CHAPTER 12. MANUFACTURER IMPACT ANALYSIS

TABLE OF CONTENTS

12.1 INTRODUCTION

................................ ................................ ................................ ............ 12

- 1
12.2 METHODOLOGY

................................ ................................ ................................ ............ 12

- 1
12.2.1 Phase I: Industry Profile

................................ ................................ ........................ 12

- 1
12.2.2 Phase II: Industry Cash

- Flow Analysis and Interview Guide

............................... 12

- 2
12.2.2.1 Industry Cash

- Flow Analysis

................................ ................................ . 12

- 2
12.2.2.2 Interview Guides

................................ ................................ .................... 12

- 3
12.2.3 Phase III: Subgroup Analysis

................................ ................................ ................ 12

- 3
12.2.3.1 Manufacturer Interviews

................................ ................................ ........ 12

- 3
12.2.3.2 Revised Industry Cash

- Flow Analysis

................................ ................... 12

- 3
12.2.3.3 Manufacturer Subgroup Analysis

................................ .......................... 12

- 4
12.2.3.4 Manufacturing Capacity Impact

................................ ............................. 12

- 5
12.2.3.5 Employment Impact

................................ ................................ ............... 12

- 5
12.2.3.6 Cumulative Regulatory Burden

................................ ............................. 12

- 5
12.3 MANUFACTURER IMPACT ANALYSIS KEY ISSUES

................................ ............. 12

- 6 12.3.1 Certification, Compliance, and Enforcement Costs

................................ .............. 12

- 6
12.3.2 Repair and Replacement Rates

................................ ................................ ............. 12

- 6 12.3.3 Alignment with ASHRAE Standards

................................ ................................ .... 12

- 7
12.4 GRIM INPUTS AND ASSU MPTIONS

................................ ................................ ........... 12

- 7
12.4.1 Overview of the GRIM

................................ ................................ ......................... 12

- 7
12.4.2 Sources for GRIM Inputs

................................ ................................ ...................... 12

- 8
12.4.2.1 Corporate Annual Reports

................................ ................................ ..... 12

- 8
12.4.2.2 Standard and Poor Credit Ratings

................................ .......................... 12

- 9
12.4.2.3 Shipment Model

................................ ................................ ..................... 12

- 9
12.4.2.4 Engineering Analysis

................................ ................................ ............. 12

- 9
12.4.2.5 Manufacturer Interviews

................................ ................................ ...... 12

- 10
12.4.3 Financial Parameters

................................ ................................ ........................... 12

- 10
12.4.4 Corporate Discount Rate

................................ ................................ ..................... 12

- 11
12.4.5 Trial Standard Levels

................................ ................................ .......................... 12

- 13
12.4.6 NIA Shipments

................................ ................................ ................................ .... 12

- 14
12.4 .7 Manufacturer Production Costs

................................ ................................ .......... 12

- 14
12.4.8 Conversion Costs

................................ ................................ ................................ 12

- 16
12.4.8.1 Capital Conversion Costs

................................ ................................ ..... 12

- 16
12.4.8.2 Product Conversion Costs

................................ ................................ .... 12

- 1 7
12.4.9 Markup Scenarios

................................ ................................ ............................... 12

- 17
12.4.9.1 Preservation of Gross Margin Percentage Scenario

............................. 12

- 18
12.4.9.2 Preservation of Per Unit Operating Profit Scenario

............................. 12

- 18
12.5 INDUSTRY FINANCIAL I MPACTS

................................ ................................ ........... 12

- 19
12.5.1 Introduction

................................ ................................ ................................ ......... 12

- 19
12.5.2 Small, Large and Very Large Air

- Cooled Commercial Package Air Con ditioner and Heat Pump Industry Financial Impacts

................................ ................................ ........... 12

- 20
12.6 IMPACTS ON SMALL BUS INESS MANUFACTURERS

................................ .......... 12

- 22

12

- i12.7 OTHER IMPACTS

................................ ................................ ................................ ......... 12

- 24
12.7.1 Direct Employment

................................ ................................ ............................. 12

- 24
12.7.2 Production Capacity

................................ ................................ ............................ 12

- 26
12.7.3 Cumulative Regulatory Burden

................................ ................................ .......... 12

- 26
12.7.3.1 DOE Regulations for Other Products Produced by Manufacturers in the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry

................................ ................................ ............................ 12

- 26
12.7.3.2 Other DOE and Federal Actions Affecting Manufacturers in the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry

................................ ................................ ................................ ..... 12

- 28
12.8 CONCLUSION

................................ ................................ ................................ ............... 12

- 29
REFERENCES

................................ ................................ ................................ ........................ 12

- 32

LIST OF TABLES

Table 12.2.1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking

................................ ................................ ................................ ........ 12

- 4 Table 12.4.1 Financial Parameters Used for GRIM Analysis (Based on 2006

– 2011 Weighted Company Financial Data)

................................ ................................ ................ 12

- 10
Table 12.4.2 Financial Parameters Used to Determine Base Case Markup

............................ 12

- 11 Table 12.4.3 Base Case Manufacturer Markups

................................ ................................ ...... 12

- 11 Table 12.4.4 Cost of Equity Calculation

................................ ................................ .................. 12

- 12
Table 12.4.5 Cost of Debt Calculation

................................ ................................ ..................... 12

- 13 Table 12.4.6 Summary of TSLs for the Small, Large, and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry

................................ .......... 12

- 13 Table 12.4.7 Manufacturer Production Cost Breakdown (2012$) for Small Commercial Package
Air Conditioners

................................ ................................ ............................... 12

- 15 Table 12.4.8 Manufacturer Production Cost Breakdown (2012$) for Small Commercial Package Heat Pumps

................................ ................................ ................................ ...... 12

- 15 Table 12.4.9 Manufacturer Production Cost Breakdown (2012$) for Large Commercial Package
Air Conditioners

................................ ................................ ............................... 12

- 15 Table 12.4.10 Manufacturer Production Cost Breakdown (2012$) for Large Commercial Package Heat Pumps

................................ ................................ ................................ ...... 12

- 15 Table 12.4.11 Manufacturer Production Cost Breakdown (2012$) for Very Large Commercial Package Air Conditioners

................................ ................................ ................ 12

- 15 Table 12.4.12 Manufacturer Production Cost Breakdown (2012$) for Very Large Commercial Package Heat Pumps

................................ ................................ ........................ 12

- 16 Table 12.4.13 Industry Cumulative Capital Conversion Cost

................................ ................. 12

- 16 Table 12.4.14 Industry Cumulative Product Conversion Cost

................................ ................ 12

- 17 Table 12.4.15 Percentage of Product Listings that Meet Proposed Standard Level

................ 12

- 17 Table 12.4.12.4.16 Base Case Markups

................................ ................................ ................... 12

- 18 Table 12.5.1 Changes in INPV for the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry, 2013

- 2048 (Preservation of Gross Margin Percentage Scenario)

................................ ................................ . 12

- 20

12

- iiTable 12.5.2 Changes in INPV for the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry, 2013

- 2048 (Preservation of Per Unit Operating Profit Scenario)

................................ ................................ . 12

- 20 Table 12.6.1 Impacts of Conversion Costs on a Small Manufacturer

................................ ..... 12

- 24 Table 12.6.2 Impacts of Conversion Costs on a Large Manufacturer

................................ ..... 12

- 24 Table 12.7.1 Potential Changes in the Total Number of Domestic Production Workers in the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry in 2019

................................ ................................ ..... 12

- 26 Table 12.7.12.7.2 Compliance Dates and Expected Conversion Expenses of Federal Energy Conservation Standards Affecting the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry

..................... 12

- 27

LIST OF FIGURES

Figure 12.4.1 Using the GRIM to Calculate Cash Flow

................................ ............................ 12

- 8 Figure 12.5.1 Annual Industry Net Cash Flows for the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry (Preservation of Gross Margin Percentage Scenario)

................................ ................................ . 12

- 21 Figure 12.5.2 Annual Industry Net Cash Flows for the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry (Preservation of Per Unit Operating Profit Scenario)

................................ ................................ . 12

- 22

12

- iiiCHAPTER 12. MANUFACT URER IMPACT ANALYSIS

12.1 INTRODUCTION

In determining whether a standard is economically justified, the U.S. Department of Energy (DOE or the Department ) 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. 6313(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 a mended energy
conservation standards on manufacturers of small, large and very large air

- cooled commercial package air conditioning and heating equipment , and assessed the impact of such standards on direct employment and manufacturing capacity.

The MIA h as 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 each product in this rulemaking. The GRIM inputs include information o n industry cost structure, shipments, and pricing strategies. The GRIM’s key output is the industry net present value (INPV). The model estimat es the financial impact of more

- stringent energy conservation standards for each product by comparing changes 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, and market and product trends, as well as the impact of standards 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 small, large and very large air

- cooled com mercial package air conditioner and heat p ump industry. This characterization included data on sales volumes, pricing, employment, and financial structure. In Phase II, “Industry Cash Flow,” DOE
used the GRIM to assess the potential impacts of amended energy conservation standards on
manufacturers . DOE also developed interview guide s to gather information on the potential impacts on these manufacturers. In Phase III, “Subgroup Impact Analysis,” DOE interviewed manufacturers representing a broad cross

- section of the small, large and very large air

- c ooled commercial package air conditioner and heat pump industry. Using information from these interviews, DOE refined its analysis in the GRIM, develo ped additional analyses for sub groups that required special consideration, and incorporated qualitative da ta from interviews into its analysis.

