oil

In defense of Tesla's price tag

May 13, 2013: 12:06 PM ET

Selling Teslas to wealthy people today may be the best way to get electric cars to everyone tomorrow, and for the U.S. to wean itself from its dependence on oil.

By Michael Levi

Tesla Model S

Tesla Model S

FORTUNE -- Tesla Motors made news last Wednesday when it posted its first quarterly profit. But the maker of luxury electric vehicles continues to come under fire.

The U.S. government gives a $7,500 tax credit to anyone who buys one of its cars, but at more than $70,000 for a Model S sedan, only the rich can afford to benefit. The Department of Energy has also provided the Palo Alto, Calif.-based company with a $465 million loan guarantee, which boosts returns for Tesla's wealthy owners while putting taxpayers' money at risk. No wonder many are furious with Washington for "subsidizing cools cars for rich people."

The truth, though, is that selling Teslas (TSLA) to wealthy people today may be the best way to get electric cars to everyone tomorrow, and for the United States to eventually reduce its dependence on oil, with all the national security and economic benefits that entails.

The U.S. economy is making big gains as domestic oil production rises, but high U.S. oil use leaves the nation vulnerable to dangerous spikes in the price of crude. With biofuels and fuel cells both faltering, electric cars may be one of the best ways out.

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But electric cars face a massive uphill battle. They lack the economies of scale and track record that traditional cars enjoy. They don't have the hundred-plus years of experience that's allowed their competitors to bring technology costs down. And while some big advances will come from people tinkering in labs, getting more electric cars onto the road is essential to figuring out how to manufacture lots of them efficiently, develop new ways to finance sales, and engineer networks of charging stations so that drivers don't run out of fuel.

Those initial cars, though, will be part of a niche market and come at a premium price. And the wealthy are a natural target market.

Take the cellular telephone. The Motorola DynaTAC 8000X, released in 1982, sold for $3,995 (equivalent to nearly $10,000 today). Gordon Gecko, who carried one of the behemoths around in the 1987 movie Wall Street, typified the cell phone user: rich, arrogant, brash. As late as 1998, the Nokia 6160 (the most popular cell phone model of the 1990s) sold for $900, well beyond the reach of most consumers. It was not until the 2000s that cell phones, which improved dramatically while they were considered a luxury good, became cheap enough for mass adoption.

During the 20 or so years that it took the cell phone to move from high-end product to mass market, the phones themselves transformed too. The DynaTAC was more than a foot long, weighed over two pounds, and had a one-hour battery life; today, you can buy a two-ounce phone that's smaller than your palm for $20.

The automobile itself benefited from early adoption by wealthy buyers. The first successful gasoline-based internal combustion engine was introduced in Germany in 1885 and over the next two decades, engines and other parts of the vehicle steadily improved. Yet it wasn't until Henry Ford introduced his Model T in 1908 that modern automobile became accessible to mere mortals. Ford (F) introduced a host of innovations -- most notably the assembly line -- that made the Model T accessible to the masses. But he was only able to do that because he could build on innovations that had been driven by smaller, upscale markets for more than 20 years.

The government, of course, didn't give rich people tax credits for buying early-model cellphones or nineteenth-century cars. And electric vehicles might eventually compete without government help. But just as Washington spends money on the military to protect the country from potential dangers in the Middle East, it makes sense for it to invest in accelerating new technology that could make the U.S. less dependent on the volatile region for oil. Despite record gains in U.S. oil production, we're still part of a global market; when things go haywire in Saudi Arabia, our economy suffers from skyrocketing oil bills. The only way to escape that danger is to use less oil in our cars and trucks even as we produce more crude at home.

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Using government to create an early market increases the odds that electric cars will help us do that. It helped the natural gas industry. During the 2000s, skyrocketing prices for natural gas created a big incentive for drillers to experiment with horizontal drilling and hydraulic fracturing (or "fracking") to extract natural gas from shale. Drillers were supported by tax credits that allowed them to quickly write off the costs of tackling risky wells. Over the course of the decade, that cushion let them improve their technology, bringing down costs and raising the amount of gas they extracted from each well. By the time natural gas prices crashed in 2008, fracking had become so cheap that it persisted nevertheless.

While it would be great if anyone could have a shot at owning one now, the reality is that making electric cars available to everyone today would be ruinously expensive. I'm just as envious of the guy who gets to drive a Tesla Model S as the next person. But if that's what it will take to get some breakthroughs that ultimately make the next generation of cars available to the masses -- and help slash American dependence on oil -- it's a price we should be willing to pay.

Michael Levi is the author of The Power Surge: Energy, Opportunity, and the Battle for America's Future. He is a senior fellow and director of the energy security and climate change program at the Council on Foreign Relations.

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