12-i 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 - Superclass es . . . . . . . . . . . . . . . . 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 S cenario . . . . . . . . . . . . 12-14 12.3.7.2 Preservation-of-Operating-Profit Scenario . . . . . . . . . . . . . . . . . . . 12-14 12.4 MANUFACTURER IMPACT ANALYSIS - LIQUID-IMMERSED . . . . . . 12-15 12.4.1 Conversion Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-15 12.4.2 Product Conversion Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-21 12.4.3 Industry Financial Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-22 12.4.3.1 Trial Standard Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-22 12.4.3.2 Impacts on Industry Net Present Value . . . . . . . . . . . . . . . . . . . . . . 12-22 12.4.3.3 Impacts on Annual Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-24 12.4.4 Other Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-26 12.4.4.1 Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-26 12.4.4.2 Production Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-27 12.4.4.3 Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-27 12.4.4.4 Cumulative Regulatory Burden . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-28 12.4.4.5 Impacts on Small Businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-29 12.4.4.6 Worker Safety . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-29 12.4.4.7 Other Engineering Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-29 12.4.5 Summary of Impacts for Liquid-Immersed Superc lass . . . . . . . . . . . . 12-30 12.5 MANUFACTURER IMPACT ANALYSIS - MEDIUM-VOLTAGE, DRY-TYPE

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-33 12.5.1 Conversion Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-33 12.5.2 Product Conversion Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-39 12.5.3 Industry Financial Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-40 12.5.3.1 Trial Standard Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-40 12.5.3.2 Impacts on Industry Net Present Value . . . . . . . . . . . . . . . . . . . . . . 12-40 12.5.3.3 Impacts on Annual Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-4112-ii

12.5.4 Other Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-43 12.5.4.1 Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-43 12.5.4.2 Production Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-44 12.5.4.3 Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-44 12.5.4.4 Cumulative Regulatory Burden . . . . . . . . . . . . . . . . . . 12-44 12.5.4.5 Impacts on Small Businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-45 12.5.5 Summary of Impacts for Medium-Voltage, Dry-Ty pe Superclass . . . . . . . . . 12-46

LIST OF TABLES
Table 12.3.1 GRIM Financial Parameters for Distribut ion Transformer Industry . . . . . . . 12-10 Table 12.3.2 Non-Production Cost Markups for the Pre servation-of-Operating-Profit Scenario

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-14 Table 12.4.1 Summary of Liquid-Immersed DistributionTransformer Conventional Annealing

Furnace Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-17 Table 12.4.2 Summary of Liquid-Immersed DistributionTransformer Amorphous Annealing

Furnace Capital Expenditures . . . . . . . . . . . . . . . . . . 12-17 Table 12.4.3 Summary of Additional Core-Cutting Mach ine Estimate for Liquid-Immersed

Superclass . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-19 Table 12.4.4 Summary of Liquid-Immersed DistributionTransformer Conventional CoreCutting Equipment Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-20 Table 12.4.5 Summary of Liquid-Immersed DistributionTransformer Amorphous Core-Cutting

Equipment Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-20 Table 12.4.6 Summary of Liquid-Immersed DistributionTransformer Conversion Capital

Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-21 Table 12.4.7 Summary of Liquid-Immersed DistributionTransformer Product Conversion

Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-22 Table 12.4.8 Changes in Liquid-Immersed Industry NetPresent Value, Preservation-of-GrossMargin-Percentage Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-23 Table 12.4.9 Changes in Liquid-Immersed Industry NetPresent Value, Preservation-ofOperating-Profit Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-23 Table 12.4.10 Projected Change in Labor Expenditures , Liquid-Immersed (2010) . . . . . . . 12-26 Table 12.5.1 Calculation of Core-Mitering Capacity M ultiplier for Design Line 9 . . . . . . 12-35 Table 12.5.2 Calculation of Core-Mitering Machines N eeded for Design Line 9 . . . . . . . 12-36 Table 12.5.3 Calculation of Core-Mitering Machines N eeded for Design Line 10 . . . . . . 12-36 Table 12.5.4 Calculation of Core-Mitering Machines N eeded for Design Line 11 . . . . . . 12-37 Table 12.5.5 Calculation of Core-Mitering Machines N eeded for Design Line 12 . . . . . . 12-37 Table 12.5.6 Calculation of Core-Mitering Machines N eeded for Design Line 13 . . . . . . 12-38 Table 12.5.7 Summary of MV, Dry-Type Distribution Tr ansformer Core-Cutting Equipment

Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-38 Table 12.5.8 Summary of MV, Dry-Type Distribution Tr ansformer Conversion Capital

Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-3912-iii

Table 12.5.9 Summary of MV, Dry-Type Distribution Tr ansformer Product Conversion

Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-39 Table 12.5.10 Changes in MV, Dry-Type Industry Net P resent Value, Preservation-of-GrossMargin-Percentage Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-40 Table 12.5.11 Changes in MV, Dry-Type Industry Net P resent Value, Preservation-ofOperating-Profit Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-41 Table 12.5.12 Projected Change in Labor Expenditures , MV, Dry-Type (2010) . . . . . . . . . 12-43

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 Preservati on-of-Gross-Margin-Percentage Scenario, Liquid-Immersed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-24 Figure 12.4.2 Industry Net Cash Flow for Preservati on-of-Operating-Profit Scenario, LiquidImmersed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-25 Figure 12.5.1 Industry Net Cash Flow for Preservati on-of-Gross-Margin-Percentage Scenario, MV, Dry-type . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-42 Figure 12.5.2 Industry Net Cash Flow for Preservati on-of-Operating-Profit Scenario, MV, Drytype . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-42a

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

12-1 CHAPTER 12. MANUFACTURER IMPACT ANALYSIS

12.1 MANUFACTURER IMPACT ANALYSIS METHODOLOGY In determining whether a standard is economically j ustified, the Secretary of Energy is required to consider "the economic impact of the st andard on the manufacturers and on the consumers of the products subject to such a standar d.” aThe legislation also calls for an assessment of the impact of any lessening of compet ition as determined in writing by the Attorney General. The Department conducted the manufacturer impact analysis (MIA) to estimate the financial impact of efficiency standar ds on manufacturers of distribution transformers and to assess the impact of such stand ards on employment and manufacturing capacity. The MIA has both quantitative and qualit ative components. The quantitative part of the MIA primarily relies on the Government Regulato ry Impact Model (GRIM), an industrycash-flow model adapted for this rulemaking. The k ey GRIM inputs relate to industry cost structure, shipments, and pricing strategies. The GRIM’s key output is the industry net present value (INPV). The model estimates the financial impact of 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 s uch as the material supply chain, manufacturing techniques and equipment, and market and product trends, and includes a subgroup assessment of the impacts on small manufac turers. In the Department’s Framework Document published onNovember 1, 2000, DOE outlined the procedural and analytical approaches f or the MIA. As outlined, the Department conducted the MIA in three phases. Phase 1, “Indus try Profile,” consisted of preparing an industry characterization, including data on market shares, sales volumes and trends, pricing, employment, and financial structure. Phase 2, “Ind ustry Cash Flow,” focused on the industry as a whole. Using publicly available information deve loped 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 represe ntative cross-section of the U.S. distribution transformer industry. During these interviews, the Department discussed engineering, manufacturing, procurement, and financial topics sp ecific to each company, and also obtained each manufacturer’s view of the potential impacts o f standards on the industry as a whole. The interviews provided valuable information that the D epartment used to evaluate the impacts of a standard on manufacturers’ cash flows, manufacturin g capacities, and employment levels. This chapter provides details on the approach the D epartment followed in developing the MIA for this rulemaking.12-2

12.1.1 Phase 1: Industry Profile In Phase 1 of the MIA, the Department prepared a pr ofile of the distribution transformer industry that built on the market and technology as sessments prepared for the advance notice of proposed rulemaking (ANOPR) analysis. Prior to ini tiating the detailed impact studies, DOE collected information about the present and past in dustry structure and market characteristics for distribution transformers—including information on national shipments, market leaders, and cost structures for a range of manufacturers. In creati ng 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 analys is of the distribution transformer industry that DOE used to derive initial cost and f inancial inputs for the GRIM, e.g., revenues; material; labor; overhead; depreciation; selling, g eneral, and administrative (SG&A) expenses; and research and development (R&D) expenses. The D epartment used public sources of information to calibrate its initial characterizati on 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 indu stry analysis from Ibbotson Associates. 12.1.2 Phase 2: Industry Cash-Flow Analysis Phase 2 of the MIA focused on the industry-wide fin ancial impacts of standards. Energy conservation standards can affect distribution tran sformer manufacturers in three distinct ways. They can: 1) require additional investment, 2) rai se production costs, and 3) impact revenues through higher prices and, possibly, lower shipment s. The analytical tool DOE uses for calculating the financial impacts of standards on m anufacturers is the GRIM. To quantify these impacts in Phase 2 of the MIA, the Department perfo rmed 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 fi nancial parameters on its topdown financial analysis but, following discussions with transforme r manufacturers, it adjusted them to be more representative of the industry. The Department use d 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 p rices are consistent with the life-cycle cost (LCC) analysis, as well as with the engineering ana lysis, on which DOE based the LCC pricing. The Department established this consistency by usin g the mean values for production costs and selling prices in the GRIM, as selected by the LCC’ s Monte Carlo algorithm. Finally, the Department’s shipments analysis (Chapter 9) provide d the basis for the shipments projection under each of the TSLs in the GRIM.12-3

