Posted by: bmeverett | June 25, 2013

Tesla’s profits are an illusion


Tesla Motors, maker of luxury electric vehicles has earned a flood of positive press coverage lately. In May, the company announced that it had paid off nine years early its entire government loan of over $450 million. The stock jumped from its 52-week low of $26 per share to $114 on May 28. Motor Trend gave Tesla’s Model S its prestigious Car of the Year Award, and Consumer Reports graded the Model S 99 out of 100, the highest score ever given to a new automobile. Surely, here is the success the federal government has been waiting for to offset its embarrassing failures, like Solyndra. Not so fast.

Let’s look closely at Tesla’s finances. In the first quarter of 2013, the Company sold 4,900 Model S sedans generating total revenue of $555 million or about $113,000 per vehicle. It’s interesting to note here that the Model S, the only car Tesla currently sells, sells for $69,900 for a 60 kWh battery pack and $79,900 with an 85 kWh battery pack. Even the limited Signature Edition Model S that Tesla sold to hype their cars sold for $95,400 and $109,400 for the two battery packs respectively. Why are revenues so high?

Part of the answer lies in sales of powertrain equipment to other vehicle manufacturers, such as the Toyota RAV4 electric vehicle. Beyond these legitimate sales, however, are some interesting issues. First of all, Tesla gets a federal rebate of $7,500 per car plus state rebates such as $2,500 per vehicle in California and $4,000 per vehicle in Illinois. Although the rebate technically goes to the buyer, the $69,900 Tesla gets for a 60 kWh Model S in California, for example, includes $59,900 from the buyer, $7,500 from the feds and $2,500 from the totally bankrupt state of California.

Second, California requires most car companies marketing in the state to meet fleet emissions target for Zero Emission Vehicles (ZEVs) and allows companies exceeding their targets to sell credits to companies unable to meet the requirements. Since Tesla makes 100% electric vehicles, they have credits available for sale. California ZEV credits totaled $68 million in 1Q 2013, which accounts for 12% of total revenues but a full 70% of gross profit. Tesla is cagey about releasing state-specific information on its sales, but the industry buzz is that about one-third of its cars are sold in California. If so, Tesla is earning about $41,000 in ZEV credits for every car it sells in California. Consumers, of course, pay for these credits through higher prices for conventional cars.

The theory behind the California ZEV credit program is that Tesla is providing a real service to the public by producing low-emission vehicles, but is that really true? To say that California’s Zero Emission Vehicle (ZEV) targets are complex is a huge understatement. The rules governing this program are so convoluted that hundreds of lawyers are likely to find career employment in their interpretation. If you’d like to really dive into the California rules, be my guest. You can find a tutorial at http://www.arb.ca.gov/msprog/zevprog/factsheets/zev_tutorial.pdf. Be warned, however, that the tutorial contains 131 slides summarizing the rules.

The basic principle, however, is that vehicle emissions are measured at the tailpipe. In other words, the energy used and emissions generated in producing and transporting the electricity are ignored. If we are trying to reduce real-world carbon emissions, this approach is just plain wrong. I discussed this problem at length in my February 8 post “The State of Play on Electric Cars”. As noted in that post, electric cars emit less carbon than gasoline-powered vehicles, but mainly because electricity is generated on the margin by natural gas, a low carbon fuel. A better comparison would be a Tesla versus a Honda GX natural gas vehicle. The California rules define a Tesla Model S as a Zero Emission Vehicle (ZEV), but categorize the Honda GX as an Advanced Technology Partial Emission Vehicle (AT PZEV). (Only California could use a term such as “partial zero emission” with a straight face. What part of zero are we talking about?) As mentioned above, each car company has a ZEV requirement, a specified part of which must be met by pure ZEVs with the rest by various types of PZEVs. Electric cars are the only ZEV currently under production so they have considerable value in meeting the emission requirements.

If you go to the dealerships and look at the EPA labels, you will see that the Honda GX has a fuel efficiency of 31 miles per gallon while the Tesla gets 94 miles per gallon. According to EPA definitions, the Tesla Model S emits no greenhouse gases, while the Honda GX emits 227 grams of carbon dioxide per mile. Since a conventional gasoline-powered Honda Civic gets 32 miles per gallon while emitting 279 grams of carbon, California would seem justified in characterizing the Tesla as far superior to the Honda GX, which in turn is slightly better than a conventional Honda. But is this taxonomy valid?

