12-i 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 12.2.1.1 Manufacturer Interviews .................. ............................................. 12-2 12.2.2 Phase II: Industry Cash-Flow Analysis ............. ......................................... 12-2 12.2.3 Phase III: Manufacturer Subgroup Analysis ......... ...................................... 12-3 12.2.3.1 Manufacturers with Production Assets Subgr oup ........................ 12-4 12.2.3.2 Small Business Manufacturer Subgroup ..... ................................. 12-4 12.2.4 Manufacturing Capacity Impact ..................... ............................................ 12-5 12.2.5 Employment Impact .................................

................................................... 12-5 12.2.6 Cumulative Regulatory Burden ...................... ............................................ 12-5 12.3 MANUFACTURER IMPACT ANALYSIS KEY ISSUES ........... ................... 12-5 12.3.1 Size Constraints ..................................

................................................... ..... 12-6 12.3.2 Impact on Manufacturer Profitability .............. ........................................... 12-6 12.3.3 Impacts on Customer Utility ....................... ................................................ 12 -7 12.4 GRIM INPUTS AND ASSUMPTIONS ....................... ..................................... 12-7 12.4.1 Overview of the Government Regulatory Impact Model (GRIM) ............. 12-7 12.4.2 Sources for GRIM Inputs ........................... ................................................. 1 2-8 12.4.2.1 2008 Final Rule for PTACs and PTHPs ...... ................................. 12-9 12.4.2.2 Shipment Model............................ ................................................ 12 -9 12.4.2.3 Engineering Analysis ..................... ............................................... 12- 9 12.4.2.4 Manufacturer Interviews .................. ............................................. 12-9 12.4.3 Trial Standard Levels (TSLs) ...................... ............................................. 12-10 12.4.4 NIA Shipments .....................................

................................................... . 12-11 12.4.5 Production Costs ..................................

................................................... .. 12-11 12.4.6 Conversion Costs ..................................

................................................... . 12-12 12.4.6.1 Capital Conversion Costs ................. .......................................... 12-13 12.4.6.2 Product Conversion Costs ................. .......................................... 12-14 12.4.7 Markup Scenarios ..................................

................................................... 12-14 12.4.7.1 Preservation of Gross Margin Percentage Sc enario ................... 12-15 12.4.7.2 Preservation of Operating Profit Scenario .................................. 12-15 12.5 INDUSTRY FINANCIAL IMPACTS ........................ .................................... 12-15 12.5.1 Introduction ......................................

................................................... ...... 12-15 12.5.2 PTAC and PTHP Industry Financial Impacts .......... ................................. 12-17 12.6 IMPACTS ON SUBGROUPS OF MANUFACTURERS ............. ................. 12-21 12.6.1 Impacts on Manufacturers with Production Assets ... ............................... 12-21 12.6.2 Impacts on Small Business Manufacturers ........... .................................... 12-23 12.7 OTHER IMPACTS .....................................

................................................... .. 12-25 12.7.1 Employment ........................................

................................................... ... 12-25 12.7.1.1 Methodology .............................. ................................................. 1 2-25 12.7.1.2 Direct Employment Impacts ................ ....................................... 12-2612-ii

12.7.2 Production Capacity ...............................

................................................... 12-27 12.7.3 Cumulative Regulatory Burden ...................... .......................................... 12-27 12.8 CONCLUSION ........................................

................................................... ..... 12-30 12.8.1 Conclusions for PTACs and PTHPs MIA ............... ................................. 12-30

LIST OF TABLES

Table 12.2.2 SBA and NAICS Classification of Small Businesses Potentially

Affected by This Rulemaking ....................... ............................. 12-4 Table 12.4.1 GRIM Financial Parameters for PTACs a nd PTHPs .......................... 12-9 Table 12.4.2 Trial Standard Levels for Analysis of PTACs and PTHPs ............... 12-10 Table 12.4.3 Manufacturer Production Cost Breakdow n (2013$) for PTACs, < 7,000

Btu/h Capacity .................................... ..................................... 12-12 Table 12.4.4 Manufacturer Production Cost Breakdow n (2013$) for PTACs, ≥ 7,000

Btu/h and ≤ 15,000 Btu/h Capacity ................. ......................... 12-12 Table 12.4.5 Manufacturer Production Cost Breakdow n (2013$) for PTACs, > 15,000

Btu/h Capacity .................................... ..................................... 12-12 Table 12.4.6 Industry Cumulative Capital Conversio n Costs (2013$ Millions) ... 12-13 Table 12.4.7 Industry Cumulative Product Conversio n Costs (2013$ Millions)... 12-14 Table 12.5.1 ASHRAE Baseline: Preservation of Gros s Margin Percentage Scenario

Changes in INPV for PTACs and PTHPs ............... ................. 12-17 Table 12.5.2 ASHRAE Baseline: Preservation of Oper ating Profit Scenario Changes

in INPV for PTACs and PTHPs........................ ....................... 12-17 Table 12.5.3 EPCA Baseline: Preservation of Gross Margin Percentage Scenario

Changes in INPV for PTACs and PTHPs ............... ................. 12-19 Table 12.5.4 EPCA Baseline: Preservation of Operat ing Profit Scenario Changes in

INPV for PTACs and PTHPs .......................... ......................... 12-19 Table 12.6.1 Manufacturer Impact Analysis Results for the Subgroup of PTAC and

PTHP Manufacturers with Production Assets* ........ ............... 12-23 Table 12.6.2 Magnitude of Conversion Costs Facing an Average Small Manufacturer

versus an Average Large Manufacturer .............. ..................... 12-25 Table 12.7.1 Potential Changes in the Total Number of Production Workers in the PTAC and PTHP Industry in 2019 .................... ...................... 12-26 Table 12.7.2 Compliance Dates and Expected Convers ion Expenses of Federal

Energy Conservation Standards Affecting PTAC and PT HP Manufacturers ..................................... ..................................... 12-29 Table 12.8.1 Manufacturer Impact Analysis Results for PTACs and PTHPs* ..... 12-31

LIST OF FIGURES

Figure 12.4.1 Using the GRIM to Calculate Cash Flo w ........................................... 12-8 Figure 12.5.1 ASHRAE Baseline: Annual Industry Net Cash Flows under Preservation

of Gross Margin Percentage Markup Scenario (in 2013 $M) ... 12-1812-iii

Figure 12.5.2 ASHRAE Baseline: Annual Industry Net Cash Flows under Preservation

of Operating Profit Markup Scenario (in 2013$M) ... .............. 12-19 Figure 12.5.3 EPCA Baseline: Annual Industry Net C ash Flows under Preservation of

Gross Margin Percentage Markup Scenario (in 2013$M) ....... 12-20 Figure 12.5.4 EPCA Baseline: Annual Industry Net C ash Flows under Preservation of

Operating Profit Markup Scenario (in 2013$M) ...... ............... 12-2112-1 CHAPTER 12. MANUFACTURER IMPACT ANALYSIS

12.1 INTRODUCTION

In determining whether a standard is economically j ustified, the U.S. Department of Energy (DOE) is required to consider “the econom ic impact of the standard on the manufacturers and on the customers of the products subject to such a standard.” (42 U.S.C. 6313(a)(6)(B)(i)) The law also calls for an assessment of the impact of any lessening of competition as determined in writing b y the Attorney General. Id . DOE conducted a manufacturer impact analysis (MIA) to e stimate the financial impact of amended energy conservation standards on manufactur ers of packaged terminal air conditioners (PTACs) and packaged terminal heat pum ps (PTHPs), and assessed the impact of such standards on direct employment and m anufacturing capacity.

The MIA has both quantitative and qualitative aspec ts. The quantitative part of the MIA primarily relies on the Government Regulato ry Impact Model (GRIM), an industry cash-flow model adapted for each equipment type in this rulemaking. The GRIM inputs include information on industry cost structu re, shipments, and pricing strategies. The GRIM’s key output is the industry net present v alue (INPV). The model estimates the financial impact of more stringent energy conse rvation standards for each equipment type by comparing changes in INPV between a base ca se and the various trial standard levels (TSLs) in the standards case. The qualitativ e part of the MIA addresses equipment characteristics, manufacturer characteristics, mark et and equipment trends, as well as the impact of standards on subgroups of manufacturers.

12.2 METHODOLOGY

DOE conducted the MIA in three phases. Phase I, “In dustry Profile,” consisted of preparing a characterization of the PTAC and PTHP i ndustry, including data on sales volumes, pricing, employment, and financial structu re. As part of this phase, DOE conducted interviews with a broad cross-section of PTAC and PTHP manufacturers to gather information on the industry as well as the p otential impacts of amended energy conservation standards. In Phase II, “Industry Cash Flow Analysis,” DOE used the Government Regulatory Impact Model (GRIM) to assess the potential impacts of amended energy conservation standards on manufactur ers. DOE used financial inputs derived from a combination of sources including man ufacturer interviews conducted in Phase I as well as public sources of information. I n Phase III, “Subgroup Impact Analysis,” DOE developed additional analyses for su bgroups that required special consideration and incorporated qualitative data fro m interviews into its analysis.

