• On Wednesday of last week, I speculated that Tesla might be counting on a billion-dollar regulatory credit bonanza in the last half of 2018.
• Reader comments led me to a twitter feed that mentioned a recent proposal to withdraw a prior EPA waiver that enabled adoption of California’s ZEV mandates.
• The proposed withdrawal of California’s waiver is, in fact, a joint action by the EPA and the NHTSA under Federal statutes that prohibit inconsistent state-level regulation.
• While California has promised to litigate, I believe the joint EPA-NHTSA action is justified and the proposed waiver withdrawal will eventually become effective.
• I also believe the issuance of the proposal on August 2^nd created enough uncertainty to immediately render Tesla’s accumulated and future ZEV credits worthless.

Over the years, some of the best ideas for my blog have come from thoughtful reader comments. It’s good to know the tradition continues.

Last Wednesday I speculated that Tesla (TSLA) might be counting on a billion-dollar regulatory credit bonanza in the last half of 2018. It was almost painful to write that after years of strident criticism I’d purchased Tesla calls.

Mercifully, a thoughtful reader directed me to a twitter stream from “People’s Grain@ad8871” that discussed a pending Environmental Protection Agency, or “EPA,” proposal that would put an end to California’s state level zero-emission vehicle, or “ZEV,” mandates.

I investigated.

I learned that the EPA plans to withdraw a 2013 waiver of Federal preemption that was granted pursuant to the express authority if Section 209(b)(1)(c) of the Clean Air Act of 1963, or “CAA.” I also learned that the National Highway Traffic Safety Administration, or “NHTSA”, plans to issue a formal finding that California’s GHG and ZEV mandates are preempted by the Energy Policy and Conservation Act of 1975, or “EPCA,” which has no waiver provisions.

• This joint factsheet from NHTSA and the EPA explains the legal basis for the EPA’s planned withdrawal of California’s 2013 exemption under the CAA.
• This joint factsheet from NHTSA and the EPA explains the legal basis for the NHTSA’s finding that the EPCA preempts California’s GHG and ZEV mandates.

I find the legal reasoning in both factsheets compelling and while courts can enjoin regulatory actions of an agency that are arbitrary and capricious, I think the planned joint actions of these two agencies are well within their statutory authority and the letter of the law. Since the two factsheets didn’t address the question whether California’s ZEV mandates created a reasonable path to accomplish its stated regulatory goal I submitted a comment on the proposal that:

• Calculated cumulative average daily driving distance for the entire Tesla fleet of approximately 32.75 miles;
• Observed that an EV with a 50-mile range that generates one ZEV Credit would eliminate the substantial bulk of the average Tesla driver's fuel consumption; and
• Concluded that there is no rational regulatory basis to award 1 ZEV Credit to an EV that eliminates the substantial bulk of the Tesla average driver's fuel consumption and to award 2.5 additional ZEV Credits to an EV with a 300-mile range that offers no material additional fuel savings.

2/ In fact, just today, the government announced the public comment period will be extended until Oct 26. https://t.co/ZovfG9Pqha

— People's Grain (@ad8871) September 21, 2018

The twitter stream from “People’s Grain@ad8871” did a wonderful job of analyzing the current supply and likely future demand for ZEV Credits. The only issue I had with the logic were Tesla’s sales of $179 million of ZEV Credits in Q4-17 and another $50 million in Q!-18. Since neither of these transactions would make a lick of sense in light of the supply and demand dynamic outlined by People’s Grain, I had to assume some other factor was and might still be in play.

In my view, the August 2^nd issuance of the joint EPA-NHTSA proposal created enough uncertainty to render Tesla’s accumulated and future ZEV credits worthless until we find out whether California’s ZEV mandate will survive.

One of the first lessons I learned in law school is, “never buy a lawsuit.” The same logic holds true for ZEV credits that will have no value if California’s ZEV mandate is eliminated. While an anemic market for ZEV Credits might continue to exist if a lawsuit instituted by California keeps the ZEV mandate in place while the case works its way through the courts, buyers would be foolish to buy any more credits than they absolutely need, which means that sellers would be unable to move large volumes of credits or command premium prices for them.

Since ZEV Credits accounted for one-eighth of Tesla’s automotive gross margin in 2017 and higher amounts in prior years, I believe the inevitable collapse of the ZEV Credit market will have a material adverse impact on Tesla’s gross margins in 2018 and all future periods.

While last Wednesday’s article described a potential ZEV and GHG banquet for Tesla longs in Q2 and Q4, my discovery of the pending EPA-NHTSA rulemaking is the gustatory equivalent of roaches in the soup.

This morning I closed my Tesla call position and reopened an aggressive put position.