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It is now a month since Tesla (TSLA) delivered the Model S to their first customers. Deliveries continue, and while the rate remains low for now (you don't want to build 70/day until you're sure everything is how you want it) the vehicle has garnered a list of glowing reviews as long as my arm -- and I have long arms. Not long enough, however, to contend with the list of Model S reservations, and further dwarfed by the list of Nissan Leaf (32,000 worldwide) and Chevy Volt (20,000+ Worldwide) sales.

There is a willing market for EVs it would seem: Auto manufacturers including GM, Honda (HMC), Nissan (OTCPK:NSANY), Toyota (TM), VW (OTCQX:VLKAY), Ford (F), Daimler (OTCPK:DDAIF), BMW, Mitsubishi (OTCPK:MSBHY), BYD, Renault (OTC:RNSDF), Kandi (KNDI) and others are increasingly placing bets that this market will grow (though their programs are at differing stages - I've thrown KNDI in there as it's a very interesting upstart, worth a look, but not a discussion topic today).

In Part 1 of this series I discussed the material supply chain constraints on EV production, and demonstrated that reserves and production were easily adequate for tens of millions of vehicles per year with realistic ramp rates. Part 2 looked at the relative emissions profile of EVs and ICEs, and made the case both for not only 'Greening the Grid', but also for starting the shift to EVs today rather than waiting for a zero carbon electricity mix… in addition to demonstrating that in the majority of cases EVs are, already, cleaner (and universally more secure). These issues were somewhat philosophical, but since customer philosophy is important for product success they're still relevant to investors.

In Part 3 we get down to brass tacks - EV economics. EVs are cleaner, more sustainable, better performing, quieter. Owners rave about them. The question is whether the 'average' buyer will eventually choose them on the basis of lifecycle cost alone.

We hear a lot from EV critics about how 'uneconomic' EVs are. This allegation begs the question: Why does an EV market exist? And why are so many major corporations placing R&D bets that it will grow? Are their really so many environmentally concerned buyers who are prepared to take a bath on the total cost of ownership (TCO) of their cars for the sake of polar bears? Well, maybe there are… but for EVs to really take off they need to appeal, economically as well as aesthetically and performance-wise, to those who figure polar bears are strong swimmers and probably need the exercise anyway.

This topic is arguably the largest of the three I've looked at, and there are several points I'd like to make so, in a break with tradition, I'm going to split part 3 in this series in two:

Part3A:

  1. EVs Today - where do they stand, economically, considering only well understood internalized costs?
  2. Kicking the subsidy - Can today's relative value proposition be maintained in the future once the USA's $7,500 subsidy is phased out?

Part3B (coming soon):

  1. It's the Stupid, Battery - Justifying my assumptions in 3A.2, and taking a look at the historical forecasting performance of market research groups.
  2. Inflection Point - The Battery vs Gas showdown, for a multivariate comparison of $/kWh, cycle life, calendar life, and annual mileage.

There are a couple of aspects I won't consider:

  • Maintenance - EVs may require dramatically less than ICE vehicles, but operating experience so far makes this hard to quantify. I'll just leave it out (except for battery amortization, which I'll very definitely include)
  • 'Intangibles' - These are aspects which aren't so much intangible, as just difficult to quantify. What's the value of silence? What's the value of zero local emissions? What's the value of instant low end torque? Just keep this in the back of your mind at the end as EVs strengths that are unpriced.

Electric Vehicle Economics Today

One of the accusations often leveled at supporters of EVs (by the more passionate EV skeptics) is that they're 'mathematically illiterate'. This is funny in itself, because what the skeptics should say is 'innumerate' and their failure to do so suggests a certain level of, if not illiteracy, at least linguistic poverty. I digress… the allegation is that people who support, let alone buy, EVs do so only because they suck at math. This probably comes as a surprise to those who are buying EVs because they like them and want to move away from oil, but lets take it at face value for the sake of argument. The supporters who have the most to lose by being innumerate are those who are actually opening their wallets and throwing down a big chunk of money for a new car. In this first section I'm going to look at the direct costs and benefits faced by such a person in today's market, and try to put a number on the price they pay for their alleged lack of education.

Because there are many different cars that people could buy instead of a given EV, I simply do a comparison with a certain MPG rating. This gives a 'break-even' price for the ICE equivalent. If the selected alternative is less than this, then the EV owner is out of pocket according to the difference. If it's more, the EV owner is in the money even before considering those aspects I'm ignoring. For fairness, the alternative should be comparable to the EV in performance/quality/accessories - comparing a Nissan Leaf with a Tata Nano is nonsensical.

There's one particular assumption I make that's quite hard on the EV. I assume that the battery is only good for its warranted life. If the manufacturer gives an 8 year, 100,000 mile warranty (as for the Leaf), then at the end of that period the comparison stops. Why is this unfair? Because EVs usually require paying significantly more up front for a significant annual saving in the future… and by limiting the period over which this annual saving is considered, I limit the realized benefit from it, probably significantly below the actual life. Why do I do it anyway? Because it means battery risk is all on the manufacturer - the buyer takes no risk within the warranty period and so doesn't need to discount their savings by some failure probability.

