CHAPTER 12. PRELIMINARY MANUFACTURER IMPACT ANALYSIS

TABLE OF CONTENTS

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

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

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

12.2.2 Phase II: 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 III: Sub­Group Analysis..........................................................................12­2

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 Impact on Financial Performance ......................................................................12­5

12.3.1.1 Conversion Costs .................................................................................12­5

12.3.1.2 Product Mix and Profitability...............................................................12­6

12.3.1.3 Customer Mix.......................................................................................12­6

12.3.2 Impact on U.S. Production and Jobs..................................................................12­6

12.3.2.1 Foreign Labor.......................................................................................12­6

12.3.2.2 Industry Consolidation .........................................................................12­7

12.3.3 Impact on Product Utility and Innovation..........................................................12­7

12.3.4 Cumulative Burdens...........................................................................................12­7

12.3.4.1 Hydrochlorofluorocarbon Phaseout and Foam Insulation Blowing Agent

Phaseout .............................................................................................................12­8

12.3.4.2 Standards for Other Products Made by Commercial Refrigeration

Equipment Manufacturers..................................................................................12­9

12.3.4.3 State Energy Conservation Standards..................................................12­9

12.3.4.4 International Energy Conservation Standards......................................12­9

12.3.4.5 Impact of Cumulative Burden on Small Manufacturers ......................12­9

12­i

 EE-2006-STD-0126 COMMENT 11.2
12­ii

 EE-2006-STD-0126 COMMENT 11.2
CHAPTER 12. PRELIMINARY MANUFACTURER IMPACT ANALYSIS

12.1 INTRODUCTION

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

impacts of efficiency standards on manufacturers. DOE will conduct this analysis with

input from manufacturers and other interested parties and will apply this methodology to

its evaluation of standards. DOE will also consider financial impacts, and of a wide

range of quantitative and qualitative industry impacts that might occur following the

adoption of a standard. For example, a particular standard level, if adopted by DOE,

could require changes to CRE manufacturing practices. DOE will identify and

understand these impacts through interviews with manufacturers and other stakeholders

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 during the Advanced Notice of Proposed

Rulemaking (ANOPR) phase; however, under this new format, DOE has collected,

evaluated, and reported preliminary information and data in the ANOPR. 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 ANOPR 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 stakeholder comments. In Phase I, an industry profile is created to

characterize the industry, and a preliminary MIA is conducted to identify important

issues that require consideration. Results of the Phase I analysis are presented in the

ANOPR TSD. In Phase II, an industry cash flow model and an interview questionnaire

are prepared to guide subsequent discussions. In Phase III, manufacturers are

interviewed, and the impacts of standards are assessed both quantitatively and

qualitatively. Industry and sub­group cash flow and NPV are assessed through use of the

Government Regulatory Impact Model (GRIM). Then impacts on competition,

manufacturing capacity, employment, and regulatory burden are assessed based on

manufacturer interview feedback and discussions. Results of the Phase II and III

analyses are presented in the NOPR TSD.

a This report is available on the DOE website at:

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

12­1

 EE-2006-STD-0126 COMMENT 11.2
12.2.1 Phase I: Industry Profile

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

and quantitative financial and market information. This includes CRE 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.

In addition, DOE relies on information from its market and technology assessment,

engineering analysis, life­cycle cost analysis, and analysis of markups to determine

equipment price to characterize the CRE manufacturing industry.

12.2.2 Phase II: Industry Cash­Flow Analysis and Interview Guide

In Phase II, 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 energy conservation

standards on the CRE industry. Standards will likely require additional investment, raise

production costs, and affect revenue through higher prices and, possibly, lower sales.

The GRIM uses a number of factors to determine a series of annual cash flows for the

year standards become effective and continuing 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. The results of the GRIM are compared against

baseline projections where no standards are in place. The financial impact of new

standards is the difference between the two sets of discounted annual cash flows.

