Tesla Energy Business Model

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Who are the customers of Tesla Energy? I guess the most important one will be the Megapack?

Yes, though the Powerwall, I believe, has their strongest margins, and it's the easiest for them to sell now. I was looking at the numbers.

Let's talk about both, then. Who is the customer, and how does the sales process work?

For Powerwall, you have both direct Tesla installs where Tesla controls the entire sales process, and the end customer would be the actual homeowner or whoever's living in that residence. They also sell through their channel business, where they sell container loads or truckloads of Powerwalls to two of the major distributors in the United States: CED Greentech Renewables and BayWa. CED Greentech Renewables are an electrical supply distributor and they sell a lot of solar panels and associated components, such as Powerwalls.

I was looking at the announcements Tesla made on Powerwalls. They haven't made any announcements since they installed their 200,000th Powerwall. From 2016 to 2020, they installed 100,000 Powerwalls, taking them four years to hit that number. Then, they reached 200,000 in 2021. I can only imagine that they're closing in on 400,000 or maybe even 500,000 Powerwalls now, as they've been producing them rapidly. They distribute these both directly and through channels, and they also sell them to utilities.

What is the share of direct versus channel sales for the Powerwall?

That's a good question. It's probably at least 60% through channels.

Wow, okay.

They've created a very efficient and well-run program. Not everyone can get them, but if you go through the training and show your competency, they can bring you on board. It's a significant selling point for solar installers to offer the Powerwall. The attachment rate, meaning if you buy a solar system and also include the battery, used to be necessary to take advantage of the investment tax credit. However, with the Inflation Reduction Act, you can now get a standalone battery system without solar and still receive the investment tax credit. This is a huge deal for people who didn't have suitable properties for solar for various reasons.

Can you explain to me the difference?

If you install a solar system on your roof and the power goes out, your power goes out as well. This was learned by many people in the New York City area, especially New Jersey. New Jersey installed a lot of solar systems in the United States through state incentives. However, these were just solar systems. The code requires that when a solar system is connected to the grid and can back feed into the grid, the solar inverter has to sense a frequency on the grid. It bases its operation off of the grid's frequency. When that frequency disappears, the solar inverter shuts down because it does not want to push power onto a dead grid, which is dangerous for people trying to fix the issue.

The genius of the Powerwall that Tesla developed is that it monitors the line side, which is the utility side, and the load side, which is the customer side. The Powerwall is connected to the line side and looks at it. When the line side starts to go out of specification, the Powerwall immediately opens up a contactor and disconnects from the grid, completely isolating the home or whatever it's powering from the grid. This is done through its gateway, a small box. The Powerwall simultaneously goes from grid-following mode, where it's using the grid frequency, to grid-forming mode, where it provides the grid frequency. The solar inverter sees the frequency, and the Powerwall starts providing the frequency for the home, solar inverters, and other appliances. The solar system can then keep generating, which is a balancing act of the load, state of charge of the battery, solar panel generation, and time of day.

The attachment rate for new solar systems refers to how many of them are also installing a battery. It used to be different because you could only get the investment tax credit on a battery installed in conjunction with a solar system. Now, you don't need to do that for tax credit purposes federally, and you can just install a battery. This is good for Tesla's Powerwall business.

In the United States, they (Tesla) have the lion's share of the home energy storage market, with 70% to 80% of battery systems in homes being Powerwalls. This is because it's easy, more affordable, and the power and energy you get for the price is still the best in class. Powerwall 3 will only improve this further.

Additionally, any utility that offers residential time of use rates or incentives or penalties by the utility to get the homeowner to consume those kilowatt hours that they are generating on their solar system at home, can increase the return on investment for the homeowner. This is especially true with California's NEM 3, net energy metering, which deals with the solar energy you're selling back to the grid. It has recently been implemented and makes homeowners with solar systems go on to time of use rates. This means that you pay different amounts for each kilowatt hour of energy based on the time of day you are asking the grid for that kilowatt hour. The cheapest kilowatt hour for the latest time of use rates, in sunny places with a lot of solar, is now the middle of the day.