I also assume that our mathematically literate EV buyers are discounting their future savings, and use a rate of 8%. I could actually argue for a much lower rate given the low risks - neither peoples driving distances nor the price of oil are likely to drop much in the next decade - and the fact that home mortgage rates are currently around 2%-3% in the USA… but hey, let's not quibble. This discounting is also bad for the EV, as it means we count saving $100 in 8 years time as only saving $54, but it's also economically sound and it would be cheating to do otherwise.

Nissan Leaf

The typical Leaf buyer is probably interested in owning an EV, but they're also just looking for a modern, comfortable commuter vehicle. With a 73mile range estimate from the EPA they know this isn't really a car suited for a cross country trip; they're not buying it for that. Let's just say our hypothetical family probably already have a car for long trips; they want one a second one for during the week. Most likely role? Work commuter or urban/city runabout. Nissan give an 8 year 100,000 mile warranty on the leaf battery, so that sets both the duration and the annual mileage. The driver is free to exceed this mileage, of course - it means the warranty might run out earlier but because of the way discount rates work, and the fact that the Leaf saves you money proportional to miles driven, this actually improves the situation for the EV - but to be sure of getting their moneys worth they should aim to hit at least 12,500 miles/yr on average. Not hard to do; assume 250 round trip commutes per year (5 days, 50 weeks) and a commute of 25miles each way would do it… and would also mean ample reserve capacity in the battery for picking up children from school, stopping at the shops on the way home, or any of the other daily needs. Opportunity charging, or charging at work, would both increase the reserves still further, but even if charging at home is the only option the battery is big enough for the task.

The numerate buyer would collate the following inputs for their analysis:

Leaf kWh/miAlternative MPG$/Gallon$/kWhDiscount RateMiles/yr
0.343140.128%12,500

The result?

(click to enlarge)

This table is similar to the cost of ownership comparisons you've likely seen elsewhere, except I look only at the purchase cost, rebates, and energy cost. Any other advantages the EV may (probably) has in reduced maintenance or additional life after the warranty period are ignored. The result of the calculation is 'breakeven' cost for an equivalent ICE vehicle, in this case $21,362. As I explained before, if the ICE is less than that, the Leaf buyer is in the red. If it's more expensive, the Leaf buyer is laughing all the way to the bank.

So, which is it? With the Leaf the comparison is very easy, as we have the Versa SL (a very similar car, and equivalent trim to the Leaf SV) at $20,070. So, by this simple and conservative analysis, over 8 years the Leaf owner pays $1,292 more than the Versa owner. Wow! Leaf owners must be complete idiots! Either that, or they feel that lower maintenance costs, reduction in CO2, independence from oil, and never needing to go to a gas station are worth… $3 a week. Because that's all they're paying. If we drop the discount rate to 4%, or increase the assessment period to 10 years, Leaf owners don't pay anything extra at all, and they still get all the benefits.

Of course, 8 years from now that battery might need to be replaced. And 8 years from now there will be no tax credit. We'll get to that later; the point is that the decisions of today's Leaf buyers seem entirely reasonable. They want an EV, the Leaf meets the requirements of the application they're buying it for, the price is about the same... so they buy one. All the other benefits are gravy. Not exactly rocket science.

But the subsidy today is more than 20% of the Leaf base price, and the Leaf, while a solid car, may not appear to the EV glamour market (in appearance or capabilities) so much as alternatives. Let's raise our sights a little.

Tesla Model S

Tesla's Model S was not built as a 'Versa/Leaf Killer' any more than the Mercedes E Class was built as a 'Civic Killer'. Tesla purchasers want more than the Leaf offers - whether that's performance, range, looks, street-cred, space… whatever. The entry level Tesla S40 (ModelS 40kWh) has an (expected) EPA range of 125Miles, more than adequate for even a demanding daily commute. The high end S85 comes in at 265Miles, enough for almost all driving needs, especially given its compatibility with Tesla's coming supercharger network (165 Miles of range added in around 30 minutes).

These are reasonably large, high performance, luxury sedans - admittedly luxury sedans with the option of seven seats, and above average storage capacity. How would the numerate luxury sedan shopper assess the offering? I compare the four different options against ICE equivalents as follow

S40S60S85S85P
Miles/yr12,50015,50020,00020,000
Miles/day50628080
Miles in 8yr100,000125,000160,000160,000
100% equiv cycles760628572572
ICE Equivalent MPG28252518

These mileages are set to ensure any battery risk is on Tesla… though in the case of the S85/S85P you could drive a lot more within the 8 years and it'd all be money in the bank. The rest of the inputs ($/gallon, $/kWh etc) are the same as in the case of the Leaf. I include the miles/day that would be driven in order to hit these targets with a 5 day week/50 week year (commuter profile), and also the cycle life impact (irrelevant for the driver, because of the warranty, but gives confidence that Tesla aren't sticking their necks out).

First up is the entry level Model S40; 0-60 in 6.5s, 130 odd miles range.

