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January 7, 2019 11:00 AM, EST

Elon Musk, Tesla Break Ground on China Plant, First Outside US

Elon Musk Tesla CEO Elon Musk (Bloomberg News)

After four years of planning, Tesla Inc. finally broke ground on its planned $5 billion factory in the world’s biggest auto market. But the timing couldn’t be more inauspicious.

CEO Elon Musk and some Shanghai officials, including Mayor Ying Yong, on Jan. 7 attended a function at a site near the city kicking off construction of what would be the electric-vehicle maker’s first car-manufacturing facility outside the U.S. While the ceremony marked a new journey for Tesla, it comes at a point where China’s economy is showing signs of strain amid the trade war with the U.S.

In China, the billionaire-entrepreneur faces a car market that probably shrank last year for the first time in at least two decades as uncertainties surrounding the trade fight between the world’s two biggest economies, signs of weakening domestic demand and a stock-market slump take their toll on consumers. The challenging environment also includes competition from several startups that all want to be like Tesla.

The automaker aims to finish initial construction of the plant this summer and start Model 3 production by the end of the year, according to Musk. The factory, currently just an expanse of muddy fields about two hours from Shanghai, will produce affordable versions of Tesla’s Model 3 and Model Y for Greater China, he said during the visit, which took place on a cold, rainy day.

Elon Musk

CEO Elon Musk (Patrick T. Fallon/Bloomberg News)

“With the resources here, I think we can build the Shanghai Gigafactory in a record time,” Musk said.

The China plant is the result of years of negotiations with local authorities, and marks somewhat of a personal triumph for Musk after a tumultuous 2018. The U.S. Securities and Exchange Commission moved to punish Tesla last year after his infamous “funding secured” tweet, with fines and a settlement that required corporate governance reforms. It also comes on the back of Tesla’s ability to ramp up production of Model 3 sedans, marking the beginning of a turn in market sentiment.

A local Chinese plant may be crucial for Tesla, which is struggling to stave off a potential dip in demand in the U.S., its biggest market, after reductions in federal tax credits for EVs. The company cut the price of all its models by $2,000 to partially offset the loss of the subsidy.

A fully owned facility also would mean Tesla won’t need to share its profits and technology with Chinese partners, unlike other foreign carmakers who are required to form a domestic joint venture.

“Affordable cars must be made on same continent as customers,” Musk wrote in another Twitter post.

Domestic production would help shield Tesla against import duties as the U.S. and China find ways to wriggle out of the tariff quandary. The two sides have called a truce in their trade fight and are engaged in talks to cool tensions, with China temporarily scrapping a retaliatory 25% tariff on U.S.-made cars starting Jan. 1.

At the height of the dispute, when China imposed the additional duty on American-made autos, Tesla sales in the Asian country — which is its second-largest market — plunged to as low as 211 in October, from 3,552 in June, according to data compiled by Bloomberg Intelligence. In November, they clocked 393.

China car demand graph

But the drop in the sales isn’t just a direct effect of the trade war, which is why the Jan. 7 groundbreaking comes at an uncertain time.

Equity losses in China last year wiped out more than $2 trillion of wealth, denting consumer appetite for luxury goods. Apple triggered global equity losses last week when it said slackening Chinese demand spurred it to cut its revenue outlook for the first time in almost two decades.

Passenger car sales in the world’s second-largest economy declined for six consecutive months through November, putting them on track for the annual decline. A key China PMI index fell below 50 in December to its lowest reading since May 2017, signaling weakening demand in the $12.2 trillion economy.

Tesla signed a preliminary agreement with the Shanghai government last year to build the 500,000-unit factory in the Chinese city. In October, it said it paid about $140 million to secure more than 200 acres of land for the planned Gigafactory 3.

The facility is expected to churn out about 250,000 vehicles annually in the first phase, and that capacity will double over time, the Shanghai government said in a statement Jan. 7. Tesla has said it plans to use mostly local debt to fund the factory.