CHAPTER 12. MANUFACTURER IMPACT ANALYSIS

TABLE OF CONTENTS

12.1 INTRODUCTION ............................................................................................................ 12-1

12.2 METHODOLOGY ........................................................................................................... 12-1

12.2.1 Phase I: Industry Profile........................................................................................ 12-1

12.2.2 Phase II: Industry Cash -Flow Analysis and Interview Guide ............................... 12-2

12.2.2.1 Industry Cash- Flow Analysis ................................................................. 12-2

12.2.2.2 Interview Guides .................................................................................... 12-2

12.2.3 Phase III: Subgroup Analysis................................................................................ 12-3

12.2.3.1 Manufacturing Interviews ...................................................................... 12-3

12.2.3.2 Revised Industry Cash- Flow Analysis ................................................... 12-3

12.2.3.3 Manufacturer Subgroup Analysis .......................................................... 12-3

12.2.3.4 Small -Business Manufacturer Subgroup ............................................... 12-4

12.2.3.5 Manufacturing Capacity Impact ............................................................ 12-5

12.2.3.6 Employment Impact ............................................................................... 12-5

12.2.3.7 Cumulative Regulatory Burden ............................................................. 12-5

12.3 MANUFACTURER IMPACT ANALYSIS KEY ISSUES ............................................. 12-5

12.3.1 Size Constraints .................................................................................................... 12-5

12.3.2 Alternative Products.............................................................................................. 12-6

12.3.3 Compliance Tolerances ......................................................................................... 12-6

12.3.4 Constrained Innovation and Customization .......................................................... 12-6

12.4 GRIM INPUTS AND ASSUMPTIONS ........................................................................... 12-7

12.4.1 Overview of the GRIM ......................................................................................... 12-7

12.4.2 Sources for GRIM Inputs ...................................................................................... 12-8

12.4.2.1 Prior Energy Conservation Standard Rulemakings ............................... 12-8

12.4.2.2 Shipment Model ..................................................................................... 12-8

12.4.2.3 Engineering Analysis ............................................................................. 12-8

12.4.2.4 Manufacturer Interviews ........................................................................ 12-8

12.4.3 Financial Parameters ............................................................................................. 12-9

12.4.4 Trial Standard Levels ............................................................................................ 12-9

12.4.5 NIA Shipments.................................................................................................... 12-10

12.4.6 Production Costs ................................................................................................. 12-10

12.4.7 Conversion Costs ................................................................................................ 12-11

12.4.7.1 Capital Conversion Costs ..................................................................... 12-12

12.4.7.2 Production Conversion Costs ............................................................... 12-13

12.4.8 Markup Scenarios ............................................................................................... 12-13

12.4.8.1 Preservation of Gross Margin Percentage Scenario ............................. 12-13

12.4.8.2 Preservation of Operating Profit Scenario ........................................... 12-14

12.5 INDUSTRY FINANCIAL IMPACTS ........................................................................... 12-14

12.5.1 Introduction ......................................................................................................... 12-14

12.5.2 SPVU Industry Financial Impacts ...................................................................... 12-15

12.6 IMPACTS ON SMALL BUSINESS MANUFACTURERS .......................................... 12-19

12.7 OTHER IMPACTS ......................................................................................................... 12-21

12 -i12.7.1 Employment ........................................................................................................ 12-21

12.7.1.1 Employment Impacts ........................................................................... 12-21

12.7.2 Production Capacity ............................................................................................ 12-23

12.7.3 Cumulative Regulatory Burden .......................................................................... 12-23

12.8 CONCLUSION ............................................................................................................... 12-26

REFERENCES ........................................................................................................................ 12-29

LIST OF TABLES

Table 12

- 1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking ........................................................................................................ 12-4

Table 12

- 2 Financial Parameters used for SPVU GRIM ........................................................... 12-9

Table 12

- 3 Trial Standard Levels for Energy Efficiency Analysis of S PVU Equipment ....... 12-10

Table 12 -4 Manufacturer Production Cost Breakdown ($2012) for SPVAC <65 kBtu/h ....... 12-10

Table 12 -5 Manufacturer Production Cost Breakdown ($2012) for SPVHP < 65kBtu/h ....... 12-11

Table 12 -6 Manufacturer Production Cost Breakdown ($2012) for SPVAC ≥65 kBtu/h and <135

kBtu/h ............................................................................................................... 12-11

Table 12 -7 Manufacturer Production Cost Breakdown ($2012) for SPVHP ≥65 kBtu/h and <135

kBtu/h ............................................................................................................... 12-11

Table 12 -8 Industry Cumulative Capital Conversion Cost ...................................................... 12-12

Table 12 -9 Industry Cumulative Product Conversion Cost ..................................................... 12-13

Table 12

- 10 ASHRAE Baseline: Preservation of Gross Margin Percentage Scenario Changes in

INPV for SPVU Equipment ............................................................................. 12-16

Table 12 -11 ASHRAE Baseline: Preservation of Operating Profit Scenario Changes in INPV for SPVU Equipment ............................................................................................. 12-16

Table 12

- 12 EPCA Baseline: Preservation of Gross Margin Percentage Scenario Changes in INPV for SPVU Equipment ............................................................................. 12-17

Table 12 -13 EPCA Baseline: Preservation of Operating Profit Scenario Changes in INPV for SPVU Equipment ............................................................................................. 12-17

Table 12 -14 Potential Changes in the Total Number of SPVU Production Workers in 2019. 12-22

Table 12 -15 Lower Bound Direct Employment Factors.......................................................... 12-22

Table 12 -16 Compliance Dates and Expected Conversion Expenses of Federal Energy Conservation Standards Affecting SPVU Manufacturers................................ 12-25

LIST OF FIGURES

Figure 12

- 1 Using the GRIM to Calculate Cash Flow ............................................................. 12-7 Figure 12 -2 ASHRAE Baseline: Annual Industry Net Cash Flows for SPVU Equipment (Preservation of Gross Margin Percentage Markup Scenario) ........................ 12-17 Figure 12 -3 ASHRAE Baseline: Annual Industry Net Cash Flows for SPVU Equipment (Preservation of Operating Profit Markup Scenario) ....................................... 12-17 Figure 12 -4 EPCA Baseline: Annual Industry Net Cash Flows for SPVU Equipment (Preservation of Gross Margin Markup Scenario) ........................................... 12-18 Figure 12 -5 EPCA Baseline: Annual Industry Net Cash Flows for SPUV Equipment (Preservation of Operating Profit Markup Scenario) ....................................... 12-19

12

- iiCHAPTER 12. MANUFACTURER IMPACT ANALYSIS

12.1 INTRODUCTION

In determining whether a standard is economically justified, the U.S. Department of Energy (DOE) is required to consider the economic impact of the standard on the manufacturers and on the consumers of the products subject to such a standard. (42 U.S.C. 6313(a)(6)(B)(i))

The law a lso calls for an assessment of the impact of any lessening of competition as determined in writing by the Attorney General. Id

. DOE conducted a manufacturer impact analysis (MIA) to estimate the financial impact of amended energy conservation standards on manufacturers of

SPVU equipment, and assessed the impact of such standards on direct employment and manufacturing capacity.

The MIA has both quantitative and qualitative aspects. The quantitative part of the MIA primarily relies on the Government Regulato ry Impact Model (GRIM), an industry cash- flow model adapted for each product in this rulemaking. The GRIM inputs include information on industry cost structure, shipments, and pricing strategies. The GRIM’s key output is the industry net present value (INP V). The model estimates the financial impact of more -stringent energy conservation standards for each product by comparing changes in INPV between a base case and the various trial standard levels (TSLs) in the standards case. The qualitative part of the M IA addresses product characteristics, manufacturer characteristics, market and product trends, as well as the impact of standards on subgroups of manufacturers.

12.2 METHODOLOGY

DOE conducted the MIA in three phases. Phase I, “Industry Profile,” consisted of preparing an industry characterization for the SPVU industry, including data on sales volumes, pricing, employment, and financial structure. In Phase II, “Industry Cash Flow,” DOE used the

GRIM to assess the potential impacts of amended energy conservation standards on

manufacturers. DOE also developed interview guides to gather information on the potential impacts on these manufacturers. In Phase III, “Subgroup Impact Analysis,” DOE interviewed manufacturers representi ng a broad cross-section of the SPVU industry. Using information from

P hase II, DOE refined its analysis in the GRIM, develo ped additional analyses for subgroups that required special consideration, and incorporated qualitative data from interviews into it s analysis.

