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 Powewall and Powepack are another line of Tesla’s revenue generators.
These are the typical money-making machines for Tesla. But what you may not know is that Tesla has another source of income that is contributing hundreds of millions of dollars, or perhaps close to a billion dollar in 2020, to the company’s coffers. And that revenue source, which has been generated 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’ emission or switch to manufacturing emission-free electric vehicle 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 2019 annual report, Tesla made about $594 million, $419 million and $360 million for the years ended December 2019, 2018 and 2017 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 selling regulatory credits would most likely be increasing over time in the future and we have seen that it has been increasing by an average of 80% year over year since 2011 (results from the plots below).
Tesla’s Sale of Regulatory Credits
The diagram above shows the business sector where the regulatory credits revenue is recognized.
As seen from the diagram, the regulatory credits revenue is recognized under Tesla’s automotive sector.
Further down the sector, the regulatory credits revenue is combined with other revenue sources such as new vehicle deliveries and sales of Supercharging, autopilot, etc to arrive at the aggregate automotive sales revenue.
Chart of Tesla’s Regulatory Credits Revenue
The chart above shows Tesla’s revenue from regulatory credits for the past 8 years from 2012 to 2019.
The long-term trend of the plot shows that the sales of regulatory credits have been increasing year over year between 2012 and 2019. Regulatory credits revenue reached the highest value at nearly $600 million in 2019, a record high for the company since the start of the sales.
Over the past 8 years, the growth of Tesla’s regulatory credits revenue from just $41 million in 2012 to $594 million in 2019 represents a growth of roughly 15X. The figure in 2019 alone produces a growth rate of 42% on a year on year basis when Tesla managed to recognize $594 million in regulatory credits sales compared to $419 million a year earlier.
The half a billion-dollar sales of regulatory credits may perhaps help Tesla to boost its gross margin at a time when the company has been aggressively pricing its vehicles in order to grab market share from fossil fuel vehicles automakers.
Ratio of Tesla’s Regulatory Credits to Total Revenue
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% in 2019. The continuous decline of the ratio shows that the contribution of sales of regulatory credits to total revenue has been getting insignificant.
While Tesla posted record sales of regulatory credits in 2019, the result didn’t help to lift the ratio a bit, indicating that perhaps, Tesla’s other revenue sources such as the automotive sales have grown at a much faster rate.
Tesla Regulatory Credits Revenue Growth Rate
The plot above shows the year on year (YoY) growth rate of regulatory credits revenue from 2013 to 2019.
From the plot, YoY growth rate had been positive in all years except in 2015 when the growth rate turned negative at -22%. In 2019, Tesla reported a very impressive result of a 42% growth rate for the regulatory credit revenue.
In a separate calculation, the average growth rate for regulatory credits revenue was roughly 74% from 2013 to 2019.
The high double-digit figures in the plot show that there are still rooms to grow for regulatory credits revenue in the future considering that the adoption of electric vehicle is still in its infancy and represents less than 5% of global vehicle sales.
Chart of Tesla Quarterly Regulatory Credits Revenue
The plot above shows Tesla’s quarterly regulatory credits revenue from 1Q 2018 to 2Q 2020.
The long-term trend shows that Tesla’s regulatory credits revenue has been increasing steadily over the years, hitting a record high of $428 million in 2Q 2020.
Moreover, 2020 has been one of the best years for Tesla in terms of sales from regulatory credits. As reflected in the chart above, the 1st 2 quarters in 2020 alone posted nearly $800 million of sales in ZEV as well as GHG credits.
At this rate of growth, Tesla’s carbon credit sales should be hitting more than $1 billion by the end of 2020.
Effect of Regulatory Credits on Gross Margin (Quarterly)
The chart above shows the quarterly gross margin comparison for automotive revenue with and without regulatory credit sales.
As expected, regulatory credits sales have contributed significantly to automotive gross margin improvement.
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 4% gross margin improvement in 1Q 2020 when ZEV and GHG credits sales were added to the automotive revenue.
This scenario is expected as 2020 represents the best years in the sales of carbon credits for Tesla.
Effect of Regulatory Credits on Gross Margin (TTM)
To smooth out the quarterly plot, I have created the trailing 12-months (TTM) plot as shown in the chart above.
Again, Tesla reported the biggest improvement in automotive revenue gross margin in 2Q 2020. On a TTM basis, automotive gross margin with and without regulatory credits sales differed by as much as 4% in 2Q 2020.
Tesla’s regulatory credits revenue has been growing at an average annual rate of 74% between 2012 and 2019, with 2019 being one of the best years when Tesla posted revenue of more than half a billion dollars.
The best is yet to come. In the 1st half of 2020 alone, Tesla has already recognized nearly $800 million of regulatory credits revenue, beating all prior records.
Even though regulatory credits revenue has risen significantly over the past several years, its contribution to total revenue is getting less significant and was only 2.4% of total revenue in 2019.
Albeit less significant in contributing to total revenue, the regulatory credit sales have helped improved automotive gross margin and the improvement can range from 2% to 6%, depending on the amount of carbon credits sales.
References and Credits
1. All information in this article was obtained from Tesla Update Letters and Presentations.
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