The Trouble with Transformers and Other Tales of Supply Chain Woes
Episode ID S3E05
May 24, 2023
Transformers of all types are now harder for utilities to source, delaying everything from infrastructure for electric vehicles to building new homes. In response, buyers and sellers are both changing the way they do business. Hear more from buyer Peter Muhoro of Rappahannock Electric Cooperative, the nation’s third largest electric co-op, and seller Tim Mills, the president and CEO of ERMCO, a transformer manufacturer.
Peter Muhoro: I would say that supply chain continues to be a challenge in terms of the things that we got comfortable being able to get. When it comes to the challenges of what we're seeing, it's all across the board with transformers probably being some of the hardest to get. Some of them, depending on the size, you may be talking three to four-year timeline.
Teri Viswanath: That was Peter Muhoro, chief strategy, technology and innovation officer for Rappahannock Electric Cooperative, a member-owned cooperative that provides electric service to nearly 170,000 connections in portions of 22 Virginia counties. For this podcast, Peter speaks candidly about his co-op supply-chain challenges. Rappahannock orders that used to arrive in a matter of weeks are now are taking years.
Hello, I’m Teri Viswanath, the energy economist at CoBank and your co-host of Power Plays. I caught up with Peter and Tim Mills, the president and CEO of ERMCO at the NRECA TechAdvantage conference back in March and thought that the conversation, between a large co-op buyer – in fact, the country’s third largest electric distribution utility – and its manufacturer should be shared. ERMCO is a subsidiary of Arkansas Electric Cooperative, and manufactures single-phase and three-phase electrical transformers at its headquarters facility in Dyersburg, Tennessee. Rappahannock is one of their many buyers.
Today, you are going to hear about supply-chain troubles from both a buyer and a seller perspective. As always, I’m joined for this discussion, with my colleague and co-host, Tamra Reynolds, a managing director at CoBank. Hello Tamra.
Tamra Reynolds: Hey, Teri.
For most of us, the experience of supply-chain bottlenecks emerged during the COVID-19 pandemic lock downs. We all shared the experience of empty shelves, making compromises on what we bought and having to take additional steps like driving that extra 15 or 20 miles or maybe making online purchases to source basic necessities.
This experience continues for utilities, where the uncertainty of knowing when essential supplies will show up – and at what cost. And it’s changing how electric cooperatives are approaching supply management.
No doubt, the pandemic dislodged the global supply chain. And while parts of the supply-chain system are seeing signs of improvement, we’re not out of the woods yet. Obstructing most major utility projects at the moment is the razor-thin level of essential equipment and component supply. Co-ops are really feeling the pinch with distribution transformers – which are necessary for both the ongoing reliability of the existing grid and for community growth.
Viswanath: Tamra, what was really fascinating to me from our conversation with Tim Mills at ERMCO is that he actually noted that the supply-chain problem pre-dates the pandemic. But, the prevailing health guidelines, social distancing… well, they significantly widened the cracks in the system. Here is that exchange with Tim.
Viswanath: You pointed out, it's not just COVID and the work stoppages that occurred, but this probably predates COVID.
Tim Mills: I think that's exactly right. If I look back at ERMCO's production volume going back to 2016, that's where we started to see a pretty significant spike. Think back into 2008 and 2009, the housing bubble hits, demand for transformers actually plummeted. Then it started to slowly recover and it tracked very, very nicely with housing starts.
What I'm seeing right now is a significant change in demand patterns. The reason I know it's not housing is because I'm selling a heck of a lot more transformers today than I did at the housing peak of 2008 and 2009. What is it? Well, our view, it's certainly the aging infrastructure, the average transformer is well over 30 years old out in the field. That's past its useful life. If you have 50% that are past their useful life, you're going to start seeing an increase in failures.
I believe personally it's aging infrastructure, it's grid hardening. There's been a lot of investment by both state and federal governments to ensure that the grid is prepared for the demands that are coming down the path.
Certainly, putting renewables more and more onto the grid, and in that final mile, due to electrification of just about everything, whether it's EVs or heat pumps or stoves, these are all major developments and demand drivers.