12.2.1 Phase I: Industry Profile

In Phase I of the MIA, DOE prepared a profile of the single package vertical unit air conditioner and heat pump industry that built on the market and technology assessment prepared

fo r this rulemaking (refer to c hapter 3 of the technical support document ( TSD ) ). Before initiating the detailed impact studies, DOE collected information on the present and past

structure and market characteristics of the SPVU industry. This information included shipments,

manufacturer marku ps, and the cost structures of various manufacturers. The industry profile includes: (1) further detail on the overall market and product characteristics; (2) estimated manufacturer market shares; (3) financial parameters such as net plant, property, and e quipment; selling, general and administrative (SG&A) expenses; cost of goods sold, etc.; and (4) trends in

12 -1the number of firms, market, and product characteristics. The industry profile included a topdown cost analysis of SPVU equipment manufacturers that DOE used to derive the preliminary financial inputs for the GRIM ( e.g. , revenues, depreciation, SG&A, and research and development (R&D) expenses).

DOE also used public information to further calibrate its initial characterization of the industry, includ ing Securities a nd Exchange Commission (SEC) 10- K reports, 1 Standard & Poor’s (S&P) stock reports, 2 market research tools ( i.e. , Hoovers 3 ), corporate annual reports, and the U.S. Census Bureau’s 2011 Annual Survey of Manufacturers (ASM)

. 4 DOE also characterized these industries using information from its engineering analysis and the life- cycle cost analysis.

12.2.2 Phase II: Industry Cash -Flow Analysis and Interview Guide

Phase II focused on the financial impacts of potential amended energy conse rvation

standards on manufacturers of SPVU equipment. More

- stringent energy conservation standards

can affect manufacturer cash flow s in three distinct ways , as it can : (1) c reate a need for

increased investment ; (2) raise production costs per unit; and (3 ) alter revenue due to higher per

unit prices and/or possible changes in sales volumes. To quantify these impacts, DOE used the GRIM to perform a cash

- flow analysis for the SPVU industry. In performing these analyses,

DOE used the financial values derived during Phase I and the shipment scenarios used in the national impact analysis (NIA). In Phase II, DOE performed these preliminary industry cash

flow analyses and prepared written guides for manufacturer interviews.

12.2.2.1 Industry Cash

- Flow Analysis

The GRIM uses several factors to determine a series of annual cash flows from the announcement year of amended energy conservation standards until 30 years after the standards’ compliance date. These factors include annual expected revenues, costs of goods sold, SG&A, taxes, and capital expenditures related to the amended standards. Inputs to the GRIM include

manufacturer production costs, markup assumptions, and shipments forecasts developed in other analyses. DOE derived the manufacturing costs from the e ngineering analysis and information provided by the industry. It estimated typical manufacturer markups from public financial reports and interviews with manufacturers. DOE developed alternative markup scenarios for each GRIM based on discussions with manufacturers. DOE’s shipments analysis, presented in c hapter 9 of the TSD, provided the basis for the shipment projections in the GRIM. The financial parameters were developed using publicly available manufacturer data and were revised with information submitted confidentially during manufacturer interviews. The GRIM results are compared to

base -case projections for the industry. The financial impact of amended energy conservation

standards is the difference between the discounted annual cash flows in the base case and

standards case at each TSL.

12.2.2.2 Interview Guides

During Phase II of the MIA, DOE interviewed manufacturers to gather information on

the effects of amended energy conservation standard s on revenues and finances, direct employment, capital assets, and industry competitiveness. Before the interviews, DOE

12 -2distributed an interview guide to interviewees. The interview guide provided a starting point for identifying relevant issues and impacts of amended energy conservation standards on individual

manufactu rers or subgroups of manufacturers. Most of the information received from these meetings is protected by non- disclosure agreements and resides with DOE’s contractors. The MIA interview topics included (1) key i ssues to this rulemaking; (2) company overview and organizational characteristics; (3 ) manufacturer markups and profitability; (4) distribution channels; (5) shipment projections and market shares; (6) product mix ; (7) financial parameters; (8) conversion costs; (9) cumulative regulatory burden; (10 ) direct employment impact assessment; (1 1) exports, foreign competition, and outsourcing; (12) consolidation; and (13) impacts on small businesses.

12.2.3 Phase III: Subgroup Analysis

For its GRIM analysis, DOE presented the impacts on all equipment classes of SPV U as a whole. DOE sought to obtain feedback from industry on the approaches used in the GRIM and to isolate key issues and concerns. During interviews, DOE defined one manufacturer subgroup,

small manufacturers , that could be disproportionately impacted by amended energy conservation

standards.

12.2.3.1 Manufacturing Interviews

The information gathered in Phase I and the cash- flow analysis performed in Phase II are supplemented with information gathered from manufacturer interviews in Phase III. The interview process provides an opportunity for manufacturers to express their views on important issues privately, allowing confidential or sensitive information to be considered in the rulemaking process. DOE sought to obtain feedback from industry on the approaches used in the GRIMs and to isolate key issues and concerns.

DOE used these interviews to tailor the GRIM to reflect financial characteristics unique

to the SPVU industry. Interviews were scheduled well in advance to provide every opportunity for key individuals to be available for comment. Although a written response to the questionnaire was acceptable, DOE sought interactive interviews, which help clarify responses and identify additional issues. The resulting information provides valuable inputs to the GRIM developed for

the equipment classes.

12.2.3.2 Revised Industry Cash -Flow Analysis

In Phase II of the MIA, DOE provided manufacturers with preliminary GRIM input financial figures for review and evaluation. During the interviews, DOE requested comments on the values it selected for the parameters. DOE revised its industry cash -flow model based on this

feedback. Section 12.4.3 provides more information on how DOE calculated the parameters.

12.2.3.3 Manufacturer Subgroup Analysis

Using average cost ass umptions to develop an industry cash

- flow estimate may not adequately assess differential impacts of amended energy conservation standards among manufacturer subgroups. For example, small manufacturers, niche players, or manufacturers exhibiting a cost structure that largely differs from the industry average could be more negatively

12 -3affected. To address this possible impact, DOE used the results of the industry characterization analysis in Phase I to group manufacturers that exhibit similar characteristics.

During the interviews, DOE discussed the potential subgroups and subgroup members it identified for the analysis. DOE asked manufacturers and other interested parties to suggest what subgr oups or characteristics are the most appropriate to analyze. As described in section 12.2.3

, DOE presents the industry impacts on SPVU equipment manufacturers as a whole because most

of the equipment classes represent the same market served by the same manufacturers. However, as discussed below, DOE identified one manufacturer subgroup that warranted a separate impact analysis: small manufacturers.

12.2.3.4 Small

- Business Manufacturer Subgroup

DOE investigated whether small business manufacturers should be analyzed as a manufacturer subgroup. DOE used the Small Business Administration (SBA) small business size standards effective on November 5, 2010, as amended, and the North American Industry Classification System (NAICS) code, presented in Table 12-1 , to determine whether any small entities would be affected by the rulemaking. 5 For the equipment classes under review, the SBA bases its small business definition on the total number of employees for a business, its subsidiaries, and its parent companies. An aggregated business entity with fewer employees than

the listed limit is considered a small business.

Table 12-1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking

Industry Description Revenue Limit Employee Limit NAICS

Air

- C onditioning and Warm Air Heating Equipment and Commercial and Industrial Refrigeration Equipment Manufacturing N/A 750 333415

DOE used publicly available and proprietary information to identify potential small manufacturers. DOE’s research involved industry trade association membership directories (including American Heating and Refrigeration Institute ( AHRI ) and North American Association of Food Equipment Manufacturers ( NAFEM ), product databases ( e.g. , AHRI Directory, NSF International listings, the SBA Database), individual company websites, and market research tools ( e.g. , Hoovers.com) to create a list of companies that manufacture or sell equipment covered by this rulemaking. DOE also asked stakeholders and industry representatives if they were aware of any other small manufacturers during manufacturer interviews and at previous DOE public meetings. DOE screened out companies that did not offer equipment covered by this rulemaking, did not meet the definition of a “small business,” or are foreign owned and operated.

Based on this analysis

, DOE identified one small business manufacturer of SPVU equipment. DOE reports the potential impact of this rulemaking on the small manufacturer in

section 12.6

.

12 -412.2.3.5 Manufacturing Capacity Impact

One significant outcome of amended energy conservation standards could be the obsolescence of existing manufacturing assets, including tooling and investment. The manufacturer interview guides have a series of questions to help identify impacts of amended standards on manufacturing capacity, specifically capacity utilization and plant location

decisions in the United States , with and without amended standards; the ability of manufacturers to upgrade or remodel existing facilities to accommodate the new requirements; the nature and value of any stranded assets; and estimates for any one -time changes to existing plant, property, and equipment (PPE). DOE’s estimates of the one

- time capital changes and stranded assets affect

the cash flow estimates in the GRIM. These estimates can be found in section 12.4.8

. DOE’s discussion of the capacity impact can be found in section 12.7.2

.

