The AI-Data Center Bubble, $8.1B into Climate Tech in Q1, and More for May

Hello VoLo Earth Community!

The AI - Energy center nexus is the darling of analyst reports. If you haven’t already been inundated with news on this front, here are a few quality synopses which touch on a few angles:

• Voyager - Decarbonizing Data

• Goldman - AI Poised to Drive 160% Increase in Power Demand

• Bloomberg - The Power Industry is Quickly Becoming One Big AI Play

Past experience in the energy sector teaches us that although we can not be certain, the development around data centers may be an energy bubble. The strategies to successfully navigate energy bubbles tend to be no regrets, so as market activity scales we assume a bubble is underway. With your time in this month’s newsletter we’re going to focus on the nuances of energy bubbles and strategies to capitalize and manage risk.

An energy bubble shares many attributes with general economy bubbles including, but not limited to:

1. Acceleration - rapidly increasing pace of infrastructure investments 

2. Scarcity (demand surge) - dislocation of prices from historical commodity trends

3. Speculative high - unknown duration of elevated market activity

4. Demand contraction to surplus - abrupt downturn of new product sales upon a bubble pop

5. Burst to bifurcation - post-bubble market bifurcation between equipment-only companies and service-oriented companies.

Let’s briefly dive into each. 

Acceleration - Rapidly increasing pace of infrastructure investments

We commonly see energy bubbles kick off an acceleration of energy equipment purchasing or energy contracting investments. Already, the acceleration is indicated by recent transactions like the MSFT <> Brookfield deal for 10.5GW, which is almost eight times larger than the previously largest single corporate power purchase agreement. 

During this phase of the cycle, with entities seeking assets in the market to transact, growing companies should focus on ramping supply chains while also managing inventory risk due to the uncertainty of purchasing bubble duration. For some companies, this may entail hard trade-offs like moving resources away from longer term R&D strategies into near-term delivery capabilities. 

For example, HST Power in our portfolio has utilized its transactive marketplace to enable energy developers to accelerate their scale and time to market. HST alone has already recognized a significant uptick in revenue growth rates because of the current bubble. 

Scarcity (Demand Surge) - Dislocation of prices from historical commodity trends

Customers in a buying bubble are often prioritizing product attributes including speed of delivery and access to product over pricing. In other words, speed and scale shape price elasticity curves, creating a premium for rapid deployment. 

This scenario opens a unique window for commercializing new technologies in the early stages of learning curves towards cost reduction and mass marketability. Even companies who launch with highly competitive products benefit greatly from the margin expansion in this environment. 

XGS is commercializing geothermal technology that accelerates and derisks the traditional geothermal development process. While geothermal technologies generally require timely subsurface mapping and hydrology studies, XGS eliminates these onerous development tasks and can in turn deliver with greater speed and certainty (see April newsletter, as well as Series A announcement below!) Current market conditions combined with XGS’ development speed is enabling the Company to engage with large scale buyers faster than VoLo Earth originally underwrote to.

Speculative High - Uncertain duration of elevated market activity

Timing a market bubble’s duration is fraught with risk. Alternatively, what we must do is risk manage our supply so that it is positioned for a bursting at any moment in a sales cycle. This includes discounting customer willingness to pay at peak prices (scarcity, above) when baking in pricing to sticky cost structures, and particularly when executing the kind of step-changes in capex required to match increases in demand.

Companies in our portfolio are currently working with customers to pre-sell manufacturing capacity and equipment so that both manufacturing lines and equipment are paid for with customer dollars in lieu of higher cost of capital equity dollars.

Demand Contraction to Surplus - Abrupt downturn of new product sales upon a bubble pop

While investors and operators riding their first energy bubble can often be caught up in the elation, experienced operators understand that the bubble pops fast and hard. Specifically, the buying frenzy often results in overcapacity. Once the bubble is done, even historical average sales can dry up. For example, if the average historical market size has been 10GWh and then ramped to 100 in the bubble, the bubble pop may take sales down to 0 and keep it there from months to years. Protective measures taken during the ‘speculative high’ can help to combat risk here.

Burst to bifurcation - Post bubble market bifurcation between equipment-only companies and service-oriented companies.

When new equipment sales drop (months, years or decades out from a bubble start), the degree of foresight and preparation starts to show. Companies which build in long term service agreements or performance contracts can sustain revenue through a post bubble contraction. As we saw at GE Energy after the 2000 bubble, companies can even flourish after a bubble by properly engineering contractual services agreements (CSAs) to align the equipment providers with the costumers. An example approach of this at GE was that we built in pre-negotiated payment terms for software and hardware upgrades that were delivered during the CSA period (post-sale). This enabled engineering and product development with no sales risk and predictable year over year revenue growth.

While we can not be certain the current growth is indeed a bubble vs. a departure from years of flat sales, we hope these insights convey the opportunity for accretive risk management.