12.2.1 Phase I: Industry Profile

In Phase I of the MIA, DOE prepared a profile of th e PTAC and PTHP industry. DOE developed its industry profile using a combinat ion of sources, including: public information, such as Securities and Exchange Commis sion (SEC) 10-K reports, 1 Standard12-2

& Poor’s (S&P) stock reports, 2 market research tools ( e.g. , Hoovers 3 ), corporate annual reports, and the U.S. Census Bureau’s 2011 Annual S urvey of Manufacturers (ASM) 4 ; information obtained through DOE’s engineering anal ysis, life-cycle cost analysis, and market and technology assessment prepared for this rulemaking; financial analysis performed as part of the 2008 energy conservation s tandards final rule for PTACs and PTHPs; and information obtained directly from manuf acturers through interviews.

The industry profile includes: (1) further detail o n the overall market and equipment characteristics; (2) estimated manufactur er market shares; (3) financial parameters such as net plant, property, and equipme nt; selling, general and administrative (SG&A) expenses; cost of goods sold; and (4) trends in the number of firms, market, and equipment characteristics.

12.2.1.1 Manufacturer Interviews

During Phase I of the MIA, DOE interviewed manufact urers to gather information on the effects of amended energy conservation stand ards on revenues and finances, direct employment, capital assets, and industry competitiv eness. Before the interviews, DOE distributed an interview guide to interviewees. The interview guide provided a starting point for identifying relevant issues and impacts o f amended energy conservation standards on individual manufacturers or subgroups of manufacturers. Most of the information received from these meetings is protect ed by non-disclosure agreements and resides with DOE’s contractors. The MIA interview t opics included: (1) key issues to this rulemaking; (2) engineering analysis; (3) company o verview and organizational characteristics; (4) manufacturer markups and profi tability; (5) shipping costs; (6) industry projections; (7) financial parameters; (8) conversion costs; (9) cumulative regulatory burden; (10) direct employment impact as sessment; (11) capacity, exports, foreign competition, and outsourcing; (12) consolid ation; and (13) impacts on small businesses.

The interview process provides an opportunity for m anufacturers to express their views on important issues privately, allowing confi dential or sensitive information to be considered in the rulemaking process. DOE sought to obtain feedback from industry on the approaches used in the GRIM and to isolate key issues and concerns. DOE used these interviews to tailor the GRIM to reflect financial characteristics unique to the PTAC and PTHP industry. Interviews were scheduled well in ad vance to provide every opportunity for key individuals to be available for comment. Al though a written response to the questionnaire was acceptable, DOE sought interactiv e interviews, which help clarify responses and identify additional issues. The resul ting information provides valuable inputs to the GRIM.

12.2.2 Phase II: Industry Cash-Flow Analysis

Phase II focused on the financial impacts of potent ial amended energy conservation standards on manufacturers of PTAC and PTHP equipment. In general, energy conservation standards can affect manufactur er cash flow in three distinct ways: (1) create a need for increased investment; (2) rai se production costs per unit; and (3)12-3

alter revenue due to higher per-unit prices and/or possible changes in sales volumes. To quantify these impacts, DOE used the GRIM to perfor m a cash-flow analysis for the PTAC and PTHP industry. In performing these analyse s, DOE used the financial values derived during Phase I and the shipment scenarios u sed in the national impact analysis (NIA).

The GRIM uses several factors to determine a series of annual cash flows from the announcement year of amended energy conservatio n standards until 30 years after the standards’ compliance date. These factors include a nnual expected revenues, costs of goods sold, SG&A, taxes, and capital expenditures r elated to the amended standards. Inputs to the GRIM include manufacturer production costs, markup assumptions, and shipments forecasts developed in other analyses. DO E derived the manufacturing costs from the engineering analysis and information provi ded by the industry. It estimated typical manufacturer markups from public financial reports and interviews with manufacturers. DOE developed alternative markup sce narios based on discussions with manufacturers. DOE’s shipments analysis, presented in Chapter 9 of the technical support document (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 d uring 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 s tandards case at each TSL.

The results of the industry cash-flow analysis are presented in section 12.5.

12.2.3 Phase III: Manufacturer Subgroup Analysis

For its GRIM analysis, DOE presented impacts on the PTAC and PTHP industry as a whole. However, using average cost assumptions to develop an industry cash-flow estimate may not adequately assess differential imp acts of amended energy conservation standards among manufacturer subgroups. For example , small manufacturers, niche players, or manufacturers exhibiting a cost structu re that largely differs from the industry average could be more negatively affected. To addre ss this possible impact, DOE used the results of the industry characterization analys is 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 m anufacturers and other interested parties to suggest what subgroups or characteristic s are the most appropriate to analyze. As described in section 12.5, DOE analyzes the indu stry impacts on PTAC and PTHP equipment manufacturers as a whole because most of the equipment classes represent the same market served by the same manufacturers. Howev er, as discussed below, DOE identified two manufacturer subgroups that could be disproportionately impacted by amended energy conservation standards and therefore warranted a separate impact analysis: (1) manufacturers with production assets; and (2) small businesses.12-4 12.2.3.1 Manufacturers with Production Assets Subgroup

DOE initially identified 22 companies that sell PTA C and PTHP equipment in the U.S. Among U.S. companies, however, few own product ion assets; rather, they import and distribute PTACs and PTHPs manufactured oversea s, primarily in China. DOE identified a subgroup of three U.S. manufacturers t hat own production assets. These companies own tooling and manufacturing asset in th e US or in foreign countries. Together, these three manufacturers account for app roximately 80 percent of the domestic PTAC and PTHP market. Because manufacturer s with production assets will incur different costs to comply with amended energy conservation standards compared to their competitors who do not own production assets, DOE conducted a separate subgroup analysis to evaluate the potential impacts of amend ed energy conservation standards on manufacturers with production assets. DOE reports t he potential impact of this rulemaking on the subgroup of manufacturers with pr oduction assets in section 12.6.1.

12.2.3.2 Small Business Manufacturer Subgroup

DOE investigated whether small business manufacture rs should be analyzed as a manufacturer subgroup. DOE used the Small Business Administration (SBA) small business size standards effective on January 1, 201 2, as amended, and the North American Industry Classification System (NAICS) cod e, presented in Table 12.2.1, to determine whether any small entities would be affec ted by the rulemaking. 5 For the equipment classes under review, the SBA bases its s mall business definition on the total number of employees for a business, its subsidiarie s, and its parent companies. An aggregated business entity with fewer employees tha n the listed limit is considered a small business.

Table 12.2.1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking Industry Description Revenue Limit Employee Limit N AICS Air-Conditioning and Warm Air Heating Equipment and Commercial and Industrial Refrigeration Equipment Manufacturing N/A 750 333415

DOE used publicly available and proprietary informa tion to identify potential small businesses. DOE’s research involved industry trade association membership directories, product databases ( e.g. , AHRI Directory), individual company websites, and market research tools ( e.g. , Hoovers.com) to create a list of companies that m anufacture or sell equipment covered by this rulemaking. DOE a lso asked stakeholders and industry representatives if they were aware of any other sma ll manufacturers during manufacturer interviews. 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.12-5 Based on this analysis DOE identified 12 small busi nesses that sell PTAC and PTHP equipment affected by this rulemaking. DOE rep orts the potential impact of this rulemaking on small businesses in section 12.6.2.

12.2.4 Manufacturing Capacity Impact

One significant outcome of amended energy conservat ion standards could be the obsolescence of existing manufacturing assets, incl uding tooling and investment. The manufacturer interview guides have a series of ques tions to help identify impacts of amended standards on manufacturing capacity, specif ically capacity utilization and plant location decisions in the United States, with and w ithout amended standards; the ability of manufacturers to upgrade or remodel existing fac ilities 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 onetime capital changes and stranded assets affect the cash flow estimates in the GRIM. These estimates can be found in section 12.4.6. DOE ’s discussion of the capacity impact can be found in section 12.7.2.

12.2.5 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 intervie ws explored current employment trends in the PTAC and PTHP industry. The interview s also solicited manufacturer views on changes in employment patterns that may result f rom more stringent standards. The employment impacts section of the interview guide f ocused on current employment levels associated with manufacturers at each produc tion facility, expected future employment levels with and without amended energy c onservation standards, and differences in workforce skills and issues related to the retraining of employees. The employment impacts are reported in section 12.7.1.

