CHAPTER 12. MANUFACTURER IMPACT ANALYSIS
TABLE OF CONTENTS
12.1 MANUFACTURER IMPACT ANALYSIS METHODOLOGY

................ 12-1 12.1.1 Phase 1: Industry Profile

........................................ 12-2 12.1.2 Phase 2: Industry Cash-Flow Analysis

.............................. 12-2 12.1.3 Phase 3: Subgroup Impact Analysis

......................... 12-3 12.1.3.1 Major Manufacturer Subgroups - Superclasses

................ 12-4 12.1.3.2 Small-Business Subgroup

................................. 12-5 12.2 MANUFACTURER KEY ISSUES

....................................... 12-6 12.3 GRIM INPUTS AND ASSUMPTIONS

................................... 12-8 12.3.1 Overview of GRIM

............................................. 12-8 12.3.2 Financial Parameters

............................................ 12-8 12.3.3 Corporate Discount Rate

.................................... 12-10 12.3.4 Shipments

.................................................... 12-12 12.3.5 Production Costs

.............................................. 12-13 12.3.6 Conversion Costs

.............................................. 12-13 12.3.7 Markup Scenarios

............................................. 12-13 12.3.7.1 Preservation-of-Gross-Margin-Percentage Scenario

............ 12-14 12.3.7.2 Preservation-of-Operating-Profit Scenario

................... 12-14 12.4 MANUFACTURER IMPACT ANALYSIS - LIQUID-IMMERSED

............ 12-16 12.4.1 Conversion Capital Expenditures

................................. 12-16 12.4.2 Product Conversion Expenses

.................................... 12-24 12.4.3 Industry Financial Impacts

....................................... 12-25 12.4.3.1 Trial Standard Levels

................................... 12-25 12.4.3.2 Impacts on Industry Net Present Value

...................... 12-25 12.4.3.3 Impacts on Annual Cash Flow

............................ 12-27 12.4.4 Other Impacts

................................................. 12-30 12.4.4.1 Employment

.......................................... 12-30 12.4.4.2 Production Capacity

.................................... 12-31 12.4.4.3 Exports

.............................................. 12-31 12.4.4.4 Cumulative Regulatory Burden

............................ 12-32 12.4.4.5 Impacts on Small Businesses

............................. 12-33 12.4.4.6 Worker Safety

......................................... 12-33 12.4.4.7 Other Engineering Issues

................................ 12-33 12.4.5 Summary of Impacts for Liquid-Immersed Superclass

................. 12-34 12.5 MANUFACTURER IMPACT ANALYSIS - MEDIUM-VOLTAGE, DRY-TYPE 12-38 12.5.1 Conversion Capital Expenditures

................................. 12-38 12.5.2 Product Conversion Expenses

.................................... 12-44 12.5.3 Industry Financial Impacts

....................................... 12-45 12.5.3.1 Trial Standard Levels

................................... 12-45 12.5.3.2 Impacts on Industry Net Present Value

...................... 12-45 12.5.3.3 Impacts on Annual Cash Flow

............................ 12-46 12.5.4 Other Impacts

................................................. 12-48

12-i12.5.4.1 Employment

.......................................... 12-48 12.5.4.2 Production Capacity

.................................... 12-49 12.5.4.3 Exports

.............................................. 12-50 12.5.4.4 Cumulative Regulatory Burden

.................. 12-50 12.5.4.5 Impacts on Small Businesses

............................. 12-51 12.5.5 Summary of Impacts for Medium-Voltage, Dry-Type Superclass

......... 12-51

Table 12.3.1 GRIM Financial Parameters for Distribution Transformer Industry

....... 12-10 Table 12.3.2 Non-Prod uction Cost Markups for the Preservation-of-Operating-Profit Scenario

Table 12.4.9 Changes in Liquid-Immersed Industry Net Present Value, Preservation-of- Operating-Profit Scenario

.................................... 12-26 Table 12.4.8 Changes in Liquid-Immersed Industry Net Present Value, Preservation-of-Gross- Margin-Percentage Scenario

..................................... 12-26 Table 12.4.7 Summary of Liquid-Immersed Distribution Transformer Product Conversion Expenses

.................................................... 12-25 Table 12.4.6 Summary of Liquid-Immersed Distribution Transformer Conversion Capital Expenditures

................................................. 12-24 Table 12.4.5 Summary of Liquid-Immersed Distribution Transformer Amorphous Core-Cutting Equipment Capital Expenditures

.................................. 12-22 Table 12.4.4 Summary of Liquid-Immersed Distribution Transformer Conventional Core- Cutting Equipment Capital Expenditures

........................... 12-22 Table 12.4.3 Summary of Additional Conventional Core-Cutting Machine Requirements for Liquid-Immersed Superclass

..................................... 12-21 Table 12.4.2 Summary of Liquid-Immersed Distribution Transformer Amorphous Annealing Furnace Capital Expenditures

.................. 12-20 Table 12.4.1 Summary of Liquid-Immersed Distribution Transformer Conventional Annealing Furnace Capital Expenditures

.................................... 12-19 LIST OF TABLES

............................................................ 12-15

Table 12.4.10 Projected Change in Labor Expenditures, Liquid-Immersed (2010)

....... 12-30 Table 12.5.1
 Calculation of Core-Mitering Capacity Multiplier for Design Line 9

...... 12-40 Table 12.5.2
 Calculation of Core-Mitering Machines Needed for Design Line 9

....... 12-41 Table 12.5.3
 Calculation of Core-Mitering Machines Needed for Design Line 10

...... 12-41 Table 12.5.4
 Calculation of Core-Mitering Machines Needed for Design Line 11

...... 12-42 Table 12.5.5
 Calculation of Core-Mitering Machines Needed for Design Line 12

...... 12-42 Table 12.5.6
 Calculation of Core-Mitering Machines Needed for Design Line 13

...... 12-43 Table 12.5.7
 Summary of MV, Dry-Type Distribution Transformer Core-Cutting Equipment Capital Expenditures

.......................................... 12-43 Table 12.5.8 Summary of MV, Dry-Type Distribution Transformer Conversion Capital Expenditures

................................................. 12-44 Table 12.5.9 Summary of MV, Dry-Type Distribution Transformer Product Conversion Expenses

................................................ 12-44

12-iiTable 12.5.10 Changes in MV, Dry-Type Industry Net Present Value, Preservation-of-Gross- Margin-Percentage Scenario

..................................... 12-46 Table 12.5.11 Changes in MV, Dry-Type Industry Net Present Value, Preservation-of- Operati ng-Profit Scenario

....................................... 12-46 Table 12.5.12 Projected Change in Labor Expenditures, MV, Dry-Type (2010)

......... 12-49

LIST OF FIGURES Figure 12.3.1 Using the GRIM to Calculate Cash Flow

............................. 12-8 Figure 12.4.1 Industry Net Cash Flow for Preservation-of-Gross-Margin-Percentage Scenario, Liquid-I mmersed

.................................................... 12-27 Figure 12.4.2 Industry Net Cash Flow for Preservation-of-Operating-Profit Scenario, Liquid- Immersed

.......................................................... 12-29 Figure 12.5.1 Industry Net Cash Flow for Preservation-of-Gross-Margin-Percentage Scenario, MV, Dry-ty pe
....................................................... 12-47 Figure 12.5.2 Industry Net Cash Flow for Preservation-of-Operating-Profit Scenario, MV, Dry- type

............................................................... 12-48

12-iiiCHAPTER 12. MANUFACTURER IMPACT ANALYSIS

12.1 MANUFACTURER IMPACT ANALYSIS METHODOLOGY In determining whether a standard is economically justified, the Secretary of Energy 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.”a The legislation also calls for an assessment of the impact of any lessening of competition as determined in writing by the Attorney General. The Department conducted the manufacturer impact analysis (MIA) to estimate the financial impact of efficiency standards on manufacturers of distribution transformers and to assess the impact of such standards on employment and manufacturing capacity. The MIA has both quantitative and qualitative components. The quantitative part ofthe MIA primarily relies on the Government Regulatory Impact Model (GRIM), an industrycash-flow model adapted for this rulemaking. The key GRIM inputs relate to industry cost structure, shipments, and product pricing. The GRIM’s key output is the industry net present value (INPV). The model estimates the financial impact of higher efficiency standards by comparing changes in INPV between the base case and the various trial standard levels (TSLs). The qualitative part of the MIA addresses factors such as the material supply chain, manufacturing techniques and equipment, market and product trends, and includes a subgroup assessment of the impacts on small manufacturers. In the Department’s Framework Document published on November 1, 2000, DOE outlined the procedural and analy tical approaches for the MIA. As outlined, the Department conducted the MIA in three phases. Phase 1, “Industry Profile,” consisted of preparing an industry characterization, including data on market shares, sales volumes and trends, pricing, employment, and financial structure. Phase 2, “Industry Cash Flow,” focused on the industry as a whole. Using publicly available information developed in Phase 1, the Department adapted the GRIM’s generic structure to perform an analysis of the impact of distribution transformer energy conservation standards on the industry cash flow. In Phase 3, the “Sub-Group Impact Analysis,” DOE conducted interviews with several manufacturers. Those interviewed included small, medium, and large manufacturers providing a representative cross-section of the U.S. distribution transformer industry. During these interviews, the Department discussed engineering, manufacturing, procurement, and financial topics specific to each company, and also obtained each manufacturer’s view of the potential impacts of standards on the industry as a whole. The interviews provided valuable information that the Department used to evaluate the impacts of a standard on manufacturers’ cash flows, manufacturing capacities, and employment levels. This chapter provides details on the approach the Department followed in developing the MIA for this rulemaking.

a The D epartment of Energy’s standards program for commercial equipmentis conducted under Title III, Part C of the Energy Policy and Conservation Act (EPCA), 42 U.S.C. 6311-6317.

12-112.1.1 Phase 1: Industry Profile In Phase 1 of the MIA, the Department prepared a profile of the distribution transformer industry that built on the market and technolog y assessments prepared for the advance notice of proposed rulemaking (ANOPR) analysis. Prior to initiating the detailed impact studies, DOE collected information about the present and past industry structure and market characteristics for distribution transformers—including information on national shipments, market leaders, and cost structures for a range of manufacturers. In creating the industry profile, the Department gathered information about product construction, product characteristics, manufacturing techniques, trends in the number of firms, and market characteristics. The industry profile included a topdown cost analysis of the distribution transformer industry that DOE used to derive initial cost and financial inputs for the GRIM, e.g., revenues; material; labor; overhead; depreciation; selling, general, and administrative (SG&A) expenses; and research and development (R&D) expenses. The Department used public sources of information to calibrate its initial characterization of the industry, including Securities and Exchange Commission (SEC) 10-K reports, corporate annual reports, the U.S. Census Bureau’s Economic Census, Dun & Bradstreet reports, and industry analysis from Ibbotson Associates.
12.1.2 Phase 2: Industry Cash-Flow Analysis Phase 2 of the MIA focused on the industry-wide financial impacts of standards. Energy conservation standards can affec t distribution transformer manufacturers in three distinct ways. They can: 1) require additional investment, 2) raise production costs, and 3) impact revenues through higher prices and, possibly, lower shipments. The analytical tool DOE uses for calculating the financial impacts of standards on manufacturers is the GRIM. To quantify these impacts in Phase 2 of the MIA, the Department performed a distribution transformer industry cash-flow analysis using the GRIM. For the industry cash-flow analysis, DOE prepared a set of financial parameters for use in the GRIM. The Department originally based these financial parameters on its topdown financial analysis but, following discussions with transformer manufacturers, it adjusted them to be more representative of the industry. The Department used a similar process during the ANOPR phase of the analysis (i.e., public financial reports and manufacturer discussions) to derive the manufacturer markups it used to establish manufacturer selling prices in the engineering analysis. The MIA production costs and manufacturer selling prices are consistent with the life-cycle cost (LCC) analysis, as well as with the engineering analysis, on which DOE based the LCC pricing. The Department established this consistency by using the mean values for production costs and selling prices in the GRIM, as selected by the LCC’s customer choice model (Monte Carlo algorithm). Finally, the Department’s shipments analysis (Chapter 9) provided the basis for the shipments projection under each of the TSLs in the GRIM.

12-212.1.3 Phase 3: Subgroup Impact Analysis Using average cost and financial assumptions to develop an industry cash-flow model is not adequate for assessing differe ntial impacts among subgroups of manufacturers. Smaller manufacturers, niche players, or manufacturers exhibiting a cost structure that differs largely from the industry average could be more negatively impacted. The Department used the results of the industry characterization to group together manufacturers exhibiting similar characteristics. It established two distinct subgroups of distribution transformer manufacturers that could be impacted by efficiency standards: (1) liquid-immersed, and (2) medium-voltage, dry-type. A discussion of these superclasses follows in section 12.1.3.1. Within each of these superclasses, the Department contacted companies from its database of manufacturers (see Chapter 3), which provided a representation of each superclass. The Department interviewed small and large companies, subsidiaries and independent firms, public and private corporations, and a mix of National Electrical Manufacturers Association (NEMA) members and non-NEMA members. It also made an effort to interview companies that had been interviewed for the engineering analysis in 2002, as well as those that had previously participated in the rulemaking process. The purpose of the meetings was to enhance the Department’s understanding of how manufacturer impacts change with each of the TSLs. A copy of the interview guides for each of the two superclasses can be found in Appendix 12.A. The Department also evaluated the impact of the energy conservation standards on small businesses. Small businesses, as defined by the Small Business Administration (SBA) for the distribution transformer manufacturing industry, are manufacturing enterprises with 750 or fewer employees. The Department conducted telephone interviews with four small businesses, to determine if the standard could result in differential impacts on these companies. A copy of the interview guide for these interviews can be found in Appendix 12.B. Discussion of the purpose of the small-business interviews and the small-business subgroup methodology follows in section 12.1.3.2.Two of the manufacturers interviewed in the lengthier, face-to-face interviews are also categorized as small businesses. The Department contacted material and equipment suppliers to the distribution transformer industry to enhance its understanding of the context in which transformer manufacturers operate and to assist in quantifying conversion costs. The Department conducted interviews with the two domestic suppliers of electrical core steel and with two core steel distributors. The domestic suppliers of core steel are large corporations that sell a broad range of steel products, one of which is electrical core steel. The core steel distributors offer manufacturers a varying degree of processing, ranging from basic slit-to-width rolls to prefabricated cores (both stacked and wound-core configurations). The Department also spoke with four equipment suppliers, including manufacturers of both distributed gap and mitered core processing machines, and two manufacturers of annealing furnaces. The information from these discussions was helpful in understanding comments and concerns expressed by manufacturers, as well as in estimating the conversion capital expenditures used in the GRIM.

