1 Carlos has prepared a first rate piece of work in comparing transformer costs by efficiency level at current material prices. However

, the analysis shows more about competition in core materials than about costs of alte rnative

MEPS levels. This is because different efficiency levels will result in different material prices

– in both absolute and relative terms. Conclusions first, followed by my assessment and explanation.

• Price competition in core materials is high.

• Cos ts of transformers are a poor competition index.

• Current material prices have questionable relevance to price of more

efficient transformers.

• Current material supplies and capacities should not be the focus

.

Price Competition In Core Materials Is High.

Rather than connecting the dots for each core material in Carlos’s least cost design graphs, the graphs may be better viewed as a collection of points. Primary attention should be focused on dEL0. There is a reasonably tight

cluster of costs. This reflect s the focus of material manufacturers to focus on price competition based largely on the current DOE MEPS as the primary market, reflecting the reported observation the most investor owned utilities buy DOE minimally acceptable transformers. These prices a lso tend to work

well for the ne xt higher efficiency.

For additional verification, consider a similar plot based on 2007 material prices (including M5 and M6) based on NEMA TP

- 1 efficiencies and the

CSLs considered for the 2007 MEPS determination. The res ult should be a similar pattern, shifted back to focus on NEMA TP

- 1.

Costs Of Transformers Is A Poor Competition Index.

The computed transformer costs is not a good predictor of what kind of transformers will actually sell in the market, or what the fin al market shares will be. Considering 25 kva 1

- phase, for example, Chart 3 suggests that

ZDMH should take the entire market. All other core materials will result in a transformer 50% higher in cost. Absent ZDMH, the market should be shared equally by M3, M 2 and SA1. Yet in reality, M3 dominates the market;2 which is certainly not the conclusion one would draw from the cost vs. efficiency plots.

Weight is a better indicator, as it does not include the misleading indication that material pricing based on comp etition for DOE MEPS units introduces. Consider, however, that weights are based on a 50% load factor, and relative weights will be different at the lower load factors that Chuck Simmons (Progress Energy) suggests may be more common.

Neither weight nor co st, however, can come close to explaining the current or past distribution or market shares of transformer core materials. If neither is a good predictor of the past, one should not expect them to be a good predictor of the future. Relative material weight s are only one of the factors that material manufacturers will consider in evolving their competitive pricing strategy. Most particularly, the consultant forecasts of material demands, including relative demands, are not credible. Indeed , review of TOC open market bids by small municipal utilities show that M3 and M2 materials not only successfully compete in but also dominate in cases with an apparent $8 A factor.

Finally, the costs that DOE presents, even for the base period, ar e subst antially higher than those observed for even small quantity open market bids available and prices paid by small municipal utilities and published on the Internet. These are very small quantities and are therefore expected to exceed the prices paid by large IOUs. The results of our limited review are

shown below.

Comparison of DOE Estimate and Open Market Bid

Transformer Size Winning TOC Bid DOE Estimate

25 kva 1P $ 1,150 $ 1,410

50 kva 1P $ 1,260 $ 2,150

500 kva 1P $ 6,820 $ 10,250

150 kva 3P $ 5,115 $ 6,140

1.5 mva 3P $ 20,660 $ 26,985

In discussions with manufactures and large IOU’s, we found that large IOU’s do, in fact, pay less due to significantly larger volumes. For example, the DOE estimate for 25 kva transformers overstated the IOU cost by between 65 and 70 percent; and overstate d the cost of the 50 kva transformer by 75 percent. Comparisons were more difficult for IOU purchases of 3

-3 phase transformers as they tend to purchase these with substantial “extras” for safety purposes. Without attempting to correct for the extras, howeve r, we found that the cost of a 1,500 kva 3

- phase unit was overstated by 35 percent; thus the overstatement would be much greater if compared with a “vanilla” 1,500 kva 3

- phase unit.

We further note that that the open

- bid prices we located were all TOC (as expected) with A factors of between $8 and $9. Thus they would tend to substantially overstate the dEL0/CSL0 costs which were reported to correspond to an A factor of $4. It should also be noted that the prices

obtained were all for steel core transformer s. We found no successful open bids for amorphous or ZDMH core units, even though the cost analysis suggests that ZDMH should dominate the market now; or SA1 should
capture a one

- third market share in the absence of ZDMH. We did note that

the unsuccessful amorphous core bids were about on par with the unsuccessful steel core bids. Accordingly, we cannot state that the DOE overestimates would also apply to amorphous or ZDMH core transformers, or even that the cost of using these more efficient materials is o verstated at

all. The open

- bid prices also clearly show that much higher efficiencies, consistent with $8 TOCs, can easily be reached with the current practice of using M3 and M2 grades.

