Pollution Credit Cash Powered Tesla’s Profit Streak, But Its Top Customer Is Done Buying

Tesla’s seven-quarter profit streak owes much to billions of dollars it’s hauled in from selling regulatory credits to makers of gasoline-powered autos that need them to meet California, U.S. and E.U. pollution rules. But with its top buyer ending such purchases–and a deluge of electric models on the way from big carmakers and startups–Tesla’s lucrative credit business may finally be winding down.   

Carlos Tavares, CEO of Stellantis, the global automaker formed by the merger of PSA Group and Fiat Chrysler, told French news magazine Le Point this week that electric vehicle technology from PSA would allow the combined company to meet European carbon emission rules as early as this year. As a result Fiat Chrysler “will no longer have to pool with Tesla or anyone,” he said, according to a translation from Reuters, which said the carmaker bought $2.4 billion of Tesla credits from 2019 through this year. 

Tesla chief Elon Musk has said for the past decade that eventually the company’s credit sales would decline, yet year after year the value of those transactions only increased as the Palo Alto, California-based company’s vehicle sales grew. Since 2008, Tesla has reported cumulative credit sales worth $4.4 billion, with $2.69 billion of that coming just since 2019. That money has been particularly impactful since 2019’s third quarter when Tesla’s unprecedented profit streak began. Whether Musk’s EV powerhouse can stay profitable without those funds after 2021 remains to be seen.

“The credit income is a legitimate source of income–that’s Tesla playing out the regulations against their competition–but if you strip it out Tesla profitability is, to be kind, not very good,” says Philippe Houchois, London-based equity analyst for Jefferies. “The credit income is a nice subsidy that pays for part of the capex, but I don’t build it into my valuation.” And if it goes away, “it’s a shortfall but in theory, it doesn’t impact valuation.”

The $2.4 billion Fiat Chrysler has spent on Tesla credits is about 55% of the company has reported since 2008.

Stellantis’ announcement is “a headwind for the Tesla EV credit dynamic although we do not see it as a material impact in the near term,” said Daniel Ives, managing director for equity research at Wedbush Securities. “That said, if this trend continues with others it will be an overhang forward.”

Since Tesla’s vehicles emit no carbon or exhaust pollution, it’s been able to bank credits for each vehicle it sells that it doesn’t need. It began disclosing revenue from credit sales after the introduction of its original Roadster in 2008, when at the time they were purchased mainly by automakers seeking to comply with California’s Zero-Emission Vehicle mandate. The price is negotiated directly between Tesla and its buyers, and the company has never disclosed them on a per-vehicle value. Some credits have also been bought by automakers needing to meet U.S. corporate average fuel economy rules, but the E.U.’s push to cut carbon pollution in recent years created a lucrative new market for the company.    

Tesla, which no longer has a public communications team, didn’t respond to a request for comment on the matter. Musk also didn’t mention it on his Twitter account, the primary source of Tesla information.

“The credit income is a legitimate source of income–that’s Tesla playing out the regulations against their competition–but if you strip it out Tesla profitability is, to be kind, not very good.”

The loss of Stellantis as a credit customer “brings into question the future profitability of Tesla,” said Louis Navellier, chief investment officer of Reno, Nevada-based Navellier & Associates, which owns Tesla shares in a managed account.

In 2021’s first quarter, Tesla reported $518 million in regulatory credit sales, as well as a $101 million gain from selling 10% of its $1.5 billion Bitcoin investment. 

“Tesla made $619 million last quarter from ‘extraordinary’ items. Subtract that $619 million from the $438 million in net earnings and they once again lost money in their operations,” Navellier said. “With all of the facts that we have on hand now, it’s difficult to forecast profitability for Tesla in 2021, and with it may go the support of fundamental investors.”

Jeffries’ Houchois noted that an uptick in auto sales in the U.S. and Europe so far in 2021, rebounding from a drop in demand triggered by the Covid-19 pandemic last year, will likely boost that subsidy in the short term. “If we sell more cars this year than last year, effectively the demand for credit is higher,” Houchois says. “It’s the gift that keeps giving but eventually it goes away.”

That’s not likely to happen until 2022, at which point Musk’s decade-old prediction of declining credit sales becomes a reality. “The question is when does it go to zero?” Houchois said. “That’s the thing about Elon Musk: he’s often late but never wrong.”