[Senate Hearing 108-572]
[From the U.S. Government Publishing Office]
S. Hrg. 108-572
THE PROPOSED LEASE OF 100 KC-767 AERIAL REFUELING TANKER AIRCRAFT BY
THE U.S. AIR FORCE
=======================================================================
HEARING
before the
COMMITTEE ON ARMED SERVICES
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 4, 2003
__________
Printed for the use of the Committee on Armed Services
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COMMITTEE ON ARMED SERVICES
JOHN WARNER, Virginia, Chairman
JOHN McCAIN, Arizona CARL LEVIN, Michigan
JAMES M. INHOFE, Oklahoma EDWARD M. KENNEDY, Massachusetts
PAT ROBERTS, Kansas ROBERT C. BYRD, West Virginia
WAYNE ALLARD, Colorado JOSEPH I. LIEBERMAN, Connecticut
JEFF SESSIONS, Alabama JACK REED, Rhode Island
SUSAN M. COLLINS, Maine DANIEL K. AKAKA, Hawaii
JOHN ENSIGN, Nevada BILL NELSON, Florida
JAMES M. TALENT, Missouri E. BENJAMIN NELSON, Nebraska
SAXBY CHAMBLISS, Georgia MARK DAYTON, Minnesota
LINDSEY O. GRAHAM, South Carolina EVAN BAYH, Indiana
ELIZABETH DOLE, North Carolina HILLARY RODHAM CLINTON, New York
JOHN CORNYN, Texas MARK PRYOR, Arkansas
Judith A. Ansley, Staff Director
Richard D. DeBobes, Democratic Staff Director
(ii)
C O N T E N T S
__________
CHRONOLOGICAL LIST OF WITNESSES
The Proposed Lease of 100 KC-767 Aerial Refueling Tanker Aircraft by
the U.S. Air Force
september 4, 2003
Page
Roche, Hon. James G., Secretary of the Air Force................. 34
Wynne, Hon. Michael W., Acting Under Secretary of Defense for
Acquisition, Technology, and Logistics......................... 47
Kaplan, Joel D., Deputy Director, Office of Management and Budget 50
Curtin, Neal P., Director for Defense Capabilities and
Management, U.S. General Accounting Office..................... 132
Sunshine, Robert A., Assistant Director for Budget Analysis,
Congressional Budget Office.................................... 145
Nelson, J. Richard, Ph.D., Assistant Director, Cost Analysis and
Research Division, Institute for Defense Analyses.............. 162
(iii)
THE PROPOSED LEASE OF 100 KC-767 AERIAL REFUELING TANKER AIRCRAFT BY
THE U.S. AIR FORCE
----------
THURSDAY, SEPTEMBER 4, 2003
U.S. Senate,
Committee on Armed Services,
Washington, DC.
The committee met, pursuant to notice, at 9:35 a.m. in room
SH-216, Hart Senate Office Building, Senator John Warner
(chairman) presiding.
Committee members present: Senators Warner, McCain, Inhofe,
Roberts, Allard, Sessions, Collins, Chambliss, Levin, Reed,
Akaka, Bill Nelson, and Clinton.
Also present: Senator Patty Murray.
Committee staff members present: Judith A. Ansley, staff
director; and Kenneth Barbee, security clerk.
Majority staff members present: William C. Greenwalt,
professional staff member; Carolyn M. Hanna, professional staff
member; Ambrose R. Hock, professional staff member; Gregory T.
Kiley, professional staff member; Patricia L. Lewis,
professional staff member; Thomas L. MacKenzie, professional
staff member; and Scott W. Stucky, general counsel.
Minority staff members present: Richard D. DeBobes,
Democratic staff director; Creighton Greene, professional staff
member; and Peter K. Levine, minority counsel.
Staff assistants present: Andrew W. Florell, Michael N.
Berger, and Sara R. Mareno.
Committee members' assistants present: Christopher J. Paul,
assistant to Senator McCain; John A. Bonsell, assistant to
Senator Inhofe; Jayson Roehl, assistant to Senator Allard; Arch
Galloway II, assistant to Senator Sessions; James P. Dohoney,
Jr., assistant to Senator Collins; Lindsey R. Neas, assistant
to Senator Talent; Clyde A. Taylor IV, assistant to Senator
Chambliss; Christine O. Hill, assistant to Senator Dole;
Russell J. Thomasson, assistant to Senator Cornyn; Mieke Y.
Eoyang, assistant to Senator Kennedy; Elizabeth King, assistant
to Senator Reed; Davelyn Noelani Kalipi, assistant to Senator
Akaka; William K. Sutey, assistant to Senator Bill Nelson; and
Andrew Shapiro, assistant to Senator Clinton.
OPENING STATEMENT OF SENATOR JOHN WARNER, CHAIRMAN
Chairman Warner. Good morning, everyone. The committee
meets to receive testimony on the proposed lease of the 100 KC-
767 tanker aircraft by the United States Air Force. Pursuant to
Section 133 of the National Defense Authorization Act of 2003,
to establish guidelines for congressional review of this lease,
the administration has submitted to the congressional defense
committees a new start notification for this lease of 100
aircraft. Only if all four committees act favorably on the
notification can the Air Force and Department of Defense (DOD)
proceed with the lease.
When my distinguished colleague Senator Levin was chairman,
he indicated that a hearing was appropriate. Now that I am in
the chair, I concur in his judgment, and therefore this hearing
is jointly called by the ranking member and myself.
We were also urged by other members of this committee to
have this hearing to help inform the committee's consideration
of this lease proposal. We are pleased to welcome today's
witnesses on the first panel: Secretary of the Air Force Jim
Roche; Acting Under Secretary of Defense for Acquisition,
Technology, and Logistics Mike Wynne; and Deputy Director of
the Office of Management and Budget Joel Kaplan. I look forward
to your testimony and the testimony of our second panel of
distinguished witnesses, which I will announce later.
This proposed tanker lease is a departure from the
traditional acquisition process and has been the source of, I
think, very important debate within the Senate and within the
administration over a period of some 2 years. One point in the
debate is eminently clear. It is vital to the national security
of the United States that we have a robust aerial refueling
capability. Tanker aircraft enable our forces to project
military power around the world and are critical to our success
in Operations Enduring Freedom and Iraqi Freedom. Far into the
future the United States will require a fleet of aerial tankers
to protect U.S. national security interests by extending the
range of our fighters, bombers, lift, and surveillance
aircraft.
The chiefs of all of the Services have personally
communicated with me, I think in a most appropriate way, their
concern for the need that this issue be addressed and somehow
these tankers be acquired by this country.
So the issue today is not whether to replace the tanker
fleet, but when and how and through what mechanism. The Air
Force proposal, really the Department of Defense proposal
because it has the concurrence of the Department as a whole, so
the DOD proposal that we have before us today to lease 100 new
tanker aircraft, is only the first step. The Air Force must
come up with an integrated plan for the overall
recapitalization of the 600-plus aircraft in the tanker fleet.
Well over $100 billion will be spent to modernize and
maintain this fleet over the next 2 decades. Decisions made in
the course of the deliberations on this issue will either cost
or save the American taxpayers billions of dollars. We have an
obligation to the taxpayers to very carefully assess this
issue.
While there is disagreement about the costs of leasing
these 100 tankers versus the cost of buying them, there is
agreement that this lease will indeed cost more than an
outright capital purchase of the fleet. But for this added
cost, the Air Force will receive these aircraft into the fleet
earlier. That is the pivotal decision, as to whether or not the
added costs justify the military requirement of receiving this
fleet at an earlier date. Is there such an urgent and
compelling case to be made for these aircraft that would
justify incurring an additional expense on the American
taxpayer? That is a pivotal question.
How does this lease comply with the terms of Section 8159
of the Department of Defense Appropriations Act of 2002, which
requires the lease be an operating lease that meets the
criteria described in the Office of Management and Budget (OMB)
Circular A-11? How much is the premium that would be paid to
lease the tankers versus an outright purchase? What impact
would this added cost have on the Department of the Air Force's
future overall acquisition requirements?
Why were other alternatives rejected, alternatives such as
the re-engining of older KC-135s or multi-year funding
authority for a future buy of KC-767s, which some believe could
have saved a considerable amount of taxpayer funds? How does
that lease proposal address the maintenance and training
issues, and is that the most cost-effective proposal?
I am confident this hearing will provide the committee
valuable information in answering these and other questions. I
note also that yesterday the distinguished chairman of the
Committee on Commerce, Science, and Transportation conducted a
hearing. We are in the process of reviewing the record of that
important hearing yesterday. Now, once this committee has had
time to review all of the information we deem appropriate, it
is my intention to hold an executive session where our members
can freely discuss this issue and share our views. I am not
scheduling that session at this time. It depends on the volume
and the amount we have to look at.
As a part of that discussion, we will then schedule the
time at which this committee will vote. So we are not going to
rush to judgment on it.
I would like to also just make another observation. My
colleague on the right, Senator Levin, and I have been
privileged to be on this committee for a quarter of a century.
Other members have had very long terms. You look at this
situation, and I went back and reviewed last evening the
actions by the Appropriations Committee in which there is a
legislative provision and indeed the actions taken by this
committee in a conference report last year, to come to the
conclusion that slightly more than 50 percent of the Senate, as
reflected by the 29 or so members of the Appropriations and 25
on this committee, are making a decision without the benefit of
the balance of the Senate, without the benefit of other
Senators who are not on these committees participating in an
open floor debate on the issue.
Now, historically we have done things in the Appropriations
Committee by way of legislation. That has always been the case
in the past and probably will be long after I am dead and gone.
But with the magnitude of this contract, the importance and its
relevance to our national security, I would be less than candid
if I did not tell you as I work through this process with an
open mind in no way have I indicated how I would eventually
vote. I will not even entertain that thought in my mind until I
have shared the views of all the colleagues on this committee
and such others that can contribute. I have this in my mind and
it will be a factor.
[The information referred to follows:]
Chairman Warner. Senator Levin.
STATEMENT OF SENATOR CARL LEVIN
Senator Levin. Mr. Chairman, first let me thank you for
your typically thoughtful opening statement laying out many of
the issues facing us and doing it in a way which puts it in a
context which is very important for us and for the entire
Senate. In addition to your last comment pointing out the
responsibility that falls on our shoulders as of the moment
without the full Senate considering the pros and cons of this
lease, there are also some very significant implications in
terms of budget principles and budget precedents here.
The Budget Committee, as far as I know, has not looked at
those. Those implications are in terms of what these long-term
leases or a long-term lease of this nature would mean in terms
of circumventing certain budget controls, such as limits on
deficits and caps on deficit spending.
But I, too, approach this with an open mind. At this
moment, I do not know how I would vote on this. I have
determined to not reach a conclusion until after this hearing
and after consideration of any other hearings of any other
committees and carefully consider the materials presented to
us.
There are, however, very significant issues which we must
address. We are going to address those in a thorough way and in
a thoughtful way and hopefully, even though the whole Senate
may not end up participating in this decision, the entire
Senate will feel as though it was given the kind of thorough,
objective, and balanced consideration that it deserves.
This issue involves really two sets of issues. One are the
military capabilities that are involved, and the importance of
those capabilities. But there are also on the other side some
very significant budgeting and financing principles which are
at issue. They may or may not be in conflict, but in any event
they are all worthy of our most thorough consideration. I again
thank you, Mr. Chairman, for laying out the parameters of that
consideration.
