CHAPTER 12. PRELIMINARY MANUFACTURER IMPACT ANALYSIS

TABLE OF CONTENTS

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

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

12.2.1 Phase 1: Industry Profile................................................................................ 12­2

12.2.2 Phase 2: Industry Cash­Flow Analysis and Interview Guide ........................ 12­2

12.2.2.1 Industry Cash­Flow Analysis........................................................ 12­2

12.2.2.2 Interview Guide ............................................................................ 12­2

12.2.3 Phase 3: Sub­Group Analysis ........................................................................ 12­3

12.2.3.1 Manufacturer Interviews............................................................... 12­3

12.2.3.2 Revised Industry Cash­Flow Analysis.......................................... 12­3

12.2.3.3 Manufacturer Sub­Group Analysis............................................... 12­3

12.2.3.4 Competitive Impact Assessment................................................... 12­4

12.2.3.5 Manufacturing Capacity Impact ................................................... 12­4

12.2.3.6 Employment Impact...................................................................... 12­4

12.2.3.7 Cumulative Regulatory Burden .................................................... 12­4

12.3 PRELIMINARY MANUFACTURER IMPACT ANALYSIS RESULTS............... 12­5

12.3.1 General Interview Structure........................................................................... 12­5

12.3.1.1 Key Issues..................................................................................... 12­5

12.3.1.2 Shipment Projections.................................................................... 12­6

12.3.1.3 Profitability ................................................................................... 12­6

12.3.1.4 Product Mix .................................................................................. 12­6

12.3.1.5 Conversion Costs, Manufacturing Capacity, and Employment

Levels ....................................................................................................... 12­6

12.3.1.6 Market Shares and Industry Consolidation................................... 12­7

12.3.1.7 Product Utility and Innovation...................................................... 12­8

12.3.1.8 Impact on Small Manufacturers.................................................... 12­8

12.3.1.9 Cumulative Burden ....................................................................... 12­8

12.3.1.10 State Energy Conservation Standards......................................... 12­9

12.3.1.11 International Energy Conservation Standards ............................ 12­9

12.3.2 Residential Heating Product Preliminary MIA Results................................. 12­9

12.3.2.1 Key Issues..................................................................................... 12­9

12.3.2.2 Residential Water Heaters........................................................... 12­10

12.3.2.3 Direct Heating Equipment .......................................................... 12­11

12.3.2.4 Pool Heaters................................................................................ 12­12

12.3.2.5 Profitability, Product Mix, and Shipments ................................. 12­13

12.3.2.6 Residential Water Heaters........................................................... 12­13

12.3.2.7 Direct Heating Equipment .......................................................... 12­14

12.3.2.8 Pool Heaters................................................................................ 12­15

12.3.2.9 Conversion Costs, Manufacturing Capacity, and Employment

Levels ..................................................................................................... 12­16

12.3.3 Impact on U.S. Production and Jobs............................................................ 12­17

12.3.3.1 Foreign Labor.............................................................................. 12­17

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12.3.3.2 Industry Consolidation................................................................ 12­17

12.3.4 Impact on Product Utility and Innovation ................................................... 12­17

12.3.5 Cumulative Burdens..................................................................................... 12­18

12.3.5.1 Air Quality Management Districts and Low NOx Requirements 12­19

12.3.5.2 Standards for Other Products Made by Residential Heating

Products Manufacturers............................................................................... 12­19

12.3.5.3 Uniform Building, Plumbing, Health and Safety Codes............. 12­19

12.3.6 Impact on Small Manufacturers................................................................... 12­20

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12.1 INTRODUCTION

The purpose of the manufacturer impact analysis (MIA) is to identify the likely

impacts of amended energy conservation standards on manufacturers. The U.S.

Department of Energy (DOE) will conduct this analysis with input from manufacturers

and other interested parties and will apply this methodology to its evaluation of amended

energy conservation standards for residential water heaters, direct heating equipment, and

pool heaters. DOE will also consider financial impacts and a wide range of quantitative

and qualitative industry impacts that might occur following the amendment of an energy

conservation standard. For example, a particular energy conservation standard level, if

adopted by DOE, could require changes to residential heating products manufacturing

practices. DOE will identify and come to understand these impacts through interviews

with manufacturers and other interested parties during the Notice of Proposed

Rulemaking (NOPR) stage of its analysis.

Recently, DOE announced changes to the MIA format through a report issued to

Congress on January 31, 2006 (as required by section 141 of the Energy Policy Act of

2005 (EPACT 2005)), entitled “Energy Conservation Standards Activities.”a Previously,

DOE did not report any MIA results until the Notice of Proposed Rulemaking (NOPR)

phase; however, under this new format, DOE has collected, evaluated, and reported

preliminary information and data during the preliminary phase (the phase preceding the

NOPR) of this rulemaking. Such preliminary information includes the anticipated

conversion capital expenditures by efficiency level and the corresponding anticipated

impacts on jobs. DOE solicited this information during the engineering analysis

manufacturer interviews and reported the results below.

12.2 METHODOLOGY

DOE conducts the MIA in three phases and further tailors the analytical

framework based on comments from interested parties. In Phase 1, DOE creates an

industry profile to characterize the industry and conducts a preliminary MIA to identify

important issues that require consideration. The preliminary technical support document

(preliminary TSD) presents the results of the Phase 1 analysis. In Phase 2, DOE prepares

an industry cash­flow model and an interview questionnaire to guide subsequent

discussions. In Phase 3, DOE interviews manufacturers, and assesses the impacts of

amended energy conservation standards both quantitatively and qualitatively. Using the

government regulatory impact model (GRIM), DOE assesses industry and sub­group

cash flow and NPV. Then, DOE assesses impacts on competition, manufacturing

capacity, employment, and regulatory burden based on manufacturer interview feedback

and discussions. The NOPR TSD presents results of the Phase 2 and 3 analyses.

a This report is available on the DOE website at

www.eere.energy.gov/buildings/appliance_standards/2006_schedule_setting.html.

