Inside the Energy Debate

If you’ve been listening to the news or reading the headlines from Washington D.C. of late, you’ve no doubt heard a lot about the recent energy debate on Capitol Hill. We’ve been right in the middle of it, and I thought it would be useful to get you folks up to speed on events from our perspective.

As I’ve written in an earlier dispatch, we are very interested in a couple of issues that we believe would accelerate the adoption of alternative technology vehicles, in general, and full performance battery electric vehicles, in particular. At a high level, we group these concerns under two headings: 1) market development and 2) infrastructure development.

“Market Development” is our way of describing policies and demand-side incentives that help pull cars like the Tesla Roadster (and future Tesla Motors cars like WhiteStar, our planned four-door sports sedan) into the market. A good example of a successful market development mechanism is the recent hybrid vehicle tax credit. It has been very effective in driving sales of the Toyota Prius, Ford Escape, and other vehicles in the hybrid category. In the absence of a meaningful use tax on gasoline (a policy that has been very effective in reducing petroleum usage in Europe but has not enjoyed political backing in the U.S.), income tax credits have been the most effective mechanism for encouraging early adoption of new vehicle technologies. Such incentives shouldn’t last forever, but they have proven to be more effective than small scale “vehicle demonstration programs” because they pull substantial unit volumes into the marketplace and encourage manufacturers to invest in the infrastructure that leads inexorably to economies of scale in production and lower unit costs over time.

“Infrastructure Development” is the term I’ve used to capture all of the policies and programs that bear upon the supply side of the market equation. Project scale loan guarantees, manufacturing incentives, and other supply side incentives lower the cost of capital for manufacturers like Tesla Motors when we contemplate the substantial investments necessary to establish manufacturing facilities, distribution infrastructure, and the like. When these programs work well, they can collapse time to market and reduce the unit cost of the delivered vehicles. Last year the Department of Energy announced an innovative Loan Guarantee Program that was intended to provide federal government backing for private debt financing of energy projects in a variety of areas, ranging from massive stationary-source energy generation, to distributed generation, to grid improvement technologies, to alternative fuel and vehicle technologies. Tesla Motors has applied to this program and we are hopeful for a positive result.

So back to the current energy debate…

Early this year under new Democratic leadership, both the Senate and the House took up work on a collection of energy related initiatives. On the Senate side, the Energy and Natural Resources Committee began work on the base Energy Efficiency Act, the overall intent of which was to spur a range of new energy efficiency initiatives, including everything from power generation to alternative fuel and vehicle technologies. By mid-June, the committee had marked up a bill and sent it to the floor for debate.

Separately, the Senate Commerce, Science, and Transportation Committee initiated its own bill with an important provision that raised Corporate Average Fuel Economy (CAFE) standards. The original CAFE standards, set in the mid-1970’s, were incredibly successful during the 10 years they were in practical effect – raising the average fuel economy of the American fleet from 14 mpg in 1975 to 27.5 mpg by 1987. Sadly, 20 years later the CAFE standard is still 27.5 mpg as a result of a lack of vision, leadership, and political will. This is a testament to the lobbying heft of the major automotive manufacturers, who have argued ad nauseum that efforts to raise fuel economy above 27.5 mpg would kill their business and result in massive layoffs – business results that, as it turns out, they have been able to accomplish in the absence of increases in fuel economy!

Today, however, the winds of change are blowing, and the Commerce Committee passed a bill that would require the CAFE standard for any manufacturer's fleet (i.e. passenger cars, light trucks, and SUV’s) get to 35 mpg by 2020, with a mandatory 4 percent year over year increase thereafter. Overall, this would result in a 40 percent increase in fuel economy standards over the next 13 years.

We at Tesla Motors are naturally supportive of the most aggressive increases in CAFE possible. We think that, in the absence of a meaningful sin tax on gas, increasing CAFE is the most effective way to reduce petroleum dependence and greenhouse gas emissions. But what we also care about is making sure the new CAFE regime includes tradability of CAFE credits. It has always been the case that manufacturers who failed to meet their annual CAFE minimums would have to pay penalties. Conversely, it has always been the case that manufacturers that exceeded their annual minimums could bank credits that they could use to offset deficiencies in other years. However, credits have never been tradable between manufacturers.

Because the Tesla Roadster is so efficient, Tesla Motors would be able to exchange excess credits with the Detroit Three (General Motors, Ford and Chrysler) and other car manufacturers. We could either monetize those transactions or obtain in-kind consideration, such as supply chain concessions. In this scenario, the manufacturers would benefit by obtaining a hedge against the possibility that they would fall short of their CAFE obligations.

Overall, such a regime would spur the development of innovators like Tesla Motors, who are willing to take a risk on new technologies, and would help a market of innovation to flourish. We were pleased when the Commerce Committee included tradability as a provision of the bill that they marked up and sent to the floor to be merged with the larger Energy Bill. It is also notable that the Bush Administration supports the tradability policy.