12-3To prepare the liquid-immersed industry conversion costs for switching to amorphous material at TSLs 5 and 6 (and also TSLs 3, 4, and A), the Department spoke with the only domestic supplier of amorphous ribbon and several transformer manufacturers who had experience working with amorphous material. Through this dialogue, the Department gained a better understanding of manufacturing amorphous core transformers, including issues surrounding core processing equipment, annealing furnaces, and material handling. In response to comments on the proposed rule, DOE subcontracted a consultancy, Matrix Power, Inc., with expertise in amorphous core transformer materials, design, and production. Matrix Power reviewed the amorphous-related conversion capital expenditure estimates from the proposed rule and compared them to its own independent (previous) estimates. Through this process, DOE revised and refined its proposed rule estimates for manufacturers’ capital expenditures in converting to amorphous technology.
12.1.3.1 Major Manufacturer Subgroups - Superclasses The Department subdivided the distribution transformer industry into two ‘superclasses’: liquid-immersed and medium-voltage, dry -type. (The low-voltage, dry-type superclass was removed after the ANOPR, because the Energy Policy Act of 2005, enacted in August 2005, prescribed standards for these types of transformers.) These superclasses take into account differences among the manufacturers, including the equipment and tooling used, product designs, customer types, and the characteristics of the markets in which the manufacturers operate. The Department believes that modeling the industry in two separate subgroups offers a robust analytical approach, for three reasons:
1. Customer profiles and market mechanisms - Generally, the profiles of the majority of customers purchasing transformers and the manner in which they are built and sold within each of the two superclasses are distinct. Discussion of customer profiles and distribution chains can be found in the LCC analysis (Chapter 8).
2. Manufacturing equipment and transformer design - The equipment necessary for production and the methods by whic h manufacturers build transformers are different for each of the superclasses. For example, in the liquid-immersed superclass, transformer cores tend to be wound, requiring distributed-gap core-winding machines, annealing furnaces, tanking machines, and other equipment that is only used in this superclass. Accordingly, the capital equipment investment necessary for compliance with a particular TSL typically differs between the two superclasses.
3. Industry structure - Reviewing the database of transformer manufacturers, the Department observed that many companies operate and specialize in one of the distribution transformer superclasses. For large companies that operate in both superclasses, each manufacturing facility tends to be dedicated to producing transformers from one of the superclasses. Thus, the industry naturally breaks down into two superclasses (actually, three superclasses, if low-voltage, dry-type is considered).

12-4The Department conducted structured, detailed, face-to-face interviews with six manufacturers, one of which produces transformers in both superclasses. Two of the sixmanufacturers are small businesses. Three of the manufacturers produce medium-voltage, drytype transformers, collectively representing more than an estimated 70 percent of the U.S. medium-voltage, dry-type market. Four of the manufacturers produce liquid-immersedtransformers, collectively representing more than an estimated 70 percent of the U.S. liquidimmersed market.
12.1.3.2 Small-Business Subgroup The Department undertook a small-business subgroup analysis to assess the importance of small businesses within the distribution transformer industry and to under stand how the impacts of standards on small business might be different from those on large manufacturers. Small businesses, as defined by the SBA for the distribution transformer manufacturing industry, are manufacturing enterprises with 750 employees or fewer.bTo prepare a list of eligible companies, the Department constructed a transformer manufacturers’ database containing available data from 11 sources, including the Department’s stakeholder contact list for this rulemaking, the Oak Ridge National Laboratory determination analysis database, the Underwriters Laboratory (UL) certification database, the NEMA membership list, and the Transformer Association membership list. (Additional details about the sources used are discussed in the market and technology assessment, Chapter 3.) The Department then selected small businesses and contacted them to assess their interest in participating in an interview. If a small business was interested, the Department sent them a short questionnaire and scheduled a date for discussion. A copy of the small-business interview guide can be found in Appendix 12.B. In addition to the two small businesses that underwent detailed, structured, face-to-face intervie ws, DOE interviewed four additional small businesses by telephone. Three of the small businesses interviewed by telephone produce medium-voltage, dry-type transformers, and one of them produces liquid-immersed transformers. The Department’s database of transformer manufacturers includes approximately 28 small businesses affected by this rulemaking, most of which have fewer than 100 employees. Small businesses operate in both superclasses. The database identifies 15 small businesses that sell liquid-immersed distribution transformers and 20 that sell medium-voltage, dry-type units. The total of these two groups exceeds 28, because some small businesses operate in more than one superclass. Upon reviewing the material provided by the small businesses interviewed, the Department concluded that using the GRIM was not the best way to capture and represent the differential impacts on small business. Instead, the differential impacts on small business are discussed qualitatively for each of the two superclasses in this chapter.

bSma ll Busin ess Ad ministratio n - www.sba.gov/size/indextableofsize.html

12-512.2 MANUFACTURER KEY ISSUES The first question in each MIA interview guide asks, “What are the key issues for your company regarding the distribution transformer energy conservation standard rulemaking?” This open question initiated the dialogue with the manufacturers, enabling them to identify key points that the Department would explore and discuss during the interview. This section lists those issues that the manufacturers interviewed raised most often. Manufacturers indicated that, for the most part, the risks associated with these issues increase with increasing TSL. Many of these issues are discussed later in this chapter.

• Core steel availability - Manufacturers expressed concer n over whether sufficient quantities of high-grade core steels needed for the construction of energy-efficient distribution transformers would be available. Manufacturers stated that this concern is amplified by recent core steel availability problems in the U.S. market. Not only will the standard drive the market to use higher grades of steel (which are thinner, and therefore take more time for steel companies to manufacture), but the quantities (pounds of steel) per transformer also will (typically) increase. Transformer manufacturers are concerned that these compounding factors may further limit the availability of core steel.

• Core steelprice volatility and uncertainty - Starting in late 2003, core steel prices started to increase, and increased dramatically after mid-2004. For some manufacturers, core steel prices have more than doubled since 2003. In response to these and other material input cost increases, transformer manufacturers have been raising their own prices. However, manufacturers reported that they have not passed all input cost increases through to customers. Furthermore, manufacturers questioned the cost-effectiveness of energy conservation standards under higher steel prices. They commented that higher transformer selling prices (driven by the higher material inputs prices), would erode customer cost savings and lengthen the payback periods of transformers under standards. The Department’s core steel market analysis is contained in Appendix 3A of this technical support document (TSD). Core steel price uncertainty is addressed in the Department’s core steel price scenarios as part of the engineering analysis and the LCC analysis (see Chapter 5 of this TSD, particularly Appendix 5C, and Chapter 8, particularly Appendix 8D).

• Dimensional and physical constraints - Manufacturers expressed concer n over meeting the Department’s efficiency standard and their customers’ dimensional and physical constraints simultaneously. In particular, manufacturers voiced concern regarding retrofit applications, mining applications, telephone pole capacities, and other installations where transformers have to comply with dimensional or physical constraints.

• Enforcement of efficiency standard- Manufacturers expressed concer n over how the Department intends to enforce the standards, to make sure all manufacturers, particularly of transformers imported to the U.S., comply with the regulations.

12-6• Definition loopholes - Manufacturers cautioned that, if the standar d is set above a certain level, some customers may start looking for standards relief by specifying transformers from the Department’s exemption list and using them in general purpose applications.

• Amorphous material- Liquid-immersed transformer manufacturers expressed concern that the Department is considering amorphous material at some of its TSLs. In particular, they discussed concerns about: 1) the ease of access to the technology, 2) the availability of amorphous-core material at quantities necessary to meet industry demand, 3) the level of capital equipment investment, 4) increased complexity associated with material processing and handling during manufacturing, and 5) the consequent obsolescence of existing core fabrication and annealing capacity within the industry.

• Backsliding - Liquid-immersed transformer manufacturers identified two impacts related to backsliding. First, manufacturers reported that they are currently beginning to experience these impacts as a result of State standards. Manufacturers reported that, in the State that has enacted NEMA’s TP-1 standard for liquid-immersed transformers, some utility customers have ceased evaluating their purchases (i.e., selecting transformers based on the capitalized cost per watt of no-load and load losses, using A and B factors), and are simply purchasing standards-compliant transformers. According to manufacturers, while the minimum efficiency of transformers sold in this State has increased, the average efficiency has decreased. The first impact of such backsliding isthat liquid-immersed manufacturers may experience lower revenue. Second, the liquidimmersed market may move from a highly customized market, where U.S. manufacturers enjoy a competitive advantage over foreign manufacturers because of their flexibility and shorter lead times, to a homogenized, commoditized market. In such a market, backsliding in efficiency would be likely to occur as customized designs become less common. Ultimately, liquid-immersed manufacturers suggest that this may lead to a deterioration in the U.S. manufacturing base of liquid-immersed distribution transformers.

12-712.3 GRIM INPUTS AND ASSUMPTIONS
12.3.1 Overview of GRIM The GRIM serves as the main tool for assessing the impact on industry of implementing efficiency standards. The GRIM is a financial model of the industry that captures the impact of efficiency standards on industry value. The GRIM, illustrated in Figure 12.3.1, carries out a standard annual cash-flow analysis, using manufacturer prices, manufacturing costs, shipments, and industry financial information as inputs, and accepts a set of regulatory conditions, such as changes in costs, investments, and associated margins. The GRIM spreadsheet calculates a series of annual cash flows, beginning with the base year of the analysis, 2007, and continuing explicitly to 2038. The model calculates the INPV by summing the stream of annual discounted cash flows during this period.1

Figure 12.3.1 Using the GRIM to Calculate Cash Flow
The Department used the GRIM to project cash flows based on standard accounting principles and compared changes in INPV between a base case (no mandatory standard) and different TSLs for the energy conservation standard (the standard case). The difference in INPV between the base case and the standard case(s) represents the financial impact of the standard on manufacturers. Appendix 12.C provides more technical detail and user information for the GRIM.
12.3.2 Financial Parameters The Department relied on several sources to obtain financial inputs and assumptions for the GRI M, including corporate annual reports and the manufacturer interviews. Corporate annual reports to the SEC (SEC 10-Ks) provided many of the draft financial inputs to the GRIM.2 These reports exist for publicly held companies, and are freely available to the general public. The Department used these annual reports to derive the following draft GRIM inputs:

12-8• Tax rate, • Working capital, • Selling, general, and administrative expenses, • Research and development expenses, • Depreciation, • Capital expenditures, and • Net property, plant, and equipment (i.e., net of accumulated depreciation). The Department then revised its own estimates of financial parameters through interviews with manufacturers during both the ANOPR and notice of pr oposed rulemaking (NOPR) phases of the rulemaking. It relied on manufacturer input for these revisions for two reasons. First, many distribution transformer manufacturers, both large and small, are not public corporations, so industry-wide financial data are not readily available. Second, many manufacturers of distribution transformers are diverse businesses that participate in markets that are substantially different from distribution transformer markets; therefore, the available financial information is not clearly representative of the distribution transformer market. Table 12.3.1 provides the representative financial parameters that DOE used for both superclasses in the distribution transformer GRIM. The Department also used information from the SEC 10-K reports to calibrate the GRIM’s base case ope rating profit margin to be representative for the industry. Operating margin is defined as earnings before interest and taxes, as a percentage of net revenue. The Department calibrated the GRIM to have a 4.9 percent operating margin in the base case.

12-9Table 12.3.1 GRIM Financial Parameters for Distribution Transformer Industry

Parameter Representative Value for Liquid-Immersed Representative Value for MV, Dry-Type
Tax Rate (% of Taxable Income) 30.0% 33.9%

Net Working Capital (% of Revenues) 15.4% 10.6%

SG&A (% of Revenues) 13.5% 14.0%

R&D (% of Revenues) 1.6% 1.1%

Depreciation (% of Revenues) 1.6% 1.8%
Capital Expenditures

(% of Revenues) 1.9% 2.1%
Net Property, Plant, and Equipment (% of R evenues) 16.6% 16.1%
Source : SEC, 1 0-K R eports, Fiscal Y ears 199 9–2 004 . Revised b ased on discussion with man ufacturers.