Chairman Warner. In my judgment, the importance of this
issue merits that those Senators who desire to make some
preliminary opening comments should be given that opportunity.
I would hope that we could keep them fairly brief and see to
our witnesses.
Senator McCain.
Senator McCain. Thank you, Mr. Chairman. I note that the
second panel is composed of Neal Curtin of the General
Accounting Office (GAO) and Robert Sunshine of the
Congressional Budget Office (CBO) and Dr. Richard Nelson of the
Institute for Defense Analyses (IDA). These organizations
testified before the Commerce Committee, all in opposition to
this deal, both on grounds of cost as well as violation of the
fundamental rules of the way that the government does business.
I hope we will pay close attention to CBO, CRS, and GAO,
three respected institutions that give us the kind of technical
expertise that is necessary to make these kinds of decisions.
Mr. Chairman, I made a long statement yesterday. I have a
lot of questions for our witnesses. More and more information
comes to light as we examine this issue, including a June 20,
2003, memorandum from the Director of Program Analysis and
Evaluation (PA&E): ``Our analysis indicates that the provisions
of the aircraft lease cost more than the equivalent purchase of
tanker aircraft measured in this-year dollars.'' All three
witnesses testified that it is about a $5 billion difference in
cost to the taxpayers.
PA&E memorandum: ``We find that leasing provides no
inherent economic efficiencies relative to direct purchase of
tankers and is therefore more expensive in the long run.'' That
is something we all agree on, as you said, Mr. Chairman. It is
more expensive. ``Our analysis shows that the current draft
lease fails to meet the requirements of OMB Circular A-11.''
That is what the CBO, CRS, and GAO also testified to. This is
shell games. This is an Enron entity run by the Air Force,
owned by the Air Force, and yet a way of funneling money in a
rather bizarre fashion, and one that is without precedent.
Here is an interesting memo. I will go into them later on,
but it says ``Ask us to put pressure on Mike Wynne to convince
PA&E to write a new letter essentially undoing the first
letter. Said he was not going to give answer, would get in
trouble no matter how he answered. Roche said he was going to
talk to Wolfowitz tomorrow.''
The relationship between Boeing here and the Air Force is
really remarkable. Mr. Chairman, there is no distance between
the two of them. This is exactly what President Eisenhower
warned us about. They are all on a first-name basis. They refer
to my staffer as ``Chrissy-Poo.'' It is really a remarkable
kind of incestuousness that--I guess with the consolidation of
the defense industries, now we are really down to two. I guess
with this rotation of people back and forth from the defense
industry into the Pentagon and back, it probably breeds a lot
of this. They are all buddies.
There is now a criminal investigation opened by the Office
of the Inspector General because of alleged leaking or giving--
not leaking--giving the information that is proprietary by
Airbus to Boeing. That is another allegation that is surfacing
this morning.
This is really an unsavory deal, Mr. Chairman. Let me try
to lift the level up a bit and point out, in The Washington
Post this morning the editorial says: ``Underlying all the
controversy over the precise numbers is a far more troubling
question: whether the leasing arrangement represents just one
more way for this administration to push the costs of
government onto future administrations and future generations
of taxpayers, an end run around normal procurement procedures.
``Leasing would effectively lock the government into buying
the tankers without having enough money set aside to pay for
them. That is reflecting a broader problem. The Defense
Department wants to build and buy far more equipment, far more
fighter systems, submarines, more combat systems, than it has
funding to pay for. If the Air Force needs to begin to replace
its tankers, it should do that and Congress should provide the
necessary funds. If that requires tradeoffs with other
programs, that decision should be made and made honestly, not
put off for future administrations to deal with. The CBO said
the tanker lease does not eliminate difficult budgetary
decisions but `merely postpones them.' This may be what a
family needs to do when it is short on funds. It is no way to
run a government.''
[The information referred to follows:]
The Washington Post
SEPTEMBER 04, 2003, THURSDAY, EDITORIAL
LEASE OR BUY? As with a family that's strapped for cash but needs a
new car, that's the choice facing the Air Force, which says it must
replace its aging fleet of Vietnam-era tanker aircraft as soon as
possible but doesn't have the funds to buy the planes outright.
Instead, under a novel financing deal that has been in the works for 2
years and is on the verge of winning final congressional approval, the
military wants to lease 100 767s from Boeing to be outfitted as
tankers, which are used for midair refueling to extend the range of
warplanes. This deal--worth between $20 billion and $30 billion,
depending on how it's measured, including the cost of buying the planes
at the end of the 6-year lease--would have the advantage for the hard-
pressed manufacturer of helping to keep its 767 production line open.
The advantages for the country are more open to debate, but it's been
promoted energetically by influential lawmakers including House Speaker
J. Dennis Hastert (R-Ill.), whose congressional district is near
Boeing's new Chicago headquarters. Three of four congressional
committees have given the required approval, and the fourth, the Senate
Armed Services Committee, will hold a hearing on the lease arrangement
today.
There are two interrelated questions about this arrangement. One is
whether new tankers are urgently needed. Tankers are increasingly
important in an era of far-flung military operations. As recently as 2
years ago, the Air Force said its fleet would last until 2040 and that
a new purchasing program could therefore be put off until 2013. Now the
Air Force says that with tankers being used at a level not anticipated
before the September 11 attacks, maintenance problems are increasing
and replacements are needed soon.
Assuming that replacement is warranted and that the Boeing 767s are
the right aircraft, there is the question of cost. Everyone agrees that
leasing will cost more than a traditional purchase. The Air Force
calculates that, given the lower cost of paying money later rather than
writing the check now, the differential will be as little as $150
million. Other analysts peg the cost far higher. The Congressional
Budget Office concluded that, even taking into account the financial
benefit to the government of not having to pay the full cost up front,
the leasing arrangement would cost $1.3 billion to $2 billion more than
purchasing over time. Others who have questioned various aspects of the
leasing arrangement include the General Accounting Office, the
Congressional Research Service and the Defense Department's own
inspector general.
Underlying all the controversy over the precise numbers is a far
more troubling question: whether the leasing arrangement represents
just one more way for this administration to push the costs of
government onto future administrations and future generations of
taxpayers, as Senator John McCain (R-Ariz.) suggested at a hearing
yesterday. An end run around normal procurement procedures, leasing
would effectively lock the government into buying the tankers without
having enough money set aside to pay for them. That's reflective of a
broader problem: The Defense Department wants to build and buy far more
equipment--more fighter jets, more submarines, more combat systems--
than it has funding to pay for. If the Air Force needs to begin to
replace its tankers, it should do that, and Congress should provide the
necessary funds. If that requires trade-offs with other programs, that
decision should be made, and honestly--not put off for future
administrations to deal with. The CBO said that the tanker lease does
not eliminate difficult budgetary decisions but ``merely postpones
them.'' This may be what a family needs to do when it's short on funds.
It's no way to run a government.
No analysis of alternatives (AOA) was conducted. Perhaps
one of the reasons for this--and I was talking about the
relationship that exists before--is a memorandum briefing
Boeing, Mr. Gower: ``Objective: Establish clearly-defined
requirements in order for the U.S. Air Force tanker
configuration that results in an affordable solution, meets the
USAF mission needs, and will prevent''--``and will prevent an
AOA''--an analysis of alternatives--``being conducted.'' That
was Boeing's objective. That was the Secretary of the Air
Force's objective, and that is what they achieved.
There was no AOA conducted, which is normal in any
acquisition process. There was no study of the Air Force
corrosion problem, a dramatic turnaround from 2 years before,
where the Air Force said that their tankers were good for the
next 20 years. No analysis of that.
Mr. Chairman, the fix was in and it is really a remarkable
and unfortunate kind of situation that we are here today asking
the taxpayers to pay $5 billion in additional funds with a
shell game, Enron-like entity funneling the money through and,
by the way, a $5 billion maintenance contract that itself was
not competed.
Mr. Chairman, we are talking about real money here, and
since we obviously have dramatically increased expenses
anticipated, according to reports this morning $65 to $70
billion for our operations in Iraq, I think we ought to really
look carefully at this. Again, if the Air Force makes the case
that they need to replace this tanker fleet, then why do we not
do it in a procurement fashion with an authorization, not by
the Appropriations Committee without a hearing, but through the
proper process, which is that the military comes forward, the
Department of Defense comes forward, with a request, with a
proposal, we have hearings for it, and we authorize the
procurement of those aircraft.
Instead, as The Washington Post points out, an end run was
completed. To show the enormous influence of the special
interest, three of the four committees approved this deal
without ever having the lease being completed. I understand,
according to reports, that last night Boeing and the Department
of Defense finally completed a deal. But three of the four
oversight committees approved the deal without the deal being
completed and without us ever seeing it. By the way, I have
questions about what I have heard about that deal.
So, Mr. Chairman, I hope that what we really need to do
here, as I think you may have indicated in your opening
remarks, is take a little time. Have this committee exercise
its oversight responsibilities, as you are seeing today. Look
at all the evidence, see why the major watchdog agencies, the
people we ask, the CBO, CRS, and GAO, all say that this is a
bad deal for the American taxpayers, and then make a measured
decision.
I appreciate your and Senator Levin's interest and
involvement in this issue. Thank you, Mr. Chairman.
Chairman Warner. Senator, you noted the second panel, the
participants. That was intentionally done to give a balanced
perspective to this hearing.
I also suggest--are you going to incorporate those
documents in the record?
Senator McCain. Yes, I will.
Chairman Warner. Without objection.
[The information referred to follows:]
Chairman Warner. Further, you used the term ``criminal'' in
connection with the Inspector General of the Department of
Defense. I met with him extensively yesterday on another
matter, but we did have some discussion, preliminary
discussion, on what you alluded to. But in my listening to him,
he did not invoke the word ``criminal.'' So I am going to ask
this morning the staff call him and to ask him to prepare a
very short letter describing precisely what it is he intends to
do with material that has been given him, so that we have that
matter clarified before this hearing is completed, and that
will be done.
Senator McCain. Thank you, Mr. Chairman. I point out, I was
referring to media reports that an investigation had been
called for. From the information that I have received, maybe an
investigation is called for.
Chairman Warner. I probed it pretty carefully last night
with him.
We will now turn to Senator Reed. Do you have an opening
statement?
Senator Reed. I have no opening statement.
Chairman Warner. Fine.
Senator Inhofe.
Senator Inhofe. Mr. Chairman, it is not my intent to have
an opening statement. I would have to echo your opening
statement and that is that there are serious concerns. I am
coming to this meeting with an open mind, and this is a very
rare thing in government, that we get to this point and minds
are not already made up. So I will be looking forward to the
hearing, looking forward to trying to make the right decision.
Chairman Warner. I thank you. I enjoyed our exchange last
night on the issues. You were helpful to me, Senator, as you
always are, because you have a special insight into the
aircraft business.
Senator Clinton.
Senator Clinton. Mr. Chairman, I too want to thank you for
holding this hearing. I think it is indicative of your
leadership and your openness. I would just add a few points.
I think there is general agreement that the Air Force needs
more tankers. I would posit that. I think that should be the
basis on which we go forward. The issue is how best to obtain
those tankers as soon as possible, put them into service, and
have them utilized.