12.2.6 Cumulative Regulatory Burden

DOE seeks to mitigate the overlapping effects on ma nufacturers due to amended energy conservation standards and other regulatory actions affecting the same products. DOE analyzed the impact on manufacturers of multipl e, product-specific regulatory actions. Based on research and discussions with man ufacturers, DOE identified regulations that impact other products made by manu facturers of PTACs and PTHPs. 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 rulemaki ng?” This question prompts manufacturers to identify the issues they feel DOE should explore and discuss further during the interview. The following sections descri be the most significant issues12-6

identified by manufacturers. These summaries are pr ovided in aggregate to protect manufacturer confidentiality.

12.3.1 Size Constraints

Manufacturers expressed concern regarding their abi lity to maintain the physical dimensions of PTACs and PTHPs while meeting amended energy conservation standards. PTACs and PTHPs are inherently space-con strained products. Their value proposition rests in large part on the ability of u nits to fit into existing wall openings of fixed dimensions: in the case of standard-size prod ucts impacted by this rulemaking, this means a wall opening of 16” x 42.” Manufacturers in dicated that increasing the efficiency of units given these size constraints poses a signi ficant technical challenge. Specifically, as units become more efficient, they tend to grow i n size. Efficiency gains are often achieved by incorporating more efficient system com ponents, including compressors and heat exchangers. Manufacturers noted that as these components become more efficient, they tend to become larger. Yet expanding the size of PTACs and PTHPs to accommodate larger, more efficient components is no t an option, as manufacturers must continue to deliver products built to pre-existing dimensions.

Manufacturers also indicated that increasing effici ency without altering equipment dimensions poses a greater technical chal lenge for higher-capacity models than for lower-capacity models. For example, redesi gning a 15,000 Btu/hour PTAC – the highest capacity offered by many manufacturers – wo uld be more difficult than redesigning a 7,000 Btu/hour model. Some manufactur ers stated this could lead them to stop offering their highest-capacity PTAC and PTHP models under an amended standard.

12.3.2 Impact on Manufacturer Profitability

Manufacturers also stated that amended energy conse rvation standards could place downward pressure on profits. Manufacturers n oted that customers typically are unwilling to pay a premium for efficiency and inste ad purchase PTACs and PTHPs largely on a first-cost basis. Accordingly, manufac turers do not anticipate being able to pass all additional costs of manufacturing more eff icient products onto customers and would expect to see some decline in profitability a s a result.

Additionally, manufacturers indicated that higher p roduction and purchase costs could impact profitability by reducing demand for P TACs and PTHPs. Specifically, manufacturers anticipate that higher purchase costs could lead greater numbers of customers to repair rather than replace existing un its. In addition, manufacturers stated higher costs could lead to equipment switching, as customers turn to alternative HVAC systems. Presently, the market for PTACs and PTHPs is predominantly a replacement market: approximately 80 percent of sales go toward replacement compared to 20 percent for new construction. Manufacturers indicated that higher costs could drive the new construction market to seek alternatives. The poten tial for market contraction in this manner could further impact profitability.12-7

12.3.3 Impacts on Customer Utility

Manufacturers stated that amended energy conservati on standards could make it difficult to meet customer needs effectively. Three primary concerns arose in this regard: concerns surrounding noise; concerns surrounding hu midity control; and concerns surrounding loss of specific equipment lines.

Noise Several manufacturers stated that there is a tradeo ff between higher efficiency in PTACs and PTHPs and noise levels. Design changes th at improve the efficiency of airflow systems ( e.g ., by increasing fan speed) tend to make units nois ier. This is especially true among higher capacity models. Becau se PTACs and PTHPs are widely used in the lodging sector, where noise is a signif icant consideration, manufacturers noted that design changes that result in noisier products are not a desirable option to increase system efficiency.

Humidity Control Several manufacturers also indicated that as units become more efficient, they tend to raise concerns surrounding humidity control and mold growth. One manufacturer indicated it has received more customer complaints about humidity levels since 2012, when the 2008 energy conservation standard for PTAC s and PTHPs took effect. Another manufacturer noted it has designed a PTAC model wit h a built-in dehumidification function to better control humidity and prevent mol d growth, but this reduces the overall system EER, making it more difficult to comply with amended standards.

Loss of Equipment Lines In addition, multiple manufacturers stated that cer tain models may become unavailable in the face of amended energy conservat ion standards. Within the standardsize market, the difficulty of redesigning higher c apacity models ( e.g. , 15,000 Btu/hour) while maintaining the existing package size could d rive manufacturers to discontinue those models, leaving lower-capacity models ( e.g. , 12,000 Btu/hour) as the maximum capacity offered.

12.4 GRIM INPUTS AND ASSUMPTIONS

The Government Regulatory Impact Model (GRIM) serve s as the main tool for assessing the impacts on industry due to amended en ergy 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 standa rds.

12.4.1 Overview of the Government Regulatory Impact Model (GRIM)

The basic structure of the GRIM, illustrated in Fi gure 12.4.1, is an annual cash flow analysis that uses manufacturer production cos ts, manufacturer selling prices, shipments, and industry financial information as in puts, and accepts a set of regulatory conditions such as changes in costs, investments, a nd associated margins. The GRIM12-8

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 conti nuing to 2048. The model calculates the INPV by summing the stream of annual discounted cas h flows during this period and adding a discounted terminal value. 6

Figure 12.4.1 Using the GRIM to Calculate Cash Flow

The GRIM projects cash flows using standard account ing principles and compares changes in INPV between the base case and the stand ard-case scenario induced by amended energy conservation standards. The differen ce in INPV between the base case and the standard case(s) represents the estimated f inancial impact of the amended energy conservation standard on manufacturers. Appendix 12 A provides more technical details and user information for the GRIM.

DOE presents MIA results relative to a base case th at uses efficiency levels specified by ASHRAE Standard 90.1-2013 as the basel ine efficiencies for PTACs and PTHPs. Consequently, when comparing the INPV impact s of the GRIM model, the baseline efficiency is greater than the current fed eral minimum efficiency requirements.

For this TSD, DOE also repeats the INPV and cash fl ow calculations relative to an alternative base case, where the baseline effici ency levels are equal to the current federal minimums, which were set in 2008. (73 FR 58 772). This alternative scenario is referred to as the “EPCA Baseline”.

12.4.2 Sources for GRIM Inputs

The GRIM uses several different sources for data in puts in determining industry cash flow. These sources include corporate annual r eports, company profiles, census data,12-9

credit ratings, the shipments model, the engineerin g analysis, and manufacturer interviews.

12.4.2.1 2008 Final Rule for PTACs and PTHPs

The 2008 Final Rule for PTACs and PTHPs (73 FR 5877 2) provided many of the initial financial inputs to the GRIM. As part of th e 2008 Final Rule, DOE derived a series of financial parameters for the industry based on a review of corporate annual reports, company profiles, credit ratings, and manufacturer interviews. DOE used these parameters as a starting point for analysis under t he current rulemaking. Drawing on feedback obtained during manufacturer interviews co nducted in Phase I of this rulemaking, DOE then revised its estimated financia l parameters to better reflect the current PTAC and PTHP industry. Table 12.4.1 presen ts the revised financial parameters used as inputs to the GRIM. The values indicated ha ve been weighted to reflect manufacturers’ respective market shares.

Table 12.4.1 GRIM Financial Parameters for PTACs an d PTHPs
Parameter Revised Estimate Tax Rate (% of Taxable Income) 34% Discount Rate 8.5% Working Capital (% of Revenue) 7% Net Property, Plant, and Equipment (% of Revenues) 15% SG&A (% of Revenue) 15% R&D (% of Revenues) 3% Depreciation (% of Revenues) 5% Capital Expenditures (% of Revenues) 5%

12.4.2.2 Shipment Model

The GRIM used shipment projections derived from DOE ’s shipments model in the national impact analysis (NIA). Chapter 9 of th e TSD describes the methodology and analytical model DOE used to forecast shipments.

12.4.2.3 Engineering Analysis

During the engineering analysis, DOE used a manufac turing cost model to develop manufacturing production cost (MPC) estimat es. The analysis provided the labor, materials, overhead, and total production co sts for different design options for PTACs and PTHPs. The engineering analysis also esti mated a manufacturer markup and a shipping cost to provide the manufacturer selling price (MSP) for design options.

12.4.2.4 Manufacturer Interviews

During the course of the MIA, DOE conducted intervi ews with a representative cross-section of manufacturers. During these discus sions, DOE obtained information to determine and verify GRIM input assumptions. Key to pics discussed during the interviews and reflected in the GRIM include:12-10 • Capital conversion costs (one-time investments i n PPE); • Product conversion costs (one-time investments i n research, product development, testing, and marketing); • Equipment cost structure; • Industry financial parameters; • Possible profitability impacts.