12.1.3 Phase 3: Subgroup Impact Analysis Using average cost and financial assumptions to dev elop an industry cash-flow model is not adequate for assessing differential impacts amo ng subgroups of manufacturers. Smaller manufacturers, niche players, or manufacturers exhi biting 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 subgr oups 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 follo ws in section 12.1.3.1. Within each of these superclasses, the Department c ontacted companies from its database of manufacturers (see Chapter 3), which provided a representation of each superclass. The Department interviewed small and large companies, s ubsidiaries and independent firms, public and private corporations, and a mix of National Ele ctrical Manufacturers Association (NEMA) members and non-NEMA members. It also made an effo rt to interview companies that had been interviewed for the engineering analysis in 2002, a s well as those that had previously participated in the rulemaking process. The purpose of the meet ings was to enhance the Department’s understanding of how manufacturer impacts change wi th each of the TSLs. A copy of the interview guides for each of the two superclasses c an be found in Appendix 12.A. The Department also evaluated the impact of the ene rgy conservation standards on small businesses. Small businesses, as defined by the Sm all Business Administration (SBA) for the distribution transformer manufacturing industry, ar e manufacturing enterprises with 750 or fewer employees. The Department conducted telephone inte rviews with four small businesses, to determine if the standard could result in different ial impacts on these companies. A copy of the interview guide for these interviews can be found i n Appendix 12.B. Discussion of the purpose of the small-business interviews and the small-busi ness 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 sup pliers to the distribution transformer industry to enhance its understanding o f 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 ste el. The core steel distributors offer manufacturers a varying degree of processing, rangi ng from basic slit-to-width rolls to prefabricated cores (both stacked and wound-core co nfigurations). The Department also spoke with four equipment suppliers, including manufactur ers of both distributed gap and mitered core processing machines, and two manufacturers of annea ling furnaces. The information from these discussions was helpful in understanding comments and concerns expressed by manufacturers, as well as in estimating the conversion capital expend itures used in the GRIM.12-4

To prepare the liquid-immersed industry conversion costs for switching to amorphous material at TSLs 5 and 6, the Department spoke withthe only domestic supplier of amorphous ribbon and several transformer manufacturers who ha d experience working with amorphous material. Through this dialogue, the Department ga ined a better understanding of manufacturing amorphous core transformers, including issues surro unding core processing equipment, annealing furnaces, and material handling. 12.1.3.1 Major Manufacturer Subgroups - Superclass es The Department subdivided the distribution transfor mer industry into two ‘superclasses’: liquid-immersed and medium-voltage, dry-type. (The low-voltage, dry-type superclass has been removed since the ANOPR was published, because the Energy Policy Act of 2005, enacted in August 2005, prescribed standards for these types o f transformers.) These superclasses take into account differences among the manufacturers, includ ing 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 - General ly, the profiles of the majority of customers purchasing transformers and the manner inwhich they are built and sold within each of the two superclasses are distinct. Discuss ion 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 which manufacturers b uild transformers are different for each of the superclasses. For example, in the liqu id-immersed superclass, transformer cores tend to be wound, requiring distributed-gap c ore-winding machines, annealing furnaces, tanking machines, and other equipment that is only used in this superclass. Accordingly, the capital equipment investment neces sary for compliance with a particular TSL typically differs between the two superclasses. 3. Industry structure - Reviewing the database of tr ansformer 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 pro ducing transformers from one of the superclasses. Thus, the industry naturally breaks down into two superclasses (actually, three superclasses, if low-voltage, dry-type is con sidered). The Department conducted structured, detailed, face -to-face interviews with six manufacturers, one of which produces transformers i n both superclasses. Two of the six manufacturers are small businesses. Three of the m anufacturers 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 manuf acturers produce liquid-immersed transformers, collectively representing more than an estimated 70 percent of the U.S. liquidimmersed market.bSmall Business Administration - www.sba.gov/size/ indextableofsize.html

12-5 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 transfo rmer industry and to understand how the impacts of standards on small business might be dif ferent from those on large manufacturers. Small businesses, as defined by the SBA for the dis tribution transformer manufacturing industry, are manufacturing enterprises with 750 employees or fewer. b To prepare a list of eligible companies, the Department constructed a transformer manufacturers database containing available data from 11 sources, including the Depar tment’s stakeholder contact list for this rulemaking, the Oak Ridge National Laboratory deter mination analysis database, the Underwriters Laboratory (UL) certification database , the NEMA membership list, and the Transformer Association membership list. (Details about the compilation of this database and the sources used are discussed in the market and te chnology assessment, Chapter 3.) The Department then selected small businesses and conta cted 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 discus sion. A copy of the small-business interview guide can be found in Appendix 12.B.
In addition to the two small businesses that underw ent detailed, structured, face-to-face interviews, DOE interviewed four additional small b usinesses 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 manufactur ers 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 s ome small businesses operate in more than one superclass. Upon reviewing the material provid ed by the small businesses interviewed, the Department concluded that using the GRIM was not th e 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 supercl asses in this chapter.12-6

12.2 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 manuf acturers, enabling them to identify key points that the Department would explore and discuss durin g the interview. This section lists those issues that the manufacturers interviewed raised mo st often. Manufacturers indicated that, for the most part, th e risks associated with these issues increase with increasing TSL. Many of these issues are discussed later in this chapter.

• Core steel availability - Manufacturers expressed concern over whether suff icient quantities of high-grade core steels needed for the construction of energy-efficient distribution transformers would be available. This concern is amplified by recent core steel availability problems in the U.S. market. No t only will the standard drive the market to use higher grades of steel (which are thi nner, and therefore take more time for steel companies to manufacture), but the quantities (pounds of steel) per transformer also will increase. Transformer manufacturers are conce rned that these compounding factors may further limit the availability of core steel.

• Core steel price volatility and uncertainty - Starting in late 2003, core steel prices started to increase, and increased dramatically after mid-2 004. For some manufacturers, core steel prices have doubled since 2003. In response to these and other material input cost increases, transformer manufacturers have been rais ing their own prices. However, manufacturers reported that they have not passed al l 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 peri ods of transformers under standards. The Department’s core steel market analysis is cont ained 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 (see Chapter 5 of this TSD, including Appendix 5C).

• Dimensional and physical constraints - Manufacturers expressed concern over meeting the Department’s efficiency standard and their cust omers’ dimensional and physical constraints simultaneously. In particular, manufac turers voiced concern regarding retrofit applications, mining applications, telephone pole c apacities, and other installations where transformers have to comply with dimensional or phy sical constraints.

• Enforcement of efficiency standard - Manufacturers expressed concern over how the Department intends to enforce the standards, to mak e sure all manufacturers, particularly importers, comply with the regulations.12-7

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

• Amorphous material - Liquid-immersed transformer manufacturers express ed concern that the Department is considering amorphous materi al at some of its TSLs. In particular, they discussed concerns about: 1) the ease of acces s 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 compl exity associated with material processing and handling during manufacturing, and 5 ) the consequent obsolescence of existing core fabrication and annealing capacity wi thin the industry.

• Backsliding - Liquid-immersed transformer manufacturers identif ied 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 trans formers. According to manufacturers, while the minimum efficiency of tran sformers sold in this State has increased, the average efficiency has decreased. T he first impact of such backsliding is that liquid-immersed manufacturers may experience l ower revenue. Second, the liquidimmersed market may move from a highly customized m arket, where U.S. manufacturers enjoy a competitive advantage over foreign manufact urers 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 liq uid-immersed distribution transformers.12-8

12.3 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 mode l 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 a ccepts a set of regulatory conditions, such as changes in costs, investments, and associated margi ns. The GRIM spreadsheet calculates a series of annual cash flows, beginning with the base year of the analysis, 2004, and continuing explicitly to 2038. The model calculates the INPV by summing the stream of annual discounted cash flows during this period. 1

The Department used the GRIM to project cash flows based on standard accounting principles and compared changes in INPV between a b ase 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) repr esents the financial impact of the standard on manufacturers. Appendix 12.C provides more technic al 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 GRIM, including corporate annual reports and th e 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, an d are freely available to the general public. The Department used these annual reports to derive the following draft GRIM inputs: GRIM Manufacturing Costs

Financial Parameters Manufacturer Selling Prices

Shipment Forecasts

Cash Flow Spreadsheet Model
Manufacturing Costs

Financial Parameters Manufacturer Selling Prices

Shipment Forecasts

Cash Flow Spreadsheet Model

Figure 12.3.1 Using the GRIM to Calculate Cash Flow12-9

• 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 fi nancial parameters through interviews with manufacturers during both the ANOPR and notice of proposed rulemaking (NOPR) phases of the rulemaking. It relied on manufacturer input for these revisions for two reasons. First, many distribution transformer manufacturers, both l arge and small, are not public corporations, so industry-wide financial data are not readily ava ilable. Second, many manufacturers of distribution transformers are diverse businesses th at participate in markets that are substantially different from distribution transformer markets; th erefore, the available financial information is not clearly representative of the distribution tran sformer market. Table 12.3.1 provides the representative financial parameters that DOE used f or both superclasses in the distribution transformer GRIM. The Department also used information from the SEC 1 0-K reports to calibrate the GRIM’s base case operating profit margin to be repr esentative for the industry. Operating margin is defined as earnings before interest and t axes, as a percentage of net revenue. The Department calibrated the GRIM to have a 4.9 percent operating margin in the base case.12-10

Table 12.3.1 GRIM Financial Parameters for Distribut ion 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 Revenues) 16.6% 16.1%
Source: SEC, 10-K Reports, Fiscal Years 1999–2004. Revised based on discussion with manufacturers.