12.2.1 Phase I: Industry Profile

In Phase I of the MIA, DOE prepared a profile of the small, large and very large air

cooled commercial package air conditioner and heat pump industry that built on the market and technology as sessment prepared fo r this rulemaking (refer to c hapter 3 of the technical support document ( TSD ) ) . Before initiating the detailed impact studies, DOE collected information on the present and past structure and market characteristics of the small, large and very large air

cooled commercial package air conditioner and heat pump industry . This information included

12

- 1shipments, manufacturer markups, and the cost structure s of various manufacturers. The industry profile includes: (1) further detail on the overa ll market and product characteristics; (2) estimated manufacturer market shares; (3) financial parameters such as net plant, property, and equipment (PPE) ; 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 small, large and very large air

- cooled commercial package air conditioner and heat pump manufacturers that DOE used to derive the preliminary f inancial 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 industry , including Securities a nd Exchange Commissio n (SEC) 10

- K reports, 1 Standard & Poor’s (S&P) stock reports, 2 market research tools ( i.e.

, Hoovers 3 ), corporate annual reports, and
the U.S. Census Bure au’s 2011 Annual Survey of Manufacturers. 4 DOE also characterized these industries using information fr om its engineering analysis and the life

- cycle cost analysis.

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 manufacturers of small, large and very l arge air

- cooled commercial package air conditioners and heat pumps

. More stringent energy conservation standards can affect
manufacturer cash flow s in three distinct ways: (1) c reate a need for increased investment ; (2) raise production costs per unit ; and (3) alter revenue due to higher per

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

flow analysis for the small, large and very large air

- cooled commercial package air conditioner

an d heat pump industry. 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 pre pared written guides
for manufacturer interviews.

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 30 years after the standards’

c ompliance date. These factors include annual expected revenues, costs of goods sold, SG&A, taxes, and capital expenditures related to the amended standards. Inputs to the GRIM include
manufactur er production costs (MPCs) , markup assumptions, and shipments forecasts developed in other analyses. DOE derived the manufacturing costs from the engineering analysis and information provided by the industry

. It estimated typical manufacturer markups from public financial reports and interviews with manufacturers. DO E developed alternative markup
scenarios for the GRIM based on discussions with manufacturers. DOE’s shipments analysis, presented in c hapter 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 GR IM results are compared to base

- case projections for the industry. The financial impact of amended energy conservat ion standards is the difference between the discounted annual cash flows in the
base case and standards case at each TSL.

12

- 212.2.2.2 Interview Guides

During Phase I I of the MIA, DOE interviewed manufacturers to gather information on
the effects of amended energy conservation standard s on revenues and finances, direct employment, capital assets, and industry competitiveness. Before the interviews, DOE distributed an interview guide to interviewees. The interview guide provided a starting point for identifyin g relevant issues and impacts of amended energy conservation standards on individual manufacturers or subgroups of manufacturers. I nformation received from these meetings is protected by non

- disclosure agreements and resides with DOE’s contractors. The MIA interview topics included : (1) engineering analysis follow

- up; (2) key i ssues to this rulemaking; (3 ) company overview and organizational characteristics; (4) manufacturer markups and profitability; (5) shipment projections; (6) financial parameters; ( 7 ) conversion costs; ( 8 ) cumulative regulatory burden; ( 9 ) direct employment impact assessment; (1 0 ) capacity, exports, foreign competition, and outsourcing; (1 1 ) consolidation; and (12 ) impacts on small businesses.

12.2.3 Phase III: Subgroup Analysis

For its analys is, DOE prese nted the impacts on all classes of small, large and very large
air

- cooled commercial package air condition ers and heat pumps as a whole. While conducting the MIA, DOE interviewed a representative cross

- section of equipment manufacturers. Durin g interviews, DOE defined one manufacturer subgroup, small manufacturers , that could be impacted disproportionately by amended energy conservation standards.

12.2.3.1 Manufactur er 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 process. DOE sought industry feedback on approaches used in the GRIM as well as input on key issues and concerns.

DOE used these interviews to tailor the GRIM to reflect financial characteristics unique
to the small, large and very large air

- cooled commercial package air conditioner and heat pump 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 to clarify responses and identify additional issues. The resulting information provides valuable inputs to the GRIM developed for
the equipment classes.

12.2.3.2 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 indu stry cash

- flow model based on this
feedback . Section 12.4.3 provides more information on how DOE calculated the parameters.

12

- 312.2.3.3 Manufacturer Subgroup A nalysis

Using average cost ass umptions to develop an industry cash

- flow estimate may not adequately assess differential impacts of amended energy conservation standards among manufacturer subgroups. For example, small manufacturers, niche players, or manu facturers exhibiting a cost structure that largely differs from the industry average could be more negatively affected. To address this possible impact, DOE used the results of the industry characterization analysis in Phase I to group manufacturers that e xhibit similar characteristics.

During the interviews, DOE discussed the potential subgroups and subgroup members it identified for the analysis. DOE asked manufacturers and other interested parties to suggest what subgroups or characteristics are the mos t appropriate to analyze. As noted , DOE presents the industry impacts on small, large and very large air

- cooled commercial package air conditioner and heat pump manufacturers as a whole because most of the equipment class es represent the
same market served by the same manufacturers. However, as discussed below, DOE identified one manufacturer subgroup that warranted a separate impact analysis: small manufacturers.

Small Business Manufacturer Subgroup

DOE investigated whether small business manufacturers should be analyzed as a manufacturer subgroup. DOE used the Small Business Administration (SBA) small business size standards effective on November 5, 2010, 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. 5 For the equipment class es under review, the SBA
bases its small business definit ion 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 considered a small business.

Table 12.2

. 1 SBA and NAICS Classification of Small Businesses Potentially Affected by This Rulemaking
Industry Description Revenue Limit Employee Limit NAICS

Air

- C onditioning and Warm Air Heating Equipment and Commercial and Industrial Refrigeration Equipment Manufacturing N/A 750 333415

DOE used publicly available and proprietary information to identify potential small manufacturers. DOE’s research involved industry trade association membership directories ( e.g., American Heating and Refrigeration Institute (AHRI) Directory 6 )

, public databases (e.g., California Energy Commission Appliance Efficiency Database 7 ), individual company websites, and market research tools ( e.g. , Hoovers reports ) to create a list of companies that manufacture
or sell equipment cov ered by this rulemaking. DOE also asked stakeholders and industry representatives if they were aware of any other small manufacturers during manufacturer interviews and at previous DOE public meetings. DOE screened out companies that did not offer equipmen t covered by this rulemaking, did not meet the definition of a “small business,” or are foreign owned and operated.

Based on this analysis

, DOE identified three manufacturers in the small, large and very large air

- cooled com mercial package air conditioner and heat pump industry that qualify as small

12

- 4businesses

. DOE made an effort to contact the small businesses to solicit feedback on the potential impacts o f energy conservation standards. DOE spoke with two of the three small
businesses . DOE obtained furth er information on small business impacts in the course of interviews with large manufacturers. In addition to posing a subset of modified MIA interview questions, DOE solicited data on differential impacts these companies might experience as a result of am ended energy conservation standards. Based on these interviews and industry research, DOE reports the potential impacts of this rulemaking on small manufacturers in section
12.6

.

12.2.3.4 Manufacturing Capacity Impact

One significant outcome of amended energy conservation standards could be the obsolescence of existing manufacturing assets, including tooling and investment. The manufacturer interview guides i nclude a series of questions to help identify impacts of amended

stan dards on manufacturing capacity. S pecifically

, questions address: capacity utilization and plant location decisions in the United States and North America, with and without amended
standa rds; 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 PPE. DOE’s estimates of the one

- time capital ch anges 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

.

12.2.3.5 Employment Impact

The impact of amended energy conservation standards on employment is an important consideration in the rulemaking process. To assess how domestic direct employment patterns might be affected, the interviews explored current employment trends in the small, large and very large air

- cooled commercial package air conditioner and heat pump industry. The interviews also solicited manufacturer views on changes in employment pat terns that may result
from more stringent standards. The employment impacts section of the interview guide focused on current employment levels associated with manufactu rers at each production facility, 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 sectio n 12.7.1

.

12.2.3.6 Cumulative Regulatory Burden

DOE seeks to mitigate the overlapping effects on manufacturers due to amended energy
conservation standards a nd other regulatory actions affecting the same products. 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
manufac turers of small, large and very large air

- cooled commercial package air conditione rs and heat pumps

, including 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

- 512.3 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 issues they feel DOE should explore and discuss further during the interview. The following sections describe the most significant issues identified by manufacturers of small, large and very large air

- cooled commercia l package air condition ers and heat pumps . These summaries are provided in aggregate to protect manufacturer confidentiality.

12.3.1 Certification, Compliance, and Enforcement Costs

Nearly all manufacturers expressed concern over certification, compliance, and

e nforcement (CC&E) costs. In particular, confusion over the definition of “basic model ,” “equipment class,” and the implementation of alternative efficiency determination methods ( AEDMs ) has made it difficult for some manufacturers to anticipate their total testing needs and total testing costs. These issues will significantly impact the number of models that require testing.