12.3.3 Corporate Discount Rate The Department used the weighted-average cost of capital (WACC) for the industry as the discount rate to calculate I NPV. 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.1 The Department estimated the WACC for the industry based on a few representative companies, using the following formula: WACC = After-Tax Cost of Debt x (Debt ratio) + Cost of Equity x (Equity Ratio) The cost of equity is the rate of return that equity investors expect to earn on a company’s stock. These expectations are reflected in the market price of the company’s stock. The capital asset pricing model (CAPM) provides one widely used means to estimate the cost of equity. According to the CAPM, the cost of equity (expected return) is: Cost of equity = risk free rate of return + Beta * risk premium
where: Risk free rate of return = rate of return on a “safe” benchmark investment. In practice, investors use a variety of different-maturity

12-10Treasury notes to estimate the risk-free rate. The Department used a long-term Treasury note return (10-year bond return) because this captures long-term inflation expectations and is less volatile than short-term rates in the GRIM. It estimated the risk-free rate to be 6.2 percent, which is the average 10-year Treasury note return from 1990 to 2003, Risk premium = the difference between the expected return on stocks and the riskless rate, assumed to be 9.2 percent, and Beta = the covariance of a stock with the market as a fraction of the market’s variance. The Beta equals one if the stock is perfectly correlated with the Standard and Poor’s (S&P) 500 market index. A Beta lower than one means the stock is less volatile than the market index. For this analysis, DOE assumed Beta to be equal to 0.8. Using these inputs, the Department estimated the cost of equity (expected return) to be 13.6percent. The Department estimated the cost of debt for each company based on the average interest rate reported on each compa ny’s SEC 10-K report. It estimated the average cost of debt to be 6.6 percent. Assuming a marginal tax rate of 35 percent, the after-tax cost of debt is 4.3 percent. The Department estimated the debt ratio (debt/total capital) of the industry to be 26 percent.cThe equity ratio estimate is therefore 74 percent. Using the formula for the WACC, the Department estimated the industry’s WACC to be 11.2percent. Subtracting an estimated inflation rate of 2.3 percent (assumed in the LCC analy sis), the inflation-adjusted WACC is 8.9 percent. For validation, Ibbotson Associates3provided a WACC for a set of companies in the electric transmission and distribution equipment industry, which the Department assumed to be a good surrogate for the distribution transformer industry. The Ibbotson nominal WACC is 12.5 percent, which corresponds to an inflation-adjusted WACC of 10.3 percent. This is close to the Department’s calculated value of 8.9 percent. During the manufacturer interviews, no manufacturer expressed disagreement with the industry-wide, inflation-adjusted WACC estimate of 8.9 per cent (although some individual companies have substantially different costs of capital). For the reasons discussed above, the GRIM uses an 8.9 percent discount rate for calculating the INPV of the distribution transformer industry.

In pre vious r ulema kings, D OE base d the d ebt ratio on b ook value; in th isrulemaking a slightly more accurate debt ratiois based on market value of equity ratherthan book value. However, DOE used the book value of long-term debt to estim ate the d ebt ra tio.

12-11 c12.3.4 Shipments In the national impact analysis, the GRIM used shipment projections derived from the Department's shipments model. The shipments model provides an estimate of the annual sales and in-service stock of distribution transformers for each year of the forecast period. The estimate includes both the age distribution of transformers for each type (according to product class) and each transformer size. The Department selected an accounting model method to prepare shipment scenarios for the base case and the all trial standard levels. Chapter 9 of this TSD provides a description of the methodology and analytical model DOE used to forecast distribution transformer shipments. In its shipments analysis, the Department determined that the demand for distribution transformers is relatively inelastic. Therefore, in the long-run, more expensive standardscompliant transformers are not expected to trigger substantial reductions in shipments. Transformers are understood to be a ‘must-have;’ thus, DOE modeled the shipments analysis with a small price-elasticity. During the MIA interviews, several manufacturers expressed their view that shipments are subject to a greater price elasticity of demand than the Department estimated. The manufacturers informed the Department of three mechanisms by which higher standards could reduce shipments. First, manufacturers commented that transformer budgets are often finite line items in a utility’s overall budget, and as costs per unit increase, it is unlikely that utilities’ transformer budgets will increase proportionately. Thus, proactive maintenance programs that replace and/or upgrade transformers nearing the end of their useful life will be reduced (on a unit basis), resulting in more failures and outages, and lower system reliability. The installed capital of the distribution network will be worked harder, and transformers will only be fixed upon failure. Second, utilities may increase their purchase of multi-voltage (primary) distribution transformers, enabling them to reduce inventories. Multi-voltage primary transformers are able to operate at more than one primary voltage, enabling utilities to reduce the number of transformers kept in stock for emergencies and upgrades. Third, engineers who specify transformer orders may look at an application and select a slightly lower kVA rating than they ordinarily would have because of the higher (standards-compliant) price. For example, a customer who would have purchased a 50 kVA unit for an application may select a 37.5 kVA unit because of the cost increase for a standards-compliant 50 kVA transformer. Working a lower kVA unit with a higher average load reduces its operating life (compared to the larger kVA operating the same load); however, on a first-cost basis, the specifier will have saved money. In the shipments analysis, DOE did not model this risk of derating transformers. Furthermore, if lower kVA ratings are specified, the actual per-unit loading may move away from the assumed 50 percent for liquid-immersed and medium-voltage, dry-type transformers, resulting in greater load losses and lower system efficiency than DOE modeled in the national impact analysis. Finally, the Department’s shipments analysis did not take into account any constraints on the availability of mater ials for manufacturing transformers. As noted in section 12.2, manufacturers expressed concern during the interviews about the availability of core steel. The transformer materials supply chain has been experiencing consolidation over the years, such that

12-12now, manufacturers would be vulnerable to changes in price or availability of wire, copper sheet, electrical paper, mineral oil, and other critical materials for building a transformer. Such input price changes would be passed through and would impact transformer prices. Since the Department’s engineering analysis assumed flat equipment prices in real terms over time, its shipments analysis could not capture such second-order impacts for any given set of equipment prices.
12.3.5 Production Costs During the engineering analysis, the Department used transformer design software to create a database of desig ns spanning a broad range of efficiencies for each of the representative units. This design software generated a bill of materials, with information including pounds of core steel, pounds of conductor, insulation, ducting, and tank or enclosure size. The software also provided information pertaining to the labor necessary to construct the transformer, including the number of turns in the windings, and core dimensions, including stack height. All the components from this bill of materials and labor estimate were combined with fixed hardware costs, such as bushings, busbar, and terminals. The Department then applied manufacturer markups to allow for scrap, handling, factory overhead, and non-production markups to estimate the manufacturer selling price. Details on the derivation of the manufacturer selling prices and discussion of manufacturer markups are in Chapter 5. The Department derived the manufacturer’s production cost inputs (for the designs selected by the LCC customer choice model) for the GRIM from the engineering analysis databases.
12.3.6 Conversion Costs Efficiency standards typically cause manufacturers to incur conversion costs prior to the standard effective date to bring their production facilities and product designs into compliance with the standard. For the purpose of the MIA, DOE classified these conversion costs into two major categories. Conversion capital expenditures are investments in property, plant, and equipment to adapt or change existing production facilities so that new product designs can be fabricated and assembled under the standard. Product conversion expenses relate to research, development, testing, and marketing that aims to make product designs comply with the new efficiency standard. Conversion costs specific to each superclass are discussed separately in sections 12.4 and 12.5.
12.3.7 Markup Scenarios To estimate the manufacturer selling price of distribution transformers, the Department applied markups to the production costs. In an effort to gather information on industry pricing scenarios, DOE invited manufacturers to discuss how standards might change the industry’s profits. In discussions on issues such as the impact of higher core steel prices and transformer pricing scenarios, DOE sought manufacturers’ insights regarding how increased production costs under standards might be passed through to their customers. All of the manufacturers interviewed had applied one or more price increases within the last several years to recover some of the production cost increases resulting from higher commodity prices. A few of the larger

12-13manufacturers had recently established with their customers pricing contracts that had a base price and a variable “surcharge.” The surcharge is adjusted on a periodic (e.g., monthly or quarterly) basis, and is calculated based on the costs of the transformer manufacturer’s major materials (e.g., core steel). All manufacturers discussed the recent material price increases within the context of the Department’s questions about markups. For the MIA, the Department considered two distinct markup scenarios, which are discussed in the following sections.
12.3.7.1 Preservation-of-Gross-Margin-Percentage Scenario Under the preservation-of-gross-margin-percentage scenario, DOE applied a single uniform “gross margin percentage” markup across all efficiency levels. As production cost increases with efficiency, this scenario implies that the absolute dollar markup will increase. The Department assumed the non-production cost markup—which includes SG&A expenses; research and development expenses; interest; and profit—to be 1.25. This markup is consistent with the one the Department assumed in the engineering analysis and the base case of the GRIM. Manufacturers believe it is optimistic to assume that as their production costs increase in response to an efficiency standard, they would be able to maintain the same gross margin percentage markup. Therefore, the Department assumes that this scenario represents a high bound to industry profitability under an energy-conservation standard.
12.3.7.2 Preservation-of-Operating-Profit Scenario Operating profit is defined as earnings before interest and taxes. The implicit assumption behind this markup scenario is that the industry can maintain its operating profit (in absolute dollars) after the standard. The industry would do so by passing through its increased costs to customers without increasing its operating profits in absolute dollars. The Department implemented this scenario in the GRIM by setting the non-production cost markups for each TSL to yield approximately the same operating profit in the standards cases in the year after standard implementation (2011) as is yielded in the base case. This scenario is less optimistic than the preservation-of-gross-margin-percentage scenario. For this scenario, the financial metrics of return on sales (percent) and return on invested capital (ROIC) decline with increasing TSL, indicating reduced industry profitability. The non-production cost markups under this scenario are summarized in Table 12.3.2.

12-14Table 12.3.2 Non-Production Cost Markups for the Preservation-of-Operating-Profit Scenario
Superclass Trial Standard Level Base Case 1 2 D C B 3 4 A 5 6LiquidImmersed 1.250 1.246 1.244 1.242 1.240 1.239 1.240 1.238 1.230 1.222 1.208
MV, DryType 1.250 1.248 1.246 NA NA NA 1.243 1.237 NA 1.219 1.219

12-1512.4 MANUFACTURER IMPACT ANALYSIS - LIQUID-IMMERSED The liquid-immersed transformer industry is characterized by a high degree of flexibility, total ownership cost evaluation, and sophisticated customers. Liquid-immersed customers typically use a Total Owning Cost evaluation (see the Total Owning Cost section of Chapter 3, Section 3.6), which minimizes the sum of first cost and the present value of future core andcoil losses that a given transformer will experience over its lifetime. Because these evaluation formulae vary from customer to customer, and because material prices fluctuate on a daily basis, the liquid-immersed industry evolved to be inherently flexible and responsive to customer needs. As the Department understands it, there are approximately 25 companies active in the liquid-immersed market in the U.S., some of which are branding units manufa ctured by another company. The Department estimated that the nine or so largest liquid-immersed transformer manufacturing companies collectively control 90 percent of the market or more. They are (in alphabetical order): ABB, Central Maloney, Cooper Power, ERMCO, GE Prolec, Howard Industries, Kuhlman Electric, Pauwels, and Power Partners. Of these, the Department estimated that the top three companies supply approximately 60 percent of the liquid-immersed market. For more information on the transformer market, refer to the market and technology assessment (Chapter 3).
12.4.1 Conversion Capital Expenditures Through its interviews with manufacturers, the Department learned that the conversion capital e xpenditures that liquid-immersed transformer manufacturers would have to make in response to an energy-conservation standard fall into three major categories: 1) annealing furnace capacity, 2) core-cutting and core-winding equipment, and 3) miscellaneous, including buildings and coil winding equipment. Manufacturers of liquid-immersed transformers provided capital cost estimates for each of these capital expenditure categories. The Department used the estimates provided by industry for comparative purposes and prepared its own bottom-up estimates of conversion capital expenditures. It based the bottom-up estimates on the Department’s understanding of typical manufacturing processes at liquid-immersed transformer facilities. This understanding is based on manufacturer interviews and discussions with suppliers of equipment to the industry. The Department obtained typical equipment throughput and cost information directly from equipment suppliers and reconciled it with information provided by manufacturers. Furthermore, it obtained transformer design parameters that vary with efficiency level (e.g., core weight) from the engineering analysis and used them to estimate the equipment capacity increases associated with increasing efficiency. In the liquid-immersed superclass, TSLs 1, 2, D, C, and B would require only conventional electrical steels. In contrast, TSL6 would require all of the liquid-immersed designlines to convert to amorphous core technology. TSL5 would require three of the five liquidimmersed design lines (DL3–DL5) to convert to amorphous core technology. According to the LCC customer choice model, 95 percent of the design line 4 transformers purchased at TSL3 and TSL4 would likely be amorphous. Similarly, TSLA would likely trigger partial conversion to amorphous technology for both design line 4 (about 50 percent of transformers are amorphous)

12-16and design line 5 (about 85 percent of transformers are amorphous). During the interviews, manufacturers discussed several reasons why, though technologically feasible, amorphous material is, in their opinion, not a good technology option for regulatory consideration:
1. Possible difficulty of access to the technology, including very limited sourcing options,
2. Concerns over availability of amorphous-core material at quantities necessary to meet industry demand,
3. The high level of capital equipment investment required (and the stranding of existing assets, particularly core-cutting equipment and annealing furnaces), and
4. Increased complexity associated with material processing and handling. The Department recognizes that the manufacturing process for amorphous core transformers is completely different from that for silicon steel transformers. TSL6 would renderobsolete a large portion of the liquid-immersed manufacturing equipment, primarily the corecutting equipment and the annealing furnaces. The Department estimates that the industry’s stranded assets at TSL6 would represent a loss of approximately $49 million. TSL5 would not render obsolete as much equipment as TSL6, because TSL5 would require conversion to amorphous core technology for only three of the five design lines. The Department estimates that the industry’s stranded assets at TSL5 would represent a loss of approximately $13 million. Similarly, the partial conversion to amorphous technology at TSLs 3, 4, and A would strand approximately $8.2 million, $8.2 million, and $3.5 million, respectively. The Department’s stranded asset estimates represent lower bounds to the book values of obsolete core-cutting equipment, annealing furnaces, and miscellaneous equipment such as conveyers, cranes, and other capital equipment at each TSL. The Department decided to conduct the MIA under a scenario where manufacturers would convert their facilities to produce amorphous core tra nsformers for TSLs where the DOE customer choice model indicated selection of amorphous core transformers in high volume. The Department is not explicitly evaluating the engineering scenario, which would imply, if modeled in the MIA, that employment would be shifted overseas to produce amorphous cores. During the manufacturer interviews, DOE learned that it was likely that many of the U.S. manufacturers would convert their facilities to produce amorphous cores if the standard required or otherwise triggered significant volumes of amorphous core transformer purchases - manufacturers indicated that production of cores is an important part of the value chain and would likely choose to continue to produce them. The Department believes that both transformer production costs and transformer pricing would be similar under the two scenarios. The difference between the two scenarios would affect only the allocation of the production costs. In the MIA, instead of manufacturers buying purchased cores (constructed with foreign labor), paying for trans-oceanic shipping, and lowering their labor costs, manufacturers would allocate costs differently by purchasing amorphous material and employing domestic labor to manufacture the amorphous cores. Since the decision a manufacturer makes between outsourcing amorphous core production