12.3.3 Corporate Discount Rate The Department used the weighted-average cost of ca pital (WACC) for the industry as the discount rate to calculate INPV. A company’s a ssets 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 industr y. 1 The Department estimated the WACC for the industry based on a few representative companie s, using the following formula: WACC = After-Tax Cost of Debt x (Debt ratio) + Cos t 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 mar ket 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-maturitycIn previous rulemakings, DOE based the debt ratio on book value; in this rulemaking a slightly mo re accurate debt

ratio is based on market value of equity rather than book value. However, DOE used the book value of long-term debt to estimate the debt ratio.

12-11 Treasury notes to estimate the risk-free rate. The Department used a long-term Treasury note return (1 0-year bond return) because this captures long-term inflat ion expectations and is less volatile than short-term r ates in the GRIM. It estimated the risk-free rate to be 6.2 pe rcent, which is the average 10-year Treasury note return f rom 1990 to 2003, Risk premium = the difference between the expected return on st ocks and the riskless rate, assumed to be 9.2 percent, and Beta = the covariance of a stock with the market as a f raction 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 co st of equity (expected return) to be 13.6 percent. The Department estimated the cost of debt for each company based on the average interest rate reported on each company’s SEC 10-K r eport. 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. c The equity ratio estimate is therefore 74 percent

. Using the formula for the WACC, the Department esti mated the industry’s WACC to be 11.2 percent. Subtracting an estimated inflation r ate of 2.3 percent (assumed in the LCC analysis), the inflation-adjusted WACC is 8.9 perce nt. For validation, Ibbotson Associates 3 provided a WACC for a set of companies in the electric transmission and distribution equipment in dustry, which the Department assumed to be a good surrogate for the distribution transformer ind ustry. 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 percent (although some individual companies have substantially different costs of cap ital). For the reasons discussed above, the GRIM uses an 8 .9 percent discount rate for calculating the INPV of the distribution transforme r industry.12-12

12.3.4 Shipments In the national impact analysis, the GRIM used ship ment 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 f or each year of the forecast period. The estimate includes both the age distribution of tran sformers for each type (according to product class) and each transformer size. The Department s elected an accounting model method to prepare shipment scenarios for the base case and th e six 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 determine d that the demand for distribution transformers is relatively inelastic. Therefore, i n 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 inte rviews, 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 budg et, and as costs per unit increase, it is unlikely that utilities’ transformer budgets will increase propor tionately. Thus, proactive maintenance programs that replace and/or upgrade transformers n earing the end of their useful life will be reduced (on a unit basis), resulting in more failur es and outages, and lower system reliability. The installed capital of the distribution network w ill 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 p rimary voltage, enabling utilities to reduce the number of transformers kept in stock for emergencie s and upgrades. Third, engineers who specify transformer orders may look at an applicati on and select a slightly lower kVA rating than they ordinarily would have because of the higher (s tandards-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-c ompliant 50 kVA transformer. Working a lower kVA unit with a higher average load reduces i ts 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-uni t 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 mo deled in the national impact analysis. Finally, the Department’s shipments analysis did no t take into account any constraints on the availability of materials for manufacturing transformers. As noted in section 12.2, manufacturers expressed concern during the intervie ws about the availability of core steel. The transformer materials supply chain has been experie ncing consolidation over the years, such that12-13

now, manufacturers would be vulnerable to changes i n price or availability of wire, copper sheet, electrical paper, mineral oil, and other critical m aterials for building a transformer. Such input price changes would be passed through and would imp act transformer prices. Since the Department’s engineering analysis assumed flat equi pment prices in real terms over time, its shipments analysis could not capture such second-or der impacts for any given set of equipment prices.
12.3.5 Production Costs During the engineering analysis, the Department use d transformer design software to create a database of designs spanning a broad range of efficiencies for each of the representative units. This design software generated a bill of materials, with information including pounds of core steel, pounds of conductor, insulation, ductin g, and tank size. The software also provided information pertaining to the labor necessary to co nstruct the transformer, including the number of turns in the windings, and core dimensions, incl uding stack height. All the components from this bill of materials and labor estimate were comb ined with fixed hardware costs, such as bushings, busbar, and terminals. The Department th en applied manufacturer markups to allow for scrap, handling, factory overhead, and non-prod uction 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 Departm ent derived the manufacturer’s production cost inputs for the GRIM from the engineering analy sis 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 f acilities 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 fa cilities so that new product designs can be fabricated and assembled under the standard. Produ ct 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 eff ort to gather information on industry pricing scenarios, DOE invited manufacturers to discuss howstandards might change the industry’s profits. In discussions on issues such as the impa ct 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 cu stomers. All of the manufacturers interviewed had applied one or more price increases within the last two years to recover some of the production cost increases resulting from higher commodity prices. A few of the larger manufacturers had recently established with their c ustomers pricing contracts that had a base12-14

price and a variable “surcharge.” The surcharge is adjusted on a periodic (e.g., monthly or quarterly) basis, and is calculated based on the co sts of the transformer manufacturer’s major materials (e.g., core steel). All manufacturers di scussed the recent material price increases within the context of the Department’s questions about mar kups. 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 S cenario Under the preservation-of-gross-margin-percentage s cenario, DOE applied a single uniform “gross margin percentage” markup across all efficiency levels. As production cost increases with efficiency, this scenario implies th at 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 pr ofit—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 th at as their production costs increase in response to an efficiency standard, they would be a ble to maintain the same gross margin percentage markup. Therefore, the Department assumes that this scenari o represents a high bound to industry profitability under an energy-con servation standard. 12.3.7.2 Preservation-of-Operating-Profit Scenario Operating profit is defined as earnings before inte rest 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 th e non-production cost markups for each TSL to yield approximately the same operating profit inthe standards cases in the year after standard implementation (2011) as is yielded in the base cas e. 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 ca pital (ROIC) decline with increasing TSL, indicating reduced industry profitability. The non -production cost markups under this scenario are summarized in Table 12.3.2.
Table 12.3.2 Non-Production Cost Markups for the Preservation-of -Operating-Profit Scenario

Superclass Trial Standard Level

Base Case 1 2 3 4 5 6 Liquid-Immersed 1.250 1.248 1.246 1.241 1.239 1.224 1.209 MV, Dry-Type 1.250 1.248 1.247 1.245 1.240 1.223 1.22312-15

12.4 MANUFACTURER IMPACT ANALYSIS - LIQUID-IMMERSED The liquid-immersed transformer industry is charact erized 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), which minimizes the sum of first cost and the prese nt value of future core and coil losses that a given transformer will experience over its lifetime . Because these evaluation formulae vary from customer to customer, and because material prices f luctuate on a daily basis, the liquid-immersed industry evolved to be inherently flexible and resp onsive to customer needs. As the Department understands it, there are approxi mately 25 companies active in the liquid-immersed market in the U.S., some of which are branding units manufactured by another company. The Department estimated that the nine or so largest liquid-immersed transformer manufacturing companies collectively control 90 per cent 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 6 0 percent of the liquid-immersed market. For more information on the transformer market, ref er 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 expenditures that liquid-immersed transform er 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 liqui d-immersed transformers provided capital cost estimates for each of these capital expenditur e categories. The Department used the estimates provided by industry for comparative purp oses and prepared its own bottom-up estimates of conversion capital expenditures. It b ased the bottom-up estimates on the Department’s understanding of typical manufacturingprocesses at liquid-immersed transformer facilities. This understanding is based on manufac turer interviews and discussions with suppliers of equipment to the industry. The Department obtai ned typical equipment throughput and cost information directly from equipment suppliers and r econciled it with information provided by manufacturers. Furthermore, it obtained transforme r design parameters that vary with efficiency level (e.g., core weight) from the engineering anal ysis and used them to estimate the equipment capacity increases associated with increasing effic iency. In the liquid-immersed superclass, TSLs 1 through 4 would require only conventional electrical steels. In contrast, TSL6 would require all of the liquid-immersed design lines to convert to amorphous core technology. TSL5 would r equire three of the five liquid-immersed design lines (DL3–DL5) to convert to amorphous core technology. During the interviews, manufacturers discussed several reasons why, thoughtechnologically feasible, amorphous material is, in their opinion, not a good technology option for regulatory consideration:12-16

