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Tesla Regulatory Credits Revenue Boosts Profits And Margins

A Tesla Model S. Image source: Flickr Image.

Tesla makes the most money from selling and leasing electric vehicles, solar energy systems and energy storage products.

In addition, Tesla also makes money from selling electricity generated from its own solar energy systems.

Best selling energy storage products such as the Powerwall and Powerpack are another line of Tesla’s revenue generators.

These are the typical money-making products for Tesla.

But what you may not know is that Tesla has another source of income that has been contributing hundreds of millions of dollars every quarter, and nearly a billion dollars in the 1st half of fiscal 2021, to the company’s bank accounts.

And that revenue source, which is created literally out of thin air, comes from the so-called “Regulatory Credits”.

What are Regulatory Credits?

Regulatory Credits are credits or points given by the state and federal government for contributing zero pollution to the environment.

Basically, in the state of California and some other states in the US, auto manufacturers such as Tesla, Ford, General Motors and so on are required by laws to meet certain minimum emission standards for all the vehicles they produce and sell.

Otherwise, they will face hefty fines or risk having their license revoked by the state government for failing to meet these emission standards.

In simple terms, auto manufacturers are required to meet these emission standards and the only way for them to be in compliance with the requirements is to either improve their own vehicles’ emissions or switch to manufacturing emission-free electric vehicles for 100% compliance or to purchase regulatory credits from other automakers that have excess credits such as Tesla.

The laws provide that automakers such as Tesla may keep the excess credits if they earn more credits than the minimum amount required. Auto manufacturers with a surplus of credits may sell their credits to other manufacturers, who can use the credits to comply with the laws.

ZEV and GHG Regulatory Credits

Since the vehicles produced by Tesla emit zero-emission, over the years, Tesla has earned a substantial amount of “Regulatory Credits” or sometimes referred to as ZEV (Zero-Emission Vehicles) credits under the state of California, which Tesla can sell to other auto manufactures.

The GHG credit or Green House Gas credit is another regulatory credit similar to ZEV credit where it’s applicable at the federal level requiring automakers to comply with the emission standard.

Based on the 2020 annual report, Tesla generated sales that totaled as much as $1.58 billion, $594 million and $419 million for the years ended on December 2020, 2019 and 2018 respectively from selling regulatory credits alone.

That’s quite a lot of money from a “product” literally with zero cost to produce.

The good news for Tesla’s investors is that the revenue from the sales of regulatory credits would most likely be increasing over time in the future when Tesla accelerates its goal of transitioning the world to renewable energy.

Keep in mind that Tesla has only commanded a market share of less than 1% in most of the regions in the world as shown in the following snapshot.

Tesla market share by region

Tesla market share by region. Source: Tesla 4Q 2020 Update Letter

For this reason, Tesla’s sales of regulatory credits will most likely be increasing or even surging in the foreseeable future when the world is slowly transitioning from fossil fuel to all-electric vehicles.

In fact, we are seeing that Tesla’s regulatory credits sales have been increasing by an average of 85% year over year since 2012, according to the results in the plots below.

Tesla’s Automotive Regulatory Credits

Tesla regulatory credits revenue stream

Tesla regulatory credits revenue stream

The diagram above shows the particular Tesla business segment that collects the revenue from regulatory credits sales.

As seen from the diagram, the sales of regulatory credits are recognized and reported under Tesla’s automotive sector.

Under the automotive sector, Tesla’s regulatory credits revenues are combined and lumped together with other revenue sources, including new vehicle deliveries, sales of Supercharging and autopilot, etc to arrive at the aggregated automotive sales revenue.

As of fiscal 2Q 2021, Tesla’s carbon credits revenue alone made up about 5% of the total automotive revenue.

On a yearly basis, Tesla’s carbon credits revenue contributed roughly 6% of sales to automotive revenue in fiscal 2020.

Tesla’s Regulatory Credits Revenue (Yearly)

Tesla's regulatory credits revenue by year

Tesla’s regulatory credits revenue by year

* Yearly regulatory credits revenue is a GAAP measure and is obtained from Tesla’s earnings releases.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

The chart above shows Tesla’s revenue from regulatory credits for the past 8 years from fiscal 2012 to 2021 on a yearly basis.

According to the chart, Tesla’s sales of regulatory credits have been increasing year over year at a compounded annual growth rate or CAGR of 57% between 2012 and 2020.