12-17and converting its facilities to produce amorphous core transformers depends on multiple competing factors, including the tradeoff between labor and trans-oceanic shipping costs, DOE believes that transformer production costs (and ultimately pricing) in the two production scenarios would be similar. It is not obvious whether manufacturers would purchase amorphous cores from abroad or produce them on-site (and manufacturers are not sure which path they would follow today) - this further implies that the cost difference between the two scenarios is likely not major. For these reasons, it is appropriate (in the MIA) to use the pricing information (based on purchased cores) together with appropriate conversion capital cost estimates. The Department recognizes that TSLs 3, 4, A, and 5 have the potential to severely distort and disturb both liquid-immersed product purchase decisions across desig n lines and manufacturers’ operations. These distortions would arise because some design lines would beconstructed with amorphous cores but some would still be designed with conventional grainoriented electrical steels (and for TSLs 3, 4, and A, some design lines might be constructed of both amorphous and silicon core steels). A significant burden, which is difficult to quantify using the GRIM, would be placed on industry if it had to maintain parallel manufacturing operations for both conventional and amorphous core technology. Based on the manufacturer interviews, TSLs 5 and 6 would cause liquid-immersed transformer manufacturers to decide whether they would tool for amorphous technology, attempt to purchase assembled amorphous cores, or exit the industry. Manufacturers indicated that those who chose to produce amorphous cores themselves would face a critical decision about whether or not to relocate outside of the U.S., since much of their equipment would become obsolete. This issue of foreign relocation also exists for TSLs 3, 4, and A, to a lesser extent. The additional conventional annealing furnace capacity that the industry would need at TSLs 1, 2, D, C, and B is directly related to the increase in wound core mass that would be processed by the industry at each TSL. The Department assumed that a typical, conventional annealing furnace that can process 6,000 tons of core steel per year has an installed cost of $2.3 million. Based on the engineering analysis and those designs selected by the LCC analysis customer choice model, the Department estimated increases in wound-core mass processed at TSLs 1, 2, D, C, and B to be three percent, two percent, one percent, seven percent, and six percent, respectively. Additional conventional annealing furnace capacity is not necessary at TSLs 3, 4, A, 5, and 6 because of the partial or complete conversion to amorphous steel. For TSL6, no additional conventional annealing furnace capacity would be necessary because all production would convert to amorphous core technology. For TSL5, no additional conventional annealing furnace capacity would be necessary because some of the annealing furnaces currently used for DL3–DL5 would become available for use in DL1–DL2. (This transfer of capacity is also accounted for in the Department’s stranded asset estimate above, to avoid overestimation of stranded assets.) Similarly, capacity could be transferred for TSLs 3, 4, and A as design line 4 (TSLs 3, 4, and A) and design line 5 (TSLA) are partially converted to amorphous technology. The Department estimated that conventional annealing furnace capital expenditures for the industry would be $4.5 million, $2.3 million, $2.3 million, and $6.8 million, and $4.5 million for TSLs 1, 2, D, C, and B, respectively, as shown in Table 12.4.1.

12-18Table 12.4.1 Summary of Liquid-Immersed Distribution Transformer Conventional Annealing Furnace Capital Expenditures Trial Standard Level

TSL1 TSL2 TSLD TSLC TSLB Additional Wound-Core Mass (Tons/yr) 6,306 4,162 2,635 12,064 10,167 Additional Annealing Furnaces Needed by Industry 2 1 1 3 2 Annealing Furnace Conversion Capital Expenditure (2006$, Millions) 4.5 2.3 2.3 6.8 4.5
The new amorphous annealing furnace capacity that the industry would need at TSLs 3, 4, A, 5, and 6 is directly related to the amorphous core mass that would be processed by the industry at each TSL. For the NOPR, based on information obtained from liquid-immersed transformer manufacturers and annealing furnace suppliers, the Department estimated that a typical amorphous annealing furnace, which can process 1,005 tons of core steel per year, has an installed cost of $0.54 million. In response to comments on the proposed rule, DOE subcontracted a consultant, Matrix Power, Inc., with expertise in amorphous core transformer materials, design, and production. Matrix Power reviewed the amorphous-related conversion capital expenditure estimates from the proposed rule and compared them to its own independent (previous) estimates.One change in the analysis that came about through this process was to model the amorphous annealing furnace capacity (i.e., oven capacity) as a conveyer-type system instead of the bell furnace system assumed for the proposed rule. The expert believes that the conveyer-type system would be more cost-effective and would likely be employed. The installed cost estimate for the final rule is $0.48 million for a 6,000 ton per year system. The Department estimated that amorphous annealing furnace capital expenditures for the industry would be $3.3 million, $3.3 million, $3.3 million, $7.6 million, and $22 million for TSLs 3, 4, A, 5, and 6, respectively, as shown in Table 12.4.2.

12-19Table 12.4.2 Summary of Liquid-Immersed Distribution Transformer Amorphous Annealing Furnace Capital Expenditures

Trial Standard Level

TSL3 TSL4 TSLA TSL5 TSL6 Amorphous Core Steel Mass (Tons/yr) 39,983 39,983 41,715 92,149 278,072 Amorphous Conveyer-Type Ovens Needed by Industry 7 7 7 16 47 Amorphous Conveyer-Type Ovens, Conversion Capital Expenditure (2006$, Millions) 3.3 3.3 3.3 7.6 22

TSLs 3, 4, A, and 5 do not require additional, conventional core-cutting machines because capacity can be transferred from the design lines that are converting to amorphous steel. TSL6 does not require additional, conventional core-cutting machines because all design lines would convert to amorphous steel. The Department assumed that the additional, conventional core-cutting equipment required by the industry for TSLs 1, 2, D, C, and B is directly related tothe increase in core weight at each TSL. Based on discussions with a leading supplier of woundcore-cutting equipment to the liquid-immersed superclass, the Department calculated the processing capacity of a distributed-gap core-winding machine. This equipment supplier estimated that a new machine can process 150 feet per minute (ft/min) of M6 core steel, whichtranslates into 2,510 pounds per hour (lbs/hr) of core steel. Allowing for set-up time, woundcore removal, and down-time, the Department applied a 75 percent utilization factor to this processing speed; as a result, DOE estimated that a single core-cutting machine would be capable of processing about 1,882 lbs/hr of core steel. Furthermore, the Department assumed that the core-cutting machines operate two shifts per day, 250 days per year. One of these core-cutting and winding machines costs approximately $0.21 million installed. DOE based its assumption—that the increase in conventional core-cutting capacity required at each of TSLs 1, 2, D, C, and B is best approximated using the increases in core weight at each TSL—on dialogue with the aforementioned leading equipment supplier. Standard core-cutting equipment used by liquid-immersed manufacturers operates at varying linear rates, depending on lamination thickness and strip width. The machines maintain approximately a constant processing throughput in terms of weight, irrespective of thickness and strip width. For each design line, the Department estimated the increases in core steel weight processed at each TSL using the engineering analysis and the designs selected by the LCC analysis customer choice model. Table 12.4.3 provides detail explaining the estimate of additional core-cutting machines needed at each TSL.

12-20Table 12.4.3 Summary of Additional Conventional Core-Cutting Machine Requirements for Liquid-Immersed Superclass

Design Line DL1 DL2 DL3 DL4 DL5 Additional CoreCutting Machines, Liquid-Immersed ApproximateNumber of CoreCutting Machines in Base Case 8.7 20.7 0.7 10.3 8.0 NA

Ratio of TSL1 Core Weight to Base Case Core Weight 0.980 1.032 1.028 1.094 1.045 2

Ratio of TSL2 Core Weight to Base Case Core Weight 0.980 1.026 0.997 1.033 1.059 2

Ratio of TSLD Core Weight to Base Case Core Weight 1.045 1.001 0.997 1.033 1.067 2

Ratio of TSLC Core Weight to Base Case Core Weight 1.067 1.089 1.005 1.033 1.067 4

Ratio of TSLB Core Weight to Base Case Core Weight 1.067 1.089 1.042 1.033 0.996 3 Notes: The Department used the above matrix to estimate the number of core-cutting machines required for TSLs 1, 2, D, C, and B. The additional machines (above the 49 machines required for the base case) are obtained by difference. For example, at TSL1: (0.98×8.7) + (1.032×20.7) + (1.028×0.7) + (1.094×10.3) + (1.045×8.0) - 48.3 = 2 machines (rounded up). TSLs 3, 4, A, and 5 do not require additional core-cutting machines because capacity can be transferred from the de sign lines tha t are co nverting to am orp hous steel. T SL6 doe s not require add itional, conventio nal co re-cutting machines b ecau se all de sign lines w ould conv ert to am orp hous steel. The Department estimated that core-cutting equipment capital expenditures for the superclass would be $0.4 million, $0.4 million, $0.4 million, $0.8 million, and $0.6 million for TSLs 1, 2, D, C, and B, respectively. These capital outlays are relatively small compared to those the industry would incur to expand annealing furnace capacity. The core-cutting equipment estimates are summarized in Table 12.4.4.

12-21Table 12.4.4 Summary of Liquid-Immersed Distribution Transformer Conventional Core-Cutting Equipment Capital Expenditures Trial Standard Level TSL1 TSL2 TSLD TSLC TSLB Additional Core-Cutting Machines Needed by Industry 2 2 2 4 3 Core-Cutting Conversion Capital Expenditure (2006$, Millions) 0.4 0.4 0.4 0.8 0.6
The Department estimated the amorphous core-cutting capacity at TSLs 3, 4, A, 5, and 6 based on the total weight of amorphous core steel projected to be processed at each TSL. Based on discussions with amorphous core-cutting equipment suppliers and transformer manufacturers, the Department estimated that a typical amorphous core-cutting machine can process 1,250 lbs/hr of core steel. The Department applied a 75 percent utilization factor to this processing speed; as a result, DOE estimated that a single core-cutting machine would be capable of processing about 938 lbs/hr of core steel. Furthermore, the Department assumed that the core-cutting machines would operate two shifts per day, 250 days per year. For the proposed rule, DOE assumed that one of these amorphous core-cutting machines costs approximately $0.50 million installed. Based on information provided by an expert in amorphous core transformers (Matrix Power, Inc.), DOE revised this estimate upwards to $0.59 million. The Department estimated that amorphous core-cutting equipment capital expenditures for the superclass would be $13 million, $13 million, $14 million, $30 million, and $89 million for TSLs 3, 4, A, 5, and 6, respectively. The amorphous core-cutting equipment estimates are summarized in Table 12.4.5.Table 12.4.5	Summary of Liquid-Immersed Distribution Transformer Amorphous CoreCutting Equipment Capital Expenditures

Trial Standard Level TSL3 TSL4 TSLA TSL5 TSL6Number of Amorphous CoreCutting Machines Needed by Industry 22 22 23 50 149
Amorphous Core-Cutting Conversion Capital Expenditure (2006$, Millions) 13 13 14 30 89
The Department estimated miscellaneous capital investments, primarily buildings and coil-winding equipment, based on a multiplier approach. With respect to buildings, the manufacturers indicated that additional building space will be necessary in some cases to accommodate expanded annealing furnace capacity. With respect to coil winding equipment, the

12-22Department understands that, as transformers become more energy efficient, manufacturers may switch from winding coils with aluminum conductor to winding coils with copper. Copper has a higher conductivity, allowing for smaller cross-sectional areas and transformer cores. However, copper requires more torque when winding to ensure the same winding quality. The higher torque can be met by slowing existing machines or winding fewer coils simultaneously. In both scenarios, additional coil-winding capacity is required. In order to estimate the total conversion capital investments for TSLs 1, 2, D, C, B, 3, 4, and A, including those required for buildings and coil-winding equipment, the Department applied a multiplier of 1.05 to the sum of the explicitly estimated core-cutting and annealing furnace capital expenditures. It based the 1.05 multiplier on information submitted by industry. For TSL6, before applying a multiplier to the explicitly estimated amorphous core-cutting and annealing furnace capital expenditures, the Department estimated the costs required for the portion of the liquid-immersed industry that uses shell designs to convert to using core form designs (affects design lines 1 and 2). For TSL5, since design lines 1 and 2 would not have to convert to amorphous core technology, the costs of converting to core form designs would be zero. For TSL6, the Department estimated the costs of converting the liquid-immersed industry fully to core form designs to be $49 million. This estimate included $6 million for lacing tables and $43 million for coil-winding equipment. After adding these costs of converting to core form designs to the previously tabulated amorphous core-cutting and annealing furnace estimates, the Department applied an assumed multiplier of 1.11 at TSL6 to account for miscellaneous capital costs. This same multiplier is also assumed for TSL5. In the analysis for the proposed rule, DOE had assumed a multiplier of 1.2 - this multiplier has been reduced based on information provided by Matrix Power. The total conversion capital expenditures for the liquid-immersed superclass are summarized in Table 12.4.6. As a resu lt of revisions to the cost assumptions for conversion to amorphous core transformer production, the total conversion capital expenditures for TSLs 5 and 6 are about half of those presented in the proposed rule analysis. These revisions are responsive to stakeholder comments and are based on information provided by Matrix Power.