That's interesting.

The most expensive time is usually dinner time in the evening. Solar power drops off, loads ramp up, and there's a massive amount of power that the California Independent System Operator (CAISO) has to cover. It's around 20 gigawatts in two hours, which is challenging for grid operators to provide. West-facing solar panels and batteries help slow down that ramp.

Just for me to understand, who operates the grid?

In different places, there are different operators. In California, it's CAISO, the California Independent System Operator.

Is that a regulated monopoly or are there several providers?

It is a regulated entity, a state organization.

Understood. How do energy generation companies interact with the regulated grid in California?

If you want to open a power plant, you would work with an IPP.

The name of the company was PG&E, the ones that had the issue with the fires a couple of years ago.

PG&E is a regulated, decoupled, investor-owned utility. They are one of the four large investor-owned utilities in California.

Got it.

One of them is called Southern California Gas, which primarily works with natural gas. PG&E proposes time of use rates and gets them approved by the California Public Utilities Commission to implement those rates for their customers. They might buy power to give to their customers or do a cost-share program, like Green Mountain Power in Vermont, which bought a ton of Powerwalls and installed them for free for their customers.

So these companies generate electricity through different forms like gas, wind, solar, and hydro. Then you have the regulated grid. Is storage required only for renewable energy?

Do you mean needed? Storage is needed, not required.It's needed everywhere, absolutely everywhere. PG&E, Pacific Gas and Electric, is the largest regulated utility in the US. They have massive Megapack projects and work with several other battery companies. Moss Landing is their biggest project to date. San Diego Gas and Electric also have large battery projects.

PG&E has customers like commercial or industrial customers that install battery backup systems. They have many data centers on their grids that have lead acid backup systems, batteries, and diesel generators. The Self Generation Incentive Program, administered by the California Energy Commission, takes a cut from utility bills of the four large investor-owned utilities and puts it back into a fund that helps homeowners and businesses offset the cost of installing energy storage systems. This helps specifically with the ramp problem in the late afternoon when solar comes off and loads are coming on.

A few years ago, they created criteria to help people in wildfire areas. PG&E now turns off large swaths of their grid if there's a danger. The California Energy Commission created additional incentives for those living in these areas, allowing them to get free solar and battery systems installed. The Powerwall is often used because it's more economical to install. When PG&E turns off their power, these people can rely on their solar battery backup.

Got it. So, the customers of those will be utilities, data centers, industrial companies, and homeowners.

Yes, pretty much everyone, including heavy industry. Data centers are still mostly using lead acid batteries, but that industry is changing.

Is the energy stored in those batteries always from renewable sources?

Not necessarily. Renewable energy is often the cheapest form of energy, and the California Energy Commission, as well as the Air Resources Board, are looking for low carbon electricity. However, if a storm is coming, you're going to charge your batteries with whatever's available. Maybe the wind isn't as strong at night, when you are trying to charge your car. CAISO will ask other generators to turn on. The goal is to use renewable energy, and that's the trend financially. Solar power is the cheapest form of electricity in 2023, and solar plus battery is becoming more competitive.

With Powerwall, we discussed who the customers are. What about Megapack?

Megapack customers are primarily utilities, and they're now using the Megapack 2 XL, which is even bigger than the initial Megapack. They decided to make them all like this since people want these huge batteries. The idea is to fill them up completely with all their AC modules inside and include fire protection. There's a pyro fuse that will blow if a module starts to exhibit any overvoltage or thermal runaway issues.

I believe the majority of Megapacks currently use lithium-ion phosphate technology or chemistry from CATL in China. These have much less thermal runaway characteristics than typical NMC or NCA chemistry. They're not as energy-dense, but they do have that profile. They can store up to about four megawatt-hours per Megapack 2 XL.

