Irrational exuberance about alternative energy.

Commentary about business and finance.
July 22 2006 9:36 AM

The Prius Bubble

We're irrationally exuberant about alternative energy—but that's good.

The tech elite and the financiers who fund them are bored with Google and MySpace. Their New, New, New Thing—apologies to Michael Lewis—is alternative energy.

Wired and Business 2.0, the print bibles of the dot-com boom, are now stuffed with stories about light-emitting diodes, zero-emission cars, rechargeable fuel cells, and hackers who pimp their Prius hybrids to run even farther on electricity.

Many of the people who cooked up the Internet revolution have moved over to the energy industry. Bill Gross (no relation) is the founder of IdeaLab!, the incubator of technology-based companies that spawned eToys, NetZero, Petsmart.com, WeddingChannel.com, and a host of other dot-coms before it nearly busted in 2000. IdeaLab is riding high again, and one of its most promising portfolio companies, Energy Innovations, develops solar panels for commercial buildings. Gross is still talking in revolutionary terms. "Reinventing energy is a multitrillion-dollar opportunity. It's the next big disruption," Gross told Wired last July. "It dwarfs any business opportunity in history."

Silicon Valley aristocrat Vinod Khosla was a founder of Sun Microsystems and a partner at Kleiner Perkins, Caufield & Byers, the venture capital firm that launched a thousand startups (Amazon.com, Google, Excite, and @Home, inter alia). Today, Khosla, who set up his own firm, Khosla Ventures, in 2004, is a big enthusiast of producing ethanol derived from grains. Last month, he joined forces with Western Milling, the largest grain miller in California, to start a new company that will build and operate ethanol plants. Khosla is also (smartly) supporting an initiative on this fall's ballot in California that would tax oil companies to generate $4 billion to help encourage the use of alternative energy.

Khosla's former firm, Kleiner Perkins, earlier this year launched a $100 million greentech initiative to invest in clean energy and related companies. According to the Cleantech Venture Network, in the first quarter of 2006, venture capitalists plunged a record $513 million into Cleantech—products and services that reduce, conserve, and maximize the efficient use of all types of energy resources. That's up 53 percent from the first quarter of 2005.

It's a natural for Silicon Valley types to get in on alternative energy. Like computer software and hardware, alternative energy is an engineering-based business. Cypress Semiconductor, an established company in Silicon Valley, last fall spun off to the public a unit that makes solar panels, SunPower. Investors have thronged to the stock the way college students flock to Cancun on spring break, and it now trades at more than 100 times its expected earnings.

Indeed, just as they did with dot-com stocks in the 1990s, individual investors are latching onto pricey alternative-energy stocks. VeraSun Energy, an ethanol company that went public in June, raised $420 million and received a healthy 30 percent pop on its first day of trading. Just as the late 1990s saw the rollout of mutual funds that were entirely devoted to the Internet sector, investors today can buy a green-power Exchange Traded Fund, the PowerShares WilderHill Clean Energy Portfolio.

The Fortune 500are jumping on the alternative-energy bus too. Just as big companies adapted to the dot-com boom of the late 1990s by dressing business casual and funding Internet startups, they're now going green. General Electric last year launched its Ecomagination initiative, an image and business strategy that represents the effort of CEO Jeff Immelt, who took over from icon Jack Welch in 2001, to stamp his own imprint on the vast company. The goal: By 2010, GE plans to ring up $20 billion in annual sales of eco-friendly products—wind turbines, fuel-efficient engines, energy-sipping appliances, solar energy panels, and water-treatment panels.

Wal-Mart has similarly sought to improve both its image and its bottom line by going green. In an interview this spring, Wal-Mart CEO Lee Scott sounded more like the head of the Sierra Club than a member of the Business Roundtable. "I had embraced this idea that the world's climate is changing and that man played a part in that, and that Wal-Mart can play a part in reducing man's impact." And so the company has built experimental green stores like the one in McKinney, Texas, which is equipped with solar panels and reuses cooking and motor oil. The mega-retailer has also embarked upon a serious effort to double the fuel efficiency of its monster trucking fleet by 2015. It's made some progress by equipping trucks with new types of tires, aerodynamic features, and an auxiliary power unit that burns less gas while idling.

So, a quick review: extravagant promises about a new technology, investor enthusiasm, grandiloquent statements by entrenched executives, herd behavior from venture capitalists. Oh boy! You don't have to be a Wall Street sharpie to notice that the cultural and financial stars seem to be aligning around alternative energy much as they did around the Internet. And we all know how that ended.

So, why isn't anyone panicking? In 2001 and 2002, when the postmortems of the dot-com era were written, it was easy to declare the whole thing a failure and a scam. But with the passage of time, another picture has emerged. In a process that has repeated itself throughout history—with the railroad and telegraph, for example—investment bubbles frequently kick-start new industries and leave behind innovations and commercial infrastructure that others can use. The fiber-optic cable and dot-com business infrastructure that was rolled out in the 1990s wasn't simply abandoned. Second-generation entrepreneurs and companies have used it to great effect. The excessive investment in infrastructure may have set off ruinous price wars in 2000. But it also led to the swift rollout of broadband and sharply reduced prices of Web-hosting and data transmission. Google, MySpace, Flickr, YouTube, and iTunes—all these highly successful, quality-of-life-improving businesses—were built on the wreckage of the dot-com era. As consumers, investors, and workers, in other words, we've all been enriched by the fruits of the dot-com boom. It just took a while.

A similar process may be unfolding now in the alternative-energy business. Many of these venture-backed alternative-energy firms will fail, and some of the publicly held ethanol stocks will turn out to be turkeys. But fierce competition will lead to price reductions in energy-saving equipment. The vast sums being plowed into research may lead to incremental improvements or revolutionary breakthroughs. And as more giant companies such as Wal-Mart become consumers of alternative-energy products and services, the industry will gain scale—a development that leads to price reductions for all consumers. So, let's hear it for the Prius Bubble.

A version of this piece appears in the Washington Post Outlook section.

Daniel Gross is an editor and columnist at the Daily Beast.