12-23Table 12.4.6 Summary of Liquid-Immersed Distribution Transformer Conversion Capital Expenditures

Trial Standard Level
TSL1 TSL2 TSL D TSL C TSLB TSL3 TSL4 TSL A TSL5 TSL6
Annealing Furnace Conversion Capital 4.5 2.3 2.3 6.8 4.5 3.3 3.3 3.3 7.6 22 Expenditure (2006$, M illions) Core-Cutting Conversion Capital 0.4 0.4 0.4 0.8 0.6 13 13 14 30 89 Expenditure (2006$, M illions) M iscellaneous incl. Buildings and Coil Winding Equipment 0.2 0.1 0.1 0.4 0.3 0.8 0.8 0.8 4.1 67*

Total Conversion Capital Expenditure (2006$, M illions) 5.2 2.8 2.8 8.0 5.4 17 17 18 41 178

*Includes $49 million to fully convert industry from she ll to core form d esigns.

12.4.2 Product Conversion Expenses Product conversion expenses include engineering, prototyping, testing, and marketing expenses incurred by a manufacturer as it prepares to come into compliance with a standard. The Department assumed that product conversion expenses for liquid-immersed transformer manufacturers at TSLs 3, 4, A, 5, and 6 will require total additional expenses equivalent to 100 percent of the industry’s R&D budget for three years. Since manufacturers already produce liquid-immersed transformers that would comply with TSLs 1, 2, D, C, and B, product conversion expenses are expected to be negligible for these TSLs. Product conversion expenses are summarized in Table 12.4.7.

12-24Table 12.4.7 Summary of Liquid-Immersed Distribution Transformer Product Conversion Expenses Trial Standard Level TSLs TSL3 TSL4 TSLA TSL5 TSL6 1, 2, D, C, B Basis Industry makes these designs today. Amount equivalent to 100% of industry R&D budget for 3 years.

Product Conversion 0 87 89 103 120 176 Expenses (2006$, Millions)

12.4.3 Industry Financial Impacts The Department used the GRIM and the inputs and assumptions described in the previous sections to produce indicators of financial impacts on the liquid-immersed distribution transformer superclass at each TSL. This document reports the results of the MIA using two key financial metrics: INPV and annual net cash flow to the industry.
12.4.3.1 Trial Standard Levels For the proposed rule, the Department developed six TSLs for the liquid-immersed distribution transformer superclass. TSL1 is the NEMA TP-1 standard. TSL6 represents the maximum TSL that is technologically feasible. TSLs 2 through 5 are bundles of various candidate standard levels as described in Chapter 10 (section 10.2.2.3) of this TSD. In addition, TSLs A, B, C, and D have been added for the final rule. TSL6 would require all liquid-immersed design lines to convert to amorphous core technology. TSL5 would require design lines 3 through 5 to convert to amorphous core technology. According to the LCC customer choice model, 95 percent of the design line 4 transformers purchased at TSL3 and TSL4 would likely be amorphous. Similarly, TSLA would likely trigger partial conversion to amorphous technology for both design line 4 (about 50 percent of transformers would be amorphous) and design line 5 (about 85 percent of transformers would be amorphous).
12.4.3.2 Impacts on Industry Net Present ValueThe INPV measures the industry value and was used in the MIA to compare the industrywide economic impacts of different TSLs. The INPV is different from the net present value (NPV) that the Department estimates for the whole U.S. economy. The INPV is the sum of all

12-25net cash flows discounted at the industry’s cost of capital, or discount rate. The Department used the GRIM to estimate cash flows between 2007 and 2038. In the MIA, the Department compared the INPV of the base case (no efficiency standard) to that of each TSL. The difference in INPV is an estimate of the economic impacts that implementing each particular TSL would have on the entire industry. To evaluate the range of cash-flow impacts on the industry, the Department constructed two MIA analyses based on the two markup scenarios discussed in section 12.3.7. In the first scenario, the gross margin percentage is held constant at all TSLs (and equal to the base case gross margin percentage). In the second scenario, DOE assumed that the industry could preserve its operating profit at all TSLs. Tables 12.4.8 and 12.4.9 provide the INPV estimates under the two scenarios.

Table 12.4.8 Changes in Liquid-Immersed Industry Net Present Value, Preservation-ofGross-Margin-Percentage Scenario
Units Trial Standard Level
Base Case 1 2 D C B 3 4 A 5 6

INPV 2006$, Millions 609 622 637 646 656 662 598 606 657 703 809
Change in INPV % - 2.1 4.6 6.0 7.7 8.8 (1.9) (0.5) 7.9 16 33

from Base Case 2006$, Millions - 13 28 37 47 53 (11) (2.9) 48 94 200

Table 12.4.9 Changes in Liquid-Immersed Industry Net Present Value, Preservation-ofOperating-Profit Scenario
Units Trial Standard Level
Base Case 1 2 D C B 3 4 A 5 6

INPV 2006$, Millions 609 590 587 577 562 558 509 497 440 357 33.3
Change in INPV % - (3.2) (3.7) (5.2) (7.7) (8.3) (17) (18) (28) (41) (95)

from Base Case 2006$, Millions - (19) (22) (32) (47) (51) (100) (112) (169) (252) (576)

12-26The results from the preservation-of-gross-margin-percentage scenario provide a more favorable projection than do the results from the preservation-of-operating-profit scenario. Industry value would generally increase (or not decrease significantly) if manufacturers could sustain their gross margin percentage as their production costs increase in response to a standard. However, as previously mentioned, the preservation-of-gross-margin-percentage assumption may be optimistic, particularly at higher TSLs. The preservation-of-operating-profit markup scenario provides a low bound for INPV under a standard. The decrease in industry value under this scenario comes from the inability of industry to fully recoup the capital investments required for standard compliance, including investments in working capital. The negative impacts on INPV are most pronounced at TSL5 and TSL6, which are the two TSLs that would require partial or full conversion of the industry to amorphous core technology.
12.4.3.3 Impacts on Annual Cash Flow While INPV is useful for evaluating the long-term effects of standards, short-term changes in net cash flow are also important and indicative of the impacts on industry during the years between final rule publication (2007) and the standard effective date (2010). For example, a large investment over a period of a few years could strain the industry’s access to capital. Consequently, the sharp drop in net cash flow might lead to additional borrowing; changes in leverage, interest coverage ratios, and/or bond ratings; and possibly increased concern among investors. Thus, a short-term disturbance can have long-term effects that the INPV cannot capture. To get an idea of the behavior of annual net cash flows, the Department reports the annual net or free cash flows from 2007 through 2023 for the different TSL levels. Figures 12.4.1 and 12.4.2 present the annual net cash flows for the base case and each of the TSLs evaluat ed for the two different markup scenarios.

Figure 12.4.1 Industry Net Cash Flow for Preservation-of-Gross-Margin-Percentage Scenario, Liquid-Immersed

12-2712-28Figure 12.4.2 Industry Net Cash Flow for Preservation-of-Operating-Profit Scenario, Liquid-Immersed
After final rule publication in 2007, cash flows are driven by the level of capital investments and product conversion expenses and the proportion of these investments spent every year. In addition, in the year of the standard (2010), a relatively large investment in working capital is required. The incremental investments in working capital are about $13 million (TSL1), $23 million (TSL2), $30 million (TSLD), $41 million (TSLC), $44 million (TSLB), $39 million (TSL3), $47 million (TSL4), $93 million (TSLA), $149 million (TSL5), and $334 million (TSL6) (with less than 10 percent variation at each TSL between markup scenarios). After final rule publication, industry cash flows begin to decline as industry uses its financial resources to prepare for the standard. In the year the standard becomes effective, new capital equipment goes into production. While the behavior of cash flows for each TSL varies between the two markup scenarios, there a re three observations that are common across the two scenarios. First, the net annual cash flows do not go negative for TSLs 1, 2, D, C, B, 3, and 4. Second, for TSLs C, B, 3, and 4, net annual cash flows dip by two-thirds or more in 2010, the year of standard implementation. The dip in cash flow in 2010 is due to a relatively large investment in working capital that would be required to finance increased inventories, accounts receivable, etc. Third, net annual cash flows go negative during the compliance period for TSLs A, 5, and 6.

12-2912.4.4 Other Impacts
12.4.4.1 Employment The Department estimated industry-wide labor expenditures based on the engineering analysis. Winding of the primary and secondary coils; cutting, forming, and annealing of the core; core assembly; testing; and packing of the completed transformer represent the bulk of the labor. The Department incorporated these assumptions into the GRIM, which projects labor expenditures annually. Labor expenditures are a function of the labor intensity of the product, the sales volume, and an implicit wage assumption that remains fixed in real terms over time. Table 12.4.10 provides the changes in labor measured as the change in labor expenditures for liquid-immersed transformers in 2010, the standard effective date, versus the base case. Table 12.4.10 Projected Change in Labor Expenditures, Liquid-Immersed (2010) Trial Standard Level TSL1 TSL2 TSLD TSLC TSLB TSL3 TSL4 TSLA TSL5 TSL6 5.4% 3.3% 3.1% 6.5% 6.6% 6.3% 6.4% 44% 18% 38%

Based on the GRIM and the assumption that 95 percent of liquid-immersed transformers sold in the U.S. are manufactured in the U.S., the Department estimated that ther e are 4,241 production employees in the U.S. liquid-immersed distribution transformer industry. This estimate excludes non-production workers and assumes a level annual production rate. In reality, including non-production workers and seasonal effects, the actual number of employees in the liquid-immersed superclass is higher. Due to the fact that labor content does not vary between the markup scenarios, projected labor expenditures are equivalent for both. Based on these results, DOE expects no significant discernable direct employment impacts among transformer manufacturers for TSLs 1, 2, D, C, B, 3, and 4, but potentially significant changes in employment for TSLA (44 percent increase), TSL5 (18 percent increase), and TSL6 (38 percent increase). These conclusions are independent of any conclusions regarding employment impacts from the broader U.S. economy, which are documented in Chapter 14 of this TSD. These conclusions also ignore the possible relocation of domestic employment to lower-labor-cost countries, such as Mexico. Also, for TSLs 3, 4, A, 5, and 6, this conclusion ignores the possibility of outsourcing amorphous core production to companies in other countries, such as India. Manufacturers expressed concern during the MIA interviews that establishing an energy conservation standard would ‘commoditize’ the distribution transformer market, making it easier for foreign manufacturers who specialize in low-cost mass production of one design to enter the U.S.market. Today's liquid-immersed market is characterized by total owning cost evaluation formulae and customer design requirements and specifications. U.S. manufacturers differentiate themselves in the market by employing rapid turn-around times and demonstrating responsiveness to their customer needs. According to some manufacturers, in Massachusetts where a State standard of NEMA TP-1 was passed for both liquid-immersed and dry-type

12-30transformers, several utilities have abandoned their evaluation formulae and simply orderedstandards-compliant transformers. In many cases, according to manufacturers, these standardscompliant units are less efficient than those that were purchased before the State standard took effect. In other words, according to manufacturers, there has been a backsliding in average efficiency in this market, and an associated ‘commoditization’ of the product offering which has opened the door to foreign competition. Industry fears this situation will worsen under a Federal standard. This concern was independently raised by several liquid-immersed manufacturers during the MIA interviews and represents a critical concern in the industry.
U.S.manufacturers believe that they could be affected by‘commoditization’ in several ways. Less efficient transformers are smaller and less costly; therefore, ‘commoditization’ could result in reduced capacity utilization and lower revenues. Increased competition from foreign manufacturers could result from U.S. manufacturers’ loss of competitive advantage, which today is derived from the flexibility of U.S. manufacturing processes and product customization capabilities. Finally, manufacturers believe they may have no alternative other than to relocate their facilities outside of the U.S. to compete on an equal basis with lower-labor-cost foreign producers. In essence, after an energy-conservation standard takes effect, manufacturers believe that the liquid-immersed distribution transformer industry will begin to more closely resemble today’s low-voltage, dry-type industry.
12.4.4.2 Production Capacity The Department believes that there are only minor production capacity implications for the standard at TSLs 1, 2, D, C, and B, a nd moderate implications at TSLs 3, 4, and A. According to the LCC customer choice model, 95 percent of the design line 4 transformers purchased at TSL3 and TSL4 would likely be amorphous. Similarly, TSLA would likely trigger partial conversion to amorphous technology for both design line 4 (about 50 percent of transformers would be amorphous) and design line 5 (about 85 percent of transformers would be amorphous). At TSL6, all liquid-immersed design lines would be required to convert to amorphous core technology. At TSL5, three design lines would be required to convert to amorphous core designs. Conversion to amorphous core designs would render obsolete a large portion of the equipment used in the liquid-immersed industry (e.g., annealing furnaces, and core-cutting and winding equipment). In summary, production capacity implications would be most severe at TSLs 5 and 6 but there would be moderate implications at TSLs 3, 4, and A.
12.4.4.3 Exports Domestic manufacturers produce and export liquid-immersed transformers around the world. Due to the inherent manufacturing flexibility built into their production lines, manufacturers can readily retool and build export units (even 50 Hz fundamental frequency). Once the standard takes effect, transformer manufacturers would still be able to produce and export units that are below the Department’s minimum efficiency standard, since the standard only applies to transformers for use in the United States.