12.2.2.2 Interview Guide

During Phase III of the MIA, DOE will conduct interviews with manufacturers to

gather information on the effects of standards on revenues and finances, direct

employment, capital assets, and on industry competitiveness. Prior to 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.

12.2.3 Phase III: Sub­Group Analysis

The Phase III activities will take place after the publication of the ANOPR, and

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

12­2

 EE-2006-STD-0126 COMMENT 11.2
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 I and the cash­flow analysis performed in

Phase II will be supplemented with information gathered during interviews with

manufacturers during Phase III. 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 is 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 that they 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 II 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 cash flow model based on the feedback provided

through the interviews.

12.2.3.3 Manufacturer Sub­Group Analysis

Using average cost assumptions to develop an industry cash flow 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 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

12­3

 EE-2006-STD-0126 COMMENT 11.2
manufacturers and other stakeholders to suggest what sub­groups or characteristics are

the 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 that is 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 on 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 consequential

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

the United States and 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 new energy­efficiency standards on employment is an important

consideration in the rulemaking process. In order to assess how domestic employment

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

air­conditioning industry. In addition, the interview will solicit manufacture 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

new or revised DOE standards and other regulatory actions affecting the same equipment.

DOE will analyze and consider the impact on manufacturers of multiple, equipmentspecific regulatory actions.

12­4

 EE-2006-STD-0126 COMMENT 11.2
Based on its own research and discussions with manufacturers, DOE identified

several regulations relevant to commercial refrigeration equipment, including: existing

or new standards for commercial refrigeration equipment, hydrochlorofluorocarbon

(HCFC) phaseout and foam insulation blowing agent phaseout, standards for other

equipment made by CRE 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 ANOPR phase, DOE conducted a preliminary evaluation of the impact

of potential new regulations on CRE manufacturer financial performance, manufacturing

capacity and employment levels, and equipment utility and innovation. A primary focus

was to identify the cumulative burden that industry faces from the overlapping effect of

new or recent DOE energy conservation standards and/or other regulatory action

affecting the same equipment or industry.

The primary sources of information for this analysis were telephone interviews

with manufacturers of commercial refrigeration equipment that were carried out during

the fall of 2006. To maintain confidentiality, DOE did not identify the individual

manufacturers that disclosed information. Instead, the evaluation only reports aggregated

information and does not disclose sensitive information or identify company­specific

information.

12.3.1 Impact on Financial Performance

DOE received views from manufacturers about what they perceived to be the

possible impact of potential new standards on their future profitability. As stated by

manufacturers, a new energy conservation standard has the potential to impact financial

performance in several different ways. The capital investment needed to upgrade or

redesign equipment and platforms before they have reached the end of their useful life

can require conversion costs that otherwise would not be expended, resulting in stranded

investments. In addition, more stringent standards can result in higher per­unit costs that

may deter some customers from buying higher­margin units with more features, thereby

decreasing manufacturer profitability.

12.3.1.1 Conversion Costs

DOE estimates that a CRE production line would have a life cycle of

approximately 15 to 20 years in the absence of standards. During that period,

manufacturers would not make major equipment changes that altered the underlying

platforms. Thus, a 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.

12­5

 EE-2006-STD-0126 COMMENT 11.2
DOE asked manufacturers what level of conversion costs they anticipated if

efficiency standards were to take effect. In general, manufacturers expected only

conversion costs associated with redesigning insulation foaming fixtures. One

manufacturer estimated this to be approximately $10 million in new fixtures, research,

and testing. Manufacturers indicated there would not be a significant amount of stranded

assets because of standards, but any stranded assets that did exist would be primarily in

the insulation foaming fixtures. The manufacturers also indicated that standards would

have little effect on capacity and utilization.

12.3.1.2 Product Mix and Profitability

DOE asked manufacturers how a new efficiency standard would affect equipment

mix and profitability. Manufacturers replied that efficiency standards would have a

significant impact on the equipment mix of commercial refrigeration equipment. They

felt that standards might push the equipment mix of the overall market toward

commercial refrigeration equipment with doors and away from low­volume equipment.

