Analysis
27 Mar 24

Tesla's dominance over the carbon credit market explained

One year after the release of its first electric vehicle (EV), the Roadster, Tesla began selling carbon credits to various automakers. While Tesla enjoyed high profits as the pioneer of all-electric passenger cars, the balance in the carbon credit market is about to change. Tesla is no longer the top all-electric producer, and major automakers are changing their strategy from just buying time to updating their zero-emission strategies. 

Selling carbon credits has always been a lucrative business for Tesla. In Q4 2020, according to CNBC, Tesla generated $270 million in net income by selling $401 million in regulatory credits. In Q1 2021, Tesla generated $518 million from selling regulatory credits. 

Profits continued to grow. According to Tesla's financial reports, revenue generated from carbon credits was $1.46 billion as of the fiscal year 2021, representing 3% of the brand's total revenue. Revenue peaked in 2023, hitting $1.79 billion, according to the brand's Q4 2023 report. Tesla has generated $9 billion from selling carbon credits to other electric vehicle (EV) manufacturers since 2009.

We shall look at the figures from Q3 2023 to note how profitable selling carbon credits is. That quarter, Tesla generated $554 million from selling carbon credits, representing 29% of the company's net income. Notably, carbon credit revenue jumped 94% in that quarter, year-on-year. 

What is a carbon credit?

Also known as a carbon emissions credit, the price of carbon credit differs according to geography and under different emission standards. For instance, the carbon emission standard in the European Union (EU) was 130 gr CO2/km between 2015 and 2019, with €95 for each excessive gram of emissions. Suppose the newly sold EV has a lower carbon emission than the EU standard. In that case, the deficit equals carbon emissions credit, which could be sold to manufacturers who could not meet the emission standard.

What is the logic?

The carbon credit market helps auto manufacturers offset carbon emissions by developing carbon reduction technologies, primarily renewable energy production. Renewable energy investment is crucial as the manufacturing process of EVs today still heavily depends on energy from fossil fuels, which are responsible for a large sum of emissions. 

Buying carbon credits helps automakers comply with regulations and continue their investments in electrification to benefit from these credits. But like Ford and GM, are all automakers able to focus on greener technologies in the space offered by carbon credits, or is it just buying time with no progress? 

How does it help the automakers? 

From the North American perspective, the US giants had their ups and downs, with ambitious zero-emission goals but also facing setbacks in the vast EV ecosystem, especially when it became overwhelming during the post-pandemic period with lacking supply chains. Ford announced that it would cut EV investments by $12 billion in October 2023, and General Motors (GM) also scaled back the EV plans following the talks with the United Auto Workers (UAW). After reaching a new labour deal, two giants announced cutting EV investments to manage costs. 

This is just one example automakers may face in the industry, not directly related to EV manufacturing. While Ford generated huge profits in 2023, the company's EV segment reported a $4.5 billion loss, and GM is not expecting earnings in the EV segment until 2025. GM also postponed opening its second electric truck plant in Michigan to 2025. 

In Europe, several automakers also faced similar slow-downs, including Volkswagen, which delayed the construction of a fourth EV battery plant due to decreased sales. The German giant plans to open up six new gigafactories in North America and Europe by the decade's end. At the beginning of 2024, VW announced the postponement of the mass production of €25,000 ID 2all EV by one year, starting in May 2026, due to the adjustments for the Euro 7 standard, which will come into effect in July 2025. 

What is the impact of the energy storage market?

It must be noted that carbon-generating businesses not only come from manufacturing BEVs but also from deploying energy storage units and renewable energy infrastructure, such as solar panels. Tesla is doing it all. 

Tesla's energy storage business has grown significantly in recent years, while many EV and battery projects have faced delays and setbacks. Tesla's leading products in this segment are Powerwalls and the massive Megapack battery storage systems. In 2023, Tesla deployed 14.7 GW/h of energy storage and tripled revenues since 2020, totalling $6.035 billion in 2023 from generation and storage. 

Witnessing the continuous growth of Tesla's energy storage segment, it could be said that the lucrative carbon credits impacted Tesla's green strategy. Nevertheless, the profits started to flow more than ten years ago, when many new entrants and significant OEMs were taking the first steps and struggling to meet emission regulations.  

For Tesla, the income stream from carbon credits is a great plus and, perhaps, a surprise. After over ten years of selling carbon credits, the demand is still strong, but this will change soon as new BEV producers enter the scene. The revenue stream of carbon credits has been questioned in the past, and Tesla will not rely on this business for decades to come.  

The former CFO (chief financial officer) of Tesla, Zachary Kirkhorn, warned the investors in 2020 about relying on carbon credits and stated that the revenue stream will not last forever and will eventually reduce. Hedge fund investor Michael Burry, who placed a long put option against 800,100 shares of Tesla in Q1 2021, equaling over $500 million, made another warning that "Tesla's reliance on regulatory credits to generate profits is an advantage as well as an impediment to the brand's long-term goals", in a later deleted tweet on X (formerly Twitter). 

