Price-Responsive demand, EPA regulations, and merger policy will be on the agenda for the coming year as the Federal Energy Regulatory Commission works its way through the list of key cases that...
New DOE rules mandate more efficient (and expensive) equipment.
demand from customers buying non-compliant designs before the Jan. 1, 2010 date. Whether their expectations prove correct will depend in part on how utilities approach their compliance activities.
Changes required by the new DOE rule mean many utility procurement professionals soon will be engaging in a sourcing effort for distribution transformers. Traditionally, the sourcing process involves reviewing the business and market conditions using a construct like the Porter’s Five Forces model. Utility procurement professionals sourcing distribution transformers face daunting market forces that all seem to be arrayed against them.
Supplies of raw materials needed to comply with the new rules are constrained. Raw materials required for manufacturing distribution transformers, such as magnet wire, strip aluminum, transformer oil, and core steel, are in scarce supply globally. Consequently, prices of raw materials and fuel have reached unprecedented levels. Over the past several months, scarcity of these raw materials, coupled with increasing demand, has driven transformer prices upward.
Furthermore, compliance with the DOE rule will require additional quantities of raw materials in the new designs, and the shortage of these materials, combined with the limited plans for development of additional supplies, strains the ability of the transformer manufacturers to diversify their supply base.
Most (if not all) of the resulting cost increases eventually will be borne by the utility buyer. Manufacturers of transformers already have addressed higher commodity prices with their customers and in the past two years, many have established pricing contracts with a similar structure consisting of a base price and a variable surcharge adjusted on a periodic basis to account for raw materials costs. There is limited flexibility in pricing for utility buyers, and future price trends are affected by multiple factors.
For example, in April, steel futures began trading on the London Metals Exchange, and other exchanges are expected to soon follow. Steel is one of the most heavily traded commodities by value in the world, and some market participants worry that the changes accompanying futures-markets trading will push up future steel prices. Likewise, costs to transport and ship any new product also will increase because of higher fuel costs—a significant factor for distribution transformers, which can weigh more than a ton.
Additionally, it’s unclear whether transformer manufacturers can or will expand their production capacity.
Suppliers for distribution transformers interviewed for this article did not expect to see significant increases in the volume of orders as a result of the new rule. Additionally, the slow-down in the economy (particularly new housing starts) might discourage some manufacturers from being aggressive in adding new manufacturing capacity for distribution transformers.
The result for utility buyers could be high prices and limited room for negotiation. Distribution transformers are must-have items for utilities, yet existing budgets only will accommodate a finite amount of cost increases. The DOE, in its manufacturer impact assessment, expected utilities might manage higher costs by reducing proactive replacement programs ( i.e., replacing units only upon failure), reducing inventory costs by procurement of multi-voltage (primary) distribution transformers, and selecting slightly lower kVA ratings.
A major U.S. electric utility commissioned