12 -i CHAPTER 12. MANUFACTURER IMPACT ANALYSIS

TABLE OF CONTENTS

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

12.2 METHODOLOGY ......................................................................................................... 12-1 12.2.1 Phase I: Industry Profile .......................................................................................... 12-2

12.2.2 Phase II: Industry Cash -Flow Analysis and Interview Guide ................................. 12-2 12.2.2.1 Industry Cash- Flow Analysis ........................................................................... 12-3

12.2.2.2 Interview Guides .............................................................................................. 12-3 12.2.3 Phase III: Subgroup Analysis .................................................................................. 12-4

12.2.3.3 Manufac turing Interviews ................................................................................ 12-4 12.2.3.4 Revised Industry Cash- Flow Analysis ............................................................. 12-4

12.2.3.6.1 Small -Business Manufacturer Subgroup ...................................................... 12-5

12.2.3.7 Manufacturing Capacity Impact ....................................................................... 12-6

12.2.3.8 Employment Impact ......................................................................................... 12-6

12.2.3.9 Cumulative Regu latory Burden ........................................................................ 12-6

12.3 Manufacturer Impact Analysis Key Issues ..................................................................... 12-6

12.3.1 Conversion costs and stranded assets ...................................................................... 12-6

12.3.2 Shortage of Materials ............................................................................................... 12-7 12.3.3 Compliance and Enforcement ................................................................................. 12-8

12.3.4 Effective Date .......................................................................................................... 12-8 12.3.5 Size and Weight Constraints .................................................................................... 12-8

12.3.6 Emergency Situations .............................................................................................. 12-8

12.4 GRIM INPUTS AND ASSUMPTIONS ......................................................................... 12-9

12.4.1 Overview of the GRIM ............................................................................................ 12-9 12.4.2 Sources for GRIM Inputs ........................................................................................ 12-9

12.4.2.1 Cor porate Annual Reports .............................................................................. 12-10 12.4.2.2 Standard and Poor Credit Ratings .................................................................. 12-10 12.4.2.3 Shipment Model ............................................................................................. 12-10 12.4.2.4 Engineering Analysis ..................................................................................... 12-10

12.4.2.5 Manufacturer Interviews ................................................................................ 12-11

12.4.3 Financial Parameters .............................................................................................. 12-11 12.4.4 Corporate Discoun t Rate ....................................................................................... 12-13

12.4.5 Trial Standard Levels ............................................................................................. 12-15 12.4.6 NIA Shipment Forecast ......................................................................................... 12-17

12.4.7 Production Costs .................................................................................................... 12-18

12.4.8 Conversion Costs ................................................................................................... 12-23 12.4.8.1 Liquid Immersed Distribution Transformers ................................................. 12-23 12.4.8.1.1 Capital Conversion Expenditures ............................................................... 12-23 12.4.8.1.1.1 Uncertainty Associated with Amorphous Demand.................................... 12-26 12.4.8.1.2 Product Conversion Expenses .................................................................... 12-27

12.4.8.2 Dry Type Transformers .................................................................................. 12-29 12.4.8.2.1 Capital Conversion Expenditures ............................................................... 12-29 12.4.8.2.2 Product Conversion Expenses .................................................................... 12-3012

- ii 12.4.9 Markup Scenarios .................................................................................................. 12-31

12.4.9.1 Preservation of Gross Margin Percentage Markup Scenario ......................... 12-31 12.4.9.2 Preservation of Operating Profit Markup Scenario ........................................ 12-31

12.5 INDUSTRY FINANCIAL IMPACTS ......................................................................... 12-32 12.5.1 Impacts on Industry Net Present Value ................................................................. 12-32 12.5.2 Impacts on Annual Cash Flow............................................................................... 12-34

12.6 IMPACTS ON MANUFACTURER SUBGROUPS .................................................... 12-42

12.6.1 Impac ts on Small Business Manufacturers ............................................................ 12-42

12.6.1.1 Description and Estimated Number of Small Entities Regulated .................. 12-42

12.6.1.2 Comparison Between Large and Small Entities ............................................. 12-44

12.6.1.3 Description and Estimate of Compliance Requirements ................................ 12-45

12.7 OTHER IMPACTS ....................................................................................................... 12-47 12.7.1 Employment........................................................................................................... 12-47 12.7.2 Production Capacity .............................................................................................. 12-48 12.7.3 Cumulative Regulatory Burden ............................................................................. 12-49

12.7.3.1 Federal Regulations on Distribution Transformer Manufacturers ................. 12-50 12.7.3.2 Foreign Regulations on Distribution Transformer Manufacturers ................. 12-50

12.8 CONCLUSION ............................................................................................................. 12-50

LIST OF TABLES

Table 12.2- 1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking ................................................................................................................... 12-5 Table 12.4-1 GRIM Financial Parameters Based on 2005–2010 Weighted Company

Financial Data .......................................................................................................................... 12-12 Table 12.4-2 GRIM Revised Distribution Transformer Industry Financial Parameters ......... 12-13 Table 12.4-3 Cost of Equity Calculation ................................................................................. 12-14

Table 12.4- 4 Cost of Debt Calculation .................................................................................... 12-15 Table 12.4-5 Trial Standard Levels for Liquid Immersed Distribution Transformers ............ 12-16

Table 12.4-6 Trial Standard Levels for Low- Voltage Dry

- Type

Distribution Transformers ........................................................................................................ 12-16

Table 12.4-7 Trial Standard Levels for Medium

- Voltage Dry

- Type

Distribution Transformers ........................................................................................................ 12-17 Table 12.4-8 Manufacturer Production Cost Breakdown ($2011) for Design Line 1 ............. 12-18 Table 12.4-9 Manufacturer Production Cost Breakdown ($2011) for Design Line 2 ............. 12-19 Table 12.4-10 Manufacturer Production Cost Breakdown ($2011) for Design Line 3 ........... 12-19 Table 12.4-11 Manufacturer Production Cost Breakdown ($2011) for Design Line 4 ........... 12-19 Table 12.4-12 Manufacturer Production Cost Breakdown ($2011) for Design Line 5 ........... 12-20 Table 12.4-13 Manufacturer Production Cost Breakdown ($2011) for Design Line 6 ........... 12-20 Table 12.4-14 Manufacturer Production Cost Breakdown ($2011) for Design Line 7 ........... 12-20 Table 12.4-15 Manufacturer Production Cost Breakdown ($2011) for Design Line 8 ........... 12-21

Table 12.4- 16 Manufactu rer Production Cost Breakdown ($2011) for Design Line 9 ........... 12-21 Table 12.4-17 Manufacturer Production Cost Breakdown ($2011) for Design Line 10 ......... 12-21 Table 12.4-18 Manufacturer Production Cost Breakdown ($2011) for Design Line 11 ......... 12-22 Table 12.4-19 Manufacturer Production Cost Breakdown ($2011) for Design Line 12 ......... 12-2212

- iii Table 12.4-20 Manufacturer Production Cost Breakdown ($2011) for Design Line 13A ...... 12-22 Table 12.4-21 Manufacturer Production Cost Breakdown ($2011) for Design Line 13B ...... 12-23 Table 12.4-22 Summary of Liquid- Imme rsed Distribution Transformer Conversion Capital Expenditures ................................................................................................................ 12-26 Table 12.4-23 Summary of Product Conversion Expenditures for Liquid Immersed Industry ................................................................................................................... 12-28 Table 12.4-24 Product and Capital Conversion Costs for Design Line 1 by TSL ................... 12-28 Table 12.4-25 Product and Capital Conversion Costs for Design Line 2 by TSL ................... 12-28 Table 12.4-26 Product and Capital Conversion Costs for Design Line 3 by TSL .................. 12-28 Table 12.4-27 Product and Capital Conversion Costs for Design Line 4 by TSL .................. 12-28 Table 12.4-28 Product and Capital Conversion Costs for Design Line 5 by TSL .................. 12-29 Table 12.4-29 Summary of Low Voltage Dry Type Distribution Transformer Capital Conversion Expenditures ......................................................................................................... 12-30 Table 12.4-30 Summary of Medium Voltage Dry Type Distribution Transformer Capital Conversion Expenditures ......................................................................................................... 12-30 Table 12.4-31 Summary of Product Conversion Expenditures for the Low- Voltage Dry

- Type Industry ................................................................................................................... 12-30 Table 12.4-32 Summary of Product Conversion Expenditures for the Medium Voltage Dry Type Industry .................................................................................................................... 12-31 Table 12.5-1 Changes in Industry Net Present Value for Liquid- immersed Distribution

Transformers - Preservation of Operating Profit Markup Scenario ......................................... 12-32 Table 12.5-2 Changes in Industry Net Present Value for Liquid- immersed Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario .......................... 12-33 Table 12.5-3 Changes in Industry Net Present Value for Low- Voltage Dry

- Type Distribution Transformers - Preservation of Operating Profit Markup Scenario .................... 12-33 Table 12.5-4 Changes in Industry Net Present Value for Low- Voltage Dry

- Type Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario .......................... 12-33 Table 12.5-5 Changes in Industry Net Present Value for Medium- Voltage Dry

- Type Distribution Transformers - Preservation of Operating Profit Markup Scenario .................... 12-34 Table 12.5-6 Changes in Industry Net Present Value for Medium- Voltage Dry

- Type

Distribution Transformers - Preservation of Gross Margin Percentage Markup Scenario ...... 12-34 Table 12.6-1 Estimated Product Conversion Costs as a Percentage of Annual R&D Expense . 12-

45 Table 12.6-2 Estimated Capital and Product Conversion Costs as a Percentage of Annual Capital Expenditures and R&D Expense ................................................................................. 12-46 Table 12.6-3 Estimated Capital and Product Conversion Costs as a Percentage of Annual Capital Expenditures and R&D Expense ................................................................................. 12-47

LIST OF FIGURES

Figure 12.4- 1 Using the GRIM to Calculate Cash Flow ........................................................... 12-9 Figur e 12.4-2 Capital Conversion Cost Methodology for Liquid Immersed Distribution

Transformers ............................................................................................................................ 12-2412

- iv Figure 12.5-1 Annual Industry Free Cash Flows for Liquid

- immersed Distribution Transformers

- Preservation of Gross Margin Percentage Markup Scenario ................................................. 12-36 Figure 12.5- 2 Annual Industry Free Cash Flows for Liquid

- immersed Distribution Transformers - Preservation of Operating Profit Markup Scenario ............................................................... 12-37 Figure 12.5- 3 Annual Industry Free Cash Flows for Low

- Voltage Dry

- Type Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario .......................... 12-38 Figure 12.5- 4 Annual Industry Free Cash Flows for Low

- Voltage Dry

- Type Distribution

Transformers - Preservation of Operating Profit Markup Scenario ......................................... 12-39 Figure 12.5- 5 Annual Industry Free Cash Flows for Medium

- Voltage Dry

- Type Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario .......................... 12-40 Figure 12.5- 6 Annual Industry Free Cash Flows for Medium- Voltage Dry

- Type Distribution

Transformers - Preservation of Operating Profit Markup Scenario ......................................... 12-4112 -1 CHAPTER 12. MANUFACTURER IMPACT ANALYSIS

12.1 INTRODUCTION
In determining whether a standard is economically justified, the U.S. Department of Energy (DOE) is required to consider “the economic impact of the standard on the manufacturers and on the consumers of the products subject to such a standard.” (42 U.S.C. 6312 (a)(6)(B)(i)) The law also calls for an assessment of the impact of any lessening of competition as determined in writing by the Attorney General. Id. DOE conducted a manufacturer impact analysis (MIA) to estimate the financial impact of amended energy conservation standards on manufacturers of distribution transformers, and assessed the impact of such standards on direct employment and manufacturing capacity.

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

12.2 METHODOLOGY
DOE conducted the MIA in three phases. Phase I, “Industry Profile,” consisted of preparing an industry characterization for the distribution transformer industry, including data on market share, sales volu mes and trends, pricing, employment, and financial structure. In Phase II, “Industry Cash Flow,” DOE used the GRIM to assess the impacts of amended energy

conservation standards on distribution transformers.

In Phase II, DOE created a GRIM for distribution transformers and an interview guide to gather information on the potential impacts on manufacturers. DOE presented the MIA results

for distribution transformers based on a set of considered TSLs. These TSLs are described in

Section 12.4.5 below.

In Phase III, “Subgroup Impact Analysis,” DOE interviewed manufacturers representing 65 percent of liquid- immersed transformer sales, 75 percent of medium -voltage dry- type transformer sales, and 5 0 percent of low -voltage dry- type transformer sales . Interviewees included large and small manufacturers with various market shares and market focu s, providing a representative cross -section of the industries. During interviews, DOE discussed financial topics specific to each manufacturer and obtained each manufacturer’s view of the industry. The interviews provided DOE with valuable information for evaluating the impacts of amended energy conservation standards on manufacturer cash flows, investment requirements, and employment.12 -2 12.2.1 Phase I: Industry Profile

In Phase I of the MIA, DOE prepared a profile of the distribution transformer industry that built upon the market and technology assessment prepared for this rulemaking (see Chapter 3 of this Technical Support Document). Before initiating the detailed impact studies, DOE collected information on the present and past structure and market characteristics of each industry. This information included market share data, unit shipments, manufacturer markups, and the cost structure for various manufacturers. The industry profile includes: (1) further detail

on the overall market and equipment characteristics; (2) estimated manufacturer market shares; (3) financial parameters such as net plant, property, and equipment; selling, general and administrative (SG&A) expenses; cost of goods sold, etc.; and (4) trends in the number of firms, market, and product characteristics. The industry profile included a top-down cost analysis of distribution transformer manufacturers that DOE used to derive preliminary financial inputs for the GRIM (e.g., revenues, depreciation, SG&A, and research and development (R&D)

expenses ).

DOE also used public information to further calibrate its initial characterization of the distribution transformer industry, including Securities and Exchange Commission (SEC) 10– K reports, Standard & Poor’s (S&P) stock reports, and corporate annual r eports. DOE supplemented this public information with data released by privately held companies.

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

Phase II focused on the financial impacts of potential amended energy conservation

standards on manu facturers of distribution transformers . More stringent energy conservation

standards can affect manufacturer cas h flows in three distinct ways: (1) create a need for increased investment, (2) raise production costs per unit, and (3) alter revenue due to hi gher per

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

- flow analysis for distribution transformers . In performing these analyses, DOE used the financial values derived during Phase I and the shipment scenarios used in the national impact analysis (NIA). In Phase II, DOE performed these preliminary industry

cash -flow analyses and prepared written guides for manufacturer interviews.

In Phase II, DOE grouped the cash flow results for design lines made by the same sets of

manufacturers serving the same markets to assess the impacts of amended energy conservation

standards with more granularity . DOE presented the MIA cash flow results for this rulemaking in

three classes : liquid

- immersed transformers, medium-voltage dry type transformers, and lowvoltage dry type transformers

. The Department believes that modeling the industry in separate ”superclasses” offers a robust analytical approach for three reasons:

1. Customer profiles and marke t mechanisms

– Generally, the profiles of the majority of customers purchasing transformers and the manner in which they are built and sold within each of the superclasses are distinct. Discussion of customer profiles and distribution chains can be

found i n the LCC analysis (Chapter 11 of the TSD ).

2. Manufacturing equipment and transformer design – The equipment necessary for production and the methods by which manufacturers build transformers are different for each of12 -3 the superclasses. For example, in the liquid

- immersed superclass, transformer cores tend to be wound, requiring distributed gap core winding machines, annealing furnaces, tanking machines, and other equipment that is commonly used in this superclass. Accordingly, the capital equipment investm ent necessary for compliance with a particular TSL typically differs between the superclasses

.

3. Industry structure – Reviewing the database of transformer manufacturers, the Department observed that many companies operate and specialize in one of the distribution transformer superclasses. For large companies that operate in more than one superclass , each manufacturing facility tends to be dedicated to producing transformers from one of the superclasses. Thus, the industry naturally breaks down into three superclasses

.

