North American venture capital and private equity investment in new businesses targeting the energy transition hit a 10-year high in 2021, with experts noting the possibility of outsized returns from carbon capture, green hydrogen and emerging clean technologies.

U.S. and Canadian venture capital and private equity firms invested nearly $6.8 billion in 2021 in energy efficiency, storage and management, along with new technologies to reduce carbon emissions, data from S&P Global Market Intelligence indicates.

"The biggest story is that electrons are going to take a very meaningful market share away from molecules," Matt Breidert, senior portfolio manager and managing director for Ecofin Advisors LLC's Sustainable Infrastructure and Energy Transition funds, said in an interview. But molecules are not finished yet, Breidert said. "The last one in molecules that's going to be an absolute monster is likely to be green hydrogen."

Breidert recommended that investors stay away from pure technology startups because of the low cost of entry and the possibility that a technical change will wipe them out. Instead, Breidert likes electricity infrastructure plays such as gas and power giant NextEra Energy Inc. and rooftop solar developer Sunrun Inc.

One firm that has made its money in technology startups and disruption is Silicon Valley venture capital giant Kleiner Perkins Caufield & Byers, an early investor in well-known names such as Apple Inc., Google parent company Alphabet Inc. and Amazon.com Inc.

Ryan Panchadsaram, technical adviser to Kleiner Perkins Chairman John Doerr, is not bothered by the amount of money flowing into energy startups.

"There's been a lot of capital coming to the scene only in the last three years," said Panchadsaram, who served in the Obama administration as the deputy chief technology officer for the U.S. "And we've seen the hits: the Tesla Inc.'s, Enphase Energy Inc.'s, the Sunruns of the world."

"The clean tech space, in particular, takes a lot longer because it's not just a digital problem," Panchadsaram said. "It's an analog one. The sheer physics of buildings and cars will take longer because you're moving physical things, not bits and bytes."

Panchadsaram and Doerr outlined some key energy transition investment areas in their recent book, Speed & Scale: An Action Plan for Solving Our Climate Crisis Now, including transportation electrification, power generation decarbonization and cleanup of heavy industry. Carbon removal is also high on their list.

"No matter how aggressive we are ... you're still left over with 10 gigatons tons of emissions," said Panchadsaram, who is also an adviser to Alphabet's GV Management Co. LLC, Google Ventures, and Microsoft Corp. founder Bill Gates' Breakthrough Energy LLC family of funds. "That's where carbon removal technologies need to come in. Carbon removal is not a silver bullet. It's the mop at the end, to clean up the final bit of mess."

The sentiment at a recent panel on investing in the energy transition at CERAWeek by S&P Global was mixed, but most of the investment bankers and private equity managers on the panel said "green swans" could shift the energy transition in unexpected ways.

"The green swan is the ingenuity of everyone in the industry," Steve Pattyn, founder and chief investment officer of Yaupon Capital Management LP, said at the event. "At any given time, with the information I had, I would have made a set of conclusions that led me to dramatically wrong investments." Pattyn said at the time that Yaupon Capital is "short oil, long Lucid Group Inc.," the electric vehicle manufacturer.

The manager of one fund dedicated to investing in equities for the energy transition has moved in the opposite direction: back to hydrocarbons. Hennessy Funds Inc. sold all of its shares in renewables and green tech in 2020 and put the money to work in upstream oil and gas companies such as EQT Corp., the largest natural gas producer in the U.S., as well as shale oil producer Diamondback Energy Inc. and LNG exporter Cheniere Energy Inc.

Ben Cook, portfolio manager for Hennessy Fund Advisors' Midstream and Energy Transition funds, said Hennessy got out of renewables in 2020 as their value climbed too high, and it bought into upstream oil and gas names, which were cheaper at the time.

"It made all the sense in the world to pivot away from renewables and go back to an energy source that has been greatly, greatly diminished," Cook said. "Given the underinvestment in the space around the last four or five years and then the recovery from the pandemic, you had both supply and demand working in your favor."

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