I am struck by the various questions concerning this
particular approach to obtaining the tankers. I do not have a
positive or negative feeling about the process. I appreciate
the effort to find out more information. But I do think there
are other related issues, that the context of this should be
recognized.
We are going over this leasing arrangement with a fine-
toothed comb and we are putting out billions of dollars in
contracts for the reconstruction of Iraq and not knowing a
single thing about them. Senator Collins and I and Senator
Wyden have been trying to find out information about
Halliburton and Bechtel and others who just basically have been
handed billion-dollar open checkbooks, and there has been very
little, if any, oversight by anyone in Congress.
So I hope that this hearing and the rather significant
amount of information that has been forthcoming will serve as a
model for other contracts that are being entered into, in this
case without any information or oversight.
Second, part of the dilemma we find ourselves in is our
failure to be honest about the costs that we confront and the
ability of our Government to sustain these costs into the
future without adequate revenues. This is not a problem that is
going away, no matter how often people try to pretend that it
does not exist. It is, to use an appropriate metaphor perhaps,
it is the giant elephant in the room. This is a huge issue.
We are not paying as we go and we are not acting
responsibly about how we fund critical needs like national
defense. So this leasing agreement, looked at on the side as
though it were some aberration, is part of a much larger
pattern of fiscal irresponsibility and failure to acknowledge
the real costs of our undertaking the kind of missions that we
are currently committed to.
So, Mr. Chairman, I think that it is imperative that we
come to an answer on this because clearly, in my review of what
I have been given, the Air Force needs these tankers. Our
continuing missions require this kind of capacity. But I think
we should take a very hard look at the broader context in which
this hearing is being held, because we are focusing on one
relatively small, albeit very important, issue and we are
failing to look at the entire context that this is occurring
in.
So I thank the chairman for having this hearing and I look
forward to the information.
Chairman Warner. Senator, I appreciate that. I note also
your reference to contracts in Iraq. You will recall the debate
that we had on the floor with the Boxer amendment. She took an
initiative and we joined on that and did put some piece of
legislation in.
But I will refer to what we did on the floor and the
subsequent actions by the Department. I think you raise a
question that is certainly within the province of this
committee to look at.
Senator Clinton. Thank you.
Chairman Warner. Thank you.
Senator Roberts.
Senator Roberts. Thank you, Mr. Chairman. I do have a
statement, and I come to this issue as chairman of the
Subcommittee on Emerging Threats and Capabilities, not as, as
has been alleged, in terms of special interest concerns.
Mr. Chairman, Scottish novelist Tobias Smollett, a name
that does not ring in history, he said and noted once that:
``Facts are stubborn things.'' He is right. They often get in
the way of the arguments that we want to make. In Dodge City,
Kansas, we simply say nothing hurts the truth so much as
stretching it or ignoring it.
In the run-up to today's hearing, we received a number of
reports asserting various claims regarding the cost and the
justification for the Air Force's proposed tanker lease. It
seems to me that much of the criticism contained in those
reports ignores key facts and obvious facts. Those facts are
these:
Number one, our tanker fleet is absolutely critical to our
military's ability to defeat the many threats we have abroad.
That has been testified to over and over again by Chairman
Myers and also Secretary Rumsfeld.
Number two, 90 percent of our aerial refueling fleet is
more than 40 years old, most of them around 42 to 45, older
than many of the pilots flying the KC-135, resulting in
increased maintenance costs and higher risks of fleet-wide
problems. If you shut down this fleet, if you have a class
problem in terms of corrosion or any other problem, you stop
the war or you stop our ability to wage war, you endanger our
national security in regards to access denial.
Number three, the proposed lease will allow the Air Force
to begin to modernize its fleet 5 years earlier than a
traditional procurement and will save up to $5 billion in
modifications planned to keep the KC-135E flying. Operations
Noble Eagle, Enduring Freedom, and Iraqi Freedom once again
demonstrated the importance of tankers to our military's
ability to defeat various threats abroad.
No one challenges the importance of these aircraft, but
some ask why we need to modernize the fleet now. The answer is
simple: Our tankers are the oldest combat aircraft in the Air
Force. Seven years ago, the GAO noted that the KC-135s were
taking progressively more time and money to maintain and
operate and questioned the fleet's long-term serviceability.
After avoiding the issue of tanker modernization for years, the
Department and the Air Force have now come forward with a plan,
along with some of us in Congress, that will field 100 new
tankers 5 years earlier than the traditional procurement and
would allow the Air Force to avoid again up to $5 billion in
KC-135E modification costs, that is not reflected in the OMB
estimate by the way.
The Air Force has acknowledged that leasing the aircraft
will be more expensive than buying them outright, but justifies
the premium not only on the basis of saving maintenance costs,
but also the enhanced ability and capability available to the
warfighter through the 767 lease. That is my number one
concern, the warfighter.
I am well aware of the various cost analyses on the lease
proposal. Many of these analyses are based on very sensitive
assumptions. However, these studies do not address the fact
that this proposal will reduce the KC-135 maintenance and
operation cost while increasing warfighter capability.
Why would we reject this plan and choose to spend up to $5
billion to keep 40-, then 45-year-old aircraft flying? The time
has come to solve, not put off, this problem.
Finally, I am well aware of the other criticisms of the
proposal as well: allegations that the lease does not satisfy
OMB requirements, suggestions that the corrosion problems are
not as significant as the Air Force claims--and I will have a
question for Secretary Roche as to that claim or as to that
allegation--and questions about the competition.
However, in the final analysis the issue comes back to
stubborn facts. OMB has concluded the proposed lease satisfies
its requirements. The corrosion problems and the costs of
continuing to operate the KC-135 will continue to escalate in
the future. With regard to competition, what other aircraft
manufacturer currently has an aircraft in production that meets
the Air Force's requirements?
It seems to me that if we reject this proposal or
continually put it off it will only ensure that future missions
and the men and women who fly them are put at greater risk than
need be while the government continues to spend increasing
amounts of money to keep 40- and 45- and 50-year-old planes
flying.
I would urge my colleagues to approve the lease. I know we
are going to take time in doing that.
Mr. Chairman, I have three press articles: one from the
Wall Street Journal as of September 3; one from the Defense
News as of September 1; and one from the Washington Times as of
September 3, and would ask permission that they be inserted in
the record at this point.
Chairman Warner. Without objection.
[The information referred to follows:]
Chairman Warner. Senator Allard.
Senator Allard. Thank you, Mr. Chairman.
This proposal I believe before us is unprecedented. The Air
Force strongly believes it needs new aerial refueling aircraft.
I agree that new aircraft is a requirement that must be met,
and in fact I would strongly support the appropriation of funds
for such aircraft. However, this is not what the Air Force
intends to do. Instead, the Air Force has brought a proposal
before this committee that would circumvent our budget and
appropriations processes and potentially cost the taxpayer
billions more than if the Service would have purchased the
planes directly.
I participated in a hearing yesterday, Mr. Chairman, on the
Budget Committee and I specifically asked the question, had
they ever seen this procedure before in budgeting. The answer
was no, implying that this was a budget precedent that had
never been used before. I hope that our panel members that you
have called can affirm or perhaps bring forward a different
view on the answer that I got yesterday from the Budget
Committee.
It is my view that if this proposal is adopted by other
agencies it would make our budget meaningless. It creates a
hidden liability, disguising our true deficit and debt numbers.
I believe we must be very careful as we listen to our
witnesses today. There is more at stake than 100 tanker
aircraft. Congress must agree to fund this program in its
entirety or else risk incurring substantial termination fees.
Congress must also agree to purchase the planes at the end of
lease or risk wasting nearly $20 billion of the taxpayers'
money.
We must also recognize that this is only the beginning. The
lease program before us will replace just over 100 tankers.
There are still another 400 that will eventually need to be
replaced. This tanker recapitalization proposal in my view is
not the end. In fact, it is only the beginning.
I would also share the same concerns that my colleague
Senator McCain brought up on the acquisition processes that
Boeing has been applying recently. I also read the same article
Senator McCain had read, where it said the Air Force--it talked
about how the Air Force had canceled more than $1 billion in
contracts with Boeing to launch rockets after it was determined
that the company improperly obtained thousands of sensitive
documents belonging to rival Lockheed Martin. Then--it stated,
it talks about how the Pentagon has launched a formal
investigation to determine whether a former Air Force official
broke the law by passing information to the Boeing Company
about a rival bid for a $21 billion contract to lease aerial
tankers.
Ignoring the procurement rules seems to be a chronic
problem with Boeing and I am concerned about that. Mr.
Chairman, I think this committee ought to spend some time in
reviewing the lack of competition among defense contractors and
how ineffective it is, in many cases applying penalties when
the procurement rules are ignored.
Mr. Chairman, I have many questions and, to be honest, many
doubts. I believe that there is a genuine requirement for
recapitalization, but I am not certain that the requirement
must be addressed now. I believe that the Air Force does not
have the funds to buy these planes directly. But I am not
certain the Air Force will ever be in a position to buy these
planes in the near future, given its priorities.
I believe that we should encourage innovative business
practices, but I am not certain that such practices should be
utilized if it requires us to obligate future Congresses to
this lease program.
I believe we must be judicious and deliberate as we
proceed. We must make certain that this is the best deal, for
more is at stake than the taxpayers' hard-earned dollars. Our
national security could be put at risk as well.
Thank you, Mr. Chairman, for the opportunity to share some
of my thoughts. I look forward to the testimony of our
witnesses.
Chairman Warner. Thank you very much, Senator Allard.
Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman. I just
want to add my welcome and thanks to Secretary Roche and
Secretary Wynne, as well as Director Kaplan, for being here
this morning. I look forward to their testimony and want to add
my welcome to you as we discuss the Air Force proposed tanker
aircraft lease.
Thank you very much, Mr. Chairman.
Chairman Warner. Thank you.
Senator Collins.
Senator Collins. Mr. Chairman, I am very eager to hear the
testimony of our witnesses today, so I will withhold my opening
comments.
Chairman Warner. Senator Chambliss.
Senator Chambliss. Mr. Chairman, thank you. No opening
statement.
Chairman Warner. Secretary Roche, you may proceed. I failed
to state in my opening comments that I and my staff were not
able to locate any historical reference to the Department of
the Air Force having ever requested an authorization that
addressed these critical needs with regard to tanker aircraft
procurement. Perhaps in your statement or at some point in time
you can supply the record with whether I am correct in that
observation or there was at some point in time before this
committee a request, either from the Defense Department or the
President's Budget Office, in the annual message from the
President, a request and/or a departmental request from the Air
Force.
Thank you.
STATEMENT OF HON. JAMES G. ROCHE, SECRETARY OF THE AIR FORCE
Secretary Roche. Thank you, Mr. Chairman, Senator Levin,
members of the committee. It is my great honor to join
Secretary Mike Wynne and Mr. Joel Kaplan today to testify on
our need to begin the modernization of our air refueling fleet.
The air refueling capability delivered by the airmen who
fly, maintain, and support our KC-135s, of which we have 544,
and our KC-10s, of which we have 59, is absolutely vital to our
Nation. Mr. Chairman, I agree, my research says that the only
request was for the KC-10s and that was in the late 1970s.
There has not been one subsequent to that.
Chairman Warner. Right, and that was granted by Congress.
