Why Size Matters

In the world of the MIT Energy Initiative, which was established in 2006 to promote innovation in the energy field capable of transforming the global energy system, multinational companies rub shoulders with young entrepreneurial operations and try to figure out how to work together.

MITEI, as it’s known, works on technology research with individual member companies ranging from ENI [S.p.A., the Italian-based oil and gas company], to Chevron Corp.

MITEI is headed by director Ernest J. Moniz, a professor of physics and engineering systems and a leader in policy studies on the future of nuclear power, coal, natural gas, and solar energy. Moniz served as Under Secretary of the U.S. Department of Energy from 1997 until January 2001. At DOE, he had oversight of science and energy programs and served as the Secretary’s special negotiator for Russian nuclear materials disposition programs.

“The number one overarching issue, which does pose business opportunity, business risk, and a need to rethink business models, is carbon constraints,” says Moniz. “As you know, 85 percent of our energy is fossil fuel. Fossil fuel equals carbon. Controlling carbon goes to the very core of the way we currently supply energy.”

But bridging the gaps between the large companies that have the ability to scale up new ventures and the small companies that are blazing some of the new paths is not easy. Moniz spoke about the challenges with Michael S. Hopkins, editor-in-chief of MIT Sloan Management Review.

You’ve been talking recently about the ways that dealing with climate change presents a real cultural challenge for large energy companies and the ways they need to think about business models.

Here’s the essential question: How can major international oil companies capture effectively the fruits of the entrepreneurial culture — which typically does not exist inside those companies in the same way it does around Kendall Square? How can they capture that in a way that they can scale it to be material in their business?

We want them to succeed, because who else has the capacity in terms of resources, supply chains, and customer bases to ramp up these new technologies so as to impact climate change in a relatively short time? That’s the business model innovation we need. And it’s not easy.

You may have seen the post-Tiger-Woods Accenture ads. Several feature an elephant and the line, “Who says you can’t be big and nimble?” In some sense that is the challenge for these oil companies.

This is a different kind of innovation challenge than the ones those companies faced in the un-carbon-constrained world. How are they attacking it? Are patterns emerging?

There are multiple strategies, with some companies pursuing several at the same time. Take biofuels. There’s a mergers-and-acquisitions strategy. Shell, for example, has taken stakes in several smaller companies, and in sugar cane ethanol in Brazil, for which existing technology is effective. There are significant investments in second- and third-generation research using nonfood feed-stocks, such as the major BP-funded center at Berkeley and Exxon’s support for algae research. Such feedstocks are presumably the key to very large scale deployment. Partnerships across business segments include the BP-Dupont butanol effort. Chevron is pursuing projects with wood conversion.

So there are many ways of getting to the innovation endpoint. But evolution of their business models is also needed in order to scale the new technologies alongside the core oil and gas business. This has not yet been achieved for renewables – biofuels, wind, solar. Those that succeed will have a competitive edge as energy suppliers in a carbon-constrained future.

Certainly, there is opportunity. The energy technology sector has never seen the kind of activity that’s going on now in terms of businesses spinning out of universities and laboratories. Some, perhaps many, will succeed in the traditional sense for an early stage company. But there’s a difference in succeeding at the level of being able to flip an investment in five years and make a 30 percent annual return for investors, and being able to scale to a level that makes a real difference at the level of the big carbon challenge.

That’s the gap that still needs to be worked out. If it’s not a business in the tens of billions of dollars, it’s not material to a huge multinational company. And neither is it material to the problem, roughly speaking.

How does that intersection between the Shells of the world and the folks in labs at MIT play out internally in the energy companies?

Well, ENI, the Italian-based oil and gas company, is supporting about 20 faculty just in different parts of the solar agenda. Every project has a corresponding person in the research environment of those companies who is engaged for the company, keeping track of the project, visiting often, on conference calls. They’re huge companies, but you’re dealing with a pretty small set of individuals. Their approach is interesting, as expressed by the Eni CEO on a visit to MIT. He basically is putting the bet on a portfolio of breakthrough technologies that have the potential to dramatically lower solar energy costs, leapfrogging the current leading technology.