12.4.3 Trial Standard Levels (TSLs)

DOE developed a number of efficiency levels (ELs) f or each equipment class. Trial Standard Levels (TSLs) were then developed by selecting likely groupings of efficiency levels for all equipment classes. Each T SL includes combinations of efficiency levels for PTACs and PTHPs of different cooling cap acity.

In this rulemaking, each TSL represents a percentag e increase in efficiency relative to the current federal minimum efficiency standard, or baseline. For both PTACs and PTHPs, TSLs 1, 2, 3, 4, and 5 represent respect ive increases of 4 percent, 8 percent, 12 percent, 16 percent, and 18 percent above the cu rrent federal minimum efficiency standard for PTACs of a specified cooling capacity. Whereas the current federal standard specifies different minimum efficiencies for PTACs and PTHPs of equivalent cooling capacity, DOE has structured TSLs in the present ru lemaking to align efficiency standards for PTACs and PTHPs of the same cooling c apacity. Table 12.4.2 presents the TSLs used for energy efficiency analysis in the GRI M.

Table 12.4.2 Trial Standard Levels for Analysis of PTACs and PTHPs

Equipment Type Cooling Capacity

(Btu/h) Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 5

PTAC <7,000 Btu/h EL 1 EL 2 EL 3 EL 4 EL 5 EL 6

≥7,000 Btu/h and ≤15,000 Btu/h EL 1 EL 2 EL 3 EL 4 EL 5 EL 6

>15,000 Btu/h EL 1 EL 2 EL 3 EL 4 EL 5 EL 6

PTHP <7,000 Btu/h Current Federal Minimum EL 1 EL 2 EL 3 EL 4 EL 5

≥7,000 Btu/h and ≤15,000 Btu/h Current

Federal Minimum EL 1 EL 2 EL 3 EL 4 EL 5

>15,000 Btu/h Current

Federal Minimum EL 1 EL 2 EL 3 EL 4 EL 5

The PTAC baseline efficiency level varies from the current federal minimum in order to align with efficiency standards establishe d by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHR AE). In October 2013, ASHRAE published ANSI/ASHRAE/IES Standard 90.1-2013, which amended efficiency standards for PTACs, increasing them to 1.8 percent above the current federal minimum. This12-11

rulemaking is considered an ASHRAE trigger. As such , the baseline for the PTACs analysis is the minimum efficiency level establishe d under the ASHRAE amendment. The baseline analyzed for PTHPs remains the current federal minimum, as PTHP standards were not modified under the ASHRAE amendm ent. Beyond baseline, as described above, each TSL represents a percentage i ncrease in efficiency for both PTACs and PTHPs relative to the current federal minimum.

12.4.4 NIA Shipments

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

As part of the shipments forecasts, DOE estimated t he base-case shipment distribution by efficiency level for each of the si x PTAC and PTHP equipment classes. In the standards case, the shipments analysis assumes a roll-up scenario, where all shipments in the base case that do not meet the sta ndard would instead ship at the new standard level. The key assumptions and methodology used to forecast shipments can be found in Chapter 9 of the TSD.

12.4.5 Production Costs

Changes in production costs affect revenues and gro ss 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 deriv ed in the engineering analysis.

The engineering analysis developed MPCs for represe ntative PTAC units at each of the three capacity categories used to define equ ipment classes: <7,000 Btu/h; ≥7,000 Btu/h and ≤ 15,000 Btu/h; and >15,000 Btu/h. The NI A shipments estimated the number of PTAC and PTHP units shipped at each equipment cl ass. The GRIM, in turn, used the MPCs from the engineering analysis and the NIA ship ments to calculate shipmentweighted average MPCs for each equipment class. Add itionally, the GRIM relied on the engineering analysis to determine labor, materials, overhead, and depreciation percentages that constitute the full MPC.

To calculate baseline MSP, DOE followed a two-step process. First, DOE derived MPCs from the engineering and tear down analyses. S econd, DOE applied a manufacturer markup, which varies with the markup s cenario (discussed in detail in section 12.4.7).

Table 12.4.3 through Table 12.4.5 show the producti on cost estimates used in the GRIM for each analyzed equipment class. A flat mark up of 1.27 was applied to all equipment classes.12-12

Table 12.4.3 Manufacturer Production Cost Breakdown (2013$) for PTACs, < 7,000 Btu/h Capacity

Materials Labor Depreciation Overhead MPC Markup MSP Baseline $277.23 $22.27 $19.33 $24.01 $342.85 1.27 $435.42 EL 1 $278.62 $23.01 $20.35 $24.36 $346.34 1.27 $439 .85 EL 2 $281.12 $23.68 $21.29 $24.69 $350.78 1.27 $445 .49 EL 3 $286.34 $24.84 $22.92 $25.32 $359.42 1.27 $456 .46 EL 4 $293.30 $25.75 $24.22 $25.89 $369.15 1.27 $468 .83 EL 5 $301.18 $26.40 $25.20 $26.41 $379.19 1.27 $481 .57 EL 6 $305.62 $26.64 $25.56 $26.66 $384.47 1.27 $488 .28

Table 12.4.4 Manufacturer Production Cost Breakdown (2013$) for PTACs, ≥ 7,000 Btu/h and ≤ 15,000 Btu/h Capacity

Materials Labor Depreciation Overhead MPC Markup MSP Baseline $294.00 $22.27 $19.33 $24.01 $359.62 1.27 $456.72 EL 1 $295.78 $23.01 $20.35 $24.36 $363.50 1.27 $461 .64 EL 2 $297.89 $23.68 $21.29 $24.69 $367.55 1.27 $466 .79 EL 3 $303.11 $24.84 $22.92 $25.32 $376.19 1.27 $477 .76 EL 4 $309.67 $25.75 $24.22 $25.89 $385.52 1.27 $489 .62 EL 5 $317.55 $26.40 $25.20 $26.41 $395.56 1.27 $502 .36 EL 6 $321.99 $26.64 $25.56 $26.66 $400.84 1.27 $509 .07

Table 12.4.5 Manufacturer Production Cost Breakdown (2013$) for PTACs, > 15,000 Btu/h Capacity

Materials Labor Depreciation Overhead MPC Markup MSP Baseline $326.51 $19.50 $20.39 $25.38 $391.78 1.27 $497.57 EL 1 $327.33 $20.98 $20.92 $26.28 $395.51 1.27 $502 .30 EL 2 $329.13 $22.38 $21.49 $27.08 $400.08 1.27 $508 .10 EL 3 $335.66 $24.93 $22.82 $28.34 $411.75 1.27 $522 .92 EL 4 $346.10 $27.13 $24.39 $29.17 $426.79 1.27 $542 .02 EL 5 $360.45 $28.99 $26.18 $29.57 $445.20 1.27 $565 .41 EL 6 $369.10 $29.80 $27.17 $29.61 $455.68 1.27 $578 .71

12.4.6 Conversion Costs

Amended energy conservation standards typically cau se manufacturers to incur one-time conversion costs to bring their production facilities and equipment designs into compliance with new regulations. For the MIA, DOE c lassified these one-time conversion costs into two major groups: capital con version costs and product conversion costs. Capital conversion costs are one-time invest ments in plant, property, and equipment to adapt or change existing production fa cilities in order to fabricate and12-13

assemble new equipment designs that comply with ame nded energy conservation standards. Product conversion costs are one-time in vestments in research, development, testing, marketing and other costs to make equipmen t designs comply with amended energy conservation standards. DOE based its estima tes of the conversion costs for each efficiency level on information obtained from manuf acturer interviews and the design pathways analyzed in the engineering analysis.

12.4.6.1 Capital Conversion Costs

To estimate the level of capital conversion costs m anufacturers would likely incur to comply with amended energy conservation standard s, DOE relied on information obtained through manufacturer interviews as well as the engineering analysis. Table 12.4.6 presents estimated capital conversion costs at each TSL. The estimates are cumulative and reflect capital conversion costs ant icipated across equipment classes and manufacturers in order to achieve compliance with e ach TSL analyzed.

Table 12.4.6 Industry Cumulative Capital Conversion Costs (2013$ Millions)

TSL Capital Conversion Costs

(2013$ Millions) TSL 1 $2.3 TSL 2 $2.9 TSL 3 $7.1 TSL 4 $7.1 TSL 5 $7.4

At TSL 1, manufacturers indicated that converting PTAC equipment lines to comply with amended standards would require minimal capital conversion costs whereas converting PTHPs would require more substantial inv estment. In particular, converting PTHP lines to meet TSL 1 would require some manufac turers to implement new coil fabrication systems. This accounts for the majority of expected capital conversion costs at TSL 1, which DOE estimates at $2.3 million for all equipment classes.

At TSL 2, manufacturers stated they would need to implement motor and control changes across PTAC and PTHP equipment classes. The additional investment would increase capital conversion costs for the industry to an estimated $2.9 million.