Additionally, manufacturers noted that the replacement of the current energy efficiency ratio ( EER ) standard with the proposed integrated energy efficiency ratio ( IEER ) standard * introduces additional testing complications. IEER testing necessitates four data points, at 25%, 50%, 75%, and 100% capacity, thereby introducing additional cumulative uncertainty.
Manufacturers noted tha t the proposed +/

- 1% repeatability standard is more stringent than current laboratory capabilities as well as current industry standard practice. Manufacturers also expressed the need for additional increases in the acceptable tolerances when testing.

12.3.2 Repair and Replacement Rates

During interviews, most manufacturers expressed concerns that an increase in standards may make customers more likely to repair an old unit rather than replace it with a new one.
Manufacturers noted that more efficient units t end to be larger, and customers may need to make significant alterations to roofs at existing installations in order to accommodate larger equipment. The high cost of redesigning, reconstructing, or possibly replacing a roof to hold a new unit
could deter customers from purchasing one. According to manufacturers, another reason an amended standard may lead to a drop in shipments is the price sensitivity of end users. More efficient units tend to be more expensive. The lo wer cost of fixing an old unit relati ve to purchasing a new unit may make repairs a more attractive option than replacement for some customers. Furthermore, manufacturers suggested a higher standard could lead to a reduction in energy savings due to the increase in the number of older, less e fficient units that are repaired

* In the February 2013 RFI, DOE noted that it was considering whether to replace the existing efficiency de scriptor, EER, with a

new energy

- efficiency descriptor, IEER. The EER metric only uses the efficiency of the equipment operating at full load. By contrast, the IEER metric factors in the efficiency of operating at part

- loads of 75 percent, 50 percent, and 25 percent of capacity, as well as the efficiency at full load. This is accomplished by weighting the full

- and part

- load efficiencies with the average amount of time operating at each loading point; thus, IEER provides a more representative measure of the annual energy consumption in actual operation. The IEER metric incorporates part

- load efficiencies measured with outside temperatures appropriate for the load levels, i.e. at lower temperatures for lower load levels. 78 FR 7296, 7299 (Feb. 1, 2013).

12

- 6rather than replaced with newer, more efficient units. Manufacturers expressed concern over a potential contraction in market size resulting from amended standards.

12.3.3 Alignment with ASHRAE Standards

Several manufacturers su ggested during interviews that DOE standards should be aligned with other industry standards set by ASHRAE and AHRI. A few standards, such as ASHRAE 37, ASHRAE 41, and AHRI 340/360 are currently being revised, and manufacturers believe that
a coordination of standards between DOE and industry organizations would be a practical way to reduce the amount of time they need to spend on redesigning products and meeting multiple regulations.

12.4 GRIM INPUTS AND ASSU MPTIONS

The G overnment R egulatory I mpact M odel 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 manufacturer production costs, manufacturer selling prices

, industry shipments, and industry financial information as inputs, and accepts a set of r egulatory 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, 2013 , and continuing to 2048 . The mod el calculates the INPV by summing the stream of annual discounted cash flows during this period and adding a discounted terminal
value. 8

12

- 7Figure 12.4

. 1 Using the GRIM to Calculate Cash Flow

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

- case scenario and the standard s

- case scenario induced by amended energy conservation standards. The diff erence in INPV between the base case and the
standard s case(s) represents the estimated financial impact of the amended energy conservation
standard on manufacturers. Appendix 12 A 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, c ensus data, credit ratings, the shipments model, the engineering analysis, and the manufacturer interviews.

12.4.2.1 Corporate Annual Reports

Corpo rate 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 exam ining the annual
SEC 10

- K reports filed by publicly traded manufacturers of small, large and very large air

cooled com mercial package air conditioners and heat pumps

. Since these companies do not provide detailed information about their individual product lines, DOE used the financial information for the entire companies when developing initial estimates of financial parameters
for the GRIM analysis. These figures were later revised using feedback from interviews to be representative of manufacturing for ea ch product grouping. DOE used corporate annual reports to derive the following initial inputs to the GRIM:

• t ax rate

12

- 8• w orking capital

• SG&A

• R&D

• d epreciation

• c apital expenditures

• n et 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

. C hapter 9 of the TSD describes the methodology and analytical model DOE used to forecast shipments.

12.4.2.4 Engineering Analysis

The engineering analysis estimates the cost

- efficiency relationship of equipment at different levels of increased energy efficiency. This relationship serves as the basis for the cost

benefit calculations for commercial customers, manufacturers, and the nation. In determining the

cost

- efficiency relationship, DOE estima tes the increase in manufacturing cost s associated with increasing t he efficiency of equipment above the baseline up to the maximum technologically feasible (“max

- tech”) efficiency level for each equipment class.

DOE conducted the engineering analyses for the small, large and very large air

- cooled commercial package air c onditioner and heat pump industry using the reverse

- engineering approach

. † DOE began its analysis by conducting industry research to select equipment classes for direct analysis, to develop baseline unit specifications, and to identify representative equip ment for further analysis. Next, DOE developed efficiency levels based on a review of industry standards, equipment available on the market , and computer simulations of equipment
efficiencies

. To develop cost estimates, DOE conducted a price analysis, based upon physical teardowns of selected units, cost estimates from publicly available sources, and price quotes from manufacturers. DOE then developed a cost model to determine manufacturing prod uction

† DO E has identified three basic methods for generating manufacturing costs: (1) the design

- option approach, which provides the incremental costs of adding to a baseline model design options that will improve its efficiency ( i.e. , lower its energy use); (2) th e efficiency

- level approach, which provides the incremental costs of moving to higher energy efficiency levels, without regard to the particular design option(s) used to achieve such increases; and (3) the reverse

- engineering (or cost

- assessment) approach, which provides “bottom

- up” manufacturing cost assessments for achieving various levels of increased efficiency based on teardown analyses (or physical teardowns) that provides detailed data on costs for parts and material, labor, shipping/packaging, and
i nvestment for models that operate at particular efficiency levels.

12

- 9costs (MPCs). By applying derived manufacturer markups to the MPC s , DOE calculated the manufacturer selling price (MSP) and constructed industry cost

- efficiency curves. See chapter 5 of the TSD for a complete discussio n of the engineering analysis.

12.4.2.5 Manufacturer Interviews

Dur ing the course of the MIA, DOE interviewed manufacturers representing approximately 97 percent of the industry by revenue

. The information gathered during these interviews enabled DOE to tailor the GRIM to reflect the unique f in

ancial characteristics of the small, large, and very large air

- cooled com mercial package air conditioner and heat pump industry. In interviews, DOE asked manufacturers to describe their major concerns about this rulemaking. Key topics discussed during the interviews and reflected in the GRIM include:

• c apital conversion costs (one

- time investments in PPE);

• p roduct conversion costs (one

- time investments in research, product development, testing, and marketing);

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

• MPCs estimated in the engineering analysis; and

• p ossible profitability impacts.

12.4.3 Financial Parameters

Table 12.4.1 provides financial parameters for seven public companies engaged in manufacturing and selling small, large and very large air

- cooled com mercial package air
conditioners and heat pumps . The val ues listed are averages over a si x

- year period (2006 to
2011 ).

Table 12.4

. 1 Financial Parameters Used for GRIM Analysis ( Based on 2006

– 201 1 Weighted Company Financial Data )

Parameter Industry

W eighted Average Manufacturers

A B C D E F G

Tax Rate (% of Taxable Income) 25.1 5 % 34.85% 41.30% 17.67% 15.43% 33.80% 30.14% 27.97%

Working Capital (% of Revenue) 6 .2 0 % 18.58% 12.16%

- 1.71% 2.93% 9.89% 13.96% 9.45%

SG&A (% of Revenue) 14

. 9 5 % 8.65% 25.34% 18.05% 10.00% 21.10% 20.27% 11.24%

R&D (% of Revenues) 2.06 % 1.21% 2.80% 1.67% 1.23% 1.41% 2.63% 3.15%

Depreciation (% of Revenues) 1.86 % 3.84% 3.92% 1.63% 2.00% 1.56% 1.84% 1.53%

Capital Expenditures (% of Revenues) 2.22 % 6.65% 4.52% 1.66% 2.42% 1.74% 1.27% 1.83%

While most of these companies also manufacture products not covered by this rulemaking, DOE used these parameters as initial estimates. During interviews, manufacturers were asked to provide their own figures for the parameters listed in Table 12.4.1 . Where

12

- 10applicable, DOE adjusted the parameters in the GRIM using manufacturer feedback and market
share information.

In addition to these parameters, DOE used financial information sourced from SEC filings for the seven public manufacturers to determine an average manufacturer markup.

Table 12.4

. 2 Financial Parameters Used to Determine Base Case Markup

Manufacturer

A B C D E F G
Average Net Revenues (Million) $255 $10,876 $12,000 $34,759 $3,359 $2,117 $54,630

Corporate Gross Margin 22% 33% 28% 14% 27% 28% 27%

Markup 1.28 1.48 1.39 1.17 1.37 1.39 1.37

Table 12.4

. 2 lists the average net revenues, estimated corporate gross margin , and estimated manufacturer markup for the years 2006 to 2011 for the seven manufacturers. The weighted average of the estima ted manufacturer markup based on public filings by these seven companies is 1.34. To further refine the base case markup, DOE solicited feedback from
manufacturers on this value in confidential interviews. Based on manufacturer feedback , DOE adjusted its e stimate manufacturer markup and applied the values listed in Table 12.4

. 3 for covered equipment.

