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Tesla Regulatory Credits Revenue Boosts Profits And Margins

A Tesla Model S. Image source: Flickr Image.

Most people see Tesla (TSLA) as a car company that makes money from selling and leasing electric vehicles.

While Tesla builds electric vehicles, it also designs and manufactures energy storage and solar generation systems.

Therefore, Tesla also makes money from selling and leasing electricity generated from solar energy systems constructed by the company.

Best selling energy storage products such as the Powerwall and Powerpack are another category of products that provide extra revenue streams to the company.

These are the typical money-making machines for Tesla.

However, 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 more than a billion dollars in 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”.

In this article, we will look at several metrics related to Tesla’s regulatory credits, including the annual and quarterly revenue figures, percentage to total revenue, growth rates, gross margin with and without regulatory credits, etc.

Let’s start with the following topics.

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 manufacturers.

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 2021 annual report, Tesla generated sales that totaled as much as $1.5 billion, $1.6 billion and $594 million for the years ended on December 2021, 2020 and 2019 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’s EV delivery keeps on growing.

Keep in mind that Tesla has only commanded a market share of less than 5% in the automotive sector in most regions in the world as shown in the following snapshot.

Tesla market share by region

Tesla market share by region. Source: Tesla 4Q 2021 Update Letter

For this reason, Tesla’s sales of regulatory credits will most likely be increasing or even surging in the foreseeable future when Tesla builds more zero-emission electric vehicles.

In fact, we are seeing that Tesla’s regulatory credits sales have been increasing by an average of 40% year over year since 2013, 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 where the regulatory credit revenue belongs in one of Tesla’s business segments.

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.

In fiscal 2021, Tesla’s carbon credits revenue alone made up only 3% of the total automotive revenue, down from 6% 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.
* Projected regulatory credits revenue is based on past results and is estimated at a growth rate of 40%.
* 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 an average annual growth rate of about 40% between fiscal 2013 and 2021.

Fiscal 2020 was the best year for Tesla when the respective emission credits sales topped $1.6 billion, a record for the company in the last 10 years.

In fiscal 2021, Tesla recorded $1.5 billion USD from the sales of regulatory credits, down slightly from the prior year.

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

From the perspective of financial figures, Tesla has benefited immensely from the sale of regulatory credits when it boosted gross margin and profitability.

Going forward, Tesla’s regulatory credits sales may reach as much as $2.1 billion in fiscal 2022 based on the historical growth rate of about 40%, and as much as $2.9 billion in fiscal 2023.

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 discal 2020 being the best performing year when regulatory credits sales surged to 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.

In fiscal Q4 2021, Tesla’s regulatory credits sales clocked at $314 million on a quarterly basis, a year-on-year decline of 20%.

Tesla’s Regulatory Credits Revenue To Total Revenue Ratio

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 $1.6 billion in the same fiscal year.

As of fiscal 2021, Tesla’s regulatory credits sales of $1.5 billion put the ratio at 2.7%, down slightly from the prior year.

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.

While Tesla may have posted record sales of regulatory credits in fiscal 2020 and 2021, the ratio represents less than 5% of the company’s total revenue.

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

The best thing about carbon credits revenue is that it comes without any costs of sales whereas Tesla has to subsidize every single energy product that gets delivered to customers because of the negative gross margin.

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 2017 to fiscal 2021.

From the plot, the YoY growth rates for Tesla’s regulatory credits sales had been positive in all fiscal years except for fiscal 2021 where the growth rate declined to -7.3%.

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

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

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 based on 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 may not be 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 4Q when Tesla’s automotive gross margin reached 30.6%, a record high for the company.

However, the automotive gross margin would have come to only 29% if emission credits revenue was excluded from the measurement in the same fiscal quarter.

In short, Tesla’s regulatory credits revenue has artificially boosted the gross margin.

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 shown in the chart above is presented on a TTM basis.
* 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 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.

As of 4Q 2021, the gap between Tesla’s automotive gross margin with and without emission credits revenue dipped slightly to 2% on a TTM basis.

A trend worth noting is that the gap with and without emission credit revenue started to diverge significantly since 2020, indicating that the effects of regulatory credits on gross margin have increased considerably.

Tesla’s TTM automotive gross margin came in at 29.3% with emission credits included or 27% without emission credit in fiscal 2021 Q4.

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 shown in the chart above is presented on a TTM basis.
* 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 made $6.5 billion of operating income as of fiscal 4Q 2021 on a TTM basis.

However, this figure turned out to be only $5.1 billion after excluding regulatory credits sales.

The difference is huge, notably at $1.5 billion USD in fiscal 4Q 2021.

Therefore, Tesla’s regulatory credits helped not only the operating profit but also the operating margin.

Nevertheless, Tesla was profitable from an operational perspective with and without regulatory credit revenue.

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 shown in the chart above is presented on a TTM basis.
* 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 came in at $5.5 billion in fiscal 4Q 2021 on a TTM basis after accounting for sales of regulatory credits.

Without regulatory credits revenue, Tesla’s net profit would have come to only $4 billion on a TTM basis in the same quarter.

Additionally, as the plots move closer to the right, the gap between the 2 plots gets larger, indicating that the effect of emission credits on Tesla’s profitability has been getting bigger.

A trend worth mentioning is that Tesla was unprofitable in the past without the help of regulatory credits revenue.

However, this trend has reversed in recent years.

Therefore, even without regulatory credits revenue, Tesla was still profitable and raked in as much as $4 billion of net income as of 4Q 2021 on a TTM basis.

Conclusion

To recap, Tesla’s regulatory credits revenue has been growing at an average annual growth rate of 40% between fiscal 2013 and 2021, with 2020 being the best year when emission credit sales surged beyond $1 billion for the 1st time.

In fiscal 2020, Tesla reported a regulatory credit revenue of $1.6 billion USD, beating all prior records.

This figure declined slightly to $1.5 billion in fiscal 2021, down roughly 7% from fiscal 2020.

While Tesla’s regulatory credits revenue contributes to less than 5% of total revenue, it helped to inflate gross margin and boost profits.

References and Credits

1. All financial figures in this article were obtained and referenced from Tesla’s quarterly and annual reports which are 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.

If you find the information in this article helpful, please consider sharing it on social media and also provide a link back to this article from any website so that more articles like this one can be created in the future. Thank you!

{ 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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