Tesla’s regulatory credits revenue reached the highest at nearly $1.6 billion in fiscal 2020, a record for the company since fiscal 2012.

Year to date, Tesla made more than $800 million from the sales of regulatory credits.

In terms of growth, Tesla’s regulatory credits revenue growth rate accelerates the most from fiscal 2019 to 2020, nearly tripling year over year.

Tesla has benefited immensely from the sales of regulatory credits when it comes to boosting its gross margin and profitability.

Going forward, Tesla’s regulatory credits sales may reach as much as $2.4 billion in fiscal 2021 at a growth rate of 50%, and as much as $3.6 billion in fiscal 2022.

And the number of sales from carbon credits will be a massive $5 billion by the end of fiscal 2023 if the compounded annual growth rate remains at 50%.

Tesla’s Regulatory Credits Revenue (Quarterly)

Tesla's regulatory credits revenue by quarter

Tesla’s regulatory credits revenue by quarter

* Quarterly regulatory credits revenue is a GAAP measure and is obtained from Tesla’s earnings releases.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

On a quarterly basis, Tesla’s regulatory credits revenue has been increasing steadily over the years, with 2020 being the best performing year when regulatory credits sales hit record highs of more than $300 million in 4 consecutive quarters.

According to the chart, in the first 3 quarters alone in 2020, Tesla has raked in nearly $1.2 billion of sales in regulatory credits, including both ZEV and GHG credits.

In 2020 Q4, Tesla’s sales of regulatory credits hit $400 million. Cumulatively, Tesla’s sales of regulatory credits totaled nearly $1.6 billion by 4Q in fiscal 2020.

As of fiscal Q2 2021, Tesla’s regulatory credits sales clocked in at $354 million on a quarterly basis, a year-on-year decline of 17%.

Again, Tesla’s projected regulatory credits revenue for fiscal 3Q and 4Q 2021 will be a massive $750 million, respectively, if the compounded annual growth rate remains at 50%.

Tesla’s Ratio of Regulatory Credits to Total Revenue

Tesla regulatory credits to total revenue ratio

Tesla regulatory credits to total revenue ratio

* Revenue ratio is calculated by the author and is based on Tesla’s regulatory credits revenue and total revenue obtained from the company’s consolidated income statements.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

The chart above shows the ratio of regulatory credits revenue with respect to total revenue expressed in percentage.

From the chart, the percentage has dropped drastically from 10% in 2012 to just 2.4% in fiscal 2019.

However, the percentage ticked slightly higher to 5% in fiscal 2020 when Tesla reported a record carbon credits sales of $1.58 billion in the same fiscal year.

Year to date, Tesla’s ratio of regulatory credits to total sales stood at the 5% level in the first half of fiscal 2021.

The continuous decline of the ratio shows that Tesla’s sales of other revenue segments, the automotive sector, in particular, have grown at a much faster pace.

However, the recent increase of the ratio from 2.4% reported in fiscal 2019 to 5% reported in fiscal 2020 illustrates that sales of carbon credits have outpaced that of total revenue.

While Tesla may have posted record sales of regulatory credits in fiscal 2020 and 2021 year-to-date, the ratio represents just 5% of the company’s total revenue.

On the surface, the 5% ratio may seem negligible, it was actually almost as big as the solar revenue that Tesla generated in fiscal 2020.

The best thing about carbon credits is that it’s a pure profit without any costs of sales while Tesla has to subsidize using its own money for every single energy product that gets sold by the company.

Tesla’s Regulatory Credits Revenue Growth Rates

Tesla's regulatory credits revenue growth rates

Tesla’s regulatory credits revenue growth rates

* Growth rates are calculated by the author and are based on Tesla’s yearly regulatory credits revenue obtained from the company’s earnings releases.

The plot above shows the year-on-year (YoY) growth rates of Tesla’s regulatory credits revenue from fiscal 2013 to fiscal 2023.

From the plot, the YoY growth rates for Tesla’s regulatory credits sales had been almost entirely positive in all fiscal years except fiscal 2015.

In fiscal 2020, Tesla reported the best YoY growth rate at 166% when its regulatory credits revenue surged beyond $1 billion for the first time.

In a separate calculation, Tesla’s regulatory credits revenue growth rate average around 85% between fiscal 2012 and 2020.

Tesla’s carbon credits sales are projected to continue to grow at high double-digit growth rates, considering that the adoption of electric vehicles is still in its infancy and represents less than 5% of global vehicle sales in 2020.

