Electric carmaker, Tesla (NASDAQ:TSLA), is a very expensive stock, considering they sold fewer than 35,000 cars world-wide last year. There is no way a car company Tesla's current size can be worth tens of billions of dollars, and there is considerable sentiment, and more than a few "shorts" in the market that believe Tesla never will be worth its current price. But there it is, a Silicon Valley startup car company that the market values at the better part of $1 million for every car they sold last year.
Tesla shares command the price they do, because their growth story is compelling and their CEO is charismatic. Many investors believe Tesla will not just compete in the car business, it will change the car business and the energy business, forever, and in the process make Tesla shareholders enormously rich. Tesla's plan includes making an SUV (Model X) to expand sales of luxury cars, and after that making a lower priced car (Model 3) to sell in much higher volumes. The plan also includes supplying electric energy to Tesla cars (and potentially electric cars from other manufacturers) at SuperCharger stations, and managing the flow of electricity on the grid with a variety of grid-connected storage systems. Each of these businesses - electric cars, road trip recharging, grid storage - could bring Tesla several tens of billions in revenue and many billions in annual profit, should Tesla gain a major player position in the respective market. Success in even one of these businesses would deliver valuation far beyond the current price.
As Tesla progresses with new models, vertical integration of battery manufacturing, SuperCharger network expansion, and grid storage roll-out, the company will become more and more valuable. Unless of course, Tesla's plans don't work out. There is risk here, and whether to go long or short TSLA is a dicey question.
Tesla is on the cusp of a tipping point where making long-range electric cars will cost less than making equivalent internal combustion engine (NYSE:ICE) cars, bundled recharging will displace gas stations, and it will be cheaper to store renewable wind and solar electricity, than generate it with fossil fuels. Tesla is positioned at the leading edge of this disruption. Tesla makes the only electric cars, price and performance competitive with ICE cars. Tesla has the only fast charging network providing ICE similar road-trip capability. Tesla is already delivering cutting edge grid storage solutions. But Tesla faces one big risk.
All of Tesla's businesses depend on one key element - batteries. If batteries cost too much or are not available in huge quantities, Tesla's businesses aren't viable, Tesla's growth story falls flat, and Tesla may even, over time, cease to exist. On the other hand, if Tesla can secure high performance batteries, in huge quantities, at attractive cost, and sooner than competitors, their future can be bright and their shareholders richly rewarded. Any investor seeking to understand Tesla, their future prospects and whether this company is worth today's price needs first and foremost to understand Tesla's batteries.
Tesla knows how critical batteries are for their future. Tesla and battery partner Panasonic (OTCPK:PCRFF), are even now building a battery factory in Nevada that will be the largest such factory on earth. But, there is a lot more to Tesla's battery efforts than a big building in the desert.
Tesla's new factory will not simply make more of the same laptop batteries the company uses today, and it will not be limited by the existing supply chain. Tesla is optimizing both the battery and the way it will be made. Tesla hopes to obtain high performance batteries, in huge quantities and at attractive cost that will enable the company to win at each of their battery dependent businesses. Let's take a look at where Tesla's battery strategy is headed.
New Factory, New Cell
An announced aim of Tesla's new factory is to streamline the cell making process by putting materials processing, cell manufacture and battery pack assembly together at one location. A slightly larger cell than the current 18650 size, that is optimized for thermal and pack assembly considerations, is also part of the plan. By these manufacturing efficiencies, Tesla has said they expect a 30% reduction in cost.
In addition to direct efficiencies of vertically integrated manufacturing, Tesla is counting on improved cell chemistry to deliver batteries that store more energy, and at the same time weigh and cost less. During Tesla's third quarter conference call, CEO Elon Musk touched on the subject of cell improvements,
... with respect to the cathode materials, I think there is a lot of technology improvements that we'll be able to apply to the battery pack and the cathode anode separator, electrolyte, counter production, the whole works and some of these improvements are independent of the others.
