How Risky Is Tesla’s Bet on a DOE Loan Guarantee?

Electric car startup Tesla Motors claims that all it needs to begin construction on a manufacturing plant in San Jose, Calif., is a $200 million loan guarantee from the federal government. CEO Elon Musk has described the loan guarantee as a “when, not an if,” adding that, “We’ll do what we need to get approval.” So what would securing a loan guarantee entail, and does the green automaker really have this one in the bag?

The short answer is that Tesla — which has already raised some $185 million, plus deposits from at least 600 would-be Roadster owners — has reason to be confident in the guarantee. But the company’s future as anything but a niche luxury green car maker is at risk if the guarantee is as critical as Musk suggests. As he explained in a blog post in October, the planned factory represents Tesla’s key to high-volume production and a long-awaited sedan.

So what are all the steps involved in a loan guarantee from the Department of Energy? Tesla began the process about two years ago, submitting a preliminary application under a program created in the Energy Policy Act of 2005 aimed at encouraging innovative green technologies. More specifically, the program backs new or “significantly improved” technologies that prevent, reduce or capture greenhouse gas emissions. For projects meeting those criteria and one more — a reasonable prospect of repayment — the DOE agreed to assume financial risk that might otherwise scare off lenders.

Unlike the $25 billion direct-loan package approved specifically for fuel-efficient vehicle development, the loan guarantee program is open to a range of energy technologies, is not meant for research and development, and requires borrowers to pay the the government’s expected long-term liability for issuing the guarantee, or subsidy cost.

Tesla sought a guarantee on loans for its sedan factory (then planned for New Mexico) by arguing that an affordable electric car could replace today’s gas-guzzling, emissions-belching vehicles, thus preventing greenhouse gas emissions. Congress authorized the program to guarantee up to $4 billion in February 2007, and later that year, the DOE invited 16 pre-applicants, including Tesla, from a pool of 143 to submit full applications.

No other vehicle technology made it that far. Diarmuid O’Connell, Tesla’s V-P of corporate development, told us last week that Tesla’s application is among the three “most progressed” in the evaluation process, although that doesn’t mean it’s first in line for a guarantee. The program has a set amount for which it can vouch, not an allotted number of guarantees it can hand out.

According to DOE spokesperson Bethany Shively, the $4 billion approved for Tesla’s cohort of applicants “remains available until used.” That means Tesla can rest assured that the authorization won’t lapse, but the notoriously slow-moving program may not approve guarantees until well after the company’s planned mid-2009 groundbreaking in San Jose. And even if Tesla’s loan guarantee wins approval from the DOE, federal regulations say it can’t go through until the company completes a report on the project’s environmental impact, as CEO Elon Musk has noted in his blog.

Musk has remained mum, however, on a number of other hurdles that need to be overcome as well. Shively told us this week that several steps remain in the evaluation process, including technical, market and legal reviews. And beyond that, Congress has not approved the DOE’s FY 2009 budget requests (appropriations for most federal programs have been delayed until March), including funds for rising administrative costs in the loan guarantee office, which has solicited two more rounds of applications since Tesla first entered the system. According to O’Connell, the program has been understaffed and lacked full support from the Bush administration. As Office of Loan Guarantees Director David Frantz told reporters last spring, “It takes us months and years on these larger projects to do our credit underwriting and due diligence process.”

The backup plan for Tesla consists of more government investment, in the form of up to $400 million in low-interest loans. O’Connell, a veteran of D.C. politics, said government advisers recommended the company apply for the loans, in addition to the guarantee, because they fall under a program designed specifically for fuel-efficient cars that offers more favorable terms (it covers those subsidy costs, for one).

Last year, Tesla founder and then-CEO Martin Eberhard, in testimony before the Senate Finance Committee, observed that the Energy Act passed in 2005 included “incentives for practically every type of alternative automotive technology except electric cars. Why? Did somebody really kill the electric car?” We’ll know early next year what happens with Tesla and the DOE, but either way, we suspect the electric car will manage to survive.

The bottom line is without the manufacturing plant and the loan guarantee Tesla has a very slick, very fast, zero-emission, low-volume electric vehicle, a nascent powertrain supply business — and heavy reliance on funding from its CEO. This represents a major accomplishment on the spectrum of green car innovation, but it’s not everything the company has promised.