What Trump's Auto Industry Meeting Says About California's Tesla Subsidies

| About: Ford Motor (F)
This article is now exclusive for PRO subscribers.

Summary

At the recent Michigan roundtable, Ford’s CEO tells President Trump on camera about a major point of emphasis for Ford.

Ford’s communications team told us that in his comments Ford’s CEO sought to emphasize “One National Program.” (ONP) On the web site for ONP, substantial emphasis is put on California’s ZEV mandate.

The ZEV mandate has lined the coffers of Tesla at the expense of the other automakers.

The ZEV mandate is set to tighten very significantly every year through 2025, hurting Ford and all other non-EV-only automakers dramatically.

In my opinion, if the Ford CEO gets what he seems to want, Tesla would be the big loser -- but the other automakers would see improved profitability.

[Editor's Note 2:30 p.m. 3/27/2017: We have updated this article with clarification of Ford CEO Mark Fields' comments as well as further detail on the author's opinion concerning the regulatory environment.]

In the Michigan automotive industry roundtable hosted by President Trump, Ford (NYSE:F) CEO Mark Fields took to the microphone. Notice what is said in the seconds after the 18:30 mark in this video clip:

You should watch the relevant section and listen, and the relevant section is less than one minute long, but here is the most relevant portion of what he said: "I would just like to emphasize, as we do this midterm review, a very important title was used when we agreed back in 2011, which is one national standard, so working together with CARB, NHTSA and also EPA..."

Ford wrote to clarify that CEO Fields was emphasizing One National Program - CARB, EPA, and NHTSA working to coordinate standards.

To see what One National Program (NYSEMKT:ONP) is, you can go to its web page.

In case it wasn't obvious, the Auto Alliance is the industry trade group to which most automakers belong. For all intents and purposes, it's one of the auto industry's key lobbying vehicles. Ford is of course one of its largest members.

Notice a meaningful part of the ONP landing page text concerns the so-called ZEV (Zero Emissions Vehicle) mandate, which is set by California's ARB (Air Resources Board) and to which several other states have signed on. So how important is ZEV to ONP, which Ford's CEO emphasized -- literally -- in his remarks to President Trump?

Apparently, it's essential. This is the ONP text: "This program cannot be considered without simultaneously evaluating the regulatory burden and consumer costs of the "Zero Emission Vehicle" (ZEV) program adopted by California and several states."

As everyone in the auto industry knows, the major nail under the foot of the emissions compliance cost in the U.S. is California's ZEV mandate. The ONP text also makes those astronomical costs explicit in its estimate. From the ONP document cited above: "The federal government estimates the costs of the current CAFE program to total about $200 Billion from 2012-2025. The ZEV program is expected to cost an additional $20-$40 billion from 2018-2025."

So basically, the ZEV mandate will cost somewhere between $20 billion and $40 billion from 2018-2025 alone. And presumably, it would get even worse every year after 2025.

According to Google Finance over the weekend, Ford's market cap is $46 billion. Granted, Ford will not have to carry the entire $20 billion to $40 billion cost in order to appease the state government of California.

Ford (including Lincoln) sold just over 2.6 million cars in the U.S. in 2016. That was 15% of the U.S. unit sales for the year, for the industry as a whole. Applying the 15% to $20 billion - $40 billion, Ford's ZEV compliance cost would be between $3 billion and $6 billion. At the mid-way point that's $4.5 billion, pretty much almost exactly 10% of Ford's current market cap.

Any time a U.S. state government seeks to impose a cost equivalent to 10% of your company's market value, you have to go war. It doesn't matter whether it's Ford or General Motors or FCA or Nissan or BMW or Jaguar Land Rover or Volvo -- when someone says "10% of what you're worth, or else!" … you have to respond forcefully.

Ford's management has a fiduciary responsibility to its shareholders to fight any government action that will cost them money, and especially if that money will be used to line the coffers of a competitor.

No, Ford's CEO didn't mention the word ZEV in his public comment to President Trump. But he emphasized One National Program, according to clarification from Ford. And ONP's own definitional text on its web site makes it crystal clear that it cannot be viewed in isolation from ZEV -- although everyone in the auto industry has already viewed that as a self-evident axiom for over a half-decade already.

What are those California set of rules that are different from the rest of the country? The ZEV mandate dictates that an increasing percentage of cars sold in California must be battery-electric or hydrogen. That number will be 15.4% by 2025, according to the current plan.

This is obviously unacceptable to the automakers. It's like saying that for every 3 iPhones, Apple would have to sell one iPad, or something like that. Perhaps the better analogy would be that a homebuilder is told that one of every seven houses he builds must be a $10 million house because the politicians have decided that some people ought to live really well. Being unable to sell one of every seven houses for $10 million, the homebuilder takes a massive loss on that one out of every seven houses sold.

If people don't want to buy as many electric cars at the market price, as the politicians want, and you therefore have to sell (or lease) these cars below your standard profit margin -- let alone below cost -- it hurts profitability. According to ONP, California imposes this cost to the tune of $20 billion to $40 billion, and Ford would be on the hook for an estimated 15% of that.

The ZEV mandate also increases cost to all consumers if a car's price is the same inside California as it is in the non-ZEV states, because it means those other states end up subsidizing ZEV buyers in California. Totally unfair, of course. Why should a regular American in Wisconsin have to subsidize the fancy car purchases of hippies and billionaires in San Francisco? If there ever were an issue tailor-made for a Trump crusade, this has to be it.

This article, while a bit confusing, gives you a flavor for the insanity that is California forcing its automakers to sell cars that the people refuse to buy at the market price.

In contrast, if Washington DC can be made to crack down on California's regulatory separatism, that would have a huge positive impact on all automakers that are not in the business of selling mostly electric and/or hydrogen cars. Among the public companies, that means everyone except Tesla (NASDAQ:TSLA).

That's why this issue is so hugely important to watch. If California's ZEV mandate is allowed to go on -- or worse yet, be "tightened" -- it would cost the other automakers even more, and benefit Tesla even more.

It looks like as of today, California is digging in, in terms of forcing the automakers to lose money on the 15.4% of cars it will sell in California.

However, if California's ZEV mandate were to be abolished and/or rolled back, the reverse would be true.

One way to get around this is if the automakers decide to price their cars higher in California than in Oklahoma or Alabama or North Dakota. That way, the harmful cross-subsidies would be reduced, and public pressure would be brought to bear on California's politicians and bureaucrats, to stop increasing the cost of regular automobiles.

This is what I suggested in my article from February 7.

Basically, the automakers should add $1,000 to the price of every car sold in California, as that's roughly what this mandate costs them. It can then reduce the price of every car sold outside of California by some amount -- $200 or $300 or whatever -- in order to compensate for a "net zero" volume impact. Meanwhile, the people in California would finally see the cost that they are imposing on the automakers.

However, in my opinion this comment by Ford's CEO tells us where Ford's priorities are. The impact needs to be watched very carefully. The investment impact would be huge, as explained above -- for all parties. Tesla is in corner, and in the other corner we find Ford and all the other publicly traded automakers.

Disclosure: I am/we are short TSLA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: At the time of submitting this article for publication, the author was short TSLA. However, positions can change at any time. The author regularly attends press conferences, new vehicle launches and equivalent, hosted by most major automakers.