The final one is our natural disasters. It's hard to ignore the fact that the number of billion-dollar incidents on an annual basis has doubled from 2012 to 2017 versus 2017 to 2022. Used to be 10 a year, now it's 20 a year. That's a big deal, and because each one of those billion-dollar incidents is going to take out transformers. There's a whole bunch of things will disrupt the distribution grid. That's not just transformers, it's all products.
Reynolds: Tim emphasizes a host of demand-side factors that have contributed to the current tight markets that co-ops are dealing with. But, beyond pent up demand, there are also larger macro-trends at play. Domestic manufacturing in general, but transformer manufacturing specifically, has been substantially reduced by offshoring and international competition. The remaining eight U.S.-based manufacturers satisfy only about 20 percent of the transformer market. And because the nation has been squeezed out of global trade, there are challenges with expanding the domestic manufacturing footprint because there is a finite pool of skilled laborers. Tim emphasized this point of limited ‘spare capacity’ in the system. Then there is the BABAA requirement playing into the equation now.
Mills: This isn't about production going down, this isn't about manufacturers not being able to do what they've done in the past. This is around a significant change in need.
Because of that, what we experienced in the past in terms of performance coming from the supply chain or from the supply base just isn't going to be there. Why? Because we don't have the factory capacity to put out that kind of output. Now, is it incumbent upon us to build that? Yes, it is, but that doesn't happen overnight.
Viswanath: I want to focus in on Tim’s comment about the ‘supply base’. A key factor limiting domestic transformer production is the availability of transformer component materials, particularly grain-oriented electrical steel, a specialty metal required for transformer cores. And, there is just one U.S. manufacturer of this specialized steel. Understanding supplier dependencies and vulnerabilities is becoming increasingly important. We talked to Tim about this.
There was a Deloitte study that came out that talked about visibility. From a buyer visibility having tier-one, which is, "I know my manufacturer." Well, that's great, but beyond that, there is these tier-two, the suppliers to you guys, and then beyond that tier-three, which are the raw materials. We talked a little bit about the steel and the raw materials here, but most buyers don't have much visibility beyond tier one. I think as you were thinking about making sure you can grow your company from the place that you're at today to really that strong, aggressive growth by 2025 I think you talked about reinforcing, making sure that you could see line of sight of problems along the chain.
Mills: Yeah, that’s a very good point. As a matter of fact, about three or four weeks ago, we convened our top 100 suppliers in Nashville and we talked to them about our growth plans. We laid out our vision and the ramp plan that we saw as possible within the ERMCO enterprise, and we challenged them to be able to ramp up with us. Now we have all of these collaborations.
There were certain suppliers, no problem, they had absolutely excess capacity and they're going to be able to keep up with this. There's others where it's going to be a little bit more challenging. Working with them on investing within their plants in order to be able to keep up with our growth is going to be paramount. We see those types of partnerships happening.
Conversely, I could look the other way as well. I could look towards my customer base and saying the kind of communication and the conversations we're having with them today is really now all about planning for 2026. We're planning for 2026. That's unheard of, and so working with customers three years out to understand what their needs are going to be so we could go ahead and get that locked into place and we can make sure that our supply chain is capable of delivering to those levels of transformer production, or that level of transformer production is really what we're working on right now with our closest customers.
Reynolds: ERMCO also made a strategic decision on how best to streamline that customer collaboration, which Tim discussed with us.
Mills: One of the big changes that we made at ERMCO was flipping from working directly with end utilities and starting to work through the nine EUDA distributors, particularly in the co-op segment. We find this to be a much more efficient model for us. We can consolidate purchases, we can minimize the numbers' points of contact, and we could allow those distributors to stock inventory to better buffer and better meet the needs of the co-op community in general.
In addition to that, it allows us to have some more direct interactions. Right now we are conducting our first quarterly business reviews, which is each of these nine distributors. You could only imagine what that would look like if we were trying to do it with hundreds of and customers. It would be impossible to get that level of intimacy and insight coming back from the customer base, but by using distribution, we could collaborate better and hear from the masses through their voice.
