Tesla’s $7 Billion Climate Change Problem?
An electric vehicle company with a $7 billion climate change problem? How Tesla’s supply chain puts it at risk in an age of climate change.
How could an innovative electric vehicle company have a $7 billion climate change problem? Tesla has made its name – and earned a 7x revenue multiple – popularizing electric sports cars that many hope will serve as a role model for how to clean up the 26% of U.S. carbon emissions from transportation.[1],[2] However, supply and demand shocks related to climate change could jeopardize Tesla’s survival.
Tesla’s thin supply chain may be the company’s weakest link in adapting to climate change. While producing the bodies of its vehicles in-house, Tesla relies on a globally dispersed supply chain for over 3,000 parts.[3] Of Tesla’s 350 suppliers, the vast majority are “single source” suppliers, i.e. the only places in the world that Tesla gets critical components, including its motors, brakes, microcontrollers, and batteries. Many of Tesla’s suppliers rely on highly customized machinery and proprietary knowledge that are difficult to replicate quickly.
We have seen what can happen to the global auto industry when natural disasters destroy supplier operations. In March 2011, the Tohoku earthquake and tsunami wreaked havoc on Japan’s automotive industry. Carmakers a world away were buffeted by the aftershocks as they struggled, in some cases for months, to locate alternate suppliers for essential microcontrollers and automotive chemicals. Global automakers outside Japan lost half a million units of vehicle production in the aftermath of the tsunami as a result of supply chain shocks.[4] Later that fall, after severe flooding wiped out 75% of Thailand’s automotive suppliers, it took some global automakers up to six months to restore operations at their Thai factories.[5]
With a changing climate, the incidence of extreme weather events will increase. Already, in the United States the average annual damage from severe storms and flooding has increased by 1,000% to over $17 billion since 1980.[6] Never-before-seen “century storms” are also on the rise. In 2004 Brazil experienced its first-ever Atlantic hurricane, a phenomenon once thought impossible. In 2013 the Philippines faced “super typhoon” Haiyan, the strongest typhoon on record. Even sunny California, where Tesla bases the bulk of its manufacturing is not immune. Hotter temperatures and prolonged drought have sparked the rise of extreme wildfires such as those in 2015 that burned 10 million acres and destroyed $3 billion of property.[7]
All companies must wrestle with increasing risk to their operations both abroad and at home. But Tesla, with its thin supply chain, faces a particularly costly challenge. A three-month supply chain disruption could easily cost Tesla over $1 billion in lost sales at today’s production levels, and over $6 billion at 2018’s projected output.[8] Tesla states that it is looking to diversify its supply chain spurring industry rumors and numerous press articles about whether Tesla is courting battery suppliers in Korea even while building its Gigafactory with Panasonic in Nevada. However, Tesla’s financial statements reveal a complacency around its supply chain resiliency, repeatedly disclosing that a majority of Tesla’s supply chain relies on single-source suppliers.
Tesla faces additional climate change risks on the demand side, although this time from climate change regulation. Electric vehicles produce 53% less lifetime greenhouse gas emissions than a conventional car, but their production – particularly the addition of large lithium-ion batteries – generates far more emissions at the start.[9] The Union of Concerned Scientists estimates that a Tesla Model S requires 6 tons, or 68% more, carbon dioxide to produce than a similarly sized conventional sedan.[10]
Tesla’s long-term strategy to scale sales of its vehicles relies on reducing the cost of its current $75,000 Model S sedans down to a more affordable $35,000 Model 3 series. However, should the U.S. government implement a carbon pricing scheme to reduce emissions of greenhouse gases, Tesla would immediately face a larger sticker price increase than its conventional vehicle competitors. Depending on the price of carbon, Tesla’s Model S vehicles could face an additional $3,000 charge or more, twice the cost imposed on conventional vehicles.[11] At Tesla’s planned 2018 production levels, this difference in the carbon cost between Tesla and conventional vehicles would be worth $660 million on an annual basis, and that is before considering the price elasticity of vehicle purchases.
To date, Tesla has focused its energies on stressing the total lifetime emissions reduction value of its vehicles, instead of the carbon emissions released during production. And this strategy is winning for now – in the United States, Tesla vehicles are eligible for a $7,500 Federal income tax rebate, more than offsetting the charge Tesla might face from a front-end carbon price. And that’s before considering the ample state tax incentives.[12] However, Tesla should have its regulatory strategy ready should Congress take up carbon pricing again.