12.2.2.1 Industry Cash -Flow Analysis

The GRIM uses several factors to determine a series of annual cash flows from the announcement year of amended energy conservation standards until several years after the standards’ compliance date. These factors include annual expected revenues, costs of sales, SG&A, taxes, and capital expenditures related to the amended standards. Inputs to the GRIM include manufacturing production costs, selling prices, and shipments forecasts developed in other analyses. DOE de rived the manufacturing costs from the engineering analysis and information provided by the industry and estimated typical manufacturer markups from public financial reports and interviews with manufacturers. DOE developed alternative markup

scenarios for the GRIM based on discussions with manufacturers. DOE’s shipments analysis, presented in Chapter 9 of the TSD, provided the basis for the shipment projections in the GRIM. The financial parameters were developed using publicly available manufacturer data and were

revised with information submitted confidentially during manufacturer interviews. The GRIM results are compared to base case projections for the industry. The financial impact of amended energy conservation standards is the difference between the discounted annual cash flows in the

base case and standards case at each TSL.

12.2.2.2 I nterview Guides
During Phase III of the MIA, DOE interviewed manufacturers to gather information on the effects of amended energy conservation on revenues and finances, direct employment, capital assets, and industry competitiveness. Before the interviews, DOE distributed an interview guide

for the distribution transformer industry. The interview guide provided a starting point to identify relevant issues and help identify the impacts of amended energy conservation standards on individual manufacturers or subgroups of manufacturers. Most of the information DOE received from these meetings is protected by non -disclosure agreements and resides with DOE’s

contractors. Before each te lephone interview or site visit, DOE provided company representatives with an interview guide that included the topics for which DOE sought input. The MIA interview topics included (1 ) k ey issues to this rulemaking; (2) company overview and organizational characteristics; (3 ) manufacturer markups and profitability; (4) distribution channels; (5 ) shipment projections and market shares; (6 ) financial parameters; ( 7) conversion costs; ( 8) cumulative regulatory burden; (9 ) direct employment impact assessment; ( 10) manufacturing capacity, foreign competition , and outsourcing ; (11) consolidation, and (12 ) impacts on small business. The interview guides are presented in Appendix 12A.12 -4 12.2.3 Phase III: Subgroup Analysis

Using average cost and financial assumptions to develop an industry cash flow model 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 impacted. For the distribution transformer industry , DOE analyze s small business manufacturers a s a subgroup.

12.2.3.3 Manufacturing Interviews
The information gathered in Phase I and the cash flow analysis performed in Phase II are supplemented with information gathered from manufacturer interviews in Phase III. The interview process provides an opportunity for interested parties to express their views on important issues privately, allowing confidential or sensitive information to be considered in the rulemaking proc ess.

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

for distribution transformer manufacturers. DOE contacted companies from its database of manufacturers and interviewed small and large companies, subsidiaries an d independent firms, and public and private corporations to provide a n accurate representation of the industry. Interviews were scheduled well in advance to provide every opportunity for key individuals to be available for comment. Although a written respo nse to the questionnaire was acceptable, DOE sought interactive interviews, which help ed clarify responses and identify additional issues. The resulting information provides valuable inputs to the GRIM developed for the equipment classes.

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

feedback. Section 12.4 provides more information on how DOE calculated the parameters.

The Department conducted structured, detailed, face- to

- face interviews with seven manufacturers, some of which produce transformers in more than one superclass. Three of the seven manufacturers are small businesses. Three of the manufacturers produce l iquid- immersed transformers, collectively representing approximately 65 percent of the U.S. liquid- immersed market. Two of the manufacturers produce medium- voltage dry

- type transformers, collectively representing approximately 75 percent of the U.S. medium- voltage dry

- ty pe market. Three of the manufacturers produce low -voltage dry- type transformers, collectively representing approximately 30 percent of the U.S. low- voltage dry

- type market. DOE also conducted many more phone interviews and follow-up discussions with trans former manufacturers, particularly small businesses, to gather important information about their businesses and their perspectives on amended standards. Additionally, DOE gained invaluable insights during the many stakeholder negotiations when manufacturers openly discussed their businesses and concerns

with amended standards.12 -5 12.2.3.6.1 Small

- Business Manufacturer Subgroup
DOE investigated whether small business manufactu rers should be analyzed as a manufacturer subgroup. DOE used the Small Business Administration (SBA) small business size standards published on August 22, 2008, as amended, and the North American Industry Classification System (NAICS) code, presented in Table 12.2-1 , to determine whether any small entities would be affected by the rulemaking. a For the equipment classes under review, the SBA bases its small business definition on the total number of employees for a business, its subsidiaries, and its parent companies. An aggregated business entity with fewer employees than

the listed limit is conside red a small business.

Table 12.2-1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking

Industry Description Revenue Limit Employee Limit NAICS

Power, Distribution and Specialty Transformer Manufacturing N/A 750 335311

DOE used the National Electrical Manufacturers Association (NEMA) member directory 1 to identify manufacturers of distribution transformers. DOE also utilized information from previous rulemakings, UL qualification directories, individual company websites, and market research tools ( e.g.

During its research, DOE identified approximately 30 companies which manufacture products covered by this rulemaking and qualify as small businesses per the applicable SBA definition. DOE contacted the small businesses to solicit feedback on the potential impacts of energy conservation standards. Two of the smal l businesses consented to being interviewed during the face

- to

- face MIA interviews and plant tours, while DOE ’s contractor also received

feedback from several additional small business es through phone interviews and email correspondence. In addition to posing the standard MIA interview questions, DOE solicited data from manufacturers on differential impacts that small companies might experience from amended energy conservation standards. Because DOE was not able to certify that the proposed rulemaking would not have a significant economic impact on a substantial number of small entities, DOE has analyzed small manufacturers as a subgroup. The results of this subgroup analysis are presented in S ection , Hoover’s reports) to create a list of companies that potentially manufacture distribution transformers covered by this rulemaking. Additionally, DOE also asked interested parties and industry representatives if they were aware of other smal l business manufacturers. DOE contacted select companies on its list, as necessary, to determine whether they met the SBA’s definition of a small business manufacturer of cover ed distribution

transformers . DOE screened out companies that did not offer products covered by this rulemaking, did not meet the definition of a “small business,” or are foreign owned and operated.

12.6

.

a The size standards are available on the SBA’s website at http://www.sba.gov/content/table

- small

- business

- size

standards12 -6 12.2.3.7 Manufacturing Capacity Impact
One significant outcome of amended energy conservation standards could be the obsolescence of existing manufacturing assets, including tooling and investment. T he manufacturer interview guides have a series of questions to help identify impacts of amended standards on manufacturing capacity, specifically capacity utilization and plant location decisions in the United States and North America, with and without amended standards; the ability of manufacturers to upgrade or remodel existing facilities to accommodate the new requirements; the nature and value of any stranded assets; and estimates for any one

- time changes to existing plant, property, and equipment (PPE). DOE’s estimates of the one- time capital changes and stranded assets affect the cash flow estimates in the GRIM. These estimates

can be found in Section 12.4.8 ; DOE’s discussion of the capacity impact can be found in Section

12.7.2

.

12.2.3.8 Employment Impact
The impact of amended energy conservation standards on employment is an important consideration in the rulemaking process. To assess how domestic direct employment patterns might be affected, the interviews explored current employment trends in the distribution

transformer industry. The interviews also solicited manufacturer views on changes in employment patterns that may result from more stringent standards. The employment impacts section of the interview guide focused on current employment levels associated with manufacturers at each production f acility, expected future employment levels with and without amended energy conservation standards, and differences in workforce skills and issues related to the retraining of employees. The employment impacts are reported in Section 12.7.1

.

12.2.3.9 Cumulative Regulatory Burden
DOE seeks to mitigate the overlapping effects on manufacturers due to amended energy conservation standards and other regulatory actions affecting the same equipment . DOE analyzed the impact on manufacturers of multiple, product-specific regulatory actions. Based on its own research and discussions with manufacturers, DOE identified regulations relevant to distribution

transformer manufacturers, such as State regulati ons and other Federal regulations that impact other products made by the same manufacturers. Discussion of the cumulative regulatory burden

can be found in Section 12.7.3

.

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

12.3.1 Conversio n costs and stranded assets

For manufacturers of distribution transformers, liquid- immersed, medium

- voltage dry

type, and low-voltage dry-type, conversion costs and stranded assets are a major concern. All12 -7 manufacturers stated that efficiency levels that r equire the use of amorphous steel would sharply increase conversion costs. Due to the thickness and brittleness of amorphous steel, unique production processes and new material handling processes must be applied. Manufacturers noted that they would need to make extensive capital investments in amorphous core production equipment, including core cutting machines, annealing ovens, and lacing tables.

Dry -type manufacturers also stated that a standard that moves the industry to silicon steel wound cores would also greatly increase conversions costs. Since the vast majority of dry type manufacturers produce stacked cores, a move to wound cores would lead to extensive stranded assets. In some cases, manufacturers may consider purchasing prefabri cated cores rather than modifying their facilities to produce wound cores due to the extensive conversion costs.

Additionally, dry- type manufactures stated that a revised standard that does not require amorphous steel or wound core designs could still lead to capital conversion costs. As the standard increases, manufacturers are likely to use higher grade steels for core production. Because high grade steels tend to be thinner, additional Georg machines, core assembly lines and workstations, custom miter cutters, and panel boards may be needed in order to maintain existing throughput levels.

Some manufacturers mentioned that stranded assets may also be an issue when equipment needs to be retired and/or replaced if it cannot be repurposed for higher efficiency designs. DOE

accounted for stranded assets in the GRIM.

12.3.2 Shortage of Materials

There is currently a limited supply of M4, M3, M2, ZDMH, H-0 DR, and SA1 amorphous steels on the market and manufacturers expressed concern that higher standards may increase both demand and prices. Of these steels, M4 and M3 steels are currently the most widely produced, with suppliers such as AK Steel, Allegheny Ludlum, ThyssenKrupp, Nippon, JFE, Wuhan, Novolipetsk, Posco, ArcelorMittal, Orb, Baosteel, Stalproduct, Angang, and Arcelor/Hunan. However, as the grade of grain

- oriented electrical steel improves, its availability decreases. M2 is a higher grade than M3 but it is produced by fewer suppliers, such as AK Steel, Allegheny Ludlum, ThyssenKrupp, Nippon, and JFE. The ava ilability of mechanically -scribed, deep domain-refined steel such as ZDMH, H-0 DR, and SA1 amorphous is even more limited. ZDMH is only produced by Nippon, JFE, and AK Steel, and H-0 DR is only produced by Nippon, JFE, AK Steel, Posco, and Baosteel. Hitachi (MetGlas) and AT&M are currently the only suppliers of amorphous steel with significant capacity . However, AT&M only supplies the

Chinese market . Other steel suppliers, such as Posco and NEC TOKIN have announced that they have begun to pursue commercial production of amorphous steel, but their production capacity is

still to be determined.

In addition to being in limited supply, higher efficiency steels are also 1) more expensive, 2) subject to tariffs when imported from a foreign supplier, 3) subject to long lead times for both domestic and international suppliers, and 4) difficult to obtain for manufacturers that do not have contracts in place with suppliers. Furthermore, due in part to the major capital investment required to build a steel plant, barri ers to entry are high and capacity cannot be easily increased.12 -8 All these factors contribute to the limited availability of higher efficiency steel for transformer

manufacturers.

12.3.3 Compliance and Enforcement

M anufacturers indicated the importance of compliance and enforcement. Some manufacturers are concerned that insufficient enforcement could result in an unfair competitive advantage for some companies who opt not to comply. Manufacturers were particularly concerned about importers of foreign manufactured products.

With regard to low-voltage dry- type transformers , some manufacturers are concerned that higher standards could lead to customers to shift from low-voltage dry- type transformers that are within th e scope of DOE coverage to low-voltage dry- type transformers that are outside the scope of DOE coverage. The market for products within the scope of DOE coverage and the market for products outside the scope of DOE coverage are approximately equal in terms of revenue. As a result, if standards increase for products that are in -scope, there may be an increase in the manufacturing of products that are out-of-scope because they will not be subject to the same compliance burdens. Some of these out-of- scope pr oducts are highly inefficient. Therefore, manufacturers are concerned that, i f those products are more widely adopted, the total energy savings from this rulemaking may be less than projected.

12.3.4 Effective Date

Manufacturers expressed concerns about the amo unt of time available to adapt to an

amended standard. Manufacturers indicated that a transition period longer than three years is needed to meet a new standard, especially if the standard requires a very high efficiency level and a technology change, like a transition to amorphous material. In order to avoid stranding too many assets and materials, sufficient time must be given to manufacturers for the purchase and use of new equipment, development of new designs if needed, and transitioning of customers to new product offerings. Also, some manufacturers stated that standards for low-voltage dry- type transformers, which were not included in the previous 2007 rulemaking, should be on an

extended timeline.

12.3.5 Size and Weight Constr aints

Manufacturers were concerned that their customers’ dimensional and physical constraints would not be able to accommodate designs required to meet higher energy efficiency standards. In particular, manufacturers voiced concern regarding retrofit applications, mining applications, telephone pole capacities, and other installations where transformers have to comply with size and weight constraints.

12.3.6 Emergency Situations

For liquid- immer sed transformer manufacturers, the ability to obtain waivers during emergency situations is an important issue. For example, when a natural disaster occurs, there may be a sharp increase in demand for transformers and manufacturers may not be able to meet DOE’s efficiency requirements under these circumstances due to limitations of high efficiency12 -9 steel availability. In order to adequately supply areas facing such emergency situations, manufacturers need to produce transformers as quickly as possible.

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

12.4.1 Overview of the GRIM

The basic structure of the GRIM, illustrated in Figure 12.4-1, is an annual cash flow analysis that uses man ufacturer prices, manufacturing costs, shipments, and industry financial information as inputs, and accepts a set of regulatory conditions such as changes in costs, investments, and associated margins. The GRIM spreadsheet uses a number of inputs to arrive at a series of annual cash flows, beginning with the base year of the analysis, 2012, and continuing

to 2045 . The model calculates the INPV by summing the stream of annual discounted cash flows during this period and adding a discounted terminal value. 2

Figure 12.4-1 Using the GRIM to Calculate Cash Flow

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

- case scenario induced by amended energy conservation standards. The difference in INPV between the base case and the standard case(s) represents the estimated financial impact of the amended energy conservation standard on manufacturers. Appendix 12B provides more technical details and user information for the

GRIM.

12.4.2 Sources for GRIM Inputs

The GRIM uses several different sources for data inputs in determining industry cash flow. These sources include corporate annual reports, company profiles, Census data, credit ratings, the shipments model, the engineering analysis, and the manufacturer interviews.12

- 10 12.4.2.1 Corporate Annual Reports
Corporate annual reports to the SEC (SEC 10-Ks) provided many of the initial financial inputs to the GRIM. These reports exist for publicly held companies and are freely available to the general public. DOE developed initial financial inputs to the GRIM by examining the annual

SEC 10 -K reports filed by publicly- traded manufacturers that manufacture distribution

transformers , among other products. Since these companies do not provide detailed information about their individual product lines, DOE used financial information at the parent company level as its initial estimates of the financial parameters in the GRIM analysis. These figures were later revised using feedback from interviews to be representative of distribution transformer manufacturing. DOE used corporate annual reports to derive the following initial inputs to the

GRIM:

**•** Tax rate

**•** Working capital

**•** SG&A

**•** R&D

**•** Depreciation

**•** Capital expenditures

**•** Net PPE

12.4.2.2 Standard and Poor Credit Ratings
S&P provides independent credit ratings, research, and financial information. DOE relied on S&P reports to determine the industry’s average cost of debt when calculating the cost of capital.

12.4.2.3 Shipment Model
The GRIM used shipment projections derived from DOE’s shipments model in the NIA. The model relied on historical shipments data for distribution transformers . Chapter 9 of the TSD describes the methodology and analytical model DOE used to forecast shipments.