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 ann ealing furnaces), and 4. Increased complexity associated with material p rocessing and handling. The Department recognizes that the manufacturing pr ocess for amorphous core transformers is completely different from that for silicon steel transformers. TSL6 would render obsolete 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 a pproximately $59 million. TSL5 would not render obsolete as much equipment as TSL6, because TSL5 would require only a conversion to amorphous core technology for three of the five des ign lines. The Department estimates that the industry’s stranded assets at TSL5 would represent a loss of approximately $16 million. The Department’s stranded asset estimates represent low er bounds to the book values of obsolete core-cutting equipment, annealing furnaces, and mis cellaneous equipment such as conveyers, cranes, and other capital equipment at each TSL. The Department recognizes that TSL5 has the potenti al to severely distort and disturb both liquid-immersed product purchase decisions acr oss design lines and manufacturers’ operations. These distortions would arise because some design lines would necessarily be constructed with amorphous cores but some would sti ll be designed with conventional grainoriented electrical steels. A significant burden, which is difficult to quantify using the GRIM, would be placed on industry if it had to maintain p arallel 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 wo uld 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 wou ld face a critical decision about whether or not to relocate outside of the U.S., since much of their equipment would become obsolete. The additional annealing furnace capacity that the industry would need at TSLs 1 through 4 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, c onventional annealing furnace that can process 6,000 tons of core steel per year has an in stalled cost of $2.2 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 p rocessed at TSLs 1 through 4 to be two percent, four percent, eight percent, and nine perc ent, respectively. For TSL5, no additional conventional annealing furnace capacity would be ne cessary because some of the annealing12-17

furnaces currently used for DL3–DL5 would become av ailable for use in DL1–DL2. (This transfer of capacity is also accounted for in the D epartment’s stranded asset estimate above, to avoid overestimation of stranded assets.) For TSL6 , no additional conventional annealing furnace capacity would be necessary because all pro duction would convert to amorphous core technology. The Department estimated that conventi onal annealing furnace capital expenditures for the industry would be $2.2 million, $4.4 millio n, $6.6 million, and $6.6 million for TSLs 1 through 4, respectively, as shown in Table 12.4.1. Table 12.4.1 Summary of Liquid-Immersed Distribution Transformer Conventional

Annealing Furnace Capital Expenditures Trial Standard Level

TSL1 TSL2 TSL3 TSL4 Additional Wound-Core Mass (Tons/yr) 3,359 8,555 15,090 17,458 Additional Annealing Furnaces Needed by Industry 1 2 3 3 Annealing Furnace Conversion Capital Expenditure (2004$, Millions) 2.2 4.4 6.6 6.6
The new amorphous annealing furnace capacity that the industry would need at TSLs 5 and 6 is directly related to the amorphous core mas s that would be processed by the industry at each TSL. Based on information obtained from liqui d-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 . The Department estimated that amorphous annealin g furnace capital expenditures for the industry would be $52.4 million and $149.6 mill ion for TSLs 5 and 6, respectively, as shown in Table 12.4.2. Table 12.4.2 Summary of Liquid-Immersed Distribution Transformer Amorphous

Annealing Furnace Capital Expenditures Trial Standard Level

TSL5 TSL6 Amorphous Core Steel Mass (Tons/yr) 96,700 278,101 Amorphous Annealing Furnaces Needed by Industry 97 277 Amorphous Annealing Furnace Conversion Capital Expenditure (2004$, Millions) 52.4 149.612-18

The Department assumed that the additional conventi onal core-cutting equipment required by the industry for TSLs 1 through 4 is di rectly related to the increase in core weight at each TSL. Based on discussions with a leading supp lier of wound-core-cutting equipment to the liquid-immersed superclass, the Department calculat ed the processing capacity of a distributedgap core-winding machine. This equipment supplier estimated that a new machine can process 150 feet per minute (ft/min) of M6 core steel, whic h translates into 2,510 pounds per hour (lbs/hr) of core steel. Allowing for set-up time, wound-core 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 1,883 lbs/hr of core steel. Furthermore, the Department assumed th at the core-cutting machines operate two shifts per day, 250 days per year. One of these co re-cutting and winding machines costs approximately $200,000 installed. The Department’s based its assumption—that the incr ease in conventional core-cutting capacity required at each of TSLs 1 through 4 is be st approximated using the increases in core weight at each TSL—on dialogue with the aforementio ned leading equipment supplier. Standard core-cutting equipment used by liquid-immersed manu facturers 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 incr eases 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.12-19

Table 12.4.3 Summary of Additional Core-Cutting Mach ine Estimate for LiquidImmersed Superclass

Design Line DL1 DL2 DL3 DL4 DL5 Additional CoreCutting Machines, Liquid-Immersed ApproximateNumber of CoreCutting Machines in Base Case 11.3 19.3 0.9 6.5 8.9 0

Ratio of TSL1 Core Weight to Base Case Core Weight 1.009 1.006 1.008 1.040 1.031 1

Ratio of TSL2 Core Weight to Base Case Core Weight 1.009 1.016 1.026 1.120 1.072 2

Ratio of TSL3 Core Weight to Base Case Core Weight 1.009 1.026 1.110 1.220 1.120 4

Ratio of TSL4 Core Weight to Base Case Core Weight 1.065 1.026 1.183 1.220 1.132 5 Notes: The Department used the above matrix to est imate the number of core-cutting machines required for TSLs 1–4. The additional machines (above the 47 machine s required for the base case) are obtained by diffe rence. For example, at TSL1: (1.009×11.3) + (1.006×19.3) + (1 .008×0.9) + (1.040×6.5) + (1.031×8.9) - 47 = 1 mach ine (rounded up).
The Department estimated that core-cutting equipment capital expenditures for the superclass would be $0.2 million, $0.4 million, $0. 8 million, and $1.0 million for TSL1 through TSL4, 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 12.4.4.12-20

Table 12.4.4 Summary of Liquid-Immersed Distribution Transformer Conventional

Core-Cutting Equipment Capital Expenditures Trial Standard Level TSL1 TSL2 TSL3 TSL4 Additional Core-Cutting Machines Needed by Industry 1 2 4 5 Core-Cutting Conversion Capital Expenditure (2004$, Millions) 0.2 0.4 0.8 1.0
The Department estimated the amorphous core-cuttingcapacity at TSLs 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 s uppliers 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 ut ilization factor to this processing speed; as a result, DOE estimated that a single core-cutting ma chine would be capable of processing about 938 lbs/hr of core steel. Furthermore, the Departm ent assumed that the core-cutting machines would operate two shifts per day, 250 days per year . One of these amorphous core-cutting machines costs approximately $500,000 installed. T he Department estimated that amorphous core-cutting equipment capital expenditures for the superclass would be $26.0 million and $74.5 million for TSL5 and TSL6, respectively. The amorp hous core-cutting equipment estimates are summarized in Table 12.4.5. Table 12.4.5 Summary of Liquid-Immersed Distribution Transformer Amorphous CoreCutting Equipment Capital Expenditures Trial Standard Level TSL5 TSL6 Number of Amorphous Core-Cutting Machines Needed by Industry 52 149 Amorphous Core-Cutting Conversion Capital Expenditu re (2004$, Millions) 26.0 74.5
For TSLs 1 through 4, the Department estimated misc ellaneous capital investments, primarily buildings and coil-winding equipment, bas ed on a multiplier approach. With respect to buildings, the manufacturers indicated that additio nal building space will be necessary in some cases to accommodate expanded annealing furnace cap acity. With respect to coil winding equipment, the Department understands that, as tran sformers become more energy efficient, manufacturers may switch from winding coils with al uminum conductor to winding coils with copper. Copper has a higher conductivity, allowingfor smaller cross-sectional areas and transformer cores. However, copper requires more t orque when winding to ensure the same winding quality. The higher torque can be met by s lowing existing machines or winding fewer coils simultaneously. In both scenarios, additiona l coil-winding capacity is required. To12-21

estimate the total conversion capital investments, including those required for buildings and coilwinding equipment, the Department applied a multipl ier of 1.05 to the sum of the explicitly estimated core-cutting and annealing furnace capita l expenditures. It based the 1.05 multiplier on information submitted by industry. For TSLs 5 and 6, before applying a multiplier to the explicitly estimated amorphous core-cutting and annealing furnace capital expendit ures, the Department estimated the costs required for the portion of the liquid-immersed ind ustry 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 technol ogy, the costs of converting to core form designs would be zero. For TSL6, the Department es timated the costs of converting the liquidimmersed industry fully to core form designs to be $48 million. This estimate included $6 million for lacing tables and $42 million for coil- winding equipment. After adding these costs of converting to core form designs to the previously t abulated amorphous core-cutting and annealing furnace estimates, the Department applied an assumed multiplier of 1.2 at TSL5 and TSL6 to account for the cost of conveyers, cranes, tank washers, hangers, buildings, etc. The total conversion capital expenditures for the liqui d-immersed superclass are summarized in Table 12.4.6. Table 12.4.6 Summary of Liquid-Immersed Distribution Transformer Conversion Capital

