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Over the last five years I've written about a couple themes with some regularity. The first is a simple explanation of why fighting climate change with electric cars and solar panels is like fighting a hurricane with a box of Depends. The second is a more complicated explanation of why we can't produce electric cars in relevant volumes unless we tame a couple of spare planets to provide the raw materials.

I've just posted a new Instablog that discusses each of these issues in depth and serves as a good background piece for this article on Tesla Motors' (TSLA) looming battery supply problem.

While I hate to say "I told you so," CNBC recently aired an extraordinary video clip from an interview with Tesla Motors' CEO Elon Musk who described the cell manufacturing process in some detail and then went on to explain that all the lithium-ion battery production capacity in the world could only support a few hundred thousand cars a year.

Mr. Musk then spoke at length about Tesla's concerns over long-term cell supplies and its current efforts to ensure that somebody in the battery industry will build a "giga-factory … a truly gargantuan battery factory of mind-boggling size" to serve its future needs.

The implications of Mr. Musk's on-air battery discussion are staggering. Even if Tesla could lock up 100% the world's lithium-ion cell manufacturing capacity, it could only build a few hundred thousand cars a year. There is absolutely no chance that Tesla can accomplish that feat of monopolistic magic because:

  • All of the idle plants were designed to produce cells using specific chemistries that can't be changed to suit Tesla's requirements without significant refurbishing;
  • Most of the idle plants were designed to manufacture large-format automotive grade cells instead of small-format consumer grade 18650 cells;
  • All of the companies that own idle plants are actively seeking alternative markets for their products that don't have the price sensitivity of automotive; and
  • Several other industries, like portable electronics, that need lithium-ion batteries are willing to pay higher prices because it's easier to pass a nickel per watt-hour through to a customer that needs 10 to 50 watt-hours than it is to pass the same nickel per watt-hour through to a customer who needs 85,000 watt-hours.

Tesla has enjoyed sweetheart cell pricing for a couple years because Panasonic (OTCPK:PCRFY) overbuilt their lithium-ion cell manufacturing capacity and then bought Sanyo before the bottom fell out of the market. Panasonic ended up taking over $10 billion of write-downs in its battery manufacturing division over the last three years. When a manufacturer owns empty factories that have no remaining book value and can be put to work at even a small margin it makes sense to do so. Once the market stabilizes, however, a manufacturer that's been brutalized by a capacity glut begins to think about recovering its losses and pricing pillow-talk can quickly turn ugly.

Last week Panasonic reported a 4.1 billion yen ($41.6 million) operating profit and a 5.8 percent margin for its lithium-ion battery division. It also announced plans to spend about $200 million to reopen closed battery plants and install new production lines for small and large format cells.

The manufacturing facility write-downs of the last couple years were the only reason Panasonic was able to report a profit from its battery division instead of a $500 million to $1 billion loss. They made money, but only because they didn't have to recover $10 billion of plant and equipment investments through depreciation.

I see no reason to believe that Panasonic will spend another $200 billion of shareholder capital to expand manufacturing capacity so that it can sell batteries at a loss in order to help Tesla reach an industry beating 25% gross margin target. When it comes to the giga-risk of a giga-factory and related raw material supply chains, Tesla will either have to pay the piper or go it alone.

I regularly remind readers that cars with plugs are incredibly inefficient users of batteries. In the case of Tesla's flagship Model S, an 85 kWh lithium-ion battery pack will save one consumer 500 to 600 gallons of fuel per year. The same cells could theoretically used to make battery packs for a fleet of 60 Prius-class HEVs that would each save their owner 160 to 200 gallons of fuel per year. When I balance fuel savings of 500 to 600 gallons per year from a Model S against savings of 9,600 to 12,000 gallons per year from a fleet of HEVs, I think the better choice for our nation, our species and our planet is crystal clear.

Tesla's stock has been a ton of fun for investors over the last three years as it rocketed from an IPO price of $17 in June of 2010 to a current price in the $170 range. Now the story is starting to unravel as analysts, bloggers and the financial media start pulling loose threads in the emperor s new clothes that are invisible to those unfit for their positions, stupid, or incompetent.

Whenever the CEO of a public company starts covering his backside by talking publicly about his stock being overvalued while simultaneously explaining that his company can't possibly meet stockholders' production expectations without first locking up 100% of the world's battery manufacturing capacity and then convincing another company to build "… a truly gargantuan battery factory of mind-boggling size," astute investors who understand market signals seek the safety of the sidelines and leave the rich educational opportunities for investing neophytes who haven't earned their degrees from the school of hard knocks.

Source: Tesla's Crushing Battery Supply Constraints