Tesla has had one hell of a ride this last few years. In 2020 alone, its stock price rose by somewhere in the region of 740%, making it one of the most valuable US companies to date.
However, the stock market often has very little to do with the real fundamentals of a company like Tesla. For example, Tesla only produced around half a million EVs in 2020, which is a very small amount of the global estimated 70 million sold worldwide to date.
But, they have brought in an approximate $3.3 billion in sales, give or take, over the last few years.
A large part of investor confidence in Tesla is the fact that it has now reported its fifth consecutive quarter in profit. However, many have reported that this profit is something of a smokescreen as it has been argued that without the revenue generated from the sale of environmental credits, Tesla would still be in the red.
But, is this true? Let's take a quick gander.
What are regulatory credits?
Many countries around the world operate some kind of environmental credit system to "encourage" certain industries to toe-the-line with regards to a particular environmental policy. The most common, by far, relate to greenhouse emissions, like CO2.
One example is the varieties of so-called carbon credits that are operated under schemes like the European Union Emission Trading Scheme, the New Zealand Emissions Trading Scheme, etc.
Such schemes tend to follow one of two systems, akin to the concept of the carrot and stick — "cap-and-trade" (stick), or "baseline-and-credit-systems" (carrot). The former sets an upper limit on emissions, with companies needing to buy credits if their emissions top this, in order to avoid regulatory punishment.
With the latter, no fixed limits are set, but producers who reduce their emissions earn credits that they can bank, sell, or trade.
Such credits can be earned by, depending on the scheme, local authorities, countries, or private organizations.
In California, for example, an environmental credit system called the Zero Emission Vehicle Program (ZEV) has been in operation, in some form or other, since the early-1990s.
This program, according to California's Air Resource Board (CARB), has been devised to "meet California's health-based air quality standards and greenhouse gas emission reduction goals, the cars we drive and the fuel we use must be transformed away from petroleum."
ZEV form part of the board's Advanced Clean Cars package to coordinate standards that control smog-causing pollutants and greenhouse gas emissions of passenger vehicles in California. The program was devised to encourage automakers in California to develop cleaner means of transport, like EVs.
Companies can earn credits for each EV an automaker makes and sells in a year, and the longer its electrical driving range, the more credits awarded to a company. A certain minimum threshold of credits needs to be earned per year, and any excess can either be "banked" for future years, traded, or sold to competitors.
You can find a detailed explanation of how credits are calculated here. Also, if you are interested, CARB releases annual summaries of current automaker performances and credits to meet the requirement of ZEV. The scheme is scheduled to run until 2025.
California is not the only U.S. state to run such a program — 13 others run similar programs, including Connecticut, Maine, Maryland, Massachusetts, New York, New Jersey, Oregon, Rhode Island, and Vermont. If an automaker cannot meet the minimum amount of credits per year, it can face legal action and/or fines from state regulators.
This usually means that automakers who cannot meet the threshold need to trade or buy excess credits off their competitors — like Tesla.
Since Tesla only produces electric vehicles, they have been steadily racking up a lot more credits than the company needs for compliance. The company is carbon-credit rich if you like.
This means Tesla is in a fairly unique position to be able to trade or sell its excess credits to other automakers, like BMW or Fiat Chrysler.
Tesla's environmental credit hoard is also boosted by incentives from other countries around the world — especially in Europe. In fact, it was recently announced that Tesla has struck a deal with Fiat Chrysler Automobiles (FCA) to allow FCA to count Tesla's cars as part of its fleet in the European Union, lowering FCA’s average emissions output ahead of strict new EU regulations coming in 2021. Tesla is expected to hundreds of millions of euros from the sale of the emissions credits.
Is Tesla really in profit?
According to Tesla's latest accounts, the gross revenues, net incomes, and revenues from credit sales for the last few years are as follows:
- Gross revenue = $4.042 million
- Net income (after taxes, costs, etc) = -$976 million
- Credit sale revenue = $419 million
- Gross revenue = $4,069 millon
- Net income (after taxes, costs, etc) = -$862 million
- Credit sale revenue = $594 million
- Gross revenue = $6,630 millon
- Net income (after taxes, costs, etc) = +$862 million
- Credit sale revenue = $1,580 million
Based on this information, it would appear that the sale of environmental credits was one of the main reasons Tesla remained profitable last year — by around $718 million.
However, remember that those credits can only be awarded based on zero-emission vehicle production and sale. These EVs cost, labor, time, money, and resources to make too. 2020 saw a massive worldwide disruption of the supply of labor and supplies due to restrictions imposed on many industries throughout lockdowns 2020.
As Tesla explains in its latest 10-K:
"As of and following December 31, 2020, there has continued to be a widespread impact from the coronavirus disease (“COVID-19”) pandemic. In 2020, we temporarily suspended operations at each of our manufacturing facilities worldwide for a part of the first half of the year. Some of our suppliers and partners also experienced temporary suspensions before resuming, including Panasonic, which manufactures battery cells for our products at our Gigafactory Nevada. We also instituted temporary employee furloughs and compensation reductions while our U.S. operations were scaled back."
Conceivably, Tesla may well have shown a much larger revenue, perhaps even a "real" profit, if environmental credits were taken out of the equation. However, arguments of this nature are predicated on the fact that selling these credits is in some way "cheating".
These incentives exist to promote the production and development of zero-carbon forms of transport. Why shouldn't Tesla cash-in on its years of development in the field?
Will Tesla remain profitable when credits like ZEV come to an end in a few years? Especially as their competitors (and credit sales clients) push hard to catch up?
We shall see.
At the time of writing, the author has no financial interest in Tesla, common stock or otherwise, but has in the past.