Tesla Can Overcome Supply Constraints In Its Fast-Growing Energy Storage Business

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About: Tesla, Inc. (TSLA)
by: Nick Cox
Summary

Fast-growing demand for both commercial and residential battery products.

2019 should be the year that Tesla finally ramps up its battery energy storage business.

Energy storage is an under-rated growth area for the company.

The world moving inevitably toward renewable energy and battery energy storage.

Opportunities now there for the company as supply constraints lessen and financing improves.

Tesla (NASDAQ:TSLA) had tremendous success in its large-scale project business for energy storage in 2018. Its residential business was however very supply-constrained due to the ramp-up of production for the Model 3 launch.

My article in January detailed the background to this.

The company has repeatedly stated that it's not essentially an auto company. Rather it's a new energy company based around battery power. They have stated on numerous occasions that they expect energy storage revenue to equal auto revenue.

There's now an opportunity for Tesla to focus more management time and resources on this side of the business. They now have the capital and the facilities to do this. The recent capital raise for US$2.7 billion was very well received. The company should receive US$1.8 billion in EV credits from Fiat Chrysler (NYSE:FCA) before 2022. Chinese banks are offering loans at very favorable rates for the Shanghai project.

Now it's a management decision whether or not to give more priority to energy storage as supply constraints wane and financing improves. The market opportunity is huge as fast-growing renewable energy leads to escalating demand for battery storage. Developments early this year seem to point to an increasing focus on energy storage by the company.

What the Company Said for Q4 2018

Tesla's management has repeatedly emphasized the centrality of energy storage to their business. At the Q4 2018 analyst call Elon Musk outlined:

"We had to convert a bunch of stationary storage lines, battery lines, to vehicle battery lines. Otherwise we would have done quite a bit more in stationary storage. I expect that to grow probably twice as fast as automotive."

As CFO Deepak Ahuja said at the call:

"The profitability of the storage business and the gross margin continues to improve as we keep ramping up production and scale."

In the results review from the company for the year as a whole, it was shown they had tripled energy storage deployment to 1.04GWh. At that time the company predicted more than 2 GWh deployments in 2019.

Legendary investor Ron Baron is a believer. He points out that Tesla overall sales have risen from US$3.7 billion in 2013 to US$21 billion in 2018. The value of the company is yet to rise in tandem with this incredible growth. He expects the company's value to reach US$1 trillion by 2030. Of that amount, he thinks US$500 billion will be from autos and US$500 billion from energy.

What the Company Said for Q1 2019

At the Q1 2019 analyst call, the company was even more bullish on energy storage. They confirmed they had been switching some battery cell production at the Nevada facility (GF1) from auto lines to commercial Powerpack and residential Powerwall lines.

Musk predicted a 300% growth rate for the business in 2019. He re-iterated future growth rates for energy storage would be far faster than for automotive. He predicted that for this year the company would allocate between 5% and 10% of their cell output to Powerpack and Powerwall products.

The 10Q for the first quarter can be seen here.

The official forecast for this year is less than what Musk stated on the call but still a doubling:

Tesla

Energy generation in 2018 produced revenue of US$1.55 billion. That was up from US$1.1 billion in 2017. A doubling or tripling of revenue in 2019 would help company revenues, but it should be noted that it would still pale in comparison to auto revenues. In 2018 these were US$17.6 billion (up from US$8.5 billion in 2017).

At a recent visit to Gigafactory 2 in Buffalo New York, Musk stated:

"This is definitely going to be the year of the Solar Roof and Powerwalls."

Panasonic (OTCPK:PCRFY) has assembly lines at GF2 for the Powerwall 2 batteries. Tesla will be hoping that the solar roof business will take off in 2019. That would of course provide more demand for the Powerwall. However. the company could anyway remain supply constrained rather than demand constrained in the short term. The company needs to show this year that it's serious about the retail energy storage business in the US after closing down many of its retail outlets. My article here detailed some of the promise and potential for Powerwall. In regard to this, the commercial Powerpack business may be the main driver of revenue this year.

For the coming year Tesla will probably broaden out its battery cell purchases. The new factory in Shanghai is likely to be supplied at least in part by local Chinese suppliers. The partnership with Panasonic will likely remain a strong one though. As this article shows, contrary to what some Tesla bears have mistakenly stated, the partnership is key for Panasonic's forward revenues. It's a win-win for both Panasonic and for Tesla.

Some analysts also have wrongly reported a strain in the relationship between the two. In fact Panasonic President Kazuhiro Tsuga confirmed this month that was not the case:

"We have a partnership relationship, not a supplier relationship."

