Tesla has reportedly struck a deal with Chinese Local Authorities in Shanghai to begin constructing a Car Factory in the Free Trade Zone. This could be potentially a major victory for both Tesla’s efforts to break into the Chinese car market and a Chinese effort to further promote electric vehicles.

The New York Times reported that Tesla hopes to complete the deal by the end of the year. While the details of the deal are still being worked out, Tesla would construct the plant in Shanghai’s free trade zone. Tesla cars constructed in the Shanghai plant and sold in China would still be subject to steep tariffs, but lower labor and transportation costs would help make their cars more affordable.

While the tariff is unfortunate, the only way for Tesla to avoid the tariff would be to establish a joint venture with a domestic Chinese company and share their trade secrets and profits with them. China has reportedly used such ventures to easily obtain trade secrets, and the Trump administration signed a memorandum in August which CNBC reported: “could lead to a trade investigation of alleged Chinese theft of intellectual property.”

China and electric vehicles

The Shanghai government has offered relatively lenient terms in part because China has demonstrated a clear interest in expanding its electric vehicle fleet. The Chinese government wants to move from gasoline due to pollution concerns as well as to reduce China’s dependence on imported oil.

As the consulting firm McKinsey notes, China has offered subsidies to domestic electric vehicles for years, and there are now 75 Chinese electric vehicles on the market. China is already the biggest market for electric vehicles in the world. However, the actual percentage of Chinese electric vehicles on the road remains small, signaling that there is plenty of room to expand.

American car companies are thus interested in selling electric cars in China, but Tesla is the only company which has made significant inroads. According to Fortune, the company broke $1 billion in sales last March by adding stores and superchargers across the country. Tesla currently caters their cars to the superrich, which limits the impact of Chinese tariffs as customers are willing to pay a great deal for the status symbol anyways.

Tesla demand growing

But just like in the United States, Tesla is determined to break into the mass car market in China. This entails lowering prices, which will happen both from lower manufacturing costs with the use of a foundry, as well as the fact that the tariffs, while still restrictive, will be lower than before.

It should be noted that there are roadblocks to the path for a Chinese Tesla factory. The deal will need to be approved by the central government in Beijing, which may demand further restrictions. Tesla itself has not yet made any announcements of such a deal, and there were reports earlier this year that a similar deal had been struck which turned out not to be the case. A potential US-China trade war would also damage Tesla’s efforts to grow in China. Nevertheless, an eventual deal appears to be likely given Tesla’s and China’s converging interests.