Changes to the cell chemistry, that is to the anode, cathode, and electrolyte may prove very important. Not only can chemistry improvements increase the amount of energy stored in each cell, changes such as more stable electrolyte may allow higher charging rates at higher states of charge - something that would shorten real-world charging times at SuperCharger stations.
Cell chemistry improvements increase the energy stored in a battery cell by reducing the amount of "active material" needed to hold a given amount of the lithium ions that actually store the electrical energy. While we don't know today exactly what cell chemistry improvements Mr. Musk alluded to last fall, we can look at the kinds of lithium ion chemistry improvements that have emerged from labs, since the current Panasonic battery cells and Tesla's Model S were designed. If Tesla is going to deliver batteries with chemistry improvements and a new generation of cars based on these batteries in two-years time, it likely means that only improvements that were first demonstrated two or more years ago will be considered.
Here are some examples of lithium ion chemistry innovations, Panasonic and Tesla might realistically be considering.
Silicon - Graphene Anode
Current lithium ion batteries use graphite as the anode material. One Li+ ion can be stored in the anode for every 6 carbon atoms. Silicon offers great advantage as an anode material, because each silicon atom can hold several Li+ ions, so much less anode material is needed, and the battery can store more energy in a given size and weight. There is a difficulty, however, in that silicon swells up when the lithium ions move into the anode, causing the silicon to break apart, lose conductive connection to the anode (negative) electrode and the cell to lose capacity over multiple charge/discharge cycles.
Several solutions have been tried, including making very fine silicon "foams" that can expand internally without getting bigger on the outside, and mixing tiny silicon particles with graphite. The latter has been tried in many variations - with the objective of using as much silicon in proportion to the graphite as possible, while retaining good battery cycle life. California Lithium Battery (CALiB) has developed a process for making a silicon-graphene anode material based on research done at the Argonne National Laboratory (ANL), which has demonstrated both high lithium ion capacity and good cycle life.
High Capacity Manganese Rich Cathode
Tesla's Panasonic battery cells for Model S use a nickel-cobalt-aluminum (NYSE:NCA) cathode material which has excellent cycle life and high charge/discharge rate capability, but which is relatively expensive due to the high proportion of nickel used. These NCA cathode cells were an improvement on the lithium cobalt oxide cells used in Tesla's Roadster, having improved specific energy (Wh/kg) and greater cycle life.
Lithium batteries are also made with nickel-manganese-cobalt cathode material (referred to as NMC or NCM). Several years ago, a variation of the NMC cathode was developed, which used a high proportion of manganese (which is less costly than either nickel or cobalt), that due to clever nano-structuring had very high storage capacity. This High Capacity Manganese Rich (HCMR) cathode material was demonstrated in high specific energy cells by Envia (400Wh/kg) and CALiB (525Wh/kg). Unfortunately, voltage-fade, internal resistance and other issues continue to plague HCMR cathode development.
Lithium cells with manganese containing cathodes are widely available, but the practical performance of these cells remains much lower than what was hoped for, several years ago. Envia, for instance, describes a cell for electric cars on their website today that has 215 Wh/kg specific energy, significantly less than the 265Wh/kg of the Panasonic NCR18650B cell, similar to cells in Tesla's Model S.
Unless a more exotic cathode chemistry such as graphene-oxide coated sulphur is considered, it seems likely Tesla and Panasonic will stick with the NCA cathode for Gigafactory batteries.
LiBOB - Lithium bis (oxaloto) borate
Lithium bis (oxaloto) borate (LiBOB) is a patented organic lithium salt, that may turn out to be critical for next generation lithium ion batteries.