According to Tesla, the basic Model S with a 60 kWh battery has a “real world” range of 232 miles or about 260 Watt-hours (Wh) per mile traveled. The larger, 85 kWh version is heavier and has a slightly lower efficiency, so let’s go with the 60 kWh model. An electric car battery loses about 10% of its input electricity in the charging process and another 10% in transmission and distribution from the power plant. A mile of travel in a Tesla Model S therefore requires the generation of about 320 Wh of electricity. Modern, efficient combined cycle natural gas power plants require about 6,800 British Thermal Units (Btus) of natural gas per kWh of electricity, so a mile in our Tesla requires about 2,175 Btus of natural gas. About 15% of the natural gas is lost in production and transportation to the power plant, so our Tesla mile requires about 2,560 Btus of natural gas. If we convert this energy to gallons of gasoline equivalent at 125,000 Btus per gallon, a Tesla gets about 49 miles per gallon, half the EPA label value. Total carbon dioxide emissions are really about 136 grams per mile, not zero.

How about the Honda GX? The car itself uses about 4,030 Btus per mile of natural gas plus a 15% gross-up for production and transportation or 4,640 Btus per mile. That’s equivalent to 27 mpg or 246 grams of carbon dioxide per mile. On balance, the Honda GX uses about 80% more energy than the Tesla (not 3 times as much) and emits about 80% more carbon dioxide (not infinitely more).

This difference is still significant, but what if Honda produced a hybrid version of the GX? The hybrid gasoline Civic uses about 30% less gasoline than its conventional cousin, so let’s assume that a hybrid Honda Civic GX could do the same. Such a vehicle would use 3,250 Btus of natural gas per mile (23% more than the Tesla Model S) and emit 172 grams of carbon dioxide per mile (27% more than the Tesla). A hybrid Honda Civic costs about $8,000 more than a conventional model ($26,305 MSRP versus $18,165). A Civic GX costs about $26,300, so we could guess that a GX hybrid would cost about $34,000, since the hybrid system would be essentially the same. Bottom line: if measured properly, a Honda natural gas hybrid vehicle would be 25-30% less efficient than a Tesla Model S but would cost only half as much.

We can draw several conclusions from this quick analysis. First, simple regulatory structures, such as a carbon tax, would allow consumers and auto companies to reduce carbon emissions in the most efficient way possible. (Please note that I am still opposed to a carbon tax on the grounds that it is economic damaging and likely to make a negligible contribution to atmospheric carbon concentrations). Governments, however, seem to prefer horribly complex regulatory structures that take much of the choice away from the market. Legislators simply cannot resist the temptation to specify in law how goals are to be met and which technologies are to be employed. It’s not coincidental that their preferred technologies are often those manufactured by powerful constituents in their districts.

Second, governments tend to make these decisions in ways that severely distort the outcome. All these systems create large bureaucracies overseeing programs that set powerful goals but allow numerous complex accounting tricks that often allow the legislative targets to be met without solving the problem supposedly being addressed. The Kyoto Protocol, for example, allowed the EU to meet its carbon reduction targets without reducing carbon emissions through complex and largely fictitious trading systems and meaningless land use definitions. The California ZEV system and the upcoming federal EPA vehicle efficiency systems will do exactly the same thing. (Those of you following the current debate on immigration reform should watch out for this same tendency.)

Third and finally, the California ZEV system, like the Kyoto Protocol, creates wonderful opportunities for rent-seeking, as company lawyers find ways of gaming the system to their advantage, while the consumer foots the bill. Tesla Motors is not a car company, it’s a rent-seeking machine. Although Tesla management predicts that revenue from credit sales will decline over time, the opposite is likely to be true. Tesla cannot now, and probably cannot in the foreseeable future, sell its electric cars for more than their production cost. Their ability to make a profit and provide a return to their shareholders depends primarily on subsidies and on their ability to sell credits, which cost consumers real money and carry little if any benefit.

Yet another reason to love big government.

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Responses

  1. Actually, qualifying electric vehicles as “zero emissions vehicles” makes more sense than you think.

    Think about it this way: The main goal of the California zero emissions vehicle program is to reduce pollution caused by vehicles, mainly in larger cities. Electric vehicles may still indirectly produce emissions, but the emissions are generated at power plants outside of the city. So it really does make sense to qualify them as zero emissions vehicles because when they do generate emissions, those emissions don’t contribute to the air quality issue.

    I agree with you that the usage of “Zero Emissions Vehicle” is misleading. But politics always taints the proper use of terms like that.

    Also, I’m curious why you oppose a carbon tax. I believe strongly in the free market, but the fact is we have a tragedy of the commons situation. Emitting greenhouse gasses has a real and tangible cost in the form of climate change, yet no one is paying for it. CO2 emissions are an unpriced externality.

    Even if you think that climate change is a hoax (or think that the risks are greatly exaggerated), that doesn’t change the fact that we are still going to run out of fossil fuels one day. We have to transition to sustainable production and consumption of energy sooner or later. The only real question is WHEN. And even if the chances of climate change doing serious damage to the environment are low, it makes sense to do it now.

    How are we going to make that transition without a carbon tax?


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