SAN FRANCISCO — Venture capital is the mother's milk of innovation but these days it flows less freely as the global financial crisis sours the appetite for risk. But venture fund watchers say investment firms continue to expand globally, particularly in China. And despite the drop of oil prices from their recent highs, green tech continues to be the most bullish sector in bearish times, as investors look beyond solar and wind to back technologies to reduce energy and water useage.

Caution bordering on fear began to grip the venture industry not long after the collapse of Lehman Brothers. VCs rely on investment banks to broker initial public offerings or acquisitions in order to liberate their cash from successful deals. The turmoil in financial markets has shut down that money flow.

"Venture is in a little bit of an uncertain state right now," says Jessica Canning, director of global research for Dow Jones VentureSource, which tracks capital flows. VCs typically raise cash from pension fund managers and other institutional investors, but as stock market losses hammer those portfolios, these limited partners, as they are called, may pull money out of venture pools or fail to make promised investments. In short, VCs aren't sure how much money they have.

"This is a pretty significant effect," Canning says, adding. "There's lots of money sitting on the sidelines right now."

In this anxious climate Canning expects two trends that prevailed before the financial meltdown to continue, though perhaps at a slower pace — the internationalization of venture investing and an increasing flow of money to green technologies.

Globalization is being driven in large part by the efforts of U.S. and European firms to open offices in emerging markets like China, Eastern Europe and India. "VCs are in a lot of different places than they were 10 years ago," Canning said. A local presence in emerging markets allows VCs to help their U.S. and European startups tap into the lower-cost talent available in these geographies. Foreign offices also give VCs a chance to make smarter investments in the startups that are cropping up in new locales. "You really need to understand the culture of the country," Canning said.

This geographic dispersal of venture capital from the United States and the leading Western European centers, the United Kingdom and France, is slow but inexorable. "Venture capital doesn't move as quickly as other capital because VCs are investing in companies and relationships rather than stocks or commodities," Canning said.

The data show steadily increasing VC interest in China. In 2002 Dow Jones VentureSource found $384 million invested in Chinese startups. By 2007, the last year for which full data are available, investment had increased seven-fold to more than $2.7 billion. By comparison, in 2007 venture investments in Europe totaled 5.14 billion euro, on par with the 5.16 billion euro invested there in 2002. Data from the United States are more recent and show the same trend. VCs invested about $28.8 billion in the U.S. in 2008, not far above the $22.2 billion recorded in 2002. China is clearly on the move.

Dow Jones VentureSource also charts the surge in green tech investment. In 2002, it found that U.S. venture capitalists put just $139 million into energy and utility startups — just over half of a percent of that year's total investment. By 2008 venture investment in energy and utilities had soared to nearly $3.6 billion — or 12.5 percent of their total U.S. investment for the year.

Joel Makower, editor of GreenBiz.com, said investors are continuing to move beyond solar, wind and other forms of renewable energy generation to develop technologies that reduce power consumption — getting rewarded by the market independently of any government subsidies.

Makower said an important niche within green technology revolves around processes to reduce water use. "Water is embedded in everything just like energy and it is increasingly scarce," said Makower, whose latest report, "State of Green Business 2009," estimates that processing a cup of coffee requires about 140 liters (37 gallons) of embedded water counting everything from the farm to the lips.

Despite his enthusiasm, Makower thinks green tech is being hyped and fears the recession will deal the sector a setback akin to the dot-com bust. "Most analysts see 2009 as a pivotal year," he says, predicting a "culling of the herd of early-stage companies."

But he thinks green tech will emerge stronger. Makower downplays the recent plunge in oil prices from record highs. "The drop is temporary and even if prices never get back up $140, the long-term trend is clear," he says. Energy and water are headed toward scarcity. "These are trillion dollar markets," he says. "Long-term, the opportunities are there."

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