To be clear, the supply chain and carbon emissions challenges facing Tesla pale in comparison to the challenges facing the broader automotive industry. However, even a darling example of the fight against climate change is not immune from climate change’s costly impacts. Hence, Tesla’s $7 billion climate change problem is just a taste of the United States’ $1.9 trillion climate change problem.[13]
[1] Devonshire Research Group, LLC. “Tesla Motors, Inc.” March 2016. (http://www.devonshireresearch.com/research/Devonshire%20Research%20Group%20-%20Tesla%20Motors%20-%20TSLA%20-%20Public%20Release.pdf).
[2] U.S. Environmental Protection Agency. “Sources of Greenhouse Gas Emissions.” 2014. (https://www.epa.gov/ghgemissions/sources-greenhouse-gas-emissions).
[3] Tesla Motors, Inc. “Annual Report for Fiscal Year Ended December 31, 2015.” 2016. (http://ir.tesla.com/secfiling.cfm?filingID=1564590-16-13195&CIK=1318605).
[4] Canis, Bill. “The Motor Vehicle Supply Chain: Effects of the Japanese Earthquake and Tsunami.” The Congressional Research Service. May 2011. https://www.fas.org/sgp/crs/misc/R41831.pdf
[5] Haraguchi, Masahiko, and Upmanu Lall. “Flood risks and impacts: A case study of Thailand’s floods in 2011 and research questions for supply chain decision making.” International Journal of Disaster Risk Reduction. 2014. (http://water.columbia.edu/files/2014/10/supply_chain_Thailand.pdf).
[6] Author’s analysis of data from NOAA National Centers for Environmental Information (NCEI) U.S. Billion-Dollar Weather and Climate Disasters. 2016. (https://www.ncdc.noaa.gov/billions/).
[7] Ibid.
[8] Author’s analysis; assumes current production levels of 2,000 cars/week and 2018 production levels of 9,600 cars/week.
[9] Union of Concerned Scientists. “Cleaner Cars from Cradle to Grave.” November 2015. (http://www.ucsusa.org/sites/default/files/attach/2015/11/Cleaner-Cars-from-Cradle-to-Grave-full-report.pdf).
[10] Ibid.
[11] Assumes a fully-loaded carbon price of $220 per ton based on Moore, Frances and Delavane Diaz. “Temperature Impacts on Economic Growth Warrant Stringent Mitigation Policy.” Nature Climate Change. 2015. (http://www.nature.com/nclimate/journal/v5/n2/full/nclimate2481.html).
[12] (https://www.tesla.com/support/incentives).
[13] Davenport, Coral. “EPA Warns of High Cost of Climate Change.” The New York Times. June 22, 2015. (http://www.nytimes.com/2015/06/23/us/politics/effects-of-climate-change-could-cost-billions-epa-report-says.html?_r=0).
The (bullwhip?) effect you describe of disruptions in Japan and Thailand to the global automotive industry is sobering and makes clear that Tesla faces major potential issues. But your description of 2011 also makes it seem like these issues run rampant across the automotive industry. Has the rest of the industry adapted since 2011 and diversified its supplier base? Or is Tesla actually just one of many companies relying on a single-source supply chain?
I also couldn’t help but wonder when you mentioned the the extra emissions generated from the construction of one electric car vs. one traditional car whether Tesla is caught in a bind: Is it possible that a multi-source supply chain would seem more emissions-intensive, because the company would have to account for a wider number of factories? And thus that Tesla is stuck between lowering the emissions of producing each car and diversifying its supply chain? I could be thinking about emissions calculations entirely wrong here but thought the situation could be an interesting Catch-22.
Interesting, hadn’t really thought of Tesla’s supply chain being affected adversely by climate change. Similarly hadn’t thought about how construction of Tesla cars is more emissions-heavy than an alternative sedan. A few more thoughts:
1) Tesla could continue to vertically integrate even further. They’ve built the largest battery manufacturing plant in the world in Nevada, and I’m sure that allows them access scale and reduce costs / emissions to a degree that other battery makers simply can’t match. By vertically integrating a larger portion of their production (similar to IKEA), they could reduce emissions and have a more sustainable production process.
2) Though the Model S generates 68% more emissions to produce the same sized sedan, that may not be the best comparison since the average, similarly sized sedan is unlikely to have the same types of technology in the car (e.g., full touchscreen panel, autopilot, electronically controlled everything). It may just be that more technologically advanced vehicles (or vehicles with premium leather / other specifications) generate higher emissions. The longer term question is if this is true and this is the inevitable trend, how auto OEMs can reduce the environmental impact of “trading up” to better technologies.