The next step is getting projects to the stage where they can attract very substantial private capital. This could come from the large energy companies, such as Eni capitalizing on the solar investment. But the U.S. government is also assuming a new role here. Take the ARPA-E awards of last year. ARPA-E [Advanced Research Projects Agency, Energy] is a new Department of Energy agency dedicated to getting technologies going towards investment on a three- to five-year horizon. Six first-round awards went to projects here in the Commonwealth — all MIT-connected— such as one for a utility-scale liquid metal battery project and one for a wind turbine company that won the MIT Clean Energy Award in 2008. Our DNA is kind of all over the place now.

At the stage when one of these spin-off companies has a technology that can scale up to the next level, it may require huge amounts of funds compared to, let’s say, information technology industries, for a demonstration project. You start running into a different scale of funding. You start running into potential policy and regulatory barriers.

But let’s say you get through that gate. Well, how do you scale a new energy solution up to a terawatt? And I say a terawatt — which is one trillion watts — because that is the material scale for the global problem. Today we use energy at a rate of 14 terawatts globally. If a technology is on the scale of one terawatt, it’s 7 percent of the total. It’s a player.

So we want to scale it way up, and we want to scale it fast — 20 years instead of 50. Those are the challenges. And that’s where this impedance matching of the entrepreneurial culture and the energy incumbents is such a critical piece. Being able to manage our way toward low-carbon solutions at sufficient scale and in a sufficiently rapid way are the critical challenges.

What do you advise executives to do who understand this impedance issue and want to set their companies up to succeed?

First of all, they’ve got to be aware and involved in the research and entrepreneurial projects. I mean, it starts at that level. And that in itself is not trivial. It takes resources and the right kind of people and a commitment to build up some strength in these areas in order to be able to make sensible investments. Simply putting some money passively into a fund and then seeing how the portfolio develops is probably not the way to be a first mover in this space. There has to be a genuine openness to new technologies.

So, a mindset change, for starters.

Yes. Then, when you think you’ve got a real winner, a solution that appears to be economically competitive and material to the balance sheet, the trick becomes how to build a business that gets the kinds of management attention it needs to grow. And I don’t really have the answer to that. It’s got to be some combination of paying attention and not getting in the way. That’s hard, because big companies inherently, and often for good reason of internal controls, have processes that can hamper major changes in a short time.

Which complicates the speed-plus-scale problem.

Very much so. Scaling is difficult in any case, but especially if it needs to be done in a compressed time frame. You talk to our colleague, Gerbrand Ceder, in materials, and he’ll tell you that introducing a new material in a significant way in the energy business is essentially a 20-year process. That’s just the nature of the business. Gas turbines took decades and decades. After a lot of incremental improvements and efficiencies, policy changed and suddenly deploying gas turbines made a lot more sense. High-temperature superconductors are a similar story. We were told in the 1980s that they were going to change the energy world. Now roughly 25 years down the road, they’re out there, but they haven’t revolutionized the industry.

None of this is because the people in the industry are bad people or silly people. They’re people who are responding to the rewards and the constraints in the energy industry. It’s a multi-trillion dollar, highly capitalized, essentially commodity business. And because it’s an industry that’s essential to more or less everything one does in society, it is highly regulated. Change, in those circumstances, isn’t easy.

How natural—or unnatural—is innovation to the culture of the energy sector, overall?

Well, that’s another piece of all this. The fact is that if you run a utility, you don’t get any reward for innovation, but you get a big penalty if you aren’t reliable. So reliability is the number one concern. That leads to very, very different behavior than if innovation provided the primary reward. You can never give up the reliability of supply while trying to bring in innovative technologies that will provide the same services such as light, heat, mobility.

Energy innovation is also very, very cost sensitive, because generally you are not providing new capabilities to the end user. It’s not like a cell phone or a search engine, which gives users brand new things to do. Biofuel, gasoline and battery cars just let you drive. Maybe they’re less noisy or emitting, but fundamentally users are doing the same thing.

So it’s a business that’s conditioned by the requirements that we put on it. We may want to shut down coal plants and to tap into the sun, but we definitely value energy reliability and want to keep lights on all the time.

And we don’t want to pay more, either.

Right. The solar plant is competing against the coal plant with the carbon charge. But it better not be a lot more money. That’s just the way it is.

Negotiating a path through all these competing requirements takes an open mind, and to an equal degree prudence in the scale of the investments. You obviously have to make decisions under uncertainty about how carbon policy will change and how fast those changes will come. Inside an energy company, the question of how to balance everything comes down to the judgment of the senior executive. There’s no magic in it.