They're primarily sold to utilities, like in the case of Moss Landing, which used to have multiple gas-fired power plants. PG&E wanted to put in another power plant, but the California Energy Commission and the Public Utility Commission suggested analyzing the economics of using a battery instead. It turned out that batteries are definitely cheaper, so they installed Moss Landing, which has around 200 megawatts and 800 megawatt-hours of energy storage. It serves as another peaker plant that can be called on to generate electricity onto the grid instantaneously, even though it's just storing it.

Can you explain why utilities purchase both Powerwalls and Megapacks? What's the difference, and when would they purchase one over the other?

To my knowledge, PG&E has not purchased Powerwalls. Only a few utilities, usually the very forward-thinking and progressive ones, have done so. Green Mountain Power in Vermont, for example, wanted more control over their customers' loads and to address their customers' dissatisfaction when the grid goes down. They developed a business plan and model where they purchased several hundred or thousand Powerwalls and installed them in participating customers' homes. This created a virtual power plant for the utility.

The agreement was that the utility could manage the battery when the grid is up, meaning they can increase or decrease the load at the customer's house as the grid operator. If the power goes out, the homeowner can use whatever energy is left in the battery during the outage. The goal is to have an aggregated virtual power plant with all the residential Powerwall homeowners, so they can control all of them with one command, either charging or discharging. They want the cost of generating energy through this method to be less than buying electricity on the open market or generating it at their other sites. Utilities can quickly look at their avoided costs and determine the economic viability of this model.

So, to summarize, they purchase Powerwalls and install them, or support customers in their geography to install them, in order to manage these and optimize their energy costs.

Exactly. However, not all utilities have done this yet, or they're incentivizing their customers in other ways.

So, Powerwall will mostly be a consumer product or for light commercial use, while Megapack will be primarily for utilities?

Yes, correct. Powerwall is for residential or very light commercial use, like a small footprint Starbucks.

Okay, and Megapack is really for utilities.

Megapack is indeed for larger-scale use. An industrial or commercial customer could want it, but they would need the space and a significant load. It's primarily for utilities.

I see.

The Powerpack 3 seems to be the missing link for the commercial and light industrial market. These customers, particularly in the commercial sector, pay higher utility costs than homeowners and industrial customers. A significant portion of electrical utility revenue comes from the commercial sector in terms of margin percentage. Tesla is reportedly planning to release a Powerpack 3, which I believe will be a standalone AC connected system. Lowering installation costs and reducing complexity is essential. I hope they introduce a standalone system in the 150 to 300 kilowatt-hour range, as no one is currently targeting that market. Tesla needs to create something like this because they have capacity maintenance agreements to honor. They have to go to these sites where they are contractually obligated, not on pieces of equipment, but just on power and energy. As batteries degrade over time, they will need to add capacity, but often don't have room or need to add another Megapack. I think we'll see a Powerpack 3 offering within the next year. Additionally, they are supposed to launch the Powerwall 3 soon. The main difference seems to be increased power and energy capacity, driving costs down further.

How does the sales process look like for the Powerwall? I assume it's a straightforward hardware purchase for homes?

They've tried to make it as uncomplicated as possible, but you still need to determine your loads. If you're going for whole home backup, which I recommend, you should consider a smart load management system like SPAN Panel. This system can automate load management and extend battery life during outages. They say it can make your battery last 40% longer, when used in an outage. You install the solar system and Powerwall, which ties into the electrical panel. The gateway is responsible for islanding the Powerwall from the grid.

So, the business model involves selling the units and charging an installation fee, correct?

You will typically receive a quote. Tesla or the installer will help you configure your system, both the solar and battery sides, and make a recommendation. It's important to have someone familiar with the process to go through it. If it's through the channel side, that would be the salesperson for the solar installer. If it's Tesla's direct side, it's all on their website and self-explanatory. You can increase or decrease the number of Powerwalls and make both the solar system and the Powerwall system bigger or smaller, depending on your roof space.

