Apr 23 2020 - Vertical Integration Will Drive Further Energy Storage Demand For Tesla

Summary

Strong demand for Tesla's energy storage products in commercial and residential applications.

COVID-19 calls into question whether company will be supply-constrained for energy storage applications again in 2020.

New large commercial contracts under way across the world should ensure continued energy storage demand for Tesla in 2020.

Company's vertical integration and diversification strengths should allow it to maintain a competitive edge in difficult times across its product ranges.

Tesla (NASDAQ:TSLA) has always said that non-auto revenues are planned to equate to 50% of revenues long-term for the company. Tesla does not regard itself as specifically an auto company as many erroneously state.

As my article in February detailed, last year showed strong growth in their energy storage business. This has a wide geographical spread and a wide usage. However, the full potential was not realised. This was primarily due to the need to divert battery production to meet soaring Model 3 demand. At the Q3 earnings update and analyst call last year, Elon Musk emphasised that energy storage supply was now back at the front of the agenda. Non-auto products were targeted to meet 50% of company revenue.

The company's vertical integration advantages should drive this business strongly forward. Vertical integration and diversification can drive incremental revenue and provide risk protection in these uncertain times. It also enables the company to spread the high fixed costs across its divisions.

The company had been hoped that this year would see the supply/demand equation balancing out. COVID-19 puts this in doubt. We will have to see how long U.S. factory shutdowns last, how much demand is postponed due to the economic fallout, and how quickly the company can ramp up production in China.

Energy storage does nevertheless represent an under-rated potential for revenue growth, which is not reflected accurately in the stock price.

Battery Developments & Renewables

My article here detailed some of the fast-moving developments. All the forecasts show the very rapid growth of the sector. This is happening as renewables take an ever-increasing share of the energy market and as battery costs fall. Lithium-ion battery costs have fallen about 85% in the last decade.

Lithium-ion will dominate for some time but batteries will continue to get cheaper and more efficient. There is enthusiasm from different quarters for new developments such as solid state batteries, potassium-based batteries, and flow batteries. It will be some time before commercial alternatives to lithium-ion get developed.

As I detailed here, battery energy storage growth is an inevitable consequence of renewables growth. The illustration below produced by Wood Mackenzie shows the growth projection for the USA:12004341-15869308284155226.png

Source: CNBC

UBS has projected that the energy storage market will be worth US6 billion ten years from now.

Figures from IRENA (International Renewable Energy Agency) show that one-third of new electricity generation in 2019 worldwide was for renewables. This is illustrated below:

12004341-15868459537194185.png

Source: LAT

Solar power represented 55% of this, and Asia was by far the largest chunk of new renewable energy. As with autos, Tesla's future is very much tied up with developments in Asia. Governments are embracing renewables in a much more positive way than in much of the West. Even in a more reluctant USA, the U.S. Department of Energy stated last year that battery energy storage could satisfy "a substantial portion" of U.S. peak capacity needs. Many utilities in the country are independent of the Federal Government, moving in this direction. Banks are reporting a lot of applications for the financing that will be required.

Unfortunately, the EPA (Environmental Protection Agency) has this month decided not to tighten up on regulations. This means pollution from coal and oil-fired power stations will continue to have its serious implications for health.

The company's "Battery Investor Day" is scheduled for May. This should give us more details of progress with Tesla's battery acquisitions Hibar Systems and Maxwell Technologies (NASDAQ:MXWL). There has been much talk of the "million mile battery". Its energy storage equivalent would amount to 20 years of energy storage. Elon Musk stated last week that the event would discuss cell chemistry, module and pack, architecture and provide a manufacturing road map for how the company would get to a terawatt per year of production.

It will be interesting to see what Musk has to say on series of issues. This includes:

* Testing new cell chemistries.

* Continuing developments in battery pack assembly method.

* Whether the company has reached the magic US0 per kWh mark (they almost certainly have).

* Update on manufacturing their own cells.

* Details of the new technology they are said to be developing for the Semi.

One of the two new buildings coming up rapidly at Shanghai is thought to be a battery facility. Details should be announced quite soon. This could well be where Tesla focus on manufacturing their own cells. The huge scale of the construction going on compared to the existing first white building is illustrated in the drone shot from Jason Yang below:

12004341-15869202343535976.png

Source: Tesmanian

China is increasingly the centre of world battery production. Of the 115 large battery facilities under firm planning, 88 are in China. It is forecast that China will have 564 GWh of capacity by 2028. Europe will have 348 GWh capacity by 2029. The USA will be some way behind. This is another reason why Tesla's future in new developments is likely to centre on Shanghai and Berlin.