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12.2.1 Phase 1: Industry Profile

In Phase 1 of the manufacturer impact analysis, DOE collects pertinent qualitative

and quantitative financial and market information. This includes residential water

heating, direct heating, and pool heating manufacturer market share, corporate operating

ratios, wages, employment, and production cost ratios. Sources of information include

reports published by industry groups, trade journals, the U.S. Census Bureau, and copies

of Securities Exchange Commission (SEC) 10­K filings. DOE also relies on information

from its market and technology assessment, engineering analysis, life­cycle cost analysis,

and analysis of markups to determine the product prices to characterize the three

industries of residential heating products.

12.2.2 Phase 2: Industry Cash­Flow Analysis and Interview Guide

In Phase 2, DOE will perform a preliminary industry cash­flow analysis and

prepare written guidelines for interviewing manufacturers.

12.2.2.1 Industry Cash­Flow Analysis

DOE uses the GRIM to analyze the financial impacts of amended energy

conservation standards on the residential heating products industries. Standards will

likely require additional investment, raise production costs, and affect revenue through

higher prices and, possibly, lower sales. The GRIM uses several factors to determine a

series of annual cash flows for the year standards become effective and for several years

after implementation. These factors include annual expected revenues, costs of sales,

selling and general administration costs, taxes, and capital expenditures related to

depreciation, new standards, and maintenance. Inputs to the GRIM include

manufacturing costs, shipments forecasts, and price forecasts developed in other

analyses. Another input, financial information, will be developed based on publicly

available data and confidentially submitted manufacturer information. DOE compares the

results of the GRIM against baseline projections where no standards are in place. The

financial impact of amended energy conservation standards is the difference between the

two sets of discounted annual cash flows.

12.2.2.2 Interview Guide

DOE will conduct interviews with manufacturers to gather information on the

effects of standards on revenues and finances, direct employment, capital assets, and

industry competitiveness. Before the interviews, DOE will distribute an interview guide

that will provide a starting point to identify relevant issues and help identify the impacts

of standards on individual manufacturers or sub­groups of manufacturers. DOE

anticipates that the interview guide will cover current organizational characteristics,

industry infrastructure, manufacturer cash­flow analysis, a competitive impacts

assessment, an employment impacts assessment, and a manufacturing capacity impacts

assessment.

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12.2.3 Phase 3: Sub­Group Analysis

Phase 3 activities will take place after the publication of the NOPM documents

and will include manufacturer interviews, revision of the industry cash­flow analysis,

manufacturer sub­group cash­flow analysis, competitive impact assessment,

manufacturing capacity impact, employment impact, and cumulative regulatory burden.

12.2.3.1 Manufacturer Interviews

The information gathered in Phase 1 and the cash­flow analysis performed in

Phase 2 will be supplemented with information gathered during interviews with

manufacturers during Phase 3. The interview process has a key role in the manufacturer

impact analyses, since it provides an opportunity for interested parties to express their

views privately on important issues, allowing confidential or sensitive information to be

considered in the rulemaking decision.

DOE will conduct detailed interviews with as many manufacturers as necessary to

gain insight into the range of potential impacts of standards. During the interviews, DOE

will solicit information on the possible impacts of standards on sales, direct employment,

capital assets, and industry competitiveness. Both qualitative and quantitative information

are valuable. Interviews will be scheduled well in advance in order to provide every

opportunity for key individuals to be available for comment. Although a written response

to the questionnaire will be acceptable, DOE prefers an interactive interview process

because it helps clarify responses and provides the opportunity to identify additional

issues.

All information transmitted will be considered, as appropriate, in DOE’s decisionmaking process. Interview participants will be asked to identify all confidential

information provided in writing or orally; no confidential information will be made

available in the public record. Participants will also be asked to identify all information

they wish included in the public record but do not want to have associated with their

interview. This information will be incorporated into the public record but reported

without attribution.

12.2.3.2 Revised Industry Cash­Flow Analysis

In Phase 2 of the MIA, DOE will provide manufacturers with a preliminary

GRIM for review and evaluation. During the interviews, DOE will seek comment and

suggestions regarding the values selected for the parameters. Upon completion of the

interviews, DOE will revise its industry cash­flow model based on manufacturer

feedback.

12.2.3.3 Manufacturer Sub­Group Analysis

Using average cost assumptions to develop an industry cash­flow estimate is not

adequate for assessing differential impacts among sub­groups of manufacturers. Smaller

manufacturers, niche players, or manufacturers exhibiting a cost structure that differs

largely from the industry average could be more negatively affected. Ideally, DOE would

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consider the impact on every firm individually; however, it typically uses the results of

the industry characterization to group manufacturers exhibiting similar characteristics.

During the interview process, DOE will discuss the potential sub­groups and sub­group

members that have been identified for the analysis. DOE will look to the manufacturers

and other stakeholders to suggest what sub­groups or characteristics are most appropriate

for the analysis.

12.2.3.4 Competitive Impact Assessment

Section 342 (6)(B)(i)(V) of the Energy Policy Act of 1992 (EPCA) directs DOE

to consider any lessening of competition likely to result from imposition of standards. It

further directs the U.S. Attorney General to determine the impacts, if any, of any decrease

in competition. DOE will make a determined effort to gather and report firm­specific

financial information and impacts. The competitive analysis will focus on assessing the

impacts on smaller, yet significant, manufacturers. The assessment will be based on

manufacturing cost data and information collected from interviews with manufacturers.

The manufacturer interviews will focus on gathering information that would help in

assessing asymmetrical cost increases to some manufacturers, the potential increase in

business risks from an increased proportion of fixed costs, and potential barriers to

market entry (e.g., proprietary technologies).

12.2.3.5 Manufacturing Capacity Impact

One of the significant outcomes of standards could be the obsolescence of

existing manufacturing assets, including tooling and investment. The manufacturer

interview guide will have a series of questions to help identify impacts on manufacturing

capacity, specifically capacity utilization and plant location decisions in North America

with and without a standard; the ability of manufacturers to upgrade or remodel existing

facilities to accommodate the new requirements; the nature and value of stranded assets,

if any; and estimates for any one­time restructuring and other charges, where applicable.