12.2.3.6 Employment Impact

The impact of amended energy conservation standards on employment is an important consideration in the rulemaking process. To assess how domestic direct employment patterns might be affected, the interviews explored current employment trends in the SPVU in dustry. The interviews also solicited manufacturer views on changes in employment pat terns that may result

from more stringent standards. The employment impacts section of the interview guide focused on current employment levels associated with manufacture rs at each production facility, expected future employment levels with and without amended energy conservation standards, and differences in workforce skills and issues related to the retraining of employees. The employment impacts are reported in section 12.7.1

.

12.2.3.7 Cumulative Regulatory Burden

DOE seeks to mitigate the overlapping effects on manufacturers due to amended energy conservation standards and other regulator y actions affecting the same products. DOE analyzed the impact on manufacturers of multiple, product-specific regulatory actions. Based on its own research and discussions with manufacturers, DOE identified regulations relevant to SPVU equipment, such as State regulations and other Federal regulations that impact other products made by the same manufacturers. Discussion of the cumulative regulatory burden can be found

in section 12.7.3

.

12.3 MANUFACTURER IMPACT ANALYSIS KEY ISSUES

Each MIA interview starts by asking: “What are the key issues for your company regarding the energy conservation standard rulemaking?” This question prompts manufacturers to identify the issues they feel DOE should explore and discuss further during the interview. The following sections describe the most significant issues identified by manufacturers. These summaries are provided in aggregate to protect manufacturer confidentiality.

12.3.1 Size Constr aints

Manufacturers noted that higher efficiency standards could force them to increase the size of their products to levels that are not acceptable to their customers. The manufacturers stated that some critical design options, such as increasing the amou nt of heat exchanger surface area,

12 -5would necessitate an increase in cabinet size and footprint that would be unacceptable to their

customers

. For example, i n the modular classroom and modular office markets, any additional floor space taken up by a larger SPVU could not be used by students and tenants. In the telecom market, manufacturers noted that telecom operators have standard

- sized telecom shelters and current SPVU designs already make use of all available wall space. Any increase in size would

force t heir customers to redesign the layout of the shelters and the complex telecommunications

electronics that are housed in the shelters. These size constraints would affect manufacturers if the amended standards are increased beyond the levels proposed in the March 16, 2011 draft of ASHRAE’s Proposed Addendum i to Standard 90.1-2010.

According to manufacturers, a change in cabinet size would be particularly problematic in the replacement market. Amended designs may no longer physically fit into existing

instal lation locations. Some examples include units that are too wide to fit through standard width doorways, that are too tall for the standard ceiling heights, and that protrude too far into

classrooms or offices. Aside from the physical space constraints, manufacturers are concerned that air vents and wall plenums would no longer align. The use of sleeves or adaptors to reroute air flow would be unsightly, take up valuable space, and affect air flow in a manner that reduces product efficiency.

12.3.2 Alternative Products

Multiple manufacturers stated that a large increase in efficiency could lead to price increases that would cause their customers to consider alternative products, such as unitary systems or commercial roof top units. They noted that these systems are often less convenient for

end -users due to the need for extensive duct work, the use of long refrigerant lines, and/or the reduced ability to control the flow of fresh air. These manufacturers were concerned that an increase in the energy conservation standard would raise the SPVU prices to the point where

end -users would accept the drawbacks of alternative products. DOE did not receive any quantitative comments on the price point at which unitary systems and commercial systems typically become cost

- co mpetitive alternatives.

12.3.3 Compliance Tolerances

Two manufacturers stated concerns about the tolerances required by compliance testing. They noted that SPVU manufacturers have no control over the variability in the performance of purchased components, such as compressors, or the variability of instrumentation within different test laboratories. As a result, the manufacturers stated that it is unrealistic for DOE to expect their products could test within the narrow confidence limits set by the 10 CFR 429.43.

12.3.4 Constrained Innovation and Customization

Multiple manufacturers noted that complying with an increased energy conservation standard would draw time, resources, and focus away from innovation, customization, and customer responsiveness. Manufacturers believe that the design, engineering, and testing resources used to comply with an amended standard would be better invested in developing features requested by their customers. Furthermore, multiple manufacturers noted that higher standards push manufacturers to ward similar designs. Manufacturers stated that standards

12 -6constrain their ability to customize products in ways that maximize efficiency based on the end user’s specific use

- case.

12.4 GRIM INPUTS AND ASSU MPTIONS

The GRIM serves as the main tool for assessing the impacts on industry due to amended energy conservation standards. DOE relies on several sources to obtain inputs for the GRIM. Data and assumptions from these sources are then fed into an accounting model that calculates the industry cash flow both with and without amended energy conservation standards.

12.4.1 Overview of the GRIM

The basic structure of the GRIM, illustrated in Figure 1 , is an annual cash flow analysis that uses manufacturer prices, manufacturing costs, shipments, and industry financial information as inputs, and accepts a set of regulatory conditions such as changes in costs, investments, and associated margins. The GRIM spreadsheet uses a number of inputs to arrive at a series of annual cash flows, beginning with the base year of the analysis, 2014, and continuing

to 2048 . The model calculates the INPV by s umming the stream of annual discounted cash flows during this period and adding a discounted terminal value. 6

Figure 12-1 Using the GRIM to Calculate Cash Flow

The GRIM projects cash flows using standard accounting principles and compares changes in INPV between the base

- case scenario and the standard- case scenario induced by amended energy conservation standards. The difference in INPV between the base case and the standard case(s) represents the estimated financial impact of the amended energy conservation

standard on manufacturers. Appendix 12A provides more technical details and user information

for the GRIM.

DOE presents MIA results relative to a base case that uses efficiency levels specified by

ASHRAE Standard 90.1-2013 a s the baseline efficiencies for SPVU equipment. Consequently, when comparing the INPV impacts of the GRIM model, the baseline efficiency is greater than the current Federal minimum efficiency requirements

.

For this TSD , DOE also repeat s the INPV and cash flow calculation s relative to an alternative base case, where the baseline efficiency levels are equal lo t the current Federal

12 -7minimums, which were set in 2009. (74 FR 12058). This alternative scenario is referred to as the

“EPCA Baseline”.

12.4.2 Sources for GRI M Inputs

The GRIM uses several different sources for data inputs in determining industry cash

flow. These sources include prior company profiles, census data, rulemaking financial metrics

, the shipments model, the engineering analysis, and the manufacturer interviews.

12.4.2.1 P rior E nergy Conservation S tandard R ulemakings

DOE used industry reviewed financial metrics from prior air conditioning and heat pump product rulemakings to estimate draft industry financial values, such as tax rate, working capital,

SG& A spending, R&D spending, depreciation, capital expenditures, and net PPE, when no reliable data was publicly available. Specifically, DOE based draft financial metrics off the 2011

direct final rule for Residential Furnaces, Central Air Conditioners and Heat Pumps (76 FR 37408) and the 2008 final rule for Packaged Terminal Air Conditioners and Heat Pumps (73 FR 58772). The draft financial metrics were then revised based on manufacturer feedback during

interviews.

12.4.2.2 Shipment Model

The GRIM used shipment projections derived from DOE’s shipments model in the NIA. Chapter 9 of the TSD describes the methodology and analytical model DOE used to forecast shipments.

12.4.2.3 Engineering Analysis

The engineering analysis establishes the relationship between manufacturer selli ng price (MSP) and energy efficiency for the equipment covered in this rulemaking. DOE adopted a design option approach to develop cost-efficiency curves in its engineering analysis. DOE began its analysis by conducting industry research to select equipmen t classes to directly analyze, develop baseline unit specifications, and select representative SPVU equipment for further analysis. Next , DOE determined efficiency levels based on the design options applicable to the specific equipment studied and the maxi mum technologically feasible efficiency level for each equipment class modeled. To develop cost estimates, DOE conducted a price analysis, based upon physical teardowns of selected units, cost estimates from publicly available sources, and price quotes from manufacturers. DOE then developed a cost model to determine manufacturer production costs (MPCs). By applying derived manufacturer markups to the MPC, DOE calculated the MSP and constructed industry cost- efficiency curves. See Chapter 5 for a complete di scussion of the engineering analysis.