Competition appears to have increased as a result of the 2007 efficiency standards, not decreased. The relative contribution of SA1 to the US market has increased, reflecting an increase in competition at both the transformer OEM and material manufacturing levels of the industry. In addition, the entry and growth of core suppliers both increases transformer OEM competition as well as allows for realization of any economies of scale available in production of cores; both of which provide a downward pressure on transformer price. Moreover, competition from off

- shore cor e suppliers of SA1, adds further competitive pressure on domestic suppliers to keep prices low, even in the face of expansion, in order to preserve and protect

market share

.

Current Material Prices Have Questionable Relevance To Price Of

More Efficient T ransformers.

Based on the above, and upon a review of the experience following the 20074 rulemaking, current material prices, even in relative terms, are a poor predictor of future prices. As Carlos also cautioned, “ analysis of the price changes from one e fficiency level to another for the DOE designs is that they are reasonably representative of what would be achieved in actual designs, if one accepts the DOE material price assumptions at increased Efficiency Levels

. Specifically, the cost differentials are the result if and only if material manufacturers and suppliers cease their past competitive

behavior and com mit to current pricing policies regardless of the actions of

their rivals. This is a very strong and unrealistic assumption. Accordingly,

transf ormer prices based on current material prices, and price differentials, are likely to represent at most an upper bound on transformer prices.

Implementation of the MEPS established by the 2007 rule caused dramatic

shifts in materials used for transformer cores. M6 and M5 grades were effectively eliminated and replaced with higher efficiency M3 and M2 and, to a lesser extent, SA1. Since M6 and M5 still must be produced when producing M3 and M2 , a substantial realignment of material shipments and pricing str ategy was required. However, as DOE’s TSD data clearly demonstrate, s teel prices have fallen despite the shift from M6 and M5 to M3 and M2 and ZDMH, and the prices of SA1 cores actually fell by 15% between 2008 and 2010. Indeed, SA1 increased capacity betw een 2007 and 2010, suggesting that incremental capacity can be increased without adversely impacting production costs. Steel prices have fallen since their high in 2008 due to economic conditions. However, the shift from M6 to M3

should have result ed in an increase in the price differential. That the differential was a maximum ($0.32) between 2008 and 2009, falling to $0.22 in 2010 suggests that standards did not adversely impact either the level or the spread in steel prices ; and that there are viable mark ets for the less

efficient grades of core steel . This suggests that the long

- run supply curves for all these materials is probably fairly flat, and that the industry is able to

ramp

- up production and shift output from one grade to another relatively quickl y and with little or no additional investment consequences, at least within the 2+ years DOE permitted for reaction. There is no indication that a similar ramp up in efficiency could not be achieved with similar costs. Material prices are driven by overall supply and demand conditions in the market, with no discernable contribution due to the change in standards.

As previously stated, assuming current material prices and price differentials will hold at increased efficiency levels is tantamount to assuming that5 material manufacturers and suppliers cease their past competitive behavior

and com mit to current pricing policies regardless of the actions of their

rivals. There is no reason to believe that any domestic material supplier will opt to relinquish market share to a competitor, domestic or foreign.

Current Material Supplies And Capacities Should Not Be The Focu s.

Manufacturers do not plan for significant excess capacity. Indeed, except for unusually severe economic conditions, firms tend to operate at or near capacity, expanding only when the business outlook so warrants. Thus the relevant question is not whether a firm or an i ndustry can meet an increase in demand out of current capacity, but can capacity be expanded and at what

cost and in what time frame.

In the case of amorphous, it was stated that Metglas is prepared to expand amorphous capability as necessary to meet new deman d. Metglas did, in fact, significantly expand their US production capacity in response to the 2007 MEPS rule. Since amorphous is not subject to patent restriction, increases in amorphous demand could also be expected to draw new or former producers into th e market. We note that amorphous for core steel is being produced by a major Chinese company and that other major silicon steel manufacturers have produced amorphous in the past in a developmental capacity and could enter the market with an amorphous produ ct in the near

future. Similarly, CRGO electrical steel is also sold and produced internationally. One would expect US producers would also expand as required to maintain market share in a growing US market for more efficient

core materials.

Finally, it s hould be noted, again, that the increased demand for more efficient core materials following the 2007 MEPS rule, and subsequent capacity expansions, were not associated with the sorts of price increases

feared then or now. There is simply no evidence to su ggest that competition will not continue to work in the future as it has in the past.