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 employment

patterns might be affected, the interview will explore current employment trends in the

heating products industry. The interview will also solicit manufacturer views on changes

in employment patterns that may result from increased standard levels. The employment

impacts section of the interview guide will focus on current employment levels associated

with manufacturers at each of their production facilities, expected future employment

levels with and without a standard, and differences in workforce skills and issues related

to the retraining of employees.

12.2.3.7 Cumulative Regulatory Burden

DOE recognizes and seeks to mitigate the overlapping effects on manufacturers of

amended energy conservation standards and other regulatory actions affecting the same

products. DOE will analyze and consider the impact on manufacturers of multiple,

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product­specific regulatory actions. Based on its own research and discussions with

manufacturers, DOE identified several regulations relevant to residential water heaters,

direct heating equipment, and pool heaters, including low nitrogen oxides (NOx) and

ignition source requirements, amended energy conservation standards for other products

made by heating products manufacturers, State energy conservation standards, and

international energy conservation standards. DOE will study the potential impacts of

these cumulative burdens in greater detail during the MIA conducted during the NOPR

phase.

12.3 PRELIMINARY MANUFACTURER IMPACT ANALYSIS RESULTS

During the preliminary rulemaking phase, DOE conducted a preliminary

evaluation of the impact of potential amended energy conservation standards on

manufacturer financial performance, manufacturing capacity and employment levels, and

product utility and innovation. A primary focus was to identify the cumulative burden

that industries face from the overlapping effect of new or recent DOE energy

conservation standards and/or other regulatory action affecting the same products or

industries.

The primary sources of information for this analysis were on­site or telephone

interviews with manufacturers of residential heating products conducted during the

winter of 2007. To maintain confidentiality, DOE did not identify the individual

manufacturers that disclosed information. The evaluation only reports aggregated

information and does not disclose sensitive or company­specific information.

For the preliminary MIA, DOE conducted interviews with manufacturers

primarily to identify key issues and gain insights into the qualitative impacts of amended

energy conservation standards. For each product, DOE used an interview guide to gather

responses from multiple manufacturers on many issues. All of the interview guides

covered the same general topic areas, but each interview guide was adapted to the needs

of each product category. Appendix A contains a copy of the interview guides for

residential water heaters, direct heating equipment, and pool heaters.

12.3.1 General Interview Structure

The manufacturer interviews included questions relating to the following topics.

DOE received responses to most, if not all, of these topics from various manufacturers.

12.3.1.1 Key Issues

Perhaps the most important aspect of the preliminary MIA is the opportunity to

identify key manufacturer issues early in the development of amended energy

conservation standards. During the interviews, DOE engages manufacturers in a

discussion about what they perceive to be the key issues in the rulemaking. Key issues,

once identified, are added to the list of topics explored during the interviews. For

example, key issues in previous rulemakings have included concerns over patent

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protections that might prevent some companies from implementing higher efficiency

designs.

12.3.1.2 Shipment Projections

Shipment projections can be a significant factor in determining the impacts of

amended energy conservation standards. The interviews provide an opportunity for

manufacturers to share information that can help DOE quantify the magnitude of any

changes in shipments resulting from amended energy conservation standards. DOE is

interested in information relating to the current number of product shipments, broken

down by product class (such as capacity rating) and efficiency level. DOE also seeks

input on the forecast of future shipments absent amended energy conservation standards.

Manufacturers are asked how they would expect shipments to change for the industry as a

whole as a function of standard levels and why they expect these changes might occur.

More specific questions aim to derive a price elasticity estimate for use in the national

impact analysis (NIA) spreadsheet.

Another aspect of the shipments discussion is understanding the impacts of a

reduction in shipments on heating products companies.

12.3.1.3 Profitability

DOE requests manufacturers’ views on what they perceive to be the possible

impact of potential amended energy conservation standards on their future profitability.

Amended energy conservation standards could affect financial performance in several

different ways. Several of these impacts are captured in previous sections. For instance,

the capital and product conversion outlays needed to upgrade or redesign products and

product platforms before they have reached the end of their useful life can engender

significant conversion costs that otherwise would not be expended, resulting in reduced

cash flow and stranded investments. Higher energy efficiency standards also can result in

higher per­unit costs that may deter some consumers from purchasing the products, or

cause some consumers to choose less efficient products, thereby reducing shipments.

12.3.1.4 Product Mix

DOE is interested in understanding if amended energy conservation standards

might change a manufacturer’s product mix and if this change affects profits. For

example, higher energy efficiency standards might limit a manufacturer’s ability to

differentiate products and market premium products that command higher profit margins.

The interview guide also investigates how amended energy conservation

standards might affect a manufacturer’s consumer mix and its distribution channels, and

how in turn this might change profitability.

12.3.1.5 Conversion Costs, Manufacturing Capacity, and Employment Levels

During the interviews, DOE asks manufacturers to quantify and explain both the

capital and product conversion costs necessary to raise the energy efficiency of their

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product lines to the proposed standard levels. In some instances, manufacturers may be

able to meet proposed standard levels by modifying existing products. In other cases, the

necessary changes may entail a complete product­line redesign. In these situations, an

increase in efficiency standards will cause manufacturers to incur one­time conversion

capital expenditures and product­conversion expenses. Conversion capital expenditures

are one­time investments in property, plant, and equipment. Product­conversion expenses

include one­time investments in research, product development, testing, and marketing.

One of the significant outcomes of amended energy conservation standards could

be the obsolescence of existing manufacturing assets, including tooling and other capital

investment. The interview guide includes questions to identify impacts on manufacturing

capacity. DOE developed these questions to understand the impact of potential amended

standards on:

• North American manufacturing capacity;

• capacity utilization and plant location decisions in North America both with and

without standards;

• the ability of manufacturers to upgrade or remodel existing facilities to

accommodate a new product mix; and

• the nature and value of stranded assets, if any.

