A study of the contribution of Zero Emission Vehicle (ZEV) credits to Tesla Inc. revenue.

1. Tesla has been the beneficiary of a large number of
government incentives at both the federal and state levels.
One of theses incentives, the Zero Emission Vehicle credits
(ZEVs) is perhaps the most guarded and shrouded of the
benefits earned by the company.
I attempt to understand what these credits are worth to the
company and whether the revenue stream they generate is
sustainable in the long-run.
Author: Rahul Deorukhkar
Slide
Number Topics
1 &2 The ZEV: Brief intro to concept and
regulations
3 Value creation factors in ZEV market
3 Sample case: Application of ZEVs to market
5 Benefit of ZEV trading to Tesla
6 & 7 Sustainability and Strategies for the future
8 Political and policy uncertainty
9 Final outlook and Sources
Tesla’s
Unconventional
Revenue Model

2. 1. Zero Emission Vehicle (ZEV) program is a California state regulation managed by The California Air Resources Board
(CARB) that requires automakers to sell electric cars and trucks in California and 9 other states.
Objective
Ensure that automakers research, develop, and market electric vehicles (EVs), which generate fewer global warming
emissions than gas-powered cars, and which don’t produce tailpipe pollution.
What is the ZEV ?
Whom does the ZEV apply to?
Auto manufacturers that sell more than 20,000 vehicles per year in California and have annual global revenue more than
$20 billion, known as Large Volume Manufacturers.
ZEV Credit : Creation of a currency
1. ZEV program assigns each automaker “ZEV credits.” Automakers are required to maintain ZEV credits equal to a set
percentage (4.5% as of 2018) of non-electric sales.
2. If an automaker doesn’t produce enough electric cars to meet its quota, it can choose to buy credits from other
manufacturers who do or pay a $5,000 fine for each credit it is short.
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3. Demand for the ZEV currency
1. Manufacturers are allowed to carry over excess credits from one year to the next.
2. In addition, automakers can purchase or trade ZEV credits from other manufacturers.
Reason for Demand glut till 2018: A policy Loop-hole
1. The Travel provision allowed automakers to receive credits in all other ZEV states for vehicles sold in California,
proportional to the vehicles sales in the states.
2. They received the credits in all ten states (California+9) despite only selling one vehicle (in California).
3. As a result of this multiple counting, auto companies have accumulated a stockpile of credit in states where they haven’t
sold many electric cars or trucks.
4. The provision has also created an incentive to concentrate sales of battery electric and fuel cell vehicles in California.
The Solution:
1. Since 2018 the travel provision has been removed, except for fuel cell vehicles.
2. The new Pooling provision allows automakers to over-comply in one ZEV state and transfer the extra credits to another
ZEV state.
3. Unlike the earlier travel provision, it will avoid double-counting, while still requiring that an actual vehicle is produced
and sold before credit is rewarded.
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4. ZEV Credits
Value Realization
Depends on
Supply-Demand
Maintain ZEV credits equal to a set
percentage of non-electric sales or pay a
$5,000 fine for each credit they are short.
Creation of Value in the ZEV regime
A demand and supply game
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5. How the ZEV Credits work ?
Number of Credits = % Credit requirement x Total vehicles sold
Year of
Implementation
Vehicles
Sold
(Assumption)
% Credit
requirement
Credits
mandated
Current FY2018 1,00,000 4.5% 4,500
Proposed FY2025 1,00,000 22.0% 22,000
This does not imply that Manufacturers need to sell 4,500 electric
cars and trucks, as most ZEVs generate more than one credit per
vehicle (depending on the vehicle credit formula)
Regulation
recognized ZEVs Definition Credits
1 Plug-in hybrid
vehicles
Combine a conventional
gasoline-powered engine with a
battery that can be recharged
from the electrical grid.
0.4 to 1.3
2 Battery electric
vehicles
Run entirely on electricity and
can be recharged from the
electricity grid.
1 to 4
3 Hydrogen fuel cell
vehicles
Run on electricity produced from
a fuel cell using hydrogen gas.