At TSL 3, DOE expects manufacturers to require new tooling and to redesign products to incorporate additional coils and/or for med coils. DOE estimates capital conversion costs at this level to increase to $7.1 million.

At TSL 4, DOE does not expect capital conversion c osts beyond those required at TSL 3. Accordingly, capital conversion costs remain level at $7.1 million.

At TSL 5, the engineering analysis suggests manufa cturers would have to increase the fin density of the heat exchanger, requiring in vestment in new jigs to position the fins. Industry capital conversion costs increase to $7.4 million.12-14 12.4.6.2 Product Conversion Costs

As with capital conversion costs, DOE relied on man ufacturer interviews as well as the engineering analysis to evaluate product con version costs. For manufacturers with production assets, DOE estimated costs related to R &D (including design engineering, technician salaries, and laboratory costs) as well as costs of testing, certification, etc. DOE assumed R&D costs ranging from $50,000 to $200, 000 per model based on the complexity of the redesign anticipated at each TSL. For all manufacturers ( i.e., manufacturers with production assets as well as man ufacturers that import and distribute PTACs and PTHPs manufactured overseas) DOE assumed a flat fee per model required for testing and certification. DOE multiplied this fee by the number of models identified for each manufacturer in order to estimate total pr oduct conversion costs facing the industry.

Table 12.4.7 presents industry-wide product convers ion costs at each TSL. The estimates are cumulative and reflect product conver sion costs anticipated across equipment classes and manufacturers in order to ach ieve compliance with each TSL analyzed.

Table 12.4.7 Industry Cumulative Product Conversion Costs (2013$ Millions)

TSL Product Conversion Costs

(2013$ Millions) TSL 1 $2.2 TSL 2 $4.7 TSL 3 $7.2 TSL 4 $8.5 TSL 5 $13.5

The increase in product conversion costs across TSL s, from a low of $2.2 million at TSL 1 to a high of $13.5 million at TSL 5, refle cts a rise in R&D effort required to meet increasingly stringent efficiency standards. A s noted, R&D costs will fall disproportionately on manufacturers with production assets. See section 12.6.1 for further analysis of financial impacts facing the subgroup o f manufacturers with production
assets.

12.4.7 Markup Scenarios

DOE modeled multiple standards-case markup scenario s to represent uncertainty surrounding the potential impacts of energy conserv ation 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 ma rkup scenarios to capture a range of potential impacts on manufacturers following implem entation of amended energy conservation standards: (1) a preservation of gross margin percentage scenario; and (2) a preservation of operating profit scenario. These sc enarios lead to different markup values, which, when applied to the inputted MPCs, result in varying revenue and cash flow impacts.12-15 12.4.7.1 Preservation of Gross Margin Percentage Scenario

Under the preservation of gross margin percentage s cenario, DOE applied a single uniform “gross margin percentage” markup across all efficiency levels, which assumes that manufacturers would be able to maintain the sa me amount of profit as a percentage of revenues at all efficiency levels within an equi pment class. As production costs increase with efficiency, this scenario implies tha t the absolute dollar markup will increase as well. Based on publicly available finan cial information for manufacturers of PTACs and PTHPs as well as comments from manufactur er interviews, DOE assumed the average markup—which includes SG&A expenses, R& D expenses, interest, and profit—to be 1.27 for all PTAC and PTHP equipment c lasses. Because this markup scenario assumes that manufacturers would be able t o maintain their gross margin percentage markups as production costs increase in response to an amended energy conservation standard, it represents a high bound t o industry profitability.

12.4.7.2 Preservation of Operating Profit Scenario

In the preservation of per unit operating profit sc enario, manufacturer markups are set so that operating profit one year after the com pliance date of the amended energy conservation standard is the same as in the base ca se on a per unit basis. Under this scenario, as the costs of production increase under a standards case, manufacturers are generally required to reduce their markups to a lev el that maintains base-case operating profit per unit. The implicit assumption behind thi s markup scenario is that the industry can only maintain its operating profit in absolute dollars per unit after compliance with the new standard is required. Therefore, operating margin in percentage terms is reduced between the base case and standards case. DOE adjus ted the manufacturer markups in the GRIM at each TSL to yield approximately the same ea rnings before interest and taxes in the standards case as in the base case. This markup scenario represents a low bound to industry profitability under an amended energy cons ervation standard.

12.5 INDUSTRY FINANCIAL IMPACTS

Using the inputs and scenarios described in the pre vious sections, the GRIM estimated indicators of financial impacts on the PT AC and PTHP industry. The following sections detail additional inputs and assumptions f or the analysis of industry financial impacts. The main results of the MIA are also repor ted in this section. The MIA consists of two key financial metrics: industry net present value (INPV) 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 NPV, which applies to the U.S. economy. The I NPV is the sum of annual net cash flows over the 30-year analysis period discounted a t the industry’s cost of capital or discount rate. The GRIM for this rulemaking estimat es cash flows from 2014 to 2048, the same analysis period used in the NIA (Chapter 10 of the TSD). This timeframe models both the short-term impacts on the industry from th e announcement of the standard until12-16

the compliance date (2014 to 2019) and a long-term assessment over the 30-year analysis period used in the NIA (2019 to 2048).

In the MIA, DOE compares the INPV of the base case (no amended energy conservation standards) to that of each TSL in the standards case. The difference between the base case and a standards case INPV is an estim ate of the economic impacts that implementing that particular TSL would have on the industry. In the NOPR, DOE presents MIA results relative to a base case that u ses efficiency levels specified by ASHRAE Standard 90.1-2013 as the baseline efficienc ies for PTACs and PTHPs. Consequently, when comparing the INPV impacts of th e GRIM model, the baseline efficiency is greater than the current federal mini mum efficiency requirements.

In analyzing the financial impacts in this TSD, DOE also presents the INPV and cash flow calculations relative to an alternative b ase case, where the baseline efficiency levels are equal to the current federal minimums, w hich were set in 2008. (73 FR 58772). This alternative scenario is referred to as the “EP CA Baseline”.

While INPV is useful for evaluating the long-term e ffects of amended energy conservation standards, short-term changes in cash flow are also important indicators of the industry’s financial situation. For example, a large investment over one or two years could strain the industry’s access to capital. Cons equently, the sharp drop in financial performance could cause investors to flee, even tho ugh recovery may be possible. Thus, a short-term disturbance can have long-term effects t hat the INPV cannot capture. To get an idea of the behavior of annual net cash flows, F igure 12.5.1 and Figure 12.5.2 below present the annual net cash flows over the analysis period.

Annual cash flows are discounted to the base year, 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 resourc es to prepare for the amended energy conservation standard. Cash flows between the annou ncement date and the compliance date are driven by the level of conversion costs an d the proportion of these investments spent every year. The more stringent the amended en ergy conservation standard, the greater the impact on industry cash flows in the ye ars leading up to the compliance date, as product conversion costs lower cash inflows from operations and capital conversion costs increase cash outflows for capital expenditur es.
Free cash flow in the year the amended energy conse rvation 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 would have enjoyed longer use if the energy conservation standard had not made them obsolete. In this year, manufacturers write down the remaining book value of existing tooling and equipment whose value is af fected by the amended energy conservation standard. This one time write down act s 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 ca sh flow from operations. A large increase in working capital is needed due to more c ostly production components and materials, higher inventory carrying to sell more e xpensive products, and higher accounts12-17

receivable for more expensive products. Depending o n these two competing factors, cash flow can either be positively or negatively affecte d in the year the standard takes effect.

12.5.2 PTAC and PTHP Industry Financial Impacts

Table 12.5.1 and Table 12.5.2 provide INPV estimate s for PTACs and PTHPs under the two markup scenarios analyzed. Figure 12. 5.1 and Figure 12.5.2 present annual industry net cash flows under the two markup scenar ios. As described in section 12.4.7, the preservation of gross margin percentage scenari o presents an upper bound to industry profitability under amended energy conservation sta ndards while the preservation of operating profit scenario presents a lower bound to industry profitability. These results are based on an ASHRAE baseline and are consistent with results presented in the NOPR.

Table 12.5.1 ASHRAE Baseline: Preservation of Gross Margin Percentage Scenario Changes in INPV for PTACs and PTHPs

Units Base Case Trial Standard Level
1 2 3 4 5
INPV 2013$M 58.47 57.37 58.76 57.53 58.46 55.90 Change in INPV* 2013$M - (1.11) 0.29 (0.94) (0.01) (2.57)

% Change - (1.89) 0.49 (1.61) (0.02) (4.40) * Parentheses indicate negative values.

