As Tesla announced $5.98 billion in revenue Q1 and beat analyst expectations by $140 million, the real surprise was that even with the COVID-19 pandemic shutting down factories, Tesla still turned a profit — and surprised Wall Street with a 650% beat on earnings per share. According to its Q1 2020 update, while Tesla’s automotive sales dropped by over $1.2 billion in Q1, there’s one revenue stream that jumped 166% since last quarter: ZEV credits; in context, this means the revenue stream helped Tesla book a whopping $354 million in revenue.
So what are ZEV credits, who’s paying for them, and how is Tesla monetizing them?
ZEV credits provide outsized incentives for electric vehicle makers
As the generally increasing trend of emissions is a cause for concern, some geographic areas have put together incentive programs for automakers that are committed to reducing emissions on the road.
For instance, California started a program called the Zero-Emissions Vehicle program, commonly known as “ZEV,” which mandates automakers to sell a benchmark of zero-emissions vehicles based on metrics like gasoline and diesel sales. Since its inception, ZEV mandates have been adopted by nine other states, including New York, Vermont, Massachusetts, and Maryland. Similar mandates have even been implemented overseas, particularly in Europe.
For EV makers like Tesla, mandates like these are no problem — and they’re even incentives to keep going. That’s because whenever traditional automakers aren’t able to hit their own benchmarks, they can buy ZEV credits from Tesla to offset their own emissions.
Slow transition to electric vehicles fuel Tesla’s ZEV credits revenue growth
Since Tesla started selling emissions credits all the way back in 2010, the company has garnered huge customers including General Motors and Fiat Chrysler (the parent company of Dodge, Alfa Romero, and others).
The question is then: “Why don’t these giants just make EVs themselves instead of paying Tesla?” The answer: it all comes down to speed — and consequently fines.
That is, while automakers are working fast to make emissions-neutral vehicles, their operation doesn’t financially allow them to work fast enough. Across the field, automakers are missing the mark as it relates to regulations — except Tesla, which far exceeds the benchmark it needs to hit on producing ZEVs.
So, automakers often have a choice: either buy ZEV credits or face billions in fines. Whether the credits come from Tesla or not, most automakers don’t have excess credits as Tesla does, a principle that fuels the growth of Tesla’s regulatory credits revenue stream.
The revenue stream has challenges ahead
While emissions regulations have allowed Tesla to grow its credits revenue stream significantly over time, there are certainly challenges that stand in the way. Back in 2017, Trefis speculated in a piece it wrote for Forbes that the Trump administration could roll the ZEV program back, which would directly hurt Tesla’s revenue. There has been some indication of this intention, but nothing has been set in stone yet.
Aside from policy, as companies produce more EVs themselves, they may very well have the leeway to put up their own ZEV credits for grabs, flooding the market with supply and driving down value per credit.
So while Tesla’s regulatory credits revenue stream is currently doing well, the company won’t be without its challenges.
This article was originally published at Forbes, where I also maintain a column.