How does that contrast with Megapack?

Megapack involves a more in-depth conversation. Each Megapack 2 XL costs around $2 million.

So it's a significant capital expenditure for a utility.

Yes, and you typically involve many engineers. If the utility is trying to solve a power flow issue, they might bring in some of Tesla's engineers. It's a more collaborative project compared to residential installs. With residential installs, they discuss panel placement on the roof and conduit placement on the side of the house. Sometimes the homeowner doesn't have much input. Megapack installations involve single line diagrams, designing layouts, transformers, and substations. It's a lot more equipment and power.

I see. But for the $2 million, how much is the hardware sale? Who provides the services? Is it Tesla or through partners? How does it work on the Megapack side?

Megapack also has a channel partner program, and many of those channel partners are certified installers of Megapacks. Tesla used to require their field technicians to perform annual preventative maintenance on-site to maintain the warranty. There were exceptions for remote locations or unsafe situations. They are now starting to open up remote warranty and preventative warranty service visits, building out that program. They can now see much more remotely about the Megapack's performance through their network operations center. They also feel more comfortable with third-party technicians working on them.

What's the business model? You sell the hardware, and I assume it's sold at a profit.

Tesla is trying to chase the profit margin on the Powerwall, which was around 30% when I was there. It could be a little more or less, but they aimed for above 30%.

Do you think they charge the same for the Megapack?

It's a lot harder to do that with the Megapack. Obviously, you have much higher capex, but if you just wanted to buy one Megapack, it's around $2 million. If you're buying 500 of them, at once, for a big utility project, you're going to negotiate that price per Megapack down quite a bit.

Tesla does install them, but they also have other partners that will install them, such as big construction companies. However, I think Tesla prides themselves on being the best, fastest, and lowest-cost installer of Megapacks.

Is the installation separately charged?

Yes, someone has to pay for it. The customer could be buying them and having them delivered to the site, but you need a very large crane on site and many trucks. So, they could structure that contract accordingly.

Tesla does make money on those services.

Yes, but not nearly as much.

Their (Tesla's) construction margins are more in line with industry standards, which are around 10%.

And what about the maintenance fees for the Megapack? It reminds me of elevator companies that have an installed base of elevators and make a lot of money on maintenance but not so much on the hardware. Is that a similar model at Tesla with the Megapack? Are they also making a lot of money on the maintenance piece?

They are trying to, yes. But really, I think what they're trying to do is keep each Megapack in the field as healthy and functioning as possible in order to make it through the warranty period, which also includes an energy retention guarantee.

I see.

But they're definitely making money on the preventative maintenance.

And tell me, maybe separately for Powerwall and Megapack, what are the key decision criteria for a customer for picking Tesla over others? And then who are these others who are competing with Tesla on those products?

There are a lot of players trying to break in. LG, the Korean electronics manufacturer, has a home battery product. Generac, the generator company, also has a home battery product. Sonnen, a German battery company, have been around. However, Sonnen's product is very expensive.

Sonnen has a much larger market share in Europe and Germany, primarily within the EU, and a very small market share in the United States. The amount you pay and the power and energy you get is not nearly as good as the Powerwall.

So, LG, Generac, Sonnen, and a new player called Franklin Watt Hour are some of the competitors. I think Franklin Watt Hour is just a battery, and you have to pair it with certain solar inverters to be compatible. It's an interesting play and less expensive because you don't have the power electronics there. However, I don't know how any of these companies island from the grid and how that all works. The seamlessness of the Powerwall and the user experience is superior because they have much more experience deploying them than any of those other customers out there.

As for solar installers, I was talking to an owner the other day who mentioned Enphase also has one. Enphase is a solar microinverter manufacturer, and they are starting to branch out into electric vehicle car chargers. They have a small battery that you can hook up with it, but again, they're more expensive, clunkier, and not as reliable. It's just not the same user experience. I think Samsung also has one.

