Explanation of regulatory credits for Tesla electric vehicles
Tesla CEO Elon Musk speaks at a delivery ceremony for the China-made Model 3 in Shanghai, east China, Jan.7, 2020.
Ding Ting | Xinhua News Agency | Getty Images
Tesla’s use of so-called regulatory credits to make money has been brought back into the limelight after a regulatory filing revealed that investor Michael Burry had taken a $ 534 million bet against the electric car maker.
Burry, who was described in Michael Lewis’s book “The Big Short,” has a short position in the company – betting Tesla shares will fall.
In a now deleted tweet, the notorious hedge fund manager said Tesla’s reliance on regulatory credits to generate profits was a wake-up call.
Tesla raked in $ 518 million in revenue from the sale of regulatory credits in the first quarter of the year, helping the U.S. electric vehicle maker to post another quarter of profit.
What are regulatory credits? How do they work?
In an effort to reduce carbon emissions, governments around the world have introduced incentives for automakers to develop electric vehicles or cars with very low carbon emissions. Credits are given to car manufacturers who build and sell environmentally friendly vehicles.
In the United States, California and at least 13 other states have rules regarding regulatory credits. They require automakers to produce a number of so-called zero emission vehicles (ZEVs) based on the total number of cars sold in that particular state.
Automakers that produce such cars will receive a number of credits depending on factors such as the range of the vehicle – longer range ZEVs will get more credits.
These car manufacturers are required to have a certain amount of regulatory credits each year. If they can’t meet the target, they can buy them from other companies that have excess credit.
Since Tesla only sells electric cars belonging to the ZEV category, the company still has excess regulatory credits and can effectively sell them at 100% profit.
Regulatory credits in China and Europe
It is not just the United States that has such a credit system. The European Union and China have similar rules.
In China, credit regulatory requirements for automakers have been increasing steadily since 2019 and will continue to do so. Chinese regulations determine the amount of credit per vehicle based on a number of factors, including the range of cars.
Tesla will also earn those green credits in China, one of its most important markets – but where it encountered a slew of negative publicity last month.
Reuters last month reported that a joint venture between German automaker Volkswagen and Chinese state-owned manufacturer FAW had agreed to buy credits from Tesla in China.
Tesla was not immediately available for comment when contacted by CNBC.
In Europe, lawmakers have been aggressive in trying to reduce emissions from cars. In 2020, the European Union declared that average CO2 emissions from cars should not exceed 95 grams per kilometer. Auto companies that exceed this threshold could be forced to pay hefty fines.
There are incentives in the form of “super credits” for vehicles emitting less than 50 grams of CO2 per kilometer to encourage the development of low carbon vehicles.
Tesla’s regulatory credit business model
Since Tesla receives all of these regulatory credits for free, it can basically sell them for a 100% profit. This has been the source of its recent profitable quarters.
But Burry’s concern about the automaker’s reliance on these credits is shared by others as well.
During Tesla’s fourth quarter 2020 earnings call earlier this year, Tesla Chief Financial Officer Zachary Kirkhorn was asked to give his outlook on regulatory credit sales in 2021. But he said it was was difficult to predict.
“What I’ve said before is that in the long run regulatory credit sales won’t be a big part of the business and we don’t plan the business around that,” he said. he said at that time. “It’s possible that for a handful of more quarters he will stay strong. It’s also possible that he won’t.”
Tesla relies on major car manufacturers to buy credits there.
An example is Stellantis, a company resulting from the merger of the PSA group in France and the Italian Fiat Chrysler Automobiles. Stellantis bought around 2 billion euros ($ 2.43 billion) in European and American green credits from Tesla between 2019 and 2021, according to Reuters.
But Carlos Tavares, CEO of Stellantis, said in an interview with French publication Le Point that the company could meet its emissions targets this year.
This means that it would no longer need to buy credits from companies like Tesla, and Tesla could potentially lose a key customer from its regulatory credits.