Trump's Auto Emissions Deregulation: Great For GM, Ford And FCA - But Disaster For Tesla

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Includes: BMWYY, DDAIF, DMLRY, F, FCAU, GELYF, GELYY, GM, HMC, HNDAF, HYMLF, HYMTF, MZDAF, MZDAY, NSANF, NSANY, TM, TSLA, VLKAF, VLKPF, VWAGY
by: Anton Wahlman
Summary

According to news reports, the Trump administration has proposed ending California’s (and the other ZEV states) automotive emissions legal separatism.

As it stands, automakers are forced to sell an increasing percentage of their cars in those states as EVs, dictating that they must lose money.

Those losses are funded by higher auto prices in the other 40 U.S. states. That means those people can afford to buy fewer new cars.

If the Federal government does not act, the automakers would have to raise their car prices in California and the other ZEV states, while lowering them elsewhere.

The current situation is unsustainable. Either of these two outcomes must therefore occur - and that would be bad for Tesla while good for all the other automakers.

Better late than never. The day after the November 8, 2016, U.S. Presidential election, I published an article on Seeking Alpha in which I laid out a scenario where the Federal Government would challenge California’s (and the other so-called ZEV states) centrally planned economies when it comes to which kind of cars people must buy.

You can see how this ZEV (zero emissions vehicle) legislation works here. Other than the fact that this legislation is nearly incomprehensible even for people inside the industry who specialize in compliance, look in particular at page 32 for the best way to understand what’s going on with the ZEV legislation in California and the other ZEV states.

Basically, the California/ZEV government(s) are mandating, central-planning style, that so-and-so many electric cars must be purchased by consumers, as a percentage of the total. It starts with a certain percentage in 2018 and goes up every year through 2025, when 16% of cars must be electric, and another 6% must be plug-in hybrids.

The practical implication of this ZEV legislation is that if automakers can’t sell these kinds of percentages of EVs and PHEVs at their regular profit margins, they will have to sell them at a loss. Those losses have to be made up somewhere. This is basic microeconomics.

What that means, is that the automakers raise prices on their other cars - the non-plugin ones. However, at least at this point they charge the same price for those cars in the ZEV states as well as outside the ZEV states. If you buy a car in Montana, you pay the same as in California.

That means that as a consumer outside California and the ZEV states, you are subsidizing buyers of electric cars in California and the ZEV states today. That’s basically consumers in 40 states who subsidize consumers in the other 10 states.

A key problem here is a total lack of public awareness. Among the general population, essentially nobody knows that somebody buying a Toyota (NYSE:TM) Corolla or Chevrolet (NYSE:GM) Silverado in South Dakota, is subsidizing somebody else in California buying a Tesla (NASDAQ:TSLA).

In other words, this legislation is very sneaky. It’s a hidden tax on all of those who don’t buy an EV in those states.

When cars become more expensive as a result of California’s legislative separatism, that means that fewer old cars around the country are replaced. Old cars pollute more and are less safe. That means that the impact of the ZEV legislation is counter-productive. It means older cars on the road, less cars on the road, and therefore unhealthier people and more road deaths - especially in those other 40 non-ZEV states.

The current California and ZEV legislation is the automotive equivalent of passing a law stipulating that only $3 million homes must be allowed to be built, because people should live in a really nice place. In reality, that means most people will be homeless or live in older substandard houses.

It’s interesting that California and the ZEV states have suddenly discovered states’ rights. That’s all fine and well, but what’s not fine and well is consumers in other states having to subsidize their cars. That’s not states’ rights. Rather, it’s government central planning - a form of socialism!

Many of the larger automakers have been making a very weak argument in favor of a meaningless goal. They’re saying that they don’t want multiple regulatory policies in the U.S. They want one law for the whole country.

But why? Different states have different sales taxes today. The automakers are perfectly capable of setting a different price in a different state. All sorts of companies do this every day:

  • The cost of a hamburger differs from location to location (McDonald’s (NYSE:MCD)).

  • The cost of a house differs from location to location (Pulte Homes (NYSE:PHM)).

  • Order any product online, and pay different sales tax depending on where you live (Amazon (NASDAQ:AMZN)).

The notion that automakers can’t set a different price based on geography of the buyer is positively ridiculous. If McDonald’s, Amazon and Pulte Homes can do it - then General Motors, Ford (NYSE:F) and FCA (NYSE:FCAU) can do it too. Any other claim by the automakers is pure laziness.

If California and the other ZEV states want to force their residents to buy so-and-so many electric cars, and this adds another $10,000 or $15,000 in cost per car sold, then let them do so - but don’t force consumers in other states to pay the bill. Instead, have Nissan and Volkswagen (VLKAY) simply add a few thousand dollars to the price of every car sold in California and the other ZEV states. Just like higher sales taxes, let people in those states pay them - not people in other states.

The mirror image of those higher car prices in California and the ZEV states, is that the price of cars in the other 40 states would be lower. Perhaps they could cut those prices by $1,000 or $2,000 per car. That would greatly spur demand in those other 40 states.

It would also rejuvenate the fleet in those other 40 states. New, fresh cars would reduce emissions and make their cars safer. The air could be cleaner and fewer people would be injured or die in traffic. It would be a huge win for everyone.

This outcome can happen in two ways:

  • The Federal government can beat California and the ZEV states, banning them from regulatory separatism. That’s the new proposal today.

  • The automakers can add a few thousand dollars to the price of cars sold in California and the ZEV states, while lowering them in the other 40 states. That’s what the automakers should have done already.

I prefer the second option, but frankly either will do. If California and the ZEV states want to impoverish their consumers and voters, let them go ahead and shoot themselves in the foot, economically speaking. Just don’t force the rest of us to pay their bills.

If either of these methods - legislation or voluntary pricing change by the automakers - become reality, it would be a disaster for Tesla, which has been mooching heavily from ZEV credits to the tune of hundreds of millions of dollars per year (just read its 10-K filings) at the expense of the other automakers. It’s been running at around $300 million a year for Tesla - all paid for by buyers of other cars, who have to pay higher prices.

The flipside to this downside for Tesla, is that all the other automakers stocks - Ford, General Motors, FCA and all the others - would benefit greatly from such regulatory relief. No more $300 million a year ZEV subsidies into Tesla’s pocket, means $300 million lower car prices for everyone else.

As an example, look at Mazda’s most recent financial report (reflecting the March 2018 results).

Look at page 17 of the report. Mazda’s profits are expected to take a huge tumble for the 2019 fiscal year, mostly “thanks” to regulatory compliance in the U.S. market. This is code for the ZEV legislation in California and the other ZEV states. It’s a profit-killer, and it needs to stop.

In other words, the California ZEV legislation has been a disaster for Mazda shareholders. Similar math should exist for the other automakers also, if they had the guts to just admit it publicly. The kind of deregulation proposed today by the Trump administration, would go a long way to rectify this profit-killing policy currently in place.

We often talk about the harmful effects of tariffs, and what higher car prices do to demand, employment, industry health and the overall economy. Well, the ZEV legislation in California and the other states, implemented at the expense of consumers in the other 40 states, is just as bad and those costs are hidden from the sight of the average consumer who does not know or understand why his car costs a few thousand dollars more than it otherwise would.

If you are an investor - long or short - in the automotive space, you have to understand California’s regulatory separatism, the ZEV legislation, and its impact on car prices in the other 40 states. The current situation is unsustainable, unfair, and it’s finally time to do something about it. Today’s proposal from the Trump administration will finally start this much-overdue debate.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.