Why Tesla's Billion Dollar China Play Is Key To Its Survival

Tesla is embarking on a Chinese expansion costing billions of dollars for a good reason: the country is set to remain the largest electric-vehicle market for decades to come, and Elon Musk has a long way to go if he wants to dominate it.

Demand for electric cars will continue to gain ground in what is the world's fastest-growing auto and consumer market, as the government -- which is cracking down on pollution and re-making its factory-led economy as high tech -- favors them over gas guzzlers. Beijing has been pushing policy to fuel the rise of EVs, giving owners registration breaks and offering tax incentives for buyers. And while other countries are making inroads, China will remain the leader through at least 2040, Bloomberg New Energy Finance predicts.

Tesla, which has come under fire from investors for burning cash and its elusive profitability, said Wednesday it plans to use debt raised in China to fund its new factory near Shanghai, the first outside of the U.S.

The facility, known as the Gigafactory 3, is expected to churn out about 250,000 vehicles and battery packs per year initially -- and that capacity will double over time. The first cars are expected to roll off the production line in about three years.

Bloomberg News reported earlier on Wednesday that the cost of the plant at full capacity would be $5 billion, citing a person familiar with the plans, who asked not to be identified as the matter is private. Later on a conference call, Musk said the cost for the factory to build 250,000 vehicles a year would be near $2 billion.

"China's determination to go electric and the sheer size of its market" are driving global EV adoption, said Nannan Kou, a senior associate at Bloomberg NEF in Beijing. "Global carmakers have brought forward their timetables for EV development by six to seven years under China's EV push."

Tesla isn't alone. Global giants such as General Motors, Toyota, and Volkswagen are pouring billions of dollars into new-energy vehicles -- but they're coming late to the party in China. Hundreds of domestic automakers are also seeking a slice of the market, spurred on by the government's ambition to boost annual sales of new-energy vehicles tenfold by 2025.

Local production is crucial for Tesla to not only secure its foothold in China, but keep costs down -- especially as the trade war with the U.S. results in higher tariffs on car imports. The automaker has already boosted prices on its Model S and Model X cars by as much as $30,000 in China after the government imposed additional duties on American-built vehicles.

That risks putting them out of reach for the country's growing middle class.

Encouraging for Tesla, though, EV demand is strongest in China's largest cities, which have imposed restrictions on gasoline-engine cars.

Places like Beijing, Shanghai and Guangzhou are also home to China's wealthiest consumers, the people that are more likely to afford a Tesla either now -- or down the road -- especially as the company rolls out the Model 3 sedan, its cheapest-ever car.

After years of to-ing and fro-ing with China, Musk secured preliminary agreement with Shanghai's government to build the plant after a flying visit to the city last month.

While construction is expected to start in the next few quarters, the carmaker's investment won't begin "in any significant way" until next year, according to a letter to shareholders out Wednesday, released alongside Tesla's second-quarter earnings.