Automotive regulatory credits are big business. More commonly referred to as carbon credits, governments around the world are issuing them to companies to encourage various initiatives including the production of zero-emissions vehicles (ZEVs). A company like Tesla has generated significant revenues from EV carbon credits and has been able to use some of the proceeds to expand its global operations by building more factories.

But what are EV carbon credits and how do they work? Let’s take a look!

In some markets, automotive companies are obligated to meet specific emissions targets established by regulators for any new vehicles they sell. Exceeding the limits can be extremely costly.

For instance, in the U.K. the penalty is £86 for every g/km a company exceeds its yearly CO2 emissions target. That number is then multiplied by the number of vehicles that the maker sells that year. Simply put, the fines can be crippling.

This is where carbon credits come in. One credit represents one ton of CO2 emissions.

To avoid emissions-based fines, automotive manufacturers have two options to balance out their excess CO2 emissions:

• modify their product portfolio mix to sell enough vehicles with lower/zero emissions.
• buy carbon credits from other companies.

Who gets carbon credits?

In some markets such as the E.U., carbon credits are automatically assigned to vehicle manufacturers based on the number of ultra-low emissions or zero emission units they sell. Some companies achieve their emissions goals and wind up with an excess of carbon credits.

Companies with excess credits can sell them to other manufacturers who cannot meet their goals.

Tesla is one such company that has greatly benefitted from this system. Since they only produce electric vehicles, they receive carbon credits for all of their units sold in regulated markets and sell those credits at a profit to other manufacturers who cannot achieve regulatory requirements.

For instance, in the E.U., every new Tesla vehicle receives 25 grams of carbon credits per kilometer.

In the first quarter of 2022 alone, they made $679 million through the sale of these credits, which accounts for 1.7% of their gross margin. Since 2017, the company has made $5.1 billion from regulatory credits.

The criticism of this carbon scheme is that it simply allows other manufacturers to exceed emissions limits applicable to their vehicle fleets. This is not deemed a sustainable strategy.

However, others insist carbon credits serve as an incentive to encourage companies to transition to lower and zero-emissions vehicles.

Automotive regulatory credits around the world

United States

The federal nature of the U.S. political structure makes regulations somewhat more complex. States have different standards, but larger markets tend to drive regulatory trends. To that end, California and 13 other states have regulatory carbon credit structures.

Their standards dictate that auto manufacturers must produce a specified number of zero-emissions vehicles (ZEVs) based on the total number of units sold in the particular state.

Europe

While the E.U. has similar rules to some of the markets in the U.S., regulators have been aggressive in their pursuit to reduce vehicle emissions.

The E.U. Emissions Trading System (ETS) operates on the cap-and-trade principle. Under the ETS, manufacturers can “buy or receive emissions allowances, which they can trade with one another as needed,” so long as they meet emissions requirements. This cap is reduced over time to ensure a decrease of gross emissions.

According to CNBC, the average CO2 emissions from cars in Europe should not exceed 95 grams per kilometer. Manufacturers that exceed this amount are subject to fines, while those with lower emissions are entitled to carbon credits.

The U.K. also offers carbon credits to manufacturers as incentives to encourage companies to produce and sell more low-emissions vehicles. The U.K. allocates a carbon credit for each low-emissions unit a company sells that produces under 50g-CO2/km.

Carbon credits in unregulated markets

Japan: a case study

While Japan ranks as the world’s fifth-largest emitter of CO2, there is currently no formal cap-and-trade system or carbon credit scheme to encourage manufacturers to move away from internal combustion engines.

Emission Regulations in Japan

However, in 2019 Japan issued a new fuel economy standard for passenger vehicles. It requires “an average fleet gasoline-equivalent fuel economy of 25.4 kilometers per liter by 2030.”

In the same year, Japan also updated its policy on heavy-duty fleet fuel economy, which will be enforceable for 2025 models. Known as JH25, it requires trucks to increase fuel efficiency by 13.4% and buses by 14.3% from 2015 standards.

However, talks to establish a formal cap-and-trade system have been ongoing. In 2020, the Ministry of Economy, Trade and Industry (METI) held discussions with industry representatives about establishing production percentages of electrified vehicles and regulatory schemes similar to the one in California.

Meanwhile, a voluntary carbon credit system has emerged. The concept, known as the J-Credit Scheme, emerged in 2013, which combined two older schemes known as the Domestic CDM and J-VER.