Expenditures Trial Standard Level TSL1 TSL2 TSL3 TSL4 TSL5 TSL6

Annealing Furnace Conversion Capital Expenditure (2004$, Millions) 2.2 4.4 6.6 6.6 52.4 149.6
Core-Cutting Conversion Capital Expenditure (2004$, Millions) 0.2 0.4 0.8 1.0 26.0 74.5
Miscellaneous incl. Buildings and Coil Winding Equipment 0.1 0.2 0.4 0.4 15.7 102.4*
Total Conversion Capital Expenditure (2004$, Millions) 2.5 5.0 7.8 8.0 94.1 326.5 * Includes $48 million to fully convert industry fr om shell to core form designs. 12.4.2 Product Conversion Expenses Product conversion expenses include engineering, pr ototyping, 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 5 and 6 will require total ad ditional expenses equivalent to 100 percent of the industry’s R&D budget for three years. Since m anufacturers already produce liquidimmersed transformers that would comply with TSLs 1 through 4, product conversion expenses12-22

are expected to be negligible for these TSLs. Prod uct conversion expenses are summarized in Table 12.4.7. Table 12.4.7 Summary of Liquid-Immersed Distribution Transformer Product

Conversion Expenses Trial Standard Level

TSL1-4 TSL5 TSL6 Basis Industry makes these

designs today. Amount equivalent to

100% of industry R&D budget for 3 years. Amount equivalent to

100% of industry R&D budget for 3 years. Product Conversion Expenses (2004$, Millions) 0 109.2 161.2

12.4.3 Industry Financial Impacts The Department used the GRIM and the inputs and as sumptions described in the previous sections to produce indicators of financia l 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 t o the industry.
12.4.3.1 Trial Standard Levels 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 bun dles of various candidate standard levels as described inChapter 10 (section 10.2.2.3) of this TSD. TSL6 w ould 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. 12.4.3.2 Impacts on Industry Net Present Value The INPV measures the industry value and was used i n 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 net cash flows discounted at the industry’s cost of capital, or discount rate. The Department used the GRIM to estimate cash flows between 2004 and 20 38, consistent with the forecast period used in the national impact analysis. 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 of12-23

cash-flow impacts on the industry, the Department c onstructed 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 es timates under the two scenarios. Table 12.4.8 Changes in Liquid-Immersed Industry NetPresent Value, Preservation-ofGross-Margin-Percentage Scenario

Units Trial Standard Level

Base Case 1 2 3 4 5 6

INPV 2004$, Millions 526 532 537 553 561 549 552 Change in INPV from Base Case % - 1.1 2.0 5.1 6.6 4.2 4.9

2004$, Millions - 5.8 10.7 27.0 34.9 22.3 25.8
Table 12.4.9 Changes in Liquid-Immersed Industry NetPresent Value, Preservation-ofOperating-Profit Scenario

Units Trial Standard Level

Base Case 1 2 3 4 5 6

INPV 2004$,

Millions 526 521 513 496 490 323 27

Change in INPV from Base Case % - -1.1 -2.4 -5.7 -7.0 -38.7 -94.9

2004$, Millions - (5.7) (12.9) (30.0) (36.9) (203.8) (499.6)

The results from the preservation-of-gross-margin-p ercentage scenario provide a more favorable projection than do the results from the p reservation-of-operating-profit scenario. Industry value would increase if manufacturers coul d sustain their gross margin percentage as their production costs increase in response to a st andard. However, as previously mentioned, the preservation-of-gross-margin-percentage assumption may be optimistic, particularly at higher TSLs. The preservation-of-operating-profit markup scenari o 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 re quired for standard compliance, including investments in working capital. The negative impac ts on INPV are much greater at TSL5 and12-24

TSL6, which are the two TSLs that would require par tial 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 e ffects of standards, short-term changes in net cash flow are also important and ind icative of the impacts on industry during the years between final rule publication and the standard effective date. For example, a large investment over a period of a few years could strai n 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 rat ings; 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 2004 through 202 0 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 six TSLs evaluated for the two different markup scenarios.

$(200.00) $(150.00) $(100.00) $(50.00) $- $50.00 $100.00 $150.00

2004 2006 2008 2010 2012 2014 2016 2018 2020

YearNet Cash Flow, 2004$, Millions .

Base TSL1 TSL2 TSL3 TSL4 TSL5 TSL6 Standard becomes effective in 2010
Figure 12.4.1 Industry Net Cash Flow for Preservati on-of-Gross-Margin-Percentage Scenario, Liquid-Immersed12-25

Prior to the final rule publication date, the cash flows are identical for all TSLs in both scenarios. After final rule publication, cash flow s 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, a relatively large investment in working capital is required. The incremental investments in working capital are about $7 million, $13 million, $30 million, $38 million, $123 million, and $284 million for TSL s 1 through 6, respectively (with about 5–6 percent variation at each TSL between markup scenarios). After final rule publication, industry cash flows begin to decline as industry uses its fi nancial resources to prepare for the standard. In the year the standard becomes effective, new capita l equipment goes into production.
While the behavior of cash flows for each TSL varie s between the two markup scenarios, there are three observations that are common across the two scenarios. First, the net annual cash flows do not go negative for TSL1 through TSL4. Se cond, for TSL3 and TSL4, net annual cash flows dip close to zero in 2010, the year of standard implementation. The dip in cash flow in 2010 is due to a relatively large investment in wor king capital that would be required to finance increased inventories, accounts receivable, etc. T hird, net annual cash flows go negative during the compliance period for TSL5 and TSL6, which are the two TSLs that would require a partial or full conversion to amorphous core technology. $(250.00) $(200.00) $(150.00) $(100.00) $(50.00) $- $50.00 $100.00

2004 2006 2008 2010 2012 2014 2016 2018 2020

YearNet Cash Flow, 2004$, Millions .

Base TSL1 TSL2 TSL3 TSL4 TSL5 TSL6 Standard becomes effective in 2010

Figure 12.4.2 Industry Net Cash Flow for Preservati on-of-Operating-Profit Scenario, Liquid-Immersed12-26

12.4.4 Other Impacts 12.4.4.1 Employment The Department estimated industry-wide labor expend itures based on the engineering analysis. Winding of the primary and secondary coi ls; cutting, forming, and annealing of the core; core assembly; testing; and packing of the co mpleted transformer represent the bulk of the labor. The Department incorporated these assumptio ns 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 measure d 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-Imme rsed (2010) Trial Standard Level TSL1 TSL2 TSL3 TSL4 TSL5 TSL6 3.1% 3.2% 0.8% 1.2% 34.9% 98.8%

Based on the GRIM and the assumption that 95 perce nt of liquid-immersed transformers sold in the U.S. are manufactured in the U.S., the Department estimated that there are currently 4,247 production employees in the U.S. liquid-immer sed distribution transformer industry. This estimate excludes non-production workers and assume s a level annual production rate. In practice, including non-production workers and seas onal effects, the actual number of employees in the liquid-immersed superclass would be 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 discer nable direct employment impacts among transformer manufacturers for TSL1 through TSL4, but potentially large increases in employment for TSL5 and TSL6. These conclusions ar e 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 ign ore the possible relocation of domestic employment to lower-labor-cost countries, such as M exico. Also, for TSLs 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 inte rviews that establishing an energy conservation standard would ‘commoditize’ the distribution transformer market, making it easier for foreign manufacturers who specialize in low-cos t 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 speci fications. U.S. manufacturers differentiate themselves in the market by employing rapid turn-ar ound 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-type12-27

transformers, several utilities have abandoned thei r evaluation formulae and simply ordered standards-compliant transformers. In many cases, a ccording 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 ‘commo ditization’ of the product offering which has opened the door to foreign competition. Industry f ears 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 affec ted by‘commoditization’ in several ways. Less efficient transformers are smaller and less costly; therefore, ‘commoditization’ could result in reduced capacity utilization and lower re venues. 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. manufacturi ng 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-conservatio n standard takes effect, manufacturers believe that the liquid-immersed distribution transformer i ndustry 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 p roduction capacity implications for the standard at TSL4 and below. At TSL6, all liqui d-immersed design lines would have to convert to amorphous core technology. At TSL5, thr ee design lines would have to convert to amorphous core designs. Conversion to amorphous co re designs would render obsolete a large portion of the equipment used in the liquid-immerse d industry (e.g., annealing furnaces, and core-cutting and winding equipment). 12.4.4.3 Exports Domestic manufacturers produce and export liquid-immersed transformers around the world. Due to the inherent manufacturing flexibili ty built into their production lines, manufacturers can readily retool and build export units (even 50 Hz fundamental frequency). Once the standard takes effect, transformer manufac turers 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. During the MIA interviews, one manufacturer express ed concern that an existing volume discount enjoyed on a low-grade, grain-oriented ste el 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, export ed transformers that have lower-quality steel may become slightly more expensive and therefore le ss competitive globally. The Department12-28