As such, Tesla’s regulatory credits projected growth rates for fiscal 2021, 2022 and 2023 will continue at 50% on an annual basis.

Effect of Regulatory Credits on Gross Margin (Quarterly)

Tesla's quarterly gross margin with and without regulatory credits revenue

Tesla’s quarterly gross margin with and without regulatory credits revenue

* Automotive gross margin is a GAAP measure and is calculated by the author using Tesla’s automotive revenue and automotive gross income obtained from the company’s consolidated income statements.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

The chart above shows Tesla’s quarterly gross margin comparison for automotive revenue with and without regulatory credit revenue.

Critics have argued that the sales of regulatory credits have artificially boosted Tesla’s gross margin and thus the company’s profitability.

These arguments are valid to some degree because Tesla’s revenue from the sales of emission credits is not sustainable in the long run.

Tesla may run out of emission credits buyers in the future when most, if not all, automakers switch to manufacturing EVs.

According to the chart, Tesla’s regulatory credits revenue has certainly helped to boost automotive gross margin.

In Tesla’s case, the improvement in gross margin can be as low as 2% to as high as 6%.

For instance, Tesla reported the biggest jump in gross margin, an improvement of as much as 6% in Q2 2020, when regulatory credits revenue was recognized as part of the automotive sales.

Similarly, we are seeing a 3% boost in gross margin in Q4 2020 when ZEV and GHG credits sales were taken into consideration.

The effect of the carbon credits sales continued into fiscal 2021 2Q when Tesla’s automotive gross margin reached 28%.

However, its automotive gross margin dropped to only 26% when emission credits revenue was excluded from the calculation in the same fiscal quarter.

In short, it’s without a doubt that Tesla’s regulatory credits revenue has artificially boosted not only the gross margin but also the profitability.

Effect of Regulatory Credits on Gross Margin (TTM)

Tesla's TTM gross margin with and without regulatory credits revenue

Tesla’s TTM gross margin with and without regulatory credits revenue

* Automotive gross margin is a GAAP measure and is calculated by the author using Tesla’s automotive revenue and automotive gross income obtained from the company’s consolidated income statements.
* TTM data consists of the sum of the quarterly data on a trailing 12-month or 4-quarter basis.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

To smooth out the quarterly plot and to better show the trend, I have created the trailing 12-months (TTM) plot as shown in the chart above.

Again, Tesla reported the biggest improvement in the automotive gross margin throughout 2020 when regulatory credits sales were the highest.

On a TTM basis, Tesla’s automotive gross margin with and without regulatory credits sales differed by as much as 4% in most quarters in 2020.

The gap between Tesla’s automotive gross margin with and without emission credits revenue maintained at 4% as of 2Q 2021.

However, the gap started to diverge significantly since the 1st quarter of 2020, indicating that the effects of regulatory credits on gross margin have increased considerably as it moved closer to the latest quarter.

When the effect of emission credits revenue kicked in, Tesla’s TTM automotive gross margin reached nearly 27% as of fiscal 2021 Q2.

Tesla’s automotive gross margin dipped to only 23% without the effect of emission credits in the same fiscal quarter.

Tesla’s Operating Profit Without Regulatory Credits Revenue

Tesla's operating profit with and without regulatory credits revenue

Tesla’s operating profit with and without regulatory credits revenue

* Operating profit without regulatory credits is a non-GAAP measure and is calculated by the author based on Tesla’s operating income net of regulatory credits revenue obtained from the company’s consolidated income statements.
* TTM data consists of the sum of the quarterly data on a trailing 12-month or 4-quarter basis.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

Is Tesla profitable without the regulatory or emission credits revenue?

That’s the question that we will answer in this discussion.

Let’s first look at Tesla’s operating profit which is shown in the chart above.

The chart shows 2 operating profit plots, one with regulatory credits and the other one without.

As seen, Tesla’s operating profit dipped to only $1.5 billion from $3.4 billion in fiscal 2Q 2021 on a TTM basis without regulatory credits revenue.

The difference between the 2 operating profit plots is huge.

For example, in 2Q 2021 quarter, Tesla’s operating profit was boosted by about $1.8 billion when the effect of emission credits kicked in.

While Tesla made only $1.5 billion in TTM operating profit without regulatory credits, Tesla was profitable from an operational perspective.