The final party to weigh in on the emerging Energy Act was the Senate Finance Committee. As I’ve reported previously, we have been working actively with a group of like minded innovators to craft a package of useful but responsible consumer and manufacturer tax credits intended to mimic the successful hybrid tax credit. In this, we were working with a bi-partisan group of legislators, including the offices of Senators Hatch, Cantwell, Obama, Bingaman, Grassley, and others. By the time the Finance Committee met to mark up their bill, there was broad agreement on a “plug-in electric drive” consumer tax credit that would serve to encourage development in a wide range of electric drive technologies – including full performance battery electric vehicles like the Tesla Roadster. The Finance committee bill went to the floor immediately following the committee mark-up and joined the larger Energy Act debate.

So what happened?

On the tax credit piece, I have some bad news to report. Basically, the tax incentives in the Finance Committee proposal were going to be funded by the elimination of the oil and gas tax credits and subsidies that were created in the Energy Policy Act of 2005 (and in previous years). The oil and gas lobby got their big guns up to the Hill and fought a successful battle to preserve those subsidies. So despite the fact that there was a spirited debate on the issue in June and very public and aggressive support from Senator Reid and others, a vote for cloture on the debate failed by two votes. As a result, the issue will continue ad infinitum, though we believe that unlike some failed amendments this one may be reconsidered or re-introduced. In the end, perhaps the most disappointing development was that despite the bi-partisan fashion in which the amendment was crafted in committee the vote for cloture ultimately fell along party lines, with the Senate Republicans caving to the retrograde interests of the oil and gas industry.

On the CAFE side of the ledger, the news is better, though imperfectly so. It’s a little harder to report on what happened in this debate because it was less a debate than a back room deal. The story goes like this. After the Commerce Committee submitted its CAFE bill, Senator Levin (D, Mich.) threatened to filibuster the bill. Then he submitted an alternative bill that offered a pathetic proposal for CAFE increases that effectively amounted to a voluntary increase. When that was summarily rejected, he offered a somewhat more aggressive proposal that split CAFE standards for passenger vehicles from light trucks and SUVs, and substantially softened the goals and extended implementation timelines. Tradability was not a provision of either of his proposals. His second proposal was poorly received as well, though his effort started to garner more support from CAFE fence-sitters. Ultimately, it was announced that a compromise had been reached. The 35 mpg combined fleet mileage standard and the 2020 target date would be preserved, but the 4 percent increase thereafter would be abandoned. Tradability was preserved, and the larger package was passed by the Senate.

Meanwhile, over on the House side...

Early in the year, Speaker Pelosi had designated July 4 as “Energy Independence Day,” and the House completed action on the first part of its energy agenda just before the Fourth of July recess. They discussed proposals from 11 committees, including the powerful Ways and Means committee. The resulting energy bill authorizes grant and loan programs for advanced batteries research and development, demonstration programs for on-road and non-road plug-in electric drive vehicles and education programs. The House leadership has said they are trying to make room for the bill on the floor schedule in July, but left open the possibility that debate would slip to September. That is also when the House is supposed to consider the climate change and fuel economy issues, both of which were too controversial to move into the initial package.

So far, the House version of the bill does not contain the same tax incentive provisions that had been architected on the Senate side. However, Speaker Pelosi has said that she would be willing to move the tax piece separately from the other provisions. This would create an opportunity for the Senate to bring its own tax package back to the floor, as it could be offered as a substitute to the House- passed measure when it is sent over. Naturally, we are very interested in such a development and have shifted the focus of our activities to advancing such a scenario.

On CAFE, Congressman Dingell (D, Mich.), Chairman of the House Energy and Commerce Committee and a traditional supporter of measures that protect GM, Ford, and Chrysler and their status quo interests, began to weigh in. He has resisted adjustments to CAFE standards, and his strategy for arresting progress appears to be to buy time. He has separated CAFE from the House Energy Bill and promised to consider it in the fall when the House and Senate both tackle global warming legislation. He and his constituents in Detroit are evidently hoping that time will give them the opportunity to build more support for lower CAFE standards and more lenient implementation timelines.

Unhelpfully, the Administration has weighed in as well. The Secretary of Energy recently fired a shot across the bow with a threat that the President would veto any energy legislation that arrived at his desk with too aggressive CAFE provisions.

The good news is that we are roughly at “half-time” on these issues. We still have a shot at meaningful tax incentives and we are generally hopeful on CAFE tradability. And while I haven’t discussed measures for manufacturing support much, the good news is that there are significant provisions in the Senate bill that would spur manufacturing of alternative vehicles and advanced battery packs, such as our Energy Storage System.

The bad news from my perspective is that, rhetoric notwithstanding, events like the Republican party line vote in defense of oil and gas subsidies, the reflexive protection of the Detroit Three by the Michigan congressional delegation, the default United Auto Workers orientation of the Democratic leadership group, the predictable Administration orientation toward the oil and gas industry, and status quo vehicle technologies, all strongly imply that it’s still largely business as usual in Washington. There is either too little appreciation of the gathering crises of our energy dependence and global warming, or there is a failure of leadership in articulating a vision and confronting the very real, deeply resourced and entrenched status quo interests – or perhaps most alarmingly, both.

I’ll wrap up with two quotes/paraphrases that emerged from the Senate energy debate:

“If Detroit spent more money on engineering and less on lawyers (lobbying) they’d be better off.” – Senator Durbin (D, Ill.)

“We can’t drill our way out of this problem.” – Senator Kohl (D, Wis.)