Senior Panasonic executives recently commented on the situation at GF1. They said battery production had only been running at 24 GWh but there's a current capacity of 35 GWh. They expect this to be realized during the course of 2019. Meaningful improvements were being made to existing lines. Three new higher-speed lines were installed and would soon be fully up and running. This is an optimistic sign for Tesla's hitherto supply constrained business.

Panasonic executives did recently admit they may not be able to provide enough supply for all the battery demand at GF1. They referenced in particular the Model Y. This may be overcome by Tesla producing most of the Model Y at their Shanghai factory and using Chinese battery manufacturers. Panasonic's Tsuga stated in his recent interview that "multiple supplier structures" for Tesla in Shanghai would make sense and Panasonic were fine with that.

This may come sooner than many had speculated. Despite the negative articles on Seeking Alpha and elsewhere on the prospects for the Shanghai factory, it's going ahead with remarkable speed, as the May 12 photo below illustrates:

The Chinese have been very forward thinking in sourcing material sources for lithium batteries and in building up factory capacity. The US looks set to be well behind the curve in this regard.

Australian Energy Storage projects

Tesla famously deployed the world's largest battery at Hornsdale in South Australia. As is well documented, huge savings were made within months of operation. A$25 million (US$17.5 million) was saved in the first year of operation. What has been seen in Australia is that batteries eliminate the evening and morning peak costs as the batteries handle the grid fluctuations. This is a revolution in use and already is seeing the phasing out of plans for gas peaker plants. The Holmsdale facility reacted within 100 milliseconds to a major lightning strike. A gas peaker plant would normally take about six seconds. Increasingly solar, wind and hydro will feed the system and the batteries operate as the middle way between the main power generator and the back-up source.

The Australian government intends to have the country operating on 50% renewable energy by 2030. This produces tremendous revenue potential for Tesla in just this one country. Around 2 million homes in Australia currently have rooftop solar and only 20,000 of these currently have battery storage. Australia is being badly hit by climate change as this summer's severe heat waves and droughts illustrated.

This article here shows the increasingly realised advantage in such a climate for energy storage. Apart from having power at a time of potentially dangerous heat intensity, the household in question was finding its annual energy bills reducing from A$4000 (US$2800) to A$600 (US$420). The heat wave knocked out 45,000 homes in Sydney that day.

Tesla has received numerous requests to work on further projects, in Australia and elsewhere. Recently they have signed a 4MW/8MWh deal for Townsville in Queensland. The city has 20,000 rooftop solar systems in existence at present. My article here detailed just some of the projects up and coming in Australia.

International Energy Storage Projects

Industry and governments everywhere are seeing the huge benefits from energy storage. Protection against blackouts and management of the grid more efficiently and cheaply than peaking power plants based on fossil fuel are chief amongst these. Renewable energy, especially solar and wind, are growing rapidly throughout the world. Intermittent power sources such as solar, wind and hydro are smoothed out by battery storage. Long-term storage may be best resolved by pumped hydro used in conjunction with renewables. Even if that became widespread, it would still need the battery storage to provide the instant bridge. Batteries respond much more quickly than peaking plants or spinning reserves.

It seems very unlikely that companies will proceed to build up gas peaker plants in the future at all. Their day is likely to be over in the long run.

A key metric in the change is the rapidly declining price of the levelized cost of energy (LCOE). This has fallen 35% since the first half of 2018. LCOE measures the cost of delivering energy over the lifetime of the installed technology. With solar and wind costs declining, the package for an energy storage project using renewables is becoming more and more competitive. Interestingly lithium battery prices only fell 6% from 2017-18. This was due to supply issues leaving prices higher than they would otherwise have been. The long-term downward cost move of lithium batteries will continue to accelerate again over the next few years as production ramps up. There also are substantial cost savings starting to be made in the cost of inverters.

Tesla sees particular promise in micro projects and has supplied more than 100 of these in 32 countries. "Virtual power plants" are a particular focus of attention. German company Sonnen, the subject of a takeover by oil company Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) is probably the market leader in this field. They stated they are especially bullish on the potential for virtual power plants.

One reason for Tesla's shortage of Powerwall supply has been the substantial number they have supplied for micro projects in Puerto Rico following the storm catastrophe there. Islands are a particular focus for energy storage projects around the world. This well-respected report here details some of the worldwide projects now ongoing. Further island projects have been resourced this year in Puerto Rico, Palau, Hawaii and the Seychelles.

There are a lot of interesting projects being undertaken by Tesla. One started earlier this year, for example, in Nova Scotia has combined Powerwalls on a residential microgrid with Powerpacks for the wind-generated electricity on Nova Scotia. The province suffers particularly from power outages due to snow storms. The project has proved very successful in handling this.

