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Tesla has sold over $1 billion emissions credits this year — and that revenue is its reward for taking on massive risk

  • Tesla has sold over $1 billion in regulatory credits in 2020, helping the company post three straight quarters of profits this year.
  • Critics argue that Tesla's profits are reliant on credits, but they're overlooking the fact that Tesla has to spend a staggering amount of money to build the cars that qualify for credits.
  • The electric-car business is also still risky: Just 2% of annual sales are EVs.
  • Tesla has always embraced this risk, and as far as regulatory credits go, the company is reaping rewards.
  • Visit Business Insider's homepage for more stories.

Tesla has sold about $1.2 billion in regulatory credits so far in 2020. These are bought by other automakers who aren't making enough vehicles with electric batteries in them to meet the demands from California and a few other states that automaker sell at least some zero-emissions vehicles to earn the right to put gas guzzlers in people's driveways. 

The revenue has been significant for Tesla, and this year's no different: $354 million in the first quarter, $428 million in the second, $397 million in the third. Without that cash, Tesla might have either lost money or eked out narrow profits.

With them, the company has pleased investors and is now sitting on a market capitalization of almost $400 million, making it the world's most valuable carmaker despite selling a fraction of the vehicles Toyota, Volkswagen, or General Motors does in a year.

Some critics call this an unfair subsidy, or point out that competitors are essentially sending money to Tesla's bottom line at the expense of their own.

But automakers who sell mainly gas-powered vehicles have enjoyed a massive subsidy in the US market for many years: The federal gas tax hasn't been raised since the 1990s. That effective discount has enabled them to bring big, expensive SUVs and pickup trucks to market, and to build up major cash reserves on their balance sheets, undertaking stock buybacks and dividend payouts. Those have kept investors placated while share prices have remained flat for a decade, and provided funds to develop new electric vehicles to compete with Tesla.

That's something of a virtuous circle, then, and when you think about it, the critics' arguments collapse.

Risk, risk, and more risk

Beyond that, Tesla can sell over a billion dollars in credits in three quarters because it has spent a decade gobbling up all the risk when it comes to EVs.

Even though nary a week seems to pass without some automaker announcing a new electric vehicle, the market has only been around since roughly 2010, when the only practical all-electric car on sale by a major car company was the Nissan Leaf. When Nissan launched the EV, it expected 10 to 15% of global sales to be electrified by now. Instead, just about 2% of new car sales in the US are electrics.

So if you'd bet big on anybody other than Tesla in those days, you'd have been sorely disappointed.

That's almost the definition of a risky market. And what people don't seem to understand about risk is that it isn't a natural resource, waiting to be dug out of the ground. It has to be created. 

Cars, factories, Superchargers, and employees

For much of Tesla's 17-existence, risk has been its main product. That's why Tesla's story, at least since 2010, has been so much about the battle between bulls and bears, investors with long positions and investors who are short the stock. The main mechanism we have in capitalism for valuing risk is the financial markets. 

Of course, Tesla couldn't simply print up some risk and sell it. The company had to do something, generate business, make things. So while it was minting risk, it was also manufacturing all-electric cars (and later solar panels and battery storage systems, not to mention building factories). 

It turns out that the undertaking intersected with the desire of California and other states to take action on climate change. At the federal level, the government also wanted to encourage innovation in the transportation sector and assisted Tesla is overcoming a near-death experience around the time of the financial crisis by arranging for a Department of Energy loan guarantee.

Enter regulatory credits, which could be construed as payment for risk. Tesla CEO Elon Musk has complained in the past about the mechanics and pricing of credit sales, but there's no debate they're important an revenue source for the company.

The credits aren't free, although some Tesla bears want you to think they are. Tesla piles them up by selling hundreds of thousands of EVs. The manufacturing process and related businesses now employ some 40,000 people and have created investments in Tesla's home state, California, Nevada (location of Tesla's large battery factory) and soon Texas, where the company plans to build a new plant.

Get ready for Tesla to sell a lot more regulatory credits

Making cars is an extremely costly way to obtain regulatory credits. And besides the capital-intensive car business, Tesla also has to maintain a global network of fast-charging stations, as well as sales and service locations. If you take the third quarter as an example, Tesla had to spend about $1.2 billion operationally to even have the option of selling $397 million in credits. 

Assuming that the regulatory credit regimes aren't retired, it's possible that they could expand, as citizens decide to use some Econ 101 techniques to fight global warming. Tesla is on track to sell 500,000 vehicles in 2020, and Musk has said that the company eventually needs to make enough vehicles to replace, every year, 1% of the world's fleet, some 2 billion cars and trucks.

That means regulatory-credit sales that make today's totals look like a drop in the bucket. 

But if you take on immense risks, you should enjoy equally immense rewards.

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