Table 12.5.2 ASHRAE Baseline: Preservation of Opera ting Profit Scenario Changes in INPV for PTACs and PTHPs

Units Base Case Trial Standard Level
1 2 3 4 5
INPV 2013$M 58.47 57.08 57.73 55.35 55.02 51.81 Change in INPV* 2013$M - (1.39) (0.74) (3.12) (3.45) (6.67)

% Change - (2.38) (1.26) (5.34) (5.90) (11.40) * Parentheses indicate negative values.

At TSL 1, DOE estimates impacts on INPV to range fr om -$1.4 million to -$1.1 million, or a change of -2.4 percent to -1.9 percen t. At TSL 2, DOE estimates impacts on INPV to range from -$0.7 million to $0.3 million, o r a change in INPV of -1.3 percent to 0.5 percent. At TSL 3, DOE estimates impacts on INP V to range from -$3.1 million to - $0.9 million, or a change in INPV of -5.3 percent t o -1.6 percent. At TSL 4, DOE estimates impacts on INPV to range from -$3.5 milli on to $0.0 million, or a change in INPV of -5.9 percent to 0.0 percent. At TSL 5, DOE estimates impacts on INPV to range from -$6.7 million to -$2.6 million, or a change in INPV of -11.4 percent to -4.4 percent. See section 12.8 for a more detailed discussion of results.12-18

Figure 12.5.1 ASHRAE Baseline: Annual Industry Net Cash Flows under Preservation of Gross Margin Percentage Markup Scen ario (in 2013$M)12-19

Figure 12.5.2 ASHRAE Baseline: Annual Industry Net Cash Flows under Preservation of Operating Profit Markup Scenario (i n 2013$M)

The following tables present alternative results ba sed on the EPCA Baseline. Table 12.5.3 and Table 12.5.4 present the INPV esti mates for the two markup scenarios relative that EPCA Baseline. Figure 12.5.3 and Figu re 12.5.4 present the net annual cash flows for the two markup scenarios under the altern ative baseline.

Table 12.5.3 EPCA Baseline: Preservation of Gross M argin Percentage Scenario Changes in INPV for PTACs and PTHPs

Units Base Case Trial Standard Level
1 2 3 4 5
INPV 2013$M 58.46 57.23 58.75 57.52 58.45 55.89 Change in INPV* 2013$M - (1.23) 0.29 (0.94) (0.01) (2.57)

% Change - (2.10) 0.50 (1.61) (0.01) (4.40) * Parentheses indicate negative values.

Table 12.5.4 EPCA Baseline: Preservation of Operati ng Profit Scenario Changes in INPV for PTACs and PTHPs

Units Base Case Trial Standard Level12-20 1 2 3 4 5
INPV 2013$M 58.46 56.90 57.68 55.29 54.94 51.80 Change in INPV* 2013$M - (1.56) (0.78) (3.17) (3.52) (6.66)

% Change - (2.66) (1.34) (5.42) (6.02) (11.39) * Parentheses indicate negative values.

Figure 12.5.3 EPCA Baseline: Annual Industry Net Ca sh Flows under Preservation of Gross Margin Percentage Markup Scenario (in 2013 $M)12-21

Figure 12.5.4 EPCA Baseline: Annual Industry Net Ca sh Flows under Preservation of Operating Profit Markup Scenario (in 2013$M)

12.6 IMPACTS ON SUBGROUPS OF MANUFACTURERS

As discussed above, using average cost assumptions to develop an industry cash flow estimate is not adequate for assessing differe ntial impacts among subgroups of manufacturers. Small manufacturers, niche players, or manufacturers exhibiting a cost structure that differs largely from the industry av erage could be affected differently. DOE used the results of the industry characterization t o group manufacturers exhibiting similar characteristics. Specifically, DOE identified two s ubgroups of manufacturers for separate impact analyses: (1) manufacturers with production assets; and (2) small business manufacturers.

12.6.1 Impacts on Manufacturers with Production Assets

As discussed above, DOE initially identified 22 com panies that sell PTAC and PTHP equipment. Most U.S. companies, however, do no t own production assets; rather, they import and distribute PTACs and PTHPs manufact ured overseas, primarily in China. DOE identified a subgroup of three U.S. manufacture rs that own production assets. These12-22

companies own tooling and manufacturing assets in t he U.S. or in foreign countries. Together, these three manufacturers account for app roximately 80 percent of the domestic PTAC and PTHP market. Because manufacturer s with production assets will incur different costs to comply with an amended ene rgy conservation standard compared to their competitors who do not own production asse ts, DOE conducted a separate analysis to evaluate the impact of an amended energ y conservation standard on the subgroup of manufacturers with production assets.

As with the overall industry analysis, DOE modeled two different markup scenarios to evaluate the range of cash flow impact s on manufacturers with production assets: (1) the preservation of gross margin percen tage markup scenario; and (2) the preservation of operating profit markup scenario. S ee section 12.4.7 for a complete description of markup scenarios.

Each of the modeled scenarios results in a unique s et of cash flows and corresponding INPV values at each TSL. In the follo wing discussion, the INPV results refer to the difference in value of manufacturers w ith production assets between the base case and each TSL in the standards case. As with th e overall industry analysis, the INPV for manufacturers with production assets is calcula ted as the sum of annual net cash flows over the 30-year analysis period, discounted at the industry’s cost of capital.

To provide perspective on the short-run cash flow i mpact, DOE includes in the discussion of results a comparison of free cash flo w between the base case and the standards case at each TSL in the year before amend ed standards would take effect. This figure provides an understanding of the magnitude o f required conversion costs relative to the cash flow generated by manufacturers with pr oduction assets in the base case.

Table 12.6.1 below presents a range of results refl ecting both the preservation of gross margin percentage markup scenario and the pre servation of operating profit markup scenario. As discussed in section 12.4.7, the prese rvation of operating profit scenario accounts for the more severe impacts presented. Est imated conversion costs and free cash flow in the year prior to the effective date of ame nded standards do not vary with markup scenario.12-23

Table 12.6.1 Manufacturer Impact Analysis Results f or the Subgroup of PTAC and PTHP Manufacturers with Production Assets*

Units Base Case Trial Standard Level

1 2 3 4 5

INPV 2013$M 46.8 45.5 to 45.8 45.7 to

46.5 43.0 to

44.7 42.6 to

45.3 39.4 to

42.7

Change in INPV 2013$M - (1.3) to (1.0) (1.1) to

(0.3) (3.8) to

(2.1) (4.2) to

(1.5) (7.3) to

(4.1)

% Change - (2.7) to (2.2) (2.3) to

(0.5) (8.2) to

(4.5) (9.0) to

(3.1) (15.7) to

(8.7)

Product Conversion Costs 2013$M - 1.4 3.9 6.4 7.7 12.7

Capital Conversion Costs 2013$M - 2.3 2.9 7.1 7.1 7.4

Total Conversion Costs 2013$M - 3.7 6.8 13.5 14.7 20.1

Free Cash Flow 2013$M 3.1 1.6 0.6 (2.0) (2.4) (4.0)

% Change - (46.7) (79.7) (165.5) (177.5) (230.1) * Parentheses indicate negative values.

As the results above demonstrate, manufacturers wit h production assets will likely experience financial impacts more negative than tho se facing the industry as a whole (see section 12.5 for industry-wide financial impacts). These differential impacts derive primarily from the conversion costs manufacturers w ith production assets will incur in order to comply with an amended standard. In partic ular, manufacturers with production assets will face capital conversion costs not share d by their competitors who import and distribute PTACs and PTHPs and do not require tooli ng investments. In interviews, manufacturers with production assets indicated that higher standards could require significant investment in new tooling to support ne w coil designs. In addition, manufacturers with production assets would face pro duct conversion costs in the form of design engineering, product development, testing, c ertification, marketing, and related costs. See section 12.4.6 for further discussion of conversion costs.

At the standard proposed in today’s notice, DOE est imates that the PTAC and PTHP industry as a whole would face $7.6 million in conversion costs; of this, the subgroup of manufacturers with production assets wo uld incur $6.8 million in conversion costs, or 89 percent of the industry total. At this level, manufacturers with production assets would also face an estimated loss in INPV of up to 2.3 percent compared to 1.3 percent for the industry as a whole.

12.6.2 Impacts on Small Business Manufacturers

DOE conducted a more focused inquiry of the compani es that could be small business manufacturers of products covered by this rulemaking. For “Air-Conditioning and Warm Air Heating Equipment and Commercial and I ndustrial Refrigeration12-24

Equipment Manufacturing,” the Small Business Admini stration (SBA) has set a size threshold of 750 employees or less for an entity to be considered a small business for this category. During its market survey, DOE used all av ailable public information to identify potential small manufacturers. DOE’s research invol ved industry trade association membership directories ( e.g. , AHRI), product databases, individual company websit es, and market research tools ( e.g. , Hoovers.com) 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 w ere aware of any other small manufacturers during manufacturer interviews and at previous DOE public meetings. DOE reviewed publicly available data and contacted companies on its list, as necessary, to determine whether they met the SBA’s definition of a small business manufacturer of covered PTAC and PTHP products. DOE screened out co mpanies that did not offer products affected by this rulemaking, did not meet the definition of a “small business,” or are foreign owned and operated.

