The Zero-Emission Vehicle (ZEV) Program: Tesla's case
What has Tesla been hiding? In recent months it has been revealed that Tesla has been selling greenhouse gas credits to General Motors Co. and Fiat Chrysler Automobiles NV. This is the result of increased pressure for carmakers to comply with stricter USA environmental regulations and in preparation for the upcoming elections, where changes in presidential party could mean stricter climate policies.
Let’s back-up… What is exactly a greenhouse gas credit? Although it has been referred to in the news as a greenhouse gas credit, the correct terminology is Zero-Emission Vehicle credit. These were launched with the Zero-Emission Vehicle (ZEV) Program initially in California and later implemented in 8 other states of the USA (Connecticut, Maine, Maryland, Massachusetts, New Jersey, Oregon, Rhode Island and Vermont). The regulation requires all car manufacturers to sell electric vehicles as a portion of total car sales. The goal of this program is to encourage carmakers to sell and invest in zero-emission vehicles in order to lower carbon emissions and tackle environmental issues to fight climate change.
How does the ZEV work? The ZEV Program assigns each carmaker with ZEV credits and car companies are required to maintain ZEV credits equal to a certain percentage of non-electric sales. Each car sold earns a number of credits that is based on the type of ZEV. The credit requirement in 2018 was 4.5% (which required 2.5% of company car sales to be ZEV) and is expected to reach 22% in 2025 (that will require 8% of company car sales to be ZEV). The manner in which a carmaker can obtain the credits is by selling zero emission cars. To complicate manners, the credits received vary per vehicle type and electric range. For example, plug-in hybrids only receive between 0.4 and 1.3 credits per vehicle sold, while battery electric and full cell vehicles receive between 1 and 4 credits. Because of this, car manufacturers can have excess credits, so companies that manufacture electric vehicles can then sell those credits to carmakers that have exceeded their pollution restrictions. Car companies will thus buy these credits to avoid the large fines for not complying with the new regulations and not making their fleets more fuel-efficient.
Now back to Tesla… It should come as no surprise that since 2010 Tesla in the USA has made about $2 billion in revenue from selling these credits. Not only have regulations become more stringent, but also Tesla has benefited from a surplus of ZEV credits. As a result, companies like General Motors Co. and Fiat Chrysler have been purchasing credits from Tesla in order to comply with current USA regulations. For the moment these ZEV transactions have only been carried out in the USA, but in Europe, there are claims that Fiat Chrysler will pool its fleet with Tesla in order to adhere to European Union Standards. Because the EU is also implementing stricter emission regulations, companies like Fiat Chrysler could face fines as high as €2 billion in 2021. The European Commission regulation announced that by 2021 it will require car makers’ fleet-wide emissions to average numbers no higher than 95 g/CO2/Km, compared to current 130 g/CO2/Km, for all newly registered cars. The penalty payment for excess emissions if the average CO2 emissions of a car manufacturers’ fleet exceeds its target for a given year is significant. Carmaker since 2019 will have to pay an excess emissions premium penalty of €95 for each g/Km of target exceeded. As a result of the new regulation, carmakers could lose billions in revenue, which will make the ‘pooling partnership’ an attractive strategy for carmakers in Europe.
What does this mean for the carbon markets? ZEV credits and the way car companies have adapted gives us an indication of what a regulated carbon market would look like in the USA. Companies that have lower emissions and thus higher credits can sell the excess credits to companies needing to offset their CO2emissions. Although the ZEV Program is a test case for how a regulated carbon market works in the auto industry, stricter environmental regulations will strengthen the role of both regulated and voluntary carbon markets. And thus at ClimateSeed, we will continue to monitor the development of such and be at the forefront of new requirements.