantial progress on the issues of nuclear waste and non-proliferation – problems that appear very amenable to a technology optimist like myself. How many millions of tons of carbon emissions do we have because nuclear plants have not been built? The irony of course, is that the typical coal plant spews tons of radioactive uranium and thorium into the air each year (more than their nuclear compatriots!) and we have hundreds of them! …Today I suspect we don’t have enough time …given typical 15 year innovation cycles compared to fifteen month innovation cycles for a technology like solar thermal power…

I agree with Khosla here (check out the views of Stewart Brand where he a makes a good case for Nuclear power). What is interesting is that he says that the option for nuclear power in the medium term is gone as the innovation needed to solve the waste and non-proliferation issues have a long lead time.

Politicians/True Believers (like Dr. Scheer) have a tendency to paint idealistic scenarios – especially because they have the ability to promise them with government funding…Personally I’m focused on what is pragmatic given political and economic realities in the US, India, and China, and where I can make the most difference. I’ve backed my beliefs with my own, private capital while Dr. Scheer gets to spend taxpayer money irrespective of the economics…Solar PV is a good idea, a good investment (we have investments in this area) but is it likely to replace 30-50-80% of our coal powered generation? By all accounts, it seems unlikely as things stand today ( or is likely to look in the next ten or twenty years).

Are we likely to convince the over 200 million homeowners with self built homes in India that can barely afford a toilet to pay extra for solar roofs?Will the average person in Mississippi miss the NFL just because the Sun went down?…Only when we meet utility grade power will green technologies start to replace fossil electricity at any scale. Along the same lines, we will only get to India and China when it meets these requirements and gets cheaper than fossil electricity – and only then will we start to make a real dent in the acceleration of global warming…

Check out his questions. “Will the average person in Mississippi miss the NFL just because the Sun went down?” or “Are we likely to convince the over 200 million homeowners with self built homes in India that can barely afford a toilet to pay extra for solar roofs?”. This is the best example of pragmatism. It is important to stand back and ask some basic questions before we suggest any solution which can change the world; is it acceptable to the normal person?. Not for the super achievors among us but to the general public. Another way of saying that would be what Atanu calls the “theory of the second best”.

The problem with the second-best world is this: policies that are wonderful for first-best systems (systems that have no imperfections) don’t necessarily work in the second-best world. In general, removing less than all the distortions simultaneously in a second-best world may indeed make the system worse off. To repeat the argument just once more: first-best systems have no distortions; second-best systems have distortions. Policies that work for first-best systems need not necessarily work in second-best systems. Finally, removing less than all the distortions may make a second-best system worse off.

Khosla explains below the difference between what should be and what is possible, another way of understanding the “second best system”.

…What “should be” is often different than what is doable pragmatically or “what can be.” I am a pragmentalist not an idealist environmentalist. I prefer the “should be” to “what can be” but focus my time on the “what can be”. I am a huge fan of Bill McDonough’s efforts to design model sustainable buildings and cities and hope that his best ideas creep into all new cities we design or evolve. This is what “should be” and Bill’s efforts in China will be role models and they will make a difference. But is the bulk of the world’s evolution going to happen this way? I hope so but I doubt it. Sustainable cities are likely be a great investment area for some developers but it is unlikely that a significant portion of the worlds population will live in such cities in the next 25-50 years…

He believes that Wind and other renewable energy sources have a place but only upto 10% of the total energy mix is feasible.

Wind is a wonderful technology and a great investment. It is very appropriate for certain locations and would benefit a lot from a national high voltage electric grid so it could be transported to where it is needed (as will all sources of electricity)…and is now cheaper than coal generation in some locations. The devil unfortunately, lies in the details. Power is only available when the wind blows and storage is difficult and expensive. Additionally, most utilities don’t need power in the middle of the night but are forced to take it today. It is off and on power generation in highly variable ways though it can be averaged across multiple locations. It is unlikely to scale beyond about 10%…

…What about Geothermal, Biomass and other alternatives? These are good alternatives and should be developed further. Geothermal can provide another 10% and because of built in heat storage it can meet many utility requirements if it can be produced cost effectively. Biomass is also appropriate for certain locations (like rural India) but in my view biomass should be reserved for making cellulosic biofuels for transportation…

The main gist of his argument is for Solar Thermal; which he is biased towards; based upon his research and understanding and also substantial investments in that area.