The impact of amended energy conservation standards on employment is an

important consideration in the rulemaking process. DOE uses the interviews to explore

current trends in production employment and solicit manufacturer views on changes in

employment patterns resulting from amended energy conservation standards. Questions

regarding employment impacts help to understand

• current employment levels associated with manufacturing the subject products at

each production facility;

• expected future employment levels both with and without amended standards; and

• differences in workforce skills and issues related to retraining employees.

12.3.1.6 Market Shares and Industry Consolidation

Amended energy conservation standards can alter the competitive dynamics of the

marketplace. This can include prompting companies to enter the market, exit the market,

or merge with other companies. The preliminary MIA interview questions ask

manufacturers to share their perspectives on industry consolidation both in the absence of

amended standards and assuming amended standards at various efficiency levels. The

interview questions focus on gathering information that helps in assessing

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• disproportionate cost increases to some manufacturers;

• increased proportion of fixed costs potentially increasing business risks; and

• potential barriers to market entry (e.g., proprietary technologies).

DOE conducts an assessment of anti­competitive effects of proposed standards in

order to protect the interests of the consumer. During the interviews, DOE solicits

information to understand if amended standards could result in disproportionate

economic or performance penalties for particular consumer/user sub­groups.

DOE also asks manufacturers if amended energy conservation standards could

result in products that will be more or less desirable to consumers due to changes in

product functionality, utility, or other features.

12.3.1.7 Product Utility and Innovation

Amended energy conservation standards can force manufacturers to compromise

product utility to consumers by eliminating energy­consuming features. During the

interviews, DOE requests information on the effects of proposed standards on product

utility.

Amended energy conservation standards may require investment in conversion

costs, including research and development (R&D). This required spending may force a

manufacturer to reduce funding usually allocated to product innovation. Amended energy

conservation standards may also force manufacturers to eliminate innovative energyconsuming features from their products. During the interviews, DOE requests

information on the effect of proposed standards on innovation.

12.3.1.8 Impact on Small Manufacturers

DOE will consider the possibility of small businesses being affected by the

promulgation of amended energy conservation standards for residential water heaters,

direct heating equipment, and pool heaters. Should any small business manufacturers be

identified, DOE will study the potential impacts on these small businesses in greater

detail during the MIA.

12.3.1.9 Cumulative 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 entire industries. Assessing the

impact of a single regulation may overlook this cumulative regulatory burden.

Expenditures associated with meeting other regulations are an important aspect of

DOE’s consideration of the “cumulative regulatory burden” the industry faces. The

interviews help DOE identify the level and timing of investments manufacturers are

expecting to incur as a result of these regulations. Manufacturers are also asked under

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what circumstances they might be able to coordinate any expenditures related to these

regulations and efficiency standards.

In addition to the amended energy conservation for residential water heaters,

direct heating equipment, and pool heaters, several other Federal regulations and pending

regulations apply to other products these manufacturers make. DOE will investigate these

cumulative regulatory burdens in greater detail during the NOPR phase of the

rulemaking.

12.3.1.10 State Energy Conservation Standards

DOE identified and described regulatory programs at the state level in the market

and technology assessment (chapter 3 of the preliminary TSD) for the products covered

in this rulemaking. Multiple States have requirements for products covered under this

rulemaking. Accommodating multiple State standards in addition to National standards

raises costs for manufacturers.

12.3.1.11 International Energy Conservation Standards

DOE discussed regulatory programs from certain other countries, such as Canada

and Mexico, in the market and technology assessment, (chapter 3 of the preliminary

TSD). A few manufacturers sell a small portion of their total production to countries

outside the United States. In these cases, the products must meet the standards for each

country. Companies may design some units to meet more stringent standards than those

imposed by the United States in order to minimize the number of product variations.

12.3.2 Residential Heating Product Preliminary MIA Results

During the preliminary MIA interview, manufacturers identified key issues

surrounding DOE’s rulemaking for heating products and provided feedback regarding the

potential impact of amended energy conservation standards. DOE summarized the

feedback below

12.3.2.1 Key Issues

One of the main questions in each of the preliminary interview guide asks: “What

are the key issues for your company regarding the heating products energy conservation

standard rulemaking?” This open question initiated dialogue with the manufacturers,

enabling them to identify key points that DOE would explore and discuss during the

interview. This section describes the key issues manufacturers felt were of the highest

importance in relation to the heating products energy conservation standards rulemaking

and that would have the most significant impact on the industry. Manufacturers indicated

that, for the most part, the risks associated with these issues increase with more stringent

energy conservation standards. The issues are overall concerns that many manufacturers

expressed and in some cases, are dependent upon the product class.

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12.3.2.2 Residential Water Heaters

In general, water heater manufacturers cited concerns regarding the development

of the ENERGY STAR program, potential increases in installation costs, impacts on

packaging and shipment costs, safety concerns regarding near­condensing instantaneous

water heaters, and fuel and equipment switching.

• ENERGY STAR ­ Many manufacturers of residential water heaters pointed out

during interviews that the ENERGY STAR program for residential water heaters

was currently under developed by DOE (criteria was finalized on April 1, 2008,

after engineering interviews). According to manufacturers, the key to maintaining

ENERGY STAR levels is setting minimum energy conservation standards for

residential water heaters that are similar and low enough to allow cost­effective

premium­efficiency products to be developed. To that end, all manufacturers with

knowledge of the ENERGY STAR development program expressed support for

the ENERGY STAR and minimum energy conservation standards programs to

collaborate in setting standards as a means of reducing manufacturer uncertainty

and development expenses.

Conventional electric, storage and gas­fired storage water heaters were not

considered in the draft proposal because the ENERGY STAR program believes

“electric resistance water heaters are not appropriate for inclusion in ENERGY

STAR” because stakeholders indicated that the energy savings are too

1 insignificant. Oil­fired products are not included in the draft criteria and

manufacturers of oil­fired products expressed their desire to be included in the

ENERGY STAR program.