An innovation likely to appear in coming generation cells is the incorporation of flame retardant electrolytes to reduce the hazard of battery fires. Phosphorus and fluorine containing co-solvents added to the electrolyte are typically used to suppress flammability, but parasitic reactions of these co-solvents at the anode, especially silicon containing anodes, adversely affect capacity and cycle life. Addition of LiBOB to the electrolyte produces a stable Solid Electrolyte Interface (SEI) layer in the anode, by decomposing before the flame retardant additives.
High purity LiBOB incorporated into the electrolyte has demonstrated exceptional cell cycle life (95% capacity after 1,000 cycles).
To understand in a general way, how improvements in cell chemistry increase storage capacity and thereby reduce cost and weight, consider the following simple example.
An Example of Cell Chemistry Improvement
The electrolyte in a lithium battery is much less conductive than say, the acid in a lead-acid battery, because organic solvents must be used instead of water, with which lithium reacts violently. Because the electrolyte isn't very conductive, the cell electrodes are very thin with as much area as possible. The anode (negative electrode) and cathode (positive electrode) each consist of very thin metal foils, coated on both sides with the active electrode material.
Cathode and anode electrodes are stacked together with thin, porous plastic separators and then rolled up like a "jelly roll" and inserted into the can that forms the outside of the cell. Liquid electrolyte is then added and the cell sealed.
Lithium ions move between the anode and cathode, residing mostly at the anode when the cell is charged and mostly at the cathode when the cell is discharged. The relative thickness of the anode and cathode active materials is chosen such that, similar amounts of lithium ions can be accommodated at either the anode or cathode.
If, for instance, a greater amount of lithium can be stored in a given amount of anode material, the thickness of the anode can be made less in proportion to the thickness of the cathode.
Lithium Cell Construction: Switching from a graphite anode to silicon-graphene allows the anode to be made thinner in comparison to the cathode, the total thickness of the combined anode, cathode and separators to be reduced, more electrode fit into the can, and more energy stored. - Author
Today's Panasonic NCR18650B lithium ion cell uses NCA cathode material and a graphite anode, and stores 12.2 Watt hours (Wh) of energy. A larger 20700 form factor cell using the same chemistry will store 16.3Wh. Replacing the graphite anode with silicon-graphene allows the anode to be much thinner (1/4 the thickness is assumed, but theoretically 10:1 reduction is possible.) This would allow the 20700 cell to store 25.6Wh. After allowing for some weight increase due to the higher proportion of heavy NCA cathode material to lighter graphite in the anode, the specific energy of the 20700 cell with silicon-graphene anode should be ~385Wh/kg, compared to 265Wh/kg for the cells used in Model S.
The advantages gained with this kind of cell chemistry improvement can have a dramatic effect on cell cost, and also on the weight and overall cost of electric vehicles using improved batteries.
Tesla's current cell cost is believed to be less than $160/kWh. That corresponds to a unit cost of $1.95 for each 18650 cell capable of storing 12.2Wh.
Producing a 1/3 larger 20700 cell using the same NCA cathode and graphite anode chemistry for the same unit cost through Gigafactory efficiencies, would reduce Tesla's cell cost/kWh by 25%. Some additional savings would result at the pack level, because slightly fewer cells would be assembled into each pack. Altogether, Tesla would realize ~30% cost savings through manufacturing integration, a slightly larger cell and simpler battery pack, using the current cell chemistry.
Chemistry improvements can bring substantial additional savings. Tesla has said such improvements will be part of the Gigafactory plan, and while we don't know exactly what improvements to expect, just improving the anode active material as described above can result in big gains. Even if more advanced materials processing raises the unit cell cost slightly, Tesla's battery cost savings with both manufacturing and chemistry improvements could approach 50%.
Cell Cost with Vertical Integration and Improved Chemistry
Cell cost reductions come from manufacturing efficiencies and from improvements in chemistry. Improved specific energy due to improved chemistry will produce additional savings in the cost of cars, because a lighter battery allows lighter, less costly drive motors, suspension, brakes, wheels, tires, etc.