Table 12.4

. 3 Base Case Manufacturer Markups

Equipment Markup Small Commercial Package Air

- Conditioners (Air

- Cooled)

- ≥65,000 Btu/h and <135,000 Btu/h 1.3 0

Small Commercial Package Heat Pumps (Air

- Cooled)

- ≥65,000 Btu/h and <135,000 Btu/h 1.3 0

Large Commercial Package Air

- Conditioners (Air

- Cooled)

- ≥135,000 Btu/h and <240,000 Btu/h 1.34

Large Commercial Package Heat Pumps (Air

- Cooled)

- ≥135,000 Btu/h and <240,000 Btu/h 1.34

Very Large Commercial Package Air

- Conditioners (Air

Cooled)

- ≥240,000 Btu/h and <760,000 Bt u/h 1.41

Very Large Commercial Package Heat Pumps (Air

- Cooled)

- ≥240,000 Btu/h and <760,000 Btu/h 1.41

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 small, large and very large air

- cooled

12

- 11com mercial package air conditioner and heat pump industry based on seven representative companies, using the following formula:

WACC = After

- Tax Co st of Debt × ( Debt Ratio ) + Cost of Equity × ( Equity Ratio )

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 th e company’s stock. The C apital A sset P ricing M odel (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 × Risk Premium

W here:

Riskless R ate of R eturn = the rate of return on a “safe” benchmark investment, typically
considered the short

- te rm Treasury Bill (T

- Bill) yield,
Risk P remium = the difference between the expected return on stocks and the riskless rate, and Beta (β) = the c orrelation between the movement in the price of the stock 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 mark et index.

DOE calculated that the industry average cost of equity for the small, large and very large
air

- cooled commercial package air conditioner and heat pump industry is 13.2 percent ( Table
12.4.4 ).

Table 12.4

. 4 Cost of Equity Calculation

Parameter Industry Weighted Average A B C D E F G

(1) Average Beta 1.32 1.11 1.00 1.60 1.73 1.07 0.80 1.09 (2) Average Yield on 10

- Year Bonds (1928

- 2012 ) 5.16%

(3) Market Risk
Premium 6.10 %

Cost of Equity (2)+[(1)*(3)] 13.2% 11.9% 11.3% 14.9% 15.7% 11.7% 10.0% 11.8%

Equity/Total Capital 68.9% 96.4% 63.1% 70.9% 71.2% 50.4% 100.0% 70.6%

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 ri sk

- free rate. DOE used this
method to calculate the cost of debt for seven public manufacturers by using S&P ratings and
estimated credit worthiness and adding the relevant spread to the risk

- free rate.

In practice, investors use a variety of different ma turity Treasury bonds to estimate the
risk

- free rate. DOE used the 10

- year Treasury bond rate because it captures long

- term inflation expectations and is less volatile than short

- term rates. The risk

- free rate is estimated to be

12

- 12approximately 5.16 percent, which is the average 10

- year Treasury bond rate between 1928 and
2012

.

For the cost of debt, DOE used bond ratings from S&P’s Credit Services to calculate an average spread of corporate bonds. ‡ DOE added these spreads to the estimated risk

- free rate of 5.16% to determine the gross cost of debt for each company. It then calculated an industry weighted average gross cost of debt of 6.5 percent. Since proceeds from debt issuance are tax deductible, DOE adjusted the gross cost of debt by the industry average tax rate to determine the net cost of debt for the industry

. Table 12.4.5 presents the derivation of the cost of debt and the capital structu re of the industry ( i.e.

, the debt ratio (debt/total capital)).

Table 12.4

. 5 Cost of Debt Calculation

Parameter Industry Weighted Average A B C D E F G

S&P Bond Rating AAA AA BBB BBB BBB B A ( 1 ) Avg. Yield on 10

- Y

r Bonds (1928

- 2012 ) 5.16 %

(2) Gross Cost of Debt 6.5 % 5.66% 5.81% 6.76% 6.76% 6.76% 10.16% 6.16% (3) Tax Rate 25.1% 34.85% 41.30% 17.67% 15.43% 33.80% 30.14% 27.97%
Net Cost of Debt (2) x [1

- (3)] 4.9% 3.7% 3.4% 5.6% 5.7% 4.5% 7.1% 4.4%

Debt/Total Capital 31.1% 3.6% 36.9% 29.1% 28.8% 49.6% 0.0% 29.4%

Using public information for these seven companies, the initial estimate for the industry’s
nominal WACC was approximately 10.6 percent. Subtracting an inflation rate of 3.0 8 percent over the analysis period used in the initial estimate, the inflation

- adjusted WACC and the initial
estimate of the discount rate used in the straw

- man GRIM is 7.52 percent . DOE also asked for feedback on the discount rate during manufacturer inter views. Based on this feedback, DOE used
a discount rate of 6.2 percent in the GRIM

.

12.4.5 Trial Standard Levels

DOE developed a number of efficiency levels for each type of equipment class . TSLs were then developed by selecting likely groupings of efficiency l evels for all equipment types.
Table 12.4.6 presents the TSLs used for energy e fficiency analysis in the GRIM.

Table 12.4

. 6 Summary of TSLs for the Small, Large, and Very Large Air

- Coole d Commercial Package Air Conditioner and Heat Pump Industry

Equipment Class TSL 1 TSL 2 TSL 3 TSL 4

‡ For two of the seven manufacturers, S& P bond ratings were not available. In these cases, DOE estimated the companies’ synthetic bond ratings based on their interest coverage ratio. The interest coverage ratio is calculated as the ratio of earnings before interest and taxes (EBIT) to current in terest expenses, with the present value of operating leases reclassified as debt. The estimated synthetic bond ratings are based on a valuation method available through the NYU Stern School of Business and may be found at: http://www.stern.nyu.edu/~adamodar/pc/ratings.xls

12

- 13Efficiency Level §

Small Commercial Package Air
Conditioners

– ≥65,000 Btu/h and <135,000 Btu/h Cooling Capacity 1 2 3 4

Large Commercial Package Air
Conditioners

– ≥135,000 Btu/h and <240,000 Btu/h Cooling Capacity 1 2 3 4

Very Large Commercial Package Air
Conditioners

– ≥240,000 Btu/h and <760,000 Btu/h Cooling Capacity 1 2 3 4

Small Commercial Package Heat Pumps

– ≥65,000 Btu/h and <135,000 Btu/h Cooling Capacity 1 2 3 4

Large Commercial Package Heat Pumps

– ≥135,000 Btu/h and <240,000 Btu/h Cooling Capacity 1 2 3 4

Very Large Commercial Package Heat Pumps

– ≥240,000 Btu/h and <760,000 Btu/h Cooling Capacity 1 2 3 4

12.4.6 NIA Shipments

The GRIM estimates manufacturer revenues based on total unit shipment forecasts and the distribution of these values by efficiency level. Changes in sales volumes and efficiency mix over time can significantly affect manufacturer finances. For this analysi s, the GRIM uses the NIA’s annual shipment forecasts derived from the shipments analysis from 2013 ( the base year )
to 204 8 ( the end year of the analysis period )

. The NIA shipments forecasts are, in part, based on
a consumer choice model that estimates cust omer sensitivity to total installed cost as well as operating costs. See c hapter 9 of the TSD for more information on the standards

- case shipment
forecast s

.

12.4.7 Manufacturer Production Costs

Changes in production costs affect revenues and gross profits. Produ cts that are more efficient typically cost more to produce than baseline products (as shown in c hapter 5 of the TSD). For the MIA, DOE used the manuf acturing production costs ( MPCs ) derived in the engineering analysis.

M anufacturing a higher efficiency pr oduct is typically more expensive than manufacturing a baseline product

. MPCs increase at higher efficiency levels due to the use of

more complex components , which are more costly than baseline components

. The se changes i n MPC s can affect the revenues , gross margins , and cash flow of the industry, making product cost data key inputs into the GRIM analysis.

To calculate the baseline manufacturer selling price ( MSP )

, DOE used the MPC s from the engineering and tear down analyses and applied a manufacturer ma rkup, which varies with the markup scenario (discussed in detail in section 12.4.9 ), to the MPCs.

§ For the IEERs that correspond to efficiency levels 1 through 4, see NOPR Section IV.C.3.

12

- 14Table 12.4. 7 through 12.4.10 show the production cost estimates used in the GRIM for each analyzed equipment class.

