Clean Energy Credits and Electric Vehicles
This blog is the first in a series about electric vehicles (EVs) in various forms of public and private means of transportation, as well as the unanswered legal and policy questions surrounding electrification. More posts about EVs will follow.
CLEAN ENERGY CREDITS
The terms “clean energy credit” or “renewable credit” are used often; but they can refer to different things in different contexts: a tax credit obtained through investment in qualified renewables ventures; or a renewable energy certificate (REC)—generated through producing energy via renewable methods of producing zero-emissions products like electric vehicles (EVs)—that can be sold as a separate commodity to other entities.
TAX CREDITS
There are a number of federal programs that subsidize investment into renewable energy, but the most famous is contained in the Internal Revenue Code § 30D and can be used by purchasers of “Qualified Plug-in Electric Drive Motor Vehicles” (which include passenger vehicles and light trucks) to offset their tax liability. Each purchaser may subtract $7,500 from his tax liability; when 200,000 units of the qualified vehicles have been sold, the tax credit is gradually reduced quarter-by-quarter until the sixth following quarter, when the credit available to purchasers of each such vehicle is reduced to zero. This federal subsidy program has been crucial in attracting customers to auto manufacturers like Tesla, functioning as a de facto rebate program. 30D was utilized in marketing Teslas to the extent that during Tesla’s tax-credit phase-out period (2018-2020), the company went so far as to guarantee reimbursement to customers if manufacturing delays placed deliveries into reduced-credit quarters and caused purchasers to be eligible for less than the full $7,500 in credits.
RECs
Renewable energy certificates (RECs) are different from renewable tax credits. They are creations of state law, being parts of larger state-enacted climate-change initiatives called Renewable Portfolio Standards (RPS.) These standards are commitments to have a certain percentage or a certain amount of a state’s power production come from renewable sources. For example, the Michigan RPS stipulates that 15% of the state’s power production will be renewably produced by 2021. Renewable usually means something like wind, solar, or other ostensibly clean sources. Currently, 37 states have enacted an RPS or less stringent renewable portfolio “goals.” There are currently no federal RPSs, although they have been proposed over the years in Congress.
Today, RECs are common parts of RPS policies. In most states, power producers—that generate power from renewable sources more than they are required to by the state’s RPS—may either trade or sell RECs to other parties that may not be meeting their own RPS requirements. Each REC represents one megawatt-hour (MWh) of electricity generated from a renewable energy source. Virtually all RPS programs allow energy producers to unbundle RECs from corresponding renewably-produced electricity and thus to collect double revenue streams. This is meant to funnel capital into the renewable energy sector. Caselaw over the past decade has solidified RECs not merely as ancillary proof-of-work aspects of renewably generated electricity, but as commodities separately generated in the process of renewable power generation. This form of RECs—personal property voluntarily unbundle-able from renewably-generated electricity—has been recognized by many government and nongovernmental organizations, including the Environmental Protection Agency, Department of Energy, Federal Trade Commission, the Climate Registry, the CDP (formerly Carbon Disclosure Project), and Center for Resource Solutions. Most states today have opted to impose “home grown” requirements as well on RECs utilized by entities to comply with in-state RPS standards.
AUTO INDUSTRY
Today, RECs are granted not only to power producers, but to auto manufacturers. Zero Emission Vehicle (ZEV) programs implemented in California and a handful of other states (Colorado, Connecticut, Maine, Maryland, Massachusetts, New Jersey, New York, Oregon, Rhode Island, Vermont, Washington) grant RECs to auto manufacturers that produce and sell qualifying “zero-emissions” automobiles. Just as in states with RPSs in which RECs are earned and sold by renewable power generators, states with ZEV programs award ZEV credits to manufacturers based on the type and range of the qualifying vehicle sold. Credits are awarded not only for pure EVs (ZEVs), but Transitional Zero Emission Vehicles (TZEVs) as well, which include plug-in hybrids. ZEV credits are worth more than TZEVs, and more credits are earned for selling vehicles with longer ranges. And because of the aforementioned “home grown” requirements of most RPSs, ZEV credits cannot be applied out-of-state to assist in compliance with other states’ RPS requirements; which is why many EVs like the Fiat 500e, VW e-Golf, Hyundai Kona EV, and Kia Soul EV are sold new only in states with ZEV programs.