• Increases in Installation Costs ­ Water heater manufacturers commented on the

impacts of installation costs on consumers if standards are amended at higher

efficiency levels. Manufacturers commented that water heaters with power vents

require electrical connections and specific vent configurations. Manufacturers

indicated that these can double the installation costs of baseline designs.

Additionally, condensing systems requiring condensate removal or heat pump

water heaters requiring ducting, which can also raise installation costs.

Manufacturers of storage water heater products cited concerns regarding loss of

market share and product switching to instantaneous systems if installation costs

become too high.

• Increases in Shipping Costs ­ Water heater manufacturers also commented on the

significance of shipping costs and their sensitivity to changes in shipping costs as

the physical dimensions of storage water heaters increase with efficiency. For gasfired and electric storage water heaters, one way manufacturers typically increase

the efficiency of products is increasing the insulation thickness surrounding the

tank to reduce standby losses from the surface area around the tank.

Manufacturers stated their concerns regarding increasing the physical dimensions

of the storage tank because they are restricted to a finite amount of space within a

shipping trailer and a finite amount of space for installing these units into existing

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closets. As the overall dimensions of a storage water heater increases, the number

of products that can be loaded into a trailer decreases. This raises the shipping

costs per product. Additionally, if more trailers are needed to compensate for this

decreased in products per trailer, the effects of increasing fuel prices for the

delivery trucks can also impact the full cost of production. Manufacturers

expressed concern that these increases in shipping costs would not be able to be

fully passed on to the consumer and further reduce their profit margins.

• Safety Concerns ­ Water heater manufacturers commented that instantaneous

water heaters near 0.85 EF are operating at near­condensing levels. Operating at

these levels may result in corrosive condensation formation. Manufacturers

expressed concern regarding the risk associated with operating instantaneous

water heaters at near condensing levels for all types of installations found in the

market. Many manufacturers stated they would be unwilling to bear the risks

associated with this level. In addition, to mitigate risk if standards require gasfired instantaneous water heaters at these energy efficiency levels, manufacturers

would incorporate a condensing design, which would significantly increase the

product cost. The safety margin is needed to account for variations due to

manufacturing tolerances, gas quality, differences in venting configurations,

altitude, ambient conditions, and installer experience. Increasing conservation

standards reduces that margin of safety, and a conservation standard at 0.85 EF

does not provide an adequate safety margin.

• Fuel Switching ­ Manufacturers also commented on potential fuel switching if

amended conservation standards required heat pump water heaters. If consumers

are required to install heat pump water heaters, in addition to drain lines for

condensate, and venting and ducting for the cooled air, manufacturers believe

consumers will most likely switch to gas­fired water heaters or fix their existing

water heaters upon failure rather than replace them. Higher first costs for these

products and installation costs may make switching to gas, and possibly installing

a gas line, an affordable option for some consumers.

12.3.2.3 Direct Heating Equipment

Direct heating equipment manufacturers cited concerns regarding the potential

increases in installation costs and impacts on utility and the consumer due to derating.

• Installation Costs ­ Direct heating equipment manufacturers cited concerns

regarding increases in installation costs similar to water heater manufacturers.

Manufacturers submitted feedback regarding the impacts of conservation

standards requiring electrical connections, power vents, and condensate removal

systems. Manufacturers of direct heating equipment cited concerns regarding loss

of market share to alternative heating methods if installation costs become too

high. In addition, some baseline direct heating equipment currently does not

require electrical connections. As efficiency levels increase for direct heating

equipment, electrical connections can become a costly adder for consumers, who

might switch to another type of heating system.

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• Derating ­ Manufacturers of direct heating equipment indicated that amended

standards might impact the utility of their products for consumers. Manufacturers

typically derate direct heating equipment products, so that can increase the

efficiency of their unit without changing the overall physical dimensions.

Traditionally, manufacturers have increased the heat exchanger dimensions to

increase the efficiency, which would also increase the overall dimensions of the

products. Instead, manufacturers of direct heating equipment would choose to

reduce the capacity of the existing models to get a higher efficiency from the

same heat exchanger. A strategy typically called derating. Manufacturers use

smaller burner assemblies while maintaining the same heat exchanger and outer

casing designs. Derating increases the ratio of heat exchanger surface area to

burner input, thus increasing the energy efficiency of the heater (which is similar

to increasing the heat exchanger surface area while maintaining the same burner

size). Manufacturers indicated this method would be used to meet amended

energy conservation standards and they believe it is typically the most cost

effective method. However, they stated their concerns on the reduction in

capacity. Derating may limit the products’ ability to provide adequate heat to

meet consumers’ needs. Manufacturers avoid incorporating design changes into

the product that would cause changes in the overall physical dimensions because

most consumers would have to make other installation changes to the space the

unit is kept. Again, manufacturers cited concerns regarding loss of market share to

alternative heating methods if installation costs become too high as a result of

increased standards.

12.3.2.4 Pool Heaters

Pool heater manufacturers cited concerns regarding the potential increases in

installation costs, the safety concerns regarding near­condensing operation, and decreases

in overall shipments as a result of increased cost to the consumer.

• Installation Costs ­ Pool heater manufacturers also cited concerns regarding

increases in installation costs similar to water heater and direct heating equipment

manufacturers. Manufacturers submitted feedback regarding the impacts of

amended energy conservation standards requiring electrical connections, power

vents, and condensate removal systems. Manufacturers cited complex installations

would require additional training for field technicians at a cost to the

manufacturer and the consumer. Manufacturers explained pool maintenance

technicians traditionally install pool heaters (i.e., pool maintenance technicians

traditionally install the pool heater, clean the pool on a regular basis, and trouble

shoot the pool heater if something is wrong). There is a lower level of field

training required because the market is not as established for pool heaters as it

may be for other appliances. As the complexity of the pool heater increases, the

required skills necessary to be able to install these systems increase.

Manufacturers would contemplate training installers, so their systems work

properly in the field and avoid potential safety concerns.

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• Safety Concerns ­ Manufacturers commented that pool heaters operating near 85

and 86 percent thermal efficiency are operating at near­condensing levels.

Operating at these levels may result in corrosive condensation formation.