Tesla’s Net Profit Without Regulatory Credits Revenue

Tesla's net profit with and without regulatory credits revenue

Tesla’s net profit with and without regulatory credits revenue

* Net profit without regulatory credits is a non-GAAP measure and is calculated by the author based on Tesla’s net income net of regulatory credits revenue obtained from the company’s consolidated income statements.
* TTM data consists of the sum of the quarterly data on a trailing 12-month or 4-quarter basis.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

Similarly, Tesla’s net profit dipped to $500 million without regulatory credit revenue in fiscal 2Q 2021 on a TTM basis.

With regulatory credits sales, Tesla’s net profit jumped to more than $2 billion on a TTM basis in the same quarter.

Additionally, as the plots move closer to the latest quarter, the gap between the 2 plots gets larger, indicating that the effect of emission credits on Tesla’s profitability is getting larger.

Tesla made its first profit without the effect from regulatory credits in fiscal 2Q 2021.

All in all, Tesla would have been non-profitable without the sales of regulatory credits in the past.

However, Tesla’s profitability has reversed in the latest quarter from unprofitable to profitable, suggesting that the company has raked in enormous profit, one that is large enough to overcome the effect of carbon credit sales.

Conclusion

Tesla’s regulatory credits revenue has been growing at an average annual growth rate of 85% between fiscal 2012 and 2020, with 2020 being the best year when Tesla posted emission credit sales that surged beyond $1 billion.

In fiscal 2020, Tesla reported a regulatory credit revenue of $1.58 billion, beating all prior records.

Albeit less significant in contributing to total revenue, the regulatory credit sales have helped Tesla to improve its automotive gross margin and generate profits.

The improvement can range from 2% to 6%, depending on the amount of emission credits sales.

We have seen that the larger the revenue from regulatory credits, the bigger the boost in automotive gross margin and profits.

Also, Tesla’s TTM net profits without regulatory credits revenue reversed from a loss of -$600 million to a profit of $500 million in fiscal 2Q 2021 from the prior quarter.

In short, Tesla has made its 1st profit without the help of emission credits revenue.

References and Credits

1. All financial figures in this article were obtained and referenced from Tesla’s quarterly and annual reports available in Tesla Update Letters and Presentations.

2. Featured images in this article are used under creative commons license and sourced from the following websites: Ian Kennedy and Lubomir Panak.

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Disclosure

The content in this article is for informational purposes only and is neither a recommendation nor a piece of financial advice to purchase a stock.

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{ 10 comments… add one }
  • David Dodini June 29, 2020, 7:30 pm

    Battery Electric Vehicles are not emissions free. It would be great to see you cover the true emissions of these vehicles both in terms of manufacture and the source of the energy. The public deserves to know, since after all they are paying for it via the subsidies as well as the passed on costs of the regulatory credits.

  • Bob Tessier September 9, 2020, 5:40 pm

    Revenue is fine but do they EARN any profits from vehicle production solely? It seems the credits make them profitable and without them they lose money on every car.

    • cckean September 9, 2020, 9:47 pm

      Even with emission credit revenue included, Tesla doesn’t seem to make any meaningful profits!

    • peter danczewski October 22, 2020, 5:21 am

      EV regulatory credits are part of the business model, not just for TSLA but for other automobile manufacturers. TESLA is way ahead of the game and therefore is reaping the highest revenues from these credits. I don’t understand why people get hung up on one aspect of this company. We should be concerned with companies that are buying these credits just to meet emissions standards.

      • Really April 1, 2021, 7:00 am

        Really? Do your research what is the carbon footprint of an electric car. Those regulatory credits are quite absurd. And why the hell are they taking them from one car manufacturer and giving them to the car manufacturers instead of planting trees for example?

  • Elia Mazzawi September 11, 2020, 2:32 am

    The Zev credit system is too complicated. The government should simply replace it with a flat tax on carbon.

    Tesla doesn’t need a $1b per year government handout.

    • cckean September 11, 2020, 6:44 pm

      Apparently, this money does not come from the government. It comes from other automakers who has yet to comply with the emission standard. The government only acts as the moderator or the middleman.

  • Frankie Boyd October 22, 2020, 7:28 pm

    Just exactly how do these regulatory credits work. Does TESLA sell vehicles, and/or vehicle technology to the ” Big Three”, etc..?

  • AgentZero October 23, 2020, 11:55 am

    What happens when everybody starts making electric vehicle ? How will Tesla be profitable ?

    • cckean October 23, 2020, 1:51 pm

      Then Tesla will have nowhere to sell its regulatory credits!

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