12.4.2.4 Manufacturer Interviews

During the course of the MIA, DOE conducted interviews with a representative crosssection of manufacturers. DOE also interviewed manufacturers representing a significant portion

of sales in ev ery equipment class. During these discussions, DOE obtained information to determine and verify GRIM input assumptions in each industry. Key topics discussed during the

12 -8interviews and reflected in the GRIM include:

• capital conversion costs (one- time investments in PPE);

• financial metrics;

• product conversion costs (one-time investments in research, product development, testing, and marketing);

• product cost structure, or the portion of the MPCs related to materials, labor, overhead, and depreciation costs;

• MPCs estimated in the engineering analysis; and

• p ossible profitability impacts.

12.4.3 Financial Parameters

Given the very limited number of public companies in the SPVU industry, DOE was not

able to apply its standard methodology of determining initial GRIM fina ncial input based on SEC filings and public documents. While t here are two public companies producing SPVU equipment, SPVU sales account for less than 1% of the companies’ revenues. In reviewing their financials, DOE did not find their corporate financial metrics in line with prior values related to air conditioners and heat pumps. DOE instead relied on prior final rule financial metrics, which had been reviewed and commented on by air conditioner and heat pump manufacturers, as draft values. During interviews, manufacturers were asked to provide their own figures for the parameters listed in Table 12-2 . Where applicable, DOE adjusted the parameters in the GRIM using manufacturer feedback and market share information.

Table 12-2 Financial Param eters used for SPVU GRIM

Parameter Value

Tax Rate (% of Taxable Income) 35.5 %

Working Capital (% of Revenue) 20.1 %

SG&A (% of Revenue) 14 .1%

R&D (% of Revenues) 1.6%

Depreciation (% of Revenues) 1.0 %

Capital Expenditures (% of Revenues) 1.4 %

Cost of Capital 10.4%

12.4.4 Trial Standard Levels

DOE developed a number of efficiency levels for each type of equipment class . TSLs were then developed by selecting likely groupings of efficiency levels for all equipment types.

Table 12-3 presents the TSLs used for energy e fficiency analysis in the GRIM.

12 -9Table 12-3 Trial Standard Levels for Energy Efficiency Analysis of SPVU Equipment

Equipment Class Baseline TSL1 TSL2 TSL3 TSL4

SPVAC < 65 kBtu/h 10.0 10.5 11.0 11.75 12.3

SPVHP < 65 kBtu/h 10.0/ 3.0 10.5/ 3.2 11.0/ 3.3 11.75/ 3.9 12.3/ 3.9

65 < SPVAC < 135 kBtu/h 10.0 10.0 10.0 10.0 10.0

65 < SPVHP < 135 kBtu/h 10.0/ 3.0 10.0/ 3.0 10.0/ 3.0 10.0/ 3.0 10.0/ 3.0

12.4.5 NIA Shipments

The GRIM estimates manufacturer revenues based on total -unit-shipment forecasts and the distribution of these values by efficiency level. Changes in the efficiency mix at each standard level are a key driver of manufacturer finances. For this analysis, the GRIM applied the NIA shipments forecasts.

As part of the shipments analysis, DOE estimated the base- case shipment distribution by efficiency level for each equipment class. In the standards case, DOE determined efficiency distributions for cases in which a potential standard applies for 2019 and beyond. DOE assumed

that all shipments in the base case that did not meet the standard under consideration would meet
the new standard in 2019 under a roll -up scenario. Consumers in the base case who purchase

units above the standard level are not affected as they are assumed to continue to purchase the

same base

- case unit in the standards case. See chapter 9 of the TSD for more information on the

SPVU equipment standards- case shipment s.

12.4.6 Production Costs

Changes in production costs affect revenues and gross profits. Products that are more efficient typically cost more to produce than baseline products (as shown in chapter 5 of the TSD). For the MIA, DOE used the MPCs derived in the engineering analysis.

M anufacturing a higher efficiency product is typically more expensive than manufacturing a baseline product. MPCs increase at higher efficiency levels due to the use of

more complex components, which are more costly than baseline components. The se changes i n MPC can affect the revenues , gross margins, and cash flow of the industry, making these product cost data key GRIM inputs for DOE’s analysis.

To calculate baseline MSP, DOE followed a three -step process. First, DOE derived

MPC s from the engineering and tear down analyses. Second, DOE applied a manufacturer markup, which varies with the markup scenario (discussed in detail in section 12.4.8), to the MPCs. The engineering analysis also provided shipping costs, but in the case of SPV U equipment, shipping was not included in the MSP.

Table 12-4 through Table 12-7 show the production cost estimates used in the GRIM for each analyzed equipment class.

Table 12-4 Manufacturer Production Cost Breakdown ($2012 ) for SPVAC < 65 kBtu/h

Efficiency

Level Materials Labor Depreciation Overhead MPC Shipping Markup MSP

9.00 $924.17 $148.28 $14.71 $62.30 $1,149.47 $46.04 1.28 $1,517.36

12

- 1010.00 $1,169.19 $168.04 $18.23 $68.64 $1,424.10 $67.74 1.28 $1,890.59

10.50 $1,230.08 $173.17 $19.11 $70.46 $1,492.81 $67.74 1.28 $1,978.54

11.00 $1,291.39 $178.01 $19.99 $72.14 $1,561.53 $67.74 1.28 $2,066.50

11.75 $1,478.44 $190.77 $22.61 $74.54 $1,766.36 $88.78 1.28 $2,349.72

12.30 $1,800.14 $232.28 $27.53 $90.76 $2,150.71 $123.96 1.28 $2,876.87

Table 12-5 Manufacturer Production Cost Breakdown ($2012 ) for SPVHP < 65 kBtu/h

Efficiency

Level Materials Labor Depreciation Overhead MPC Shipping Markup MSP

9.00 $1,018.14 $161.11 $16.90 $124.40 $1,320.55 $46.04 1.28 $1,736.34

10.00 $1,263.04 $183.24 $20.94 $168.84 $1,636.06 $67.74 1.28 $2,161.90

10.50 $1,349.71 $188.65 $21.95 $154.69 $1,715.00 $67.74 1.28 $2,262.94

11.00 $1,433.36 $193.75 $22.96 $143.87 $1,793.94 $67.74 1.28 $2,363.98

11.75 $1,621.38 $206.98 $25.97 $174.92 $2,029.26 $88.78 1.28 $2,686.23

12.30 $1,974.19 $252.02 $31.63 $212.98 $2,470.82 $123.96 1.28 $3,286.61

Table 12-6 Manufacturer Production Cost Breakdown ($2012 ) for SPVAC ≥ 65 kBtu/h and

<135 kBtu/h

Efficiency

Level Materials Labor Depreciation Overhead MPC Shipping Markup MSP

8.90 $1,158.87 $178.87 $19.24 $146.10 $1,503.07 $70.45 1.28 $1,994.38

10.00 $1,455.00 $205.43 $24.12 $200.16 $1,884.72 $70.45 1.28 $2,482.89

Table 12-7 Manufacturer Production Cost Breakdown ($2012 ) for SPVHP ≥ 65 kBtu/h and

<135 kBtu/h

Efficiency

Level Materials Labor Depreciation Overhead MPC Shipping Markup MSP

8.90 $1,331.35 $193.40 $22.10 $179.93 $1,726.78 $70.45 1.28 $2,280.73

10.00 $1,671.57 $223.02 $27.72 $242.94 $2,165.24 $70.45 1.28 $2,841.96

12.4.7 Conversion Costs

Amended energy conservation standards typically cause manufacturers to incur one

- time conversion costs to bring their production facilities and product designs into compliance with new regulations. For the MIA, DOE classified these one- time conversion costs into two majorgroups: capital conversion costs and product conversion costs. Capital conversion costs are onetime investments in plant, property, and equipment to adapt or change existing production facilities in order to fabricate and assemble new product design s that comply with amended energy conservation standards. Product conversion costs are one- time investments in research, development, testing, marketing and other costs to make product designs comply with amended energy conservation standards. DOE based its estimates of the conversion costs for each

12

- 11efficiency level on information obtained from manufacturer interviews and the design pathways analyzed in the engineering analysis.

12.4.7.1 Capital Conversion Costs

To evaluate the level of capital conversion expenditures manufacturers would likely incur to comply with energy conservation standards, DOE used the manufacturer interviews to gather data on the level of capital investment required at each efficiency level . DOE validated manufacturer comments through estimates of capital expenditure requirements derived from the product teardown analysis and engineering model described in c hapter 5 of the TSD.