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 signif icant burden on manufacturers, the combined effects of several regulations, existing o r 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 regu latory burden. Companies that produce a wider range of regulated p roducts may be faced with more capital and product development expenditures than their competitors. This can prompt those companies to exit the market or reduce their produc t 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 contri butes 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 Man ufacturers - In addition to potential efficiency regulations on distribution tr ansformers, the National Energy Code (NFPA 70) places additional restrictions on liquid- immersed transformers, requiring that indoor liquid-immersed transformers be located in s eparate transformer vaults. Furthermore, the code provides stipulations for fir e 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 prev ent fires associated with flammable insulating fluids; however, this mandate applies to all indoor liquid-immersed transformers, including those containing non-flamma ble liquid products.
2. Regulations and Pending Regulations at the State Le vel - Manufacturers also discussed the recent trend of State governments to implement NEMA TP-1 as a mandatory standard for transformers sold within State borders. At thi s time, the Department knows of one State that requires this minimum efficiency standar d for liquid-immersed distribution transformers. These standards, when preempted by F ederal energy-efficiency regulation, will not create a cumulative burden on domestic manufacturers.
3. Other Regulations and Standards - Manufacturers were not aware of other regulations or standards, in effect or pending, which affect liqui d-immersed distribution transformers.12-29

12.4.4.5 Impacts on Small Businesses The SBA defines a small business, for the distribut ion transformer industry, as a business that has 750 or fewer employees. The Department es timated that, of the approximately 25 U.S. manufacturers that make liquid-immersed distributio n transformers, about 15 of them are small businesses. About one-third of the small businesse s have fewer than 100 employees. Because the liquid-immersed distribution transforme r superclass largely produces customized transformers, small businesses can compe te because each unique design is produced in relatively small volumes for a given order. Imp lementation of an energy-conservation standard would have a relatively minor differential impact on small manufacturers of liquidimmersed distribution transformers. Disadvantages to small businesses, such as having little leverage 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 conc ern for their workers, who handle heavy material 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 handlin g 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 impossibl e 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 tr ansformer exceeding the capacity of the industry-standard, pole-mounting brackets. Accordi ng to manufacturers, these transformers hit their maximum height at TSL2 (between the power lin es overhead and the telephone and cable lines underneath), and thus all size expansion at h igher TSLs is in the diameter of the tank. Approximately 80 percent of overhead transformers s old are for replacement installations, so this issue of a pre-existing space limit will cause prob lems for utilities and may increase outage times. Manufacturers also expressed concern over a second dimensionally constrained liquidimmersed transformer—subsurface retrofit transforme rs. These liquid-immersed units are designed to be installed within an existing concret e vault to service an underground distribution network. If the efficiency standard is significant ly different from the levels being built today, it may require substantial (extremely expensive) rewor k of these vaults, increasing downtime or stress on the local distribution network while a fa iled unit is replaced.12-30

12.4.5 Summary of Impacts for Liquid-Immersed Superc lass The electric utility industry appears to be making mostly evaluated transformer purchase decisions. However, in the State that has adopted an energy-co nservation 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 manu facturers, is that after the efficiency standards were implemented, electric utilities abandoned thei r 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 l iquid-immersed design lines to convert to amorphous core technology. Since the manufacturingprocess 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 $16 million and $59 million , respectively. In addition, manufacturers detailed many technical reasons why amorphous core material is difficult and potentially hazardous for workers. TSL4 can be met without using amorphous core techno logy. However, manufacturers expressed concerns over meeting TSL4 while simultan eously being able to meet customer specifications, including size and weight limitatio ns. Conversion capital expenditures in the liquid-immer sed distribution transformer superclass include, primarily, expanded annealing furnace capacity, but also additional corecutting equipment, coil-winding equipment, and buil ding construction. The need for additional annealing furnace capacity and core-cutting equipme nt is driven by the increase in core weights that would be experienced at higher TSLs. Conversi on capital expenditures would be relatively modest for TSL1 through TSL4, ranging from $2.5 mil lion (TSL1) to $8.0 million (TSL4) in an industry with projected revenue of $1.4 billion in 2007. The industry would experience negligible product conversion expenses in the TSL1 to TSL4 range because products meeting these efficiency levels are produced in significant quantities today. Conversion capital expenditures and product conversion expenses would be substantially higher for TSL5 and TSL6, the standard levels that would require partial or f ull conversion to amorphous core technology. The Department estimated that conversion capital expenditures would be $94.1 million and $326.5 million for TSL5 and TSL6, respectively. Th e Department estimated the corresponding product conversion expenses to be $109 million and $161 million, respectively. The impact on INPV at TSL6 ranges between -94.9 per cent and +4.9 percent, depending on the assumed markup scenario. There is a great d eal of uncertainty in these impact estimates, primarily due to uncertainty around transformer pri cing at high TSLs. At TSL6, the magnitude12-31

of the peak negative net annual cash flow would be more than three times that of the positive base case cash flow. The impact on INPV at TSL5 ranges between -38.7 per cent and +4.2 percent, depending on the assumed markup scenario. There is a great d eal of uncertainty in these impact estimates, primarily due to uncertainty around transformer pri cing at high TSLs. At TSL5, the magnitude of the peak negative net annual cash flow would be about equal to that of the positive base case cash flow. A significant burden, which is difficul t to quantify using the GRIM, would be placed on industry if it had to maintain parallel manufact uring operations for both conventional and amorphous core technology under TSL5. The impact on INPV at TSL4 ranges between -7.0 perc ent and +6.6 percent, depending on which markup scenario is assumed. The impact onannual net cash flow would be significant at TSL4, bringing net cash flow nearly to zero in 2 010 in a low markup scenario. The 2010 impacts would largely be driven by the need to inve st in working capital. Although cash-flow impacts would be significant at TSL4, the industry would likely recover from them in the years following standard implementation. The impact on INPV at TSL3 ranges between -5.7 perc ent and +5.1 percent, depending on which markup scenario is assumed. The impact onannual net cash flow would be significant at TSL3, bringing net cash flow nearly to zero in 2 010 in a low markup scenario. The 2010 impacts would largely be driven by the need to inve st in working capital. Although cash-flow impacts would be significant at TSL3, the industry would likely recover from them in the years following standard implementation. At TSL2, the impact on INPV ranges between -2.4 per cent and +2.0 percent. The impact on annual net cash flow would be small. At TSL1, the impact on INPV ranges between -1.1 per cent and +1.1 percent. The impact on annual net cash flow would be negligible. Finally, there are several additional factors to be considered from the standpoint of manufacturers in selecting the proposed standard:
1. If the liquid-immersed standard is high relative to the standard for medium-voltage, dry-type transformers, there could be a switch to m edium-voltage, dry-type transformers for certain products where there is su bstitutability between the superclasses. For reasons related to the propertie s inherent in their operation, for equivalent kVA ratings and TSLs, the efficiency lev els of medium-voltage, dry-type transformers are lower than those of liquid-immerse d 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 trans former through which they can circumvent the standard. If a speciality or niche application transformer exempted from standards is less expensive than a standards-c ompliant distribution transformer,12-32 these customers may purchase a standards-exempt transformer that is also capable of serving a distribution function. 3. Several manufacturers expressed concern about e nforcement. Many manufacturers urged the Department to make enforcement a top prio rity to ensure an effective standard. 4. At TSL2 and higher, certain liquid-immersed des igns that incorporate less-flammable cooling fluids (also called ‘high fire-point’ fluid s) may become uncompetitive. These transformers incorporate a substitute fluid to cool the core-coil assembly, but is lessflammable than mineral oil, enabling the transforme rs to be used indoors. Designs using less-flammable cooling fluids that were cost- optimized around NEMA TP 1, may become uncompetitive at higher efficiency level s. 5. Differential impacts on small businesses do not appear to be important for the liquidimmersed distribution transformer superclass. 6. Manufacturers mentioned maximum practical effic iencies based on dimensional, weight, and other practical limitations. The pract ical 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 capi tal budgets. If standards go above a certain level, the capital budgets for distributiontransformers might not be able to accommodate the transformer price increases, thereb y creating downward pressure on manufacturer profit margins.12-33

