Getting Equipped: No Single Bullet Wounded the World Transformer Market

By Kathleen Davis, associate editor

The power industry buzzes with talk of transformer prices. Sometimes, the issue gets laid at the feet of the metals industry; sometimes not. It depends entirely on whom you ask.

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So, bottom line: What wounded the transformer market? Is there a single reason for the rise in transformer costs?

According to our experts, it’s more an amalgamation of issues rather than a single silver bullet–or, a single steel bullet. Steel prices might be getting the blame, but they aren’t the only culprit.

“Transformer prices have risen for both demand and manufacturing input cost reasons,” said Gerry Yurkevicz, managing director in Global Insight’s worldwide Energy Group. “Global Insight views transformer prices as a function of both production costs and market activity, where costs are assumed to exert the dominant influence over transformer prices through time.”

So, yes, the steel prices figure in the equation. But, other factors exist: the increasing price of other metals, the rising demand for those metals in other industries, increased economic growth in the Middle East and Asia and the increased power demand that creates (let alone the increased demand on the aforementioned metals)–as well as the immediate and demanding need for some utilities to replace older transformers that have served well past their limitations.

The factors wind together and intertwine without a real single cause to be pulled from the mix. But, however many and varied the causes, the single result remains: a very costly transformer that’s very, very hard to get.

“Based on my conversations with member companies, the market is very expensive and very tight,” stated Steve Rosenstock, energy solutions manager at the Edison Electric Institute. “Lead times to obtain transformers, especially larger ones, have tripled or quadrupled over the past five years. Prices for transformers have skyrocketed well above the rate of inflation.”

Stats, Data and a Trip to the Other Side of the Globe

To get an idea of how metal prices, increased Asian economic demand, and other factors might be impacting the transformer market, we need to first get a grasp on the market itself–from large transformers down to the distribution variety.

According to Chuck Newton at Newton-Evans research, for size ranges of 2 MVA and larger, the global sales of large transformers was running in excess of $2 billion in 2005, and the annual growth rate since 2005 has topped 10 percent. The North American region accounted for about $400 million of that $2 billion slice. (In terms of units, that’s about 8,600 units worldwide, with 1,900 units in North America.)

Chuck Newton tells us that the “market range estimates from multiple sources indicate current annual global power transformer sales range from $14 billion to $20 billion.” But that’s for the whole shebang. When taking in just the 2 MVA slice from 2005, Newton figures in a range of $2.5 to $2.9 billion for that market these days–an expansive growth of 25 percent to 50 percent of the original 2005 market value.

China, Mexico, Sweden and Germany are the biggest exporters of large power transformers with the U.S., Mexico and China being the biggest importers of large power transformers.

According to Newton, “The Far East appears to be the largest market this year for very high end transformers.”

In fact, demand from the Far East is a leading factor in the great gray area of transformer cost causes. It figures prominently into the transformer market equation for many of the experts interviewed for this article, including Rosenstock, and on both the materials side and the end-product side of the equation.

“There are several reasons [that transformer prices have skyrocketed], but the main reason that I have seen is the explosion in demand for commodities and economic transformation in developing countries in Asia and the Middle East, where economies are growing at 8 percent to 10 percent plus per year,” Rosenstock said.

Yurkevicz agreed on both the prices and Asian demand factor, saying that their market analysis suggests a 60 percent increase in overall transformer prices from 2001 to 2007–or more than 8 percent per year. But, that’s the overall average; according to Yurkevicz, slices of the power equipment market have increased far more.

“These price increases resulted from worldwide demand increases over the same period of over 5 percent annually and cost increases for the bundle of labor, materials, and capital inputs needed to produce transformers of over 6 percent annually,” he said.

He continued, “As everyone is well aware, input cost increases for manufacturing materials and commodities, such as steel, copper, and aluminum, have risen greatly over this period, driven by worldwide market demand. China’s economy alone expanded by 81 percent from 2001 to 2007 vs. just 17 percent for the U.S.”

That’s the materials side of the equation. Rosenstock also presented an “end-result” glimpse of how growing Asian and Middle Eastern economies are impacting prices.

“In terms of transformers, overseas demand has been exploding. For example, I have seen news reports that over 10 percent of the world’s cranes are located in Dubai. All of those high-rise buildings need electricity and transformers,” he inserted.

According to Rosenstock, this particular factor–we’ll call it the modernization factor–stretches all the way back to 2002 or earlier.

“Ironically, at a time when commodity prices were below their historic averages. Copper was about $0.70 per pound, and, historically, it had been about $1.10 per pound,” he commented.

But when that modernization factor began to butt up against those already rising commodity prices–well that particular template started quite the pricing fireball.

A Peek at Metal Prices

“There is a direct relationship between steel, copper, aluminum, and other prices and the price of transformers, since they are made up of cores and coils and any outer protection,” Rosenstock said.

Yurkevicz added, “Material cost for such inputs as core steel, enclosure steel, copper wire and strip, and aluminum wire and strip represent over 70 percent of the cost structure.”