Image: Tesla

 

Who is buying Tesla carbon credits?

While most of the Tesla credit buyers are not known, Chrysler is one of them, and it bought $2.4 billion worth of credits as of 2022. According to Reuters, another, who bought around 2 billion euros of European and US regulatory credits from Tesla between 2019 and 2021, appellants have underlined the high emissions during production and announced a more comprehensive sustainability strategy called Dare Forward 2030, aiming to reach zero emissions by 2038. 

Figures provided by Stellantis present the hardship automakers face in electrification, regardless of their human source and resources, requiring fully-fledged planning. Emmanuel Houery, Carbon Net Zero Worldwide Purchasing Manager at Stellantis, says, "Each part in an EV contributes to carbon emissions." Marcela Arrambide, Carbon Net Zero Engineering Manager, adds that "batteries, steel, and aluminium represent around 70% of the EV emissions alone" and that "getting everyone on board to meet the carbon reduction goals" is a monumental task for all EV manufacturers. 

Stellantis, with 14 automotive brands under its umbrella, aims to reduce CO2 emissions of EV parts by 40% by 2030, compared to 2021 levels. 

Tesla will likely continue enjoying substantial revenue in the mid-2020s, which is expected to change towards the 2030s. Under the Fit for 55 package, the EU aims to reduce passenger and commercial fleet emissions to 0gr CO2/km from 2035. And under the Inflation Reduction Act (IRA) guideline, introduced in 2022, the US aims to reduce greenhouse emissions (GHG) by %40 by 2030. The UK aims to eliminate GHG emissions by 2050 under the 2021 Net Zero Strategy. Even though delayed by five years, selling new petrol and diesel cars will be banned by 2035. 

China is another crucial market for Tesla to potentially benefit from selling carbon credits. According to Reuters, the joint venture formed by Volkswagen and the local FAW Group was expected to buy green credits from Tesla. According to Chinese media, Tesla was expected to generate around $390 million in 2021 by selling carbon credits to Chinese EV makers. But the details about the buyers are unclear. 

Does it help Tesla? 

It is unclear whether selling carbon credits provides much-needed relief to Tesla compared to its rivals and even slows down other projects on the timeline.  

In 2020, Tesla generated $1.6 billion from regulatory credits, which could also be called zero-emission vehicle or BEV credits, securing profits for four consecutive quarters, helping Tesla to join the S&P 500 index in December 2020. But following the successes on carbon credits, Tesla seemed to slow down projects, including the delayed release of the new Tesla Model S and X (expected launch year is 2025 for both) and the 4680 batteries, which was initially announced in 2020 (In October 2023, Tesla announced the production of 20 millionth 4680 cell). 

Tesla CEO Elon Musk also indefinitely suspended the acceptance of cryptocurrency to avoid an increase in the use of fossil fuels for Bitcoin (BTC) In May 2021. According to the US Energy Information Administration, cryptocurrency mining consumes between 0.6% and 2.3% of the electricity generated in the country annually. 

Tesla moved on with ambitious projects, including the already launched Tesla Cybertruck and Model 3 Highland, but shares dropped 20% in 2021 after exploding 740% in 2020. Volatility resumed since then; Tesla stock again surged in 2023 by around 102%. At the end of January 2024, Tesla shares plunged 12%, resulting in a $80 billion loss and the worst performance in the last 21 months. 

The reason? Slowing BEV sales and increased competition from Chinese EV manufacturers, primarily BYD. This could be tied to the massive growth in the energy storage segment, which will likely bolster carbon credit sales and boost renewable energy solutions. 

Another frontier against BYD? 

Under strict national and international regulations and clear zero-emission and sales targets, EV makers worldwide will eventually require fewer carbon credits from Tesla. 

Regarding China and the APAC region, Tesla may not enjoy record-breaking carbon emission credits as in North America and Europe. BYD, Tesla's most significant global rival, shows the potential to take over the dominance of carbon credits in essential markets, including China and Australia.
 
BYD surpassed the 3 million EV mark by the end of 2023 and took over the top BEV producer title from Tesla in the last quarter of 2023, delivering 526,000 BEVs, compared to Tesla's 484,000. 

The rivalry can refire in the global carbon credit market as Australia emerges as a new lucrative target. In February, the Australian Federal Government announced a new vehicle efficiency standard from 1 January 2025, restricting the average amount of CO2 emissions of carmakers released in a year. Exceeding the limit per gram/km of CO2 will result in a fine of 100 Australian dollars. 

The new standard also declares a new battle among the three BEV sellers in the country: Tesla, BYD, and Polestar. Who will be the most profitable? The question of how much the sold carbon credits will help zero emissions in the country is already creating curiosity. One thing is clear: Tesla will no longer enjoy 100% profits from carbon credits. 

The main image is courtesy of Tesla.

Authored by: Mufit Yilmaz Gokmen