Table 12-8 Indust ry Cumulative Capital Conversion Cost

TSL Capital Conversion Cost ( $ millions )

TSL 1 2.4

TSL 2 2. 4

TSL 3 2. 9

TSL 4 11.0

At TSL 1, the engineering analysis suggest s that manufactures will increase the size of heat exchangers by inserting an additional coil row to meet the 10.5 EER standard s for SPVUs less than 65,000 Btu/h. DOE expect s capital conversion costs of $ 2.4 million. Some manufacturers stated that they would need to build additional lab space to accommodate astandard that required extensive redesign and testing of product lines. The investment in new inhouse test capability accounts for expected capital con version costs of up to $2.4 million for the industry.

At TSL 2, the engineering analysis suggests that manufacturers would add two coil rows beyond the baseline heat exchanger design to meet the 11 EER standard s for SPVUs less than 65,000 Btu/h. DOE does not expect any growth in cabinet size would be required for most

models. Similar to TSL 1, manufacturers stated that the driver of capital expenditures would be

the need for additional lab space to accommodate the testing of new products. DOE expects capit al conversion costs to remain at $2.4 million at TSL 2.

At TSL 3, DOE expects manufacturers to increase heat exchanger face size to meet the

11.75 EER standard s for SPVUs less than 65,000 Btu/h. 97 percent of models listed in the AHRI directory require redesign at TSL 3. Manufacturers would likely need to increase cabinet size to accommodate the larger heat exchanger and add a more efficien t 2

- stage compressor. The design changes increase capital conversion costs to $2.9 million at this level.

At TSL 4, DOE expects manufacturers to add an additional condensed heat exchanger to their original heat exchangers to meet the 12.3 EER standard s for SPVUs less than 65,000 Btu/h. This change would require deeper product cabinets and the setup of a production line to product secondary heat exchangers. Almost all of the models listed in the AHRI directory require redesign at TSL 4. The extensive product line redesigns increase capital conversion costs to
$11.0 million at this level.

12

- 1212.4.7.2 Production Conversion Costs

DOE assessed the equipment conversion costs at each level by integrating data from quantitative and qualitative sources. DOE considered feedback regarding the potential costs of each efficiency level from multiple manufacturers to determine conversion cost s such as R&D expenditures and certification costs. Manufacturer numbers were aggregated to better reflect the industry as a whole and to protect confidential information.

Based on both manufacturer feedback and the engineering analysis, many design option s were considered to be component swaps, which required substitutions of new components but did not require product redes i gns . Lighting changes, fan motor substitutions, compressor upgrades, and night curtain retrofits were understood to not require significant product development investments. However, changes in evaporator coil, condenser coil, and insulation were modeled to incur development expenses. Additionally, DOE included the cost of industry certifications in the product conversion costs.

Table 12-9 Industry Cumulative Product Conversion Cost

TSL Product Conversion Cost ($ millions)

TSL 1 4.1

TSL 2 4. 8

TSL 3 13.2

TSL 4 22.8

Product conversion costs for SPVUs were primarily derived from manufacturer value provided during confidential interviews. The conversion costs are driven by engineering and testing requirements. As the standard increases, increasing levels of engineering effort is required to meet the efficiency requirements more product models require redesign. Manufacturers noted

a large jump in the complexity of changes and the number of product lines that would require redesign at TSL 3 . This is reflected in the product conversion costs. At TSL 4 , product

conversion cost increase dramatically as nearly all manufacturers would have to develop an entirely new platform to meet this standard.

12.4.8 Markup Scenarios

DOE used multiple standards case markup scenarios to represent the uncertainty about the impacts of energy conservation standards on prices and profitability. In the base case, DOE

used the same markups applied in the engineering analysis. In the standards case, DOE modeled two markup scenarios to represent the uncertainty about the potential impacts on prices and profitability following the implementation of amended energy conservation standards: (1) a preservation of gross margin percentage scenario and (2) a preservation of operating profit

scenario. These scenarios l ead to different markups values that , when applied to the inputted MPCs, result in varying revenue and cash flow impacts.

12.4.8.1 Preservation of Gross Margin Percentage Scenario

Under the preservation

- of

- gross

- margin -percentage scenario, DOE applied a single uniform “gross margin percentage” markup across all efficiency levels. As production costs

12

- 13increase with efficiency, this scenario implies that the absolute dollar markup will increase as well. DOE assumed the non-production cost markup—which includes SG&A expenses, R&D expenses, interest, and profit— to be 1.28 for the SPVU industry. Th is markup is consistent with

the one DOE assumed in the engineering analysis . Manufacturers indicated that it is optimistic to assume that, as their MPC s increase in response to an energy conservation standard, they would be able to maintain the same gross margin percentage markup. Therefore, DOE assumes that this scenario represe nts a high bound to industry profitability under an energy conservation standard.

12.4.8.2 Preservation of Operating Profit Scenario

During interviews, multiple manufacturers expressed concern that the higher production costs could harm profitability. Because of ma rket characteristics, several manufacturers suggested that the additional costs of higher minimum efficiency products could not be fully passed through to customers. Incorporating this feedback, DOE modeled the preservation of operating profit scenario.

In the preservation of operating profit scenario, manufacturer markups are set so that operating profit one year after the compliance date of the new energy conservation standards is the same as in the base case. Under this scenario, as the cost of production and the cost of sales go up, manufacturers are generally required to reduce their markups to a level that maintains

base -case operating profit. The implicit assumption behind this markup scenario is that the industry can only maintain only its operating profit in absolute dollars after the standard. Operating margin in percentage terms is squeezed (reduced) between the base case and standards

case.

12.5 INDUSTRY FINANCIAL IMPACTS

Using the inputs and scenarios described in the previous sections, the GRIM estim ated indicators of financial impacts on the SPVU industry. The following sections detail additional inputs and assumptions for SPVU equipment. The main results of the MIA are also reported in this section. The MIA consists of two key financial metrics: INP V and annual cash flows.

12.5.1 Introduction

The INPV measures the industry value and is used in the MIA to compare the economic impacts of different TSLs in the standards case. The INPV is different from DOE’s net present value, which is applied to the U.S. economy. The INPV is the sum of all net cash flows discounted at the industry’s cost of capital or discount rate. The GRIM for this rulemakin g estimates cash flows from 2014 to 2048 , the same an alysis period used in the NIA (c hapter 10 of

the TSD ). This timefr ame models both the short- term impacts on the industry from the base year

of the analysis until the compliance date (2014 – 2019) and a long- term assessment over the 30

- year analysis period used in the NIA (2019 – 2048 ).

In the MIA, DOE compares the INPV of the base case to that of each TSL in the

standards case. The difference between the base

- case and a standards

- case INPV is an estimate of the economic impacts that implementing that particular TSL would have on the industry. In the NOPR Notice, DOE pres ents MIA results relative to a base case that uses efficiency levels specified by ASHRAE Standard 90.1-2013 as the baseline efficiencies for SPVU equipment.

12

- 14Consequently, when comparing the INPV impacts of the GRIM model, the baseline efficiency is

greater than the current Federal minimum efficiency requirements

.

In analyzing the financial impacts in this TSD , DOE also presents the INPV and cash

flow calculation s relative to an alternative base case, where the baseline efficiency levels are equal to the cu rrent Federal minimums, which were set in 2009. (74 FR 12058). This alternative

scenario is referred to as the “EPCA Baseline”.

While INPV is useful for evaluating the long

- term effects of amended energy conservation standards, short- term changes in cash f low are also important indicators of the industry’s financial situation. For example, a large investment over 1 or 2 years could strain the industry’s access to capital. Consequently, the sharp drop in financial performance could cause investors to flee, even though recovery may be possible. Thus, a short- term disturbance can have long- term effects that the INPV cannot ca pture. To provide an idea of the beh avior of annual net cash flows, Figure 12 through Figure 12 -5 present the annual net cash flows from 2013 through

2049.

Annual cash flows are d iscounted to 2014. After the standards announcement date ( i.e.

, the publication date of the final rule), industry cash flows begin to decline as companies use their financial resources to prepare for the amended energy conservation standard. Cash flows

bet ween the announcement date and the compliance date are driven by the level of conversion costs and the proportion of these investments spent every year. The more stringent the amended energy conservation standard, the greater the impact on industry cash fl ows in the years leading up to the compliance date, as product conversion costs lower cash inflows from operations and capital conversion costs increase cash outflows for capital expenditures.

Free cash flow in the year the amended energy conservation standards take effect is driven by two competing factors. In addition to capital and product conversion costs, amended energy conservation standards could create stranded assets, i.e. , tooling and equipment that could have been used longer if the energy conse rvation standard had not made them obsolete. In this year, manufacturers write down the remaining book value of existing tooling and equipment whose value is affected by the amended energy conservation standard. This one- time write -down acts as a tax shield that alleviates decreases in cash flow from operations in the year of the write

down. In this year, there is also an increase in working capital that reduces cash flow from operations. A large increase in working capital is needed due to more costly production components and materials, higher inventory carrying to sell more expensive products, and higher accounts receivable for more expensive products. Depending on these two competing factors, cash flow can be either positively or negatively affected in the year the standard takes effect.

