Metal Lease
All the talk about Musk's secret weapon has raised lots of ideas around leasing batteries. I want to share a related idea that exposes some pretty fundamental economic issues around advancing batteries. So we like this particular kind of lease or not it is at least a way to think more deeply about the value of batteries and sustainable growth.
So here's the idea of a metal lease. Suppose that an 85kWh pack has presently about $5000 in recoverable metal. That is if you were to recycle the battery and sell the metals you could recover about $5000. (This is about $60 per kWh. If someone has a better estimate please let me know.) In a metal lease, the lessee buys the car at a reduced price and has unlimited use of the battery, but agrees to pay a quartery payments until the battery is returned to the lessor for disposal. In essence, the lessee is merely renting the recyclable material and has an aggreed upon plan for recycling the battery. To put some hypothetical numbers to this suppose that the lessee recieves a $5000 reduction in the purchase price of th car for entering into this agreement. Morever, the quarterly payment is $50. This amounts to a $5000 perpetual bond with 4% coupon with the recoverable metals as the principle. The value this creates for the lessee is a lower front end cost of car (and on a $35k Model 3 $5k reduction could be a big deal) and peace of mind that they can walk away from an old battery anytime and know that it is properly repurposed or recycled. Beyond facilitating a sale, Tesla, the lessor gets two assets: a cash flow which can also be securitized for capital and the recovable metals. This metal asset is particularly interesting. As an EM maker, Tesla is short the metals needed to make batteries. This exposes Tesla to commodity price inflation. However, the metal component of the lease makes Tesla long on the very metals it needs for production. So the metal lease is a natural inflation hedge. Should competition in the EV market ever take off to such an extent that shortage of key metal drive up prices such a natural hedge may offer strategic value. The lease also exposes Tesla to credit risk, but this risk can be shed through securitization. One risk that is quite limited in this set up is the physical condition of the battery. If the battery is returned with residual useful life as a battery it can be reused or repurposed. If the useful life is completely spent, then it can be recycled and the full residual value of the lease is recovered. Only in extreme cases will recovery value be lost.
Now lets decompose the value of the battery itself. Suppose a price of $200/kWh, or $17,000 for the whole pack. Suppose gross margin is about 30% or $5000. So the cost of the battery is $12,000. The recovery value of $5000, and this leaves a non-durable cost of $7000. This non-durable portion includes the costs of manufacturing and nonrecoverable materials. For the most part, Tesla wants to squeeze every las cent of non-durable cost from the manufacturing process. The metal lease also creates a financial incentive to minimize the use of unrecoverable materials or figure out ways to make them more recoverable. This is smart both financially and environmentally. When we think about the Gigafactory eliminating about 30% of the cost this takes the total price from $17,000 to $12,000 and total cost from $12,000 to $8,400. But it does not really change the recoverabe value, still $5,000. So the nondurable cost is sharply squeezed from $7,000 to $2,400. So under the metal lease what the car buyer actually consumes is $2400 nondurabl plus $3600 profit to Tesla, $6000 altogether. This is less than $71/kWh consumed. Additionally the customer makes a modest $200 per year payment for the lease. In ten years this is a combined cost of $8000, or $94/kWh, to the customer. This actually looks quite affordable from a consumption point of view. Remember that the full price is $12,000, or about $141/kWh. We are able to squeeze out another third of this total cost to the customer through the mechanism of the metal lease, while Tesla hedges itself against commodity inflation.
But now lets take this one step further to see the impact of advancing technology. Let's assume that through technology density continues to double every decade. Suppose a customer buys a car and returns the battery in ten years. It gets recycled. Because density has doubled in this time, the recovered metal is now sufficient to produce two new batteries of the same energy capacity. The nonrecoverable materials have to be sourced new, but the recoverable materials are covered. So it matters quite a bit in the longrun how much of the battery can be recovered because that portion can double the supply of batteries every ten years. This supports a sustainable annual growth rate of 7.2%. However, let's suppose that 90% of certain materials can be recovered. Then upon recycling in ten years there are materials to make 2*0.90 = 1.8 times the capacity. This is an annualized sustainable growth rate of 6.0%. Longterm economic growth rates are likely to be around 3% or 4%. Thus, a 90% recovery rate coupled with decenial doubling is enough to satisfy perpetual growth in demand with a fixed amount of recyclable materials. In fact, if just 67% is recoverable, this is enough to sustain 3% annual growth in perpetuity. Additionally, note that if the usable life can be extended beyond 10 years, this will also enhance the sustainable growth rate.
Sustainable growth rates are well off into the future. In the present moment Tesla is attempting to grow at 50% rate. This is well above any sustainable rate, so new materials must be sourced from the earth or other markets. It is important nonetheless to have sustainability in sight. I think something like a metal lease can help an EV maker do the right things that lead most swiftly to sustainability. The metal value of the lease not only hedges inflation, but it also motivates the right level of R&D and business development to extract the greatest value out of used batteries. It is also beneficial that there are clear pathways to assure that batteries are recovered. Customers might not always realize that their old batteries contain highly valuable recoverable materials. This lead consumers not to value EV fully when buying a new one and not to secure that value when disposing of an old one. The quarterly payments on a metal lease remind the lessee that they are merely renting a portion of the earth but for a short time.