Secretary Roche. Yes, it was, sir.
Chairman Warner. I remember it very well. Thank you.
Secretary Roche. Air refueling tankers enable our entire
joint force to protect our homeland, conduct combat operations,
and provide humanitarian relief around the world. They enable
Air Force, Navy, Marine Corps, and allied strike, electronic
warfare, reconnaissance, and mobility aircraft to perform their
missions. They have been essential in Operations Enduring
Freedom and Iraqi Freedom, as well as in the skies over the
United States.
As we recently demonstrated in the war on terrorism, the
Air Force tanker fleet was a critical force enabler that
allowed our coalition force to operate over distant
battlefields. In Afghanistan, air refueling made joint
operations in a distant, landlocked nation possible. In Iraq,
our ground forces' overwhelming speed, firepower, and decisive
maneuvering were enabled by air dominance over the entire
country, a condition that was made possible through the
thousands of air refueling sorties that moved the forces to the
fight and kept reconnaissance and strike aircraft overhead 24
hours a day. Of our roughly 69,000 sorties to date in Operation
Iraqi Freedom, close to 10,000 have been tanker aircraft.
I have with me today, Mr. Chairman, a couple of our airmen
who have flown and worked on the maintenance of the KC-135s.
Lieutenant Colonel Smiedendorf and Colonel Westhoff are here
should you have any questions of any of the pilots on that
subject, sir.
This distinctive capability, our Nation's ability to
rapidly project air, land, and sea forces around the globe, is
critical to our Nation's ability to deter enemies, assure our
friends and allies, project force, and, when necessary, win our
wars. In short, Mr. Chairman, our national security strategy
cannot be executed without aerial refueling tankers. This
dependence and the advanced age of the Nation's air refueling
aircraft fleet drive our urgency to recapitalize.
The ongoing global effort to fight terror heightens our
aging aircraft concerns, particularly because of the need to
protect our Nation's skies with fighters, requiring our tanker
capability, as well as the need to maintain our global reach
capability.
Chairman Warner. Secretary Roche, I am going to interrupt.
We will admit for the record the full statements of all
witnesses.
Secretary Roche. All right, sir.
To the point of Operation Noble Eagle, we keep a number of
aircraft, tankers, on alert every day, around the clock. Today,
the on-average 42-year-plus old KC-135 represents 90 percent of
our combat air refueling capability or about 82 percent of our
capacity. The 544 KC-135s on duty today have the oldest average
age of any of our aircraft combat aircraft, and the E model,
the 131 aircraft we are choosing to replace with this lease,
are now 44 years old on average.
Our 135s in general, Mr. Chairman, are older than the
average age of Navy oilers, which is roughly 40 years, I am
told.
During Operation Iraqi Freedom, we severely restricted the
deployment of these aircraft due to operational limitations--
the E models I am referring to. They were unsuited for the high
temperatures and short runways in the operating area and they
had insufficient fuel capacity and less efficient engines.
Instead, we limited their use to the European theater in order
to support the air bridge and global power operations, and the
commander of the Air Mobility Command made the point to me that
we only used them at three hubs where there were a lot of spare
parts and support for aircraft of this age.
While demand for these assets is increasing, the data show
their availability steadily decreasing, while the costs to keep
them flying are swelling. In the last 12 years, mission capable
rates are down 7 percent, program depot maintenance costs
tripled, depot work packages doubled, and the depot flow days
more than doubled, primarily due to the challenges posed by
aircraft aging.
Just to correct fatigue and corrosion problems in the KC-
135E engine struts will cost over $3 million per aircraft. If
these repairs are not done, the fleet will be grounded. Both
General Jumper and I have visited the depot where much of this
work is being done. I can tell you that the men and women who
are keeping these planes flying are performing magnificently,
but they are doing much more than our Nation should reasonably
expect of them.
I would also point out proudly, sir, that the Air Logistics
Center (ALC) at Tinker Air Force Base has by virtue of
benchmarking with other ALCs and with commercial firms, is now
judged to be more productive than the two commercial firms that
are also overhauling 135s, and we would expect by benchmarking
the commercial firms will come up. But it is an example of
where a Government-owned institution can perform very well.
Across the Air Force, we are now migrating dollars from
procurement to operation and sustainment accounts to sustain
our aging fleets. In 1997, the direct cost of corrosion
maintenance for all U.S. aircraft was $795 million. Today we
estimate it will cost over $1 billion a year, despite a 5-
percent reduction in aircraft inventory over the same period of
time. Currently, roughly 30 percent of the depot hours for our
135s are dedicated to fixing corrosion, and we expect over the
next 4 years for that to increase.
Given the value of air refueling tankers to our Nation's
security, the operational risks of flying these aged aircraft,
and the spiral costs to operate and sustain this fleet, we
believe there is a compelling set of circumstances that demand
we begin recapitalizing our Nation's tanker force. After a
comprehensive and deliberate review that validated the urgent
need to start modernizing our tankers now and the advantages of
leasing, we urge your support for our proposal to enter into a
multi-year lease of 100 KC-767 tanker aircraft.
Even if we were to begin this, Mr. Chairman, we will still
have KC-135s that will be flying well into their 70s. So we
will have to maintain these other aircraft over a very long
period of time.
The dominant reason for proposing a lease is the advantage
it affords for quickly delivering needed tankers to our
warfighters without requiring significant up-front funding.
This will hedge the risk to the force of KC-135s across the
board.
I want to assure both you and your colleagues that we
looked at several alternatives to our tanker needs. We
seriously evaluated a tanker offering from Airbus and we took a
hard look at re-engining the KC-135s. The fact is we could
spend billions to put new engines on an old airframe, but still
not stem the corrosion and structural challenges we face in the
main body of the aircraft.
We looked at stored commercial aircraft that would be
suitable, the 767-ER200. There were very few of them because
they are the choice of freighters, people who do air freight
work. Those that were in storage had an extraordinary number of
hours on them.
We looked at fee for service, which is something Navy has
looked at as well, and it is not suitable for our fleet given
our projection forces. We looked at designing a new aircraft
and realized that would be extraordinarily expensive to do, as
any new program has done. So we conducted a request for
information to both of the manufacturers, Airbus as well as
Boeing.
Mr. Chairman, we recognize that this lease will cost
marginally more from a net present value analysis than a normal
procurement program. But in the Department's view the immediate
and long-term benefits, including operational savings which are
not included in the calculations, greatly offset the
differentiated costs of the lease option. By operational
savings, Mr. Chairman, I mean if you use this aircraft you do
not have to use a lot of others. You get savings as you go.
So for instance, if we had to maintain a combat air patrol
(CAP) somewhere that consisted of Navy aircraft as well as Air
Force aircraft, or that consisted of coalition aircraft, we now
would require three KC-135s. In the case of the 767 tanker, it
would only be one. If we were to move Marine Corps aircraft
from Cherry Point over to Japan, we would use half the pounds
of fuel, using the newer aircraft than existing aircraft
because they also can carry cargo.
So there are savings as you go. We did not project any of
those because you cannot tell how often you would do that and
therefore we felt it would not be part of the analysis. But it
is one of those things that we would benefit from if they were
in place.
Our report shows, as has been discussed, that we can lease
and deliver 100 767 tankers 5 years sooner than we can under a
normal procurement program. Most significant, to purchase these
aircraft on the same schedule we would need $5 billion in
additional funding in the Air Force account through fiscal
years 2006 and more than $11 to $14 billion more across the
Future Year Defense Program (FYDP). This is money the Air Force
does not have and is not programmed for and will result in
significant impacts and delays to our other modernization
programs.
We agree that in the past this should have been addressed
and allowing the tankers to get to the age they are without
addressing a recapitalization program was wrong.
There are a number of safeguards, we believe, in the
leasing program which can be discussed. For instance, part of
our proposed contract, the third party trust, will buy the
aircraft from Boeing and will lease them to the government. The
trust will not make a profit, but will provide for the funds
necessary to pay bondholders and pay off the debt after the
sale of the aircraft.
At yesterday's Commerce Committee hearing I was in error. I
said that the trustee was the Air Force. The trustee is not the
Air Force. The administrator of the trust is an employee of the
Wilmington Trust Company, not Boeing nor the Air Force.
Further, any residual funds acquired from a possible sale
of any aircraft subsequent to the termination would be refunded
to the government as an overpayment.
We have also insisted, and Boeing has agreed, that the
contract will include most favored customer clauses stating
that if Boeing sells comparable aircraft during the term of the
contract for a lesser price the government will receive an
equitable adjustment.
To further guarantee the taxpayers receive a favorable
deal, Boeing has agreed to a return on sales cap of 15 percent,
whereby any return on sales in excess of 15 percent in either
commercial or military manufacturing centers will be returned
to the government. This is something unprecedented in military
acquisitions and we believe is a way to account for the
different models and different estimates. If we are wrong and
in fact the planes are cheaper, this provision allows money to
be returned to the government because it will be audited and it
will be audited annually.
Thus, I am pleased to report to the committee that, through
the combined efforts of the OMB and the Office of Secretary of
Defense and, honestly, Congress, we arrived at what I can
characterize as a good deal for the Air Force and the American
people. In addition to the business considerations that make
this approach attractive, there are compelling operational
benefits to the KC-767. It can offload 20 percent more fuel. It
can use many more runways, and it can refuel itself as well as
pass fuel. Therefore it can be used for consolidation like the
KC-10, which has proved so valuable to us.
Mr. Chairman, as I note in my written testimony to this
committee, our proposal for using commercial airline bodies as
tanker platforms is not without precedent. In the late 1970s,
Secretary of Defense Harold Brown arranged to begin to acquire
DC-10 aircraft converted into tankers. Secretary Weinberger
continued this program. The DC-10, like the Boeing 767 today,
was nearing the end of its production run. The airliner had
been designed and proven successful as a platform, the result
of billions of dollars by the contractor, not the taxpayer.
In hindsight, the success of the KC-10 fleet, with 59 of 60
still in the inventory, proves the wisdom of Secretary Brown's
approach. Even though the KC-135 fleet at that time was only 16
to 18 years old, they believed they needed a hedge.
We hope you will agree with us that this innovative new way
of delivering capability is as compelling today as it was to
Secretaries Brown and Weinberger 20-plus years ago. I would
point out, Mr. Chairman, that in Operation Iraqi Freedom we
made use of 80 percent of our KC-10s, 50 percent of our R model
135s, but only 25 percent of the E models.
Mr. Chairman, America's Air Force is able to perform the
extraordinary feats asked of us because we are blessed with the
full support of the American people, Congress, and the
President of the United States. I join my colleagues here today
in urging your support for this proposal.
I also would like to tell you, Senator, that my good
colleague our new Vice Chief of the Air Force General Buz
Moseley is here. He was the coalition forces combined air
component commander, and if there are any questions about the
use of tankers in the recent conflict he would be glad to
address them.
So on behalf of General Jumper, we thank you for the
investment you have made in our future and trust that you have
placed in us. Thank you, sir.
[The prepared statement of Secretary Roche follows:]
Prepared Statement by Hon. James G. Roche
Thank you for the opportunity to appear before you today to discuss
the necessity of the Air Force's tanker lease proposal and the status
of the KC-135 fleet. In my testimony I will outline the importance of
the Air Force's tanker fleet to this Nation's security, the status of
that fleet, the proposals that were before us, and finally, our choice
of the tanker lease proposal which best serves this Nation's security
interests, the American public's interests, and the operational needs
of the Air Force and our warfighting combatant commanders.