12.5.2 SPVU Industry Financial Impacts

Table 12-11 and Table 12 -11 present the INPV estimates for the two markup scenarios

. Figure 1 2 and Figure 12-3 present the net annual cash flows for the two markup scenarios

. These results are based on an ASHRAE baseline and are consistent with the results presented in the

NOPR Notice.

12

- 15Table 12-10 ASHRAE Baseline: Preservation of Gross Margin Percentage Scenario Changes in INPV for SPVU Equipment

Units Base

Case Trial Standard Level

1 2 3 4

INPV 2013 $ M 36.5 34.2 38.0 49.2 47.4

Change

in INPV 2013 $ M

- (2.3) 1.5 12.7 10.9

(%)

- (6.3) 4.1 34.9 29.9

Table 12-11 ASHRAE Baseline: Preservation of Operating Profit Scenario Changes in

INPV for SPVU Equipment

Units Base

Case Trial Standard Level

1 2 3 4

INPV 2013 $ M 36.5 32.4 33.2 27.5 3.0

Change

in INPV 2013 $ M

- ( 4.1 ) ( 3.3 ) ( 9.0 ) (33.4 )

(%)

- (11.3 ) (9.0 ) ( 24.7 ) ( 91.7 )

($15.0) ($10.0)

($5.0) $0.0 $5.0 $10.0 $15.02013 $ Millions Base Case TSL 1 TSL 2 TSL 3 TSL 4

12

- 16Figure 12-2 ASHRAE Baseline: Annual Industry Net Cash Flows for SPVU Equipment (Preservation of Gross Margin Percentage Markup Scenario)

Figure 12-3 ASHRAE Baseline: Annual Industry Net Cash Flows for SPVU Equipment (Preservation of Operating Profit Markup Scenario)

The following tables present alternati ve results based on the EPCA Baseline. Table 12-12 and

Table 12-13 present the INPV estimates for the two markup scenarios relative that EPCA

Baseline

. Figure 12-4 and Figure 12 -5 present the net annual cash flows for the two markup

scenarios under the alternative baseline

.

Table 12-12 EPCA Baseline: Preserv ation of Gross Margin Percentage Scenario Changes in INPV for SPVU Equipment

Units Base

Case Trial Standard Level

1 2 3 4

INPV 2013 $

M 33.9 36.4 4 0.2 51.4 48.8

Change

in INPV 2013 $

M - 2.5 6.3 17.5 14.9

(%)

- 7.5 18.6 51.8 44.0

Table 12-13 EPCA Baseline: Preservation of Operating Profit Scenario Changes in INPV for SPVU Equipment ($14.0) ($12.0) ($10.0)

($8.0) ($6.0) ($4.0) ($2.0) $0.0 $2.0 $4.0 $6.0 $8.02013 $ Millions Base Case TSL 1 TSL 2 TSL 3 TSL 4

12

- 17Units Base

Case Trial Standard Level

1 2 3 4

INPV 2013 $

M 33.9 23.4 24.0 20.8 (8.4 )

Change

in INPV 2013 $

M - (10.4 ) (9.9 ) ( 13.1 ) ( 42.3 )

(%)

- (30.8 ) (29.2 ) (38.7 ) (124.8 )

Figure 12-4 EPCA Baseline: Annual Industry Net Cash Flows for SPVU Equipment (Preservation of Gross Margin Markup Scenario) $(15.00) $(10.00)

$(5.00) $- $5.00 $10.00 $15.002013 $ Million Base Case TSL 1 TSL 2 TSL 3 TSL 4

12

- 18Figure 12-5 EPCA Baseline: Annual Industry Net Cash Flows for SPUV Equipment (Preservation of Operating Profit Markup Scenario)

12.6 IMPACTS ON SMALL BUSINESS MANUFACTURERS

DOE conducted a more focused inquiry of the companies that could be small business manufacturers of products covered by this rulemaking. For “Air-Conditioning and Warm Air Heating Equipment and Commercial and Industrial Refrigeration Equipment Manufacturing,” the SBA has set a size threshold of 750 employees or less for an en tity to be considered as a small business for this category. During its market survey, DOE used all available public information to identify potential small manufacturers. DOE’s research involved industry trade association membership directories ( e.g. AHRI ), product databases ( e.g. , Federal Trade Commission (FTC) and ENERGY STAR ® databases), individual company websites, and market research tools ( e.g. , Hoovers reports) to create a comprehensive list of companies that manufacture or sell products covered by this rulemaking. DOE also asked stakeholders and industry representatives if they were aware of any other small manufacturers during manufacturer interviews and at previous DOE public meetings. DOE reviewed publicly available data and contacted select comp anies on its list, as necessary, to determine whether they met the SBA’s definition of a small business manufacturer of covered SPVU equipment. DOE screened out companies that did not offer products covered by this rulemaking, did not meet the definition

o f a “small business,” or are foreign owned and operated.

DOE identified seven companies that produce equipment covered under the single package vertical unit energy conservation standard rulemaking. Two of the seven companies are foreign -owned and operated. Of the remaining five businesses, two companies met the SBA

definition of a “small business.” One small business manufacturer has the largest market share of any manufacturer in the SPVU industry and 48 percent of the active listings in the AHRI $(20.00) $(15.00) $(10.00)

$(5.00) $- $5.00 $10.002013 $ Millions Base Case TSL 1 TSL 2 TSL 3 TSL 4

12

- 19Directo ry. [1] The other has a more modest market share and 5 percent of active listings in the AHRI Directory.

At the time of analysis, the domestic small manufacturer with the large market share had 229 active listings. Fifty -four of those listings, or 24 percent, would meet the proposed standards. The other 76 percent of the listings would not meet the proposed standard. The small manufacturer would need to either redesign those products or drop those products and move their

customers to more- efficient offe rings. However, DOE notes that the small manufacturer had more product listings than any other manufacturer that could meet the proposed standard.

The domestic small manufacturer with the smaller market share had 27 active listings. None of those listings would meet the proposed standards. At the proposed standard level, this manufacturer would need to redesign its entire product offering or leave the SPVU

market.

If small manufacturers chose to redesign their products that do not meet the proposed standard, they would need to make capital conversion and product conversion investments. DOE estimated an average total conversion cost of $1.49 million per manufacturer. DOE expects this investment, which is roughly 12% of an average manufacturer’s annual revenue, to be made over the four-year period between the publication of the final rule and the effective date of the

standard. Since small businesses may have a greater difficulty obtaining credit or may obtain less favorable terms than larger businesses, the small manufacturers may face higher overall costs if they choose to finance the conversion costs resulting from the change in standard.

DOE notes that the small manufacturer with the larger market share produces more SPVU units than its larger competitors. The company could potentially spread the conversion costs over a larger number of units than its competitors. However, the small manufacturer did express concern in MIA interviews that such an effort would tie up their available engineering

re sources and prevent them from focusing on technology advancements and customer-driven feature requests. Larger manufacturers, which do not have the same shipment volumes as the small manufacturer, may have fewer engineers dedicated to SPVU equipment but p otentially could marshal engineering and testing resources across their organization. The concern about adequate availability of engineering resources would also likely apply to the small manufacturer

with the smaller market share.

Smaller manufacturers generally pay higher prices for purchased parts, such as BPMs, relative to larger competitors. Even the small manufacturer with the larger market share, and the highest number of SPVU shipments of any manufacturer in the industry, could pay higher prices for component than the larger competition. If their competitors have centralized sourcing, those companies could combine component purchases for SPVU product lines with purchases for other non-SPVU product lines and obtain higher volume discounts than tho se available to small

manufacturers.

[1] Based on model lis tings in the AHRI directory accessed on June 6, 2012 (Available

at: http://www.ahridirectory.org/ahridirectory/pages/ac/defaultSearch.aspx ).

12

- 20Based on DOE’s analysis, including interviews with manufacturers, the Department believes one of the identified small businesses would be able to meet the proposed

standard. That small manufacturer has the strong mark et share, technical expertise, and the production capability to meet the amended standard. The company successfully competes in

both the current baseline- efficiency and premium

- efficiency market segments. The other small business has significantly less m arket share and does not compete in the premium- efficiency market today. Given the lack of existing product that meets the standard, potential conversion costs, and disadvantages in financing costs as well as in pricing for sourced components, the second small business may face headwinds in meeting the proposed standard.