Improved cell chemistry, because it allows more energy to be stored in each cell, reduces the weight of the battery. This battery weight savings results in a knock-on effect, wherein a lighter battery allows lighter, less costly drive motors, suspension, brakes, wheels, tires; which in turn reduce the energy needed to propel the car, further reducing the weight of battery needed... Large, additional cost savings at the finished car level result from these knock-on weight savings.
Of course, all the cost savings, efficiencies and lighter battery weight will do Tesla little good, if they cannot get enough input materials to build the huge numbers of batteries for which the Gigafactory is designed. This is where strategic partnering with materials suppliers matters.
Gigafactory Strategic Suppliers
Tesla's ambition to make half a million or more electric cars a year will require step-changes in the upstream battery materials supply chain. Some parts of the supply chain may need to expand to many times the present capacity, to meet needs specific to Tesla and their chosen cell chemistry.
An example of such specialized supply chain demand results from the high performance NCA cathode material used in the Tesla/Panasonic cells. While most lithium ion cathode materials are synthesized using lithium carbonate, NCA cathode material requires high purity lithium hydroxide feedstock. Tesla's incremental demand for high purity lithium hydroxide will be the predominant factor, increasing global demand for this material by three times between now and 2018. Tesla's requirements will exceed the combined capacity of FMC (NYSE:FMC) and Albemarle (NYSE:ALB), the historical suppliers of battery grade lithium hydroxide. In the near to medium term, Panasonic and Tesla will look to chinese suppliers, but cost and political considerations require a different long-term solution.
Tesla's growing battery needs will out-strip existing world refining capacity for battery grade lithium hydroxide used for NCA cathodes. - courtesy of Global Lithium LLC - 2014
Tesla has said they want material supplier partners who will locate processing facilities at the Nevada Gigafactory site. Tesla has already leveled a second large pad at their Nevada site, North of the main factory site. The combination of a quickly available site and a customer with large, long-term demand will be attractive to material suppliers needing to increase capacity to meet growing world-wide demand, provided of course, that Tesla can convince suppliers and the investment community that their battery venture will succeed.
Even before potential Tesla materials suppliers have signed on at the Gigafactory, major industry players are making strategic moves to meet increasing demand for lithium battery materials. European chemical giant BASF (OTCQX:BASFY) has teamed in a joint venture with Japan's Toda Kogyo (TOY:4100) to deliver NCA and NCM cathode materials from expanded facilities in Japan. Asahi Kasei (TSE1:3407) is buying the battery separator business of Polypore International (NYSE:PPO) in a complex transaction, that sees Polypore's non-battery separator business going to 3M (NYSE:MMM).
An interesting strategic move has been the $6.2B acquisition of Rockwood Holdings by Albemarle that closed earlier this year, roughly doubling the size of Albemarle. The acquisition brings with it Rockwood's lithium business with lithium resources in Chile, Nevada, and Australia; the world's second largest lithium hydroxide refinery (after FMC); and the patents covering LiBOB, a potentially critical ingredient for advanced lithium cell electrolytes, all of which support Albemarle's strategic push into lithium chemicals and particularly lithium battery materials.
Albemarle, prior to this acquisition, was a major player in flame-retardant, bromine-based chemicals and catalysts. The addition of Rockwood's lithium resources, intellectual property and lithium chemicals business, positions the company to be a major player in lithium battery flame retardant electrolytes and possibly cathode materials.
Albemarle is 'betting the company' to a significant degree on supplying the lithium battery industry. A year and a half ago, prior to acquiring Rockwood, the company hired Michael Wilson away from FMC where he had run FMC's lithium operations and later their specialty chemicals arm. Mr. Wilson is now in charge of Albemarle's Performance Chemicals Global Business Unit, which includes lithium chemicals and lithium battery related materials.