And that's just for Powerwall.

Those are just the residential home batteries.

And Megapack.

Megapack's biggest competitor is probably Fluence, a joint venture between Siemens and AES, a large independent power producer. They have hundreds of gigawatts of generation capacity internationally, but they're more of an aggregator. They buy components and combine them into a container. which is different from Megapack's cabinetized solution.

A few years ago, a Fluence container exploded at an Arizona utility storage system, several years ago. The fire department responded to a thermal runaway event inside the container, which had a fire suppression system. This is a containerized solution, as compared to the cabinetized solution of Megapack; there is no space for a human to dangerously enter into it. There is nowhere for them to go. For the containerized solution, you open the doors and you can go inside. They are, typically, air conditioned, versus the Megapack is liquid cooled. That is both an efficiency and safety benefit. However, the nature of lithium-ion batteries and the fire suppressant used didn't stop the fire completely. When the firefighters opened the container, oxygen rushed in, causing an explosion. Thankfully, no one was killed, but several firefighters were injured.

Safety is paramount in Tesla's product design, and their engineering teams consider potential issues and build in resilient and redundant safety systems. This helps prevent situations like the one with Fluence. Tesla teams don't look at, if this happens but when this happens, what happens next. How do we ensure this doesn't progress further or get worse. If it does, then what happens.

There is another big company in the US, based out of Oregon; the name escapes me for the moment. They are an aggregator.

I'll look into that further. From what you've said, it seems the key decision criteria for customers choosing Tesla Energy are seamlessness and customer experience, reliability, price, and safety. Is that correct?

Yes, I agree.

I have a question about Tesla's business model, which combines hardware, software, and services. Could you explain the significance of each component and how they work together? How important is the integration and software piece, and how defensible is it compared to others?

Let's start with the Powerwall software. It comes with the Powerwall and there are no recurring subscription fees. It's similar to the Supercharger network for early Tesla owners, which Tesla viewed as essential for selling cars. They see the software that comes with the Powerwall as essential for homeowners to make the decision to purchase it. The software updates automatically and informs users about grid status and power availability. If a utility wants to use aggregated Powerwalls, Tesla can work out a software package and an associated service charge, probably on a monthly basis. To allow the utility to control aggregated Powerwalls, Tesla would charge for that service and help the utility manage and control those.

Why does Tesla let the utility manage customer relations?

It's because the utility might want to, or maybe the utility owns the batteries. For example, Green Mountain Power maintains ownership of the batteries, installs them for free at the customer's house, but still owns them. This is what they're starting to do in places like Texas and California. In Texas, Tesla is a retail energy provider, meaning they can sell electricity to homeowners. The more homeowners with solar and batteries, the easier it is for Tesla to manage the cost of stored electricity and the cost to discharge it when needed.

That makes sense.

In California, Tesla has an experimental virtual power plant with, I believe, 50 MW capacity. That's a significant number of Powerwalls.

Who manages that? Tesla manages the decentralized units, aggregating and managing the electricity, load, and price. It's abstract for someone not in the business.

It is abstract and hard to understand. Roughly, 50 MW would be about 6,600 individual Powerwalls. Some customers might have multiple units at their home. Tesla aggregates them together, effectively creating a new power plant. They can discharge 50 MW into the grid at a specified price. There are also ancillary services that can be provided.

If Tesla discharges that electricity, homeowners get rewarded, right? How does Tesla make money?

Tesla makes money because they receive more than they pay the homeowners.

Okay.

Homeowners were recently compensated quite well, at around $2 per kilowatt-hour in one of the most recent examples in California.

What would be the price that Tesla charges the buyer for that?