12.7 OTHER IMPACTS

12.7.1 Employment

To quantitatively assess the impacts of energy conservation standards on employment, DOE used the GRIM to estimate the domestic labor expenditures and number of employees in

the base case and at each TSL from 201 4 through 204 8 . DOE used statistical data from the U.S. Census Bureau’s 2011 ASM, the results of the engineering analysis, and interviews with manufacturers to determine the inputs necessary to calculate industry-wide labor expenditures and domestic employment levels. Labor expenditures related to manufacturing of the product are

a fu nction of the labor intensity of the product, the sales volume, and an assumption that wages remain fixed in real terms over time. The total labor expenditures in each year are calculated by multiplying the MPCs by the labor percentage of MPCs.

The total labor expenditures in the GRIM were then converted to domestic production employment levels by dividing production labor expenditures by the annual payment per production worker (production worker hours times the labor rate found in the U.S. Census

Bureau ’s 2011 ASM). The estimates of production workers in this section cover workers, including line-supervisors who are directly involved in fabricating and assembling a product within the original equipment manufacturer (OEM) facility. Workers performing serv ices that are closely associated with production operations, such as materials handling tasks using forklifts, are also included as production labor. DOE’s estimates only account for production workers who manufacture the specific products covered by this rulemaking.

12.7.1.1 Employment Impacts

Using the GRIM, DOE estimates in the absence of new energy conservation standards, there would be 412 domestic production workers for SPVU equipment. DOE estimates that 95

percent of SPVU units sold in the United States are manufactured domestically. Table 12-15 shows the range of the impacts of potential amended energy conservation standards on U.S. production workers.

12

- 21Table 12-14 Potential Changes in the Total Number of SPVU Production Workers in 2019

Trial Standard Level

Base Case 1 2 3 4

Total Number of Dom estic

Production Workers in 2019 (without changes in production locations) 4 12 4 21 4 32 461 5 59

Potential Changes in

Dom estic Production

Workers in 201 9 * − (2 1 ) to

9 (2 1 ) to

20 ( 66 ) to

49 (1 15 ) to

147

*DOE presents a range of potential employment impacts, where the lower bound represents the scenario in which

some domestic manufacturers move production to other countries.

The employment impacts shown in Table 12-14 represent the potential production employment that could result following the compliance date of amended energy conservation standards. The upper end of the results in the table estimates the maximum increase in the number of production workers after the implementation of new energy conservation standards and it assumes that manufacturers would continue to produce the same scope of covered products within the United States. The upper end of the range also assumes that domestic production does not shift to countries with lower labor costs. The lower end of the range indicates the total number of U.S. production workers in the industry who could lose their jobs if all existing production were moved outside of the United States. The lower end of the range represents the

maximum decrease to the total number of U.S. production workers in the industry due to manufacturers choosing to leave the industry or due to moving production to other countries.

Table 12-15 shows the employment factors used to estimate the lower bound employment. The employment factor is the largest portion of manufacturers that could choose to leave the industry.

Table 12-15 Lower Bound Direct Employment Factors

TSL 1 2 3 4

Lower Bound Employment

Factor 5% 5% 16 % 28 %

To estimate a lower bound employment factor at TSL 1 and TSL 2, DOE assumes that all

manufacturers with less than 5% market share would leave the industry. At TSL 3, DOE assumes all manufacturers with less than 10% market share leave the industry. And at TSL 4, DOE

assumes all manufacturers with less than 2 5% market share would leave the industry. The employment impacts shown a re independent of the employment impacts from the broader U.S. economy, which are documented in the Employment Impact Analysis, chapter 13 of the TSD

.

Although the methodology presents a wide range of potential impacts, information provided by the engineer ing analysis and by manufacturers indicates that potential amended standards would have a relatively small impact on domestic employment . For TSL 1 through

12

- 22TSL 4, the available design options identified in the engineering analysis consist of increasing

the size of the heat exchanger, increasing the size of the cabinet to accommodate the large heat exchanger, and swapping motors for the indoor blower. While these changes may require some reconfiguration of production lines, they do not dramatically alter the number of man-hours required to produce a SPVU unit once the production lines are running. The lower bound of the direct employment analysis models the impact if companies exit the industry. Under this worst

case scenario for the TSL proposed, TSL 2, dome stic direct employment drops by 21 workers.

12.7.2 Production Capacity

According to SPVU manufacturers interviewed, demand for SPVUs, which roughly correlates to trends in telecommunications spending and construction of new schools, peaked in the 2001-2006 timeframe. As a result, excess capacity exists in the industry today.

R edesign s of SPVU models as a result of an energy conservation standard would not

fundamental ly change the assembly of the equipment. B ottlenecks are more likely to come from the redesign, testing, and certification process rather than from production capacity. To that end, some interviewed manufacturers expressed concern that the redesign of all products to include BPM motors would require a significant portion of their engineering resource s, taking resources away from customer responsiveness and R&D efforts. Furthermore, some manufacturers noted that an amended standard requiring BPMs would monopolize their testing resources and facilities – to their point when some manufacturers anticipated the need to build new psychr ometric test labs just to have enough in- house testing capacity to meet the amended standard. Once all products have been redesigned to meet an amended energy conservation standard, manufacturers did not anticipate any production constraints.

12.7.3 Cumulative Regulatory Burden While any one regulation may not impose a significant burden on manufacturers, the combined effects of several impending regulations may have serious consequences for some manufacturers, groups of manufacturers, or an entire industry. Assessing the impact of a single regulation may overlook this cumulative regulatory burden. For the cumulative regulatory burden analysis, DOE looks at other significant product- specific regulations that could affect

SPVU equipment manufacturers that will take effect 3 years before or after the compliance date of amended energy conservation standards for these products a . In addition to the amended energy conservation regulations on SPVU equipment , several other Federal regulations ap ply to these products and other equipment produced by the same manufacturers.

For equipment with proposed standards that are more stringent than those contained in ASHRAE Standard 90.1-2013, the compliance date is four years after publication of

an ener gy conservation standards final rule ( i.e. , compliance date assumed to be 2019 for the purposes of MIA). For equipment with proposed standards that are set at the levels contained in

a The compliance date for SPVU equipment is proposed to be in the year 2017.

12

- 23ASHRAE Standard 90.1-2013, the compliance date is two or three years afte r the effective date of the requirements in ASHRAE Standard 90.1-2013, depending on equipment size ( i.e. , 2015 or 2016). For this cumulative regulatory burden analysis, DOE considered regulations that could

affect SPVU manufacturers that take effect from 2 012 to 2022, to account for the range of compliance years.

In interviews, manufacturers cited Federal regulations on equipment other than SPVUs that contribute to their cumulative regulatory burden. In particular, manufacturers noted that

some of them als o produce residential central air conditioners and heat pumps, residential furnaces, room air conditioners, and water-heating equipment. These products have amended energy conservation standards that go into effect within three years of the compliance dat e for any amended SPVU standards. The compliance years and expected industry conversion costs

are listed below:

12

- 24Table 12-16 Compliance Dates and Expected Conversion Expenses of Federal Energy Conservation Standards Affecting SPVU Manufacturers

Federal Energy Conservation

Standards Approximate Compliance

Date Estimated Total Industry
Conversion Expense

2008 Packaged Terminal Air
Conditioners and Heat Pumps

73 FR 58772 (Oct. 7, 2008) 2012 $33.7M (2007$)

2011 Room Air Conditioners
76 FR 22454 (April 21, 2011);
76 FR 52854 (August 24, 2011) 2014 $171M (2009$)

2007 Residential Furnaces & Boilers
72 FR 65136 (Nov. 19, 2007) 2015 $88M (2006$)*

2011 Residential Furnaces
76 FR 37408 (June 27, 2011);
76 FR 67037 (Oct. 31, 2011) 2015 $2.5M (2009$)**

2011 Residential Central Air
Conditioners and Heat Pumps
76 FR 37408 (June 27, 2011);
76 FR 67037 (Oct. 31, 2011) 2015 $ 26.0M (2009$)**

2010 Gas Fired and Electric Storage

Water Heaters
75 FR 20112 (April 16, 2010) 2015 $95.4M (2009$)

Walk

- in Coolers and Freezers
79 FR 32050 (June 3, 2014) 2017 $33.6M (2012$)

Dishwashers*** 2018 TBD

Commercial Warm

- Air Furnaces*** 2018 TBD

Commercial Packaged Air
Conditioners and Heat Pumps***
79 FR 58948 (September 18, 2014) 2019 $226.4M (2013$)

