Tesla's Gigafactory will not manufacture better or cheaper batteries.

Summary

• Batteries are chemistry in a can and changing the size of the can does not change the energy density or cost of the chemistry inside the can.
• According to the “Tesla Battery Report” from Total Battery Consulting, 2170 cells from Tesla’s Gigafactory will not have more energy density or cost less than 18650 cells from Panasonic.
• Under optimal conditions, Gigafactory cells will cost $140 per kWh but that figure will be much higher if Model 3 and Powerwall sales don’t keep it running at capacity.
• A cost increase of at least $10 per kWh is a virtual certainty when nickel prices recover to levels that are marginally profitable for nickel miners.

In my opinion, one of the best sources for accurate, comprehensive and unbiased information on the lithium-ion battery industry is Total Battery Consulting of Oregon House, California. As the organizer of the Advanced Automotive Battery Conferences, the firm has a global reach and unparalleled access to battery users, manufacturers and component suppliers.

I always learn something new from their publications.

In late May I received a marketing e-mail for the 2017 update to their Tesla Battery Report that included a hyperlink to download a free 33 slide extract from the report. What a treat! After unsuccessfully trying to wrangle a free copy of the full report, I decided half a loaf was more than I could say grace over and a huge load of balanced factual information is far better than the typical Tesla (TSLA) diet of speculation, hype, blue smoke and mirrors.

Bulls and bears can both have a field day with the extract since it clearly summarizes Tesla’s many accomplishments and dispassionately discusses its equally daunting risks and challenges. I’d encourage anybody who’s interested in the merits and risks of Tesla’s stock to download the extract and study it carefully. Frankly I’d encourage large Tesla stockholders to buy the full report.

For this article, I’m going to cherry pick a few points that were important to me and should be important to my readers. I'm sure I'll read about all the critical points I missed in the comments.

• First, the cell capacity ratings table on Slide 14 show that 2170 Gigafactory cells have slightly lower energy density than 18650 Panasonic cells. While the stated capacity of 4.9 Amp-hours for a 2170 Gigafactory cell is higher than the stated capacity of 3.4 Amp-hours for an 18650 Panasonic cell, a 2170 can has 46.6% more volume than an 18650 can and a proportional increase would give a 2170 cell 5 Amp-hours of capacity. These numbers are shockingly inconsistent with Tesla’s claims that Gigafactory cells have higher energy density than Panasonic cells.
• Second, Slides 17 and 21 show that the NCA 83,13,4 cathode powder used in 2170 Gigafactory cells contains 3.7% more nickel and 13.3% less cobalt than the NCA 80,15,5 cathode powder used in 18650 Panasonic cells. Based on this new data, I’ve reduced my estimate of Tesla’s annual cobalt requirements from 7,000 MT to 4,465 MT, which doesn’t natter all that much since Tesla plans to rely on the kindness of the market instead of nailing down a reliable long-term supply contract like Volkswagen did.
• Third, Slide 19 suggests that Tesla doesn't have any significant partners beyond Panasonic in the Gigafactory, there will be no meaningful benefits from vertical integration of the supply chain for the Gigafactory and Tesla will simply buy components and supplies from the same vendors as everyone else.
• Fourth, Slide 21 clearly states that the Gigafactory will offer “no reduction in cost,” another shocking inconsistency with Tesla’s public claims that Gigafactory cells will be cheaper than Panasonic cells.
• Fifth, Slides 21 and 25 suggest that Panasonic will earn a gross margin of 5% to 7% for providing the manufacturing equipment and doing the heavy lifting of manufacturing cells in the Gigafactory so that Tesla can target gross margins of 25% for assembling those cells into battery packs and building EVs. While some might think it noble for Panasonic to sacrifice its stockholders for Tesla’s benefit, I have to ask, “What’s up with that?”