“The replacement costs of new transformers are increasing significantly,” agreed William H. Bartley, P.E., an electrical specialist with Hartford Steam Boiler. (Hartford Steam Boiler is one of the largest equipment-breakdown insurers in the industry, especially of transformers.) But, he disagreed with Rosenstock and Yurkevicz that metal prices, especially copper, are such a high percentage of the end-result transformer costs. “Some people have blamed this price increase on the increase in the price of copper. My response has been this: The total cost of copper content in a transformer is small, and a copper price increase would be insignificant. For example: If the copper in a transformer is 10 percent of the cost, and copper prices double, the cost of the total transformer would only go up 10 percent. Likewise, if the copper cost in a transformer is 20 percent of the total, and copper prices double, the cost of the total transformer would only go up 20 percent. But, we are seeing transformer costs increasing by 200 percent to 400 percent.”

So, if copper isn’t the issue, could it be steel? Could it be both? Could demand play a significant factor not just directly into the market of transformers but also into the immediate area of raw materials?

Indeed, as both Rosenstock and Yurkevicz pointed out, the power industry isn’t the exclusive user of these metals, and increased demand inside our market, paired with a steady or also increasing demand outside of our market, can only lead to more issues with pricing the commodities required to mold a good transformer.

Tom Stundza, executive editor of Purchasing Magazine, provided a glimpse at the market for electrical steel specifically. He authors the magazine’s “Steel Flash Report,” a monthly online update on the steel market. Like the overall issue with transformer prices, steel prices are a mixed bag. It’s not just the raw material cost. It’s the production costs, the surcharges and the demand all mixed together.

Stundza laid it out simply, “Purchasing of electrical steel had gone through three years of decline before it rose 2 percent in 2004 and increased 2 percent again in 2005 before an explosive 8 percent growth in 2006. In 2007, buying has been on a pace to improve by 1 percent to 444,000 net tons, based on nine-month market data.”

When asked if steel prices have skyrocketed, Stundza didn’t agree with that terminology. Instead, he gave us an explanation of the layering of steel prices and how the real problem lies in a mill hedging its bets.

“Silicon electrical steel prices haven’t really skyrocketed,” he said. “Pricing depends on the grade of steel, of which there are a few dozen based on their electrical conductivity. The mills want an average $70/ton in increase on early 2008 shipments to offset higher production costs. It is the alloying-metal surcharges atop the purchase-order prices that have exploded. Just as stainless steel mills want to offset nickel costs with their surcharges, the electrical steel mills want to offset their silicon costs. That metal cost $0.92 per pound in January 2007 but now is around $1.55.”

According to Stundza, this increase in steel prices–or, specifically, steel surcharges–began in December 2003 in reaction to October 2003 raw material purchase prices, alloy purchase prices, energy costs, and production, leading to overall steel prices that could be characterized as “high and volatile.”

He added, with a touch of hope, “The costs will remain elevated this year, but the analysts believe the sharp increases seen in recent years may dissipate.”

Whether or not prices stop rising so sharply in line with analyst predictions, Stundza pointed out that certain manufacturers are expanding early in anticipation of even more rising domestic demand attributed to aging transmission equipment. In fact, American steel manufacturer AK Steel has plans to expand capacity to make an additional 335,000 tons/year of electrical steel. They noted the replacement of transmission equipment as a factor in the expansion.

Will the Real Culprit Please Stand Up?

So, we have steel prices and other metal prices rising. We have the modernization factor, and, as the note about AK Steel pointed out, both of those existing factors will be impacted by yet another factor: aging equipment that needs to be replaced by an industry traditionally rather unable or unwilling to do so.

Bartley with Hartford Steam Boiler explains: “Over the last 20 years, the utility industry has been in a capital investment doldrums. Consequently, the worldwide transformer manufacturing capacity has been shrinking. Many U.S. transformer factories have closed their doors, or sold out to competitors.

“In the last year, however, the global utility industry (including China) is now investing in power. Today, we live in a global capital environment. In supply and demand economics, two things have occurred: the demand has increased globally; and, at the same time, the supply (the number of factories in the world) has decreased. The result is a significant increase in the equilibrium prices.”

Will the market adjust for this? Absolutely. But, Bartley points out, it will take some patience.

“As the suppliers catch up to this new demand, we may see transformer prices fall again, and delivery times improve. But that is not going to happen overnight. If the demand remains stable, it will take several years for the suppliers to catch up,” Bartley said.

Rosenstock isn’t sure if that market will stabilize at all, however. There are other factors at play, he said, including a U.S. DOE rule that mandates efficiency standards for liquid-filled distribution transformers to take effect Jan. 1, 2010.

“These rules could have an effect on transformer prices, since more efficient transformers tend to use higher grades of steel and copper,” he added. This, of course, loops us back to increased metal prices again.

Rosenstock agrees with Bartley, but, again, brings increasing demand back into the equation.

“It really depends on overseas demand,” he said. “If demand for transformers overseas keeps growing at a 10-percent-plus per year pace, then the market will still stay tight, and prices will keep rising or stay at their current plateau.

“If there is an overseas “Ëœbubble pop’ effect with commercial construction, and building/electric demand suddenly stops growing, then there may be some price relief in the U.S.”

Whether you focus on Rosenstock’s “pop” hypothesis or Bartley’s leveling philosophy, one thing remains clear: High transformer prices will stick around for awhile. And that’s just the way it is, according to Yurkevicz. In fact, Global Insight predicts an annual price increase ranging from 1 percent to 3 percent over the next five years.

“We wish that Global Insight could send a message that transformers will become “Ëœmore affordable,'” he said. “However, the message that we can deliver is that prices should increase less in the future. High prices are here to stay. Utilities will continue sourcing in a high-cost transformer market.”

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