What is a ZEV Credit and how does Tesla make money with them?

When Tesla turned another profitable quarter in 2020, it sparked some serious online discussion about one of the contributing factors: regulatory credit sales.

While regulatory credit systems can be complicated due to all their legal-ese, they’re an important topic that electric vehicle shoppers and enthusiasts should have some understanding of. They drive many of the decisions automakers make when it comes to electrifying their lineups and deciding where to sell their electric vehicles.

The United States features a regulatory credits program that originated in California, the ZEV (Zero Emission Vehicle) Program. This ZEV program is a state law, so it only applies for California and the 11 other so-called “ZEV States” that have adopted the standard, including Colorado, Connecticut, Maine, Maryland, Massachusetts, New Jersey, New York, Oregon, Rhode Island, Vermont, and Washington.

There are a dozen ZEV States as of 2020, highlighted in blue in the map above

The 12 ZEV States mandate that a certain percentage of each manufacturer’s yearly sales must be made up of zero emissions vehicles, measured with ZEV Credits. There are a number of different clean vehicle technologies the regulation rewards, but the two most notable categories are Zero Emission Vehicles (ZEVs), which include battery electric vehicles and hydrogen fuel cell electric vehicles, and Transitional Zero Emission Vehicles (TZEVs), which includes plug-in hybrids.

ZEV Credits are earned when manufacturers sell such vehicles in ZEV states. Counterintuitively, one sale does not equal one credit. Instead, ZEV Credits are awarded based on the type and range of the vehicle sold. ZEVs are worth more than TZEVs and long range vehicles are worth more than short range ones. This method ultimately encourages automakers to build long range electric vehicles over anything else, though short range EVs are useful if an automaker doesn’t have a long range EV platform.

For example, the 2013 Nissan Leaf had a 24 kWh battery pack and an 84 mile EPA-rated range, which combines highway and city range. However, the California Air Resource Board (CARB) uses just a city driving test for the ZEV calculation. The Urban Dynamometer Driving Standard (UDDS) provides a somewhat higher result than EPA-published figures do. Specifically, the Leaf returned a 119.12 mile result from that test. The range then gets plugged into an equation to determine how many ZEV credits it would get.

Meanwhile, the Tesla Model Y was rated at 441.91 miles on the alternative cycle, which gives it a much higher value.

It actually exceeds the credit cap. The most any automaker can get for any single sale is four ZEV Credits.

Each state tracks the sales within its own borders for compliance – there is no transferring from state-to-state. No ZEV Credits are earned when an automaker sells a zero emissions vehicle outside of a ZEV state which is why many electric vehicles like the Fiat 500e, Volkswagen e-Golf, Hyundai Kona EV, and Kia Soul EV are only sold new in ZEV states. These automakers aren’t building EVs on the same scale as Tesla, Nissan, or Chevrolet, and they need to earn those credits to avoid penalties for not complying with the law.

Another option that is available to automakers, and one that has been incredibly lucrative for Tesla, is the sale of ZEV Credits from one automaker to the next.

Just like every other automaker, Tesla is required to generate and hold a certain number of ZEV Credits every year. Unlike every other automaker, every single one of Tesla’s vehicles is a long range electric vehicle, which means the company generates a ton of them. It keeps the small amount needed, while selling the rest off to companies that aren’t producing enough EVs.

Between September 1, 2017, and August 21, 2018, it transferred over 88,000 California ZEV Credits to Toyota, the equivalent of approximately 22,000 of its vehicles. Tesla makes big money of these sales too. In Q2 of 2020, it brought in $428 million in revenue from the sale of ZEV and other such regulatory credits. As long as other automakers aren’t building enough EVs to meet the ZEV Program requirements, they’ll have to buy them from automakers like Tesla, who are.

The ZEV Program has done a great deal to encourage the production of more electric vehicles, but its limited state-by-state nature means not everybody in the country gets to benefit from it. That said, it looks like more states will continue to join over time (Colorado just joined in 2019), and the ZEV State-exclusive electric vehicles will find their way to the rest of the country on the pre-owned market.