Tesla is adding to the close relationship forged in the USA with Japanese company Panasonic (OTCPK:PCRFY) with new co-operation agreements in China. These are with South Korean giant LG Chem (OTCPK:LGCLF) and China's largest battery manufacturer CATL. It will be interesting to see what emphasis Tesla puts on energy storage in China. It has been advertising for project managers for energy storage to be based at its Shanghai facility. Its vertical integration and local supply chain out of Shanghai are enabling the company to restart production very rapidly.

The German government has a policy in place to encourage lithium-ion battery production. The new Tesla facility will no doubt tie in with this. The Berlin operation has already started advertising for battery expertise. Battery cell production is likely to be a strong focus there.

Tesla's Energy Storage Numbers

Despite the supply constraints, in 2019, the company supplied 1.65 GWh of storage. That was more than all the previous years combined. This was detailed by the company here.

However, on Q4 2019 revenues of US.38 billion, autos represented US.36 billion, or 86%. Total company revenue was US.6 billion in 2019, of which auto revenue was US.8 billion. Energy generation and storage was US.5 billion and "Others" was US.3 billion. So, energy was only 6% of revenue. The company target, re-iterated at the Q3 earnings call, remains for energy to become 50% of revenues. The potential revenue stream has been under-rated by analysts.

In Q4 alone, they supplied 530 MWh. For 2020, Tesla had forecast a 50% increase in volume to about 2.5 GWh. Much of the increase at the end of the year was driven by the new 3MWh "Megapack" commercial product which has given the company an edge over the competition.

The 13.5K "Powerwall 2" residential product remains in strong demand, but apparently on a long lead time. The company will hope that it will be able better to meet strong demand for Powerwall residential batteries this year. In another example of Tesla's advantage in vertical integration, it is increasing integration between customers' home battery systems and Tesla vehicles. This will enable the Powerwall app to look at how to switch capacity between the need for the car to be charged and the need for the house to be charged during a utility power shutdown.

This is another key advantage for Tesla, similar to the way that Apple (NASDAQ:AAPL) ramps up its business on its iPhone base.

The historical energy storage growth for Tesla is illustrated below:

12004341-1586758433378106.jpg

Source: PV Tech

As with autos growth, energy storage growth is only going one way.

Solar installations showed growth in 2019, but still only managed a disappointing 173MW for the year. There has been some bullish talk about the Solarglass Roof Systems business for 2020. Much of this might be centred in California. Further growth may depend upon how quickly the State can recover from COVID-19. Any growth in solar installations would boost the numbers of Powerwall residential product. However, that pre-supposes Tesla has the product to supply.

In another example of vertical interaction, on Tesla's website, customers can now combine the ordering procedures for both residential and commercial systems with battery requirements.

Projects in 2020

My article here detailed some of the many projects Tesla is supplying or expanding. The highlights for 2020 are likely to include the expansion of the famous "largest battery in the world" project at Hornsdale Wind Farm in South Australia, the virtual power plant network in Australia, numerous mini-grids, and the long-delayed Moss Landing facility in California.

* The VPP (Virtual Power Plant) network in South Australia is already a tremendous success, even though it is only in its early stages. The recent report from the AEMO (Australian Energy Market Operator) was very optimistic on its long-term benefits. They foresee a potential of 50 GW for such projects.

Grid failures have been compensated for by this VPP despite the factor that it is only in it every early stage. Even so early in its build-up, it has been successful in stabilising the grid. At the same time, individual homeowners are accruing the benefit of an average 20% reduction in their utility bills. It is a win-win situation for all parties.

Phase 2 to bring the number of homes up to 1,100 is currently being installed. A total of 50,000 homes is envisaged over the next couple of years. The system would be about a 250MW/650MWh one. The value of that in Powerwalls alone would probably be about US0 million.

The success of this VPP is a signal that combining residential solar and battery units to help the grid does indeed work. Tesla is also participating in a "Home Battery Scheme" around the State. As this paper shows in detail, energy arbitrage and reactive energy compensation can greatly cut costs for end-users. South Australia and Tesla are ground-breakers for this development, but other States are following suit.

Northern Territories recently announced they are bringing in incentives for a similar home battery storage scheme in their State. The State has a target to have 50% of electricity generation from renewables by 2030.

Another way in which Tesla has been innovative in its use of Powerwalls across the community has been with its work with the Resilient Energy Collective. This has enabled many residents affected by the devastating forest fires this summer around the country to get power up and running quickly with Powerwalls and solar panels.

* The Hornsdale Wind Farm expansion is proceeding with its 50% expansion. This is expected to add 64.5 MWh of capacity and 50 MW of output. Just last week, the Neoen managing director announced that the network connections for the upgrading of the Hornsdale Power Reserve had been completed. The expansion will cover grid applications such as inertia using Tesla's unique "Virtual Machine Mode". The South Australia government saw almost instant payback for its Hornsdale investment. Consumers saved A million in its first year of operation. This is another win-win situation for all.