Table 12.4

. 7 Manufacturer Production Cost Breakdown ( 2012 $ ) for Small Commercial Package Air Conditioners
Efficiency

Level Material Labor Depre

ciation Overhead MPC Markup MSP

Baseline $1,553.36 $185.25 $76.26 $105.20 $1,920.07 1.30 $2,753.23

EL 1 $1,658.01 $192.25 $80.07 $105.67 $2,036.00 1.30 $2,903.94

EL 2 $2,054.08 $245.12 $83.89 $120.45 $2,503.54 1.30 $3,511.74

EL 3 $2,230.21 $263.72 $106.76 $108.25 $2,708.95 1.30 $3,778.78

EL 4 $2,651.64 $303.84 $114.39 $127.24 $3,197.11 1.30 $4,516.24

Table 12.4

. 8 Manufacturer Production Cost Breakdown ( 2012 $ ) for Small Commercial Package Heat Pumps
Efficiency

Level Material Labor Depre

ciation Overhead MPC Markup MSP

Baseline $1,654.65 $237.19 $78.16 $110.58 $2,080.58 1.30 $2,961.90

EL 1 $1,759.31 $244.19 $82.06 $114.78 $2,196.51 1.30 $3,112.61

EL 2 $2,155.37 $297.07 $85.97 $131.61 $2,664.05 1.30 $3,720.41

EL 3 $2,331.50 $315.67 $109.42 $139.93 $2,869.46 1.30 $3,987.44

EL 4 $2,752.94 $355.79 $117.23 $160.85 $3,357.62 1.30 $4,724.91

Table 12.4

. 9 Manufacturer Production Cost Breakdown ( 2012 $ ) for Large Commercial Package Air Conditioners
Efficiency

Level Material Labor Depre

ciation Overhead MPC Markup MSP

Baseline $2,828.22 $411.02 $127.90 $184.73 $3,551.88 1.34 $5,016.66

EL 1 $3,204.91 $438.20 $134.30 $199.94 $3,971.04 1.34 $5,578.34

EL 2 $3,518.48 $480.76 $140.69 $214.14 $4,344.64 1.34 $6,271.82

EL 3 $3,892.54 $529.08 $179.06 $231.46 $4,788.86 1.34 $6,867.07

EL 4 $4,167.27 $557.73 $191.85 $244.41 $5,106.14 1.34 $7,292.23

Table 12.4

. 10 Manufacturer Production Cost Breakdown ( 2012 $ ) for Large Commercial Package Heat Pumps
Efficiency

Level Material Labor Depre

ciation Overhead MPC Markup MSP

Baseline $3,154.04 $2,273.19 $647.63 $331.87 $4,002.14 1.34 $5,620.01

EL 1 $3,530.73 $2,300.37 $680.01 $347.07 $4,421.30 1.34 $6,181.68

EL 2 $3,844.30 $2,342.92 $712.39 $361.27 $4,794.90 1.34 $6,875.17

EL 3 $4,218.36 $2,391.25 $906.68 $378.59 $5,239.12 1.34 $7,470.42

EL 4 $4,493.09 $2,419.90 $971.44 $391.55 $5,556.40 1.34 $7,895.58

Table 12.4

. 11 Manufacturer Production Cost Breakdown ( 2012 $ ) for Very Large Commercial Package Air Conditioners
Efficiency

Level Material Labor Depre

ciation Overhead MPC Markup MSP

Baseline $5,914.24 $700.12 $197.56 $335.91 $7,147.82 1.41 $10,678.43

EL 1 $6,400.31 $732.00 $201.09 $357.06 $7,690.47 1.41 $11,443.56

EL 2 $7,065.54 $778.33 $210.48 $389.88 $8,444.23 1.41 $12,506.36

12

- 15EL 3 $7,527.41 $829.39 $215.06 $410.63 $8,982.49 1.41 $13,265.31

EL 4 $8,338.11 $891.64 $222.71 $448.68 $9,901.14 1.41 $15,004.61

Table 12.4

. 12 Manufacturer Production Cost Breakdown ( 2012 $ ) for Very Large Commercial Package Heat Pumps
Efficiency

Level Material Labor Depre

ciation Overhead MPC Markup MSP

Baseline $6,497.42 $879.52 $163.83 $348.02 $7,888.78 1.41 $11,723.18

EL 1 $6,983.50 $911.41 $167.36 $369.17 $8,431.43 1.41 $12,488.32

EL 2 $7,648.72 $957.73 $176.75 $401.99 $9,185.19 1.41 $13,551.12

EL 3 $8,110.59 $1,008.79 $181.33 $422.74 $9,723.45 1.41 $14,310.06

EL 4 $8,921.29 $1,071.04 $188.98 $460.79 $10,642.1 1.41 $16,049.36

12.4.8 Conversion Costs

Amended energy conservation standards typically cause manufacturers to incur one

- time conversion costs to bring their production facilities and product designs into compliance with new regulations. For the MIA, DOE classified these one

- ti me conversion costs into two major groups: capital conversion costs and product conversion costs. Capital conversion costs are one

time investments in property, plant and equipment to adapt or change existing production
facilities in order to fabricate and assemble new product design s that comply with amended energy conservation standards. Product conversion costs are one

- time investments in research, development, industry certification testing, marketing

, and other costs to make product designs comply with amended energy conservation standards. DOE based its estimates of the conversion

costs for each efficiency level on information obtain ed from manufacturer interviews and the design pathways analyzed in the engineering analysis.

12.4.8.1 Capital Conversion Costs

To evaluate the level of capital conversion expenditures manufacturers would likely incur to comply with amended energy conservation standards, DOE used the manufacturer interviews to gather data on the level of capital investment required at each efficien cy level. DOE validated manufacturer comments through estimates of capital expenditure requirements derived from the product teardown analysis and engineering model described in c hapter 5 of the TSD. In general, as the trial standard level increased, a gre ater number of production lines would need to be re

tooled. A large portion of capital conversion cost was related to tooling costs for revised cabinet designs.

Table 12.4

. 13 Industry Cumulative Capital Conver sion Cost

TSL Capital Conversion Cost $millions

Base 0
TSL 1 14.9
TSL 2 39.2
TSL 3 105.5
TSL 4 113.3

12

- 1612.4.8.2 Product Conversion Costs

DOE assessed the product conversion costs at each considered efficiency level by integrating data from quantitative and qualitative sources. DOE considered market

- share

weighted feedback regarding the potential costs of each efficiency level from multiple manufacturers to estimate product conversion costs and validated those numbers against engineering estimates of redesign efforts. In general, as the standard increases, more product s require redesign, as show in Table 12.4.15 . Furthermore, as the standard increases, the complexity of redesign increases. Additionally, DOE incorporated estimates of the incremental Certification, Compliance & Enforcement (CC&E) testing costs that result from the change in

tes t procedure. This results in product conversion costs that occur even at the baseline.

Table 12.4

. 14 Industry Cumulative Product Conversion Cost

TSL Pr oduct Conversion Cost $millions

Base 12 .7
TSL 1 38.7
TSL 2 58.52
TSL 3 120.9
TSL 4 210.9 Table 12.4

. 15 Percentage of Product Listings that Meet Proposed Standard Level **

TSL % of Product Listings

TSL 1 62%

TSL 2 33%

TSL 3 19%

TSL 4 2%

In the base case, conversion costs of $ 12 .7 million are attributed to CC&E costs associated with new product certification requirements under t he proposed test procedure. These costs reflect modeling and equipment

- testing requirements needed to recertify available products. In particular, the base

- case product conversion cost represents the projected cost to physically test units to validate AEDM s and the cost to run simulations on every basic model listing in the AHRI Directory and CEC Appliance Database. The figure is based on a simulation

cost

- per

- listing of approximately $900 applied to 6,366 listings plus t he additional cost of physical testi ng two units per equipment class per manufacturer, at an expense of $10,000 per test (covering the cost of the unit and the testing expense ).

12.4.9 Markup Scenarios

DOE modeled two markup scenarios to capture uncertainty regarding potential impacts on prices and profitability following implementation of amended energy conservation standards: (1) a preservation of gross margin percentage markup scenario and (2) a preservation of per

- unit operating profit markup scenario. These scenarios l ead to differ ent markup values that , when applied to MPCs, result in varying revenue and cash flow impacts.

** Based on product listings in the AHRI Certification Directory, accessed June 2013.

12

- 1712.4.9.1 Preservation of Gross Margin Percentage Scenario

U

nder the preservation of gross margin percentage scenario, DOE applied a single uniform “gross margin percentag e” markup across all efficiency levels. This assumes manufacturers would be able to maintain the same amount of profit, as a percentage of revenues, at all efficiency levels within an equipment class. A s production costs and sales prices increase
with more stringent efficiency levels , this scenario implies that the absolute dollar markup will
increase as well. The manufacturer, in this case, will see more profit in absolute terms on a per

unit basis. In analyzing the preservation of gross margin percentage scenario, DOE assumed the

average non

- production cost markup

— which includes SG&A expenses, R&D expenses, interest, and profit

— to be the follow ing for each equipment class in the small, large and very large air

cooled commercial package air conditioner and heat pump industry :

Table 12

. 4

. 12.4

. 16 Base Case Markups

Equipment Markup
Small Commercial Package Air

- Conditioners (Air

- Cooled)

- ≥65,000 Btu/h and <135,000 Btu/h 1.3

Small Commercial Package Heat Pumps (Air

- Cooled)

- ≥65,000 Btu/h and <135,000 Btu/h 1.3

Large Commercial Package Air

- Conditioners (Air

- Cooled)

- ≥135,000 Btu/h and <240,000 Btu/h 1.34

Large Commercial Package Heat Pumps (Air

- Cooled)

- ≥135,000 Btu/h and <240,000 Btu/h 1. 34

Very Large Commercial Package Air

- Conditioners (Air

Cooled)

- ≥240,000 Btu/h and <760,000 Btu/h 1.41

Very Large Commercial Package Heat Pumps (Air

- Cooled)

- ≥240,000 Btu/h and <760,000 Btu/h 1.41

Because this markup scenario implies manufacturers would be able to maintain their gross margin percentage markups as production costs increase in response to amended energy conservation standards, DOE assumes this scenario represents a n upper bound to industry profitability under amended standard s

.