Manufacturers expressed concern regarding the risk and additional costs to

mitigate risk if standards require pool heaters at these energy efficiency levels.

Manufacturers stated there are variations and constraints that must be addressed,

which require a margin of safety. The safety margin is needed to account for

variations due to manufacturing tolerances, gas quality, differences in installation

configurations, altitude, ambient conditions, and installer experience. Increasing

conservation standards reduces that margin of safety, and conservation standards

at 85 to 86 percent thermal efficiency for pool heaters does not provide an

adequate safety margin. Instead, either manufacturers would contemplate

incorporating condensing designs at these levels to avoid safety issues in certain

installations or they would choose not to manufacturer products at these levels.

• Product Price Increases Resulting in Declining Market ­ Manufacturers of

residential pool heaters also commented that amended energy conservation

standards might result in a decrease in overall shipments. If amended energy

conservation standards require power venting, electrical connections, condensate

drain lines, and a condensate neutralization system, consumers may be

discouraged from purchasing products entirely due to the increase in total

installed costs. Unlike water heaters, pool heaters are not considered a commodity

or a necessity, rather they are luxury products. A consumer’s decision to purchase

a pool heater often depends on several factors, including total installed cost. For

example, current financial status, desire of use, and weather can influence a

consumer’s decision. Compounding these factors with increased product and

installation cost and complexity, a consumer may decide to avoid the burdens of

purchasing and installation all together if amended standards raise the level to a

point, where such technologies are required.

DOE considered all of the feedback and comments supplied by the manufacturers

who participated in the engineering interviews.

12.3.2.5 Profitability, Product Mix, and Shipments

12.3.2.6 Residential Water Heaters

DOE asked manufacturers during the preliminary manufacturer interviews how

amended energy conservation standards would affect their profitability. All

manufacturers of residential water heaters stated that amended energy conservation

standards could have a significant impact on the product mix of certain products

depending upon the efficiency level under consideration by DOE. In particular,

manufacturers were concerned about fuel and equipment switching, a reduction in the

number of product tiers they are able to offer consumers, and an overall reduction in

shipments as a result of fixing upon failing instead of replacement.

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Manufacturers of all types of water heaters were concerned about fuel and

equipment switching. In particular, storage manufacturers stated that if storage, water

heater standards are increased to a level, which is significantly more stringent than

instantaneous water heaters and the first cost differences shrink, they believe more

consumers will begin purchasing instantaneous water heaters. On the contrary,

instantaneous water heater manufacturers voiced their concerns regarding the stringency

of instantaneous water heater standards. In particular, they believe any significant

increase in the amended energy conservation standards will cause a further disparity

between the first cost of storage and instantaneous water heaters, thus shifting the market

back to storage water heaters. All manufacturers echoed a similar concern of maintaining

equivalent stringencies across all product classes of residential water heaters. All

manufacturers also had concerns about DOE considering efficiency levels near the maxtech efficiency levels identified in the engineering analysis.

In particular, manufacturers would be very concerned if DOE considers amended

energy conservation standards, which require condensing technologies for gas products

or heat pump technologies for electric water heaters. At these levels, fuel switching and

declining shipments can become a major issue due to the high first costs and increased

installation costs.

Another issue, which affects manufacturers’ profitability, is the number of

product tiers they are able to offer to consumers. As the stringency of amended energy

conservation standards is increased, the efficiency span for which manufacturers are able

to produce units shrinks, diminishing the number of tiers they offer to consumers. In turn,

decreasing the product offering would reduce profits because manufacturers typically

enjoy a higher markup with premium products. Reducing the number of tiers also

decreases the amount of differentiation between baseline and premium products, further

reducing product mix and profitability. In particular, manufacturers stated if amended

energy conservation standards are raised to a level requiring power vent or condensing

technologies for gas water heaters, the differentiation they offer to consumers and the

associated higher profits offered with premium products would be diminished. Water

heater manufacturers said that amended energy conservation standards requiring power

venting or condensing that increase installation costs could affect low­income families.

Additionally, consumers without a means to dispose of condensate may be forced to

switch fuels. If amended standards require heat pump water heaters, consumers without a

means to duct the cool air may also be forced to switch fuels.

12.3.2.7 Direct Heating Equipment

Manufacturers of direct heating equipment stated that increased standards could

reduce profitability. The direct heating industry is a small market and some products are

sold only as replacement units. Amended energy conservation standards could cause

increased first costs. Increased installation costs and requirements (i.e., an electrical

connection could be required for electronic ignition) may deter consumers from

purchasing products or cause them to switch to other methods to heat their homes.

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Manufacturers cited particular concerns regarding low­income families being

deterred by increased costs. Many low­income households opted for direct heating

equipment as an affordable means to heat their homes. Equipment switching may occur if

direct heating equipment costs become comparable to other home heating methods as a

result of amended standards. Consumer mix may also be affected if consumers are

required to have electrical connections for ignition because standards are raised to a level

that would require the elimination of pilots. Consumers not capable of installing an

electrical connection would be forced to use a means other than direct heating equipment

to supply heat.

12.3.2.8 Pool Heaters

Pool heater manufacturers said that an increase in standards would most likely

reduce profits. Since pool heaters are typically considered luxury items and not necessary

for homes, a consumer’s decision to purchase a pool heater often depends on family

dynamics, economic conditions, and the season. An increase in standards that increases

costs could deter consumers when high prices are compounded by these other factors.

Additionally, product mix could be reduced if amended standards require condensing,

since this would raise the standard to the current maximum available technology. This

scenario may cause consumers to switch to heat pumps, solar heaters, or geothermal pool

heaters.

With regards to the impact of amended standards on sub­groups, manufacturers

indicated that overall shipments might decrease amongst all consumers. However,

manufacturers do not think an individual sub­group would be adversely affected since

pool heaters are considered a luxury item.

Manufacturers would be particularly concerned if DOE considers amended

energy conservation standards that require condensing technologies. At these levels, fuel

switching and declining shipments can become a major issue due to the high first costs,

increased installation costs, increased complexity, and lack of training for field

technicians.