In Vermont the company has a virtual power plant project with utility Green Mountain Power on a purchase to lease basis. The system also operates as a meter for the home owner. The state plans to have only renewable energy sourcing by 2030. Despite the pro-fossil fuel policy of the Trump Administration, many states (notably California and New York) are going down the renewables road.

Tesla in fact recently filed a patent in the US for a grid by-passing system. This foresees the time when customers will no longer have to be reliant at all on the utility infrastructure constraints with which they are currently faced.

Elsewhere there's a growing market for mini grids in developing countries. Tesla already has supplied these in countries such as the Philippines and Eritrea. The Eritrean project was for two communities and brought electricity to 40,000 people with 1.25MW and 1.2MW installations. Tesla is said to be working with U.K. company Solarcentury on a host of projects in Africa. Reliance on diesel has been replaced with solar power and energy storage. This has strong social, environmental and economic benefits for developing countries. According to the U.N. approximately 1 billion people in the world lack access to electricity. Mini grids allied to energy storage are proving a far less expensive and quicker way to give people power than building out traditional power stations and transmission lines.

In yet another new and interesting development Tesla has just installed its largest energy storage project in Asia. This 7MWh installation is in Osaka, Japan for the railways there. It is illustrated below:

greentech media

The back-up battery power will ensure a train can get to the next station in the event of a power outage. It's just another example of the almost endless applications for battery back-up power.

As my article in November detailed, energy storage on a commercial scale is an undoubted huge market and Tesla is one of the market leaders. The growth in coming years seems certain to be rapid as the illustrated prediction from Bloomberg below shows:

Guardian

Whether the lithium ion base battery use will be the main choice long term is much discussed, as this article points put. Solid state batteries seem a long way off from commercial usage and lithium should dominate for at least the next decade. Tesla's vertical integration as an energy company gives them the perfect opportunity to increase this side of the business.

Their renewed interest in energy storage seems to have been confirmed by the announcement in February of the intent to purchase Maxwell Technologies (NASDAQ:MXWL). This company has two main focuses. Firstly there is their work on ultracapacitors for high-power density and rapid-charging functions. Secondly there's their work on developing dry battery electrode technology. An article here explored some more details of this purchase.

It's no coincidence that the world's-largest EV supplier, BYD Auto (OTCMKTS:OTCPK:BYDDF) is going down the same path as Tesla. They also are ramping up their energy storage business. They have deployed 462MW/463MWh in commercial projects so far. They expect this number to increase substantially in the next couple of years.

California Projects

California is an outrider to much of the US. The state is committed to having a completely carbon-free grid by 2045. Recent events illustrate how it's moving rapidly in this direction.

The state authorities recently turned down the application by NRG Energy Inc (NYSE:NRG) to build its new Puente gas peaker plant. This can probably be seen as the final death knell of gas peaker plants in California. In December last year NRG had announced the closure of three gas peaker plants in the state.

California environmentalists would say they have won out over having their coastline looking like this:

digital journal

In its place the state is proceeding with a 100 MW/400 MWh project to be supplied by Strata Solar. This itself will then extend out to a series of mini grids in the surrounding areas.

One uncertainty in the state is the status of four large energy storage contracts handed out by PG&E (NYSE:PCG). The utility is currently under Chapter 11 bankruptcy. One of these contracts was to Tesla for a 182.5 MW battery storage project. The California Public Utilities Commission recently stated it expected the projects to proceed. Further delays may happen first though as the PG&E situation gets sorted out.

In the US, gas plants had been replacing coal plants as their costs have reduced, as the chart below illustrates:

Clean Technica

The administration's "clean coal" mantra is just a mirage which will not survive the current presidency. What's very much on a continuing ascent are renewables. The California decisions are far reaching.

With the state probably equating to the fifth-largest economy in the world, this represents a huge opportunity for Tesla and others.

Conclusion

Energy storage is the quiet cousin to autos as all the speculation and articles in the media center around the auto business. Energy storage has huge potential and tremendous growth for the company. If Tesla can get energy storage revenue to equal auto revenue it would be a game changer for how the company is valued.

Recent moves on a capital raise and the astonishing rapid build-out of the Shanghai factory are promising. The company may finally have the financing and the factory production to go all out on energy storage products. What still needs to be shown is that management is focused to do this. Inevitable increased growth in renewables leads to inevitable increased growth in energy storage. Bloomberg New Energy Finance forecasts that the global energy storage market will reach a cumulative 942GW/2857 GWh capacity by 2040 and will have resulted in US$620 billion of investment.

As the world moves toward renewables, as batteries get cheaper and more efficient, Tesla is very well placed to reap the rewards. It might be a sound commercial move to increase the focus on the almost unlimited opportunities renewables provide for energy storage.

Disclosure: I am/we are long TSLA BYDDF. 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.