My Energy Investment Thesis #8: Outsourcing Innovation by the Industry
Start at the beginning or jump in to read about the primary factor impacting your business:
- Part 1: Oil Prices
- Part 2: Unconventional Oil and Gas
- Part 3: The Energy Transition
- Part 4: The Advance of Software and Technology Adoption
- Part 5: The Great Generational Crew Change
- Part 6: Houston
- Part 7: The Maturation of Local Energy VC Funds
Every industry has to innovate. But the path from here to there is never a straight line. That leaves plenty of room for smart entrepreneurs who can find ways to serve underserved markets. It can also leave great ideas in the dust because of missed timing, outsourcing, inexplicable dips in funding, and bigger economic shifts. Let's take a look.
Corporate R&D Is Outsourcing Like Everything Else
- Chevron ($1.14 billion in 2010)
- Exxon ($1.12 billion in 2010)
- Schlumberger ($920 million in 2010)
- GE ($3.9 billion in 2010)
- Weatherford ($214 million in 2010)
Across the oil and gas industry, research and development spending by the companies, including big names like Shell and Exxon, decreased by 15% in 2015 — and this dip followed a steady decline from 2014. In 2016, spending dropped an additional 5%.
Typically, most companies try to smooth out research and development spending over time. But that spending can be incredibly vulnerable to market changes, cash availability within the companies themselves, and other factors. Unfortunately, the decreased spending in research and development appears to be a consistent trend, rather than a temporary dip in spending.
A look at Shell's R&D spending shows a common trend across the industry: while the company committed more funds to R&D in 2018, that number is still lower than it was in 2010, when I began investing. It's significantly lower than it was in 2012 and 2013, when R&D spending was high and seemed destined to continue to grow.
As of 2018, Shell's R&D spending totaled around $986 million — up from $922 in 2017. BP's spending peaked in 2010: in 2018, BP spent only $429 million in R&D. Take a look at how many of the other investors in the field line up:
- Chevron ($1.21 billion in 2018)
- Exxon ($1.06 billion in 2017)
- Schlumberger ($702 million in 2018)
- GE: ($4.9 billion in 2018) - - WOW!
- Weatherford ($158 million in 2017)
The corporate venture capital arms of many of these organizations are becoming increasingly active. However, research and development spending is down in many of the industry giants as they choose to rely on outside organizations to pick up the research and development trend.
Luckily, clean energy spending is, to some extent, standing in the gap. By 2018, investment in research and development in the clean energy sector had increased by 9%. R&D spending in clean energy may continue to increase as many professionals realize the critical importance of clean energy development.
This increase in clean energy R&D spending, however, may not fully offset the decrease in spending experienced by the energy industry as a whole. This could slow down much of the progress needed in order to come up with more effective energy models. Startups need to be careful.
Not only that, it's important to note that clean energy spending has not been entirely consistent. It experienced a multi-year drop between 2013 and 2016, and current research and development spending in clean energy has not yet risen to match the numbers from 2012 (before the drop began).
Where's the good news?
Even with the decreased research and development spending across the energy industry, the United States remains one of the biggest spenders in terms of research and development, committing 25% of the funds that go toward research and development spending in the energy industry each year. Only Europe, at 28%, is higher. The United States continues to offer more research and development opportunities for interested parties who are able to take advantage of it: entrepreneurs, startups, and venture capitalists alike.
What About Federal Funding?
Funding opportunities in the United States are one thing. Funding from the United States government is something else entirely.
For years, many research and development facilities, including universities, relied on the federal government to provide the funding needed for those research efforts.
Unfortunately, in recent years, funding has dropped or become inconsistent across many industries — and the energy industry, along with many others, is starting to feel the strain.
The lack of federal funding creates uncertainty as to where the funds for research and development will come from. It means that now, more than ever, the industry relies on private funding to make the progress needed to sustain the industry and build better energy opportunities.
The Need for External Innovation
Let's focus on how those two core trends — decreases in direct R&D and federal funding — are shaping where the industry is going next.
Thanks to the decrease in R&D spending within the industry, it has become increasingly necessary for outside companies — those who do not make up the big names in either providers or operators — to contribute to research and development within the energy industry. This is true for both clean energy and traditional oil and gas innovation. For new companies looking to break into the industry or companies looking for funding from venture capitalists, that could prove incredibly valuable. What does this mean for the industry?
There are more openings than ever for innovation. With research and development spending down among the big names in energy, there's room for smaller businesses to take advantage of that shortage. If they create their own innovations, they can create a place for themselves within the industry.
Small businesses have a chance to catch up. Often, smaller businesses, especially startups, may feel as though they cannot compete with the big names, especially in the energy industry, where a few giants tend to dominate. With research and development spending down in those industries, however, there's room for smaller companies to step into the gap (and one of the reasons I am doing this!).
Venture capitalists are looking for effective places to invest. Many people are committed to the clean energy movement or to seeing innovation within the energy industry that will help carry those innovations and changes. As a result, savvy entrepreneurs are able to find the available funds by presenting an effective plan that appears able to carry some of the needs of the industry.
With research and development spending down among the big names of the energy industry, in fact, it has become critical that smaller businesses, including startups, step up to the table and begin to produce results. In order to remain sustainable, the energy industry needs the support of these smaller businesses — and that could mean incredible opportunities for investors and entrepreneurs alike.
That concludes my notes on the critical factors that impact an energy investment thesis. As we start to see how the energy industry changes in 2020, I will continue to modify and adapt these factors (keep reading). The next decade will be an important one. The workforce will change. Technology will change even more. Fluctuations in market demand, government policy about energy sources, and investment powerhouses will change our industry in ways no one can predict. But if you want to take a stab at it, let me know what you think will happen— or, even better, how you intend to make it happen.