12.4.9.2 Preservation of Per Unit Operating Profit Scenario

In the preservation of per unit operating profit scenario, manufacturer markups are set so that operating profit one year after the compliance date of the amended energy conservation
standards is the same as in the base case on a per

- unit basis . Under this scenario, as the production costs and sales price increase with more stringent efficiency standards , manufacturers are generally required to reduce their markups to a level that maintains base

- case operating profit per unit . The implicit assumption behind this markup scenario is that the industry can only maintain its operating profit in absolute dollars per unit after compliance with the new standar d.
O perating profit per unit does not change in absolute dollar terms but declines as a percentage of revenue. As a result, o peratin g margin in percentage terms falls between the base case and
standards case. In analyzing the preservation of operating prof it scenario, 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 as in the base case. This markup scenario represents a low bound to industry profitability u nder an amended energy conservation standard.

12

- 1812.5 INDUSTRY FINANCIAL I MPACTS

Using the inputs and scenarios described in previous sections, DOE estimated financial impacts on the small, large and very large air

- cooled commercial package air conditioner and
he at pump industry resulting from amended energy conservation standards . The following
sections address two key financial metrics analyzed in the MIA : industry net present value ( INPV ) and annual cash flows.

12.5.1 Introduction

The INPV measures the industry value and is used in the MIA to compare the economic impacts of different TSLs. 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 di scount rate. The GRIM for this rulemaking estimates cash flows from 2013 to 2048

, the same an alysis period used in the NIA ( c hapter 10 of the TSD ). This timeframe models
both the short

- term impacts on the industry from the base year of the analysis until the compliance date ( 2013 until 2019 ) and a long

- term assessment over the 30

- year analysis period used in the NIA ( 2019

– 2048 ).

In the MIA, DO E compares the INPV of the base case (no amended energy conservation standards) to that of each TSL. The difference between the base case and a standards case INPV is an estimate of the economic impacts the TSL would have on the industry. The markup scenarios are described in greater detail in section 12.4.9

.
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 ex a mple, 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 provide an idea of the behavior of
short

- term annual net cash flows, Figures 12.5.1 and 12.5.2 present annual net cash flows through 2048.

Annual cash flows are discounted to the base year, 2013 . After the standards announcement date ( i.e. , the publication date of the final rule), industry cash flows begin to decline as companies use their financial resources to prepare for the amended energy
conservation standard. Cash flows between the announcement dat e and the compliance date are driven by the level of conversion costs and the proportion of these investments spent each year. The more stringent the amended energy conservation standard, the greater the impact on industry cash flows in the years leading u p to the compliance date, as product 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
driv en 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 could

12

- 19have been used longer if the energy conservation standard had not m ade 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 decrease s 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 mate rials, 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 be affected either positively or negatively in the year the standard takes effect.

12.5.2 Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry Financial Impacts

Table 12.5.1 and Table 12.5.2 provide the INPV estimates for the small, large and very large air

- cooled commercial package air conditioner and heat pump industry under the two markup scenarios analyzed

.
Figure 12.5

. 1 and Figure 12.5

. 2 graph the net annual cash flo ws for the two scenarios.

Table 12.5

. 1 Changes in INPV for the Small, Large and Very Large Air

- Cooled Com mercial Package Air Conditioner and Heat Pump Industry , 2013

- 2048 ( Preservation of Gross Margin Percentage Scenario)

Units Base
Case Trial Standard Level
1 2 3 4
INPV 2012$ M 1,260.91 1,249.47 1,208.04 1,172.36 1,142.78
Change in
INPV 2012$ M

- (11.45) (52.87) (88.55) (118.13)

(%)

- ( 0.91 ) ( 4.19 ) ( 7.02 ) ( 9.37 ) * Numbers in parentheses indicate negative numbers.

Table 12.5

. 2 Changes in INPV for the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry , 2013

- 2048 ( Preservation
of Per Unit Operating Profit Scenario)

Units Base
Case Trial Standard Level
1 2 3 4
INPV 2012 $ M 1,260.91 1,187.02 1,015.61 949.34 822.75 Change in
INPV 2012 $ M

- (73.89) (245.30) (311.58) (438.16) (%)

- (5.86) (19.45) (24.71) (34.75) * Numbers in parentheses indicate negative numbers.

12

- 20Figure 12.5

. 1 Annual Industry Net Cash Flows for the Small, Large and Very Large Air

Cooled Commercial Package Air Conditioner and Heat Pump Industry (Preservation of Gross Margin Percentage Scenario)

12

- 21Figure 12.5

. 2 Annual Industry Net Cash Flows for the Small, Large and Very Large Air

Cooled Commercial Package Air Conditioner and Heat Pump In dustry (Preservation of
Per Unit Operating Profit Scenario)

12.6 IMPACTS ON SMALL BUS INESS MANUFACTURERS

DOE conducted a more focused inquiry of the companies that could be small business manufacturers of products covered by this rulemaking. For the category “ Air

- Conditioning and Warm Air Heating Equipment and Commercial and Industrial Refrigeration Equipment Manufacturing ,” the SBA has set a size threshold of 750 employees or less for an entity to qualify as a small business. To identify the number of companies that could be small business manufacturers of products covered by this rulemaking , DOE conducted a market survey using
available public information. DOE’s research included industry trade association membership
directories ( e.g., A HRI ), public databases ( e.g. , California Energy Commission Appliance Efficiency Database ), individual company websites, and market research tools ( e.g. , Hoovers reports) to create a comprehensive list of companies that manufacture or sell products covered by this rulemaking. DOE also asked stakeholders and industry representatives if they were aware of any small manufacturers during manufacturer interviews and at DOE public meetings. DOE reviewed publicly available data and contacted select companies on its list, as necessary, to determine whether they met the SBA’s definition of a small business manufacturer of covered equipment . DOE screened out companies that do not offer products covered by this rulemaking,
do not meet the definition of a small business, or are foreign owned and operated.

DOE initially identified at least 1 3 potential manufacturers of small, large and very large
air

- cooled commercial package air conditioners and heat pumps sold in the U.S. DOE then

12

- 22determined that 10 were large manufacturers, manufacturers that are foreign owned and operated, or manufacturers that do not produce equipment classes covered by this rulemaking.
DOE was able to determine that three manufacturers meet the SBA’s definition of a “ small
busine ss ” and manufacture products covered by this rulemaking.

Before issuing this NOPR, DOE spoke with two of the small business manufacturers of commercial packaged air conditioners. DOE also obtained information about small business impacts while interviewing large manufacturers.

Based on DOE’s research, one small manufacturer focused exclusively on the design and specification of product

– but had no production assets of its own. All production was outsourced. The other small manufacturers performed all desig n and specification work but also owned domestic production facilities and employed production workers. The proposed standard s for the small, large and very large air

- cooled com m

ercial package air conditioner and heat pump industry could disadvantage small manufacturers r elative to large manufacturers. One way in which small manufacturers could be at a disadvantage is that they may be disproportionately affected by product conversion costs. Product redesign, testing, and certification costs tend to be
fixe d and do not scale with sales volume. For each product model, small businesses must make investments in research and development to redesign their products, but because they have lower sales volumes, they must spread these costs across fewer units. Moreov er, smaller manufacturers may experience higher testing costs relative to larger manufacturers as they may not possess their own test facility and therefore must outsou rce all testing at a higher per

- unit cost. In general, the
small manufacturers had a num ber of product lines that was similar to that of larger competitors with similar market share. However, b ecause small manufacturers have fewer engineers than large manufacturers, they may face greater difficulty bringing their portfolio of products in

- line with an amended energy conservation standard within the allotted timeframe or may have to divert engineering resources from customer and new product initiatives for a longer period of
time.

Furthermore, smaller manufacturers may lack the purchasing pow er of larger manufacturers. For example, since motor suppliers give discounts to manufacturers based on the number of motors they purchase, larger manufacturers may enjoy a pricing advantage because
the y have higher volume purchases. This purchasing power differential between high

- volume
and low

- volume orders applies to other components of small, large and very large air

- cooled commercial package air conditioner s and heat pumps as well

.

In order to meet the proposed standard, manufacturers may have to see k outside capital to cover expenses related to testing and product design equipment. Smaller firms typically have a higher cost of borrowing due to higher perceived risk on the part of investors, largely attributed

to lower cash flows and lower per

- unit pr ofitability. In these cases, small manufacturers may observe higher costs of debt than larger manufacturers.

To estimate how small manufacturers would potentially be impacted, DOE compared required conversion costs at each TSL for a small manufacturer with on

- site production to those
of an average large manufacturer ( see Table s 12.6.1 and 12. 6.2 ). In the following tables, TSL 2 represents the proposed standard.