12-31During the MIA interviews, one manufacturer expressed concern that an existing volume discount enjoyed on a low-grade, grain-oriented steel that the manufacturer uses to build transformers for export may no longer be available if the Department’s standard drives the minimum efficiency to a point where M3 and M2 core steel become the primary steels used by the U.S. transformer industry. In this way, exported transformers that have lower-quality steel may become slightly more expensive and therefore less competitive globally. The Department recognizes this concern, but does not expect its impact to significantly degrade the existing export market.
12.4.4.4 Cumulative Regulatory Burden While any single regulation may not impose a significant burden on manufacturers, the combined effects of several reg ulations, existing or pending, may have serious consequences for some manufacturers, groups of manufacturers, or an entire industry. Assessing the impact of a single regulation may overlook this cumulative regulatory burden. Companies that produce a wider range of regulated products may be faced with more capital a nd product development expenditures than their competitors. This can prompt those companies to exit the market or reduce their product offerings, potentially reducing competition. Smaller companies can be especially impacted since they have lower sales volumes over which to amortize the costs of meeting new regulations. The Department considers that a proposed standard is not economically justified if it contributes to an unacceptable level of cumulative regulatory burden. The Department looked at three areas of regulatory burden: 1) Federal, 2) State, and 3) other regulations and standards.
1. Federal Regulations on Distribution Transformer Manufacturers - In a ddition to potential efficiency regulations on distribution transformers, the National Energy Code (NFPA 70) places additional restrictions on liquid-immersed transformers, requiring that indoor liquid-immersed transformers be located in separate transformer vaults. Furthermore, the code provides stipulations for fire walls, doors, ventilation, and oil containment, increasing the installed cost of these types of transformers. The impetus for this section of the National Energy Code is to prevent fires associated with flammable insulating fluids; however, this mandate applies to all indoor liquid-immersed transformers, including those containing non-flammable liquid products.
2. Regulations and Pending Regulations at the State Level - Manufacturers also discussed the recent trend of State governme nts to implement NEMA TP-1 as a mandatory standard for transformers sold within State borders. At this time, the Department knows of one State that requires this minimum efficiency standard for liquid-immersed distribution transformers. These standards, when preempted by Federal energy-efficiency regulation, will not create a cumulative burden on domestic manufacturers.

12-323. Other Regulations and Standards - Manufacturers were not awa re of other regulations or standards, in effect or pending, which affect liquid-immersed distribution transformers.

12.4.4.5 Impacts on Small Businesses The SBA defines a small business, for the distribution transformer industry, as a business that has 750 or fewer employees. The Department estimated that, of the approximately 25 U.S. manufacturers that make liquid-immersed distribution transformers, about 15 of them are small businesses. About one-third of the small businesses have fewer than 100 employees. Because the liquid-immersed distribution transformer superclass largely produces customized transformers, small businesses can compete because each unique design is produced in relatively small volumes for a given order. Implementation of an energy-conservationstandard would have a relatively minor differential impact on small manufacturers of liquidimmersed distribution transformers. Disadvantages to small businesses, such as having littleleverage over suppliers (e.g., core steel suppliers), are present with or without an energyconservation standard.
12.4.4.6 Worker Safety During the interviews, manufacturers expressed concern for their workers, who handle heavy mate rial and equipment on a daily basis while producing transformers. For manufacturing industries like those that produce distribution transformers, the Occupational Safety and Health Administration (OSHA) established a maximum handling weight of 70 pounds per worker. As transformers become larger and more energy efficient, the core material will get heavier, coils will become heavier, and tanks and enclosures will increase in size. Bearing this in mind, plant managers are concerned about the fact that, as weights increase, so do accident frequencies.
12.4.4.7 Other Engineering Issues Manufacturers are concerned that the dimensionally constrained transformers they produce today may be difficult or perhaps impossible to build to meet standards. For example, for round-tank, liquid-immersed transformers (design line 3), they indicated that going above TSL3 would be problematic due to the size of the transformer exceeding the capacity of the industry-standard, pole-mounting brackets. According to manufacturers, these transformers hit their maximum height at TSL2 (between the power lines overhead and the telephone and cable lines underneath), and thus all size expansion at higher TSLs is in the diameter of the tank. Approximately 80 percent of overhead transformers sold are for replacement installations, so this issue of a pre-existing space limit will cause problems for utilities and may increase outage times. Manufacturers also expressed concern over a second dimensionally constrained liquidimmersed transformer—subsurface re trofit transformers. These liquid-immersed units are designed to be installed within an existing concrete vault to service an underground distribution

12-33network. If the efficiency standard is significantly different from the levels being built today, it may require substantial (extremely expensive) rework of these vaults, increasing downtime or stress on the local distribution network while a failed unit is replaced.
12.4.5 Summary of Impacts for Liquid-Immersed Superclass The electric utility industry appears to be making mostly evaluated transformer purchase decisions. However, in the State that has adopted an energy-conservation standard for liquidimmersed distribution transformers (Massachusetts), the average efficiency of the purchased transformers is reported by manufacturers to be in decline. The explanation for this counterintuitive trend, as reported by several manufacturers, is that after the efficiency standards were implemented, electric utilities abandoned their evaluation formulae and simply have purchased the least-expensive standards-compliant transformers. This backsliding may result in ‘commoditization’ of liquid-immersed transformers, ultimately making it easier for foreign competition to compete in the U.S. liquid-immersed market. Manufacturers fear that this situation may worsen under a Federal standard. TSL6 would require all liquid-immersed design lines to convert to amorphous core technology. TSL5 would require three of the five liquid-immersed design lines to convert to amorphous core technology. Since the manufacturing process for amorphous core transformers is completely different from that for conventional transformers, TSLs 5 and 6 would obsolete a significant portion of U.S. industry’s equipment. The Department estimated the stranded assets for TSL5 and TSL6 to be $13 million and $49 million, respectively. In addition, manufacturers detailed many technical reasons why amorphous core material is difficult and potentially hazardous for workers. TSLs 3, 4, and A can be met without using amorphous core technology, but the LCC customer choice model indicates that partial conversion to amorphous core technology would likely occur at these TSLs. For TSLs 3 and 4, DOE expects that about 95 percent of the design line 4 transformers would likely be amorphous core transformers. For TSLA, DOE expects that about 50 percent and 85 percent of the design line 4 and design line 5 transformers, respectively, would likely be amorphous core transformers. DOE estimated the stranded assets for TSLs 3, 4, and A to be $8.2 million, $8.2 million, and $3.5 million, respectively. Conversion capital expenditures in the liquid-immersed distribution transformer superclass include expanded annealing furnace capacity, additional core-cutting equipment, coilwinding equipment, and building construction. The need for additional annealing furnace capacity and core-cutting equipment is driven by the increase in core weights that would be experienced at higher TSLs. For TSLs 1, 2, D, C, and B, which would be met exclusively with silicon core steel, expanded annealing furnace capacity represents the majority of the conversion capital expenditures. For TSLs 3, 4, A, 5, and 6 which would trigger or require partial or complete conversion to amorphous core technology, core-cutting equipment represents the majority of the conversion capital expenditures. Conversion capital expenditures would be relatively modest for TSLs 1, 2, D, C, B, 3, 4, and A, ranging from $2.8 million to $18 million in an industry with projected revenue of $1.5 billion in 2007. For TSLs 5 and 6, the conversion

12-34capital expenditures would be substantially higher. DOE estimated that conversion capital expenditures would be $41 million and $178 million for TSL5 and TSL6, respectively. While large relative to the other TSLs, these estimates for TSL5 and TSL6 are about half of those presented in the proposed rule TSD - DOE revised these estimates based upon guidance from an expert in amorphous core transformer materials, design, and production (Matrix Power). The industry would experience negligible product conversion expenses for TSLs 1, 2, D, C, and B because all products meeting these efficiency levels would be constructed of silicon core steel and are widely available today. Product conversion expenses would be substantially higher for TSLs 3, 4, A, 5, and 6, which are the standard levels that would trigger or require partial or full conversion to amorphous core technology. The Department estimated the corresponding product conversion expenses to be $87 million, $89 million, $103 million, $120 million, and $176 million, respectively. The impact on INPV at TSL6 ranges between -95 percent and +33 percent, depending on the assumed markup scenario. There is a great deal of uncertainty in these impact estimates, primarily due to uncertainty around transformer pricing at high TSLs. At TSL6, the magnitude of the peak negative net annual cash flow would be more than four times that of the positive base case cash flow. The impact on INPV at TSL5 ranges between -41 percent and +16 percent, depending on the assumed markup scenario. There is a great deal of uncertainty in these impact estimates, primarily due to uncertainty around transformer pricing at high TSLs. At TSL5, the magnitude of the peak negative net annual cash flow would be about 50 percent higher than that of the positive base case cash flow. The 2010 impacts would largely be driven by the need to invest in working capital. A significant burden, which is difficult to quantify using the GRIM, would be placed on industry if it was required to maintain parallel manufacturing operations for both conventional and amorphous core technology under TSL5. The impact on INPV at TSLA ranges between -28 percent and +7.9 percent, depending on which markup scenario is assumed. At TSLA, the magnitude of the peak negative net annual cash flow would be about 60 percent of the positive base case cash flow. The 2010 impacts would largely be driven by the need to invest in working capital. A significant burden, which is difficult to quantify using the GRIM, would be placed on industry if it maintained parallel manufacturing operations for both conventional and amorphous core technology under TSLA. The impact on INPV at TSL4 ranges between -18 percent and -0.5 percent, depending on which markup scenario is assumed. The impact on annual net cash flow would be significant at TSL4, bringing net cash flow nearly to zero in 2010 in a low markup scenario. A significant burden, which is difficult to quantify using the GRIM, would be placed on industry if it maintained parallel manufacturing operations for both conventional and amorphous core technology under TSL4. The impact on INPV at TSL3 ranges between -17 percent and -1.9 percent, depending on which markup scenario is assumed. The impact on annual net cash flow would be significant at

12-35TSL3, bringing net cash flow under a low markup scenario to about 20 percent of its magnitude in the base case in 2010. A significant burden, which is difficult to quantify using the GRIM, would be placed on industry if it maintained parallel manufacturing operations for both conventional and amorphous core technology under TSL3. The impact on INPV at TSLB ranges between -8.3 percent and +8.8 percent, depending on which markup scenario is assumed. The impact on annual net cash flow would be significant at TSLB, bringing net cash flow nearly to zero under a low markup scenario in 2010. The impact on INPV at TSLC ranges between -7.7 percent and +7.7 percent, depending on which markup scenario is assumed. The impact on annual net cash flow would be significant at TSLC, bringing net cash flow under a low markup scenario to about 15 percent of its magnitude in the base case in 2010. The impact on INPV at TSLD ranges between -5.2 percent and +6.0 percent, depending on which markup scenario is assumed. The impact on annual net cash flow would be moderate at TSLD, bringing net cash flow under a low markup scenario to about 40 percent of its magnitude in the base case in 2010. At TSL2, the impact on INPV ranges between -3.7 percent and +4.6 percent. The impact on annual net cash flow would be small to moderate. At TSL1, the impact on INPV ranges between -3.2 percent and +2.1 percent. The impact on annua l net cash flow would be negligible to small. Finally, there are several additional factors to be considered from the standpoint of manufacturers in selecting the proposed sta ndard:
1. If the liquid-immersed standard is high relative to the standard for medium-voltage, dry-ty pe transformers, there could be a switch to medium-voltage, dry-type transformers for certain products where there is substitutability between the superclasses. For reasons related to the properties inherent in their operation, for equivalent kVA ratings and TSLs, the efficiency levels of medium-voltage, dry-type transformers are lower than those of liquid-immersed transformers.
2. If the standard is set above a certain level, some customers may look for loop-holes in the Department’s definition of a distribution transformer throughwhich they can circumvent the standard. If a speciality or niche application transformer exempted from standards is less expensive than a standards-compliant distribution transformer, these customers may purchase a standards-exempt transformer that is also capable of serving a distribution function.
3. Several manufacturers expressed concern about enforcement. Many manufacturers urged the Department to make enfor cement a top priority to ensure an effective standard.

12-364. At TSL2 and higher, certain liquid-immersed designs that incorporate less-flammable cooling fluids (also called ‘high fire-point’ fluids) may become uncompetitive. Thesetransformers incorporate a substitute fluid to cool the core-coil assembly, but is lessflammable than mineral oil, enabling the transformers to be used indoors. Designs using less-flammable cooling fluids that were cost-optimized around NEMA TP 1, may become uncompetitive at higher efficiency levels.
5. Differential impacts on small businesses do not appear to be important for the liquidimmersed distribution transformer superclass.
6. Manufacturers mentioned maximum practical efficiencies based on dimensional, weight, and other practical limitations. The practical maxima reported to the Department fell in the range of 99.4 to 99.5 percent for liquid-immersed transformers.
7. Manufacturers relayed concerns about utility capital budgets. If standards go above a certain level, the capital budgets for distribution transformers might not be able to accommodate the transformer price increases, thereby creating downward pressure on manufacturer profit margins.

