Last week Tesla announced its second-ever quarterly profit. Analysts were stunned by the results . Tesla has historically been largely unprofitable because it reinvests its cash into R&D and manufacturing, but it managed to squeeze out a small $22 million in profit this Q3 2016 .
This profit, however, would have been impossible without climate change regulations.
In 1990 California adopted the Zero Emission Vehicle (ZEV) regulation, which is still in effect today. Managed by the California Air Resources Board (CARB), the regulation aims to hasten the development of non-polluting vehicles in order to mitigate the effects of climate change. Automakers are required to sell a certain number of ZEVs each year, in proportion to their overall sales. 
Each automaker is required to maintain a certain number of ZEV credits and can only receive these credits when selling non-polluting vehicles. Automakers lacking credits can purchase credits from competitors, like Tesla, who hold more ZEV credits than required by the regulation. Automakers holding insufficient credits are fined.
Tesla sold $139 million of ZEV credits this past quarter.
Taking into account Tesla’s $22 million profit and $139 million ZEV credit revenue, it’s easy to see that Tesla would not have been profitable without ZEV credits – it would have faced a Q3 loss of $117 million. Tesla’s automobile-related revenues are not yet profitable, and its reliance on ZEV credit revenue is crucial in the near-term.
In Q4, however, Tesla is projecting negligible revenue from ZEV credits. This is because there are so many excess ZEVs flooding the market. Tesla CEO Elon Musk is therefore pushing CARB to significantly raise ZEV standards:
“The California Air Resources Board is being incredibly weak in its application of ZEV credits,” Musk said on the company’s earnings call Wednesday, referring to the state’s zero-emission vehicle program. “The standards are pathetically low. They need to be increased. There’s massive lobbying by the big car companies to prevent CARB from increasing the ZEV credit mandate, which they absolutely damn well should. It’s a crying shame that they haven’t. And as a result, you can barely sell the ZEV credits for pennies on the dollar.” 
Musk’s comments are no surprise – Tesla would bring in far more revenue from ZEV credits if CARB raised standards. But even though Musk is biased, we should not disregard his suggestion.
Right now, with so many available ZEV credits – largely caused by Tesla’s rapid success –automakers can fulfil their regulatory requirements with as little as 6 percent of their sales consisting of ZEVs. California was hoping for this figure to reach 15.4 percent by 2025, but there is little incentive with ZEV credits so inexpensive. 
California needs to raise these standards as soon as possible. The ZEV regulation is designed to force automakers to manufacture a larger percentage of non-polluting vehicles each year, but this only works if automakers produce the bare minimum. Tesla has decided to go above and beyond, producing hundreds of thousands of electric vehicles and flooding the market with cheap credits. This removes the incentive for competitors to produce more ZEVs; they can instead purchase credits for pennies on the dollar.
CARB should also not limit the number of credits per company (this is a commonly suggested solution). Tesla should be rewarded for going above and beyond, and competitors need to be incentivized to catch up fast.
Ultimately, Tesla needs to break its reliance on ZEV credits for profitability. Its Q3 profit is just a fluke – without ZEV regulation, Tesla would have not been profitable. Musk is currently on the right path. While pushing CARB to raise standards, he is also pushing Tesla to reach profitability without the assistance of ZEVs. Musk is actually predicting a Q4 profit without ZEV credit revenues!
 Higgins, Tim. “Tesla Generates a Profit.” Wall Street Journal. October 26, 2016.
 Musk, Elon. “Tesla Third Quarter 2016 Update.” Tesla. October 26, 2016.
 California Air Resources Board. “Zero Emission Vehicle (ZEV) Program.” California Environmental Protection Agency. October 16, 2016.
 Hull, Dana and Lippert, John. “Musk Tears Into California Board Over Emission Credits Rules.” Bloomberg. August 4, 2016.
 Lippert, John. “California Ponders Changes to Fuel Rules as Tesla Cries Foul.” Bloomberg. July 7, 2016.
All images from Tesla.com