12.4.2.4 Engineering An alysis
Using several transfo rmer design characteristics in the Engineering Analysis , DOE developed ten equipment classes. Within each of these equipment classes, DOE further classified distribution transformers by their kilovolt- ampere (kVA) rating. These kVA ratings are essentially size categories , of which there are more than 100 across all ten equipment classes in this rulemaking. Because DOE found that many of the units share similar designs and construction methods, DOE simplified the analysis by creating engineering design lines (DLs), which group kVA ratings based on similar principles of design and construction. After developing its DLs, DOE then selected one representative unit from each DL for study in the engin eering analysis, greatly reducing the number of units for direct analysis. For each representative unit, DOE generated hundreds of unique designs by contracting with Optimized Program Services, Inc. (OPS), a software company specializing in transformer des ign. DOE obtained thousands of transformer designs for each representative unit. The performance of these designs ranged in efficiency from a baseline level, equivalent to the current distribution transformer energy conservation standards, to a theoretical max

- tech efficiency level.12

- 11 After generating each design, DOE used the out puts of the OPS software to create a manufacturer selling price (MSP). The material cost outputs of the OPS software, along with labor estimates were marked up for scrap factors, fac tory overhead, shipping, and nonproduction costs to generate an MSP for each design. Thus, DOE obtained a cost versus efficiency relationship for each representative unit. Finally, after DOE had generated the cost

efficiency relationship for each represen tative unit, it extrapolated the results for the other unanalyzed kVA ratings within that same engineering design line.

12.4.2.5 Manufacturer Interviews
During the course of the MIA, DOE conducted interviews with a representative crosssection of manufacturers. DOE also interviewed manufacturers representing a significant portion of sales in every equipment class. During these discussions, DOE obtained information to determine and verify GRIM input assumptions in each industry. Key topics discussed during the

interv iews and reflected in the GRIM include:

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

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

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

**•** possible profitability impacts;

**•** impacts on small businesses; and

**•** cost

- efficiency curves calculated in the engineering analysis.

12.4.3 Financial Parameters

Table 12.4-1 below provid es financial parameters for five public companies engaged in manufacturing and selling distribution transformers . The values listed are ave rages over a 6

- year period (2005 to 2010) and include manufacturers from all transformer superclasses

.12

- 12 Table 12.4-1 GRIM Fi nancial Parameters Based on 2005 –2010 Weighted Company

Financial Data

Parameter Weighted Average Manufacturer

A B C D E

Tax Rate % of taxable income 22.9 24.1 18.7 3.8 28.2 24.1

Working Capital % of revenues 16.1 25.5 10.9 10.4 8.9 13.3

SG&A % of revenues 16.5 15.7 19.0 17.0 16.4 20.7

R&D % of revenues 3.6 3.2 2.1 2.8 4.5 1.1

Depreciation % of revenues 3.2 1.9 2.4 3.9 4.8 3.2

Capital Expenditures % of revenues 3.3 2.8 2.0 2.7 4.6 2.1

Net PPE % of revenues 14.4 12.0 12.4 18.6 16.1 9.2

During interviews, distribution transformer manufacturers were asked to provide their own figures for the parameters listed in Table 12.4-1. Where applicable, DOE adjusted the parameters in the GRIM using this feedback and data from publicly traded companies to reflect the distribution transformer industry. Table 12.4-2 presents the revised parameters for distribution transformer manufacturers broken out into the three superclasses – liquid

- immersed,

medium- voltage dry

- type , and low-voltage dry- type

.12

- 13 Table 12.4-2 GRIM Revised Distribution Transformer Industry Financial Parameters

Parameter Revised Estimates

Liquid

- immersed Medium

- voltage Dry

- type Low

- voltage

Dry

- type

Tax Rate % of taxable income 23.0 23.0 23.0

Working Capital % of revenues 19.4 18.0 16.0

SG&A % of revenues 13.4 12.5 13 .0

R&D % of revenues 3.0 3.0 3.0

Depreciation % of revenues 2.5 2.0 3.2

Capital Expenditures % of revenues 3.0 2.3 3.0

Net PPE % of revenues 14.4 14.4 14.4

12.4.4 Corporate Discount Rate

DOE used the weighted

- average cost of capital (WACC) as the discount rate to calculate the INPV. A company’s assets are financed by a combination of debt and equity. The WACC is the total cost of debt and equity weighted by their respective proportions in the capital structure of the industry. DOE estimated the WACC for the distribution transformer industry based on several representative companies, using the following formula:

WACC = After -Tax Cost of Debt x (Debt Ratio) + Cost of Equity x (Equity Ratio) Eq. 1

The cost of equity is the rate of return that equity investors (including, potentially, the company) expect to earn on a company’s stock. These expectations are reflected in the market price of the company’s stock. The capital asset pricing model (CAPM) provides one widely used means to estimate the cost of equity. According to the CAPM, the cost of equity (expected return) is:

Cost of Equity = Riskless Rate of Return + β x Risk Premium Eq. 2

where:

Riskless rate of return is the rate of return on a “safe” benchmark investment, typically

considered the short- term Treasury Bill (T

- Bill) yield.

Risk premium is the difference between the expected return on stocks and the riskless rate.12

- 14 Beta (β) is the correlation between the movement in the price of the st ock and that of the broader market. In this case, Beta equals one if the stock is perfectly correlated with the S&P 500 market

index. A Beta lower than one means the stock is less volatile than the market index.

DOE determined that the industry average cost of equity for the distribution transformer industry is 14.5 percent

.

Table 12.4-3 Cost of Equity Calculation

Parameter Industry

Weighted Average

% Manufacturer

A B C D E

(1) Average Beta 1.52 1.50 1.55 1.42 1.58 1.65

(2) Yield on 10

- Year T

- Bill (1928

- 2009) 5.23

- - - - -

(3) Market Risk Premium (1928

- 2009) 6.09

- - - - -

Cost of Equity (2)+[(1)*(3)] 14.48

- - - - -

Equity/Total Capital 76.62 93.1 69.3 68.6 62.4 66.8

Bond ratings are a tool to measure default risk and arrive at a cost of debt. Each bond rating is associated with a particular spread. One way of estimating a company’s cost of debt is to treat it as a spread (usually expressed in basis points) over the risk- free rate. DOE used this

method to calculate the cost of debt for all f ive manufacturers by using S&P ratings and adding the relevant spread to the risk- free rate.

In practice, investors use a variety of different maturity Treasury bonds to estimate the

risk

- free rate. DOE used the 10 -year Treasury bond return because it captures long- term inflation expectations and is less volatile than short- term rates. The risk free rate is estimated to be approximately 5.2 percent, which is the average 10- year Treasury b ond return between 1928 and

2010.

For the cost of debt, S&P’s Credit Services provided the average spread of corporate

bonds for the five public manufacturers. DOE added the industry-weighted average spread to the average T

- Bill rate. Since proceeds from debt issuance are tax deductibl e, DOE adjusted the gross cost of debt by the industry average tax rate to determine the net cost of debt for the industry. Table 12.4-4 presents the derivation of the cost of debt and the capital structure of the industry (i.e. the debt ratio (debt/total capital)).12

- 15 Table 12.4-4 Cost of Debt Calculation

Parameter Industry

- Weighted Average

% Manufacturer

A B C D E

S&P Bond Rating

-- A A A

- A+ BB

(1) Yield on 10

- Year T-Bill (1928-2009) 5.23

- - - - -

(2) Gross Cost of Debt 6.21 6.23 6.23 6.33 6.08 8.58

(3) Tax Rate 23.4 24.1 18.7 3.8 28.2 24.1

Net Cost of Debt (2) x (1

- (3)) 6.21

- - - - -

Debt/Total Capital 23.38 6.86 30.70 31.36 37.55 33.18

Using public information for these f ive companies, the initial estimate for the distribution

transformer industry’s WACC was approximately 12.2 percent. Subtracting an inflation rate of 3.1 percent between 1928 and 2010 , the inflation

- adjusted WACC and the initial estimate of the

discount rate used in the straw- man GRIM is 9 .1 percent. DOE also asked for feedback on the 9.1 percent discount during manufacturer interviews and used this feedback to determine that the following WACCs for each superclass were appropriate discount rate s for use in th e GRIM: 7.4

percent for liquid- immersed, 9 percent for medium

- voltage dry

- type, and 11.1 percent for low

voltage dry

- type.

12.4.5 Trial Standard Levels

DOE developed TSLs for distribution transformers. Consistent with the engineering analysis, DOE analyzed 10 equ ipment classes , which were subdivided into 14 design lines with

14 representative units. Tables 12.4-5 through 12.4-7 show the efficiency levels (EL) at each

TSL for the design lines analyzed by DOE. DOE scaled the standards for these representative equipment classes to create standards for other equipment classes that were not dire ctly analyzed, as set forth in chapter 5 of the TSD.12

- 16 Table 12.4-5 Trial Standard Levels for Liquid Immersed Distribution Transformers

Design

Line Transformer Type, Rep Unit kVA, and

Phase Count TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7

1 Liquid

- Immersed, 50kVA, single

- phase EL 1 EL 1 EL 1 EL 2 EL 3 EL 4 EL 6

2 Liquid

- Immersed, 25kVA, single

- phase Base EL 1 EL 1 EL 2 EL 3 EL 4 EL 6

3 Liquid

- Immersed, 500kVA, single

- phase EL 1 EL 1 EL 2 EL 4 EL 3 EL 5 EL 7

4 Liquid

- Immersed, 150kVA, three

- phase EL 1 EL 1 EL 1 EL 2 EL 3 EL 4 EL 7

5 Liquid

- Immersed, 1500kVA, three

- phase EL 1 EL 1 EL 2 EL 4 EL 3 EL 5 EL 7

TSL 1 represents an increase in efficiency where a diversity of electrical steels are cost

competitive and economically feasible for all design lines. TSL 2 represents EL1 for all design

lines

. TSL 3 represents the maximum efficiency level achievable with M3 core steel. TSL 4 represents the maximum NPV with 7 percent discounting. TSL 5 represents EL 3 for all design lines. TSL 6 represents the maximum source energy savings with positive NPV with 7 percent discounting. TSL 7 represents the maximum technologi cally feasible level (max tech)

.

Table 12.4-6 Trial Standard Levels for Low -Voltage Dry- Type Distribution Transformers

Design

Line Transformer Type, Rep Unit kVA, and

Phase Count TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6

6 Low

- Voltage Dry

Type, 25kVA, single

phase Baseline Baseline EL 4 EL 6 EL 6 EL 7

7 Low

- Voltage Dry

Type, 75kVA, three

phase EL 2 EL 3 EL 4 EL 6 EL 6 EL 7

8 Low

- Voltage Dry

Type, 300kVA, three

phase EL 2 EL 2 EL 4 EL 6 EL 7 EL 7

TSL 1 represents the maximum efficiency level achievable with M6 core steel

. TSL 2 represents EL 3 for design line 7, EL 2 for design line 8 and no efficiency increase for design

line 6 . TSL 3 represents the maximum EL achievable using butt- lap miter core manufacturing for single -phase distribution transformers, and full miter core manufacturing for three- phase

distribution transformers. TSL 4 represents the maximum NPV with 7 percent discounting. TSL 5 represents the maximum source energy savings with positive NPV with 7 percent discounting. TSL 6 represents the maximum technologically feasible level (max tech).12

- 17 Table 12.4-7 Trial Standard Levels for Medium

- Voltage Dry

- Type Distribution

Transformers

Design

Line Transformer Type, Rep Unit kVA, and

Phase Count TSL 1 TSL 2 TSL 3 TSL 4 TSL 5

9 Medium

- Voltage Dry

Type , 300kVA, three

phase, 45kV BIL EL 1 EL 1 EL 2 EL 2 EL 6

10 Medium

- Voltage Dry

Type , 1500kVA,

three

- phase, 45kV BIL EL 1 EL 2 EL 2 EL 2 EL 6

11 Medium

- Voltage Dry

Type , 300kVA, three

phase, 95kV BIL EL 1 EL 1 EL 4 EL 4 EL 6

12 Medium

- Voltage Dry

Type , 1500kVA,

three

- phase, 95kV BIL EL 1 EL 2 EL 4 EL 4 EL 7

13A Medium

- Voltage Dry

Type , 300kVA, three

phase, 125kV BIL EL 1 EL 1 EL 4 EL 4 EL 7

13B Medium

- Voltage Dry

Type , 2000kVA,

three

- phase, 125kV

BIL EL 1 EL 2 EL 4 EL 4 EL 5

TSL 1 represents EL1 for all design lines. TSL 2 represents an increase in efficiency where a diversity of electrical steels are cost

- competitive and economically feasible for all design

lines . TSL 3 represents the maximum NPV with 7 percent discounting. TSL 4 represents the maximum source energy savings with positive NPV with 7 percent discounting. TSL 5 represents the maximum technologically feasible level (max tech).

12.4.6 NIA Shipment Forecast

The GRIM estimates manufacturer revenues based on total -unit-shipment forecasts and

the distribution of th ese values by efficiency level. Changes in the efficiency mix at each standard level are a key driver of manufacturer finances. For this analysis, the GRIM used the

NIA’s ann ual shipment forecasts from 2012 to 2045, the end of the analysis period. The ship ments analysis assumes that growth in distribution transformer shipments will be driven by long-term growth in electricity consumption. DOE’s shipments analysis also includes an elasticity factor based on the potential for transformers purchasers to elect to refurbish rather than replace failed transformers as the purchase price increases. The assumptions and methodology that drive this analysis are described in Chapter 9 of the Final Rule TSD.12

- 18 12.4.7 Production Costs

During the engineering analysis, the Department used transformer design software to create a database of designs spanning a broad range of efficiencies for each of the representative units. This design software generated a bill of materials, with informati on including pounds of core steel, pounds of conductor, insulation, ducting, and tank size. The software also provided information pertaining to the labor necessary to construct the transformer, including the number of turns in the windings, and core dimensions, including stack height. All the components from this bill of materials and labor estimate were combined with fixed hardware costs, such as bushings, busbar, and terminals. The Department then applied markups to allow for scrap, handling, factory overhead, and a “ manufacturer markup ” to account for per unit research and development, selling expenses , administrative expenses, and profit. This yielded an estimate of the manufacturer selling price. Details on the derivation of the manufacturer selling pr ices and discussion of manufacturer markups are in chapter 5. These designs and their MSPs are subsequently inputted into the LCC customer choice model. For each EL and within each design line, the LCC model uses a Monte Carlo analysis and criteria describ ed in TSD chapter 8 to select a subset of all the potential designs options (and associated MSPs). This subset is meant to represent those designs that would actually be shipped in the market under various standard levels. DOE inputted into the GRIM the we ighted average cost of the designs selected by the LCC model and scaled those MPCs to other selected capacities in each design line’s KVA range.

Table s 12.4-8 through 12.4-21 show the average production cost estimates used in the

GRIM for each design line at each efficiency level

.