For the energy provided to the utility? I'm not sure, but presumably, it's less than what the utility can procure from elsewhere. There's another natural gas power plant, an independent power producer (IPP), offering their services at a certain price. However, the utility chooses Tesla because they're slightly cheaper.

I'm trying to understand if Tesla can outcompete others. So, let's say the homeowners get $2. What does Tesla charge the other party? What would the spread be?

I don't know the answer to that. But consider ERCOT, the Electricity Reliability Council of Texas. It's like the CAISO of Texas but operates as an isolated grid network in the United States. They don't allow much power trading in or out of the state and manage their own electrical grid, which has its pros and cons. In Texas, we had a big freeze two years ago in February, causing natural gas lines to freeze due to insufficient regulation. Independent power producing natural gas plants shut down because they didn't have any gas to run, leading to a downward spiral. During that outage, spot pricing for wholesale energy increased by around 4,000%. Batteries can only last for a few hours, but sometimes that's all you need to ride through such events.

The software aspect seems important to me, even if it might not be monetized, because that's how the entire system is managed?

They have automated software, like Stem, which has an AI software called Athena. It analyzes commercial or industrial customers' historical loads, looking at 15-minute intervals over the past year. All utilities have this information, and it overlays that with their utility tariff, demand charges, and energy charges. Then, it discharges the battery to optimize the electricity they're buying from the grid.

Tesla also has similar software for commercial and industrial customers, and they might add that to their channel partners on the commercial and industrial side. These are Megapacks currently, and maybe Powerpack 3 in the future. Additionally, research their Autobidder, which is for Megapack and utilities. It's using predictive algorithms that are much faster than a human being can monitor, adjusting buying and selling quickly in open markets, and disrupting the industry.

Are they buying and selling on behalf of Tesla?

Yes, or they might manage this for a customer. They set up Autobidder agreements in different ways based on the risk level that both Tesla and the customer are taking.

So, the customer pays a commission on those volumes purchased?

It might be a revenue share of profit generated. They can set it up in different ways, but typically the more risk one side is taking, the more upside they get. Autobidder is outperforming traditional energy trading desks, and they have it running in Australia, ERCOT in Texas, the UK, Europe, and maybe one other European market.

Okay.

Now that they've built it, they can more easily bring in new markets for it. It seems to be quite successful for them.

What's the main challenge Tesla Energy faces, or the main challenges if you have two or three?

I would say their customer service. As a customer, I find it frustrating that it's hard to call Tesla. I think that's a downside, and I'm not the only one.

That's the same feedback as with their cars in the first years.

Yes. And also, the Powerwall and Megapack are products with their production rates right now, maybe just sell availability, but I think they're doing a pretty good job on that.

Do you think Elon is right that Tesla Energy will become just as big as the car business?

I think it could, eventually. I believe there is a lot more opportunity for it, especially as more cars are sold, increasing the need for energy storage and solar. The more cars you sell, the more pressing the problem becomes, which needs to be solved with other products.

Yes.

They are also deploying Megapacks at Superchargers to balance power demands.

Yes.

They are even implementing mobile Superchargers. The Supercharger team anticipates when they will be hit with high demand. Instead of tripling the size of a Supercharger for occasional peak demand, they can deploy mobile Superchargers to balance the loads.

Tesla's core is constant innovation, making their products better, faster, and cheaper.

It's hard not to be bullish on Tesla after talking to you.

I agree. Since our last conversation, the stock has gone up, and we haven't discussed cars much. The Ford announcement hadn't been made yet, I think.

When we talked, it had just been made.

It was just made then. I've been thinking about that a lot. A Rivian caught fire while charging at an Electrify America station yesterday. CCS might not be so lucky.

I don't know.

It might be the end of CCS. We'll see.

The competition isn't as strong either.

And they're not focused on it.

Correct.

I might come back to you at some point about the energy business. You taught me a lot. Thanks for your time, and maybe we'll speak again in the foreseeable future.

You now know more about the energy industry than 99% of the world.