Despite recent squabbles with various state auto dealer associations, the U.S. remains by far the top market for luxury electric-car maker Tesla Motors Inc. (NASDAQ:TSLA). However, there have been plenty of warning signs in the last six months or so that U.S. demand for the Model S sedan has peaked.

Any diversification of sales would be a good thing for Tesla at this point. Fortunately, China is poised to come to the rescue. Tesla delivered its first Model S sedans in China last month, and it is positioned for massive growth there in the next few years.

Tesla Model S

Tesla delivered its first Model S sedan in China last month. Photo: Tesla Motors

In fact, China is likely to overtake the U.S. as Tesla's largest market by the end of the decade -- or sooner! Tesla will be just a few years behind other major global automakers, like General Motors (NYSE:GM), that are seeing sales volumes in China overtake sales in their home markets.

Support from the government
There are two key forces that should propel Tesla's growth in China. The first is smog. Smog has become a very serious public health problem in Beijing and many other urban areas in China. As a result, the Chinese government is very interested in promoting electric-vehicle technology.

Some local governments are also hopping on the electric-vehicle bandwagon. In Shanghai, where license plates can cost more than $10,000 in public auctions -- due to strict limits designed to alleviate congestion -- the local government is giving free license plates to Tesla Model S buyers. This creates great value for Tesla customers at no cost to the company.




GM is just following general industry practice with this pricing scheme. However, Tesla decided to break the mold by selling the Model S in China at a price where it would earn the same margin as it would for a U.S. sale -- increasing the price only enough to compensate for customs duties, taxes, and transit costs.

The result, according to Tesla (link opens a PDF), is that "in China the Model S is priced comparable to a mid-sized premium vehicle, instead of a large luxury vehicle." Considering all of the other benefits of having an electric car, this should allow Tesla to capture a higher proportion of the luxury market in China than it has in the U.S. Most importantly, China is the top luxury car market in the world.

Getting there
According to Tesla executives, the company has already seen strong initial demand for the Model S in China. In fact, on the company's recent conference call, Tesla CEO and founder Elon Musk told analysts that if the company tried to fully meet Chinese demand for the Model S this year, it would starve the rest of the world. (In other words, there would be hardly any Teslas left for customers in other countries.)

Tesla Cars Charging

Tesla needs to build a big Supercharger network in China to boost sales. Photo: Tesla Motors

Still, for Tesla to reach its full potential in China, it will need to vastly expand its infrastructure there -- which is exactly what it's doing. On several occasions recently, Musk has stated that he is urging the Tesla China group to spend money as fast as possible without wasting it. This primarily entails creating a broad network of Supercharger facilities and service centers.

Foolish final thoughts
There is obviously no guarantee that Tesla will be able to follow through on its potential in the Chinese market. However, the government's push for more clean vehicle technology and Tesla's lower markups in China compared to other luxury automakers create an enormous amount of growth potential for Tesla in China.

Between Tesla's likely growth in China, the arrival next year of its Model X crossover (which fits well with the growing popularity of crossovers and SUVs in China), and the potential for a mass-market vehicle later in the decade, Tesla has plenty of growth catalysts ahead. If Tesla stock continues to pull back this year, it will be worth a look for long-term investors.

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Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends General Motors and Tesla Motors. The Motley Fool owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.