Table 12.4-8 Manufacturer Production Cost Breakdown ($2011) for Design Line 1

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $186.11 $1,010.14 $78.69 $47.58 $1,322.51 $170.74 1.25 $1,866.57

EL 1 $184.88 $1,064.62 $83.35 $49.73 $1,382.58 $176.69 1.25 $1,949.08

EL 2 $166.29 $1,288.69 $104.49 $56.59 $1,616.07 $192.55 1.25 $2,260.77

EL 3 $160.25 $1,294.06 $105.34 $56.42 $1,616.07 $192.55 1.25 $2,260.77

EL 4 $163.57 $1,348.25 $108.26 $60.27 $1,680.35 $204.37 1.25 $2,355.91

EL 5 $144.47 $1,521.52 $123.51 $66.68 $1,856.19 $216.05 1.25 $2,590.29

EL 6 $155.78 $1,830.99 $149.85 $79.03 $2,215.65 $249.11 1.25 $3,080.95

EL 7 $155.78 $1,830.99 $149.85 $79.03 $2,215.65 $249.11 1.25 $3,080.9512

- 19 Table 12.4-9 Manufacturer Production Cost Breakdown ($2011) for Design Line 2

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $128.40 $662.10 $51.55 $31.21 $873.26 $107.42 1.25 $1,225.85

EL 1 $134.63 $722.12 $56.51 $33.76 $947.01 $114.81 1.25 $1,327.28

EL 2 $128.69 $751.67 $59.11 $34.85 $974.33 $119.64 1.25 $1,367.46

EL 3 $91.20 $814.51 $65.48 $36.34 $1,007.52 $123.37 1.25 $1,413.62

EL 4 $93.02 $849.73 $68.43 $37.78 $1,048.96 $132.39 1.25 $1,476.69

EL 5 $90.78 $995.73 $80.72 $43.74 $1,210.98 $153.31 1.25 $1,705.37

EL 6 $90.35 $1,112.01 $90.18 $48.82 $1,341.36 $175.78 1.25 $1,896.43

EL 7 $89.56 $1,483.58 $124.73 $60.72 $1,758.59 $146.13 1.25 $2,380.91

Table 12.4-10 Manufacturer Production Cost Breakdown ($2011) for Design Line 3

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $410.81 $4,149.98 $338.63 $180.11 $5,079.53 $618.60 1.25 $7,122.66

EL 1 $305.99 $4,874.69 $404.41 $204.92 $5,790.02 $655.57 1.25 $8,056.99

EL 2 $301.96 $5,040.06 $418.61 $211.40 $5,972.02 $639.14 1.25 $8,263.95

EL 3 $447.92 $5,284.14 $433.75 $226.76 $6,392.57 $655.67 1.25 $8,810.30

EL 4 $306.35 $5,496.46 $458.30 $228.76 $6,489.86 $664.39 1.25 $8,942.82

EL 5 $300.64 $5,865.99 $490.18 $243.07 $6,899.87 $698.94 1.25 $9,498.51

EL 6 $303.99 $7,194.61 $603.77 $295.56 $8,397.92 $842.13 1.25 $11,550.07

EL 7 $319.91 $9,223.29 $776.24 $376.68 $10,696.11 $1,070.05 1.25 $14,707.70

Table 12.4-11 Manufacturer Production Cost Breakdown ($2011) for Design Line 4

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $327.69 $2,828.64 $222.66 $130.92 $3,509.91 $564.16 1.25 $5,092.59

EL 1 $346.78 $3,046.55 $241.18 $139.64 $3,774.15 $579.26 1.25 $5,441.76

EL 2 $364.00 $3,362.28 $266.94 $153.34 $4,146.56 $604.29 1.25 $5,938.56

EL 3 $279.81 $3,437.11 $282.59 $147.05 $4,146.56 $604.29 1.25 $5,938.56

EL 4 $200.00 $3,508.05 $290.29 $148.21 $4,146.56 $604.06 1.25 $5,938.27

EL 5 $220.88 $3,518.48 $285.16 $154.65 $4,179.17 $614.92 1.25 $5,992.62

EL 6 $233.02 $4,123.05 $334.82 $180.56 $4,871.44 $717.00 1.25 $6,985.55

EL 7 $230.23 $6,089.59 $510.01 $251.19 $7,081.01 $753.89 1.25 $9,793.6312

- 20 Table 12.4-12 Manufacturer Production Cost Breakdown ($2011) for Design Line 5

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $1,668.71 $13,200.38 $1,016.01 $634.04 $16,519.15 $2,247.55 1.25 $23,458.37

EL 1 $1,819.05 $15,108.11 $1,177.98 $710.53 $18,815.67 $2,303.29 1.25 $26,398.70

EL 2 $1,804.61 $15,394.02 $1,203.39 $720.87 $19,122.88 $2,345.28 1.25 $26,835.21

EL 3 $1,827.31 $16,465.92 $1,292.42 $765.82 $20,351.47 $2,456.47 1.25 $28,509.91

EL 4 $1,848.08 $17,102.47 $1,344.69 $793.11 $21,088.36 $2,538.09 1.25 $29,533.06

EL 5 $1,894.49 $19,028.35 $1,503.23 $875.32 $23,301.38 $2,782.40 1.25 $32,604.74

EL 6 $2,040.91 $32,843.19 $2,717.39 $1,388.01 $38,989.50 $2,989.89 1.25 $52,474.23

EL 7 $2,040.91 $32,843.19 $2,717.39 $1,388.01 $38,989.50 $2,989.89 1.25 $52,474.23

Table 12.4-13 Manufacturer Production Cost Breakdown ($2011) for Design Line 6

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $221.50 $396.63 $20.84 $28.74 $667.71 $37.16 1.25 $881.08

EL 1 $221.85 $404.68 $21.45 $29.13 $677.12 $37.38 1.25 $893.12

EL 2 $171.94 $480.54 $29.41 $30.66 $712.55 $40.20 1.25 $940.95

EL 3 $183.68 $536.11 $33.11 $33.90 $786.80 $43.47 1.25 $1,037.84

EL 4 $181.28 $684.96 $44.65 $40.97 $951.85 $43.51 1.25 $1,244.20

EL 5 $179.63 $715.88 $47.01 $42.47 $984.99 $46.19 1.25 $1,288.98

EL 6 $172.63 $837.41 $56.44 $48.23 $1,114.72 $55.11 1.25 $1,462.28

EL 7 $172.90 $1,274.48 $89.50 $69.81 $1,606.69 $87.53 1.25 $2,117.78

Table 12.4-14 Manufacturer Production Cost Breakdown ($2011) for Design Line 7

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $363.74 $1,054.95 $63.60 $68.27 $1,550.55 $131.69 1.25 $2,102.81

EL 1 $410.51 $1,194.11 $72.31 $76.95 $1,753.88 $139.65 1.25 $2,366.91

EL 2 $415.58 $1,189.60 $71.93 $76.77 $1,753.88 $139.65 1.25 $2,366.91

EL 3 $372.85 $1,229.32 $77.69 $75.98 $1,755.84 $139.59 1.25 $2,369.28

EL 4 $316.76 $1,428.18 $94.76 $83.76 $1,923.47 $123.03 1.25 $2,558.12

EL 5 $298.55 $1,636.31 $111.78 $92.76 $2,139.39 $116.35 1.25 $2,819.68

EL 6 $292.50 $1,774.92 $122.31 $99.55 $2,289.29 $129.67 1.25 $3,023.69

EL 7 $278.60 $2,686.36 $191.51 $144.29 $3,300.75 $207.24 1.25 $4,384.9912

- 21 Table 12.4-15 Manufacturer Production Cost Breakdown ($2011) for Design Line 8

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $644.47 $2,729.41 $176.13 $165.05 $3,715.06 $276.92 1.25 $4,989.97

EL 1 $805.45 $2,946.67 $186.64 $181.70 $4,120.45 $294.44 1.25 $5,518.61

EL 2 $773.04 $3,447.92 $227.80 $203.19 $4,651.95 $324.00 1.25 $6,219.93

EL 3 $856.27 $4,028.47 $268.49 $235.07 $5,388.30 $350.22 1.25 $7,173.15

EL 4 $851.41 $4,619.88 $313.08 $264.41 $6,048.77 $370.54 1.25 $8,024.14

EL 5 $821.29 $5,149.34 $354.99 $288.68 $6,614.29 $356.94 1.25 $8,714.03

EL 6 $719.26 $5,239.24 $366.45 $288.45 $6,613.40 $356.88 1.25 $8,712.86

EL 7 $651.66 $8,956.38 $656.75 $462.80 $10,727.59 $530.85 1.25 $14,073.04

Table 12.4-16 Manufacturer Production Cost Breakdown ($2011) for Design Line 9

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $1,756.20 $4,581.52 $386.14 $186.55 $6,910.40 $386.26 1.25 $9,120.83

EL 1 $1,716.25 $4,679.51 $397.98 $186.96 $6,980.70 $386.49 1.25 $9,208.99

EL 2 $1,705.13 $4,961.69 $425.21 $195.00 $7,287.03 $389.99 1.25 $9,596.28

EL 3 $1,629.32 $5,640.27 $491.32 $213.72 $7,974.63 $417.90 1.25 $10,490.67

EL 4 $1,184.02 $6,380.29 $572.51 $225.03 $8,361.85 $473.75 1.25 $11,044.50

EL 5 $1,076.52 $6,798.05 $614.36 $235.40 $8,724.33 $506.12 1.25 $11,538.05

EL 6 $1,036.03 $8,958.79 $819.51 $300.34 $11,114.67 $672.50 1.25 $14,733.96

EL 7 $1,036.03 $8,958.79 $819.51 $300.34 $11,114.67 $672.50 1.25 $14,733.96

Table 12.4-17 Manufacturer Production Cost Breakdown ($2011) for Design Line 10

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $3,139.96 $15,742.83 $1,404.37 $563.49 $20,850.64 $1,351.13 1.25 $27,752.22

EL 1 $3,053.53 $15,960.31 $1,426.33 $568.71 $21,008.88 $1,344.47 1.25 $27,941.69

EL 2 $2,997.40 $17,344.34 $1,560.52 $607.52 $22,509.78 $1,513.07 1.25 $30,028.57

EL 3 $2,831.68 $20,742.52 $1,884.06 $708.76 $26,167.02 $1,774.37 1.25 $34,926.74

EL 4 $2,579.69 $25,694.62 $2,353.97 $857.85 $31,486.14 $2,049.31 1.25 $41,919.31

EL 5 $2,538.12 $27,821.04 $2,555.83 $921.80 $33,836.79 $2,221.47 1.25 $45,072.83

EL 6 $2,320.33 $32,670.64 $3,016.75 $1,067.08 $39,074.79 $2,588.02 1.25 $52,078.52

EL 7 $2,320.33 $32,670.64 $3,016.75 $1,067.08 $39,074.79 $2,588.02 1.25 $52,078.5212

- 22 Table 12.4-18 Manufacturer Production Cost Breakdown ($2011) for Design Line 11

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $2,246.16 $7,294.14 $632.05 $279.71 $10,452.06 $540.58 1.25 $13,740.80

EL 1 $2,326.95 $7,772.70 $675.37 $296.22 $11,071.24 $563.59 1.25 $14,543.54

EL 2 $2,298.84 $8,597.61 $753.45 $321.25 $11,971.15 $643.74 1.25 $15,768.62

EL 3 $2,445.65 $9,259.37 $812.99 $344.44 $12,862.44 $637.75 1.25 $16,875.24

EL 4 $2,200.74 $9,623.58 $854.65 $348.30 $13,027.26 $634.76 1.25 $17,077.53

EL 5 $2,094.07 $10,861.51 $973.91 $383.78 $14,313.27 $727.93 1.25 $18,801.50

EL 6 $1,947.03 $13,605.51 $1,236.94 $463.75 $17,253.23 $909.33 1.25 $22,703.19

EL 7 $1,947.03 $13,605.51 $1,236.94 $463.75 $17,253.23 $909.33 1.25 $22,703.19

Table 12.4-19 Manufacturer Production Cost Breakdown ($2011) for Design Line 12

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $3,447.63 $20,472.49 $1,846.60 $712.46 $26,479.18 $1,666.97 1.25 $35,182.69

EL 1 $3,499.66 $21,554.30 $1,947.81 $746.48 $27,748.25 $1,631.23 1.25 $36,724.35

EL 2 $3,481.31 $23,163.47 $2,099.56 $795.88 $29,540.21 $1,681.79 1.25 $39,027.50

EL 3 $3,649.82 $26,167.23 $2,379.24 $891.66 $33,087.95 $2,018.95 1.25 $43,883.63

EL 4 $3,330.93 $27,818.49 $2,542.60 $934.72 $34,626.73 $2,184.80 1.25 $46,014.40

EL 5 $2,863.09 $30,374.01 $2,797.33 $999.43 $37,033.85 $2,345.07 1.25 $49,223.66

EL 6 $2,874.77 $34,221.12 $3,159.12 $1,118.52 $41,373.53 $2,703.23 1.25 $55,095.96

EL 7 $2,741.49 $40,916.95 $3,793.69 $1,320.93 $48,773.06 $3,242.73 1.25 $65,019.74

Table 12.4-20 Manufacturer Production Cost Breakdown ($2011) for Design Line 13A

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $3,561.01 $8,534.01 $715.20 $351.55 $13,161.77 $734.97 1.25 $17,370.93

EL 1 $3,426.87 $8,971.18 $759.84 $361.55 $13,519.44 $766.94 1.25 $17,857.98

EL 2 $3,544.69 $9,595.94 $815.68 $383.81 $14,340.12 $791.00 1.25 $18,913.90

EL 3 $3,791.47 $10,820.37 $924.97 $427.58 $15,964.38 $876.46 1.25 $21,051.06

EL 4 $3,252.93 $12,524.69 $1,102.98 $462.60 $17,343.21 $872.83 1.25 $22,770.06

EL 5 $3,192.24 $13,581.46 $1,204.42 $493.26 $18,471.38 $943.28 1.25 $24,268.33

EL 6 $2,758.89 $18,565.27 $1,685.40 $635.25 $23,644.82 $1,291.78 1.25 $31,170.75

EL 7 $2,758.89 $18,565.27 $1,685.40 $635.25 $23,644.82 $1,291.78 1.25 $31,170.7512

- 23 Table 12.4-21 Manufacturer Production Cost Breakdown ($2011) for Design Line 13B

EL Labor Materials Overhead Depreciation MPC Shipping Markup MSP

Baseline $4,174.29 $26,399.26 $2,387.53 $912.38 $33,873.45 $2,420.49 1.25 $45,367.43

EL 1 $3,887.76 $27,129.03 $2,447.63 $943.50 $34,407.92 $2,512.39 1.25 $46,150.39

EL 2 $4,217.87 $30,412.80 $2,758.59 $1,043.01 $38,432.28 $2,532.58 1.25 $51,206.07

EL 3 $4,617.64 $35,162.33 $3,205.11 $1,190.18 $44,175.27 $2,877.82 1.25 $58,816.37

EL 4 $4,712.67 $40,401.65 $3,695.63 $1,354.57 $50,164.52 $2,887.32 1.25 $66,314.80

EL 5 $4,783.93 $45,787.74 $4,210.10 $1,513.36 $56,295.14 $3,263.41 1.25 $74,448.19

EL 6 $3,814.98 $46,649.03 $4,314.42 $1,516.71 $56,295.14 $3,263.41 1.25 $74,448.19

EL 7 $3,814.98 $46,649.03 $4,314.42 $1,516.71 $56,295.14 $3,263.41 1.25 $74,448.19

12.4.8 Conversion Costs

New and amended energy conservation standards will cause manufacturers to incur conversion costs to bring their production facilities and product designs into compliance. For the MIA, DOE classified these conversion costs into two major groups: (1) capital conversion costs and (2) product conversion costs. Capital conversion costs are investments in property, plant, and equipment necessary to adapt or change existing production facilities such that new product designs can be fabricated and assembled. Product conversion costs are investments in research, development, testing, marketing, and other non- capitalized costs necessary to make product designs comply with the new or amended energy conservation standard.

12.4.8.1 Liquid Immersed Distribution Transformers
The liquid-immersed industry has evolved to be inherently flexible due to variation in customer purchasing criteria and wide fluctuations in critical materials prices, which represent the most significant fraction of product cost. Additionally, as the Department understands it,

there is substantial excess production capacity for silicon steel transformers currently due to the recent economic downturn. Some manufacturers reported during interviews that shipments we re down 25%-50% from their pre- recession peak. However, as discussed below, the production process for amorphous core transformers is much different and requires mostly new capital equipment. As such, currently the industry has very limited capacity for p roducing amorphous core distribution transformers and that capacity is concentrated among a few of the more sophisticated manufacturers in the industry.

12.4.8.1.1 Capital Conversion Expenditures
Through interviews, DOE determined that two key factors will influence the extent of investment liquid

- immersed distribution transformer manufacturers make in response to energy

conservation standards:

**•** T he grade of core steel that manufacturers would most likely use to meet the standard;

**•** T he change in core mass required to meet the standard for a given steel grade.12

- 24 These two factors , which vary with the stringency of the standard, shape manufacturers’ response to amended energy conservation standards. The most cost- effective core steels and the equipment necessary to proc ess those steels affect manufacturer s’ sourcing decisions, investments in production equipment, and selections of core designs. In light of these two
considerations, DOE used a multi

- step process to estimate capital conversion costs for liquid

immersed tra nsformers. First, it developed base- case and standards

- case forecasts for core steel usage by steel grade and quantity. These forecasts provided an estimate of the change in core

steel demand for each steel grade at each TSL . Second, based on forecasted c hanges in steel use, the Department estimated the conversion costs for the entire industry to adapt to the change in
standard at each TSL. Third, DOE analyzed potential manufacturer responses to the change s in

steel grades and in core masses. The methodology, sources of data and assumptions, and

calculation flow are shown below in Figure 12.4-2.

Figure 12.4-2 Capital Conversion Cost Methodolog y for Liquid Immersed Distribution

Transformers

As shown by the figure above, to estimate conversion costs, DOE first needed an understanding of the steel grades used by manufacturers in the base case . Based on the LCC consumer choice model, DOE identified the most likely core design choices at each TSL. Using the engineering analysis, DOE determined the design parameters (e.g., core weight) for those design choices . Comb in ing the core weights with industry shipments developed in the NIA, DOE projected future core steel needs by steel grade at each TSL. By comparing steel usage in the base case to that in the standards case, the department estimated change in core steel mix triggered by each TSL. In the liquid immersed superclass the transition to amorphous core steel12

- 25 is the most important variable in determining capital conversion costs because the production process is entirely different from that used for silicon steel.