Great article on supply chain risks. Given the high tech components that go into a Tesla EV, the company does have significant reliance on certain highly specialized suppliers. A similar case can be observed in the aviation industry – Boeing and Airbus both rely heavily on specialized parts manufacturers to deliver components ranging from jet engine fan blades to advanced avionic systems. Some measures can be taken to hedge against geographical/financial risks: for example, Boeing provides cheap financing for its suppliers in order to guarantee an uninterrupted supply chain. Going forward, Tesla can provide similar financing options to help its at-risk suppliers diversify geographically to protect themselves from climate events.
Thank you for the thoughtful message. It is a good point to remember that even though they are doing much better than other companies, they still have a challenge. The one supplier issue can lead to problems from lack of diversification in more ways than just climate change, but may be more cost effective if there were no further changes coming.
Interesting post! I hadn’t considered the supply-chain impact of extreme weather events. On the increased upfront emissions in constructing a Tesla, I think this is definitely something that consumers should become more informed about. In the long-run though, it isn’t clear to me how big the impact of this will be in comparison to the emissions saved. A 68% increase to 6 tons of upfront carbon dioxide is significant, but according to the EPA a typical car will emit 4.7 tons per year (https://www.epa.gov/sites/production/files/2016-02/documents/420f14040a.pdf). If we look at what this might add up to in a typical car lifetime, the 53% less lifetime emissions from an electric car should produce emissions savings many times larger than the upfront difference. Tesla should certainly try to reduce upfront emissions and be vigilant of changes in tax incentives and regulations, but for now it seems the environmental benefits of their cars far exceed the tradeoff in their production.
JJ – thank you for a great and insightful article!
It is a coincidence, because since the launch of the Tesla Solar Roof, I too have been thinking about the Value Proposition of Tesla products. You have identified two concrete issues with Tesla and in extension all electric vehicles. The weak links or high risks involved in their supply chain is definitely a concern. I hadn’t thought of that before how climate change has a cascading effect that reverberates in even the automotive industry. The most viable and long term solution to this problem has to be, like JJL suggested, vertical integration. With the foresight and vision that Tesla has, I don’t doubt for a second that they’re not thinking of taking most/all of their component manufacturing in-house. This would also give them the value addition of quality control and not to mention lower their carbon-footprint by drastically reducing their supply chain (to a single link). The other problem hinted upon in your assessment is, in my opinion, a more serious one. That reflects towards a paradigm shift rather than just an adaptive or mitigative measure. Mining of the resources required to make electric cars or similar products a reality is energy intensive and the technology basis used today has not changed in decades. This is a part of the process that Tesla doesn’t have any expertise in and would probably remain beyond their control. And if the emission cost for production per electric vehicle remains high, it doesn’t answer the problem they were manufactured to solve. What this conundrum require is a complete overhaul in the technology, basing it more on the elements and materials of tomorrow rather than base and rare metals mining.
Great post, JJ! I wrote about the viability of SolarCity – another one of Elon’s projects. I would be curious to hear your thoughts on the proposed $2.6bn merger of SCTY and TSLA. Is vertical integration a step in the right direction for Tesla? Shareholders seem hesitant to accept the idea that the deal could be mutually beneficial, allowing both firms to realize synergies and optimize their respective cost structures. Is this actually just a financial engineering decision? Many critics have cited the fact that Elon’s companies (TSLA, SCTY, SpaceX), have all benefited from billions of dollars of government subsidization. What do you believe the path to profitability looks like for TSLA? Can the business reach its goals without taxpayer support?
This is fantastic analysis that presents an unconventional view of Tesla. Do you think carbon pricing has a chance in Congress any time soon? If so, why would Tesla’s current argument that the lifetime emissions of their product should reduce their tax obligation no longer be effective? Form an operations perspective, supply chain management disruptions due to climate events seem to be the biggest concern for Tesla. In the current political environment, regulatory risk, while always important to consider, does not present a significant enough concern for Tesla’s bottom line to incent them to green their manufacturing process. This is a shame, as Tesla has been the most effective marketer of climate causes to an unconventional audience; we need them to be an example on all fronts.
Thanks for the article!
One more effect on the demand side Tesla can face – it’s inability to work due to changing climate conditions. Internet is full of complaints about Tesla work in Northern Countries. Ironically, at the same time Tesla became the most selling car in Norway, where even the slightest climate change can push Tesla cars to its limits.