This would result in an overall equipment mix that is less diverse than what is currently

available. However, manufacturers felt that it was very difficult to make accurate

projections without knowing the level of the standards.

Also, manufacturers suggested that standards would not have a significant effect

on profit margins, since they would pass the increase in cost along to the customer.

Because the majority of commercial refrigeration equipment sales is directly to the

customer, there are no distribution markups that would be affected.

12.3.1.3 Customer Mix

Because manufacturers would pass on cost increases to the customer, many

manufacturers believed that the customer stood to lose the most from a new efficiency

standard. Several manufacturers predicted that the increased cost of commercial

refrigeration equipment could squeeze smaller “mom and pop” grocers financially, and

could cause consolidation within the supermarket industry. However, some

manufacturers felt there would be little change in the customer mix, thus indicating the

difficulty in projecting these trends.

12.3.2 Impact on U.S. Production and Jobs

The impact of new efficiency standards on employment is an important

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

might be affected by new energy efficiency standards for commercial refrigeration

equipment, DOE posed several questions related to this topic to manufacturers.

12.3.2.1 Foreign Labor

Over the past several years, some CRE manufacturers have moved a portion of

their production out of the United States, primarily driven by concerns about profitability

and the opportunity for lower labor costs. Mexico is the most common location for U.S.

manufacturers to establish new production capacity, since it offers low labor rates

12­6

 EE-2006-STD-0126 COMMENT 11.2
(relative to the United States) and proximity to the U.S. market. Manufacturers indicated

that they anticipate new standards will accelerate the trend to manufacture commercial

refrigeration equipment outside of the United States. Further, new standards may

accelerate the rate at which CRE production is moved to Mexico because if

manufacturers need to make large capital investments to produce redesigned platforms,

they have strong financial incentives to invest in a location with lower labor costs.

12.3.2.2 Industry Consolidation

Manufacturers indicated that new standards could cause them to exit one or more

portions of the markets affected by the standards. Thus, standards could affect the degree

to which a limited number of companies dominate a market. At present, four companies

account for a large majority of CRE sales.

DOE asked manufacturers to what degree they expected industry consolidation to

occur in the absence of standards. In general, manufacturers felt that there would be little

industry consolidation in the future. Historically, the commercial refrigeration industry

has not seen extensive consolidation, although several manufacturers have been bought

and sold by parent companies in the past.

12.3.3 Impact on Product Utility and Innovation

DOE understands that new standards can impact purchasers of commercial

refrigerators and commercial freezers by increasing or decreasing the utility of such

equipment, e.g., the interior volume or non­energy­related features. Manufacturers

generally believed that more stringent energy efficiency standards would decrease

innovations and, in some cases, result in reduced equipment utility.

DOE asked manufacturers how a new efficiency standard would affect

innovation. Some manufacturers stated that more stringent standards would require

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

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

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

existing equipment or developing new equipment. They pointed out that their primary

customers (major supermarket chains) drive innovation by demanding unique equipment,

and standards could hurt a manufacturer’s ability to meet customer demands for

customized equipment. Other manufacturers asserted that standards would spur technical

innovation, leading to advancements in air­curtain design, and other case features.

12.3.4 Cumulative Burdens

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

several regulations relevant to commercial refrigeration equipment, including:

• Existing or new standards for commercial refrigeration equipment;

• Phaseout of HCFC refrigerants and foam insulation blowing agents;

• Standards for other equipment made by CRE manufacturers;

12­7

 EE-2006-STD-0126 COMMENT 11.2
• 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

impacting the CRE industry.

Also, DOE considers the possibility of small businesses being particularly

impacted by the promulgation of minimum efficiency standards for commercial

refrigeration equipment. In the market and technology assessment (chapter 3) of the

Technical Support Document (TSD), DOE identified a number of small businesses, as

defined by the Small Business Administration (SBA).

DOE will study the potential impacts of these cumulative burdens and impacts to

small businesses in greater detail during the MIA, which it will conduct as a part of the

NOPR analysis.