Before I begin, I must commend the men and women who fly, maintain,
and deliver the impressive combat capability that is our topic today.
Without these incredibly talented uniformed and civilian airmen, this
discussion would be irrelevant. These airmen, the heart of our air
refueling force, operate everyday all over the globe. From active duty
and our Reserve component units, we draw our vital tanker capabilities
from places like Selfridge, Michigan; Phoenix, Arizona; Altus,
Oklahoma; Forbes, Kansas; Birmingham, Alabama; Honolulu, Hawaii;
Bangor, Maine; Tampa, Florida; Lincoln, Nebraska; Warner-Robins,
Georgia; Grissom, Indiana; Niagara, New York; and Goldsboro, North
Carolina.
During the past 2 years, these airmen and our tanker fleet have
been tested hard, flying Operation Noble Eagle (Homeland Defense),
Operation Enduring Freedom (Afghanistan), and Operation Iraqi Freedom
(Iraq). They delivered far more than could reasonably be expected while
operating and maintaining the oldest fleet in the United States Air
Force inventory.
CURRENT STATUS OF FLEET
Tanker dependence in recent wars and the advanced age of the
Nation's air refueling aircraft fleet drive the Air Force's urgency to
recapitalize as soon as possible. Today, a single 44-year-old aircraft
type, the KC-135, supports 82 percent of our combat air refueling
capability. Beginning manufacture under the Eisenhower administration,
732 KC-135s entered military service between 1957 and 1965. The
remaining 544 KC-135s on duty today have the oldest average fleet age
of any Air Force combat aircraft, and the ``E'' model (131) is 44 years
old on average. It is the old KC-135Es we seek to replace soonest. The
ongoing war on terrorism heightens our concerns regarding these aging
aircraft. Our new ``steady state'' includes tankers supporting fighters
defending the homeland as well as the need to maintain the Nation's
global reach capability.
Aircraft life can be measured in three ways--usage (flight hours),
physical age (years), and utility (usefulness). The KC-135's physical
age is the driving need to recapitalize. Through the 1990s, the KC-135
fleet started to show its age. In 1991, Air Force Materiel Command
initiated aging aircraft inspections and repairs to maintain the
airworthiness of this legacy fleet. By 2000, 32 percent of the KC-135
fleet (a significant portion of this Nation's overall Air Force
refueling capability) was unavailable due to programmed depot level
maintenance as the number and complexity of repairs drastically
increased. This reduced the refueling capability to our warfighters and
caused a backlog at the depot facilities, as the average number of days
in depot-level maintenance peaked at over 400 days.
Annual depot price per aircraft grew significantly as the fleet
availability decreased. The combination of increasing costs and
decreasing availability projected into the future compels the Air Force
to act now to balance cost, capability, and risk; it compels us to
begin recapitalization of the KC-135 fleet.
Although General John Jumper, our Chief of Staff, and I have
visited the depot at Tinker Air Force Base to investigate the condition
of our KC-135s, we do not rely on our observations or anecdotal
evidence alone. Independent teams, including teams from Office of the
Secretary of Defense, the GAO, and many others, that have visited the
KC-135 depot maintenance line at Tinker Air Force Base unanimously
recognized the risk that this 44-year-old aircraft could encounter a
fleet-grounding event, negatively impacting combat operations across
all services and coalition partners.
It should be noted that aircraft corrosion is a significant concern
for aging aircraft, both military and civilian. Congress enacted the
Aging Aircraft Safety Act, Title IV of Public Law 102-143, in October
of 1991 after the in-flight structural damage of a Hawaiian Airlines
737 in April 1988. As you may remember, corrosion had so weakened the
fuselage of the aircraft that it burst when it reached altitude and
could not sustain the pressure differential between the pressurized
cabin and the atmosphere outside. The Federal Aviation Administration
has enacted additional rules regarding corrosion and inspections for
corrosion since it is of such critical concern for aging aircraft.
The KC-135E fleet--our oldest--is beset with problems that
adversely impact its utility to the Air Force, our sister services, and
our friends and allies. The planes are operating under flight
restrictions pending interim repair of an engine strut--interim repair
costs $150,000 per aircraft, must be complete by September 2004. If the
repairs are not made at that time, the unrepaired aircraft must be
grounded. The interim repair will only last for 5 years at which time
the permanent repair must be made. Permanent repair of the engine strut
would cost $2.9 million per aircraft. If the permanent repairs are not
made, the unrepaired aircraft in that case must also be grounded. We
are facing a continual set of repairs and maintenance actions that only
delay that event. There is also the KC-135 fuel system, which requires
repair to deteriorating internal corrosion barriers. Those repairs are
estimated to cost $500,000 per aircraft. Of course, there are always
the ``unknown unknowns'' which become much more prevalent in aging
hardware--for example, 40 percent of the KC-135 fleet was non-mission
capable from September 1999 to February 2000 as a result of a
requirement to replace the horizontal stabilizer trim actuator--an
unexpected event that grounded a major portion of our fleet.
REQUIREMENT FOR RECAPITALIZATION
The cost of continuing to operate the existing KC-135 air refueling
force will continue to escalate dramatically. Corrosion, major
structural repairs, and an increased rate of inspection are major
drivers for increased cost and time spent in depot. More time in the
depot directly decreases operational aircraft availability. Operational
availability is expected to continue to decrease throughout the
remainder of the KC-135's lifespan. Under these conditions of
increasing costs and steadily declining availability and performance,
combined with the increasing operational demands, actions to replace
the KC-135 must begin now.
Our proposal--using commercial airline bodies as tanker platforms--
is not without precedent. In the late 1970s, Secretary of Defense
Harold Brown began to buy DC-10 aircraft converted into tankers, and
Secretary Weinberger continued the program, resulting in the 60 KC-10s
that ultimately became our lifeblood. The airplane had been designed
and proven successful as a platform, the result of investment by the
contractor, not the taxpayer. In hindsight, the success of the KC-10
fleet (59 of 60 are still in the inventory) proves the wisdom of
Secretaries Brown and Weinberger's decision to buy commercially
developed aircraft, even though the KC-135 fleet at that time was only
16 to 18 years old.
In the case of the KC-135, military aircraft was specially
developed for the Air Force. From this model the industry created the
commercial carrier, the B-707. These commercial airplanes have been
retired for the most part in favor of newer airplanes. In this case, it
was the contractor who benefited from the investment made by the Air
Force.
You will recall that we capitalized the original 732 KC-135s at a
rate of 90 aircraft per year. To recapitalize the 544 that remain at an
economical but affordable rate could take more than 30 years. We may
already be behind the power curve. We can no longer accept the risk of
these venerable aircraft continuing their age-induced death spiral
without taking immediate action. A realistic replacement program will
take decades to recapitalize a fleet of this size. Even beginning
today, some of our KC-135s will pass their 70th birthday before they
retire.
OPERATIONAL NEED FOR TANKERS
We do not propose leasing tankers as a bailout for Boeing or any
other aircraft manufacturer. We propose leasing tankers because we need
tankers to fight our Nation's wars, and we do not believe we should
take the risk to wait for years before we begin.
The Air Force tanker fleet delivered over 375 million pounds of
fuel during 30 days of Operation Iraqi Freedom, 90 percent of the total
fuel delivered by all joint and coalition forces. In addition, our
tanker fleet participated in air bridge operations, long-range strike
missions, and other global commitments during this time. This great
feat allowed Air Force strike aircraft to put relentless pressure on
the Iraqi leadership and the Iraqi armed forces. It was the key to 24-
hour airborne surveillance. Aerial refueling was the reason that the
Air Force could dedicate so many assets to on-call close air support,
on-call strikes on time-sensitive targets, and on-call support for our
highly successful special operations forces.
But more than just an Air Force asset, our tanker capability
enables the combat capabilities that our sister services and coalition
partners bring to the fight. For instance, tankers made it possible for
Navy and Marine fighters to launch from carriers in the Persian Gulf
and strike targets deep inside Iraq. Tankers permitted C-17s to take
off from Italy and drop Army paratroopers in northern Iraq. United
States Air Force air refueling aircraft delivered over 90 percent of
fuel offloaded to our sister services and allies during OIF. On a
global scale, General John Handy and his folks at US Transportation
Command managed the tanker air bridge throughout these campaigns,
simultaneously sustaining our airlift to the theater while our combat
forces continued to deter our enemies in the Pacific. Without these
vital refuelings, troops and materiel that our Nation needed halfway
around the world would have been less effective and slower to respond,
jeopardizing our ability to project global land, sea, and air power.
Air refueling tankers enable our entire force to protect our
homeland, conduct combat operations, and provide humanitarian relief
around the world. They enable other Air Force, Navy, Marine Corps and
allied aircraft to fly farther, stay airborne longer, and carry more
weapons, equipment, and supplies. As we just experienced in Operation
Enduring Freedom and Operation Iraqi Freedom, the Air Force tanker was
a critical force enabler and force multiplier that allowed our
coalition force to operate over a distant battlefield. Air refueling
tankers ensure our Nation has the global reach to respond quickly and
decisively anywhere in the world. In short, our National Security
Strategy is unexecutable without air refueling tankers.
NEED/UTILITY OF THESE TANKERS
But again, 90 percent of our current air refueling fleet rests in
this single aged weapon system. In fact, the warfighter had to adapt
his basing plan to address the limitations of the ``E'' model of the
KC-135. During Operation Iraqi Freedom, the ``E'' models were deemed
incapable of sustained operations in the area of responsibility (AOR)
due to the high temperatures and shorter runway lengths in theater and
the lower fuel capacity and less efficient engines of the ``E'' model.
We found use for them in EUCOM locations during the war, but their
support was limited to airbridge, homeland defense, and global power
operations. The KC-767A, however, will truly enhance our warfighting
flexibility. We will replace 131 KC-135Es with 100 KC-767As, and
greatly increase our capabilities.
The KC-767A is a tanker version of the long-range commercial
aircraft. This tanker was developed and commercially offered to the
international community by the Boeing Company as the Global Tanker
Transport Aircraft (GTTA). Italy was the first customer, ordering four
aircraft, and has been followed by Japan. The KC-767 tanker will be the
world's newest and most advanced tanker. It can offload 20 percent more
fuel than the KC-135E, and unlike the E-model, but like the KC-10, can
itself be refueled in flight. The KC-767 tanker also has the capability
to refuel probe- and receptacle-equipped aircraft on every mission--an
enormous benefit for joint operations. While the KC-767 will have
roughly the same maximum fuel offload as the KC-135R, it can takeoff at
maximum gross weight in approximately 3,500 ft. less runway--hence,
along with greater operational capabilities, the KC-767A is able to
operate from four times as many runways as the KC-135. As delivered,
the KC-767A will be configured as a convertible freighter being able to
carry all passengers (approximately 200) or all cargo (19 pallets vs. 6
on the KC-135).
It will have a digital cockpit, cargo door, auxiliary fuel tanks,
remote air refueling boom operators station, centerline hose drum unit,
crew rest facilities, larger 120 kilovolt-Ampere generators, advanced
air refueling boom, and aeromedical evacuation capability.