Reynolds: I want to expand on Tim’s discussion about the importance of collaboration but from a slightly different angle. Rappahannock’s Peter Muhoro discusses the importance of breaking down internal silos, when it comes to supply-chain management, so that ‘material management’ is a shared responsibility within the cooperative and not just the responsibility of the warehouse manager.
Muhoro: For us, specifically, what we did is we did create a specific tool that allows us to manage jobs based on materials a little bit different than what we're doing. That was an in-house tool that we stood that up pretty quick. It wasn't so much the tool but the people we got in the room to evaluate this. Now all of a sudden in the days where your operations and construction and your engineering and your procurement may be worked independently, now we have all of them, including our fiber folks, everyone in there. Let me just add on, including folks like communications as well, so that they're aware of what's happening.
The magic bullet to me is who do you get together? While digitalization of inventory, and digitalization of your systems, in general, is becoming more and more critical, and in fact being able to automate some of this, I think the bigger piece of it is how you bring it all together. What we've seen is a successful way of these teams working together where now procurement, for example, has a much better insight of what they need to be thinking about. They're making calls left and right because now they've seen what the jobs look like versus, "Oh, now I've got my staking sheets, I can order the equipment."
Now they're hearing to say, "In six months, we know this is what we're going to need." Now they're calling and saying because, at this point, the reality of it is when you had your preferred vendors, now you're just looking for a vendor who could supply. It's created this environment of collectively planning which unfortunately it's a supply chain crisis that brought us to be able to work together but I guess that's the result and the positive side of it is we're able to get people working together to provide even better results. In fact, we're going to continue to do that regardless if we ever fix the supply chain crisis. That's the way we're going to continue our planning in the future.
Viswanath: In the long run, having more co-op staff involved in the process will undoubtedly pay off. Peter goes on to explain how managing costs is everyone’s job at the co-op.
Muhoro: It's unbelievable what we've seen. In some places, in some areas such as transformers, we've seen a 200% increase in the past of what it used to be. Some even a 300% increase. It's the reality of what we're facing every day in terms of system costs have gone up.
What it has made us do is actually stop and think about maybe what can we reuse. It used to be the things like bolts and nuts you never really thought about reusing them necessarily but maybe from, and I go back to what our mission is, affordable, reliable, safe, and sustainable energy solutions, maybe it just allowed us to really push on this sustainability piece a little bit more, where if there are things that we can reuse to the best that we can, why not? It also has made us think about our planning.
In one aspect, we've had this supply chain and the cost and everything that have really put us in a bind but at the same time, it said, "Maybe it slowed us down a little bit," which may not be a bad thing when I begin to think about I need to consider system upgrades as I think of the growth, especially when we think of electric vehicles. Maybe I may need to buy a bigger transformer. Maybe by having this delay, it allows me to really think twice and say, "You know what, maybe this area, instead of putting that 15 kVA transformer, maybe I need a 25 kVA, or maybe I need to go 37.5 kVA. Now all of a sudden it's made us actually be able to stop and think a little bit differently.
I have to say, the big thing that we've gotten out of supply chain crisis is actually how you think about your utility planning. We've traditionally done a very static type of planning where your engineering work plan, put on the shelf and you execute, over the next three or four years, great, wonderful, you move on.
Today we're having to think of it more dynamic. Using data to help us understand how we do our planning, what's happening on supply chain fits in into that equation. You look at the data. You say, "Well, maybe this is how we need to plan ahead. Maybe this is what we need to order ahead." There is a silver lining beyond it, but it is a painful message that we have to tell our members that this is where the costs have gone.
Reynolds: On the basis of the conversations we’ve had over the past year, it’s apparent that the supply-chain issues are not going away anytime soon. In fact, to mitigate far-reaching impacts, the power sector will likely need to adopt new, holistic approaches. Developing resilient supply chains will require a cohesive supply chain management strategy. That’s Peter’s take on the problem.