DOE initially identified 22 companies that sell PTA C and PTHP equipment that would be affected by today’s proposal. Of these 22 companies, DOE identified 12 as small businesses. DOE contacted the identified smal l businesses to invite them to take part in a manufacturer impact analysis interview. O f the 12 small businesses contacted, DOE was able to reach and discuss potential standar ds with two. DOE also obtained information about small businesses and potential im pacts on small businesses while interviewing large manufacturers.

Within the PTAC and PTHP industry, no small busines s identified is an original equipment manufacturer of products covered under th is rulemaking. Rather, small businesses tend to import, rebrand, and distribute PTACs and PTHPs manufactured overseas, primarily in China. Some small businesses identified are original equipment manufacturers of non-standard size PTACs and PTHPs; however, non-standard products are not impacted by this rulemaking and therefore a re not considered in this small business subgroup analysis.

Because small businesses import and distribute, rat her than directly manufacture, covered products, they are not expected to incur ca pital conversion costs in order to comply with an amended energy conservation standard nor are they expected to incur product conversion costs related to engineering and redesign of equipment. Instead, the primary conversion costs facing small businesses in the PTAC and PTHP industry center on testing and certification. Specifically, small b usinesses may incur costs to test and certify products that undergo redesign by original equipment manufacturers in order to comply with amended standards. Typically, testing a nd certification costs are proportional to the number of models offered by a c ompany and not to the volume of sales. Because the volume of sales of a small busin ess is often lower than that of a larger manufacturer, a small business’s testing and certif ication costs may be spread over fewer units and lower revenue per model relative to a lar ger manufacturer. This could result in a disproportionate cost burden on small manufacturers

.12-25 Table 12.6.2 below presents estimated conversion co sts as a percentage of annual financial metrics for an average small business com pared to an average large manufacturer.

Table 12.6.2 Magnitude of Conversion Costs Facing a n Average Small Manufacturer versus an Average Large Manufacturer

Capital Conversion Costs as a Percentage of Annual Capital Expenditures Product

Conversion Costs as a Percentage of Annual R&D Expense Total Conversion

Costs as a Percentage of Annual Revenue Total Conversion Costs as a Percentage of Annual EBIT

Average Small Manufacturer 0% 61% 2% 56%

Average Large Manufacturer 29% 70% 4% 109%

Because small businesses are not expected to incur capital conversion costs and are expected to face limited product conversion cos ts in order to comply with the proposed rule, DOE estimates that small businesses will experience lower conversion costs as a percentage of annual revenue and other f inancial metrics compared to large manufacturers. Nevertheless, DOE recognizes that am ended energy conservation standards could potentially impact small businesses disproportionately. As noted, larger businesses tend to have larger production and/or sa les volumes over which to spread costs and could have a competitive advantage due to their size and ability to access capital that may not be available to small business es. Small businesses could also face higher per-unit costs for products if conversion co sts incurred by overseas original equipment manufacturers are passed through to small business importers. If small businesses are not able to pass all additional cost s onto customers, they could face reduced markups and profits.

DOE provides additional analysis in section VI.B of the NOPR, Review Under the Regulatory Flexibility Act.

12.7 OTHER IMPACTS

12.7.1 Employment

12.7.1.1 Methodology To quantitatively assess the impacts of energy cons ervation standards on employment, DOE used the GRIM to estimate the domes tic labor expenditures and number of employees in the base case and at each TS L from 2014 through 2048. DOE used statistical data from the U.S. Census Bureau’s 2011 Annual Survey of Manufacturers (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 equipment are a function of th e labor intensity of the product, the sales volume, and an assumption that wages remain f ixed in real terms over time. The12-26

total labor expenditures in each year are calculate d 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 ho urs times the labor rate found in the U.S. Census Bureau’s 2011 ASM). The production worker estimates in this section cover workers up to the line-supervisor level who a re directly involved in fabricating and assembling equipment within the original equipment manufacturer facility. Workers performing services that are closely associated wit h production operations, such as materials handling tasks using forklifts, are also included as production labor. DOE’s estimates only account for production workers who m anufacture the specific products covered by this rulemaking.

To estimate an upper bound to employment change, DO E assumes all domestic manufacturers would choose to continue producing pr oducts in the U.S. and would not move production to foreign countries. To estimate a lower bound to employment, DOE estimates the maximum portion of the industry that would choose to leave the industry or relocate production overseas rather than make the n ecessary conversions at domestic production facilities.

12.7.1.2 Direct Employment Impacts DOE estimates that 50 percent of standard-size PTAC and PTHP units are manufactured domestically. In the absence of amende d energy conservation standards, DOE estimates that the PTAC and PTHP industry would employ 170 domestic production workers in 2019.

Table 12.7.1 shows the range of impacts of potenti al amended energy conservation standards on U.S. production workers o f PTACs and PTHPs. The potential changes to direct employment presented suggest that the PTAC and PTHP industry could experience anything from a slight gain in domestic direct employment to a loss of all domestic direct employment.

Table 12.7.1 Potential Changes in the Total Number of Production Workers in the PTAC and PTHP Industry in 2019
Trial Standard Level*

Base Case* 1 2 3 4 5
Potential Changes in Domestic Production Workers in 2019** - (170) (170) (170) (170) (170)

to to to to to
4 10 17 22 24 *Base Case assumes 170 domestic production workers in the PTAC and PTHP industry in 2019. ** Parentheses indicate negative values.

The upper end of the range estimates the maximum in crease in the number of domestic production workers in the PTAC and PTHP in dustry after implementation of an12-27

amended energy conservation standard. It assumes ma nufacturers would continue to produce the same scope of covered products within t he United States and would require some additional labor to produce more efficient pro ducts.

The lower end of the range represents the maximum d ecrease in total number of U.S. production workers that could result from an a mended energy conservation standard. During interviews, manufacturers stated their conce rns about increasing offshore competition entering the market. If the cost of com plying with amended standards significantly erodes the profitability of domestic manufacturers relative to their competitors who manufacture and/or import PTACs and PTHPs from overseas, manufacturers with domestic production could decide to exit the PTAC and PTHP market and/or shift their production facilities offshore. The lower bound of direct employment impacts therefore assumes domestic production of PT ACs and PTHPs ceases, as domestic manufacturers either exit the market or sh ift production overseas in search of reduced manufacturing costs.

The direct employment impacts discussed here do not include indirect employment impacts on the broader U.S. economy, whi ch are documented in Chapter 16 of the TSD.

12.7.2 Production Capacity

According to PTAC and PTHP manufacturers interviewe d, amended energy conservation standards would not significantly cons train manufacturing production capacity. Among manufacturers with production asset s, some indicated that higher energy conservation standards could reduce sales vo lumes, thereby resulting in excess capacity. Among importers and distributors, amended energy conservation standards would not likely impact production capacity. Accord ingly, DOE believes manufacturers would be able to maintain production capacity level s sufficient to meet market demand under the proposed standard (TSL 2).

12.7.3 Cumulative Regulatory Burden

While any one regulation may not impose a significa nt burden on manufacturers, the combined effects of several impending regulatio ns may have serious consequences for some manufacturers, groups of manufacturers, or an entire industry. Assessing the impact of a single regulation may overlook this cum ulative regulatory burden. Multiple regulations affecting the same manufacturer can str ain profits and can lead companies to abandon equipment lines or markets with lower expec ted future returns than competing products. For these reasons, DOE conducts an analys is of cumulative regulatory burden as part of its rulemakings pertaining to equipment efficiency.

Companies that produce a wide range of regulated pr oducts may be faced with more capital and product development expenditures t han competitors with a narrower scope of products. Regulatory burdens can prompt co mpanies to exit the market or reduce their equipment offerings, potentially reducing com petition. Smaller companies in12-28

particular can be affected by regulatory costs sinc e these companies have lower sales volumes over which they can amortize the costs of m eeting new regulations. A proposed standard is not economically justified if it contri butes to an unacceptable level of cumulative regulatory burden.