The South Australia government is going full steam ahead with further projects planned.

* French project manager company Neoen is also reportedly proposing another project at Geelong in the State of Victoria of 900 MWh at a cost of A0 million (US2 million). Tesla would probably be well placed for this due to their close working relationship with Neoen. Their product has been specified as the standard for the job. It is reported that Tesla's Megapack product is a definite part of the Neoen bid. Neoen has much to thank Tesla for. It recently announced soaring revenues from its Hornsdale project.

When the South Australian projects emerged, cynics suggested that it was just a one-off by one State. However, this was as always clearly mistaken. The Victoria State Government is quickening up the pace of such projects. It intends for the Geelong one to provide a fast frequency response for the National Electrical Market. It would also provide back-up power for the State and improve reliability.

* The similar neighbouring 278 MW Lake Bonney Wind Farm for Infigen Energy is now thought to have been fully commissioned. This evidences yet again the advantages of Tesla's vertical integration. Infigen has been emphasising the flexible capacity and system security services to South Australia's grid and firming an additional 18 MW of power. In addition, though, they are contracted with Tesla to supply the company's fast-charging supercharger network across the country. Recent figures show that Tesla has an incredible 80% share of the Australian BEV market this year. This is led by soaring sales of the Model 3 but backed up with solid sales for the Model S and X.

Australia is fast becoming a perfect model market for Tesla's diversified portfolio of energy storage and autos.

* Moss Landing Facility: Wood Mackenzie had forecast that the use by U.S. utilities of energy storage would increase tenfold between 2018 and 2023. The approval signed and sealed in late February with California utility PG&E (NYSE:PCG) will be Tesla's largest energy storage project yet. It is set to break ground in April and complete by the end of the year. To be officially known as the "Elkhorn Battery Storage Facility", Tesla will be supplying a huge 1.095GWh of capacity using its unique Megapack product. This will be probably the largest energy storage facility in the world and about ten times the size of the completed phase of the Hornsdale Wind Farm.

* Saint John Canada: in an interesting pilot 1st phase project, Tesla is supplying a 1.25MW/2.5MWh Megapack system to Saint John. This is pictured below:12004341-15867663663844569.jpg

Source: Tesmanian

Even the very cold temperatures in the locality are not seen as a problem for its efficacy.

* In Africa, Tesla has been showing that battery energy storage is not just a First World luxury environmental idea. In Zimbabwe, for instance, after a year-long trial, they are progressively installing 520 Powerwall batteries to Econet Wireless. Countries in Africa frequently have power outs due to insufficient grid capacity. In Kenya, the company has been installing Powerwalls at desalination plants to keep the water flowing when the solar array does not have sufficient sunlight.

* It is known that Tesla is bidding on a host of projects large and small. For instance, it was revealed they were one of the bidders for a new utilities project from Hawaiian Electric. This is another huge project to replace the AES Hawaii coal plant on the island of O'ahu. That is due to be decommissioned in 2022. It will be used for both load-shifting and backup. Tesla is offering 244 Megapacks for a 732 MWh storage project. Market talk has it that Tesla is close to securing the job, but it has not been confirmed so this project should not be factored in to 2020.

244 Megapacks would probably amount to a value of about US5 million depending upon configuration. A further 258 MWH of smaller projects on the island in Hawaii is also planned by Hawaiian Electric. Hawaii is mandated to be all renewable for its electricity needs by 2045.

It will be interesting to see what percentage of these sort of projects Tesla is able to win. It may depend upon battery supply constraints and management focus. We might get more idea on this when Tesla announces their Q1 earnings on 29th April. If energy storage volume is down this year, it will only be because demand for autos is so strong, assuming factories are not closed down for a long period. So, investors in Tesla can be happy either way.

Conclusion

Tesla has always emphasised that they are not just an auto company. They have ridden on the first wave of a lithium-ion boom market for autos. They can now ride on a second wave of the lithium-ion boom market for energy storage. Their vertical integration and technological know-how give them an advantage over competitors. Supply chains are only as good as their weakest point, and Tesla's competitors will have great problems when trying to repair the supply chain when starting up after COVID-19 shutdowns.

The market for battery energy storage is for both big and small projects, all around the world, and for rich and poor countries.

As with autos, strong long-term demand for Tesla's energy storage offerings is a given. This year is seeing a healthy increase in projects for the company in Australia and the USA in particular. How badly such demand in the short term is affected by COVID-19 is still anyone's guess. Buying the stock on the back of the increased revenues to come depends upon the individual's viewpoint of how long the effects of COVID-19 will endure.

Tesla's diversification, technological know-how, and vertical integration strength do, though, give them a unique advantage in a time of economic uncertainty.

Disclosure: I am/we are long TSLA AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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