(click to enlarge)

The S40 costs $57,400, but the $7,500 tax credit effectively brings this down to $49,900. It delivers discounted energy savings of $6,986 compared to a BMW 3 series sedan (28mpg) over the 8 year evaluation (warranty) period, leading to a 'breakeven' price (as described for the Leaf) for the alternative of $42,913.

Let's put this up against a BMW 328i Coupe, one of the most popular mid-range luxury cars in the USA, with the 3 series overall selling roughly 95,000 units in the country in 2011. The base variant of this car is priced at $40,400, but once I added even the bare minimum of extras to get it to the level of the base S40 the price climbed to $42,445. No giant touchscreen for that though, no 19" alloy wheels, around 1/3rd the cargo capacity.

The result? Tesla S40 buyers are paying $1/week extra over an 8 year period. As with the Leaf, that $1/week means they likely have significantly lower maintenance costs, they never need to wait in line at a gas station, and they're reducing CO2 emissions and eliminating their dependence on oil for personal mobility. Drop the discount rate a touch? Compare to a higher tier BMW (the 5 or even 7 series)? Increase the comparison period to 9 years? Any of these things have the Tesla owner coming out ahead before pricing in all the aspects I've externalized.

The picture remains largely the same as we step up the range, as shown in the following tables.

(click to enlarge)

(click to enlarge)

Tesla S60 buyers are better off than those in a Mercedes E class (62,000 sold in 2011). S85 buyers are better off than those in a BMW 5 Series (52,000 sold in 2011).

What really surprised me is just what a bargain the S85Performance is compared to its equivalents. I think some skeptics perhaps don't appreciated the company this cars specs place it in - it's a full size luxury sedan that pulls 0-60 in 4.4 seconds. It's as fast as a Porsche Panamera GTS ($111,000 base) or a BMW M5 ($89,900 base). It's as fast as a Mercedes CLS AMG ($95,900 base). It's as fast as a 911 Carrera GTS ($103,100 base), and Porsche sold more than 6,000 of the 911 series in the USA in 2011.

Impressive numbers. How does it place on dollars?

(click to enlarge)

Not only is the S85P $11,000 cheaper than the 911 up front, it also saves a massive $16,000 in energy costs over an 8 year life (assuming a higher mileage driving profile of 20,000/yr). And it seats 5 in comfort. The energy savings compared to the very thirsty (18MPG) M5, shown in the table above, are even larger.

These results really made me smile because there's been a lot of talk lately about when Tesla might reveal their Gen III platform, an affordable electric sedan "to go toe-to-toe with the BMW 3 series" (in the words of a journalist whose name has faded from my memory, but whose quote remained). I smile as it seems Tesla has already done so - it's called Model S. Buyers appear to have realized this, hence the large (and growing) reservation list.

For a closer look at some of the Model S competitors take a look here; and contrast with the 2011 luxury sales totals or 'sporty' sales totals.

In all the cases assessed above the EVs, and the numeracy cred of their buyers, came out looking pretty good. Tesla's offering, compared to its peers, was good in all cases and exceptional in the case of the performance version. These highly competitive results above were achieved partly through the grace of the $7,500 tax credit extended to EV buyers in the USA. I am very happy for immature yet attractive technologies to receive government support to grow, but I also like to a realistic path to their standing on their own. We've just seen that EVs today are directly competitive with the subsidy, even ignoring the various other benefits they offer. In order to meet the same benchmark without the subsidy EVs need to reduce their MSRP by $7,500.

Kicking The Subsidy - How to lose $7,500 in 7 years.

It's easy to think of ways to lose $7,500 - for example, you could have bought $15,000 of AXPW stock on January 26th and sold 6 months later: boom, money gone! But our goal is to make money... and to make money we want to understand how Nissan, Tesla, and their various competitors are going to remain profitable while knocking $7,500 off the purchase price of their electric vehicles, because that's what's needed for their markets to kick the subsidy.

The widely acknowledged key-differential-cost-driver in EVs is the battery, so lets start our search there. Below I tabulate, for each of the vehicles I assessed above, the saving potential considering the battery alone using today's prices vs a 2020 price estimate. Battery prices today (and future) vary somewhat by pack size. The savings are in bold.

LeafS40S60S85
Battery Size (kWh)24406085
$/kWh Today$500$450$425$400
Battery Price Today$12,000$18,000$25,500$32,000
$/kWh 2020$220$210$200$190
Battery Price 2020$5,280$8,400$12,000$15,200
Savings Achieved$6,720$9,600$13,500$16,800

The Leaf is almost off the subsidy on the battery savings alone, though still needs to find around $800 more savings over the vehicle drivetrain (unlikely to be a significant challenge). The really interesting part is that the Tesla series are not only off the subsidy, but offering quite significant additional price reduction potential despite no longer being subsidised. Where the subsidised Tesla of 2012 succeeds, the unsubsidized Tesla of 2020 will succeed wildly.

Of course, this is predicated on battery prices falling dramatically over the next 8 years. Next time I'll justify this assumption using the historic and current 'market intelligence' forecasts, and I'll also go into the thick of future battery potential and economics.

For now, one thing is clear. EVs, even today, are delivering their buyers a highly competitive solution even before maintenance savings are considered, let alone broader externalities.

Disclosure: I am long TSLA, KNDI.