Will Cheaper Oil Burn Tesla?

Will Cheaper Oil Burn Tesla?

Some things are simply immutable. It doesn't matter how much we wish things were different. Or how hyped something is. If basic laws are violated, reality comes rushing back in.

It looks like that's about to play out with Tesla Motors (TSLA) as shares of the electric car maker violate their 200-day moving average for the first time in more than two years. The catalyst: The crash of oil prices to five-year lows near $65 a barrel. Suddenly, Tesla's sky high valuation of 80 times estimated 2015 earnings looks like peak-oil hyperbole. 

TSLA Chart

TSLA data by YCharts

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The simple laws of economics, and the cold-blooded attempt by the oil sheiks half a world away to regain market share from U.S. shale oil producers with a higher all-in cost structure, threaten to wipe out the poster child of the new-tech/alt-energy movement. Because no matter the green chic credentials gained by stepping out of a Model S at your local Greenpeace meeting, Elon Musk and his Tesla true believers cannot escape the flood of cheap oil coming their way.

For all the efforts to portray Teslas as a luxury good, with performance advantages ranging from its instant torque response to its ultra-low center of gravity, its value proposition depended on the savings earned from avoiding the gas pump, and government tax credits.

Anyone looking to buy a $64,000 family car can crunch the numbers. The lower gas prices go, the higher the opportunity cost of switching to a battery-powered vehicle becomes. Already, the dynamic is pulling down sales of Toyota's iconic Prius hybrids, with purchases down 14 percent year-over-year. But let's do the math together.

Back in April, according to government data, regular gasoline prices nationwide peaked at $3.71 a gallon. According to Tesla's fuel savings calculator, assuming you drove 15,000 miles a year, that would save you about $2,200 annually vs. a gas-powered vehicle that gets 20 miles per gallon.

Now, the latest data has gasoline at $2.77 a gallon on average — a level that hasn't been seen since 2010. As a result, the annual fuel savings has dropped to $1,500. And if gas prices follow crude oil prices back to late 2009 levels, the savings could drop to around $1,300.

That's pretty significant, given that fuel savings was a big factor offsetting issues like range anxiety, expensive battery-replacement costs, and the higher off-the-lot price of a Tesla vs. more conventional luxury cars. The difference of $100 a month really changes the calculus when considering an $800 Tesla Model S lease payment: Suddenly, what was closer to $600 including gas savings is now around $700.

Not huge, admittedly, but enough to change behavior at the margin. Which is where the magic happens in economics.

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Moreover, the drop in oil prices looks like it could be sustained. According to Capital Economics, increased efficiency in the shale oil industry has pushed down the breakeven cost for many wells to between $50 and $70 a barrel. Moreover, The Wall Street Journal reported on Wednesday that Saudi officials see crude stabilizing near $60 a barrel.

If lower energy prices persist, analysts’ assumptions about Tesla quadrupling its revenue from 2013 to 2016 will look increasingly unrealistic. And let's not forget that capital expenditures are expected to swell as the company looks to expand its battery production capacity. According to Credit Suisse, capex is expected to grow from $89 million at the end of 2013 to $430 million by the end of 2015, resulting in a sizeable burning of cash reserves from $2.4 billion now to $1.2 billion.

For the numbers to work, the company needs to spool up production with its upcoming Model X SUV and Model 3 mid-size sedan, getting unit numbers high enough to boost profitability. Production is expected to more than double, year-over-year, in the third quarter of 2015.

It's hard to see this all running smoothly with the cost of dinosaur juice dropping so fast just as traditional car makers make their gas-powered vehicles increasingly efficient (witness Ford's new aluminum F-150 pickup, for example). U.S. Department of Transportation data shows that new passenger car fuel efficiency is up 20 percent from 2006 to 36 miles per gallon.

Pumping that into the Tesla fuel savings calculator gives an annual fuel savings of just $600 between a Model S and a traditional vehicle. Suddenly, a new car shopper trading in an old gas guzzler has much less incentive to take the plunge and go electric.

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Plus, let's remember that this all happened before. Detroit responded to the oil crises of the 1970s with horrible compact cars, unreliable diesel engines, and finicky variable displacement systems. But as the crisis passed, and gas prices fell from an inflation-adjusted peak of just under $4 a gallon in 1980 and 1981 to under $1.70 in 1986, consumer interest in these fuel-saving options waned.

I've recommended to my Edge Pro subscribers that they prepare for a re-rating of Tesla's earnings potential, and a technical breakdown of the 200-day average, by moving into the December $230 puts. Whether you want to take that advice or not, you should keep in mind all the different ways plunging oil prices could affect your portfolio.

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