It is important to note that the LCC consumer choice model assumes no availability constraints on amorphous s teel , the core steel optio n which the engineering analysis generally

found to be the most cost- effective at efficiency levels 1 o r 2 and above (depending on the design

line ) for most liquid immersed design lines. The engineering and LCC analyses also hold the relative prices of amorphous and silicon steels fixed, regardless of demand, which creates a ‘toggle’ effect between the steels, in which at a given EL for a given DL, all or most demand swings to one steel type, a prospect that may not occur depending on how changes in demand of certain steel types cause steel suppliers to alter pricing schemes. By presuming unlimited availability at the prices assumed in the engineering analysis, it is no surprise that the st eel forecast heavily favors amorphous steel usage at TSL 3 and above for the liquid immersed superclass.

Next , DOE determined what investment would be required at each TSL, given the change

in core steel demand estimated for each TSL. DOE used data gathered from interviews with core

steel suppliers, core manufacturers, distribution transformer manufacturers, equipment suppliers and industry experts, as well as information gathered during the 2007 rulemaking to estimate equipment costs. Based on the gathered information, DOE assumed an amorphous production line with 1,200 tons of annual capacity would cost $950,000 to build. This figure includes costs associated with an annealing oven, core cutting machine, lacing tables and other miscellaneous equipment.

In general, where manufacturers must use amorphous materials in substantially larger quantities than the base case, conversion costs escalate quickly because all new production equipment is necessary, as opposed to just adding incremental capacity to augment existing production. For the liquid immersed superclass, when conventional steels, or even ZDMH and

H-0 , can be used to meet the standard, incremental increases in production equipment are driven by the need to use thinner steels or produce large r cores to achieve higher efficiencies.

Manufacturers could elect to source amorphous cores rather than produce them in-house. Many do this currently for the relatively small number of amorphous transformers they sell currently. During the manufacturer interviews, many manufacturers indicated that production of cores is an important part of the value chain and they would likely choose, in the long-run, to continue to produce them in-house rather than source them. A few of the larger manufacturers

have al ready begun limited production of amorphous cores, as have some smaller Canadian manufacturers. Consequently, DOE believes most U.S. manufacturers would likely convert their facilities to produce the required number of amorphous cores at each TSL. As such, f or the MIA, the Department modeled the scenario in which manufacturers would convert their facilities for

in -house production of amorphous core s at the capacity necessary to meet the demand estimated

at each of the TSLs by the LCC selection model. T he LCC shows a migration to much h igh er volumes of amorphous core steel at every TSL for the liquid- immersed superclass.

Based on the engineering analysis, the LCC, and the estimated capital costs necessary for an amorphous transformer production line , DOE e stimates the conversion costs for liquidimmersed transformers presented in Table 12.4-22 below.12

- 26 Table 12.4-22 Summary of Liquid

- Immersed Distribution Transformer Conversion Capital Expenditures

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7

Total Capital Conversion Costs ($M) 25.3 57.8 60.6 92.8 96.2 101.5 124.5

In terms of timing, DOE models all conversion costs occurring in the time period between the announcement year of the standard and the complianc e date of the amended energy conservation standard. However, this may be an aggressive scenario in terms of timeline . In interviews, manufacturers expressed strong reservations about the availability of amorphous steel and stability of pricing under regulatory s cenarios that triggered substantial increases in demand. Tight supply of amorphous could lead to higher prices and undercut the material’s relative cost

advantage over conventional steels. This is one reason manufacturers may take a gradual approach to facility conversion at efficiency levels where conventional steels, while not currently forecast to be cost competitive with amorphous steel, could become so if amorphous prices increase in relative terms. As a result, the MIA may overstate the negative cash

- flow impacts of the conversion costs on industry during the period leading up to the effective date of the standard. DOE therefore considers its estimates of capital conversion costs to be conservative, and most likely so at TSL 1 through TSL 3.

12.4.8.1.1.1 Uncertai nty Associated with Amorphous Demand
During interviews, manufacturers discussed several reasons why transformer production with amorphous material causes severe concerns:

**•** The possible difficulty of access to the technology and manufacturing know-how;

**•** The possible lack of availability of amorphous- core material at quantities necessary to meet industry demand;

**•** The high level of capital equipment investment required (and the stranding of existing assets, particularly core -cutting equipment and annealing furnaces); and

**•** The increased complexity associated with material processing and handling.

The Department recognizes that the manufacturing process for amorphous core

transformers is significantly different from that for silicon steel transformers. As such, all TSLs

would render obsolete some portion of the liquid- immersed manufacturing equipment, primarily

the core -cutting equipment and the annealing furnaces. Simply put, the more rapidly and substantially amorphous steel use penetrates the market, the greater the industry’s stranded silicon steel production assets will be. For example, the partial conversion to amorphous technology at TSL 1 would strand approximately $21.7 million in conventional s teel core steel production equipment. If the highest (max tech) TSL is selected for the liquid

- immersed superclass, DOE estimates that the industry would have $57.7 million in stranded assets.

As mentioned above, all TSLs would likely trigger liquid

- immers ed transformer

manufacturers to evaluate (though not force) whether to tool for amorphous technology, attempt12

- 27 to purchase assembled amorphous cores, or exit the industry. At TSL 1, manufacturers could choose to operate parallel processes for conventional steel and amorphous steel since only partial conversion to amorphous is expected in the LCC consumer choice model . However, this would make for complex operations within the same plant and would be especially burdensome for

small manufacturers. At TSL 1, some manufacturers would likely choose to maintain a focus on

silicon st eel. Additionally, a few manufacturers indicated that those who choose to produce amorphous cores themselves would face a critical decision about whether or not to relocate outside of the U.S., since much of their existing equipment would become obsolete a nyway.

For those TSLs that can only be met with design options utilizing amorphous cores, industry conversion costs are easily estimated because, regardless of any assumptions about material availability or relative steel prices, manufacturers must either convert their facilities to produce amorphous, source amorphous cores, or exit the market. Since DOE is evaluating the
scenario in which manufacturers convert their facilities, rather than source their cores, there is less uncertainty about total industry conversion costs. Based on DOE’s projections, TSL s 4 through 7 fall into this category because only amorphous designs can meet the efficiency levels represented by these levels. No option to continue conventional steel production exists.

For TSLs 1 , 2, and 3, however, the dynamics of the core steel market introduce a great deal of uncertainty about potential manufacturer responses to standards. At these TSLs, manufacturers may still be able to meet minimum efficiency standards with traditional steel s in
some cases, but they may also transition to a greater use of amorphous. The extent to which manufacturers convert their facilities to manufacture more amorphous cores depends on their assessment of two core steel market dynamics. First, what are the prospects for the availability of amorphous steel? If manufacturers doubt that the supply of amorphous steel can match the
market demand at these TSLs, then there will be at least some need for conventional steels, even though these steels are not cost- competitive designs at the prices assumed in the engineering analysis. The second major consideration depends on the first: to what extent would tight supply of amorphous steel increase its price and therefore make conventional steel once again

cost compet itive?

Manufacturer views on these two considerations will drive their response to standards at TSL 1, 2, and 3. Each manufacturer’s response, in the context of their base case market position and production capabilities, will determine the timing and level of conversion costs the industry ultimately incurs as a result of standards. Consequently, manufacturers could incur a range of conversion costs, depending upon how they elect to approach the market.

12.4.8.1.2 Product Conversion Expenses

Product conversion expenses include engineering, prototyping, testing, and marketing expenses incurred by a manufacturer as it prep ares to come into compliance with a standard. The Department’s estimates for product conversion expenses for liquid- immersed transformer

manufacturers are based upon the industry’s annual R&D expenses and the extent to which the industry would need to convert to amorphous technology. DOE believes this is reasonable because the industry has very little experience producing amorphous transformers and will have12

- 28 to prepare to produce at volumes several times more than current volumes. Product conversion expenses are summarized in Tabl e 12.4-23.

Table 12.4-23 Summary of Product Conversion Expenditures for Liquid Immersed Industry

TSL 1 TSL

2 TSL

3 TSL

4 TSL5 TSL 6 TSL 7

Product

Conversion Expenditures ($M) 24.2 65.2 65.7 96.1 96.1 96.1 96.1

DOE’s estimates of the product and capital conversion costs for each representative design line can be found in Tables 12.4-24 through 12.4-28 below.

Table 12.4-24 Product and Capital Conversion Costs for Design Line 1 by TSL

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7 Capital Conversion Costs ($M) $3.13 $3.13 $3.13 $18.85 $18.85 $20.55 $29.83
Product Conversion Costs ($M) $0.00 $0.00 $0.00 $16.20 $16.20 $16.20 $16.20
Total Conversion Costs ($M) $3.13 $3.13 $3.13 $35.05 $35.05 $36.75 $46.02

Table 12.4-25 Product and Capital Conversion Costs for Design Line 2 by TSL

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7 Capital Conversion Costs ($M) $0.00 $32.52 $32.52 $33.82 $37.11 $38.00 $49.78
Product Conversion Costs ($M) $0.00 $41.09 $41.09 $41.09 $41.09 $41.09 $41.09
Total Conversion Costs ($M) $0.00 $73.61 $73.61 $74.90 $78.19 $79.09 $90.86

Table 12.4-26 Product and Capital Conversion Costs for Design Line 3 by TSL

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7 Capital Conversion Costs ($M) $0.30 $0.30 $0.60 $0.80 $0.80 $0.90 $1.50

Product Conversion Costs ($M) $0.46 $0.46 $0.91 $0.91 $0.91 $0.91 $0.91
Total Conversion Costs ($M) $0.76 $0.76 $1.51 $1.71 $1.71 $1.81 $2.41

Table 12.4-27 Product and Capital Conversion Costs for Design Line 4 by TSL

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7 Capital Conversion Costs ($M) $1.30 $1.30 $1.30 $15.26 $15.26 $15.26 $18.95
Product Conversion Costs ($M) $0.00 $0.00 $0.00 $14.24 $14.24 $14.24 $14.24
Total Conversion Costs ($M) $1.30 $1.30 $1.30 $29.50 $29.50 $29.50 $33.1912

- 29 Table 12.4-28 Product and Capital Conversion Costs for Design Line 5 by TSL

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 7 Capital Conversion Costs ($M) $20.55 $20.55 $23.04 $24.04 $24.14 $26.83 $24.44
Product Conversion Costs ($M) $23.70 $23.70 $23.70 $23.70 $23.70 $23.70 $23.70
Total Conversion Costs ($M) $44.25 $44.25 $46.74 $47.74 $47.84 $50.53 $48.14

12.4.8.2 Dry Type Transformers

The low-voltage dry-type and medium-voltage dry-type industries primarily rely on stacked core technologies. In large part, the medium- voltage dry -type market is standardized on

mitered cores while the low

- voltage market typically uses butt lap designs.

12.4.8.2.1 Capital Conversion Expenditures
To determine capital conversion costs for dry type transformers for the final rule , DOE performed a bottoms-up analysis of conversion costs in a three

- step process . In the first step, the Department developed base

- case and standards

- case forecasts for core steel usage using the LCC

consumer choice model , which provided a distribution of likely design choices. Based on that distribution of design choices, DOE determined the most likely steel selections and identified a set of representative core design parameters ( e.g.

For the purposes of modeling conversion costs, DOE assumed that transformers built

with silicon steels would use stacked core designs. A representative core cutting machine is projected to cost $0.75 million installed for the low-voltage, dry type industry. A representative core cutting and mitering machine is projected to cost $2.5 million for the medium- voltage dry type industry. , core stack heights and lamination thicknesses ). In the second step, based on the forecasted change in steel use and transformer core design, DOE determined the changes in production equipment necessary to produce the new mix of

distribution tr ansformer designs. The modeling of the production process and the equipment required (as well as the cost of that equipment) was based on data gathered through interviews with core steel manufacturers, core manufacturers, distribution transformer manufacturers, equipment suppliers and industry experts, as well as information gathered during the 2007 rulemaking, In the third step, DOE estimate d the capital outlays at each TSL for the industry based on the additional production equipment required. In the proc ess of calculating capital conversion expenditures for dry type transformers, DOE also took into account feedback from manufacturers and industry experts.

For low-voltage and medium-voltage distribution transformers using amorphous steel, DOE assumed that transformers would be built using wound core designs. Very few domestic dry-type manufacturers use wound core designs tod ay. D ry -type manufacturing facilities would need to substantially retool to produce wound core products . Based on data gathered from interviews with core steel suppliers, core manufacturers, distribution transformer manufacturers,12

- 30 equipment suppliers and industry experts, DOE estimated that an amorphous production line with 1,200 tons of annual capacity would cost $950,000 to build. This production line cost was applied to calculate capital conversion costs for TSLs when the LCC analysis indicated the dry type market would convert to amorphous steel.

The results of DOE’s capital conversion cost analysis can be found in Table 12.4-29 and

Table 12.4.30.

Table 12.4-29 Summary of Low Voltage Dry Type Distribution Transformer Capital Conversion Expenditures

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6

Total Capital Conversion Costs ($M) 4.5 5.3 12.0 28.5 30.7 45.6

Table 12.4-30 Summary of Medium Voltage Dry Type Distribution Transformer Capital Conversion Expenditures

TSL 1 TSL 2 TSL 3 TSL 4 TSL 5

Total Capital Conversion Costs ($M) 0.2 0.5 3.9 3.9 13.9

12.4.8.2.2 Product Conversion Expen ses

In the low-voltage dry-type market, DOE aggregated estimates of product conversion costs from manufacturers that were gathered during interviews and scaled those estimates to each design line based on market share. DOE’s estimates of product conversion costs for the lowvoltage dry

- type market can be found in Table 12.4-31 below.

Table 12.4-31 Summary of Product Conversion Expenditures for the Low -Voltage DryType Industry

TSL 1 TSL 2 TSL 3 TSL 4 TSL5 TSL6

Total Product Conversion Costs ($M) 2.9 3.6 5.0 8.0 8.0 8.0

In the med ium-voltage dry-type market, DOE calculated product conversion costs based

on annual R& D expenditures for the industry and the steel types required at each efficiency level, focusing on the high volume design line 12. DOE’s estimates of the product conversion

costs for the med ium-voltage dry-type market can be found in Table 12.4- 32 below.12

- 31 Table 12.4-32 Summary of Product Conversion Expenditures for the Medium Voltage Dry Type Industry

TSL 1 TSL 2 TSL 3 TSL 4 TSL5

Total Product Conversion Costs ($M) 2.0 2.0 3.7 3.7 8.2

12.4.9 Markup Scenarios

DOE used several standards case markup scenarios to represent the uncertainty about the impacts of amended energy conservation standards on prices and profitability. In the base case, DOE used the same baseline markups calculated in the engineeri ng analysis for all product design lines. In the standards case, DOE modeled two markup scenarios to represent the uncertainty about the potential impacts on prices and profitability following the implementation of amended energy conservation standards: (1 ) a preservation of gross margin percentage markup scenario, and (2) a preservation of operating profit markup scenario. These sce narios lead to different markup values, which, when applied to the inputted MPCs, result in varying revenue and cash flow impa cts.

12.4.9.1 Preservation of Gross Margin Percentage Markup Scenario
Under the preservation of gross margin percentage scenario, DOE applied a single uniform “gross margin percentage” markup across all efficiency levels. As production costs increase with efficiency, this scenario implies that the absolute dollar markup will increase as well. Based on publicly available financial information for manufacturers of distribution transformers and comments from manufacturer interviews, DOE assumed the non-production cost markup—which includes SG&A expenses; research and development expenses; interest; and profit—to be 1.25 for distribution transformers. Because this markup scenario assumes that manufacturers would be able to maintain their gross margin percentage markups as production costs increase in response to an energy conservation standard, it represents a high bound to industry profitability under an energy conservation standard.