Albemarle offers a combination of aggressive strategy, range of resources, products, IP, and talent focused on chemicals for lithium cells that is compelling, and in my view make Albemarle a serious potential supplier for Tesla's Gigafactory. I am currently long ALB. Notwithstanding my enthusiasm for the company, investors should consult their financial advisors and make independent investigation of the company and others in this space, before making any investment.
Whatever supplier partner or partners Tesla attracts to the Gigafactory, it is likely Tesla will build batteries that are optimized for high specific energy, high rates of charge and discharge and long cycle life. These batteries are likely to use, at least for sometime, the NCA cathode material which is more costly than some NMC formulations that do not offer the same combination of energy density and charge/discharge rates. None the less, Tesla is likely to come out ahead of manufacturers choosing the cheaper chemistry, because it isn't the cost of the battery that matters, it is the cost of the car that counts in the end. And the savings in the cost of the car that come with a lighter battery will more than offset the higher cost of NCA cathode cells.
Model III and the Knock-On Effect
Battery cells that store more energy in a given weight don't just make the battery lighter. Because a lighter battery allows a smaller motor, tires, brakes, suspension, and structure, the whole car loses more weight than that saved in the battery alone. And, when the whole car gets lighter, the energy required for a given range goes down and a smaller, still lighter battery may be used, and so on. This means that both the cost of the battery cells ($/kWh), and the specific energy (Wh/kg) must be considered to arrive at the lowest overall cost of an electric car. Of course, before the car designer can optimize his design, he must know what specific energy the battery will have.
Back in November 2012, I did an analysis of Model 3 (called Bluestar back then) that included this knock-on effect and some assumptions about what kinds of batteries might be available. A lot has changed since. The very promising HCMR cathode failed to live up to expectations, and Tesla's Model 3 has slipped at least two years.
But we know more now than we did in late 2012. We know Model 3 will be a bit smaller than I assumed back in 2012 - Tesla says 80% the size of Model S, or exactly the size of the BMW 320i. Measured data for the aerodynamic drag of Model S has been published, and this can be scaled directly to the Model 3.
Updating the model from 2012 for a smaller car and using the new aero drag data, I looked at how the weight and number of battery cells in a 310 mile range (EPA) Model 3 varies with the specific energy of the battery cells.
What this analysis shows is that the ICE-to-BEV tipping point is very close. For battery specific energy somewhat better than the current NCA-graphite 18650 cells, an optimized Model 3 will weigh less than the comparable ICE BMW. If battery cost is reasonable, and I will get to that in a bit, a lighter BEV will likely cost less to manufacture than a heavier ICE car.
Will Automotive Pouch Cells Challenge Tesla?
But, if Tesla can do this, won't every ICE carmaker do the same? Surprisingly, the answer is, probably not. Competing car makers have chosen to go with larger format, "automotive" battery cells, and that choice has left them with heavier, lower specific energy cells than what Tesla and Panasonic are likely to deliver from the Gigafactory. And lower specific energy cells doom any effort in building a BEV with lower weight than a comparable ICE car.
Using the same analysis as before, we can start with a baseline car using the 215Wh/kg Envia automotive pouch cell, then see what happens to the battery weight and curb weight, with improved specific energy.
Even using an advanced automotive pouch cell, like that offered by Envia, the battery approach taken by ICE carmakers will not come close to the solution Tesla is likely to achieve with Model 3.
Battery Cost and a High Margin 'D' Segment Car
Without going into detail on the cost of building Model 3, our model shows likely cell costs for the 310 mile 'primary' version and for a 220 mile range 'entry' version Model 3 car.
When Gigafactory efficiencies are combined with improved cell chemistry and knock-on effects are considered, cell cost falls dramatically. Cells for the 220 mile range Tesla Model 3 will cost less than $4,500 assuming middle-range chemistry improvements. - Author
A cell cost less than $4,500 (obtainable with the earlier described chemistry improvements) for the entry level Model 3 car is only 12.9% of the target $35,000 selling price, and should not present a barrier to Tesla building a highly competitive 'D' segment product.