12

- 23Table 12.6

. 1 Impacts of Conversion Costs on a Small Manufacturer

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 Revenue Total Conversion
Cost as a Percentage of
Annu al EBIT

TSL 1 122% 526% 14% 159%

TSL 2 199% 932% 24% 276%

TSL 3 407% 1948% 49% 573%

TSL 4 430% 3369% 77% 896%

Table 12.6

. 2 Impacts of Conversion Costs on a Large Manufacturer

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 Revenue Total Conversion
Cost as a Percentage of
Annual EBIT

TSL 1 42% 213% 5% 62%

TSL 2 105% 287% 9% 100%

TSL 3 279% 536% 19% 216%

TSL 4 310% 898% 26% 307%

At TSL 3 , the level proposed in the NOPR , DOE estimates capital conversion costs of $ 2.32 million and product conversion costs of $ 7.04 million for a typical small manufacturer th at

owns production facilities. This compares to capital conversion costs of $ 9.08 million and product conversion costs of $ 11.0 5 million for a typical large manufacturer.

At these levels, the amended standard could contribute to the consolidation of the industry

. The GRIM free cash flow results indicate that some manufacturers may need to access capital markets in order to fund conversion costs directly related to amended standard s . Given
small manufacturers tend to have more limited access to capital and face conversion costs that tend to be higher relative to the size of the business, it is possible the small manufacturers will choose to leave the industry or choose to be purchased by or merged with larger market players. Since the proposed standard could dis advantage small manufacturers relative to large manufacturers, DOE c annot certify that the proposed standards would not have a significant impact on small businesses

.

12.7 OTHER IMPACTS

12.7.1 Direct Employment

Employment impacts from new or amended energy conservati on standards include direct and indirect impacts. Direct employment impacts are any changes in the number of employees of manufacturers of the equipment subject to standards. Indirect employment impacts are changes in national employment that occur due to the shift in expenditures and capital investment caused by the purchase and operation of more efficient equipment

12

- 24To quantitatively assess the direct employment impacts of amended energy conservation
standards o n the small, large and very large air

- cooled com mercial package air conditioner and heat pump industry , DOE used the GRIM to estimate the domestic labor expenditures and number of employees in the base case and at each TSL from 2013 through 2048 . DOE used
statistical data from the U.S. Census Bureau’ s 2011 Annual Survey of Manufacturers (ASM), the results of the engineering analysis, and interviews with manufacturers to determine the inputs necessary to calculate industry

- wide labor expenditures and domestic employment levels. Labor expenditures relat ed to manufacturing of the product are a function of the labor intensity of the product, the sales volume, and an assumption that wages remain fixed in real terms over time. The total labor expenditures in each year are calculated by multiplying the MPCs b y the labor percentage of MPCs.

The total l abor expenditures in the GRIM a re then converted to domestic production employment levels by dividing production labor expenditures by the annual payment per production worker (production worker hours times the labor rate found in the U.S. Census Bureau’s 2011 ASM). The estimates of pro duction workers in this section cover workers, including line supervisors who are directly involved in fabricating and assembling a product
within the manufacturing facility. Workers performing services that are closely associated with production operation s, such as materials handling tasks using forklifts, are also included as production labor. DOE’s estimates only account for production workers who manufacture the specific products covered by this rulemaking. The total direct employment impacts calculated in
the GRIM are the changes in the number of production workers resulting from the amended energy conservation standards for small, large and very large air

- cooled commercial package air conditioners and heat pumps, as compared to the base case. In general, more efficient equipment is larger, more complex, and mor e labor intensive to build. Per

- unit labor requirements and production time requirements increase with a higher energy cons ervation standard. As a result, the total labor calculations described in this paragraph are considered an upper bound to direct employment forecasts.

On the other hand, the domestic HVAC industry has had a track record of consolidation over the past decad e. DOE recognizes the potential for industry consolidation and its concomitant impacts on employment levels, especially at higher TSLs. As shipments drop and conversion costs increase, some manufacturers may choose not to m ake the necessary
investments. Al ternatively, they may choose to relocate product ion facilities where conversion costs are lower. To establish a lower bound to negative employment impacts, DOE estimated the maximum potential job loss due to manufacturers either leaving the industry or mov ing production to foreign locations as a result of an amended standard. These lower bound estimates were based on GRIM results, conversion cost estimates, and content from manufacturers
interviews.

DOE estimates that 95 percent of small, large, and very l arge air

- cooled com mercial package air conditioners and heat pumps sold in the United States are manufactured domestically. In the absence of amended energy conservation standards, DOE estimates that the industry would employ 1, 085 domestic production work ers in 2019

. Table 12.7

. 1 below depicts the range of potential employment impacts projected to result from amended energy conservation
standards

.

12

- 25Table 12.7

. 1 Potential Changes in the Total Number of Domesti c Production Workers in
the Small, Large and Very Large Air

- Cooled Commercial Package Air Conditioner and Heat Pump Industry in 2019

Trial Standard Level*

Base Case 1 2 3 4
Potential Changes in Domestic
Production Workers in 2019 (Compared

to Base

- Case Employment of 1,085) - (181)

to (10) (482)

to (69) (543)

to (27) (1,085)

to (31)
*Paren theses indicate negative values

12.7.2 Production Capacity

According to small, large and very large air

- cooled commercial package air conditioner
and heat pump manufacturers interviewed

, amended energy conservation standards could lead to
h

igher fabrication labor hours. However, excess capacity in the industry today and any drop in shipments that result from higher prices could offset the additiona l production times. In the long

- term, no manufacturers expected to face capacity constraints.

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 regulat ions may have serious consequences for some manufacturers, groups of manufacturers, or an entire industry. Assessing the impact of a single regulation may overlook thi s cumulative regulatory burden. In addition to energy conservation standards, other regul ations 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 these reasons, DOE conducts an analysis of cumulative regulatory burden as part of its rulemakings pertaining to appliance efficiency.

12.7.3.1 DOE Regulations for Other Products Produced by Manufacturers in the Small, Large and Very Large Air

- Cooled Commerci al Package Air Condition er and Heat Pump Industry

For the cumulative regulatory burden analysis, DOE looks at other regulations that could
affect manufacturers of small, large and very large air

- cooled commercial package air
conditioner s and heat pump s and that will take effect approximately three years before or after the 2019 compliance date of amended energy conservation standards for these products. In interviews, manufacturers cited Federal regulations on equipment other than small, large and very l arge air

- cooled commercial package air conditioners and heat pumps that contribute to their cumulative regulatory burden. The compliance years and expected industry conversion costs of relevant amended energy conservation standards are indicated in the tab le below:

12

- 26Table 12

. 7. 12.7

. 2 Compliance Dates and Expected Conversion Expenses of Federal Energy Conservation Standards Affecting the Small, Large and Very Large Air

- Cooled
Commercial Package Air Condition er and Heat Pump Industry

Federal Energy Conservation Standards Approximate Compliance
Date Estimated Total Industry Conversion Expense
2007 Residential Furnaces &
Boilers Final Rule
72 FR 65136 (Nov. 19, 2007) 2015 $88M (2006$)*

2010 Gas Fired and Electric Storage Water Heaters 75 FR 20112 (April 16, 2010) 2015 $95.4M (2009$)

2011 Residential Furnaces Direct Final Rule
76 FR 37408 (June 27, 2011); 76 FR 67037 (Oct. 31, 2011) 2015 $ 2.5 M (2009$) **

2011 Residential Central Air Conditioners and Heat Pumps
76 FR 37408 (June 27, 2011); 76 FR 67037 (Oct. 31, 2011) 2015 $ 26.0 M (2009$) **

Walk

- in Coolers and Freezers 79 FR 32050 (June 3, 2014) 2017 $33 .6M (2012$)

Furnace Fans

79 FR 38129 (July 3, 2014) 2019 $40.6M (2012$)

Packaged Terminal Air Conditioners and Heat Pumps*** TBD TBD

Commercial and Industrial Fans
and Blowers*** TBD TBD

Furnace Test Procedures*** TBD TBD Residential Central Air
Condition er s and Heat Pumps*** TBD TBD

* Conversion expenses for manufacturers of oil

- fired furnaces and gas

- and oil

- fired boilers associated with the November 2007 final rule for residential furnaces and boilers are excluded from this figure. The 2011 direct final
rule for residential furnaces sets a higher standard and earlier compliance date for oil furnaces than the 2007 Final Rule. As a result, manufacturers will be required design to the 2011 direct final rule standard. The conversion costs
associated with the 2011 direct final rule are lis ted separately in this table. EISA 2007 legislated higher standards and earlier compliance dates for residential boilers than were in the November 2007 final rule. As a result, gas

- and
oil

- fired boiler manufacturers were required to design to the EISA 2 007 standard beginning in 2012. The conversion costs listed for residential gas

- and oil

- fired boilers in the November 2007 residential furnaces and boilers final rule analysis are not included in this figure.

** Estimated industry conversion expense and a pproximate compliance date reflect DOE’s January 2013 remand of

the residential non

- weatherized and mobile home gas furnaces standards set in the 2011 Energy Conservation
Standards for Residential Furnaces and Residential Central Air Conditioners and Heat Pumps

. *** The final rule for this energy conservation standard has not been published. Where available, draft compliance date and draft conversion costs estimates have been provided. However, these values have not been finalized and are subject to chang e.