For the cumulative regulatory burden analysis, DOE looks at other regulations that could affect PTAC and PTHP manufacturers that will take e ffect approximately three years before or after the 2019 compliance date of amended energy conservation standards for PTACs and PTHPs. In interviews, manufacturers cited federal regulations on equipment other than PTACs and PTHPs that contribute to their cumulative regulatory burden. The compliance years and expected industry conversion c osts of relevant amended energy conservation standards are indicated in Table 12.7. 2 below.12-29

Table 12.7.2 Compliance Dates and Expected Conversi on Expenses of Federal Energy Conservation Standards Affecting PTAC and PT HP Manufacturers Federal Energy Conservation

Standards Approximate Compliance Date Estimated Total Industry

Conversion Expense 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 $95.4M (2009$)

Dishwashers*** 2018 TBD Commercial Packaged Air Conditioners and Heat Pumps*** 2018 TBD

Commercial Warm-Air Furnaces*** 2018 TBD

Furnace Fans 79 FR 38129 (July 3, 2014) 2019 $40.6M (2013$)

Miscellaneous Residential Refrigeration*** 2019 TBD
Single Packaged Vertical Units*** 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 assoc iated with the November 2007 final rule for residential f urnaces and boilers are excluded from this figure. The 2011 direct final rule for residential furnaces set s a higher standard and earlier compliance date for oil-fired furnaces than the 2007 final rule. As a result, ma nufacturers will be required design to the 2011 dir ect final rule standard. The conversion costs associated wit h the 2011 direct final rule are listed separately in this table. EISA 2007 legislated higher standards and e arlier compliance dates for residential boilers tha n were in the November 2007 final rule. As a result, gas- fired and oil-fired boiler manufacturers were requi red to design to the EISA 2007 standard beginning in 2012. The conversion costs listed for residential gas-f ired and oil-fired boilers in the November 2007 resident ial furnaces and boilers final rule analysis are no t included in this figure.

** Estimated industry conversion expense and approxima te compliance date reflect a court-ordered April 24, 2014 remand of the residential non-weatherized and mobile home gas furnaces standards set in the 2 011 Energy Conservation Standards for Residential Furna ces and Residential Central Air Conditioners and He at Pumps. The costs associated with this rule reflect implementation of the amended standards for the remaining furnace product classes (i.e., oil-fired furnaces).12-30

***The final rule for this energy conservation stan dard has not been published. The compliance date a nd analysis of conversion costs have not been finalize d at this time. (If a value is provided for total industry conversion expense, this value represents an estima te from the NOPR.)

Additionally, manufacturers cited increasing ENERGY STAR standards for room air conditioners and ductless heating and cooling s ystems as a source of regulatory burden. However, DOE does not consider ENERGY STAR in its presentation of cumulative regulatory burden because ENERGY STAR is a voluntary program and is not federally mandated. DOE also notes that it does not consider proposed legislation in its cumulative regulatory burden analysis because the i mpacts of such legislation would be speculative.

12.8 CONCLUSION The following section summarizes the range of finan cial impacts DOE believes PTAC and PTHP manufacturers are likely to experienc e as a result of amended energy conservation standards. DOE also notes that while t hese scenarios bound the range of most plausible impacts on manufacturers, there pote ntially could be circumstances that cause manufacturers to experience impacts outside t his range.

Each TSL analyzed in this rulemaking represents a p ercentage increase in efficiency above current federal minimum efficiency standards. Specifically, TSLs 1, 2, 3, 4, and 5 represent respective increases of 4 per cent, 8 percent, 12 percent, 16 percent, and 18 percent above the current federal minimum ef ficiency standard for PTACs of a specified cooling capacity. See section 12.4.3 for further discussion of the TSLs.

12.8.1 Conclusions for PTACs and PTHPs MIA

Table 12.8.1 presents a range of results reflecting both the preservation of gross margin percentage markup scenario and the preservat ion of operating profit markup scenario. As explained in section 12.4.7, the prese rvation of operating profit scenario accounts for the more severe impacts presented. Est imated conversion costs and free cash flow in the year prior to the effective date of ame nded standards do not vary with the markup scenario.12-31

Table 12.8.1 Manufacturer Impact Analysis Results f or PTACs and PTHPs*

Units Base

Case Trial Standard Level

1 2 3 4 5

INPV 2013$M 58.5 57.1 to 57.4 57.7 to

58.8 55.4 to

57.5 55.0 to

58.5 51.8 to

55.9

Change in INPV 2013$M - (1.4) to (1.1) (0.7) to

0.3 (3.1) to

(0.9) (3.5) to

0.0 (6.7) to

(2.6)

% Change - (2.4) to (1.9) (1.3) to

0.5 (5.3) to

(1.6) (5.9) to

0.0 (11.4) to

(4.4)

Product Conversion Costs 2013$M - 2.2 4.7 7.2 8.5 13.5

Capital Conversion Costs 2013$M - 2.3 2.9 7.1 7.1 7.4

Total Conversion Costs 2013$M - 4.5 7.6 14.3 15.6 20.9

Free Cash Flow 2013$M 3.8 2.2 1.2 (1.5) (1.8) (3.4)

% Change - (43.5) (69.9) (138.6) (148.2) (190.3) * Parentheses indicate negative values.

TSL 1 represents a 4 percent increase above current federal minimum efficiency standards for PTACs. At TSL 1, DOE estimates the im pacts on INPV to range from -$1.4 million to -$1.1 million, or a change of -2.4 perce nt to -1.9 percent. Industry free cash flow is estimated to decrease by $1.7 million, or a change of 43.5 percent compared to the base-case value of $3.8 million in the year bef ore the compliance date (2018).

DOE estimates that in the year of compliance (2019 ), 51 percent of all PTAC and PTHP shipments in the base case would already meet or exceed the standard levels at TSL 1. The capital and product conversion costs req uired to bring the balance of shipments into compliance with amended standards dr ive the negative INPV results at this level. DOE estimates industry conversion costs of $4.5 million at TSL 1.

TSL 2 represents an 8 percent increase above curren t federal minimum efficiency standards for PTACs. At TSL 2, DOE estimates impact s on INPV to range from -$0.7 million to $0.3 million, or a change in INPV of -1. 3 percent to 0.5 percent. At this level, industry free cash flow is estimated to decrease by $2.7 million, or a change of 69.9 percent compared to the base-case value of $3.8 mil lion in the year before the compliance date.

The INPV impacts at TSL 2 are slightly less severe than those at TSL 1 due to the interplay of conversion costs, manufacturer selling prices, and shipment projections. DOE estimates that in the year of compliance (2019) , 37 percent of all PTAC and PTHP base case shipments would meet efficiency levels at TSL 2 or higher. DOE expects conversion costs required to bring the balance of s hipments into compliance would increase to $7.6 million, reflecting the need for a dditional motor and control changes as12-32

well as a more significant R&D and testing burden. However, an anticipated increase in per-unit purchase price at this level combined with steady shipments could dampen the effects of conversion costs on INPV.

TSL 3 represents a 12 percent increase above curren t federal minimum efficiency standards for PTACs. At TSL 3, DOE estimates impact s on INPV to range from -$3.1 million to -$0.9 million, or a change in INPV of -5 .3 percent to -1.6 percent. At this level, industry free cash flow is estimated to decrease by $5.3 million, or a change of 138.6 percent compared to the base-case value of $3.8 mil lion in the year before the compliance date.

DOE estimates that in the year of compliance (2019) , only 6 percent of all PTAC and PTHP base case shipments would already meet eff iciency levels at TSL 3 or higher. DOE also estimates conversion costs would nearly do uble relative to conversion costs at TSL 2, increasing to $14.3 million. Anticipated con version costs at this level include investing in new tooling and redesigning products t o incorporate additional coils and/or formed coils.

TSL 4 represents a 16 percent increase above curren t federal minimum efficiency standards for PTACs. At TSL 4, DOE estimates impact s on INPV to range from -$3.5 million to $0.0 million, or a change in INPV of -5. 9 percent to 0.0 percent. At this level, industry free cash flow is estimated to decrease by $5.7 million, or a change of 148.2 percent compared to the base-case value of $3.8 mil lion in the year before the compliance date.

DOE estimates that in the year of compliance (2019) , less than 1 percent of all PTAC and PTHP base case shipments would already mee t efficiency levels at TSL 4 or higher. Conversion costs required to bring nearly 1 00 percent of products into compliance would increase to an estimated $15.6 mil lion. At this level, however, DOE does not anticipate capital conversion costs beyond those required at TSL 3. Rather, product conversion costs account for the full incre ase.
TSL 5 represents the use of max-tech design options for each equipment class. At this level, DOE estimates impacts on INPV to range from -$6.7 million to -$2.6 million, or a change in INPV of -11.4 percent to -4.4 percen t. Industry free cash flow is estimated to decrease by $7.3 million, or a change of 190.3 p ercent compared to the base-case value of $3.8 million in the year before the compliance d ate.

DOE estimates that in the year of compliance (2019) , less than 1 percent of all PTAC and PTHP base case shipments would already mee t efficiency levels at TSL 5. At this level, conversion costs required to bring near ly 100 percent of products into compliance would increase to an estimated $20.9 mil lion.

At all TSLs, INPV impacts could prove more severe i f customer demand falls in the face of higher per-unit purchase prices.12-33 REFERENCES

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