12.5 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 ar e concerned about losses when making transformer purchase decisions. This superclass ha s 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-vo ltage, dry-type production facility closing in North Carolina, and the associated business bein g taken over by a competitor in Virginia. The Department estimated that there are approximately 25 companies active in the medium-voltage, dry-type market in the United State s. Of these, the seven largest companies retailing medium-voltage, dry-type distribution transformers are (in alphabetical order): ABB, Federal Pacific, General Electric, Hammond, MGM, Ol sun, and Square D. Of the two distribution transformer superclasses, the medium-v oltage, dry-type superclass is the more concentrated; The top three companies manufacture o ver 75 percent of all transformers in this superclass. For more information on the transforme r 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 expenditures that medium-voltage, dry-type transformer manufacturers would have to make in response to a standard. These are: 1) inve stments in additional core-cutting equipment capable of making mitered cuts, and 2) investments in miscellaneous tooling and equipment, including equipment used for conductor winding. Co re-cutting equipment capable of making mitered cuts is a key component of the medium-volta ge, dry-type analysis. Mitered and cruciform core construction techniques are often us ed to reduce no-load losses in mediumvoltage, dry-type transformers. Mitered joints hav e lower destruction factors and are more efficient than butt-lap joints. Reviewing the shipments analysis, the Department es timated that the equivalent of five full-time, mitered, core-cutting machines are curre ntly being used by the medium-voltage, drytype industry. The Department estimates that about 85 percent of the medium-voltage, dry-type transformers produced today have mitered cores. At TSL1, the Department assumed that 95 percent of the medium-voltage, dry-type transformer s 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 c ore-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 cor e-cutting equipment. This equipment manufacturer then prepared processing time estimate s based on the core dimensions. The manufacturer’s assumptions are applicable for proce ssing M6 core steel in batches of one. The assumption of single-unit batches is appropriate fo r the medium-voltage, dry-type superclass because there is often a high degree of customizati on associated with customer orders. Based on12-34

the core-cutting equipment manufacturer’s processin g 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 t o cost the medium-voltage, dry-type distribution transformer industry about $2.4 millio n installed, plus $0.3 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 laminati ons, industry indicated that additional core-stacking equipment would be ne cessary 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 the medium-voltage, dry-type industry would include aut omatic 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 machi nes 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 rep ort that their core-mitering equipment operates poorly with thinner steels, which would re quire 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 engineeringanalysis. It accounted for these two factors in estimating the increases in core-mitering equipm ent required at each TSL. Table 12.5.1 shows an example calculation for the core-mitering capaci ty multiplier at each TSL for design line 9, not accounting for the fraction of transformers that are mitered at each TSL.12-35

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

Typical Core Weight (lbs) 1,251 1,221 1,230 1,235 1,238 1,588 Typical Stack Height (in.) 6.94 6.89 7.06 7.80 8.19 10.20 Typical Lamination Thickness (in.) 0.0114 0.0109 0.0092 0.0090 0.0090 0.0090
Typical Number of Laminations per Inch (in -1 ) 87.4 91.5 109 111 111 111
*Multiplier for Increased Core-Mitering Capacity 1.00 1.04 1.26 1.43 1.50 1.93
* For TSL1

–TSL4, the multiplier is based on the ratios of stac k heights and number of laminations per inch, normalized to the base case. For example, at TSL3, the multiplier is calculated as (7.80/6.94)×(111/8 7.4) = 1.43. For TSL5 and TSL6, the multiplier is based on the r atios of core weight and number of laminations per inch, normalized to TSL4. At TSL5 and TSL6, the mu ltiplier is calculated as (1,588/1,238)×(111/111)×1 .50 = 1.93. The multiplier at TSL5 and TSL6 is calculated diffe rently because, for some medium-voltage, dry-type d esign lines, particularly DL12 which is high volume and therefor e critical for the analysis, the designs in the eng ineering database involve longer pieces of core steel above TSL4 and therefore the required increased cutting t ime is better captured through core weight increases than through stack height increases (in the Department's engine ering analysis stack height increases are not significant for DL12 above TSL4). After speaking with the primary supp lier of core-mitering equipment and reviewing equipment per formance curves, the Department confirmed the assum ption 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 372, 592, 423, 2,761, and 260, respectively. Using these shipment s projections, the assumed core production rates per core-mitering machine for each design lin e (discussed above), and the multipliers for increased core-mitering capacity, the Department es timated 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.12-36

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

Multiplier for Increased CoreMitering Capacity 1.00 1.04 1.26 1.43 1.50 1.93
Number of Core-Mitering Machines if all Transformers are Mitered 0.27* 0.28 0.34 0.38 0.40 0.51

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.23 0.26 0.34 0.38 0.40 0.51 * (372 units shipped)/(1,400 units per machine per year) = 0.27 core mitering machines Table 12.5.3 Calculation of Core-Mitering Machines N eeded for Design Line 10 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.09 1.11 1.21 1.23 1.71
Number of Core-Mitering Machines if all Transformers are Mitered 0.85* 0.92 0.94 1.02 1.04 1.44

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.72 0.87 0.94 1.02 1.04 1.44 * (592 units shipped)/(700 units per machine per ye ar) = 0.85 core mitering machines12-37

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

Multiplier for Increased CoreMitering Capacity 1.00 1.28 1.31 1.38 1.32 1.54
Number of Core-Mitering Machines if all Transformers are Mitered 0.30* 0.39 0.40 0.42 0.40 0.46

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 0.26 0.37 0.40 0.42 0.40 0.46 * (423 units shipped)/(1,400 units per machine per year) = 0.30 core mitering machines Table 12.5.5 Calculation of Core-Mitering Machines N eeded for Design Line 12 Trial Standard Level Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Multiplier for Increased CoreMitering Capacity 1.00 1.10 1.22 1.30 1.32 1.76
Number of Core-Mitering Machines if all Transformers are Mitered 3.94* 4.35 4.81 5.14 5.19 6.96

Fraction of Transformers that are Mitered 0.85 0.95 1.0 1.0 1.0 1.0
Number of Core-Mitering Machines 3.35 4.13 4.81 5.14 5.19 6.96 * (2,761 units shipped)/(700 units per machine per year) = 3.94 core mitering machines12-38

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

Multiplier for Increased CoreMitering Capacity 1.00 1.01 1.11 1.17 1.17 1.67
Number of Core-Mitering Machines if all Transformers are Mitered 0.50* 0.50 0.55 0.58 0.58 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 0.42 0.47 0.55 0.58 0.58 0.83 * (260 units shipped)/(525 units per machine per ye ar) = 0.50 core mitering machines Based on the assumption that each core-mitering mac hine for the medium-voltage, drytype industry would cost $2.7 million installed (in cluding $0.3 million for the building adder), the Department estimated that core-mitering equipme nt capital expenditures for the industry would be $3.1 million, $5.6 million, $6.9 million, $7.1 million, $14.1 million, and $14.1 million for TSL1 through TSL6, respectively. The core-cutt ing equipment estimates are summarized in Table 12.5.7.

Table 12.5.7 Summary of MV, Dry-Type Distribution Tr ansformer Core-Cutting

Equipment Capital Expenditures Trial Standard Level

Base Case TSL1 TSL2 TSL3 TSL4 TSL5/6

Mitered Core-Cutting Machines Needed by Industry 5.0 6.1 7.0 7.5 7.6 10.2
Incremental Mitered Core-Cutting Machines Needed by Industry - 1.1 2.0 2.5 2.6 5.2
Core-Mitering Conversion Capital Expenditure (2004$, Millions) - 3.1 5.6 6.9 7.1 14.1
The Department estimated total conversion capital e xpenditures, including capital investments for additional miscellaneous equipment such as coil-winding equipment, based on multipliers applied to the core-cutting equipment c apital investment. Based on information submitted by industry, DOE estimated this multiplie r was estimated to be 1.06. The conversion capital expenditures are summarized in Table 12.5.8

.12-39

Table 12.5.8 Summary of MV, Dry-Type Distribution Tr ansformer Conversion Capital

Expenditures Trial Standard Level TSL1 TSL2 TSL3 TSL4 TSL5/6 Core-Cutting Conversion Capital Expenditure (2004$, Millions) 3.1 5.6 6.9 7.1 14.1
Multiplier for Miscellaneous Tooling Including Coil Winding Equipment 1.06
Total Conversion Capital Expenditure (2004$, Millions) 3.2 5.9 7.3 7.5 15.0
12.5.2 Product Conversion Expenses Product conversion expenses include engineering, pr ototyping, 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 tota l additional expenses equivalent to 100 percent of the industry’s R&D budget for three year s. At TSL3 and above, manufacturers indicated that R&D engineers would be fully utilize d (both electrical and mechanical engineers), as would production design engineers and mechanical drafters, during the conversion and compliance period. Since manufacturers already pro duce 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 Tr ansformer Product Conversion

Expenses Trial Standard Level TSL1-2 TSL3 TSL4 TSL5/6
Basis 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 Expenses (2004$, Millions) 0 3.3 3.6 5.012-40

12.5.3 Industry Financial Impacts Using the inputs and assumptions described in the p revious sections, the GRIM produced indicators of financial impacts on the medium-volta ge, 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-voltag e, dry-type distribution transformers. TSL1 is the NEMA TP-1 standard. TSL 6 represents the maximum TSL that is technologically feasible. TSL5 is the highest TSL that yields national NPV greater than zero. For dry-type transformers, TSL5 and TSL6 are the same. TSL4 results in the maximum LCC savings. TSL2 and TSL3 are spaced equally between TSL1 and TSL4. 12.5.3.2 Impacts on Industry Net Present Value The INPV measures the industry value; DOE used it i n 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 2004 and 2038, consistent with the forecast period used in the national impact analysis. 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 c onstructed two MIA analyses based on the two markup scenarios discussed above. In the firstscenario, 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. Table 12.5.10 Changes in MV, Dry-Type Industry Net P resent Value, Preservation-ofGross-Margin-Percentage Scenario

Units Trial Standard Level

Base Case 1 2 3 4 5/6

INPV 2004$, Millions 32 30 29 27 28 30 Change in INPV from Base Case % - -5.5 -10.1 -15.7 -11.8 -6.1