…Solar thermal plants were fashionable in the early 1980’s. The idea is to concentrate the sun’s rays to heat a fluid to generate steam that can then run a regular steam turbine…The great advantage is that in certain configurations the heat can be stored either as steam or hot water or in molten salt or hot oil and reused when the Sun’s heat is not available (as in the evening). Doing this “storage” with batteries would be prohibitive in cost…For full disclosure, Khosla Ventures has invested in certain solar thermal technologies that we believe are far more cost effective than the generally used numbers for CSP (“concentrated solar power” ) costs. At 1 GW scale plants we believe these will start to be competitive with coal power plants in the US in the next few years even without carbon sequestration…

…On the flip side you can accuse Khosla Ventures of being idealist in a different sense. We have seen good financial opportunities to invest in Biodiesel but despite its “green credentials” (better green house gas emissions than corn ethanol) its trajectory wont scale to solve the problem and more importantly its misuse is starting to cause significant damage in Indonesia and Malaysia. We have chosen to pass up on such “green” opportunities to make money.

Khosla was very interested in Ethanol for a while and he did have some great debates over it. One good summary is provided by Atanu Dey (Atanu’s post explains the economics behind the general energy solutions). However, as suggested above he has realised the problems in de-forestation, water and food/fuel issues created by biofuel. This shows the ability of the capitalist to change to what makes economic sense rather than being idealist about beliefs and direct scarce resources (human, financial and technical) towards these solutions. Even though he has written (Download: PPT or Watch Video Online) and argued hard for bio-fuels before; he now says that he has “chosen to pass up on such “green” opportunities to make money”.

Finally, I am a big believer in a very diverse set of technology bets (we have twenty five investments in our renewable portfolio – possibly the largest portfolio in the venture business) but in my mind there is a big difference between a solution to the global carbon emission problem and what makes a good investment for us (like wind or battery technology). Diversity is a good idea but history teaches us that every industry segments into a few major categories and then a big “other” category. I suspect wind will be in “other”. The winning technology for low carbon power generation is likely to be solar thermal or clean coal (I would handicap solar thermal to win that battle but clean coal has many political allies) or a yet as unexpected surprise like fusion (maybe even cold fusion)!

There is a big difference between what middle and upper class German’s will pay for the privilege or luxury of being green and what convinces the poor in India and China to adopt green technologies. Without solutions that work for India and China (the latter of which is building coal plants at the rate of one a week) we will not solve the global warming problem. And in the long run, the only way to beat fossil fuels is on economics, and not simply good intentions.

In the previous post on his energy investments I had suggested that “He is betting wide in this area which may suggest that one, he is not yet decided on the best combination of alternative energy options that will be needed or two, we can interpret that it is a combination of sources combined with energy efficiency measures that will make the difference.”

Khosla suggests both and a third one. One, he does not know which one of these would be the big winners and which would be in the “other category”. So, invest in all. Second, even though each of them by themselves may not be a big solution to the carbon reduction problem they will make be part of the future energy mix. So, invest in all. Third, irrespective of their total effect on the carbon problem they still make investment sense; so invest in all.

Khosla in this essay clearly shows the thinking behind a successful VC. He is tackling a big issue at a global scale; which means big opportunity. He is working in the area which he understands (technology); in locations where he can make a difference (US, China and India) and researched the entire alternative energy field available. And; as a capitalist he is worried about the profitability and scalability of the solutions and in the end; this will provide a sustainable solution to the energy issue.