Another issue, which affects manufacturers’ profitability, is the number of

product tiers they are able to offer to consumers. As energy conservation standards are

increased, the efficiency span for which they are able to manufacturer products shrinks,

diminishing the number of tiers they offer to consumers. In turn, decreasing the product

offering would reduce profits because manufacturers typically enjoy a higher markup

with premium products. Reducing the number of tiers also decreases the amount of

differentiation between baseline and premium products, further reducing product mix and

profitability. In particular, manufacturers stated if amended energy conservation

standards are raised to a level requiring power vent or condensing technologies, the

differentiation they offer to consumers and the associated higher profits offered with

premium products would be diminished. Additionally, consumers without a means to

dispose of condensate or regulated by local noise ordinances (regulations against high

powered, high noise fans installed near property lines) may be forced to switch fuels or

equipment.

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12.3.2.9 Conversion Costs, Manufacturing Capacity, and Employment Levels

DOE estimated that a domestic storage water heater production line would have a

life cycle of approximately 15 years in the absence of amended energy conservation

standards. During that period, manufacturers would not make major equipment changes

that alter the underlying platforms. Thus, an amended energy conservation standard that

took effect and resulted in a major platform redesign before the end of the platform’s life

would strand a portion of the earlier capital investments.

DOE asked manufacturers what level of conversion costs they anticipate if

amended energy conservation standards were to take effect. Generally, water heater

manufacturers said that conversion costs would be significant if amended standards

require a significant alternation to tank size, heat pump, power venting, or condensing

technologies that would now represent the baseline products. In addition, manufacturers

of electric storage water heaters voiced a concern regarding increasing the physical

dimensions of the tank size.

Manufacturers would have to incorporate changes in order to include new

production lines or increase production volumes of existing lines. Changes would also

include new fabrication processes for flue baffles and heat exchangers so that they work

properly with power vent systems. Also, proper protection of the flue and vent parts

would need to be determined so that condensing does not create any safety or

performance issues.

Direct heating equipment manufacturers said that conversion costs would be

significant if amended standards require electronic ignition or power venting. Typically,

manufacturers would need to add new equipment to manufacturing processes so that

electronic ignitions could be installed. Also, conversion costs would be significant if

power venting were required in an industry dominated by natural draft products.

Manufacturers would need to include equipment for installation of fan motor assemblies.

Power venting would also require new heat exchanger designs, and manufacturers would

need to convert this fabrication and assembly process as well.

DOE also asked pool heater manufacturers about conversion costs. Generally,

pool heater manufacturers cited concerns similar to water heater manufacturers regarding

safety and performance issues if a standard requires condensing. Manufacturers also said

that additional installation, repair, and maintenance training would be required for pool

heater repair technicians. If amended standards require power vents or condensing

operations, the overall complexity of pool heater products will increase. According to

manufacturers, the pool heater maintenance industry is immature and lacks regulation.

Manufacturers are burdened with training and educating repair technicians properly so

that products can be serviced correctly and safely. To maintain consumer confidence in

their pool heater brand, manufacturers anticipate this conversion cost with an amended

standard.

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12.3.3 Impact on U.S. Production and Jobs

The impact of amended energy conservation standards on employment is an

important consideration in the rulemaking process. To assess how domestic employment

patterns might be affected by amended energy conservation standards for residential

heating products, DOE posed several questions about this topic to manufacturers.

12.3.3.1 Foreign Labor

For storage water heaters, manufacturers said that the majority of production

occurs in the United States and that amended energy conservation standards could affect

this status. For gas­fired instantaneous water heaters, products are produced by foreign or

international manufacturers operating facilities outside of the United States. This is

primarily driven by concerns about profitability and the opportunity for lower labor costs.

If a large shift is seen between these storage and instantaneous water heating markets, a

shift in the location where product occurs will be seen as a result.

Direct heating equipment is manufactured mostly in the United States, except for

some hearth products, and manufacturers said that they do not anticipate moving their

manufacturing facilities offshore.

Pool heater manufacturers said that nearly 100 percent of pool heaters are

manufactured in the United States and that a small portion of these products are exported

to foreign counties.

12.3.3.2 Industry Consolidation

Three companies now account for the majority of residential water heater sales.

2 The January 2001 water heater final rule , in addition to other industry factors,

contributed to recent consolidation. For instantaneous water heaters, manufacturers could

only see consolidation if the market dynamics shift to further increase the cost differential

between instantaneous and conventional water heating systems.

The direct heating equipment industry is comprised of several companies and

manufacturers do not anticipate any consolidation.

In the pool heater industry, four manufacturers have an equal share of the majority

of pool heater sales. Manufacturers do not anticipate any consolidation, but if an

amended standard requires condensing operations some manufacturers may be at a severe

disadvantage.

12.3.4 Impact on Product Utility and Innovation

Amended energy conservation standards (e.g., requirements for electrical

connections or installation requirements that increase the space needed) can affect

purchasers of residential heating products by increasing or decreasing the utility of such

products. Manufacturers generally believe that more stringent energy efficiency standards

would decrease innovations and, in some cases, result in reduced product utility.

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Water heater manufacturers said that patents for insulation application methods

and heat exchanger (i.e., flue baffle) limit other manufacturers’ methods for improving

energy efficiency. Some manufacturers stated that more stringent standards would require

redesigning some portion of their product lines. In turn, this would consume research and

development resources, both human and financial, and direct these assets away from

other potential investments that would normally go toward enhancing the functionality of

existing products or developing new products. Manufacturers stressed the impact on

utility of a standard requiring power venting, heat pump, or condensing. An increase in

installation requirements (i.e., electrical connection, drain for condensate, and plenum

space for airflow) would limit the utility of certain products to some consumers.

Direct heating equipment manufacturers indicated similar impacts on utility and

innovation, similar to water heater manufacturers. Conversion costs would draw from

resources intended for improving current products. Also, if standards require electronic

ignition or power venting, this may affect the utility of direct heating equipment for some

consumers since electrical connections would be required. From section 12.3.2.3,

manufacturers may also derate products as a result of amended standards as a means to

maintain cost­competitiveness. This would impact utility for consumers since products

may no longer be capable of supplying the same amount of heat the consumer is

accustomed to with the baseline product.