2004$, Millions - (1.8) (3.3) (5.1) (3.8) (2.0)12-41

Table 12.5.11 Changes in MV, Dry-Type Industry Net P resent Value, Preservation-ofOperating-Profit Scenario

Units Trial Standard Level

Base Case 1 2 3 4 5/6

INPV 2004$, Millions 32 30 28 25 24 15 Change in INPV from Base Case % - -7.7 -13.4 -21.5 -24.3 -52.8

2004$, Millions - (2.5) (4.3) (6.9) (7.8) (17.0)
The results from the preservation-of-gross-margin-p ercentage scenario provide a more favorable projection than do the results from the p reservation-of-operating-profit scenario. Industry value would not decrease as much if manufa cturers could sustain a constant gross margin percentage as their production costs increas e 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 d ecline with increasing TSL, because the incremental conversion costs above TSL3 are small r elative 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 f ully recoup the capital investments required for standard compliance, including investments in worki ng capital. 12.5.3.3 Impacts on Annual Cash Flow While INPV is useful for evaluating the long-term e ffects of standards, short-term changes in net cash flow are also important and ind icative of the impacts on industry during the years between final rule publication and the effect ive date of the standard. For example, a large investment over a period of a few years could strai n 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 rat ings; 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 2004 through 202 0 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 scenarios.12-42

Prior to the final rule publication date, the cash flows are identical for all TSLs in both $(6.00) $(4.00) $(2.00) $- $2.00 $4.00 $6.00

2004 2006 2008 2010 2012 2014 2016 2018 2020

YearNet Cash Flow, 2004$, Millions .

Base TSL1 TSL2 TSL3 TSL4 TSL5 & 6 Standard becomes effective in 2010

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

$(6.00) $(5.00) $(4.00) $(3.00) $(2.00) $(1.00) $- $1.00 $2.00 $3.00 $4.00

2004 2006 2008 2010 2012 2014 2016 2018 2020

YearNet Cash Flow, 2004$, Millions .

Base TSL1 TSL2 TSL3 TSL4 TSL5 & 6 Standard becomes effective in 2010

Figure 12.5.2 Industry Net Cash Flow for Preservati on-of-Operating-Profit Scenario, MV, Dry-type12-43

scenarios. After final rule publication, cash flow s 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 inc remental investments in working capital are about $0.20 million, $0.34 million, $0.66 million, $1.56 million, $5.90 million, and $5.90 million for TSL1 through TSL6, respectively (with a bout 5–6 percent variation at each TSL between markup scenarios). These investments in wo rking capital are relatively insignificant, except those at TSL5 and TSL6. After final rule pu blication, 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. The Department assumed that no assets are stranded for the TSLs evaluated.
While the behavior of cash flows for each TSL varie s between the two markup scenarios, there are 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 expend itures based on the engineering analysis. Winding of the primary and secondary coi ls, stacking and assembly of the core, enclosure manufacturing, testing, and packing of th e completed transformer represent the bulk of the labor. The Department incorporated these assump tions 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 over time. Table 12.5.12 provides the changes in labor measured as the chang e in labor expenditures for medium-voltage, dry-type transformers in 2010 (the standard effecti ve 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 2.1% -1.0% -1.4% -1.6% -0.1% Based on the GRIM and the assumption that 100 perce nt of medium-voltage, dry-type transformers sold in the U.S. are manufactured in the U.S., the Departme nt estimated that there are currently 252 production employees in the U.S. medium-voltage, dry-type distribution transformer industry. The Department recognizes th at 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-produc tion 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 scen arios, projected labor expenditures are equivalent for both. Based on these results, DOE e xpects no significant discernable employment12-44

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 durin g the interviews is the potential impact from the competitiveness of cast-coil design s at higher TSLs . These manufacturers claim that setting a standard above a certain threshold m ay trigger a market switch from open-wound transformers to cast-coil transformers. Manufactur ers suggested that this cross-over point likely occurs 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 leve l will 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 indus try’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, manufacturers would have to invest in additional co re-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-effi cient transformers tend to be larger, this could also contribute to the need for additional floor sp ace. 12.5.4.3 Exports Distribution transformer exports comprise a small f raction of distribution transformer sales. However, domestic manufacturers do sell to countries that do not currently require products to meet minimum efficiency requirements fo r distribution transformers. Since the medium-voltage, dry-type industry is largely a cust omized 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 signif icant burden on manufacturers, the combined effects of several regulations, existing o r 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 regu latory burden.12-45

Companies that produce a wider range of regulated p roducts may be faced with more capital and product development expenditures than their competitors. This can prompt those companies to exit the market or reduce their produc t 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 contri butes 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 Man ufacturers - Manufacturers were not aware of any Federal regulations on medium-volt age, dry-type distribution transformer manufacturers that would cause a cumulative regulatory burden in conjunction with the proposed efficiency regulation s on distribution transformers.
2. Regulations and Pending Regulations at the State Le vel - manufacturers discussed the recent trend of State governments in instituting NE MA 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 Massac husetts, Minnesota, and Oregon. The city requiring TP-1 is Burlington, Vermont. Federa l regulation would preempt these standards, so no cumulative burden would be imposed

. 3. Other Regulations and Standards

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

12.5.4.5 Impacts on Small Businesses The SBA defines a small business, for the distribut ion transformer industry, as a business that has 750 or fewer employees. The Department es timated 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-vo ltage, dry-type industry will go negative 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, th e use of M3 core steel will be needed. Cutting M3 core steel on the core-mitering equipment typica lly purchased by smaller businesses can be problematic because of the extremely thin laminatio ns. 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 woul d be recouped over lower sales volumes by small businesses. Product redesign costs tend to b e fixed and do not scale with sales volume.12-46

At TSL2, all designs would have to be mitered. Thi s could constrain the core-mitering resources of small businesses that share core-cutti ng 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 o n 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 con solidated 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 i mpact on small businesses is expected to be less in moving from TSL1 to TSL2 (as opposed to mov ing 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-Ty pe Superclass
More than one-half of the customers for medium-volt age, dry-type transformers consider efficiency when purchasing transformers. A sizeabl e portion of the market is evaluating losses and making rational economic judgements in purchasi ng transformer products. With this in mind, it is significant to note that about one perc ent or less of the market chooses to purchase transformers that meet TSL3 or above. Conversion capital expenditures in the medium-volta ge, 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 full-time equivalent core-mitering machines are req uired 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-cutti ng equipment capable of making mitered cuts. At TSL2 and above, 100 percent of medium-vol tage, dry-type transformers would be produced with core-mitering equipment. The core-cutting time per transformer, and conseque ntly the number of core-mitering machines required by the industry, increases with i ncreasing 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 lam ination thickness. The Department accounted for these two factors in estimating the increases i n core-cutting equipment required at each TSL. It estimated that total equipment capital expenditures for the industry would be $3.2 million, $5.9 million, $7.4 million, $7.5 million, $15.0 million, and $15.0 million for TSL1 through TSL6, respectively. Product conversion expenses for the medium-voltage, dry-type superclass would be negligible at TSL1 and TSL2 because products meetin g these levels are produced in relatively large volumes today. Above TSL2, product conversio n expenses would become more significant. The impact on INPV at TSL5 and TSL6 would range between -53 percent and -6 percent. The impact on INPV at TSL4 would range between -24 percent and -12 percent. The impact on INPV at TSL3 would range between -22 percent and -1 6 percent. In the preservation-of-gross-12-47

margin-percentage scenario, impacts above TSL3 decl ine with increasing TSL. This is because the incremental conversion costs above TSL3 are sma ll 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-operat ing-profit scenario. Net annual cash flows would go negative during the compliance period, irr espective 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 half that 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 tw ice that of the positive base case cash flow. For some of the medium-voltage, dry-type design lin es, the cost-effective designs at TSL4 would require laser-scribed, domain-refined, H-O co re steel. In the U.S., this steel is only manufactured by one company. H-O is also manufactured in Japan, but steel imports from Japan are subject to import duties, providing a productio n cost advantage to foreign transformer manufacturers. The cost-effective designs at TSL3 would likely rely on M3 core steel and copper windings. TSL3 would therefore not have the same s upply chain constraints as TSL4. At TSL2, the impact on INPV would range between -13 percent and -10 percent. At TSL1, the impact on INPV would range between -8 per cent and -6 percent. The impact on annual net cash flow from capital expenditures duri ng the compliance period would be greater for TSL2 than for TSL1. At TSL2, the net annual ca sh 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 fo r 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-eff ectively 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 standard: 1. If the medium-voltage, dry-type standard is set l ow relative to that for liquidimmersed transformers, there could be a switch to m edium-voltage, dry-type transformers for certain products where there is su bstitutability between the two superclasses. For otherwise equivalent transformer s, the TSLs are less stringent for medium-voltage, dry-type transformers. 2. According to some manufacturers, pushing the medi um-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 lo ng 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 produc e transformers at TSL2 or TSL3.12-48

1. McKinsey & Company, Inc. Valuation: Measuring and Managing the Value of Companies, 3 rd

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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