The smaller battery size for Model 3 using improved chemistry batteries, together with SuperChargers being upgraded to 135kW, will greatly improve SuperCharger based road trip performance. With the 310 mile version car, 200 miles added range in 20 minutes should be achievable. This will bring road trip times on par with real-world ICE road trip performance.
Implications for Grid Storage
Tesla and Panasonic are poised to disrupt the grid storage market, big time. When the Gigafactory starts delivering cells for well under $100/kWh, companies like Imergy Power Systems touting "low cost" $250-300/kWh flow batteries, in shipping-container sized packages will be in real trouble. Not only will Tesla have cell costs low enough to trounce these companies, they will also have the most compact solution and volume manufacturing that will let them scale into the grid storage market just as fast as they can build Gigafactory capacity.
Conclusions - What to look for...
Tesla stock is really expensive if an investor thinks the company is the next, great niche carmaker. To be an attractive investment with upside potential commensurate with the risks, one must see Tesla as a disrupter of the car business, the gasoline business, and/or the electric power business. And Tesla can only succeed in their lofty goals if they get batteries that are good enough, cheap enough and plentiful enough, soon enough.
Panasonic has made tremendous strides, even with the current NCA-graphite chemistry, 18650 cells. Delivering these cells to Tesla for less than $160/kWh, even without Gigafactory manufacturing efficiencies means Tesla cell costs remain the lowest in the industry. The next generation of NMC cathode, large, flat automotive pouch cells - like the 215Wh/kg cells from Envia - represent a substantial fall-back from the performance HCMR cathode cells would have achieved had that chemistry succeeded, and aren't close to the 265Wh/kg Panasonic is already delivering. With coming Gigafactory efficiencies and expected chemistry improvements, Tesla's little round cells will continue delivering nearly twice the energy for half the price of those big, flat "automotive" cells.
If there is a stumbling block in the path of Tesla's battery plans, it is materials supplier capacity. The huge numbers of batteries Tesla plans to make at the Gigafactory cannot be produced unless total, world-wide materials capacity grows dramatically. The problem is not available resources, but rather the refining and manufacturing plant capacity to convert raw input materials into the various precision feedstocks required. Tesla's and Panasonic's materials supply chain will be the critical piece needed to deliver a plentiful supply of batteries, quick enough to support Tesla's electric car, road trip fueling and grid storage ambitions.
Fortunately, major materials suppliers are already aligning their businesses and making the strategic "bets" necessary to deliver huge amounts of lithium battery materials and feedstocks. If Tesla can partner or form supplier relationships with large supply chain players, they should be able to get enough batteries, soon enough to win.
Tesla investors, "long" or "short", should pay attention to how the battery component of the company's business is progressing. Batteries, how good, how cheap, how many and how soon are the key drivers determining whether Tesla will succeed or fizzle in the car business, the road-trip recharging business, and the grid storage business.
If we see Tesla signing up supplier partners to operate at the Gigafactory site, or even to supply materials and feedstocks to that effort, that will be extremely positive. If we see the company land one or more grid storage deals, or if the coming "home battery" looks like a winner, that will be good news, too. Any indication of improved battery chemistry - for instance increased range for Model X, or good weight numbers for Model 3 - would be especially encouraging. And of course, seeing the Gigafactory continue to take shape will be a positive sign.
There may be bad news as well as good for Tesla and such news ought not to be ignored. If Tesla appears to be supply constrained because Panasonic has supply chain issues, that would be bad. If Tesla has to go to another battery maker to get the batteries they need, near term, watch out. And schedule slips for Model X or for the Gigafactory would be cause for concern.
Investors should not invest on the basis of the information and arguments given here. Investors are urged to seek independent, professional financial advice and to perform their own investigations into the issues discussed as well as other important aspects of companies' business when contemplating an investment.
Disclosure: The author is long TSLA, ALB. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.