ALTERNATIVES CONSIDERED
In selecting the KC-767A, the Air Force considered a variety of
airframes and acquisition strategies. By DOD regulations, the Air Force
was not required to conduct an analysis of alternatives (AOA) for the
KC-767 tanker lease, the reasons for which I will address in more
detail later. Even though the Air Force did not complete a formal AOA
on the KC-767A, we performed several trade analyses to ensure the KC-
767A was the right solution to meet the operational requirements.
Maintain current force structure: The Air Force first considered
maintaining the current force structure. The damaging effects of aging
quickly became apparent from KC-135 depot work. The unpredictable
nature of age-related corrosion--its timing, location, and extent--
increases our concern for the risk of an event that would ground the
KC-135 fleet. Thus, continuing the status quo was rejected because of
unpredictable and potentially calamitous operational mission impacts.
Re-engine: The Air Force also quickly recognized that re-engining
the venerable KC-135Es did not address the aging issues, risks to our
combat operations, or increasing costs. Re-engining would amount to
spending billions of dollars for only a 20 percent improvement over KC-
135E capability, but without addressing the ``old iron'' that needs
replacing. Re-engining was not selected as the solution.
Commercial alternative: The Air Force considered acquisition of
commercial derivative platforms in tanker configurations. This strategy
acquires air refueling tankers derived from commercially available
airframes to avoid the high costs of new aircraft research and
development. The use of a commercial-based airframe forges synergy with
industry in worldwide logistics networks and other support. The
question then became: How can we get these mission critical assets to
the warfighter in the most expeditious way, at a reasonable cost to
taxpayers? Our answer: lease a tanker aircraft that is already
commercially available.
In February 2002, the Air Force issued a request for information
(RFI) to both Boeing and European Aeronautic Defense and Space Company
(EADS) to evaluate available technologies and associated risks.
Consideration of acquisition of commercially derived platforms included
the B757, B767, B777, and the Airbus A330 in tanker configurations,
considering both a lease option and a direct purchase. Based on the
responses to the RFI, the Boeing 767 was found to be the most
favorable. The Boeing 757 was too small to replace KC-135 one-for-one,
and would drive additional manpower requirements on a tanker force that
is already limited by available crews. The Boeing 777 required almost
twice as much ramp space as a KC-135--more than a KC-10--but had a
reduced fuel offload capability when compared to the KC-10. Further,
the B777 required significant engineering analysis and design work to
be modified into a tanker, including the possibility of a shortened
fuselage to accommodate a refueling boom during takeoff. The Boeing 767
was selected over EADS aircraft as a result of its favorable design,
schedule, risk factors, and proven boom technology.
To begin the recapitalization of the 544 KC-135 aircraft, the Air
Force considered two primary alternatives as acquisition strategies--a
traditional procurement of 100 KC-767A aircraft, and an operating lease
of commercially derived air refueling tankers in accordance with
section 8159 in fiscal year 2002 legislation. In addition, the Office
of the Secretary of Defense Leasing Review Panel considered several
alternate procurement approaches in contrast to the lease or planned
purchase, including purchases on the same delivery schedule as the
lease and applying the funding stream required for a lease to a more
traditional purchase program. The Secretary of Defense determined that
the lease option best satisfied this nation's military needs.
The Air Force, with permission from Congress, began negotiations
with Boeing for an operating lease of 100 commercially developed KC-
767A air refueling tankers. At the time of the fiscal year 2004
President's budget (PB) submittal, negotiations for the lease were
unfinished. Plan A, a KC-X procurement program, was included in the
President's fiscal year 2004 budget, with the program to begin, because
of affordability constraints, in fiscal year 2006. This program in the
fiscal year 2004 PB would deliver one tanker to the warfighter in
fiscal year 2009. The 100th aircraft would be delivered in fiscal year
2016.
In contrast, under the negotiated lease, the contractor will
deliver 60 new tankers to the warfighter by fiscal year 2009, and
deliver all 100 by fiscal year 2011 which is 5 years sooner than the
fiscal year 2004 PB procurement program. This plan provides for a
quicker start to recapitalization of the tankers. To match such a
recapitalization schedule under a purchase option would require
billions of additional dollars to be invested during the FYDP as well
as waivers of various acquisition rules. Since those funds are already
committed to other uses, there would have to be significant
restructuring and/or cancellation of ongoing and planned programs.
BUSINESS CASE ANALYSIS
Obviously, cost is a big driver when choosing an acquisition
strategy. In isolation, a leasing strategy requires additional funds in
then-year dollars relative to the cost of a traditional purchase.
Economic considerations, however, are not limited to expected funding
flows, which ignore the time-value of money. To account for this time-
value of money and gain insight into the economic implications of
leasing as an acquisition strategy, Office of Management and Budget
Circular (OMB) A-94 directs a present value comparison between the
proposed lease and a hypothetical purchase based on the same delivery/
return profile. The financial analysis for the A-94 test is highly
sensitive to the underlying assumptions such as purchase price,
expected inflation and appropriate discount rate. Since OMB oversees
governmental leases, the A-94 analysis, and the defining requirements
for an operating lease, the Air Force consulted them in developing its
analytic assumptions. Applying the A-94 test the Air Force determined
that the net present value of the multiyear lease option and a
traditional purchase option results in a net present value difference
favoring a purchase by $150 million--about 1 percent of the total cost.
These calculations do not take into account any operational savings
which the lease would permit to accrue sooner.
The advantages in schedule and reduced impact to currently budgeted
programs outweighed the results of the A-94 analysis and drove the
leasing decision. The Air Force and Department of Defense selected
leasing as the acquisition strategy primarily based on affordability--
by reducing the near-term cost--and minimizing the budgetary impact to
our plans for getting accelerated capability of the new weapon system
to our frontline troops.
Under the lease option, the Air Force can afford to field this new
fleet of tankers at a quicker pace than under a traditional purchase
plan. Jumpstarting replacement of the older, less-capable tankers
enables faster modernization of air expeditionary forces. The lease not
only advances the first delivery by 3 years, it puts the 100 aircraft
fleet at the disposal of our frontline commanders for combat operations
by fiscal year 2011, 5 years ahead of the planned purchase. If we were
to purchase these aircraft in a traditional buy on the same delivery
schedule, while maintaining our financial top-line, we would have to
take billions of dollars out of other important programs.
IMPLEMENTATION PLANS
Under this pilot program, the Air Force intends to lease 100 KC-
767A aircraft with congressional approval of the new start
notification. The lease program will be sole source, using terms and
conditions germane to commercial aircraft leases and commercial
business practices in accordance with the Federal Acquisition
Regulation and section 8159. Terms and conditions of the lease
arrangement meet all requirements of the fiscal year 2002 Defense
Appropriations Act including OMB Circular A-11 criteria for an
operating lease. Full details of the lease are included in the Report
to the Congressional Defense Committees.
This will be a three-party contract between the U.S. Government,
Boeing Integrated Defense Systems, and a third-party Trust, the KC-767A
USAF Tanker Statutory Trust. The Trust will issue bonds on the
commercial market based on the strength of the lease contract with the
U.S. Government (rather than the credit worthiness of Boeing), will buy
the aircraft from Boeing, and will lease them to the Government. The
Trust will not make a profit but will provide for the funds necessary
to pay bondholders and pay off the debt after the sale of the aircraft.
Any residual funds acquired from the possible sale of the aircraft
subsequent to lease termination will be refunded to the Government as
an overpayment.
The contract will include ``most favored customer'' clauses stating
that if Boeing sells comparable aircraft (up to 100) during the term of
the contract for a lesser price, the Government will receive an
equitable adjustment. Besides being a fixed-price contract, and to
further guarantee the taxpayers receive a favorable deal, Boeing has
agreed to a return-on-sales (ROS) cap of 15 percent, whereby in 2011,
any ROS in excess of 15 percent in either commercial or military
manufacturing centers will be returned to the Government. Again, this
is something unprecedented in military acquisitions.
It is not unexpected that new ways of doing business might raise
questions or controversies. There have been several questions with
respect to this arrangement that I would like to address.
Analysis of alternatives: As stated earlier, the Air Force was not
required to conduct an AOA for the KC-767 tanker lease. There is no
statutory requirement to conduct an AOA. Regulatory requirements for
AOAs are contained in our DOD instruction, Operation of the Defense
Acquisition System, which provides for their flexible application.
Under ``Plan A,'' an AOA was planned to complement the work done under
the Tanker Requirements Study and the Economics Service Life Study, to
lead to a traditional purchase beginning with the delivery of one
aircraft by 2009. However, the operational requirements of the global
war on terror and the increased demand on the tanker fleet highlighted
the need to accelerate the recapitalization of this national asset.
``Plan B,'' this lease program, addressed the critical need the
Congress and we saw for jump-starting recapitalization and it made good
business sense.
In fact, it is not unusual for a major program to not conduct an
AOA. The GAO has previously stated (NSIAD-94-194), ``Applicable defense
acquisition regulations allow management discretion in these matters
for the purpose of minimizing development time and reducing costs.''
There is additional precedence for not completing an AOA when either
the item is a commercial product or there is a low-risk in delivering a
product that will be militarily useful. The Air Force did not complete
an AOA for the C-130J program since this was an acquisition of a
commercial product that had already been marketed to foreign
customers--similar to the KC-767A tanker. No AOAs were conducted for
programs such as the KC-10 or the F/A-18 E/F.
Even though the Air Force did not complete a formal AOA on the KC-
767A, we performed several trade analyses to ensure the KC-767A was the
right solution to the operational requirements. We looked at
maintaining the status quo, but we judged the risk too high to not
begin the recapitalization effort now as a result of September 11,
increased tanker operations tempo for homeland defense and Operation
Enduring Freedom, increased operations and support costs and risks of
an aging fleet (catastrophic/grounding event that would significantly
erode our ability to meet our mission). We evaluated the feasibility of
re-engining KC-135Es, but this does not reduce the aging aircraft
risk--we would still have old aircraft that will need to be
recapitalized, and the payback of the re-engining cost AND retirement
savings [if we were allowed to retire 31 KC-135Es] exceeds 11 years. We
researched using ``stored'' commercial aircraft, but all the aircraft
had high hours, different engines, required heavy modifications and
there were insufficient numbers of aircraft available to be cost
effective. We investigated using a commercial fee-for-service, but
while this has been successful in Navy training scenarios, it did not
meet our overall operational requirements. We looked at other
operational commercial platforms to include an Airbus 330, Boeing 757,
and Boeing 777. The Airbus 330 had significant technical risk with
integrating boom technology into the aircraft. The B-757 could not
carry enough fuel to make it an efficient tanker. The B-777 was too
large, reducing the airfields where the aircraft could be deployed.
Finally, we researched the feasibility of building a new tanker from
the ground up, but this alternative carries a much higher cost and
developmental risk, and would not be available within the timeframe the
KC-767As would be delivered. The decision to select Boeing was based on
Boeing's response to our RFI, including its favorable design, schedule,
risk factors, and boom technology.