12.4.9.2 Preservation of Operating Profit Markup Scenario
In the preservation of operating profit scenario, manufacturer markups are set so that operating profit one year after the compliance date of the new energy conservation standard is the same as in the base case. Under this scenario, as the cost of production and the cost of sales go up, manufacturers are generally required to reduce their markups to a level that maintains base case operating profit. The implicit assumption behind this markup scenario is that the industry can only maintain its operating profit in absolute dollars after the standard. Therefore, operating margin in percentage terms is squ eezed (reduced) between the base case and standards case. DOE adjusted the manufacturer markups in the GRIM at each TSL to yield approximately the same earnings before interest and taxes in the standards case in the year after the compliance

date of the am ended standards as in the base case. This markup scenario represents a low bound to industry profitability under an energy conservation standard.12

- 32 12.5 INDUSTRY FINANCIAL IMPACTS
Using the inputs and scenarios described in the previous sections, the GRIM estima ted indicators of financial impacts on the distribution transformer industry. The following sections detail additional inputs and assumptions for distribution transformers. The main results of the MIA are also reported in this section. The MIA consists of two key financial metrics: INPV and

annual cash flows.

12.5.1 Impacts on Industry Net Present Value

The INPV measures the industry value and is used in the MIA to compare the economic impacts of different TSLs in the standards case. The INPV is different from DOE ’s net present value, which is applied to the U.S. economy. The INPV is the sum of all net cash flows discounted at the industry’s cost of capital, or discount rate. The distribution transformers GRIM

estima tes cash flows from 2012 to 2045 . This timeframe models both the short- term impacts on the industry from the announcement of the standard until the compliance date (2012 until an estimated compliance date of January 2016 ) and a long

- term assessment over the 30

- year analysis period used in the NIA (2016 – 2045 ).

In the MIA, DOE compares the INPV of the base case (no amended energy conservation standards) to that of each TSL in the standards case. The difference between the base case and a standards case INPV is an estimate of the economic impacts that implementing that particular TSL would have on the industry. For the distribution transformer industry, DOE examined the

two m arkup scenarios described above, the preservation of gross margin percentage markup

scenario and the preservation of operating profit markup scenario, for each superclass . Tables 12.5-1 through 12.5-6 provide the INPV estimates for the three superclasses in the distribution

transformers industry.

Table 12.5-1 Changes in Industry Net Present Value for Liquid

- immersed Distribution

Transformers - Preservation of Operating Profit Markup Scenario

Units Base

Case Trial Standard Level

1 2 3 4 5 6 7

INPV 2011 $ M 575.1 526.9 465.9 461.7 389.0 382.1 358.4 181.6

Change

in INPV 2011 $ M - (48.2) (109.3) (113.4) (186.1) (193.0) (216.7) (393.5)

%
- (8.4) (19.0) (19.7) (32.4) (33.6) (37.7) (68.4)12

- 33 Table 12.5-2 Changes in Industry Net Present Value for Liquid

- immersed Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario

Unit

s Base

Case Trial Standard Level

1 2 3 4 5 6 7

INPV 2011 $ M 575.1 551.6 508.1 506.2 477.8 473.8 486.6 575.6

Change

in INPV 2011 $ M - (23.5) (67.0) (68.9) (97.3) (101.4) (88.5) 0.5

%
- (4.1) (11.7) (12.0) (16.9) (17.6) (15.4) 0.1

Table 12.5-3 Changes in Industry Net Present Value for Low -Voltage Dry- Type

Distribution Transformers - Preservation of Operating Profit Markup Scenario

Units Base Case Trial Standard Level

1 2 3 4 5 6

INPV 2011$ M 237.6 229.6 226.5 219.0 198.7 190.8 159.0

Change in INPV 2011$ M (8.0) (11.1) (18.6) (38.9) (46.8) (78.6)

% (3.4) (4.7) (7.8) (16.4) (19.7) (33.1)

Table 12.5-4 Changes in Industry Net Present Value for Low -Voltage Dry- Type

Distribution Transformers - Preservation of Gross Margin Percentage Markup Scenario

Units Base Case Trial Standard Level

1 2 3 4 5 6

INPV 2011$ M 237.6 252.4 249.4 265.7 279.9 298.6 356.6

Change in INPV 2011$ M 14.8 11.8 28.1 42.3 61.0 118.9

% 6.2 5.0 11.8 17.8 25.7 50.112

- 34 Table 12.5-5 Changes in Industry Net Present Value for Medium -Voltage Dry- Type

Distribution Transformers - Preservation of Operating Profit Markup Scenario

Units Base

Case Trial Standard Level

1 2 3 4 5

INPV 2011$ M 68.7 67.3 65.7 57.9 58.0 34.5

Change in

INPV 2011$ M

- (1.4) (2.9) (10.7) (10.7) (34.1)

%

- (2.0) (4.2) (15.6) (15.5) (49.7)

Table 12.5-6 Changes in Industry Net Present Value for Medium -Voltage Dry- Type

Distribution Transformers - Preservation of Gross Margin Percentage Markup Scenario

Units Base

Case Trial Standard Level

1 2 3 4 5

INPV 2011$ M 68.7 69.3 71.7 74.4 74.3 81.5

Change in

INPV 2011$ M

- 0.7 3.0 5.7 5.6 12.9

%

- 1.0 4.4 8.3 8.2 18.7

12.5.2 Impacts on Annual Cash Flow

While INPV is useful for evaluating the long

- term effects of amended energy conservation standards, short-term changes in cash flow are also important indicators of the industry’s financial situation. For example, a large investment over one or two years could strain the industry’s access to capital. Consequently, the sharp drop in financial performance could cause investors to flee, even though recovery may be possible. Thus, a short- term disturbance can have long

- term effects that the INPV cannot capture. To get an idea of the behavior of annual free cash flows, Figures 12.5-1 through 12.5-6 below present the annual free cash flows from 2012 through 2023 for the base case and different TSLs in the standards case.

Annual cash flows are discounted to the base year, 2012. Between 2012 and the 2016, the compliance date of the amended energy conservation standard, cash flows are driven by the level of conversion costs and the proportion of these investments spent every year. After the standard announcement date (i.e., the publication date of the final rule), industry cash flows begin to decline as companies use their financial resources to prepare for the amended energy conservation standard. The more stringent the amended energy conservation standard, the gre ater the impact on industry cash flows in the years leading up to the compliance date, as product12

- 35 conversion costs lower cash inflows from operations and capital conversion costs increase cash outflows for capital expenditures.

Free cash flow in the year the amended energy conservation standards take effect is driven by two competing factors. In addition to capital and product conversion costs, amended energy conservation standards could create stranded assets, i.e., tooling and equipment that would have enjoyed longer use if the energy conservation standard had not made them obsolete. In this year, manufacturers write down the remaining book value of existing tooling and equipment whose value is affected by the amended energy conservation standard. This one- time

write

- down acts as a tax shield that alleviates decreases in cash flow from operations in the year

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

In the years following the compliance date of the standard, the impact on cash flow depends on the operating revenue. In the preservation of gross margin percentage scenario , the manufacture markup i s held constant to yield the same gross margin percentage in the standards

case at each TSL as in the base case in the year after the standard takes effect

. The implicit assumption is that manufacturers can freely pass on and mark up higher cost units. The result

under this scenario is that operating cash flow increases (in absolute terms ) as revenue increases. At the highest TSLs where MPCs dramatically increase, this scenario drives large increases in operating cash flow relative to the base case. The larger the production cost increase, then, the more likely it is that the increase in operating cash flow after the standard takes affect will outweigh the initial conversion costs.

Under the preservation of operating profit scenario, cash flow decreases at each TSL in the standards case compared to the base case because , since the absolute dollar amount of the gross margin does not change despite an increase in sales and cost of goods sold, the gross margin percentage is reduced

. Figures 12.5-1 through 12.5-6 present the annual free cash flows

for each superclass of distribution transformers.12

- 36 Figure 12.5-1 Annual Industry Free Cash Flows for Liquid

- immersed Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario $(200) $(150) $(100)

$(50)

$

- $50 $1002011$ Millions

Year

Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 712

- 37 Figure 12.5-2 Annual Industry Free Cash Flows for Liquid

- immersed Dis tribution

Transformers - Preservation of Operating Profit Markup Scenario $(200) $(150) $(100)

$(50)

$

- $502011$ Millions

Year

Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 6 TSL 712

- 38 Figure 12.5-3 Annual Industry Free Cash Flows for Low -Voltage Dry- Type Distribution

Transformers - Preservation of Gross Margin Percentage Markup Scenario $(60) $(50) $(40) $(30) $(20) $(10)

$

- $10 $20 $30 $402011$ Millions

Year

Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 612

- 39 Figure 12.5-4 Annual Industry Free Cash Flows for Low -Voltage Dry- Type Distribution

Transformers - Preservation of Operating Profit Markup Scenario $(70) $(60) $(50) $(40) $(30) $(20) $(10)

$

- $10 $20 $302011$ Millions

Year

Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 5 TSL 612

- 40 Figure 12.5-5 Annual Industry Free Cash Flows for Medium -Voltage Dry- Type

Distribution Transformers - Preservation of Gross Margin Percentage Markup Scenario $(15) $(10)

$(5) $

- $5 $102011$ Millions

Year

Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 512

- 41 Figure 12.5-6 Annual Industry Free Cash Flows for Medium -Voltage Dry- Type

Distribution Transformers - Preservation of Operating Profit Markup Scenario $(20) $(15) $(10)

$(5) $

- $5 $102011$ Millions

Year

Baseline TSL 1 TSL 2 TSL 3 TSL 4 TSL 512

- 42 12.6 IMPACTS ON MANUFACTU RER SUBGROUPS

As described in Section 12.2.3 above, DOE identified one subgroup of distribution

transformer manufacturers: small manufacturers . The results of th is subgroup analysi s are described below.

12.6.1 Impacts on Small Business Manufac turers

12.6.1.1 Description and Estimated Number of Small Entities Regulated
DOE conducted a more focused inquiry of the companies that could be small business manufacturers of products covered by this rulemaking. During its market survey, DOE used all available pu blic information to identify potential small manufacturers. DOE’s research involved industry trade association membership directories (including NEMA), UL qualification directories, individual company websites, and market research tools (e.g., Dun and Brad street reports) to create a list of every company that manufactures or sells distribution transformers covered by this rulemaking. DOE also asked stakeholders and industry representatives if they were aware of any other small manufacturers during manufactu rer interviews and at previous DOE public meetings. DOE contacted select companies on its list, as necessary, to determine whether they met the SBA’s definition of a small business manufacturer of covered distribution

transformers . DOE screened out companies that did not offer products covered by this rulemaking, did not meet the definition of a “small business,” or are foreign owned and operated.

DOE initially identified at least 63 potential manufacturers of distribution transformers sold in the U.S. DOE reviewed information on these 63 potentia l manufacturers and determined

33 were large manufacturers, were foreign owned, and/or operated or did not manufacture

transformers covered by this rulemaking. DOE then attempted to contact the remaining companies that were potential small business manufacturers. Though many companies were unresponsive, DOE was able t o determine that approximately 30 meet the SBA’s definition of a small business and likely manufacture transformers covered by this rulemaking.

Before issuing this NOPR, DOE attempted to contact the small business manufacturers of

distribution transformers it had identified. Three of the small businesses consented to being interviewed during the MIA interviews, and DOE received feedb ack from additional small

business es through surveys, phone interviews, follow-up discussions, and consensus meetings. DOE also obtained information about small business impacts while interviewing large

manufacturers.

Liquid Immersed.

Six major manufactur ers supply more than 80 percent of the market for liquid- immersed transformers. None of the major manufacturers of distribution transformers covered in this rulemaking are considered to be small businesses. The vast majority of shipments are manufactured domestically. Electric utilities compose the customer base and typically buy on

first -cost. Many small manufacturers position themselves towards the higher end of the market or in particular product niches, such as network transformers or harmonic mitigatin g transformers, but, in general, competition is based on price after a given unit’s specs are prescribed by a

customer.12

- 43 Low-Voltage Dry- Type.

Four major manufacturers supply more than 80 percent of the market for low-voltage dry-type transformers. None of the major low-voltage dry- type manufacturers of distribution transformers covered in this rulemaking are small businesses. The customer base r arely purchases on efficiency and is very first-cost conscious, which, in turn, places a premium on economies of scale in manufacturing. DOE estimates approximately 80 percent of the market is served by imports, mostly from Canada and Mexico. Many of the s mall businesses that compete in the low-voltage dry- type market produce specialized transformers that are exempted from standards. Roughly 50 percent of the market by revenue is exempted from DOE standards. This market is much more fragmented than the one serving DOE -covered low- voltage dry

- type
transformers.

In the DOE

- covered low- voltage dry

- type market, low -volume manufacturers typically do not compete directly with large manufacturers using business models similar to those of their bigger rivals because scale disadvantages in purchasing and production are usually too great a barrier in this portion of the market.. The exceptions to this rule are those companies that also compete in the medium- voltage market and, to some extent, are able to leverage that experience and production economies. More typically, low-volume manufacturers have focused their operations on one or two parts of the value chain— rather than all of it —and trained their sights on market segments outside of the high- volume baseline efficiency market.

In terms of operations, some small firms focus on the engineering and design of transformers and source the production of the cores or even the whole transformer, while other small firms focus on just production and rebrand for companies that offer broader solutions through their own sales and distribution networks.

In terms of market focus, many small firms simply compete entirely in the DOE

exempted markets. DOE did not attempt to contact companies operating entirely in this very fragmented market. Of those that do compete in the DOE- covered market, a few small businesses reported a focus on the high-end of the market, often selling NEMA Premium or better transformers as retrofit opportunities. Others focus on particular applications or other niches, like data centers, and become well -versed in the unique needs of a particular customer

base.

Medium -Voltage Dry- Type.

The medium-voltage dry-type transformer market is relatively consolidated with one large company holding a substantial share o f the market. Electric utilities and industrial users make up most of the customer base and typically buy on first-cost or features other than efficiency. DOE estimates that at least 75 percent of production occurs domestically. Several manufacturers also compete in the power transformer market. Like the low-voltage dry- type industry, most small business manufacturers often produce transformers exempted from DOE standards. DOE estimates 10 percent of the market is exempt from standards.12

- 44 12.6.1.2 Comparison Between Large and Small Entities
Small distribution transformer manufacturers differ from large manufacturers in several ways that affect the extent to which they would be impacted by the proposed standard.

Characteristics of small manufacturers include: less acc ess to capital, lower production volumes, fewer engineering resources, less technical expertise, and lack of purchasing power for high performance materials.

In general, small manufacturers have less access to capital which would be needed to

cover the con version costs associated with a new standard. Investors have less of an incentive to make loans to small businesses because they are typically riskier than loans made to large businesses. Therefore, a manufacturer that has more than 750 employees, or that is owned by a parent company with more than 750 employees, would be able to obtain funds (either by itself or through its parent company) more easily than would a small manufacturer.

Small manufacturers also have lower production volumes than large manufacturers. Therefore, their conversion costs would need to be spread across fewer units and the reduction in profit/unit would be significantly greater for them than for a large manufacturer. Although the same equipment would need to be purchased by both large and small manufacturers in order to produce transformers that meet DOE standards, the return on investment for a small manufacturer would be lower because it does not sell as many units.

Since they have fewer employees, smaller companies are also more likely to have smaller engineering teams. If new standards require a lot of product development time to implement, the engineering staff of a small manufacturer may not be large enough to address higher efficiency standards while performing routine work. In addition, if investments need to be made for conversion costs, smaller companies are less likely to have enough capital left over to invest in the necessary additional engineering resources.

Generally, smaller companies may also have less experien ce and expertise in working with newer technologies. Large companies with better access to capital and bigger R&D budgets have more resources to invest in the development of new technologies and product lines. In the case of transformers, large manufacturers have exhibited greater technical expertise and experience in working with amorphous core and symmetric core technologies, both of which allow higher efficiency levels to be achieved. During manufacturer interviews, one manufacturer

stated that there sho uld be no major impact on small manufacturers if standards can be met with stacked core technology, but if alternative core constructions are needed, then small manufacturers may be negatively impacted because they lack the resources to pursue or develop such technologies.

