Technology

What are “Regulatory Loans” – and why are they so important to Tesla?

what-are-regulatory-loans-and-why-are-they-so-important-to-tesla

Elon Musk, Tesla CEO, speaks at a delivery ceremony for the Tesla China-made Model 3 in Shanghai, east China, on Jan. 7, 2020.

Ding Ting | Xinhua News Agency | Getty Images

Tesla’s reliance on so-called regulatory loans to make money came back into the spotlight after a regulatory filing revealed that investor Michael Burry had placed a $ 534 million bet on the electric automaker.

Burry, pictured in Michael Lewis’ book “The Big Short,” has a short position in the company – he is betting that Tesla stock will fall.

In a now-deleted tweet, the famous hedge fund manager said Tesla’s reliance on regulatory credit to generate profits was a red flag.

Tesla had $ 518 million in revenue from regulatory loan sales in the first quarter of the year and helped the US-based electric vehicle maker earn another quarter of the profit.

What are regulatory credits? How do you work?

In order to reduce CO2 emissions, governments around the world have created incentives for automakers to develop electric vehicles or cars with very low CO2 emissions. Car manufacturers who build and sell environmentally friendly vehicles receive loans.

The United States, California, and at least 13 other states have regulatory credit requirements in place. They require automakers to produce a certain number of so-called emission-free vehicles (ZEV) based on the total number of cars sold in that particular state.

Automakers who make such cars receive a certain number of credits based on factors such as the range of the vehicle. ZEVs with a greater range receive more credits.

These automakers are required to have a certain number of regulatory credits each year. If they can’t achieve the goal, they can buy them from other companies that have excess credit.

Because Tesla only sells electric cars that fall under the ZEV category, the company always has excess regulatory credits and can effectively sell them for a 100% profit.

Regulatory loans in China and Europe

It’s not just the US that has such a credit system. The European Union and China have similar rules.

In China, regulatory credit requirements for automakers have steadily increased since 2019 and will continue to do so. Chinese regulations determine the amount of credit per vehicle based on a number of factors, including the range of the vehicle.

Tesla will also earn those green loans in China, one of its key markets – but one where it encountered a ton of negative publicity last month.

Last month, Reuters reported that a joint venture between German automaker Volkswagen and Chinese state-owned FAW had agreed to buy loans from Tesla in China.

Tesla wasn’t immediately available for comment when CNBC contacted him.

In Europe, legislators have aggressively tried to reduce emissions from cars. In 2020 the European Union announced that the average CO2 emissions from cars must not exceed 95 grams per kilometer. Automakers who go above and beyond this could be forced to pay hefty fines.

There are incentives in the form of “super credits” for vehicles that emit less than 50 grams of CO2 per kilometer in order to promote the development of low-carbon vehicles.

Tesla’s regulatory credit business model

Since Tesla receives all of these regulatory credits for free, Tesla can essentially sell them for a 100% profit. This has been the reason for the most recent profitable quarters.

But Burry’s concern about the automaker’s confidence in these loans is shared by others.

In Tesla’s fourth quarter 2020 earnings call earlier this year, Tesla CFO Zachary Kirkhorn was asked about his outlook on regulatory loan sales in 2021. However, he said it was difficult to predict.

“What I said earlier is that selling credit is not going to be an integral part of the business in the long run and we don’t plan the business after that,” he said at the time. “It’s possible it could stay strong for a handful of additional quarters. It’s also possible that it doesn’t.”

Tesla relies on major automakers to buy credit.

One example is Stellantis, a company formed through the merger of the French PSA group and the Italian company Fiat Chrysler Automobiles. According to Reuters, Stellantis bought European and US green credits from Tesla for around 2 billion euros between 2019 and 2021.

Carlos Tavares, the CEO of Stellantis, said in an interview with French publication Le Point that the company could meet its emissions targets this year.

This means there will no longer be a need to buy loans from companies like Tesla and Tesla could potentially lose a major customer of its regulatory loans.

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Katherine Clark