The J-Credit Scheme

J-Credit allows companies in a variety of fields to obtain carbon credits by initiating renewable energy or energy-saving projects. For vehicle manufacturers, carbon credits can be generated by introducing battery electric hybrids (BEVs) and plugin hybrid vehicles (PHVs).

But compared to most cap-and-trade markets there is a key difference.

In most markets, the manufacturer is  eligible to receive  carbon credits for the sale of a low-emissions vehicle. However, in Japan, the vehicle user is the one who is entitled to it since they are considered to reduce emissions through their use of the EV.

However, registering for the platform to receive the credit takes time and money. There is room for the manufacturer to aggregate all their customers and make one application on their behalf. This leaves the door open for companies to offer a variety of programs for customers through the use of carbon credits.

Nevertheless, companies in Japan are free to decide whether to participate in setting their own goals for emissions reductions in the J-Credit Scheme. Unlike other regions, since these targets are voluntary, there are no penalties for failing to achieve them.

Cap-and-trade Schemes Might Be on the Horizon

However, regulations that will establish traditional cap and trade schemes may be coming. METI is currently looking into developing a more traditional carbon credit system in order to reach its goal of reducing Japan’s greenhouse gas emissions by 2030. This would establish emissions standards for manufacturers more in line with the U.S. and European models.

As a potential first step towards establishing a more traditional carbon credit system, METI commissioned the Tokyo Stock Exchange to conduct a carbon exchange pilot program. In the past, these J-Credits have been traded in auctions run by the J-Credit secretariat. As of September 2022, participating members in the pilot program can buy and sell J-Credits on the Tokyo Stock Exchange.  

Should Japan switch to a regulated carbon market, the risk of penalties could help supercharge ZEV initiatives and bolster companies that have already taken the plunge. Companies ahead of the EV development curve would benefit enormously.

Mitsubishi Fuso, the first manufacturer of ZEV light-duty trucks in Japan, is positioning itself for this upcoming shift with its flagship eCanter.

Generating carbon credits from EV charging stations

U.S.: a case study

A notable difficulty surrounding the EV boom is the lack of a fully developed charging infrastructure. Most EV owners charge their vehicles at home overnight. But as EV and battery technology advance and provide greater range, charging stations will have a larger role to play, akin to gas stations of the 21^st century.

In order to promote the growth of the EV charging infrastructure some jurisdictions including some areas in the U.S. have started issuing EV charging-based carbon credits.

These have emerged as tradable commodities, albeit on the voluntary market. This could provide a much-needed revenue source – an important boost for expanding the number of EV charging stations.

Carbon offsets from charging stations

The emissions reductions are calculated by third-party carbon credit certification group Verra and the Electric Vehicle Charging Carbon Coalition. They provide independent assessments to ensure the validity of credits.

In addition to the scenarios above, voluntary carbon credits are used to fund a variety of sustainability initiatives. This includes reducing emissions by increasing the use of clean energy sources.

Need a refresher on the voluntary carbon market? Check out our tutorial!

Here’s a breakdown of how it works.

EV charging stations provide a fueling alternative to cars, reducing CO2 emissions. Operators of EV charging stations who register with Verra receive carbon credits from this action. The operators can then sell the credits on the voluntary market to entities that are trying to become carbon neutral. The money from the credits can help fund more EV infrastructure.

Will carbon credits be phased out?

While carbon credits remain a profitable business model for companies like Tesla, some regions eventually plan on phasing them out. Others are adding additional restrictions.

In the U.S., President Biden signed legislation in August that ended credits for 70% of the 72 models of vehicles previously eligible. An added restriction requires the remaining qualifying vehicles to be manufactured in North America.

Additionally, some countries are establishing dates to phase out the sale of petrol and diesel vehicles. The U.K. has banned the sale of petrol and diesel cars from 2030 onward, with even the sale of hybrids to follow in 2035.

The writing is on the wall. While some innovative companies are enjoying a financial windfall from carbon credits, they may dominate the market if their competitors don’t catch up.

Carbon credits may have an expiration date, but ZEVs are poised to continue to reduce CO2 emissions in our industry.

What is your take on carbon credits? Are they a necessary incentive to encourage CO2 emissions reductions? How can manufacturers sustainably participate in this ecosystem?

FUSO GreenLab wants to hear from you. Drop us a comment below!