Furthermore, small manufacturers can be at a disadvantage due to their lack of purchasing power for high performance materials, especially considering the limited availability of high grade steels in the production of distribution transfo rmers. During manufacturer interviews, one manufacturer stated that it was unable to even obtain a quote for amorphous steel, let alone purchase the material.12

- 45 12.6.1.3 Description and Estimate of Compliance Requirements
Liquid Immersed. Based on interviews with manufacturers in the liquid- immersed market, DOE does not believe small manufacturers will face significant capital conversion costsat the levels proposed in today’s rulemaking. DOE expects small manufacturers of liquidimmersed distribution transformers to continue to produce silicon steel cores, rather than invest in amorphous technology. While silicon steel designs capable of achieving TSL 1 would get larger, and thus reduce throughput, most manufacturers said the industry in g eneral has substantial excess capacity due to the recent economic downturn. Therefore, DOE believes TSL 1 would not require the typical small manufacturer to invest in additional capital equipment. However, small manufacturers may incur some engineering an d product design costs associated

with re -optimizing their production processes around new baseline products. DOE estimates TSL 1 would require industry production development costs of only one-half of one year’s annual industry R&D expenses, as the levels do not require any changes in technology or steel types. Because these costs are relatively fixed per manufacturer, these one

- time costs impact smaller manufacturers disproportionately compared to larger manufacturers. Table 12.6-1 below

illustrates this effect by comparing the conversion costs to the annual R&D expenses of a typical small company and a typical large company

.

Table 12.6-1 Estimated Product Conversion Costs as a Percentage of Annual R&D Exp ense

Product

Conversion Cost Product Conversion Cost as a Percentage of Annual R&D Expense

Typical Large Manufacturer $1. 3 4 M 20%

Typical Small Manufacturer $1. 3 4 M 222%

While the costs disproportionately impact small manufactures, the standard levels, as stated above, do not require small manufacturers to invest in entirely different production processes nor do they require steels or core construction techniques with whic h these manufacturers are not familiar. A range of design options would still be available.

Low-Voltage Dry- Type. For the low-voltage dry- type market, at TSL 2, DOE estimates capital conversion costs of $0.75 million and product conversion costs of $0.2 m illion for a typical small and large manufacturer, based on manufacturer interviews. Because of the largely fixed nature of these one-time conversion expenditures that distribution transformer manufacturers would incur as a result of standards, small manufacturers who choose to maintain

in -house production will likely be disproportionately impacted compared to large manufacturers.

As Table 12.6-2 indicates, small manufacturers face a greater relative hurdle in complying with standards should they opt to continue to maintain core production in-house.12

- 46 Table 12.6-2 Estimated Capital and Product Conversion Costs as a Percentage of Annual Capital Expenditures and R&D Expense

Capital Conversion Cost as a Percentage of Annual Capital Expenditures Product Conversion Cost as a Percentage

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

Annual EBIT

Large Manufacturer 37 % 10 % 15 %

Small Manufacturer 137 % 44 % 70 %

As demonstrated in the table above, the investments required to meet TSL 2 disproportionately impact small businesses. However, DOE’s capital conversion costs estimates in the table above assume that small businesses are currently producing their cores in -house and will choose to do so in the future, rather than source them from third- party core manufactures who often have significant cost advantages through bulk steel purchasing power and greater production efficiencies due to higher volumes. As such, many small businesses DOE interviewed already source a large percentage of their cores and many indicated they expected such a strategy would be the low-cost option under higher standards.

Compared to higher TSLs, TSL 2 provides many more design paths for sm all manufacturers to comply. DOE’s engineering analysis indicates manufacturers can continue to

use the low- capital butt

- lap core designs, meaning investment in mitering capability is not necessary to comply. Manufacturers can use higher-quality grain oriented steels in butt- lap designs to meet these proposed efficiency levels, source some or all cores, or invest in mitering capability. DOE notes that roughly half of the small business low- voltage dry

- type manufacturers DOE interviewed already have mitering capability. For all of the reasons discussed, DOE believes the capital expenditures it assumed for small businesses are likely conservative and that small businesses have a variety of technical and strategic paths to continue to compete in the market at T SL 2.

Medium -Voltage Dry- Type. Based on its engineering analysis and interviews, DOE

expects minimal capital expenditures for the industry to meet TSL 2. DOE understands that the market is already standardized on step

- lap mitering, so manufacturers will n ot need to make major investments for more advanced core construction. Furthermore, TSL 2 does not require a change to much thinner steels such as M3 or H0. The industry can use M4 and H1, thicker steels with which it has much more experience and which are easier to employ in the stacked

- core production process that dominates the medium- voltage market. However, some investment will be required to maintain capacity as some manufacturers will likely migrate to more M4 and H1 steel from the slightly thicker M5 , which is also common. Additionally, design options at TSL 2 typically have larger cores, also slowing throughput. Therefore, some manufacturers may need to invest in additional production equipment. Alternatively, depending on each company’s availability capacity, manufacturers could employ addition al production shifts, rather than invest in additional capacity.

For the medium- voltage dry

- type market, at TSL 2, DOE estimates low capital and product conversion costs that are relatively fixed for both smal l and large manufacturers. Similar to the low-voltage dry- type market, small manufacturers will likely be disproportionately12

- 47 impacted compared to large manufacturers due to the fixed nature of the conversion expenditures. Table 12.6-3 illustrates the relative impacts on small and large manufacturers.

Table 12.6-3 Estimated Capital and Product Conversion Costs as a Percentage of Annual Capital Expenditures and R&D Expense

Capital Conversion Cost as a Percentage of Annual Capital Expenditures Product Conversion Cost as a Percentage

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

Annual EBIT Large Manufacturer 3 % 9 % 8 %

Small Manufacturer 40 % 117 % 98 %

Summary of Compliance Impacts. The compliance impacts on small businesses are

discussed above for low- voltage dry -type, medium- voltage dry -type, and liquid- filled distribution transformer manufacturers. Although the conversion costs required can be considered substantial for all compani es, the impacts could be relatively greater for a typical small manufacturer because of much lower production volumes and the relatively fixed nature of the R&D and capital investments required.

12.7 OTHER IMPACTS

12.7.1 Employment

Liquid Immersed. Based on interviews and industry research, DOE estimates that there are roughly 5,000 employees associated with DOE-covered liquid immersed distribution transformer production and some three- quarters of these workers are located domestically. DOE does not expect large changes in domestic employment to occur due to today’s standard. Manufacturers generally agreed that amorphous production is more labor-intensive and would require greater labor expenditures than tradition al steel core production. So long as domestic plants are not relocated outside the country, DOE expects moderate increases in domestic employment at TSL1 and TSL2. There could be a small drop in employment at small, domestic manufacturing firms if small manufacturers beg i n sourcing cores. Thi s employment would presumably transfer to the core makers, some of whom are domestic and some of whom are foreign. There is a risk that energy conservation standards that largely require the use of amorphous steel could cause even large manufacturers who are currently producing transformers in the U.S. to evaluate offshore options. Faced with the prospect of wholesale changes to their production process, large investments and stranded assets, some manufacturers expect to strongly consider shifting production offshore at TSL 3 or TSL 4 due to the increased labor expenses associated with the production processes required to make amorphous steel cores. In summary, at TSLs 1 and 2, DOE does not expect significant impacts on employment, but at TSL 3 or higher, which would require more investment, the impact is very uncertain.12

- 48 Low-Voltage Dry- Type. Based on interviews with manufacturers, DOE estimates that there are approximately 2,200 employees associated with DOE

- covered low-voltage dry- type production. Approxim ately 75 percent of these employees are located outside of the U.S. Typically, high volume units are made in Mexico, taking advantage of lower labor rates, while custom designs are made closer to the manufacturer’s customer base or R&D centers. DOE does not expect large changes in domestic employment to occur due to a standard. Most production already occurs outside the U.S. and, by and large, manufacturers agreed that most design changes necessary to meet higher energy conservation standards would increase labor expenditures, not

decrease them . If, however, small manufacturers began sourcing cores instead of manufacturing

them in -house, there could be a small drop in employment at these firms. This employment would presumably transfer to the core makers, some of whom are domestic and some of whomare foreign. In summary, DOE does not expect significant changes to domestic low-voltage drytype industry employment levels as a result of the proposed standards. Higher TSLs may lead to small declines in domestic employment as more firms will be challenged with what amounts to

clean -sheet redesigns. Facing the prospect of greenfield investments, these manufacturers may

elect to make those investments in lower -labor cost countries or source their cores from potentially foreign manufacturers.

Medium -Voltage Dry- Type. Based on interviews with manufacturers, DOE estimates that there are approximately 1,850 employees associated with DOE

- covered medium- voltage dry- type transformer production. Approximately 75 percent of these employees are located domestically. With the exception of TSLs that require amorphous cores, manufacturers agreed that most design changes necessary to meet higher energy conservation standards would increase labor expenditures, not decrease them, but current production equipment would not be stranded, mitigating any incentive to move production offshore. Corroborating this, the largest manufacturer and domestic employer in this market has indicated that the standard, as proposed in this rule, will no t cause their company to reconsider production location. As such, DOE does not expect significant changes to domestic medium

- voltage dry

- type industry employment levels as a result of the standard proposed in this rule. For TSLs that would require amorphou s cores, DOE does anticipate significant changes to domestic medium-voltage dry- type industry employment levels.

12.7.2 Production Capacity

Capacity can be viewed from two perspectives: one focused on core steel supply and one focused more broadly on transformer production (which would encompass core steel supply issues).

In terms of core steel, the issue of capacity rests largely with the liquid immersed market, which uses roughly three quarters of the core steel consumed by the entire DOE- covered

distribution transformer market. It must be noted also that core steel is a global market and an active import/export market exists. Thus, surges in demand in foreign countries can constrain supply with respect to U.S. market needs. Additionally, some steel types and grades are used not only across superclasses but are also used substantially in transformers not covered by this analysis. Most notably, H0 and H1, steels well -suited to high- efficiency stacked

- core designs in the dry-type market, happen to be most popular in the power transformer market.12

- 49 With that said, based on industry interviews, DOE expects minimal core steel capacity issues at those TSLs that do not force the entire market into amorphous steel usage. At those TSLs that are projected to move the majority of the market to amorphous steel, DOE believes there could be capacity issues associated with ramping amorphous steel production in time to meet the 1/1/2016 compliance date. This occurs at TSL 4 in the liquid immersed market

, at TSL

5 in the med ium- voltage dry

- type market , and at TSL 4 in the low-voltage dry- type market. In aggregate, based on DOE analysis, at current steel prices, these levels portend more than a 10- fold increase in the demand of amorphous ribbon in the U.S. Because this is only supplied by one supplier, and because most of that supplier’s output is currently used to meet foreign demand, which DOE has no reason to believe will subside, let alone stop growing, the department has concerns about the availability of a sufficient supply of amorphous at these high

TSLs.

DOE unders tands that M2 steel , which remains cost competitive with amorphous designs at efficiencies higher than M3 is capable of, has a technical engineering constraint associated with its output. A maximum of 1 pound of M2 steel can be produced for every 4 pounds of M3 or lower steel. Therefore, if there is no market for M3 steel, it is highly unlikely that M2 steel could be used to meet a significant portion of the liquid immersed market demand.

In terms of transformer production capacity, DOE understands from interviews that there is significant excess capacity in silicon steel production assets. Shipments are well off their peak from 2008. Therefore, DOE does not expect capacity problems at levels that maintain silicon steels as viable design options in the market. However, at the TSLs noted above, at which only amorphous cores would likely be competitive, transformer manufacturers would face large hurdles in changing over their entire production processes in three years, particularly in the medium dry- type market which has no experience using amorphous technology. Even under the assumption that all core steels are widely available, substantial changes in transformer efficiency standards could require the entire industry to order the same types of specialized equipment, which come with long lead times, and could only be ordered after a lengthy R&D process of engineering, testing, and prototyping.

In summary, at TSLs 1 through 3 for the liquid immersed market, TSL s 1 through 4 for medium-voltage dry type market, and TSLs 1 through 3 for the low-voltage dry type market, DOE does not expect significant impacts on capacity. However, at higher TSLs, DOE believes there is a risk of adverse impacts on capacity due to a potential near

- term limitation on amorphous steel supply and, to a lesser extent, long lead times for specialized production equipment.

12.7.3 Cumulative Regulatory Burden

While any one regulation may not impose a significant burden on manufacturers, the combined effects of recent or impending regulations may have serious consequences for some manufacturers, groups of manufacturers, or an entire industry. Assessing the impact of a single regulation may overlook this cumulative regulatory burden. In addition to energy conservation standards, other regulatio ns can significantly affect manufacturers’ financial operations. Multiple regulations affecting the same manufacturer can strain profits and lead companies to abandon product lines or markets with lower expected future returns than competing products. For these12

- 50 reasons, DOE conducts an analysis of cumulative regulatory burden as part of its rulemakings pertaining to appliance efficiency. During previous stages of this rulemaking DOE identified a number of requirements in addition to amended energy conservation standards for distribution

transformers.

12.7.3.1 Federal Regulations on Distribution Transformer Manufacturers

For low-voltage dry- type transformers, the Energy Policy Act of 2005 required compliance with NEMA TP -1 standards by the beginning of 2007. For liquid- immersed and medium voltage dry type transformers, DOE’s 2007 energy conservation standards rulemaking required compliance by the beginning of 2010. Since the last set of energy conservation standards for distribution transformers went into effect very recently and required large capital investments and retooling, any new standards which would require additional retooling and

investment would create a cumulative burden for manufacturers.

In addition to efficiency regulations, liquid

- immersed distribution transformer manufacturers also need to comply with the National Energy Code (NFPA 70), which requires that indoor liquid- immersed transformers be located in separate transformer vaults and provides stipulations for fire walls, doors, ventilation, and oil containment. The impetus for this section of the National Energy Code is to prevent fires associated with flammable insulating fluids , but such requirements increase the installed cost of liquid

- immersed transformers

.

12.7.3.2 Foreign Re gulations on Distribution Transformer Manufacturers
Manufacturers that export their products to places such as Canada, China, Mexico, or the Middle East need to comply with foreign as well as domestic regulations. The Canadian government regulates efficien cy of dry-type transformers through its Canadian Standards Association (CSA) standard C802.2-00 (effective January 1, 2005). China regulates transformer efficiency through its China Compulsory Certification (CCC) program (effective May 1, 2002), which requires manufacturers of various products including transformers to obtain the CCC Mark before exporting to or selling in the Chinese market. In Mexico, liquid- immersed units are regulated through NOM-002- SEDE -2010.

12.8 CONCLUSION
The following section summarize s the impacts for the scenarios DOE believes are most likely to capture the range of impacts on distribution transformer manufacturers as a result of amended energy conservation standards. DOE also notes that while these scenarios bound the range of most plausible impacts on manufacturers, there potentially could be circumstances which cause manufacturers to experience impacts outside of this range.

Liquid Immersed.

TSL 1 represents an increase in efficiency where a diversity of electrical steels are cost

competitive and economically feasible for all design lines. At TSL 1, DOE estimates impacts on INPV for liquid- immersed distribution transformer manufacturers to range from -$48.2 million to -$23.5 million, corresponding to a change in INPV of -8.4 percent to -4.1 percent. At this level, industry free cash flow is estimated to decrease by approximately 54.4 percent to $16.412

- 51 million, compared to the base-case value of $36.0 million in the year before the compliance date (2015).

While TSL 1 can be met with traditional steels, including M3, in all design lines, amorphous core transformers will be incrementally more competitive on a first cost basis. According to manufacturer interviews, this would likely induce some manufacturers to gradually build amorphous steel transformer production capacity. Because the production process for amorphous cores is entirely separate from that of silicon steel cores, large investments in new capital, including new core cutting equipment and annealing ovens will be required. Additionally, a great deal of testing, prototyping, design and manufacturing engineering resources will be required because most manufacturers have relatively little experience, if any, with amorphous steel transformers. These capital and production conversion expenses lead to a reduction in cash flow in the years preceding the standard. In the lower-bound scenario, DOE assumes manufacturers can only maintain annual operating profit in the standards case. Therefore, these conversion investments, and manufacturers’ higher working capital needs associated with more expensive transformers, drain cash flow and lead to a greater reduction in INPV, when compared to the upper-bound scenario. In the upper bound scenario, DOE assumes

manufacturers will be able to fully markup and pass on the higher product costs, leading to higher operating income. This higher operating income essentially offsets the conversion costs and the increase in working capital requirements, leading to a negligible change in INPV at

TS L1 in the upper-bound scenario.

