Tesla Puts Out Fire in China as Production Plant Gets Under Way

Footage has emerged purportedly of a first-generation Tesla (TSLA) Model S smoking, then exploding in an underground car park in Shanghai. The electric carmaker has dispatched a team to China to investigate the incident, and it can't do it quickly enough.

China is the second-largest market globally for Tesla. In the absence of a free press, social media has an even greater currency in China than elsewhere in the world, so the repeat viewing of the dramatic clip is doing potentially permanent damage to the carmaker's reputation.

Besides free press, Chinese people also do not benefit from free markets. As a result, they often have a dim view of how they work, particularly when they "lose" money.

Price cuts announced by Tesla in late February would seem ostensibly to be good news. Hey, cheaper Tesla! In China, though, they were greeted by demonstrations from peeved previous buyers, who claim to have "lost money" on their vehicle.

One social-media user joked that "buying a Tesla is more thrilling than buying stocks." Car owners in Changsha, in central China, put up a banner outside the local Tesla store claiming "Tesla cut prices on its own will, hurting the legal interests of consumers." These are probably the same people who rush into the Chinese stock market when it rallies, then complain that the Chinese government should bail it out when it all goes wrong.

You certainly shouldn't believe everything you see, read, touch, eat or smell in China. My Chinese wife smells a rat - she says the fire could have been staged by a competitor. (I doubt it, but nod along). The online clip will most certainly be circulated eagerly by Tesla haters keen to bring the company down a notch.

NIO  (NIO) went public last September, and other startups such as Byton and Xpeng are keen to muscle in on Tesla's turf. So whatever the cause, the Tesla "fire" comes at a particularly bad time, and shares in Tesla were lower in morning trading.

Tesla in March unveiled its Model Y small SUV to the Chinese market to mixed reviews. And Tesla began building its "Gigafactory Shanghai" in January, a joyous start to what should be a capitalist/socialist marriage made in heaven.

Its first international factory should produce cars at half the cost - in terms of capital spend per unit of capacity - of its facility in Fremont, CA. It expects to have general assembly, stamping, body joining and paint shop operations up and running by the end of the year.

The China factory is targeting a weekly production rate of 3,000 Model 3 vehicles per week, on top of the 7,000-vehicle pace now established in Fremont. The company therefore targets to hit a total annualized production rate of 500,000 Model 3s at some point between the end of this year and the middle of next, once the Shanghai plant is up and running.

That's a substantial ramp-up, after it delivered 63,359 Model S vehicles to North American customers in Q4 2018, an annualized pace of half its final target. The company will be doing well, it says, to deliver 400,000 of all models of its vehicles in 2019.

It's about to start delivering the Model 3 in China, as well as Europe, meaning North Americans get around 10,000 fewer of the vehicles per quarter for the time being. The increased production, and lower production cost in China, should allow the company to hit a gross margin of 25% on the vehicle at some point this year, it says.

It should also start producing the Model Y by the end of next year, most likely in Nevada. That will share 75% of its components with the Model 3, and is based on that platform, so presumably it will also soon be made in Shanghai.

The Shanghai factory will at first make a "truly affordable" version of the Model 3. Most of that compact sedan's competitors are locally made within China, so it's an essential step toward capturing the China market. Tesla will still be shipping higher-spec models from the U.S.

Tesla's car would be far from the first to set fire in China. There were at least 40 fire-related incidents involving new-energy vehicles in 2018, according to the State Administration for Market Regulation.

But electric vehicle sales continue to skyrocket while the combustion-engine market slumps. Electric passenger vehicles sold 788,000 units in China last year, up 68.4% over 2017, the China Association of Automobile Manufacturers says. Total sales of passenger vehicles fell 4.1%, to 23.7 million vehicles, a lower tally than expected.

The electric market is big enough in China for all the existing competitors. Tesla, with its foreign brand, has a leg up in reputation over Chinese manufacturers, which will look first and foremost to compete on price.

Let's hope that reputation remains intact once Tesla's team finishes going over the footage of that wreckage in Shanghai.

At the time of publication, Alex Frew McMillan had no position in the securities mentioned.