Furnace Fans
79 FR 38130 (July 3, 2014) 2019 $40.6M (2013$)

Packaged Terminal Air Conditioners
and Heat Pumps***
79 FR 55538 (September 16, 2014) 2019 $14.3M (2013$)

Miscellaneous Residential
Refrigeration*** 2019 TBD

Commercial Water Heaters*** 2019 TBD
Commercial Packaged Boilers*** 2020 TBD

Residential Water Heaters*** 2021 TBD
Clothes Dryers*** 2022 TBD

Central Air Conditioners*** 2022 TBD

Room Air Conditioners*** 2022 TBD

* Conversion expenses for manufacturers of oil

- fired furnaces and gas

- fired and oil

- fired boilers associated with the November 2007 final rule for residential furnaces and boilers are excluded from this figure. The 2011 direct final

rule for residential fur naces sets a higher standard and earlier compliance date for oil

- fired furnaces than the 2007 final rule. As a result, manufacturers will be required design to the 2011 direct final rule standard. The conversion costs associated with the 2011 direct final rule are listed separately in this table. EISA 2007 legislated higher

12

- 25standards and earlier compliance dates for residential boilers than were in the November 2007 final rule. As a result,

gas

- fired and oil

- fired boiler manufacturers were required to d esign to the EISA 2007 standard beginning in 2012. The conversion costs listed for residential gas

- fired and oil

- fired boilers in the November 2007 residential furnaces and boilers final rule analysis are not included in this figure.

** Estimated industry conversion expense and approximate compliance date reflect a court

- ordered April 24, 2014

remand of the residential non

- weatherized and mobile home gas furnaces standards set in the 2011 Energy

Conservation Standards for Residential Furn aces and Residential Central Air Conditioners and Heat Pumps . The costs associated with this rule reflect implementation of the amended standards for the remaining furnace product classes ( i.e. , oil

- fired furnaces).

***The final rule for this energy conse rvation standard has not been published. The compliance date and analysis of conversion costs have not been finalized at this time. (If a value is provided for total industry conversion expense, this value represents an estimate from the NOPR.)

Some sta keholders have expressed concern regarding potential conflicts with other certification programs, in particular EPA ENERGY STAR requirements. DOE realizes that the cumulative effect of several regulations on an industry may significantly increase the burden faced by manufacturers who need to comply with multiple certification programs from different organizations and levels of government. However, the Department does not consider ENERGY STAR in its presentation of cumulative regulatory burden, because ENERG Y STAR is a voluntary program and is not Federally mandated.

Some stakeholders also noted that The Clean Air Act has historically affected their products. The Clean Air Act defines the EPA's responsibilities for protecting and improving the nation's air quality and the stratospheric ozone layer. For SPVU manufacturers, the most significant of these additional regulations are the EPA mandated phase-out of hydrochlorofluorocarbons (HCFCs). The Act demands on a quarterly basis that any person who produced, imported, or exported certain ozone-depleting substances, including HCFC refrigerants, must report the amount produced, imported and exported. Additionally, effective January 1, 2015, selling, manufacturing, and using any ozone-depleting such substance is banned unless such substance has been used, recovered, and recycled; is used and entirely consumed in the production of other chemicals; or is used as a refrigerant in appliances manufactured prior to January 1, 2020. Finally, production phase-outs will continue until January 1, 2030 when such production will be illegal. For HCFC-22, which is commonly used in older A/C equipment, EPA regulations make it illegal to manufacture a new appliance using virgin HCFC- 22 refrigerant or

pre

- charge any appliance or appl iance component with HCFC -22 as of January 1, 2010. Additionally, HCFC-22 production will stop by Jan uary 1, 2020. These bans could trigger design changes to low global warming potential continue to encourage transition to non-ozone- depleting refrigerants.

12.8 CONCLUSION

The following section summarizes the impacts for the scenarios DOE believes are most likely to capture the range of impacts on SPVU equipment manufacturers as a result of amended energy conservation standards. DOE also notes that while these scenarios bound the range of

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- 26most plausible impacts on manufacturers, there potentially could be circumstances that cause manufacturers to experience impacts outside of this range.

At TSL 1, the standard for all equipment classes with capacity less than 65,000 Btu/h is set at 10.5 EER / 3.2 COP. The standard for all equipment classes with capacity greater than or equal to 65,000 Btu/h and less than 135,000 Btu/h and greater than or equal to 135,000 Btu/h and less than 240,000 Btu/h is set at the baseline ( i.e. , 10.0 EER/3.0 COP). DOE estimates the change in INPV to range from -$2.3 million to -$4.1, or a change of -6.3 percent to -11.3 percent. At this level, free cash flow is estimated to decrease to $0.6 million, or a decrease of 78.2 percent compared to the base -case value of $2.9 million in the year 2018. DOE does expect a standard at this level to require changes to manufacturing equipment, thereby resulting in capital conversion costs. The engineering analysis suggests that manufacturers would reach t his amended standard by increasing heat exchanger size. Roughly sixty

- five percent of the SPVU models listed in the AHRI Directory would need to be updated to meet this amended standard level. Estimated industry conversion costs total $6.5 million.

At TS L 2, the standard for all equipment classes with capacity less than 65,000 Btu/h is set at 11.0 EER / 3.3 COP. The standards for all equipment classes with capacity greater than or equal to 65,000 Btu/h and less than 135,000 Btu/h and greater than or equal to 135,000 Btu/h and less than 240,000 Btu/h remain at baseline as in TSL 1. DOE estimates impacts on INPV to range from $1.5 million to -$3.3 million, or a change in INPV of 4.1 percent to -9.0 percent. At this level, free cash flow is estimated to decre ase to $0.4, or a change of -85.0 percent compared to the base -case value of $2.9 million in the year 2018. Based on the engineering analysis, DOE expects manufacturers to reach this level of efficiency by further increasing the size of the heat exchanger. Roughly seventy- six percent of the SPVU models listed in the AHRI Directory would need to be updated to meet this amended standard level. Product updates and associated testing expenses would further increase conversion costs for the industry to $7.2

mill ion.

At TSL 3, the standard increases to 11.75 EER / 3.9 COP for equipment with capacity less than 65,000 Btu/h. The standards for SPVAC and SPVHP equipment with capacity greater than or equal to 65,000 Btu/h and less than 135,000 Btu/h and greater than or equal to 135,000 Btu/h and less than 240,000 Btu/h remain at baseline as in TSLs 1 and 2. DOE estimates impacts on INPV to range from $12.7 million to -$9.0 million, or a change in INPV of 34.9 percent to - 24.7 percent. At this level, free cash flow is estimated to decrease to less than zero, to -$2.1 million, or a change of -174.0 percent compared to the base-case value of $2.9 million in the year 2018. The engineering analysis suggests that manufacturers would reach this amended standard by once again in creasing heat exchanger size and by switching to more

- efficient two

- stage compressors. Manufacturers that produce heat exchangers in-house may need to add coil fabrication equipment to accommodate the size of the heat exchanger necessary to meet the standard. Additionally, the new heat exchanger size may require manufacturers to invest additional capital into their sheet metal bending lines. Ninety -four percent of the SPVU models listed in the AHRI Directory would require redesign at this amended standard l evel. DOE estimates total conversion costs to be $16.1 million for the industry.

At TSL 4, the standard increases to 12.3 EER / COP of 3.9 for SPVAC and SPVHP equipment with capacity less than 65,000 Btu/h. The standards for SPVAC and SPVHP

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- 27equipment with capacity greater than or equal to 65,000 Btu/h and less than 135,000 Btu/h and greater than or equal to 135,000 Btu/h and less than 240,000 Btu/h remain at baseline as in TSLs 1, 2, and 3. DOE estimates impacts on INPV to range from $10.9 million to -$33.4 million, or a change in INPV of 29.9 percent to -91.7 percent. At this level, free cash flow is estimated to

decrease to -$9.5 million, or a decrease of 428.2 percent compared to the base-case value of $2.9 million in the year 2018. TSL 4 represents the m ax

- tech standard level. DOE expects manufacturers to meet the amended standard by dramatically increasing the size of the evaporating heat exchanger and incorporating two condensing heat exchangers. Virtually all SPVU models listed in the AHRI Directory wo uld require redesign at this amended standard level. Additionally, DOE expects designs to use BPMs for both the indoor and outdoor motors. Total conversion costs are expected to reach $33.9 million for the industry.

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- 28REFERENCES

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4. U.S.Census Bureau, Annual Survey of Manufacturers: General Statistics: Statistics for Industry Groups and Industries (2010) (Available at:

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< http://www.sba.gov/content/table- small -business- size -standards >.

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