Tesla Motors (TSLA -0.95%) CEO Elon Musk has big plans for the first Gigafactory. The battery factory will have 35 GWh of annual production capacity and the capability to assemble another 15 GWh of battery packs each year, bringing the total annual capacity to an astounding 50 GWh of finished products. That will be more than enough to supply batteries for the company's stated goal of 500,000 electric vehicles, so the additional capacity is being dedicated to a growing portfolio of stationary energy storage products for home (Powerwall) and utility (Powerpack) customers.

The energy storage market is still in its infancy today, as technologies mature and companies iterate business models that work as seamlessly as possible within the complicated ecosystem of power distribution. While the economics work only for a small niche of individual customers, Musk is hoping that an integrated Tesla Powerwall plus solar panels from SolarCity (Nasdaq: SCTY) will generate more interest and value over time. The economics are slightly easier for utility-scale deployment of Powerpacks in the near term, but only after state and federal incentive programs are factored in. Success in the nascent industry is more difficult to achieve than it looks.

A cartoon of a battery with very low charge left.

Image source: Getty Images.

Some speculate that Tesla is willing to take on short-term pain to grow market share, establish relationships with key customers, and build its brand. That, the argument goes, should position the company for long-term success as battery prices fall and the kinks are ironed out of financing models. After all, Tesla has substantially more capital to deploy than nearly all other energy storage manufacturers and wields the largest battery manufacturing facility on Earth. 

There's just one problem: Lithium-ion batteries probably aren't the future of home or grid energy storage. Although capital and a Gigafactory provide Tesla with a formidable competitive advantage today, that could evaporate in the next decade as the energy storage market becomes segregated by application.

Limitations of lithium-ion batteries

Lithium-ion batteries dominate mobile and on-the-move applications today, whether the cordless machine is a smartphone or a power drill or an electric vehicle. Why? They provide high energy density, resulting in lighter, smaller formats. They boast lifetimes sufficient for most mobile applications, even electric cars. And they boast relatively high thermal stabilities, making them safe for mass consumer markets -- when manufactured properly. 

However, many of the characteristics of lithium-ion batteries that make them difficult to beat for on-the-move applications don't extend the same benefits in stationary applications

The Panasonic and Tesla battery chemistries are limited to about 500 deep cycles, which is the number of times a battery can go from full charge to about 20%, before their performance deteriorates significantly. That's fine for smartphones that get replaced every two years and electric vehicles that use a fraction of their driving range each day. But that's incredibly limiting for a battery that needs to be used daily to extract maximum value from solar panels on your roof -- your battery would begin fading in less than 16 months. 

That forces Tesla and other lithium-ion battery providers into a delicate balancing act between price and performance. A battery with a larger capacity would never encounter a deep cycle and thus have a long lifetime, but it would be so expensive that no one would buy it. A smaller battery would be more economical, but it would require deep cycles every time it's used and thus have a lifetime that wouldn't make sense for stationary applications.

Tesla's current Powerwall uses the latter approach, boasting a capacity of just 6.4 kWh and costing a "relatively manageable" $3,000. The average American home used about 30 kWh of electricity daily in 2014, according to the U.S. Energy Information Administration.

In any event, this conundrum may not seem obvious in a world where lithium-ion batteries are seemingly ubiquitous, but application matters tremendously for energy storage. You wouldn't power an electric vehicle with a series of lead acid batteries. Similarly, it doesn't quite make sense to use lithium-ion batteries for stationary applications where lifetime is more important than physical footprint.

The most likely future for energy storage will see specific battery technologies leveraged for specific applications. Need a really big, cheap battery that lasts decades for use on a wind or solar farm? A giant flow battery may be the perfect fit. Need something lighter and energy dense for applications on the move? A lithium-based battery may be difficult to beat.

What does it mean for investors?

Tesla, being well capitalized and well positioned with its Gigafactory, isn't encountering much competition today for home- or grid-scale energy storage applications. But the company could become significantly more constrained as more application-specific technologies mature and reach the market in the next decade. Some are already available. In other words, early market success may bias investors to expect long-term success -- even though the broader technological ecosystem hints that may not be the case. 

The near-term value is real and simple to understand. Selling into stationary energy storage markets will increase the Gigafactory's utilization rate, driving down costs per unit, and boost near-term growth, making investors happy, especially if packaged with solar offerings from SolarCity or sold to utility companies for grid response. The longer-term picture is much murkier. 

The Gigafactory, as currently planned, will have the capacity to supply 60 kWh batteries for over 800,000 electric vehicles each year -- hardly a bad fall-back option if Tesla retreats from stationary applications. The company could also repurpose its spare capacity to supply additional on-the-move applications. But given the limitations of lithium-ion batteries for stationary applications, investors may want to downsize their expectations for Tesla's growth in this market.