There is no consensus among regulators, industry groups, or scholars as to how much RECs are aiding in efforts to transition the world to greener economic habits. However, some private-sector entities have benefited massively from RECs, especially ZEV credits.
Tesla has been the most high-profile utilizer of renewable energy certificates in the automotive space. In addition to their use of the IRC § 30D tax credit to market their automobiles, they have also reaped enormous benefits from selling ZEV credits. Their annual Form 10-K filing says: “We earn tradable credits in the operation of our business under various regulations related to zero-emission vehicles (“ZEVs”), greenhouse gas, fuel economy, renewable energy and clean fuel. We sell these credits to other regulated entities who can use the credits to comply with emission standards, renewable energy procurement standards and other regulatory requirements.”
The 10-K’s Revenue by source section that disaggregates revenue by major source shows that sales of ZEV credits (“automotive regulatory credits”) brought Tesla $419MM, $594MM, and $1.58B of revenue in years 2018, 2019, and 2020, respectively. Tesla, however, showed a profit (positive net income) for the first time in 2020. Tesla showed a net loss of $976MM and $862MM in years 2018 and 2019, respectively; and showed a profit of $721MM in 2020. As a result, market analysts and commentators have noted since that Tesla’s recent profitability is purely attributable to the sale of regulatory credits, without the $1.58B in regulatory-credit-sale revenue, they would not have ended 2020 with $721MM in profit.
Short traders Michael Burry (who was the subject of Michael Lewis’s book The Big Short and the movie based on it) have taken large short positions against Tesla, reasoning that a balance sheet sustained by regulatory artifice cannot be sustainable. On the analyst side, commentators like Tim Benson at RealClearEnergy have painted depressing pictures about ZEV programs’ effects on the auto industry’s progression toward EVs. Benson writes that automakers are effectively given two choices: buy ZEV credits from Tesla to fulfill regulatory requirements, or spend billions on EV R&D and maybe one day fulfill regulatory requirements by EV sales. They have mostly chosen to delay EV R&D, instead opting to buy hundreds of millions of ZEV credits from Tesla—because it’s the cheaper option. So ZEV programs have mostly amounted to direct wealth transfers from incumbent auto manufacturers to Tesla. A question we should now ask is whether this arrangement is actually aiding in our societal transition to renewable energy sources and whether the opportunity or transaction costs make the arrangement worth it.
To start, energy credits systems such as ZEV credits are undeniably spurring investment into renewables. Enterprises focused on renewable energy production and zero-emissions products like EVs have more capital in their coffers than they otherwise would have. If we assume that zero-emissions vehicles like Teslas are truly zero-emissions products (by ignoring the environmental effects of mining required to build EV components such as batteries, nonrenewable power used along every stage of the production process, etc.), then it would seem to be a good thing that an EV market is flourishing as a result of Tesla becoming profitable and staying in business. However, the next (and more important) analytic step is one of costs and benefits. If auto manufacturers other than Tesla were not effectively held hostage by the ZEV credit system and forced to fork over hundreds of millions to Tesla, and if instead they had more of a real choice to invest that money in renewables technology would we maybe be farther along on our journey to a world powered by renewables?
The empirical data we have so far is worrying, but not dispositive as to the counterfactual question above. The National Renewable Energy Laboratory (NREL) has been tracking voluntary procurements of renewable energy since the 1990s; according to them, the purchase and use of unbundled RECs has grown by over 60 million MWhs between 2010 and 2020.
In 2020, sales of unbundled RECs comprised 44.97% of all purchases of renewable energy. Assuming that regulatorily unnecessary purchases of green power did not happen (in other words, no entity purchased more renewable power than they were required to by RPSs), it means that almost half of all RPS requirements imposed on polluters were satisfied using RECs. We can conclude that a corresponding amount of capital was transferred to the renewables sector; however, we can also conclude that RPSs across states had only half the effect they sought in aggregate, because while more renewable energy was produced and purchased than before, only half of RPS requirements was satisfied using actual energy; the other half was satisfied by using an artifice of regulation—RECs.
In sum: unbundled RECs have become a reality in the regulation of electric utilities and automotive manufacturers; they are undeniably contributing to increased investment in renewables technologies and enterprises; but it remains to be seen whether permitting unbundled RECs to be used to comply with climate initiatives like RPSs is the best—most effective and efficient—arrangement we could have.