Pool heater manufacturers cited similar concerns if standards require power

venting or condensing. Manufacturers said that condensing operations shorten the life of

a water heater due to the increased risk of corrosion. Manufacturers also said that energy

efficiency scales with repair and maintenance requirements because as efficiency

improves, product complexity increases. Finally, products with loud noises generated by

power vents may not appeal to consumers and may even violate regional zoning

regulations.

12.3.5 Cumulative Burdens

Based on its own research and discussions with manufacturers, DOE identified

several regulations relevant to residential heating products, including:

• California, Texas, and Florida Air Quality Management Districts low nitrogen

oxides (NOx) and design requirements;

• uniform building, plumbing, and health and safety codes

• standards for other products made by residential heating products manufacturers;

• other State energy conservation standards; and

• international energy conservation standards.

Complying with such regulations requires corporations to invest both human and

capital resources. The following subsections discuss in greater detail regulations affecting

the residential heating products industry.

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12.3.5.1 Air Quality Management Districts and Low NOx Requirements

California, Texas, and Florida have regulations to limit the amount of NOx that

residential products may exhaust into the atmosphere. For regions like the South Coast

Air Quality Management District (SCAQMD), stricter regulations will go into affect

through 2012. Other States and regions may adopt similar standards in the future, which

may affect gas and oil­fired residential heating products. (See chapter 3 of the

preliminary TSD for more information.)

Low NOx standards require manufacturers to develop cleaner burning fuel

burners and methods to properly control the amount of primary and secondary air.

Manufacturers have spent time and resources on developing cleaner burning products and

these costs have been passed along to the consumer. The introduction of amended

standards may compound the burden on consumers.

Currently, low NOx standards affect fuel­fired water heaters. Manufacturers said

that incorporating a low NOx burner into a design makes it more difficult and costly to

obtain higher energy efficiency levels.

Direct heating equipment is similarly burdened by low NOx requirements.

As of May 2006, pool heater manufacturers are exempt from low NOx

requirements. States have determined that the increase in cost to meet the requirements is

not justified since water heaters are used for a short time over the course of a year.

However, this exemption may change since California, the largest market for pool

heaters, is considering setting pool heater requirements.

12.3.5.2 Standards for Other Products Made by Residential Heating Products

Manufacturers

In addition to the efficiency regulations on residential water heaters, direct heating

equipment, and pool heaters, several other Federal regulations and their pending

regulations apply to other products that heating products manufacturers make. For

example, some manufacturers in the residential heating products industry are subsidiaries

of larger parent companies that manufacture equipment, such as heating, ventilating, and

air­conditioning (HVAC) equipment, that is subject to Federal regulations. The HVAC

industry must address the Environmental Protection Agency (EPA) mandated phaseout of

hydrochlorofluorocarbons (HCFC) refrigerants and blowing agents in their products as

well. DOE will investigate these cumulative regulatory burdens in greater detail during

the MIA analysis.

12.3.5.3 Uniform Building, Plumbing, Health and Safety Codes

Building, plumbing, and health and safety codes regulate how residential heating

products may be installed. Water heater manufacturers said that amended standards

requiring power venting, electronic ignition, or condensing would increase installation

costs. Manufacturers described instances when consumers were required to obtain

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permits or inspections or have a certified technician perform the work, which increased

the cost of installation.

Direct heating equipment manufacturers cited similar instances and explained

how amended standards requiring power venting or electrical connections would increase

installation costs.

Pool heater manufacturers cited similar instances. Pool heater manufacturers also

said zoning regulations may prohibit installation of power vented pool heaters near

property lines where high noise levels could disturb neighbors.

DOE will investigate these codes in greater detail during the MIA analysis.

12.3.6 Impact on Small Manufacturers

The Small Business Administration (SBA) defines small business manufacturing

enterprises for residential heating products as having 500 employees or fewer. In chapter

3 of the preliminary TSD, DOE identified several such small businesses as defined by the

SBA. SBA lists small business size standards that are matched to industries as they are

described in the North American Industry Classification System (NAICS). A size

standard is the largest that a for­profit concern can be and still qualify as a small business

for Federal Government programs. Size standards are generally based on the average

annual receipts or the average number of employees at a firm. For residential water

heater, the size standard is matched to NAICS code 335228, Other Major Household

Appliance Manufacturing, which has a size standard of 500 employees. For residential

direct heating equipment and pool heaters, the size standard is matched to NAICS code

333414, Heat Equipment (except Warm Air Furnaces) Manufacturing, which has a size

standard of 500 employees.

The manufacturer interviews indicated that smaller heating products

manufacturers typically have smaller corporate research and development staff than

larger manufacturers. Smaller manufacturers tend to produce niche or specialty products

and focus on providing products that other larger manufacturers do not produce.

Although small manufacturers often have a more limited product range than larger

manufacturers, the effort to address some aspects of regulations are relatively fixed and

do not scale directly with the number of products or product platforms produced.

Consequently, the cumulative burden of regulations will tend to place more of a burden

on smaller manufacturers because of their more limited resources.

DOE will study the potential impacts to these small businesses in greater detail

during the MIA.

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REFERENCES

1 U.S. Department of Energy, ENERGY STAR Program. Water Heater Criteria

Development. October 26, 2007.

<http://www.energystar.gov/ia/partners/prod_development/new_specs/downloads/water_

heaters/WaterHeaterSecondDraftCriteriaAnalysis.pdf>

2 U.S. Department of Energy, Office of Energy Efficiency and Renewable Energy.

Energy Conservation Program for Consumer Products: Energy Conservation Standards

for Water Heaters; Final Rule. January 17, 2001. Washington, D.C. Last accessed March

18, 2008.

<http://www.eere.energy.gov/buildings/appliance_standards/residential/pdfs/water_heate

r_fr.pdf>

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