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Will The Tesla Inc. Model 3 Finally Make Electric Cars Mainstream?

From Zacks: The market for electric vehicles (EV) and plug-in hybrid electric vehicles (PHEV) has been growing at very strong double-digits, of course off a very small base.

As a result, they were a little under 1% of total passenger car sales in 2016. But market watchers believe that 2016 was like the appetizer before the main course with 2017 and 2018 expected to see some momentum. This is not without reason because things do appear to be coming together for the market.

Regulatory Support

Most important amongst these reasons is the fact that world leaders are coming together on environmental and climate change matters. There is a visible effort to promote clean energy in every aspect of life. Since auto emissions are one of the biggest reasons for air pollution and also contribute to global warming, this is where a lot of research is going on.

Within the U.S., there is the Zero Emission Vehicle (ZEV) mandate that has been adopted by 10 states led by California and including Connecticut, Maine, Maryland, Massachusetts, New Jersey, New York, Oregon, Rhode Island and Vermont. The goal is to push automakers to research, develop and sell zero emission cars (these would be EVs rather than PHEVs although both receive some benefit).

The ZEV authority of the concerned state certifies ZEVs, which then qualify for credits. An automaker has to sell a steadily rising number of EVs each year to meet the credit goal in a given year. For instance, in 2018, the percentage of zero-emission passenger cars and light-duty trucks produced by the manufacturer and delivered for sale is required to be 4.5%, in 2019 that number will rise to 7.0%, in 2020 it will be 9.5%, 2021 12.0%, 2022 14.5%, 2023 17.0%, 2024 19.5% and 2025 22.0%. So far so good.

In February, the Auto Alliance trade group approached President Trump to relax the requirements from 2022 to 2025 because they say that Obama rushed through the mid-term review without taking into consideration upcoming research that would show the targets to be too burdensome. But President Trump has his work cut out if he is to relax the requirements, because he along with the Transportation Department would have to ask the Environmental Protection Authority to revise their rules and cancel a couple of waivers to the State of California that allow the state to frame its own stricter rules if the federal government relaxes.

Moreover, California’s rules can be adopted by other states, creating a messy compliance problem for automakers. So stopping California becomes important.

So any alterations will take time and involve a complex process. Moreover, even if they are done, it will be a moderation of the rule rather than a directional change. Bottom line: the regulatory environment remains positive for EVs.

Rapidly Falling Battery Costs

Batteries are of course extremely important for electric cars because they determine how far they can go on a single charge. So the cost of the battery pack (the individual cells plus the supporting structure, cell cooling mechanisms and battery management systems) also determines to an extent the price of the car itself.

According to a recent McKinsey report, battery costs have dropped from around $1,000 per kWh in 2010 to around $227 per kWh in 2016. McKinsey expects battery pack prices to drop to around $190/kWH by 2020 and $100/kWH by 2030, at which time the business is expected to be profitable for automakers.

But R&D appears to be moving faster than estimates because Tesla (TSLAFree Report) has said that it’s already using a battery pack below the $190 range and expects to lower cost by another 30% before the Model 3 gets to market. The company, along with partner Panasonic has started mass production for its other storage products at the Gigafactory in Nevada.

Production for the Model 3 will start in the second quarter and capacity can be expanded as needed (estimated to be 35 GWh/year in 2018, or nearly as much as the rest of the rest of the world’s battery production combined). Musk claims that Gigafactory makes the “highest energy density cell in the world and also the cheapest”. So let’s hope they will allow the Model 3 to enter the market at the targeted $35,000 price point for mass market adoption.

Tesla isn’t the only one making progress. General Motors (GMFree Report) product chief Mark Reuss has reportedly said that the Chevy Bolt uses battery cells (not the entire pack) costing $145 per kWh and is working to lower that number.

An ancillary factor that can also help adoption is convenient and possibly wireless battery charging options. We seem to be really far from this today, not because the technology isn’t there (it almost is), but because the number of battery charging stations are nowhere near the number of gasoline stations, so there’s some infrastructure catchup waiting to get done there.

Increasing Product Range

The most popular electric and hybrid cars in 2016 were the Tesla Model S, Chevy Volt, Tesla Model X, Ford (FFree Report) Fusion Energi, Nissan LEAF, Ford C Max Energi and BMW i3. Of these, the Tesla cars, the Nissan LEAF and the BMW i3 were fully electric with the rest being hybrids.

This year will see new fully electric models from players like GM, which launched the Chevy Bolt last December. Initial testers sound enthusiastic about the car despite its somewhat boxy design. So they could be popular with customers and also government departments that may not be so hung up on the more sexy Teslas.

Tesla itself will launch the more efficient and lower-priced Model 3 (with autopilot and possibly, a solar roof option), but the launch date can have something to do with how many it manages to sell.

Then there’s also BMW, which estimates that it will sell 100,000 i3s this year, up from 40,000 last year. The company expects EVs and PHEVs to make up 15-25% of its sales by 2025 as it gradually electrifies all the BMW Group brands.

Another car that picked up steam in the fourth quarter of 2016 is the hybrid Toyota (TMFree Report) Prius Prime, so 2017 could see an uptick.

One limiting factor for EVs and hybrids is their availability. If customers can’t test drive the vehicle, they most likely won’t place an order. Testing is largely available only in the ZEV mandate states.

Growing Consumer Interest

Low gas prices are an obvious deterrent to buying clean energy vehicles, but lower costs and discounting in some cases make them attractive. Plus, they also get a federal tax break. All this combined is leading to increased awareness of the concept, which could result in a spike in sales.

Possible Problems for Tesla

Increasing Competition: We now know quite a bit about Tesla’s battery production and also know that it intends to sell 500,000 electric cars a year by 2018 (that’s next year). This is an exciting number on its own, but today there are a growing number of players in the space, increasing choice for consumers.

Tesla’s edge is in its design and autopilot system, and its battery technology that can allow it to give more at lower prices while making more profit. All these advantages may be put to the test more now than ever before.

Cash strapped/competitors have deeper pockets: Tesla makes fully electric cars, which has both its positive and negative sides. In the current environment, since it produces only all-electric cars, it generates a whole lot of credits it doesn’t need in the ZEV states. So it can sell these for a profit to those who need it, thus helping its profits and cash flow. This isn’t of course enough to keep a leading edge company afloat because the thing that keeps it ahead of peers is R&D, which is expensive.

The company has raised cash through both equity and debt so the Model 3 launch will go smoothly. But it certainly doesn’t have a whole lot of marketing dollars left over, which will come in handy as the established automakers sink their teeth into EVs.

Bottom Line

Tesla still appears to be well ahead of the pack. Not only is its battery tech more advanced, but it also has a fully compliant glass roof, which may be used to generate solar power to drive the car. Yes, others have tried it with limited success (such as the Prius). And no, that doesn’t mean Tesla won’t do a better job.

The glass roof means that there probably won’t be too much extra cost to add the PV cells, so who knows? After battery cost reduction, battery charging is the next big problem to solve in order to hasten electric car adoption and what can be better than a free-of-charge, auto recharge system?

Tesla Inc (NASDAQ:TSLA) was trading at $256.76 per share on Friday morning, up $1.98 (+0.78%). Year-to-date, TSLA has gained 20.16%, versus a 4.90% rise in the benchmark S&P 500 index during the same period.

This article is brought to you courtesy of Zacks Research.

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