12.3.4.1 Hydrochlorofluorocarbon Phaseout and Foam Insulation Blowing

Agent Phaseout

Due to the phase­out of chlorofluorocarbons (CFCs) and HCFCs, the commercial

refrigeration industry must transition to non­ozone­depleting refrigerants. As a result, the

refrigeration industry is transitioning to hydrofluorocarbon­based (HFC­based)

refrigerants in its equipment. For the remote condensing and self­contained equipment

covered in this rulemaking, DOE understands that most of the industry has already been

using HFC­based refrigerants such as HFC­134a and HFC­404a.

Production of foam insulation uses a blowing agent. The Environmental

Protection Agency’s (EPA) strategy for meeting U.S. obligations under the Montreal

Protocol requires the United States to phase out the production and use of HCFC blowing

agents. For example, the United States phased out HCFC­141b on January 1, 2003.

Further, import of HCFC­141b is prohibited and production of HCFC­141b may only

continue in the United States for export to other countries with a later phaseout date, such

as Mexico. HCFC­22 and HCFC­142b will be phased out on January 1, 2010. This

impacts equipment produced in the United States and causes manufacturers to switch to

other blowing agents with zero ozone depletion potential (ODP). One CRE manufacturer

estimated the required investment to be approximately $500,000. An example of a zeroODP blowing agent is HFC­245fa. Only one company, however, produces HFC­245fa

for the U.S. market. This represents a significant challenge for manufacturers to control

equipment costs and avoid future production disruptions. Alternative blowing agents

such as HFC­134a or cyclopentane have other drawbacks, such as lower thermal

resistance or increased implementation costs due to flammability.

12­8

 EE-2006-STD-0126 COMMENT 11.2
12.3.4.2 Standards for Other Products Made by Commercial Refrigeration

Equipment Manufacturers

In addition to the efficiency regulations on commercial refrigeration equipment,

several other Federal regulations and their pending regulations apply to other equipment

made by CRE manufacturers. For example, some manufacturers in the commercial

refrigeration 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 EPA­mandated

phaseout of HCFC refrigerants in their equipment as well. DOE will investigate these

cumulative regulatory burdens in greater detail during the MIA analysis in the NOPR

phase of the rulemaking.

12.3.4.3 State Energy Conservation Standards

DOE identified and described regulatory programs at the State level in Chapter 3

of the TSD for the equipment covered in this rulemaking. For example, the California

Energy Commission regulates commercial ice­cream freezer energy consumption. Other

States have requirements for other types of commercial refrigeration equipment not

covered under this rulemaking. Most manufacturers have equipment lines that include

equipment under both categories.

12.3.4.4 International Energy Conservation Standards

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

and Australia, in Chapter 3 of the TSD for commercial refrigeration equipment. Most

CRE manufacturers sell a small portion of their total production to countries besides the

United States. In such cases, the equipment must meet the standards for each of those

countries. Companies may design some units to meet standards that are more stringent

than those imposed by the United States to minimize the number of equipment variations.

12.3.4.5 Impact of Cumulative Burden on Small Manufacturers

In Chapter 3 of the TSD, DOE identified a number of small businesses as defined

by the SBA. The SBA defines small business manufacturing enterprises for commercial

refrigeration equipment as having 750 employees or fewer. 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 commercial refrigeration equipment, the size standard is

matched to NAICS code 333415, Air­Conditioning and Warm Air Heating Equipment

and Commercial and Industrial Refrigeration Equipment Manufacturing, which has a size

standard of 750 employees.

The manufacturer interviews indicated that smaller CRE manufacturers typically

have smaller corporate research and development staff than do larger manufacturers.

Smaller manufacturers tend to produce niche or specialty equipment and focus on

12­9

 EE-2006-STD-0126 COMMENT 11.2
providing equipment 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 as a part of the NOPR analysis.

12­10

 EE-2006-STD-0126 COMMENT 11.2