WHY WE NEED TANKERS SO URGENTLY DESPITE THE 2001 ECONOMIC SERVICE LIFE
STUDY (ESLS) REPORT THAT INTIMATED THAT THE CURRENT FLEET WOULD LAST
UNTIL 2040
Much has been made about the ESLS's prediction that we could
operate the current tanker fleet until 2040. What is rarely mentioned
is that even the optimistic 2001 study predicted that operations and
sustainment (O&S) costs would increase 43 percent by 2040 with 15
percent decrease in availability. The study assumed only 1 percent/year
cost growth, but even in as little time as 18 months, that figure was
seen as flawed. The updated report raised that figure to 1.5 percent/
year. The study was based on statistical calculations, but actual depot
sales rates show much greater increases in O&S costs. There have been
several studies regarding the aging aircraft.
1995 Fatigue Life Study: Boeing and the C/KC-135 SPO continued
their evaluation of the KC-135 expected service life with a fatigue
analysis in 1995. This analysis indicated that the KC-135R fleet would
not exhibit significant fatigue damage, in the absence of corrosion or
widespread fatigue damage, until 70,000 flight hours (66,000 for the
KC-135E).
The Air Force and industry debate over the unknown effects of
corrosion on fatigue life prompted the C/KC-135 SPO to contract with
Boeing to update the fatigue life to include effects of increased
stress from corrosion-associated material thinning. Using this combined
``net-area'' fatigue/corrosion life, the KC-135R service life was
adjusted to 39,000 flight hours and the KC-135E life was adjusted to
36,000 hours. Today, the average flight-hour distribution for R models
is 16,000-17,000 hours, and 17,000-19,000 hours for the E models. An
Air Force/industry ``Blue Ribbon Panel'' convened in 1996 and
acknowledged operation of the fleet out to 2040 is achievable, assuming
aggressive corrosion control. Further analysis would conclude that the
KC-135 service life is actually limited by age in years, not flight
hours.
As early as the Air Mobility Master Plan of 1995, Air Mobility
Command (AMC) acknowledged corrosion as a ``major factor in the
continued service life of the KC-135 forces.'' At that time, AMC
pursued corrosion forecasting technologies and planned on initiating
replacement of the KC-135 fleet in fiscal year 2007 pending
verification of the magnitude of the corrosion problem. The 1998 Air
Mobility Master Plan again noted that corrosion studies were required
with a notional replacement date of fiscal year 2013. However, as more
and more of these inspections took place, it was obvious by 2001, that
our reports may have been overly optimistic. In Air Force studies
conducted in 2001 we proposed a notional replacement date of fiscal
year 2010.
The depot level maintenance cost growth experienced due to the
aggressive maintenance practices implemented with the Aging Aircraft
Program caused concern within AMC. The Mobility Master Plan of 2000
called into question the high cost required to maintain the aging KC-
135 fleet. The plan states, ``The major factor limiting structural life
is fleet corrosion. Previous studies did not include corrosion as a
significant factor in the service life, nor did they address increased
costs and decreased availability that would result from the aggressive
maintenance practices required to maintain adequate safety margins.''
Consequently, previous service life estimates and projected retirement
dates may be overly optimistic.
1994-1995 RAND studies: The Air Force contracted RAND to conduct
aging aircraft studies based on commercial and military aircraft fleets
in order to determine the feasibility of long-term sustainability of
the Air Force's aging fleets. RAND completed a series of five studies
beginning in 1994 and ending in 1999. These studies raised technical
concerns regarding the 1) viability of retaining commercial aircraft
past their design lives, 2) viability of retaining Air Force aircraft
past their design lives, 3) potential maintenance cost growth
associated with aging aircraft, 4) potential engine cost growth, and 5)
projection of Air Force fleet-specific Program Depot Maintenance (PDM)
and engine cost growth through 2022. The results of the studies
concluded that ``major support challenges may result from corrosion,
insulation cracking, composite delamination, and other material
degradation processes for which there are no scientific aging models or
relevant historical experience. Most important, many of the challenges
associated with aging material have emerged with little or no warning.
This raises the concern that a new challenge may suddenly jeopardize an
entire fleet's flight safety.'' The final study recommended a three-
pronged strategy for maintaining aging aircraft: 1) risk management
strategy to identify age-related hazards that affect cost and safety
hazards and develop solutions to reduce their effects, 2) fleet
contingency strategy to reduce aircraft design and production lead
times of obsolete replacement parts to minimize fleet-wide failures,
and 3) mission management strategy to implement acquisition and
retirement plans that balance fleet ages within mission areas, making
the Air Force less dependent upon a particular fleet of aging aircraft.
The Air Force has implemented two out of three prongs of RAND's
strategy for maintaining aging aircraft. The C/KC-135 SPO's Aging
Aircraft Program created a risk management strategy by establishing
major structural repairs and tracking their repair. The SPO also
developed fleet contingency strategies by contracting with new vendors
for obsolete parts. The Air Force partially implemented a mission
management strategy with the acquisition of the KC-10s; however, 90
percent of the refueling fleet still resides within the KC-135 fleet,
creating the potential for fleet-wide system failure. At least partial
recapitalization of the KC-135 fleet is needed to satisfy all of RAND's
recommendations.
1996 GAO study: The GAO drafted this report in 1996 to validate Air
Force actions to preserve its aging tanker fleet and to examine the
effects of increased demands on the services' air refueling fleets
after Operation Desert Storm. The study noted that ``the Air Force's
principal tanker aircraft--the KC-135s--are 30 to 40 years old and, as
a result, are taking progressively more time and money to maintain and
operate.'' The results of the study noted, ``Air Mobility Command
doubts that the KC-135 can be economically operated beyond 2020.'' This
is the result of projected cost-per-flying-hour increases of 24 percent
from 1996 to 2001, and historical depot labor hour increases of 36
percent, and depot flow day (aircraft time spent in depot) increases of
55 percent from 1991 to 1995. The study recommends recapitalizing the
air refueling fleet with a ``dual-use replacement aircraft (that) could
fulfill both airlift and air refueling missions.''
NEGOTIATED PRICE
The Air Force negotiated this agreement at the highest levels
possible. We employed standard commercial ``best'' business practices
as we negotiated the deal. We firmly believe that the Air Force price
is the best price--the best price that can be achieved in the
commercial market place in the real world. The difference is primarily
one of assumptions. The Air Force treated the tanker lease as a
commercial item. The Air Force followed the guidance for buying
commercial items contained in Federal Acquisition Regulation (FAR) Part
12. In addition, Section 8159 of the fiscal year 2002 DOD
Appropriations Act specifically authorized the Air Force to use terms
and conditions that are customary in non-Government leases. The final
price is a product of a careful analysis and market research by the Air
Force and extensive price negotiations with the contractor. We believe
the Air Force has received a fair and reasonable price under the lease.
However, we are not relying solely on our price analysis. The lease
agreement contains most favored customer provisions and a 15-percent
limitation on the contractor's total return on sale for the tankers. In
addition, the contractor bears the risk of delivering conforming
aircraft at a fixed price.
Also, the aircraft price must be viewed in a larger context. The
aircraft must meet the performance specifications stated in the
contract and must have a high [80 percent] operational availability
rate. The contractor must maintain the aircraft to the specifications
and the high (80 percent) availability rate throughout the term of the
lease.
In contrast, the study conducted by IDA used a different basis of
estimate; they looked at the manufacturing process used, associated
development costs, risk management, and contract type. Nonetheless, the
Air Force capitalized on much of the additional information derived
through the review by the Office of the Secretary of Defense in our
final negotiations.
PROGRAMMED RETIREMENTS
Our plan to retire 68 KC-135Es in fiscal year 2004 will increase
fleet utilization by freeing money and personnel that would be required
for maintaining KC-135Es that could be used on KC-135Rs. This is true
even if we do not lease the 767. This retirement of 13 percent of the
fleet would result in only 4 to 5 percent decrease in average sortie
generation. If we only retire 12 aircraft in fiscal year 2004 versus
going with the original 68-reduction plan, we would need approximately
$40 million fiscal year 2004 dollars to cover the additional costs of
keeping the Es around. This is based on 3 additional programmed depot
maintenance requirements at approximately $8 million a piece and 13
additional engine overhaul requirements at $962,000 a piece.
Additionally, we will need to replace $75 million in funds offset in
fiscal year 2004 to divest 44 tankers. This includes flying hours and
military personnel costs. The total bill in summary: added depot
purchased equipment maintenance costs plus fiscal year 2004 offset, $40
million + $75 million = $115 million. The ``retire 12 in fiscal year
2004'' plan has no monetary impact on the ``68-reduction'' plan in
fiscal year 2005 and fiscal year 2006, assuming that we use fiscal year
2005 to ``catch up'' on aircraft retirements, but may require some
operational workaround to account for the rapid retirement.
CONCLUSION
I want to thank the committee for allowing the Air Force to share
its concerns about the need for a new tanker. I believe the KC-767A
Multi-Year Aircraft Lease Pilot Program offers us the opportunity to
jumpstart recapitalization of our aging KC-135 tankers. Recent events
and increased requirements to support homeland defense have spotlighted
our reliance on these critical refueling assets. Tanker dependence in
recent wars and the advanced age of the Nation's air refueling aircraft
fleet drive the Air Force's urgency to begin recapitalization as soon
as possible. The KC-767A supports the requirements for our next
generation tanker aircraft. The negotiated lease proposal would provide
for the delivery of 60 aircraft within the FYDP and field the 100th
aircraft by 2011, 5 years faster than current purchase plans. This
minimizes near-term budgetary impact to other important programs.
I fully support this leasing alternative to provide the warfighters
with new equipment as quickly as possible. This leasing program
supports the Air Force's essential mission requirements that support
the defense of America.
I appreciate the support provided by Congress and look forward to
working with this committee to best satisfy our warfighter needs in the
future. Thank you for the opportunity to provide this statement for the
record.
Chairman Warner. Secretary Wynne.
STATEMENT OF HON. MICHAEL W. WYNNE, ACTING UNDER SECRETARY OF
DEFENSE FOR ACQUISITION, TECHNOLOGY, AND LOGISTICS
Secretary Wynne. Mr. Chairman, Senator Levin, members of
the committee: I am pleased to come before you today to talk
about the Air Force's new start request to lease 100 KC-767 air
refueling tanker aircraft. There is consensus within the
Department that we must start recapitalizing the airborne
tanker fleet as soon as possible. It is a vital component to
our defense capability and it is aging badly.
Re-engining the KC-135E aircraft may not be sufficient to
extend their service life. Options included an aircraft
incorporating a new design or a variant of an existing
aircraft. An aircraft based on a new design would cost the
Department research and development funds and some estimates
are that such a new aircraft would cost in the range of $200
million to $250 million a unit, while the planned commercial
derivative, if it was available at the time, was estimated to
cost between $150 million to $161 million.
There are only four suppliers that I consider as capable to
develop and produce such a tanker aircraft. That would be
Boeing, Lockheed Martin, European Air Defense Systems, and the
Russians. Only three currently produce wide-body aircraft.
The Department's plan in the President's fiscal year 2004
budget was to begin a tanker development program or commercial
derivative in fiscal year 2006, with the first tanker delivery
targeted for fiscal year 2009. However, when Congress gave us
the opportunity in this pilot program authority to lease, this
allowed the Department to aggressively pursue the tanker
version of the 767 aircraft, an option which might not have
been available in the fiscal year 2006 should Boeing have been
unable to maintain the commercial production line due to no
current market.
On its face, this is clearly a less expensive alternative
than new development. It has far less cost risk than waiting
until fiscal year 2006 when the same commercial opportunity
might no longer exist.