1 to 4
Not every EV is treated the same
Assuming 1,00,000 vehicles manufactured at 4.5% credit
requirement
Type Popular
Electric
Vehicles
Range
(in Miles)
Credits
(Past)
Credits
(Present)
Number of cars
to be
manufactured
for 4500
credits
EV Tesla Model S 200+ 3.3 4.0 1125
EV Nissan Leaf 84 1.8 3.0 1500
FCEV Honda Clarity NA NA 9.0 500
FCEV Toyota Mirai 312 NA 9.0 500
PHEV Prius Prime 25 NA 0.9 5000
PHEV Chevy Volt 53 NA 1.3 3460
ZEV Fiat 500e 80 NA 1.7 2650
Fine Tuning the ZEV Credits
• ZEV credits increase with a vehicle’s all electric range
(AER). Credits equal 0.01*AER+0.5.
• Each vehicle gets 0.5 credit plus 1.0 more credit for each
additional 100 miles of range.
As an All-Electric manufacturer, Tesla always has a surplus of ZEV
credits for sale, which makes it a lucrative revenue stream.
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6. How is Tesla benefited by this ?
1. As Tesla sells only electric vehicles, it racks up a
massive number of ZEV and non-ZEV credits (credits
are earned by Tesla outside the Zero Emissions
Vehicle regime).
2. Consider ZEVs as a bonus payment for Tesla's
shouldering the risk of being the only all-electric
carmaker in the US.
3. Tesla would essentially incur no direct costs to earn
them.
4. These credits can be saved up and traded at any point
in the future, although their value may be quite
volatile (depending on demand-supply dynamics).
5. The timely and strategic sale of ZEV credits has
helped the company mitigate the extent of its overall
losses (as evident from the table).
Source: Annual SEC 10-k filing for Tesla
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Revenue (Figures in $ Billion) FY2018 FY2017 FY2016 FY2015
Automotive sales 17.63 8.53 5.59 3.43
Automotive leasing 0.88 1.11 0.76 0.31
Total automotive revenues 18.51 9.64 6.35 3.74
Services and other 1.39 1.00 0.47 0.29
Total Automotive Service + Sales 19.91 10.64 6.82 4.03
Energy Generation and storage 1.56 1.12 0.18 0.01
Total Revenues 21.46 11.76 7.00 4.05
Cost of Revenues
Automotive sales 13.69 6.72 4.27 2.64
Automotive leasing 0.49 0.71 0.48 0.18
Total automotive cost of revenues 14.17 7.43 4.75 2.82
Energy generation and storage 1.36 0.87 0.18 0.01
Services and other 1.88 1.23 0.47 0.29
Cost of revenues 17.42 9.54 5.40 3.12
Gross profit 4.04 2.22 1.60 0.92
Operating expenses
Research and development 1.46 1.38 0.83 0.72
Selling, general and administrative 2.83 2.48 1.43 0.92
Restructuring and other 0.14 - - -
EBITDA -0.39 -1.63 -0.67 -0.72
% EBITDA -1.8% -13.9% -9.5% -17.7%
EBITDA excluding Revenue from ZEV -0.81 -1.99 -1.10 -1.02
% EBITDA excluding Revenue from ZEV -3.8% -16.9% -15.7% -25.2%

7. Short term Price volatility
1. ZEV credits should theoretically be worth about $5,000 (the fine for non-compliance). But their market value is typically lower.
2. For example, over the 1st half of the FY2017, Tesla sold around $100 million in ZEV credits. Assuming that Tesla sold about
16,000 cars in states that offer ZEV credits over the period (about one third of the company’s 47,000 cars delivered for 1st half
of FY2017), revenue from ZEV credits per vehicle sold would stand at about $6,250.
3. Assuming 4 credits per Tesla, this would amount to an average trading price of ~ $1,600 per credit.
Long Term Devaluation
1. Moreover, with electric vehicles gaining traction, there is a possibility that the number of credits available in the market will
start to outstrip the number of credits required by manufacturers, causing prices to decline.
2. Tesla’s own mass-market Model 3 could itself boost the supply of ZEV credits, with the company targeting a run-rate of 500k
vehicles next year.
Is this strategy Sustainable in the long run ?
Auto Sales Revenue
(Figures in $ Billion)
FY2018 FY2017 FY2016 FY2015
Revenue 17.63 8.53 5.59 3.43
% Growth 106.6% 52.7% 62.9%
Revenue from ZEV 0.42 0.36 0.44 0.30
% Contribution to revenue 2.4% 4.2% 7.8% 8.8%
However, despite drastically increasing sales
y-o-y, the contribution of ZEVs to the top-
line has been reducing, belying a shortage of
demand.
