Explanation of Tesla’s Electric Vehicle Regulatory Credits

Tesla CEO Elon Musk speaks at an award ceremony for Tesla’s China-made Model 3 in Shanghai, east China, on January 7, 2020.

Ding Ting | Xinhua News Agency | fake images

Tesla’s reliance on so-called regulatory credits to make money has returned to the spotlight after a regulatory filing revealed that investor Michael Burry accepted a $ 534 million bet against the electric car maker.

Burry, who was depicted in Michael Lewis’s book “The Big Short,” is short in the company, betting that Tesla shares will fall.

In a now-deleted tweet, the famous hedge fund manager said that Tesla’s reliance on regulatory credits for profit is a red flag.

Tesla raised $ 518 million in revenue from regulatory loan sales in the first quarter of the year, helping the US electric vehicle maker post another quarter of earnings.

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 very low-carbon cars. The credits are awarded to car manufacturers that build and sell green vehicles.

In the US, California and at least 13 other states have rules governing regulatory credits. They require automakers to produce a certain amount of so-called zero-emission vehicles (ZEVs) based on the total number of cars sold in that particular state.

The automakers that produce such cars will earn a certain amount of credits based on factors such as the range of the vehicle; longer range ZEVs get more credits.

These automakers must have a certain amount of regulatory credits each year. If they can’t meet the goal, they can buy them from other companies that have excess credit.

Because Tesla only sells electric cars that belong to the ZEV category, the company always has excess regulatory credits and can effectively sell them at a 100% profit.

Regulatory credits in China and Europe

It is not only the United States that has this credit scheme. The European Union and China have similar rules.

In China, regulatory credit requirements for automakers have steadily increased since 2019 and will continue to do so. Chinese regulations determine the amount of credit per vehicle based on several factors, including the extent of the car.

Tesla will also get these green credits in China, one of its biggest markets, but where it ran into a lot of negative publicity last month.

Last month, Reuters reported that a joint venture between German automaker Volkswagen and Chinese state-owned automaker FAW agreed to buy Tesla credits in China.

Tesla was not immediately available for comment when contacted by CNBC.

In Europe, lawmakers have been aggressive in trying to cut car emissions. In 2020, the European Union said that the average CO2 emissions from cars should not exceed 95 grams per kilometer. Automotive companies that exceed this limit could be forced to pay heavy penalties.

There are incentives in the form of “super credits” for vehicles that emit less than 50 grams of CO2 per kilometer to drive the development of low-carbon vehicles.

Tesla’s regulatory credit business model

Since Tesla receives all of these regulatory credits for free, you can essentially sell them for a 100% profit. This has been behind its last profitable quarters.

But Burry’s concern about the automaker’s reliance on these credits is shared by others as well.

In Tesla’s 2020 fourth-quarter earnings call earlier this year, Tesla CFO Zachary Kirkhorn was asked his outlook on regulatory credit sales in 2021. But he said it was difficult to predict.

“What I’ve said before is that, in the long run, regulatory credit sales will not be a material part of the business and we don’t plan the business around that,” he said at the time. “It may be strong for a handful of additional quarters. It is also possible that it is not.

Tesla relies on the big automakers to buy it credits.

An example is Stellantis, a company formed through the merger of the PSA group of France and the Italian Fiat Chrysler Automobiles. Stellantis bought about 2 billion euros ($ 2.43 billion) of European and US 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 emissions targets this year.

That means it would no longer need to buy credits from companies like Tesla, and Tesla could lose a key customer of its regulatory credits.

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