12-3712.5 MANUFACTURER IMPACT ANALYSIS - MEDIUM-VOLTAGE, DRY-TYPE The medium-voltage, dry-type transformer market is characterized by large commercial and industrial users, some of which evaluate and are concerned about losses when making transformer purchase decisions. This superclass has substantially lower shipments and revenue than the liquid-immersed superclass. In recent years, there has been some consolidation in the medium-voltage, dry-type industry, with a medium-voltage, dry-type production facility closing in North Carolina, and the associated business being taken over by a competitor in Virginia. The Department estimated that there are approxima tely 25 companies active in the medium-voltage, dry-type market in the United States. Of these, the seven largest companies retailing medium-voltage, dry-type distribution transformers are (in alphabetical order): ABB, Federal Pacific, General Electric, Hammond, MGM, Olsun, and Square D. Of the twodistribution transformer superclasses covered by DOE’s rulemaking, the medium-voltage, drytype superclass is the more concentrated; The top three companies manufacture over 75 percent of all transformers in this superclass. For moreinformation on the transformer market in general, and medium-voltage, dry-type transformers in particular, see the market and technology assessment (Chapter 3).
12.5.1 Conversion Capital Expenditures Through its MIA interviews, the Department gained an understanding of the conversion capital e xpenditures that medium-voltage, dry-type transformer manufacturers would have to make in response to a standard. These are: 1) investments in additional core-cutting equipment capable of making mitered cuts, and 2) investments in miscellaneous tooling and equipment, including equipment used for conductor winding. Core-cutting equipment capable of making mitered cuts is a key component of the medium-voltage, dry-type analysis. Mitered andcruciform core construction techniques are often used to reduce no-load losses in mediumvoltage, dry-type transformers. Mitered joints have lower destruction factors and are more efficient than butt-lap joints. Reviewing the shipments analysis, the Department estimated that the equivalent of five full-time, mitered, core-cutting machines are currently being used by the medium-voltage, drytype industry. The Department estimates that about 85 percent of the medium-voltage, dry-type transformersproduced today have mitered cores. At TSL1, the Department assumed that 95 percent of the medium-voltage, dry-type transformers would be manufactured using mitered cores. At TSL2 and above, the Department assumed that 100 percent of the medium-voltage, dry-type transformers would be manufactured using core-cutting equipment capable of making mitered cuts. The Department provided a few core designs from the medium-voltage, dry-type engineering database to the primary supplier of core-cutting equipment. This equipment manufacturer then prepared processing time estimates based on the core dimensions. The manufacturer’s assumptions are applicable for processing M6 core steel in batches of one. The assumption of single-unit batches is appropriate for the medium-voltage, dry-type superclass

12-38because there is often a high degree of customization associated with customer orders. Based on the core-cutting equipment manufacturer’s processing time estimates, the Department derived the following production assumptions: For design lines 9–13, the number of cores produced per machine per year are estimated to be 1,400; 700; 1,400; 700; and 525, respectively. A representative core-mitering machine is projected to cost the medium-voltage, dry-type distribution transformer industry about $2.47 million installed, plus $0.31 million for expanded building capacity. Because of the large amount of core steel that needs to be processed for a typical medium-voltage, dry-type transformer, and the increased cutting requirements at higher efficiency due to greater stack height (or piece length) and thinner laminations, industry indicated that additional core-stacking equipment would be necessary to optimize production at higher TSLs. The Department recognizes the potential for this automatic core-stacking machine expenditure and accounted for it by assuming that the core-mitering equipment purchased by themedium-voltage, dry-type industry would include automatic core-stacking capability. Coremitering equipment in the medium-voltage, dry-type industry typically includes such corestacking capability. At TSL1 and higher, the processing time per core is higher than for the base case, increasing the number of mitered-core cutting machines required by the superclass. The processing time per core increases for two reasons: 1) More core-cutting time is required as core size increases with higher efficiencies, and 2) the processing time increases in inverse proportion to lamination thickness, and more efficient grades of steel typically are thinner (e.g., lamination thickness changes from 0.011" for M4 to 0.009" for M3, representing a 22-percent increase in core-mitering time for M3). Some manufacturers report that their core-mitering equipment operates poorly with thinner steels, which would require them to operate at lower speeds, exacerbating the capacity impacts. The Department based its estimates of the core size increases and lamination thickness changes on the engineering analysis. It accounted for these two factors in estimating the increases in core-mitering equipment required at each TSL. Table 12.5.1 shows an example calculation for the core-mitering capacity multiplier at each TSL for design line 9, not accounting for the fraction of transformers that are mitered at each TSL.

12-39Table 12.5.1 Calculation of Core-Mitering Capacity Multiplier for Design Line 9 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Typical Core Weight (lbs) 1,226 1,191 1,216 1,234 1,269 1,585 Typical Stack Height (in.) 6.83 6.80 7.19 7.80 8.32 10.21 Typical Lamination Thickness (in.) 0.0115 0.0107 0.0099 0.0090 0.0090 0.0090
Typical Number of Laminations per Inch (in-1) 87.0 93.2 101 111 111 111
*M ultiplier for Increased Core-M itering Capacity 1.00 1.07 1.22 1.46 1.55 1.94

*For TSL1

–TSL4, the multiplier is based on the ratios of stack heights and number of laminations per inch, normalized to the base case. For example, at T SL3, the multiplier is calculated as (7.80/6.83)×(111/87.0) = 1.46. For TSL5 and TSL6, the multiplier is based on the ratios of core weight and number of laminations per inch, normalized to TSL4. At TSL5 and TSL6, the multiplier is calculated as (1,585/1,269)×(111/111)×1.55 = 1.94. The multiplier at TSL5 and TSL6 is calculated differently because, for some medium-voltage, dry-type design lines, particularly DL12 which is high-volume and therefore critical for the analysis, the designs in the engineering database involve longer pieces of core steel above TSL4 and therefore the required increased cutting time is better captured through core weight increases than through stack height increases (in the Department's engineering analysis stack height increases are not significant for DL12 above TSL4). After speaking with the primary supplier of core-mitering equipment and reviewing equipment performance curves, the Department confirmed the assumption that core steel piece length (and consequently weight when stack height and piece width are relatively fixed) is an important determinant of mitering time. Base case 2010 unit shipments projections for DL9 through DL13 are 293, 553, 350, 2,633, and 238, respectively (note: the single-phase shipments are divided by three to achieve approximate mass equivalence with the three-phase units). Using these shipments projections, the assumed core production rates per core-mitering machine for each design line (discussed above), and the multipliers for increased core-mitering capacity, the Department estimated the number of core-mitering machines needed at each TSL. Table 12.5.2 through Table 12.5.6 provide the calculations for the estimated number of core-mitering machines needed at each TSL for DL9 through DL13, respectively.

12-40Table 12.5.2 Calculation of Core-Mitering Machines Needed for Design Line 9 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.07 1.22 1.46 1.55 1.94
Number of Core-Mitering Machines if all Transformers are Mitered 0.21* 0.22 0.26 0.30 0.33 0.41

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.18 0.21 0.26 0.30 0.33 0.41

*(293 units shipped)/(1,400 units per machine per year) = 0.21 core mitering machines Table 12.5.3 Calculation of Core-Mitering Machines Needed for Design Line 10 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.03 1.20 1.36 1.40 2.00
Number of Core-Mitering Machines if all Transformers are Mitered 0.79* 0.81 0.95 1.07 1.10 1.58

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.67 0.77 0.95 1.07 1.10 1.58

*(553 units shipped)/(700 units per machine per year) = 0.79 core mitering machines

12-41Table 12.5.4 Calculation of Core-Mitering Machines Needed for Design Line 11 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.32 1.35 1.43 1.38 1.61
Number of Core-Mitering Machines if all Transformers are Mitered 0.25* 0.33 0.34 0.36 0.34 0.40

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.21 0.31 0.34 0.36 0.34 0.40

*(350 units shipped)/(1,400 units per machine per year) = 0.25 core mitering machines Table 12.5.5 Calculation of Core-Mitering Machines Needed for Design Line 12 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.02 1.19 1.23 1.25 1.69
Number of Core-Mitering Machines if all Transformers are Mitered 3.76* 3.82 4.47 4.63 4.71 6.34

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 3.20 3.63 4.47 4.63 4.71 6.34

*(2,633 units shipped)/(700 units per machine per year) = 3.76 core mitering machines

12-42Table 12.5.6 Calculation of Core-Mitering Machines Needed for Design Line 13 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.00 1.14 1.27 1.27 1.84
Number of Core-Mitering Machines if all Transformers are Mitered 0.45* 0.45 0.52 0.57 0.83 0.83

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.38 0.43 0.52 0.57 0.58 0.83

*(238 units shipped)/(525 units per machine per year) = 0.45 core mitering machinesBased on the assumption that each core-mitering machine for the medium-voltage, drytype industry would cost $2.78 million installed (including $0.31 million for the building adder), the Department estimated that core-mitering equipment capital expenditures for the industry would be $2.0 million, $5.2 million, $6.4 million, $6.7 million, $13.7 million, and $13.7 million for TSL1 through TSL6, respectively. The core-cutting equipment estimates are summarized in Table 12.5.7.

Table 12.5.7 Summary of MV, Dry-Type Distribution Transformer Core-Cutting Equipment Capital Expenditures Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Mitered Core-Cutting M achines Needed by Industry 4.6 5.4 6.5 6.9 7.1 9.6
Incremental Mitered Core-Cutting Machines Needed by Industry - 0.7 1.9 2.3 2.4 4.9
Core-Mitering Conversion Capital Expenditure (2006$, M illions) - 2.0 5.2 6.4 6.7 13.7 The Department estimated total conversion capital expenditures, including capital investments for additional miscellaneous equipment such as coil-winding equipment, based on multipliers applied to the core-cutting equipment capital investment. Based on information submitted by industry, DOE estimated this multiplier was estimated to be 1.06. The conversion capital expenditures are summarized in Table 12.5.8.

12-43Table 12.5.8 Summary of MV, Dry-Type Distribution Transformer Conversion Capital Expenditures Trial Standard Level TSL1 TSL2 TSL3 TSL4 TSL5/6 Core-Cutting Conversion Capital Expe nditure (200 6$, M illions) 2.0 5.2 6.4 6.7 13.7
M ultiplier for M iscellaneous Tooling Including Coil Winding Equipment 1.06
Total Conversion Capital Expenditure (200 6$, M illions) 2.1 5.5 6.8 7.1 15

12.5.2 Product Conversion Expenses Product conversion expenses include engineering, prototyping, testing, and marketing expenses incurred by a manufacturer as it prepares to come into compliance with a standard. The Department assumed that product conversion expenses for medium-voltage, dry-type transformer manufacturers at TSLs 3 through 6 will require total additional expenses equivalent to 100 percent of the industry’s R&D budget for three years. At TSL3 and above, manufacturers indicated that R&D engineers would be fully utilized (both electrical and mechanical engineers), as would production design engineers and mechanical drafters, during the conversion and compliance period. Since manufacturers already produce relatively large volumes of transformers that would comply with TSL1 and TSL2, product conversion expenses are expected to be negligible for these lower TSLs. Product conversion expenses are summarized in Table 12.5.9. Table 12.5.9	Summary of MV, Dry-Type Distribution Transformer Product Conversion Expenses Trial Standard Level TSL1-2 TSL3 TSL4 TSL5/6
Ba sis Industry makes relatively large volumes of these transformers today. Amount equal to 100% of industry R&D budget for 3 years. Amount equal to 100% of industry R&D budget for 3 years. Amount equal to 100% of industry R&D budget for 3 years.

Product Conversion Expe nses 0 3.7 4.1 5.8 (2004$, M illions)

12-4412.5.3 Industry Financial Impacts Using the inputs and assumptions described in the previous sections, the GRIM produced indicators of financial impacts on the medium-voltage, dry -type distribution transformer industry at each TSL. This document reports the results of the MIA using two key financial metrics: INPV and annual net cash flow to the industry.
12.5.3.1 Trial Standard Levels The Department developed six TSLs for medium-voltage, dry-type distribution transformers. TSL1 is the NEMA TP-1 standard. TSL6 represents the maximum TSL that is technologically feasible. TSL5 is the highest TSL that yields national NPV greater than zero (level set based on proposed rule analysis). For dry-type transformers, TSL5 and TSL6 are the same. TSL4 results in the maximum LCC savings (for proposed rule analysis). TSL2 and TSL3 are spaced equally between TSL1 and TSL4.
12.5.3.2 Impacts on Industry Net Present ValueThe INPV measures the industry value; DOE used it in the MIA to compare the industrywide economic impacts of different TSLs. The INPV is different from the NPV that DOE applied to the whole U.S. economy. The INPV is the sum of all net cash flows discounted at the industry’s cost of capital, or discount rate. The GRIM estimated cash flows between 2007 and 2038. In the MIA, the Department compared the INPV of the base case (no efficiency standard) to that of each TSL. The difference in INPV is an estimate of the economic impacts that implementing each particular TSL would have on the entire industry. To evaluate the range of cash-flow impacts on the industry, the Department constructed two MIA analyses based on the two markup scenarios discussed above. In the first scenario, the gross margin percentage is held constant at all TSLs (and equal to the base case). In the second scenario, it is assumed that the industry could preserve its operating profit at all TSLs. Tables 12.5.10 and 12.5.11 provide the net present value estimates for the industry under the two scenarios.

12-45Table 12.5.10 Changes in MV, Dry-Type Industry Net Present Value, Preservation-ofGross-Margin-Percentage Scenario Units Trial Standard Level Base Case 1 2 3 4 5/6
INPV 2006$, Millions 36 35 33 31 33 37 Change in INPV from Base Case %

- (3.1) (8.9) (14.5) (8.9) 2.5 2006$, Millions

- (1.1) (3.2) (5.2) (3.2) 0.9

Table 12.5.11 Changes in MV, Dry-Type Industry Net Present Value, Preservation-ofOperating-Profit Scenario Units Trial Standard Level Base Case 1 2 3 4 5/6
INPV 2006$, Millions 36 34 31 27 25 12 Change in INPV from Base Case %

- (5.9) (15) (25) (29) (67) 2006$, Millions

- (2.1) (5.2) (8.8) (11) (24) The results from the preservation-of-gross-margin-percentage scenario provide a more favorable projection than do the results from the prese rvation-of-operating-profit scenario. Industry value would not decrease as much if manufacturers could sustain a constant gross margin percentage as their production costs increase in response to a standard. However, as previously mentioned, the preservation-of-gross-margin-percentage assumption may be optimistic. In this scenario, impacts above TSL3 decline with increasing TSL, because the incremental conversion costs above TSL3 are small relative to the revenue gains under the preservation-of-gross-margin-percentage scenario. The preservation-of-operating-profit scenario provides a lower bound for INPV under a standard. The decrease in industry value under both scenarios comes from the inability of industry to fully recoup the capital investments required for standard compliance, including investments in working capital.
12.5.3.3 Impacts on Annual Cash Flow While INPV is useful for evaluating the long-term effects of standards, short-term changes in net cash flow are also important and indicative of the impacts on industry during the years between final rule publication (2007) and the effective date of the standard (2010). For example, a large investment over a period of a few years could strain the industry’s access to capital. Consequently, the sharp drop in net cash flow might lead to additional borrowing;

12-46changes in leverage, interest coverage ratios, and/or bond ratings; and possibly increased concern among investors. Thus, a short-term disturbance can have long-term effects that the INPV cannot capture. To get an idea of the behavior of annual net cash flows, the Department reports the annual net or free cash flows from 2007 through 2023 for the different TSL levels. Figures 12.5.1 and 12.5.2 present the annual net cash flows for the base case and each of the six TSLs evaluated for the two different markup sce narios.