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8. Strategy Matrix for players involved
Scenario A Scenario B
Credit trading policy remains the same Credits tradable in a year are limited by regime
Scenario 1
Mandate Level
remains same
(4.5% of sales)
• Currently Supply> Demand because of Travel
provision credit back-up.
• As credits are trading at a discount, it makes sense to
buy credits rather than ramp-up EV production
through expenditure in R&D and marketing (Counter-
intuitive to ZEV program objective).
• Long-term: It may make sense to acquire smaller EV
companies, preferably in the FCEV segment or
manufacture in that segment owing to higher credits
earned.
• Although Travel-provision stock piles would take longer
time to be wiped out, the resulting market would be
much more sustainable for all players.
• Tesla's ZEV credits would begin to appreciate for a
while, allowing for other players to ramp-up EV
production and marketing gradually.
• Once all players have levelled up, Tesla’s credits will be
rendered worthless .
Scenario 2
Mandate
becomes strict
(22% of sales)
• Higher number of Credits will be required.
• Short-term: Supply excess will be wiped out quicker
and credits will begin to trade at fair price or
premiums, which will benefit Tesla.
• Long term: Consumer-demand and prices would limit
the market size. This would put a burden on Non-EV
profit margins. This move would be opposed by
lobbyists, unless consumer demand can be
supported with tax credits and cheap financing
options.
• Not sustainable.
It would wipe out the excess credit too fast.
• There would not be an EV market size to support Non-
EV sales. Even Tesla credits would be insufficient.
• None of the other players would buy into this scenario.
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9. 1. Zero Emission Vehicle (ZEV) program is a California state
regulation that requires automakers to sell electric cars and
trucks in California and 9 other states. Most of these states
are Democratic Party leaning as evident from a comparison
of the two maps.
2. Under Section 177 of the Clean Air Act, individual states are
given the right to adopt California’s vehicle emissions
regulations, but may not develop their own.
Source: Centre for Automotive research
The Trump Administration proposed to withdraw the waiver of the
Clean Air Act pre-emption for California’s Advanced Clean Car (ACC)
program, Zero Emissions Vehicle (ZEV) mandate and Greenhouse
Gas (GHG) standards that apply to MY’s 2021 through 2025.
Source: Wikipedia|2014 Elections
ZEV runs into the political wall
States following California’s Low
Emission Vehicle (LEV) regulations.
States following California’s LEV
and ZEV regulations.
States with intention to follow
California’s LEV and ZEV regulations.
Signees of petition for review, but
are not LEV and ZEV states.
Democrat states
Republican states
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10. The long term outlook:
• In case you were making Financial projections for Tesla,
it would be prudent to reduce the contribution of ZEV
credits to Tesla’s top-line going forward.
• The ZEV credits will not be able to cushion Tesla for
long. The market for ZEV credits is rapidly changing
with players like Toyota and Honda entering with
Higher ZEV rating FCEV offerings. This would undercut
the existing demand for Tesla’s credits.
• As more of the manufacturers begin offering EV
products, they will wean away their dependence on
Tesla credits.
• If Tesla is aiming to stay put in the transportation
market, it would have to begin focusing on ramping up
its production and create a market (since there isn’t
much of an existing market to capture in this case).
Sources and links for further reading:
1. Tesla Annual Report: sec.gov:
https://www.sec.gov/Archives/edgar/data/1318605/000156459019
003165/tsla-10k_20181231.htm
2. Union of Concerned Scientists: https://www.ucsusa.org/clean-
vehicles/california-and-western-states/what-is-zev
3. Business Insider:
https://www.businessinsider.in/A-zombie-argument-has-come-back-
to-undermine-Teslas-most-recent-profitable-
quarter/articleshow/66515838.cms
4. Forbes:
https://www.forbes.com/sites/greatspeculations/2017/09/01/teslas-
lucrative-zev-credits-may-not-be-sustainable/#73a507d46ed5
5. Centre for Automotive Research:
https://www.cargroup.org/fuel-economy-and-greenhouse-gas-
regulation-in-the-united-states-change-is-coming-part-3/
6. Green Car reports:
https://www.greencarreports.com/news/1116711_automakers-
play-high-stakes-carb-game-to-earn-zero-emissions-vehicle-credits
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