Muhoro: While I don't know if it's here forever, but I think it's here to stay for a while, and what we now have to think about is not how we mitigate the supply chain crisis but how we adapt to living through the supply chain crisis, and how we adapt to it and how we create processes and procedures to align ourselves with where we need to be as we think of the future, and I think if anything else, it will make us stronger utilities and be stronger co-ops to serve our membership.
Viswanath: Peter identified a novel, whole-team approach to planning but he also spoke to us about known problems that can derail safe levels of stocking—namely the response to storm activity. Severe weather is the single leading cause of power outages in the United States. Utilities have long engaged in storm preparation, response planning, and readiness. But how does this change, given supply-chain constraints? This is what Peter had to say.
Muhoro: Last year on our very first business day, we had a once-in-a-lifetime storm, which by the way, two weeks later, we were being threatened with a similar storm coming our way. You are right, the once in a lifetime storms or the 100-year storm is no longer the case anymore, and the frequency of them, we know will just continue to increase. What it's forced us to do is really evaluate how we do our everyday business from a growth, a system maintenance, and then thinking of storm. One of the things we've actually done is, we actually have a separate storm warehouse.
Now we're not hoarding materials, it's the same materials we would've had in our regular warehouses. What we wanted to do is just create a much easier process to focus on saying, here's where we know the storm materials, and then we had to begin to predict and say, how much of that do we need to add on based on the storms that we had?
Last year on that one storm, we had nearly 700 poles broken that we had to replace. When you've got a lead time on poles, if you've not planned ahead of time, now yet again, that was a once in a lifetime event that we had a threat a few weeks after. Thankfully, we didn't have the same experience. You have to create strategies like that where you say, maybe let me separate my materials so that in my mind I can have a better grasp on what will it look like for storms.
I can actually begin to model and say, if this is the weather patterns that I see, what can I expect, and if I know where that's going to happen, I can also look at my infrastructure and begin to say, well, I've got a lot of old poles in that area, for example. Then I can already begin to project that I'm going to need more because of that specific. That's how all this ties in, but I think having just a separate storm warehouse was something that we recognize, gave us a little bit more insight into knowing we're truly prepared for a storm or not. While I wouldn't say we've necessarily added more for storms, we have added a little bit more with our projections of how bad the storms get, but it's primarily allowed us to have a better visualization of what a storm restoration would look like and understanding how supply chain could affect that piece of it specifically.
Reynolds: So, if lean inventories will continue to plague the industry, how do we best work together to keep the lights on?
Muhoro: The supply chain crisis may have caused you to shift a little bit and you know what, it forced people to maybe change a little bit, but I would say a consideration to really address these issues as we move forward is, how do you position your workforce to really be prepared for these type of changes, and how do you position them to give them the right tools to be able to make these decisions, because you can have the right folks without the right tools, they can't get there.
I'll use Jim Collins, having the right people on the right seat on the right bus and the bus moving. It's the whole idea of how do you position all that. If you can get your workforce there, I think that's the last missing piece that brings it all together for success.
Mills: I would say, don't lose hope, don’t lose hope. I think, as I've seen from other pieces of our industry, certainly through my competition, the commitment to step up and rise to the challenge is there. Again, we might not be able to turn on a dime, and we might not be able to give you everything that you need next month or even next year, but we are going to continue to work tirelessly as a supply base to meet the needs of the utility industry.
We know that it's way too important to the United States of America not to have a reliable grid, and it's our responsibility as a key portion of that chain to produce as much as we possibly can. Don't lose the faith, things are going to get better because we're working tirelessly to make sure that that happens.
Reynolds: These gentlemen provided a terrific overview of the challenges the energy industry faces and are hopeful about how all of us will step up to meet that challenge. I hope you’ve enjoyed this program and will tune in next month as we pivot to a very different set of problems facing electric co-ops.
Viswanath: That’s right, we are going to tackle both emerging physical and cyber-security threats. That is, the recent spate of attacks targeting electrical substations, and how utilities have emerged as the primary targets for cyber-security.
Reynolds: Bye for now.