Unless you've been hiding in a cave, you've surely noticed trade tensions between the U.S. and China heating up. As recently as May, China planned to reduce import tariffs on many vehicles from 25% to 15%. Then tensions escalated, and in response to President Donald Trump's move to impose tariffs on $34 billion worth of Chinese goods, China slapped tariffs on U.S. products, including car imports, pushing that 15% tariff up to 40%. Now the Trump administration is threatening to more than double down and unleash 10% tariffs on an additional $200 billion worth of Chinese goods.
Tesla (NASDAQ:TSLA) has been in negotiations to build a factory in China for some time -- as a way to avoid such tariffs on the vehicles it sends to China -- and the automaker's recent agreement to build its second global assembly plant will put the power back into its hands.
Problem and solution
Setting aside the trade tension topic, there's a reason Tesla and China are a match made in heaven. China has a massive and well-documented pollution problem. Decades of rapid economic expansion have turned the country into a global power, but also into the world's biggest emitter of carbon dioxide. In fact, China's "environment census" revealed that the number of sources of pollution -- think factories and such -- has jumped from 5.9 million in 2010 to 9 million currently.
Those pollution problems are a primary concern for the government, and its answer has been to heavily push electric vehicle incentives to help reduce emissions. China is already the world's largest market for electric vehicles, so what better region for Tesla, which is burning cash at a frightening pace, to accelerate its sales in, and thus get help in its march toward profitability? That's why Tesla's recent preliminary agreement with Shanghai to build a factory there will be one of the biggest developments for investors over the next couple of years.
Why is the China plant so important?
China is already a big part of Tesla's business. The company tripled its sales there from 2015 to 2016, generating over $1 billion, and then doubled that in 2017 to $2 billion --accounting for 17% of Tesla's 2017 revenue. Here's the problem: Because of China's retaliatory tariffs on U.S. imports, including American-built autos, Tesla was forced to increase prices on its Model X and S vehicles by more than $30,000 in China. Tesla's hand was forced because it's still losing money and burning cash, and is thus unable to absorb the tariff costs, but the increase will inevitably put the price tag out of reach for some Chinese consumers.
Fortunately, Tesla's China assembly plant will enable the automaker to dodge those tariffs, even if it's a few years down the road. Tesla's planned capacity for its second global assembly plant is 500,000 vehicles a year, and in November, CEO Elon Musk commented that the company was roughly three years away from production there. That still seems like a solid ballpark time frame.
Last year in China, sales of new-energy vehicles -- a figure that includes plug-in hybrid, battery-powered, and fuel-cell vehicles -- checked in at 777,000 and is forecast to reach roughly 1 million this year, according to Automotive News. Here's the kicker: China's government is targeting 7 million such vehicles a year as soon as 2025. That's growth that has Tesla investors drooling. In the automotive industry, which is cyclical and capital-intensive, Tesla can't afford to have uncertainty such as import tariffs fluctuating between 15% and 40%, so building its factory in China is a no-brainer. It could mark the point in time when Tesla turns from an unprofitable question mark to a cash-printing global EV powerhouse. The big question now is: Who's going to pay for it?