- Tesla dominates the renewable energy credit (REC) market for clean vehicles, an environmental financing tool that is responsible for the company’s string of quarterly profits.
- A new credit market for zero-emission trucks will take effect under California’s Advanced Clean Truck rule.
Tesla (NASDAQ: TSLA) is set to release its Q3 2020 earnings on Wednesday, and expectations are high.
Ahead of the earnings release, the electric vehicle (EV) company has released figures showing it delivered a record 139,300 cars and produced more than 145,036 vehicles between July and September.
Although all eyes are on Tesla vehicles, its path to success so far isn’t the Model Y, the new gigafactory — or the long-delayed Tesla Semi. It’s the company’s total domination of the renewable energy credit (REC) market, an environmental financing tool that is responsible for Tesla’s string of quarterly profits.
In Q2 2020, Tesla revenue from the REC market was $428 million, triple the amount generated in Q2 of 2019.
“They would not have posted a profit without that revenue,” said Garrett Nelson, an equities analyst at CFRA Research. “It’s the number one factor why Tesla beat analyst estimates by so much.”
As Nelson explains, “what is underappreciated is the margins on those credits are so high.” While the actual manufacturing of vehicles is a low-margin, high fixed-cost business, he said, there is no cost associated with generating REC revenue. The cash goes directly in Tesla’s pocket, helping offset the huge costs of getting EV manufacturing plants up and running.
Tesla’s REC revenue is expected to increase in the third quarter, Nelson said, and even more so in the fourth quarter thanks to its record third-quarter production.
Tesla did not immediately respond to FreightWaves’ request for comment.
Sales mandates drive market
The REC vehicle market exists as a result of regulations in California and other states with zero-emissions sales mandates. Those states require OEMs to sell a certain number of clean light-duty vehicles. If vehicle manufacturers can’t meet their quota, they must buy RECs from companies that do.
Right now, Tesla is the top seller — by far. As Nelson points out, Tesla accounted for around 58% of all EVs sold in the U.S. last year. All those vehicles are zero emissions, whereas for most of the traditional manufacturers, EVs are a very small percentage of the overall mix.
“So [Tesla] is in the enviable position of selling credits to other manufacturers: General Motors (NYSE: GM) Ford, Chrysler,” Nelson said.
A GM spokesperson was not immediately able to track down information regarding the company’s REC payments.
Trucks to enter the credit markets
More states, along with other jurisdictions, are expanding their credit programs, granting new categories of vehicles including heavy-duty trucks access to the financing mechanism.
“The credit market for zero-emission trucks through the Advanced Clean Truck (ACT) rule will likely be robust and, on a per-credit basis, possibly more valuable than the light-duty credits,” said Patricio Portillo, a transportation analyst with the Natural Resources Defense Council’s climate and clean energy program.
The ACT rule, approved by California regulators in June, requires truck manufacturers to sell an increasing percentage of zero-emissions trucks, with a goal of phasing out diesel models completely by 2045.
In an email to FreightWaves, Portillo said the penalty for noncompliance is higher under the truck rule, which means the credit ceiling price could be higher.
“These regulatory credits are valuable revenue streams for zero-emission truck manufacturers,” he said, “and are even more crucial when state incentive dollars are limited.”
This summer 15 U.S. governors signed an agreement saying they will pursue zero-emission requirements for commercial trucks, opening up the credit market and potentially allowing Tesla to earn credits from the Semi truck.
Other electric vehicle companies such as Rivian, maker of Amazon’s new delivery van, would also benefit.
Rivian did not immediately respond to a request for comment.
Lack of transparency
Although investors understand the REC mechanism far more than they did in the recent past, “it’s not as transparent and liquid as the equity and bond markets, and each company’s disclosure is different,” Nelson said.
“One of the difficulties we face as analysts is trying to forecast that line item,” complicating efforts to forecast Tesla’s overall revenue.
Nevertheless, Tesla’s credit disclosure is better than the other companies, according to Nelson, which is not a surprise, given the company’s reigning status.
“With Tesla, it’s a material part of overall revenue and a growing part,” he said.