Figure 12.5.1 Industry Net Cash Flow for Preservation-of-Gross-Margin-Percentage Scenario, MV, Dry-type

12-47Figure 12.5.2 Industry Net Cash Flow for Preservation-of-Operating-Profit Scenario, MV, Dry-type
After final rule publication, cash flows are driven by the level of capital investments and the proportion of these investments spent every year. In addition, in the year of the standard, investment in working capital is required. The incremental investments in working capital are about $0.30 million, $0.68 million, $1.2 million, $2.4 million, $7.9 million, and $7.9 million for TSL1 through TSL6, respectively (with less than 10 percent variation at each TSL between markup scenarios). These investments in working capital are relatively insignificant, except those at TSLs 4, 5, and 6. After final rule publication, industry cash flows decline as industry uses its financial resources to prepare for the standard. In the year the standard becomes effective, new capital equipment goes into production. The Department assumed that no assets are stranded for the TSLs evaluated. While the behavior of cash flows for each TSL varies between the two markup scenarios, there a re two observations that are common across the two scenarios. First, the net annual cash flows go negative at TSL3 and above. Second, net annual cash flows go nearly to zero during the compliance period at TSL2 but not at TSL1.
12.5.4 Other Impacts
12.5.4.1 Employment The Department estimated industry-wide labor expenditures based on the engineering analysis. Winding of the primary and secondary coils, stacking and assembly of the core, enclosure manufacturing, testing, and packing of the completed transformer represent the bulk of the labor. The Department incorporated these assumptions into the GRIM, which projects labor expenditures annually. Labor expenditures are a function of the labor intensity of the product,

12-48the sales volume, and an implicit wage assumption that remains fixed over time. Table 12.5.12 provides the changes in labor measured as the change in labor expenditures for medium-voltage, dry-type transformers in 2010 (the standard effective date) versus the base case. Table 12.5.12 Projected Change in Labor Expenditures, MV, Dry-Type (2010) Trial Standard Level TSL1 TSL2 TSL3 TSL4 TSL5 & 6 3.0% -1.3% -1.9% -2.0% -1.4% Based on the GRIM and the assumption that 100 percent of medium-voltage, dry-type transformers sold in the U.S. are manufactured in the U.S., the Department estimated that there are currently 257 production employees in the U.S. medium-voltage, dry-type distribution transformer industry. The Department recognizes that this estimate is somewhat low, perhaps by 30 percent. This estimate excludes non-production workers and assumes a level annual production rate. In practice, including non-production workers and seasonal effects, the actual number of employees in the medium-voltage, dry-type superclass would be higher. Because labor content does not vary between the markup scenarios, projected labor expenditures are equivalent for both. Based on these results, DOE expects no significant discernable employment impacts among medium-voltage, dry-type transformer manufacturers for any TSL compared to the base case. Increased employment levels are not expected at higher TSLs because the Department assumed that the core-cutting equipment typically purchased by the medium-voltage, dry-type industry is highly automated and includes core-stacking equipment. This conclusion is independent of any conclusions regarding employment impacts from the broader U.S. economy. Another concern relayed by some manufacturers during the interviews is the potential impact from the competitiveness of cast-coil designs at higher TSLs. These manufacturers claim that setting a standard above a certain threshold may trigger a market switch from open-wound transformers to cast-coil transformers. Manufacturers suggested that this cross-over point likelyoccurs at TSL3 and higher. If the market does shift to cast-coil, there is a risk of imported prefabricated cast-coils dominating the market in the long term. This would have a significant effect on domestic industry value and domestic employment. Some manufacturers feel that regulation at any levelwill decrease the diversity of transformer designs, which will make it easier for foreign production to compete in the U.S. market. These manufacturers claim that designs may cluster around the standard, allowing foreign competition to produce large quantities of common-kVA-rated transformers at lower labor costs.
12.5.4.2 Production Capacity Energy conservation standards will impact the industry’s manufacturing capacity because the core stack heights (or core steel piece length) will increase and laminations will become thinner. Thinner laminations require more cuts and are more cumbersome to handle. Therefore,

12-49manufacturers would have to invest in additional core-mitering machinery or modifications and improvements to recover any losses in productivity, and these factors might also contribute to a need for more plant floor space. Because more-efficient transformers tend to be larger, this could also contribute to the need for additional floor space.
12.5.4.3 Exports Distribution transformer exports comprise a small fraction of distribution transformer sales. However, domestic manufacturers do sell to countries that do not currently require products to meet minimum efficiency requirements for distribution transformers. Since the medium-voltage, dry-type industry is largely a customized industry, the impact of a standard on U.S.exports will be minimal.
12.5.4.4 Cumulative Regulatory Burden While any single regulation may not impose a significant burden on manufacturers, the combined effects of several reg ulations, existing or pending, may have serious consequences for some manufacturers, groups of manufacturers, or an entire industry. Assessing the impact of a single regulation may overlook this cumulative regulatory burden. Companies that produce a wider range of regulated products may be faced with more capital a nd product development expenditures than their competitors. This can prompt those companies to exit the market or reduce their product offerings, potentially reducing competition. Smaller companies can be especially impacted since they have lower sales volumes over which to amortize the costs of meeting new regulations. The Department considers that a proposed standard is not economically justified if it contributes to an unacceptable level of cumulative regulatory burden. The Department looked at three areas of regulatory burden: 1) Federal, 2) State, and 3) other regulations and standards.
1. Federal Regulations on Distribution Transformer Manufacturers - Manufacturers were not aware of any Federal regulations on medium-voltage, dry-type distribution transformer manufacturers that would cause a cumulative regulatory burden in conjunction with the proposed efficiency regulations on distribution transformers.
2. Regulations and Pending Regulations at the State Level - manufacturers discussed the recent trend of State governments in instituting NEMA TP-1 as a mandatory standard for transformers sold within their State’s borders. At this time, three States and one city require this minimum efficiency standard for medium-voltage, dry-type distribution transformers. The States requiring TP-1 are Massachusetts, Minnesota, and Oregon. The city requiring TP-1 is Burlington, Vermont. Federal regulation wouldpreempt these standards, so no cumulative burden would be imposed.

12-503. Other Regulations and Standards

-Manufacturers were not aware of other regulations or standards, in effect or pending, that pertain to medium-voltage, dry-type distribution transformers.

12.5.4.5 Impacts on Small Businesses The SBA defines a small business, for the distribution transformer industry, as a business that has 750 or fewer employ ees. The Department estimated that, of the 25 U.S. manufacturers that make medium-voltage, dry-type distribution transformers, about 20 of them are small businesses. About one-half of the small businesses have fewer than 100 employees. At TSL3 and above, net cash flows for the medium-voltage, dry-type industry will go negati ve during the compliance period. At TSL3 and above, the impacts on the industry as a whole are large and affect businesses of all sizes, but there would be some differential impacts on small businesses. For example, at these levels, the use of M3 core steel will be needed. Cutting M3 core steel on the core-mitering equipment typically purchased by smaller businesses can be problematic because of the extremely thin laminations. Small businesses would also be at a relative disadvantage at TSL3 and higher because R&D efforts would be on the same scale as those for larger companies, but these expenses would be recouped over lower sales volumes by small businesses. Product redesign costs tend to be fixed and do not scale with sales volume. At TSL2, all designs would have to be mitered. This could constrain the core-mitering resources of small businesses that share core-cutting capacity between low-voltage, dry-type and medium-voltage, dry-type transformers. At TSL1, many kVA ratings could still be constructed using butt-lap joints, alleviating the constraint on core-mitering resources. Thus, TSL1 is less capital-intensive for small businesses than TSL2. In an industry such as the medium-voltage, dry-type transformer industry, which is heavily consolidated already, there is the risk that TSL2 could lead to further advantage for the largest manufacturers and thus further concentrate the industry’s production. However, the differential impact on small businesses is expected to be less in moving from TSL1 to TSL2 (as opposed to moving from TSL2 to TSL3). Today, the market currently demands significant quantities of medium-voltage, dry-type transformers that meet TSL2.
12.5.5 Summary of Impacts for Medium-Voltage, Dry-Type Superclass More than one-half of the customers for medium-voltage, dry-type transformers consider efficiency when purchasing transformers. A sizeable portion of the market is evaluating losses and making rational economic judgments in purchasing transformer products. With this in mind, it is significant to note that about one percent or less of the market chooses to purchase transformers that meet TSL3 or above. Conversion capital expenditures in the medium-voltage, dry-type distribution transformer superclass include primarily core-mitering equipment, but some additional expenditures would be necessary to upgrade coil-winding equipment and miscellaneous tooling. Today, about five

12-51full-time equivalent core-mitering machines are required by the medium-voltage, dry-type superclass. At TSL1, the Department estimates that 95 percent of the medium-voltage, dry-type transformers would be manufactured using core-cutting equipment capable of making mitered cuts. At TSL2 and above, 100 percent of medium-voltage, dry-type transformers would be produced with core-mitering equipment. The core-cutting time per transformer, and consequently the number of core-mitering machines required by industry, increases with increasing TSL because of two factors. First, more core-cutting time is required in proportion to increases in core size at higher efficiencies.Second, the shift to thinner core steel laminations at higher efficiencies implies increases in corecutting time that are inversely proportional to lamination thickness. The Department accounted for these two factors in estimating the increases in core-cutting equipment required at each TSL. It estimated that total equipment capital expenditures for the industry would be $2.1 million, $5.5 million, $6.8 million, $7.1 million, $15 million, and $15 million for TSLs 1 through 6, respectively. Product conversion expenses for the medium-voltage, dry-type superclass would be negligible at TSL1 and TSL2 because products meeting these levels are produced in relatively large volumes today. Above TSL2, product conversion expenses would be more significant. The impact on INPV at TSL5 and TSL6 would range between -67 percent and +2.5 percent. The impact on INPV at TSL4 would range between -29 percent and -9 percent. Theimpact on INPV at TSL3 would range between -25 percent and -15 percent. In the preservationof-gross-margin-percentage scenario, impacts above TSL3 decline with increasing TSL. This is because the incremental conversion costs above TSL3 are small relative to the revenue gains under the preservation-of-gross-margin-percentage scenario. This counterintuitive trend does not exist for the low-markup scenario, the preservation-of-operating-profit scenario. Net annual cash flows would go negative during the compliance period, irrespective of the markup scenario, for TSLs 3 through 6. For TSLs 3 and 4, the magnitude of the peak negative net annual cash flow would be about one-third of the positive base case cash flow. For TSLs 5 and 6, the magnitude of the peak negative net annual cash flow would be more than 50 percent higher than that of the positive base case cash flow. At TSL2, the impact on INPV would range between -15 percent and -8.9 percent. At TSL1, the impact on I NPV would range between -5.9 percent and -3.1 percent. The impact on annual net cash flow from capital expenditures during the compliance period would be greater for TSL2 than for TSL1. At TSL2, the net annual cash flows would go nearly to zero during the compliance period. The primary difference between TSL1 and TSL2 from the manufacturers’ viewpoint is that TSL1 preserves more design pathways, each trading off material for capital. Butt-lap designs would be cost-effective at TSL1 for some kVA ratings, which would allow small businesses to remain more competitive because they would not necessarily have to make large capital outlays. TSL2 cannot be met cost-effectively with butt-lap designs; thus, TSL2 could hurt the margins or decrease the market share of small businesses in the long term. Finally, there are three additional factors to be considered from the standpoint of manufacturers in selecting the proposed sta ndard:

12-521. If the medium-voltage, dry-type standard is set low relative to that for liquidimmersed transformers, there could be a switch to medium-voltage, dry-type transformers for certain products where there is substitutability between the two superclasses. For otherwise equivalent transformers, the TSLs are less stringent for medium-voltage, dry-type transformers.
2. According to some manufacturers, pushing the medium-voltage, dry-type standard above TSL2 could trigger a market switch from open-wound to cast-coil designs. If the market does shift to cast-coil, there is a risk of prefabricated Chinese imported cast-coils dominating the market in the long term.
3. The medium-voltage, dry-type superclass is already heavily consolidated. If the standard is set above TSL1, it will likely increase consolidation because the largest manufacturers are better equipped to produce transformers at TSL2 or TSL3.

12-53REFERENCES

1. McKinsey & Company, Inc. Valuation: Measuring and Managing the Value of Companies, 3rd Edition, Copeland, Koller, Murrin. New York: John Wiley & Sons, 2000. 2. Securities and Exchange Commission,Annual 10- K Reports, Various Years, Washington D.C., <www.sec.gov>.

3. Ibbotson Associates,Ibbotson Beta Book, 2003, Chicago, IL. <http://www.ibbotson.com>

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