Code View | Source Code Capital's Di Wang: What Carbon-Neutral Investing Demands Most Is Multi-Level Cognition

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Recently, Wang Di, an executive director at Source Code Capital who focuses on dual-carbon investments, sat down with *Caijing* magazine for an interview alongside industry peers to discuss the sector's unique characteristics and how to properly support its development.

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Source Code Capital invests in technology-driven innovation,

and in the creation of lasting, real value.

Recently, Wang Di, executive director and investor in Source Code Capital's dual-carbon practice, sat down with Caijing magazine for an interview alongside industry peers to discuss the sector's distinctive characteristics and how to properly support industrial development.

Wang Di specifically noted that businesses in the dual-carbon space all require long-term accumulation. Investors need deep understanding and genuine comprehension of the industry to have any chance of partnering with companies to create enduring, real value together.

This article is excerpted from: Caijing magazine | Reporter: Feng Yiying

Carbon neutrality, new energy, and related themes are among the hottest buzzwords in both primary and secondary markets right now.

Large amounts of capital are accelerating into the space. Since the establishment of the National Green Development Fund in July 2020 with an initial scale of 88.5 billion yuan, China has seen a steady stream of PE/VC funds in the decarbonization sector raising at the 10-billion-yuan level. Recently, in May 2022, the Inner Mongolia HuanTou Xindongneng Fund completed its establishment with 10 billion yuan raised; in June 2022, the Yancheng Gongrong HuiChuang New Energy Equity Investment Fund was established, also raising 10 billion yuan.

Carbon neutrality investing has transformed from a relatively cold investment area to what many primary market investors now consider the most certain major track — all within just over a year. On the path to achieving carbon peaking and carbon neutrality, PE/VC can achieve a win-win of social value and economic value through continuous exploration of optimal resource allocation.

Despite the sudden surge in attention, investors feel that investment in this track has only just begun. According to National Energy Administration data, in the first 11 months of 2021, China's new energy power generation accounted for 13.8% of total national electricity consumption, up 2.14 percentage points year-over-year. This means there remains substantial room for growth in new energy replacing traditional energy sources.

Over the next five years, capital investment and support in the carbon neutrality sector will differ by orders of magnitude from where things stand today.

For PE/VC investors betting on the future, doing good investment in carbon neutrality is no easy task. How to identify technology choices capable of leapfrogging on performance and commercialization, how to face longer investment cycles, and how to address increasingly diverse demands from capital providers and companies have become mandatory questions for PE/VC investment in this field.

The Space for Carbon Neutrality Investment

Investment cannot be too far ahead of its time. The crushing defeat of global venture capital firms in "cleantech" investment over a decade ago has become a frequently cited cautionary tale whenever investors enter the carbon neutrality space.

Most investors believe this time is different. From the perspective of ordinary people, whether it's the phase-out of electric vehicle subsidies or the achievement of grid parity in solar and wind power this year, today's decarbonization industry has developed healthier economic models.

Wang Di of Source Code Capital believes the industry inflection point has arrived. Technology maturation requires substantial early-stage capital铺垫, and 2020 marked the point where this early capital accumulation reached an inflection point. Only after reaching an "economic equilibrium point" can the industry autonomously scale. Taking photovoltaics as an example, early Chinese solar companies often experienced intense volatility and cycles. After green electricity achieved grid parity, the situation for PV companies rapidly turned around.

Overall, the industry believes new energy penetration remains relatively low. For instance, while electric vehicle sales exploded last year, according to the China Association of Automobile Manufacturers' 2022 first-half auto industry report, new energy vehicles held a 21.6% market share in the first half of the year — still with considerable room for growth.

All of this means carbon neutrality investment has vast potential market space within a foreseeable timeframe. Additionally, for Chinese investors, many industries in the carbon neutrality space have their global high ground in China, which means opportunities to invest in global enterprises.

Under these expectations, just over a year ago carbon neutrality was still a cold investment area in primary markets, yet this year virtually every mainstream market-oriented institution is looking at the new energy track.

In the specific investment process, what needs to be judged is — when is the inflection point for technology and commercialization in a sub-sector? A negative example: over a decade ago, various thin-film photovoltaic and chemical battery technologies were hot, yet startups in these areas still haven't broken through to this day, clearly exceeding the fund cycle of PE/VC.

First, define which areas of investment fall under so-called carbon neutrality investment. There are two paths to reducing carbon: either reduce carbon emissions, or increase carbon absorption, also known as "carbon sequestration."