By combining new information from the extract with information from other sources, I was able to cobble together this chart that summarizes extract data in the pie section and my estimated allocation cathode powder costs in the bar section. The numbers aren't perfect, but they’re very close.

My undergraduate degree was in accounting and when I look at the chart, I see a cell cost of $140 per kWh under the best possible scenario. The cathode powder and other materials, roughly $83 per kWh or 60% of cost, are variable costs of producing cells that rise and fall with production levels. The remaining costs, roughly $57 per kWh or 40% of cost, are fixed costs of owning and operating a factory that don’t change with production levels.

If one assumes a production capacity of 100 kWh per month, the cost of materials used in cells would be $8,300 and the fixed costs of owning and operating the factory would be $5,700. In a slow month when Tesla only needs 50 kWh of cells, the cost of materials used in cells would fall to $4,150 but the fixed costs of owning and operating the factory would still be $5,700. In that low capacity utilization scenario, the fully loaded cost of the 50 kWh of cells produced would be $197 instead of $140.

The interplay between fixed and variable costs is the primary reason that Tesla must be successful in its efforts to develop a robust market for Powerwalls among customers who are willing to wait until Tesla gets around to filling their order. EV production will almost certainly bounce up and down from month to month. Optimal operation of the Gigafactory requires stable cell production from month to month. Without the ability to use Powerwall sales to ensure high levels of capacity utilization, the variability will be mind boggling.

Readers should note that my bar chart cost allocation is based on prices of $7,400 per tonne for lithium carbonate, $11,500 per tonne for nickel and $61,000 per tonne for cobalt. As those prices fluctuate, the metal components of the bar chart will change. However, I believe it’s reasonable to assume that processing costs are unlikely to fluctuate with commodity prices.

Since Tesla’s executives have made a big deal out of the fact that nickel is the most important metal in their cathode powder and the extract shows that nickel represents a whopping 83% of cathode powder weight, I believe a few words about the global nickel market are in order. In April, I created these graphs for an article titled, “Cobalt, The Weak Link In Tesla’s Supply Chain.” The graph on the left uses daily price data I got from InfoMine.com and shows the 10-year price histories for copper, nickel and cobalt.

You can see at a glance that the post-crash period has not been kind to nickel miners. In fact, these graphs from Glencore show that the bulk of the world’s nickel miners were losing money in 2013 when prices were significantly higher than the current $11,500 per tonne.

Since most of the world’s nickel miners are hemorrhaging cash, many are putting mines into care and maintenance mode until prices recover and they can make a buck by working. Under the circumstances, I think it’s patently absurd to believe nickel prices will remain anywhere near current levels over the long term or to think nickel miners will develop new projects because the battery industry wants more cobalt. A meaningful nickel price recovery will almost certainly add $10 per kWh to the cost of cells from the Gigafactory.

Conclusion

One of my favorite metrics for assessing the upside potential of a company’s stock is the spread between its market cap and its book value, which is traditionally referred to as blue-sky. While a modest blue-sky premium is normal, it’s a bright red flag when the premium gets too high. To simplify comparisons among companies, I like to calculate a ratio between blue-sky and book value. As a general rule, I've found that "BS to book" ratios below 2 are healthy while ratios above 10 are dangerous.

As of June, Tesla's book value was $5.1 billion and its market cap was $60.2 billion. That gave Tesla an eye-watering BS to book ratio of 10.8. With a ratio that high, the upside potential of an investment in Tesla’s stock is insignificant while the downside risk is huge. It's easy to imagine events that could result in a halving of the stock price but difficult to imagine events that could result in a doubling.

This article focuses on a second reason why I think Tesla’s business model is fatally flawed and its inherent investment value is zero. I will discuss several more reasons in weeks and months to come. That being said, Elon Musk is the most talented stock promoter I’ve ever seen and I can’t encourage anyone to short Tesla’s stock. From my perspective the only safe vantage place to watch this circus is the sidelines.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Written by John Petersen

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