TSL 2 represents EL1 for all design lines. At TSL 2, DOE estimates impacts on INPV for liquid -immersed distribution transformer manufacturers to range from -$109.3 million to -$67.0 million, corresponding to a change in INPV of -19.0 percent to -11.7 percent. At this level, industry free cash flow is estimated to decrease by approximately 133.7 percent to -$12.1 million, compared to the base-case value of $36.0 million in the year before the compliance date (2015).

TSL 2 requ ires the same efficiency levels as TSL 1, except for DL 2, which is increased from baseline to EL1. EL1, as opposed to the baseline efficiency, could induce manufacturers to build more amorphous capacity, when compared to TSL 1, because amorphous core tra nsformers become incrementally more cost competitive. Because DL2 represents the largest share of core steel usage of all design lines, this has a significant impact on investments. There are more severe impacts on industry in the lower-bound profitability scenario when these greater one

- time cash outlays are coupled with slight margin pressure. In the high- profitability scenario, manufacturers are able to maintain gross margins, mitigating the adverse cash flow impacts of

the increased investment in workin g capital (associated with more expensive transformers).

TSL 3 represents the maximum efficiency leve l achievable with M3 core steel. At TSL 3, DOE estimates impacts on INPV for liquid

- immersed distribution transformer manufacturers to range from -$113.4 m illion to -$68.9 million, corresponding to a change in INPV of -19.7

percent to -12.0 percent. At this level, industry free cash flow is estimated to decrease by approximately 137.6 percent to -$13.6 million, compared to the base-case value of $36.0 million in the year before the compliance date (2015).12

- 52 TSL 3 results are similar to TSL 2 results because the efficiency levels are the same except for DL3 and DL5, which each increase to EL 2 under TSL 3. The increase in stringency makes amorphous core transfo rmers slightly more cost competitive in these DLs, according to the engineering analysis, which would likely increase amorphous core transformer capacity needs, all other things being equal, and drive more investment to meet the standards.

TSL 4 represents the maximum NPV with 7 percent discounting. At TSL 4, DOE estimates impacts on INPV for liquid -immersed distribution transformer manufacturers to range

from -$186.1 million to -$97.3 million, corresponding to a change in INPV of -32.4 percent to - 16.9 per cent. At this level, industry free cash flow is estimated to decrease by approximately 206.6 percent to -$38.4 million, compared to the base-case value of $36.0 million in the year before the compliance date (2015).

During interviews, manufacturers express ed differing views on whether the efficiency levels embodied in TSL 4 would shift the market away from silicon steels entirely. Because DL3 and DL5 must meet EL4 at this TSL, DOE expects the majority of the market would shift to amorphous core transformers at TSL 4 and above. Even assuming a sufficient supply of amorphous steel were available, TSL 4 and above would require a dramatic build up in amorphous core transformer production capacity. DOE believes this wholesale transition away

from silicon steels could seriously disrupt the market, drive small businesses to either source their cores or exit the market, and lead even large businesses to consider moving production offshore or exiting the market altogether. The negative impacts are again driven by t he large conversion costs associated with new amorphous steel production lines. If the higher first costs at TSL 4 drive more utilities to refurbish rather than replace failed transformers, a scenario many manufacturers predicted at the efficiency levels and prices embodied in TSL 4, reduced

transformer sales could cause further declines in INPV.

TSL 5 repre sents EL 3 for all design lines. At TSL 5, DOE estimates impacts on INPV for liquid- immersed distribution transformer manufacturers to range from -$193.0 million to - $101.4 million, or a change in INPV of -33.6 percent to -17.6 percent. At this level, industry free cash flow is estimated to decrease by approximately 210.8 percent to -$39.9 million, compared to the base-case value of $36.0 million in the year before the compliance date (2015).

TSL 5 would likely shift the entire market to amorphous core transformers, leading to even greater investment needs than TSL 4, and further driving the adverse impacts discussed

above.

TSL 6 represents the maximu m source energy savings with positive NPV with 7 percent discounting. At TSL 6, DOE estimates impacts on INPV for liquid

- immersed distribution transformer manufacturers to range from -$216.7 million to -$88.5 million, corresponding to a change in INPV of -37.7 percent to -15.4 percent. At this level, industry free cash flow isestimated to decrease by approximately 217.5 percent to -$42.3 million, compared to the basecase value of $36.0 million in the year before the compliance date (2015).

The impacts at TSL 6 are similar to those DOE expects at TSL 5, except that slightly more amorphous core production capacity will be needed because TSL 6- compliant transformers12

- 53 will have somewhat heavier cores and thus require more amorphous steel. This leads to slightl y greater capital expenditures at TSL 6 compared to TSL 5.

TSL 7 represents the maximum technologically feasible level (max tech)

. At TSL 7, DOE estimates impacts on INPV for liquid -immersed distribution transformer manufacturers to range

from -$393.5 million to $0.5 million, corresponding to a change in INPV of -68.4 percent to 0.1 percent. At this level, industry free cash flow is estimated to decrease by approximately 246.2

percent to -$52.7 million, compared to the base-case value of $36.0 million in th e year before the compliance date (2015).

The impacts at TSL 7 are similar to those DOE expects at TSL 6, except that slightly more amorphous core production capacity will be needed because TSL 7- compliant transformers

will have somewhat heavier cores and thus require more amorphous steel. This leads to slightly greater capital expenditures at TSL 7 compared to TSL 6, incrementally reducing industry value.

Low-Voltage Dry- Type.

TSL 1 represents the maximum efficiency level achievable with M6 core steel. At TSL 1, DOE estimates impacts on INPV for low

- voltage, dry -type distribution transformer manufacturers to range from -$8.0 million to $14.8 million, corresponding to a change in INPV

of -3.4 percent to 6.2 percent. At this level, industry free cash flow is estimated to decrease by approximately 5.0 percent to $14.5 million, compared to the base-case value of $15.5 million in the year before the compliance date (2015).

TSL 1 provides many design paths for manufacturers to comply. DOE’s engineering analysis indicates manufacturers can continue to use the low- capital butt

- lap core designs, meaning investment in mitering or wound core capability is not necessary. Manufacturers can use higher- quality grain oriented steels in butt -lap designs to meet TSL1, sourc e some or all cores, or invest in modified mitering capability (if they do not already have it).

TSL 2 represents EL 3 for design line 7, EL 2 for design line 8 and no efficiency increase for design line 6. At TSL 2, DOE estimates impacts on INPV for low -voltage, dry- type distribution transformer manufacturers to range from -$11.1 million to $11.8 million, corresponding to a change in INPV of -4.7 percent to 5.0 percent. At this level, industry free cash flow is estimated to decrease by approximately 9.1 percent to $13.8 million, compared to the

base -case value of $15.5 million in the year before the compliance date (2015).

TSL 2 differs from TSL1 in that DL7 must meet EL3, up from EL2. Comments received from the NOPR and consultations with technical experts suggest that butt-lap technology can still be used to achieve EL 3 for DL 7. However, DOE expects the high volume manufacturers which supply most of the market to employ mitered cores at this efficiency level. Therefore, the

increase in conversion costs for DL 7, which represents more than three- quarters of the market by core weight in this superclass, is primarily driven by the need to purchase additional core cutting equipment to accommodate the production of larger, mitered cores. Furthermore,

manufac turers also indicated that there would be a reduced burden at TSL 2 relative to TSL 1 because they would be able to standardize the use of NEMA Premium® (with the exception of DL 6).12

- 54 TSL 3 represents the maximum EL achievable using butt- lap miter core manufacturing for single -phase distribution transformers, and full miter core manufacturing for three- phase

distribution transformers. At TSL 3, DOE estimates impacts on INPV for low -voltage, dry- type distribution transformer manufacturers to range from -$18.6 million to $28.1 million, corresponding to a change in INPV of -7.8 percent to 11.8 percent. At this level, industry free cash flow is estimated to decrease by approximately 31.9 percent to $10.4 million, compared to

the base -case value of $15.5 million in the year before the compliance date (2015).

Although manufacturers may be able to meet EL4 using M4, comments and interviews suggest uncertainty about the ability of M4 to meet EL 4 for all design lines. Manufacturers may be forced to use higher- grade an d thinner steels like M3, H1, and H0. However, these thinner steels, in combination with larger cores, will dramatically slow production throughput and therefore require the industry to expand capacity to maintain current shipments. This is the

reason for the increase in conversion costs. In the lower-bound profitability scenario, when DOE assumes the industry cannot fully pass on incremental costs, these investments and the higher working capital needs drain cash flow and lead to the negative impacts shown in the preservation of operating profit scenario. In the high- profitability scenario, impacts are slightly positive because DOE assumes manufacturers are able to fully recoup their conversion expenditures through higher operating cash flow.

TSL 4 repr esents the maximum NPV with 7 percent discounting. At TSL 4, DOE estimates impacts on INPV for low -voltage, dry-type distribution transformer manufacturers to range from -$38.9 million to $42.3 million, corresponding to a change in INPV of -16.4 percent

to 17.8 percent. At this level, industry free cash flow is estimated to decrease by approximately 87.2 percent to $1.9 million, compared to the base-case value of $15.5 million in the year before the compliance date (2015).

TSL 4 and higher would create significant challenges for the industry and likely disrupt the marketplace. DOE’s conversion costs at TSL 4 assume the industry will entirely convert to amorphous wound core technology to meet the efficiency standards. Few manufacturers of distribution transformers in this superclass have any experience with amorphous steel or wound core technology and would face a steep learning curve. This is reflected in the large conversion costs and adverse impacts on INPV in the Preservation of Operating Profit scenario. Most manufacturers DOE interviewed expected many low -volume manufacturers to exit the DOEcovered market altogether if amorphous steel was required to meet the standard. As such, DOE believes TSL 4 could lead to greater consolidation than the industry w ould experience at lower

TSLs

.

TSL 5 represents the maximum source energy savings with positive NPV with 7 percent discounting. At TSL 5, DOE estimates impacts on INPV for low -voltage, dry-type distribution transformer manufacturers to range from

- $46.8 m illion to $61.0 million, corresponding to a change in INPV of -19.7 percent to 25.7 percent. At this level, industry free cash flow is estimated to decrease by approximately 93.9 percent to $0.9 million, compared to the base- case value of $15.5 million in the year before the compliance date (2015).12

- 55 The impacts at TSL 5 are similar to those DOE expects at TSL 4, except that slightly more amorphous core production capacity will be needed because TSL 5- compliant transformers

will have somewhat heavier cores an d thus require more amorphous steel. This leads to slightly greater capital expenditures at TSL 5 compared to TSL 4.

TSL 6 represents the maximum technologically feasible level (max tech). At TSL 6, DOE estimates impacts on INPV for low -voltage, dry- type distribution transformer manufacturers to range from -$78.6 million to $118.9 million, corresponding to a change in INPV of -33.1 percent to 50.1 percent. At this level, industry free cash flow is estimated to decrease by approximately 138 percent to -$5.8 million, compared to the base-case value of $15.5 million in the year before the compliance date (2015).

The impacts at TSL 6 are similar to those DOE expects at TSL 5, except that slightly more amorphous core production capacity will be needed because TS L 6

- compliant transformers will have somewhat heavier cores and thus require more amorphous steel. This leads to slightly greater capital expenditures at TSL 6 compared to TSL 5.

Medium -Voltage Dry-Type.

TSL 1 represents EL1 for all design lines. At TSL 1, DOE estimates impacts on INPV for

medium- voltage dry -type distribution transformer manufacturers to range from -$1.4 million to $0.7 million, corresponding to a change in INPV of -2.0 percent to 1.0 percent. At this level, industry free cash flow is es timated to decrease by approximately 2.3 percent to $4.3 million, compared to the base -case value of $4.4 million in the year before the compliance date (2015).

For DL12, the largest design line by core steel usage, manufacturers have a variety of

steels a vailable to them, including M4, the most common steel in the superclass. Additionally, the vast majority of the market already uses step -lap mitering technology. Therefore, DOE anticipates only moderate conversion costs for the industry, mainly associated with slower throughput due to larger cores. Some manufacturers may need to slightly expand capacity to maintain throughput and/or modify equipment to manufacturer with greater precision and tighter tolerances. In general, however, conversion expenditure s should be relatively minor compared to INPV. For this reason, TSL 1 yields relatively minor adverse changes to INPV in the standards

case

.

TSL 2 represents an increase in efficiency where a diversity of electrical steels are cost

competitive and economi cally feasible for all design lines. At TSL 2, DOE estimates impacts on INPV for medium-voltage dry-type distribution transformer manufacturers to range from -$2.9 million to $3.0 million, corresponding to a change in INPV of -4.2 percent to 4.4 percent. A t this level, industry free cash flow is estimated to decrease by approximately 6.0 percent to $4.2 million, compared to the base-case value of $4.4 million in the year before the compliance date (2015).

Compared to TSL 1, TSL 2 requires EL2, rather than EL1, in DLs 10, 12, and 13B. Because M4 (as well as the commonly used H1) can still be employed to meet these levels, DOE expects similar results at TSL 2 as at TSL 1. Slightly greater conversion costs will be required as12

- 56 the compliant transformers will ha ve heavier cores, all other things being equal, meaning additional capacity may be necessary depending on each manufacturer’s current capacity utilization rate. As with TSL 1, TSL 2 will not require significant changes to most manufacturers production proc esses because the thickness of the steels will not change significantly, if at all

.

TSL 3 represents the maximum NPV with 7 percent discounting. At TSL 3, DOE estimates impacts on INPV for medium -voltage dry-type distribution transformer manufacturers to range from -$10.7 million to $5.7 million, corresponding to a change in INPV of -15.6 percent to 8.3 percent. At this level, industry free cash flow is estimated to decrease by approximately 53.4 to $2.1 million, compared to the base-case value of $4.4 million in the year before the compliance date (2015).

TSL 4 represents the maximum source energy savings with positive NPV with 7 percent discounting. At TSL 4, DOE estimates impacts on INPV for medium -voltage dry- type distribution transformer manufacturers to range from -$10.7 million to $5.6 million, corresponding to a change in INPV of -15.5 percent to 8.2 percent. At this level, industry free cash flow is estimated to decrease by approximately -53.4 percent to $2.1 million, compared to

the base

- case value of $4.4 million in the year before the compliance date (2015).

TSL 3 and TSL 4 require EL2 for DL9 and DL10, but EL4 for DL11 through DL13B, which hold the majority of the volume. Several manufacturers were concerned TSL 3 would require some of the high volume design lines to use H1 or H0, or transition entirely toamorphous wound cores (with which the industry has experience). Without a cost effective Mgrade steel option, the industry could face severe disruption. Even assuming a sufficient supply

of Hi -B steel, which is generally used and priced for the power transformer market, relatively large expenditures would be required in R&D and engineering as most manufacturers would have to move production to steel with which they have little experience. DOE estimates total conversion costs would more than double at TSL 3, relative to TSL 2. If, based on the movement of steel prices, EL4 can be met cost competitively only through the use of amorphous steel or an exotic design with little or no current place in scale manufacturing, manufacturers would facesignificant challenges that DOE believes would lead to consolidation and likely cause many lowvolume manufacturers to exit the product line.

At TSL 5, DOE estimates impacts on INPV for medium -voltage dry- ty pe distribution transformer manufacturers to range from -$34.1 million to $12.9 million, corresponding to a change in INPV of -49.7 percent to 18.7 percent. At this level, industry free cash flow isestimated to decrease by approximately 189.1 percent to -$3.9 million, compared to the basecase value of $4.4 million in the year before the compliance date (2015).

TSL 5 represents max-tech and yields results similar to but more severe than TSL 4 results. The engineering analysis shows that the entire market must convert to amorphous wound cores at TSL 5. Because the industry has no experience with wound core technology, and little, if any, experience with amorphous steel, this transition would represent a tremendous challenge for industry. Interviews suggest most manufacturers would exit the market rather altogether or source their cores rather than make the investments in plant, equipment, and R&D required to meet these levels

.12

- 57 1 NEMA

– NEMA Members. Last Accessed December 30, 201 0.

< http://www.nema.org/about/pages/members.aspx >.

2 McKinsey & Company, Inc. Valuation: Measuring and Managing the Value of Companies , 3rd Edition, Copeland, Koller, Murrin. New York: John Wiley & Sons, 2000.