Following these two lines of thinking, carbon emission reduction methods include: reducing fossil fuel usage (raw material recycling, etc.), replacing fossil fuels with clean energy (wind, solar, nuclear, hydrogen), and improving energy efficiency (energy storage, ultra-high-voltage transmission, etc.); increasing carbon absorption includes carbon capture, ecological carbon sinks, and other contributing areas. These sub-sectors are all current focuses of PE/VC carbon neutrality investment.

Specific to each investment institution, definitions of carbon neutrality track investment vary somewhat. From the energy substitution perspective, batteries, photovoltaics, energy storage, and hydrogen are the four core tracks for carbon neutrality investment. Additionally, new energy vehicle industry chains, advanced manufacturing, and software companies that help specific industries manage energy consumption, conservation, and carbon emissions are also investment directions.

Multiple investors told Caijing reporters that across these areas, there are considerable investment opportunities. Although there are already established listed companies in many new energy sub-sectors, technological changes of varying scales across these areas constitute diverse commercial and investment opportunities in the carbon neutrality space. "Just like photovoltaics — actually every industry, perhaps every three to four years there's a technology iteration cycle, so there are sustained opportunities," said Tongchuang Weiyue partner Zhang Peng.

For example, in batteries alone, technological iteration occurs continuously, and commercial landscape shifts accordingly. In the new energy vehicle industry, the main batteries currently in use are ternary lithium batteries and lithium iron phosphate batteries. In early new energy vehicle models, ternary lithium batteries were more commonly used as the power source. In July 2021, lithium iron phosphate battery installation volume surpassed ternary lithium for the first time and has maintained the lead ever since. However, ternary lithium is now undergoing further evolution — recent moves by high-market-cap listed companies like Huayou Cobalt (603799.SH) show renewed focus on the ternary lithium battery industry chain.

Capital and Talent Influx

Over the past two years, the carbon neutrality sector has attracted massive capital and large numbers of investors. According to preliminary statistics by Caijing reporters, there are already over ten specialized industry funds with scales exceeding 3 billion yuan, with additional projects still in fundraising.

Currently, capital participating in primary market carbon neutrality investment seems to have developed a certain "division of labor." VC invests in some technology innovation projects, while capacity expansion of mature companies is often funded by PE. For government capital, beyond fiscal subsidies in relevant supported areas: on one hand, heavy-asset downstream companies receive funding support through various financial models including green credit and green bonds; on the other hand, various levels of green fund-of-funds are launched to amplify fiscal capital to support PE/VC in the carbon neutrality space.

In fact, substantial early government investment has been an important guarantee enabling PE/VC capital to enter carbon neutrality investment. Green industry has upstream, midstream, and downstream segments. Among these, downstream is known as asset-class investment — for example, investing in photovoltaic power stations, functional power stations, energy storage stations, and electric vehicle manufacturers all require capital in the tens of billions or even hundreds of billions of yuan.

Wang Di believes that the global high-ground enterprises in the carbon neutrality industry are in China because the state has invested massive amounts of capital over the past decade-plus, covering photovoltaics, wind power, lithium batteries, and other areas. "I think the state has already done the main things that needed to be done very well."

Meanwhile, various large-scale carbon neutrality government guidance funds have become important fundraising sources for market-oriented institutions. The entry of capital has accelerated the development pace of the carbon neutrality industry, and talent has begun to gather as well.

In the industry, on one hand, relevant universities and research institutions, professors and their research directions are being closely watched by investment institutions. Additionally, existing companies in this sector have also quickened their development pace.

Moreover, talent competition in the carbon neutrality sector is extremely fierce. The global investment boom in carbon neutrality has driven up talent prices in this field. Wang Yang noted that in actual investment practice, he has found that gathering talent is a more pressing need for startups.

Although in new energy investment, professional PhDs in relevant technical directions have certain advantages, most investors indicate that cognition is the most needed capability for investing in the carbon neutrality space. "The number of companies doing similar things in this field is huge, and unlike other industries, it's not easy to see at very early stages which one is running clearly better," Wang Di said. This makes cognition at various levels particularly important.

At the same time, carbon neutrality investment, similar to manufacturing investment, involves factories that have been operating for many years, making them more cautious about bringing in shareholders.

"Founders will definitely communicate or test you multiple times. Because businesses in the new energy field are all built up through long-term accumulation — they may grow very fast these past few years, but early-stage accumulation and the costs paid were very substantial. Perhaps through repeatedly building trust and connection, one day they finally feel that this investor can truly serve as a new shareholder," Wang Di told Caijing reporters.

This has made the sources of investor competitiveness in this field extremely diverse.

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