During previous stages of this rulemaking, DOE identified a number of requirements in
addition to amended energy conservation standards for small, large, and very large air

- cooled commercial package air conditioners and heat pumps

. The following sectio n briefly summarizes those identified regulatory requirements and addresses comments DOE received with respect to

12

- 27the cumulative regulatory burden , as well as other key related concerns manufacturers raised during interviews.

12.7.3.2 Other DOE and Federal Actions Affecting Manufacturers in the Small, Large and Very Large Air

- Cooled Commercial Package Air Condition er and Heat Pump Industry

DOE Certification, Compliance, and Enforcement Rule

On May 31, 2012, DOE published a notice of proposed rulemaking proposing to revise and expand its existing regulations governing the use of particular methods as alternatives to testing, known as Alternative Efficiency Determination Methods (AEDM), including for u se in rating small, large and very large air

- cooled commercial package air conditioners and heat

pumps . The last public meeting was held on June 5, 2012

, and the rule is currently in negotiations with stakeholders. 77 FR 32038

. Manufacturers highligh ted the regulatory burden from certification and compliance testing as one of the primary concerns for the industry’s health going forward. Several manufacturers asserted the potential for additional industry consolidation and potential exit of current com petitors due to the large number of basic models that may need to be tested as well as uncertainty regarding IEER tolerance for compliance purposes.

EPA Phaseout of Hydrochlorofluorocarbons (HCFCs)

The U.S. is obligated under the Montreal Protocol to lim it production and consumption of HCFCs through incremental reductions, culminating in a complete phaseout of HCFCs by
2030 ††

. On December 15, 2009, EPA published the “2010 HCFC Allocation Rule,” which allocates production and consumption allowances for HCFC

- 22 for each year between 2010 and
2014. ( 74 FR 66412 ) The rule also prohibited the manufacture of new appliances using virgin
HCFC

- 22, effective January 1, 2010, with limited exceptions. On April 3, 201 3 , EPA published
the “2012

- 2014 HCFC Allocation Proposed Rule,” which lift ed the regulatory ban on the production and consumption of HCFC

- 22 (following a court decision ‡‡ in August 2010 to vacate a portion of the “2010 HCFC Allocation Rule”) by establishing company

- by

- company HCFC

- 22
bas elines and allocating allowances for 2012

- 2014. 7 8 FR 2 0004

. On December 24, 2013, EPA published the “2015

- 2019 HCFC Allocation Proposed Rule,” which would provide HCFC allowances, including HCFC

- 22, through 2019. 78 FR 78072. Effective January 1, 2020, th ere will be no new production or import of virgin HCFC

- 22.

Manufacturers of small, large, and very large air

- cooled commercial package air conditioning equipment must comply with the allowances established by the allocation rule as well as the prohibition on manufacture of new HFC

- 22 appliances that took effect January 1, 2010. As such, no covered manufacturers offer R

- 22 products today. The MPCs used for the baseline and higher efficiency design options account for the move away from R

- 22 and the changes in production costs that resulted from the shift to HFC refrigerants.

†† "Montreal Protocol." United Nations Environment Programme . Web. 26 Aug. 2010. <http://ozone.unep.org/new_site/en/montreal_protocol.php>. ‡‡ See Arkema v. EPA , 618 F.3d 1 (D.C. Cir. 2010).

12

- 28ASHRAE Standard 90.1

ASHRAE Standard 90.1, “Energy Standard for Buildings Except Low

- Rise Residential Buildings,” sets minimum effi ciency standards for buildings with the except ion of lo w

- rise residential buildings. On May 16, 2012, DOE published the final rule in the Federal Register for Energy Conservation Standards and Test Procedures for Commercial Heating, Air

- Conditioning,
and Water

- Heating Equipment, through which DOE adopted the efficiency levels specified in ASHRAE Standard 90.1

– 2010. 77 FR 28928. Included in the ASHRAE standards are minimum efficiency levels for commercial heating, air

- conditioning, and water

- heating equipment.

12.8 CONCLUSION

The following section summarizes the impacts for the scenarios DOE believes are most likely to capture the range of impacts on manufacturers of small, large and very large air

- cooled

com mercial package air conditioners and heat pumps as a result of amended energy conservation
standards. DOE also notes that while these scenarios bound the range of most plausible impacts on manufacturers, circumstances could potentially cause manufacturers to experience impacts outside of this range

.

The table below summarizes INPV impacts and conversion costs projected to result from
each of the trial standard levels analyzed

.

Table 12.8.1 INPV and Conversion Cost Impact s at E ach TSL (Evaluated over the Full Analysis Period, 2013

- 2048)

Base
Case TSL 1 TSL 2 TSL 3 TSL 4

INPV ($MM) 1,260.9 1187.02 to
1249.47 1015.61 to
1208.04 949.34 to
1172.36 822.75 to
1142.78 Change in INPV ($MM) - - 73. 9 to

- 11. 5

- 245.3 to

- 52. 9

- 311. 6 to

- 88. 6

- 4 38. 2 to

- 118.1

Change in INPV (% )

- - 5. 9 to

- 0.9

- 19.5 to

- 4.2

- 24.7 to

- 7.0

- 34. 8 to

- 9.3

Product Conversion Costs ($MM) 12.7 38.73 58.52 120.90 210.96

Capital Conversion Costs ($MM) - 14.94 39.23 105.54 113.31

Total Investment Required ($MM) 12 .7 53.68 97.75 226.44 324.28

TSL 1 represents EL 1 for all equipment classes. At TSL 1, DOE estimates impacts on INPV for commercial packaged air conditioning manufacturers to range from

- 5.8 6 percent to

- 0.9 1 percent, or a change in INPV of

- $ 73. 89 million to

- $ 11. 45 million. At th is potential standard level, industry free cash flow is estimated to decrease by approximately 20.7 percent to $ 58.19 million, compared to the base

- case value of $7 3.3 8 million in the year before the compliance date (2018).

12

- 29At TSL 1, the industry is likely to face a small contraction. Industry wide shipments drop by approximately 5.04 %. In addition, manufacturers incur conversion costs totaling $ 53.68 million due to CC&E requirements, product redesigns for the Very Large equi pment classes, and new tooling associated with their largest equipment offerings. While impacts on the industry as a whole are relatively mild, small manufacturers may have greater difficulty with re

- rating their products to an IEER metric since they gener ally do not have the testing capacity or engineering resources of larger competitors.

TSL 2 represents EL 2 across all equipment classes. At TSL 2, DOE estimates impacts on INPV for commercial packaged air conditioning manufacturers to range from

- 19.45 p ercent to

- 4. 1 9 percent, or a change in INPV of

- $ 245.30 million to

- $ 52.87 million. At this potential standard level, industry free cash flow is estimated to decrease by approximately 44.37 percent to $40.82 million, compared to the base

- case value of $ 73.38 million in the year before the compliance date (2018).

At TSL 2, industry

- wide shipments drop by 28.32 % relative to the base case. Additionally, DOE anticipates conversion costs to increase to $ 97.75 million for the industry as roughly 67% of equipm ent listed in the AHRI directory would need to be redesigned in order to meet the higher proposed efficiency levels. A key indicator of impact on the industry is the industry free cash flow. The negative free cash flow indicates that players in the industr y would need to access cash reserves or borrow money from capital markets to cover conversion costs. Given the industry’s existing trend of consolidation, DOE expects further consolidation at TSL 2. Manufacturers with limited market share may choose to se ll off their small, large, and very large air

- cooled commercial package air conditioning and heating equipment business to larger competitors.

TSL 3 represents EL 3 for all equipment classes. At TSL 3, DOE estimates impacts on INPV for commercial package d air conditioning manufacturers to range from

– 24.71 percent to

- 7.02 percent, or a change in INPV of

- $ 311.58 million to

- $ 88.55 million. At this potential standard level, industry free cash flow is estimated to decrease by approximately 112.70 percent

to

- 9.32 relative to the base

- case value of $ 73.38 million in the year before the compliance date (2018).

At TSL 3, industry

- wide shipments drop by 28.76 % relative to the base case. DOE anticipates large capital conversion costs at TSL 3, as exte nsive redesigns necessitate additional investments in tooling for cabinets and heat exchangers to meet amended efficiency standards. Roughly 81% of equipment listings would require changes to meet the standard. Conversion costs total $ 226.44 million for t he industry. Given expectation for a shrinking market and high conversion costs, some manufacturers indicated they would move production to lower

- cost

12

- 30foreign markets at this level. Additionally, DOE would anticipate further consolidation in the industry.

TSL 4 represents max tech across all equipment classes. At TSL 4, DOE estimates impacts on INPV for commercial packaged air conditioning manufacturers to range from

- 34.75 percent to

- 9.37 percent, or a change in INPV of

- $ 438.16 million to

- $ 118.13 mi llion. At this potential standard level, industry free cash flow is estimated to decrease by approximately
157.42 percent relative to the base

- case value of $ 73.38 million in the year before the compliance date (2018).

At max

- tech, DOE estimates a 35.12 % drop in shipments, a maximum loss of nearly
34.75 % of industry value, and conversion costs approaching $ 650 million. Only 2% of equipment listings could meet this trial standard level today. At TSL 4, all manufacturers would
be re

- evaluating their role in the industry. Those that do remain would strongly consider all cost cutting measures, including relocation to foreign countries.

12

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- 32