The Air Force proposed leasing tankers and brought their
proposal to the Leasing Review Panel, which compared the merits
and shortcomings of both leasing and purchasing KC-767
aircraft. Based on input from the co-chairs of this panel,
Under Secretary Aldridge and Under Secretary Zakheim, the
Secretary has determined that the lease option best met the
needs of the Air Force and was preferable because leasing
minimizes the near-term cost to the Department of Defense and
delivers these aircraft sooner, gaining those benefits.
If we were to purchase the aircraft and Boeing were to
deliver them on the same schedule as it will under the lease,
it would require billions of dollars more in the FYDP. As we
have pursued a goal of stability in programs and that was
fostered by our goals that we set out in the acquisitions,
technology, and logistics (AT&L), such a reallocation would
have been counter to our goals and disrupted many ongoing
programs, barring further appropriation of needed funds.
While the proposed lease will provide for delivery of a
total of 100 KC-767s, approximately 60 of which will be
delivered in the period covered by our Fiscal Year Defense
Plan, fiscal year 2005 to 2009, the Department does intend to
go further and recapitalize the airborne tanker fleet. The Air
Force has thus been directed to develop a long-range
recapitalization plan beyond the current lease proposal, and we
will address that plan in the President's fiscal year 2006
budget.
At my request, the Department of Defense Inspector General
(DODIG) has recently completed an evaluation of the process by
which the Department arrived at the decision to lease tankers
from Boeing. The results of this evaluation frankly have
provided insight as to how to strengthen the leasing panel's
deliberation. During a review, the DODIG indicated there were
no impediments that they were currently aware of to entering
this lease agreement. I intend to carefully consider all the
recommendations from this report as future lease opportunities
come before this panel.
I do recall in the mid-1970s the lease of maritime
prepositioning ships that your staff may go see. They are still
on station. It was a long-term, 25-year lease, as I recall, to
build, operate, and charter. It is a dim memory of mine,
because I happened to be with the corporation that did that,
but you might look into that, sir.
Chairman Warner. I remember the precedent quite well.
Secretary Wynne. Thank you, Mr. Chairman, for the
opportunity to testify before this committee. I urge this
committee to approve this lease and the replacement plan it
represents. I stand ready to answer any questions that you and
the members of the committee might have.
Thank you, sir.
[The prepared statement of Secretary Wynne follows:]
Prepared Statement by Hon. Michael W. Wynne
Mr. Chairman and members of the committee, I am pleased to come
before you today to talk about the Air Force's new start request to
lease 100 KC-767 air refueling tanker aircraft.
On May 23, the Department announced the Secretary's decision to
approve the Air Force's proposal to enter into a multi-year pilot
program for leasing general purpose Boeing 767 tanker aircraft.
There is consensus within the Department that we must start
recapitalizing the airborne tanker fleet as soon as possible, and that
re-engining the KC-135E aircraft may not be sufficient to extend their
service life. Options included an aircraft incorporating a new design,
or a variant of an existing aircraft. An aircraft based on a new design
would cost the Department research and development funds and some
estimates are that such a new aircraft would cost in the range of $200-
$250 million per unit, while the planned commercial derivative, if it
was available, was estimated to cost between $150-$161 million.
There are only four suppliers who could develop and produce such a
tanker aircraft--Boeing, Lockheed Martin, EADS, and the Russians--and
only three currently produce wide-body aircraft. The Department's plan,
in the President's fiscal year 2004 budget, was to begin the tanker
development program--a commercial derivative--in fiscal year 2006, with
the first tanker delivery targeted for fiscal year 2009. However, when
Congress gave us pilot program authority to lease, this allowed the
Department to aggressively pursue the tanker version of the 767
aircraft, an option which might not have been available in fiscal year
2006 if Boeing had shut down the commercial production line. On its
face, this is clearly a less expensive alternative than new
development. It also has far less cost risk than waiting until fiscal
year 2006 when the same commercial opportunity might no longer exist.
The Air Force proposed leasing tankers and brought their proposal
to the Leasing Review Panel, which compared the merits and shortcomings
of both leasing and purchasing KC-767 aircraft, given the 767 line
remained open for both leasing and purchasing. Based on input from the
co-chairs of this panel, Under Secretary Aldridge and Under Secretary
Zakheim, the Secretary determined that the lease option best met the
needs of the Air Force and was preferable because leasing minimizes the
near-term cost to the Department of Defense and delivers the aircraft
sooner. If we were to purchase the aircraft and Boeing were to deliver
them on the same schedule as it will under the lease, it would require
billions of dollars more in the Future Years Defense Program (FYDP). As
we have pursued a goal of stability in programs, such a reallocation
would have been counter to that goal, and disrupted many ongoing
programs.
On July 10, the Secretary of the Air Force notified the Defense
Committees of the Department's intent to lease 100 Boeing 767 aircraft
under the Multi-year Aircraft Lease Pilot Program and provided a report
on tanker leasing to those committees, in accordance with section 8159
of the Department of Defense Appropriations Act, 2002. Section 8159
requires the Air Force to wait at least 30 calendar days after it
submits the report before entering into the lease contract.
On July 11, the Air Force provided to the Defense Committees and to
the Appropriations Committees a new-start notification associated with
the proposed lease of 100 KC-767 air refueling tankers. As the Air
Force has noted in both cover letters for the report and this
notification, it is the Department's intention not to award a contract
until the Defense Committees of Congress indicate that they concur with
the Department's plans as set forth in the notification. To assist the
Defense Committees in their review of the lease proposal, the
Department has supplied all four committees with draft versions of the
contract with Boeing. Thus far, the House and Senate Defense
Appropriations Subcommittees and the House Armed Services Committee
have indicated to us that they concur.
While the proposed lease will provide for delivery of a total of
100 KC-767 aircraft, approximately 60 of which will be delivered in the
period covered by the FYDP, the Department intends to recapitalize the
airborne tanker fleet. The Air Force has been directed to develop a
long-range recapitalization plan beyond the current lease proposal and
we will address that plan in the President's fiscal year 2006 budget.
At my request, the DOD Inspector General has recently completed an
evaluation of the process by which the Department arrived at the
decision to lease tankers from Boeing. The results of this evaluation
provide insight into the decisionmaking process conducted by the
Leasing Review Panel.
Thank you, Mr. Chairman, for the opportunity to testify before the
committee. I would be happy to answer any questions that you and the
members of the committee may have.
Chairman Warner. Thank you very much.
Mr. Kaplan, we welcome you.
Mr. Kaplan. Thank you, Mr. Chairman.
Chairman Warner. This is your first appearance?
Mr. Kaplan. Other than my confirmation hearing, yes, sir,
Mr. Chairman.
Chairman Warner. You are on your own. [Laughter.]
Mr. Kaplan. I appreciate that.
Senator Levin. Unlike your confirmation hearing, by the
way.
Mr. Kaplan. It felt like I was on my own there too,
Senator. [Laughter.]
STATEMENT OF JOEL D. KAPLAN, DEPUTY DIRECTOR, OFFICE OF
MANAGEMENT AND BUDGET
Mr. Kaplan. Thank you, Mr. Chairman and members of the
committee. I am pleased to be here today to discuss the Air
Force's planned lease of Boeing KC-767A refueling aircraft. I
will make a brief statement describing OMB's role in the
process that led to the decision to approve the lease proposal,
and I will be happy to answer any questions you may have.
As with all lease proposals, OMB reviewed the terms of the
lease as they were developed by the Air Force. OMB's role in
such transactions is to ensure that our warfighters have the
resources they need, while maintaining fiscal discipline to
protect the taxpayer.
Both the Secretary of the Air Force and the Office of the
Secretary of Defense convincingly argued that a modernized
tanker fleet made available on an expedited basis was and
remains essential to ensure that our military is adequately
supported in the war on terror and other critical missions. The
facts supporting the military necessity for the lease are
discussed at length in the Air Force's report to Congress and
in Secretary Roche's testimony before you. I will not repeat
those facts in detail, but simply highlight the Air Force's
strong belief in the urgent need to recapitalize its aging
tanker fleet.
The arguments in support of the need for new tankers may
also have informed Congress's judgment in enacting section 8159
of the Fiscal Year 2002 Defense Appropriations Act. In section
8159, Congress expressly authorized the Air Force to lease
Boeing 767 aircraft for these purposes.
Shortly thereafter, the Air Force proposed a tanker lease
that was extensively reviewed both by OMB and within the
Department of Defense. OMB's unflagging focus during nearly 2
years of review and negotiation was to ensure that the Air
Force entered into the most advantageous deal possible under
the circumstances.
The tanker lease proposal was not without its challenges.
The Air Force presented an exceedingly complex lease proposal
that raised many unique issues. During the review process and
pursuant to its longstanding institutional responsibilities,
OMB posed a number of tough questions regarding the need for
the aircraft, the business case supporting the lease proposal,
and the aircraft price.
Of all these issues, from OMB's perspective ensuring that
the price represents the best value for the taxpayer was
paramount. As a result, OMB was aggressive in working to hold
down costs while preserving capabilities. Early on, OMB was
concerned that the initial price of the tanker aircraft was too
high and believed that through negotiation with Boeing the Air
Force should and could reduce the price. By the time
negotiations were concluded, the aircraft price had dropped
from an early estimate of $150 million to a final price of $131
million. Reducing the price per plane $20 million achieved $2
billion in savings for the taxpayer.
The committee has requested that I address the decisions to
proceed with a lease instead of purchase and to classify the
lease as an operating lease. Both of these issues were
challenging, involving subjective judgments on difficult
analytical questions. Under our Circular A-94, OMB requires a
lease versus purchase analysis for any agency proposing a lease
and the results are an important part of our decision-making
process.
OMB worked closely over many months with the Air Force to
understand its business case supporting the lease proposal and
the give and take of these discussions resulted in significant
improvements to the Air Force's model. While OMB and the Air
Force agreed that leasing in present value terms is a higher
cost option than purchase, the magnitude of the difference
varies depending on certain assumptions. The Air Force
estimates that the net present value of the lease proposal is
$150 million more than a purchase. However, the Air Force
report to Congress also states that the difference between the
net present value of the lease and purchase could be as high as
$1.9 billion depending on a variety of complex assumptions.
The administration decided to approve the lease
understanding this range of financial costs in order to satisfy
an important military requirement in the post-September 11
world. Leasing these aircraft will result in delivery of 60 new
767 tanker aircraft by 2009. There is no question that without
a substantial reallocation of resources that would have a
negative impact on other programs critical to national
security, direct purchase would take much longer to acquire for
the Air Force the same number of aircraft.
Determining whether the proposed lease qualifies as an
operating lease under OMB Circular A-11 also raised difficult
analytical questions. Of necessity, the assessment of whether
or not a lease is an operating lease under A-11 is based on
estimates and assumptions that can be subject to honest
disagreement. Some of the A-11 criteria contain considerable
ambiguity. As a result, capable and impartial analysts applying
those criteria to the same information may reach different
conclusions about whether a lease is a capital lease or an
operating one, especially when the proposal is right at the
margin.
In light of the Air Force's conviction that these planes
are needed to meet an urgent military need and in light of
clear congressional intent to support a lease as expressed in
legislation, OMB believed it appropriate to resolve ambiguities
in favor of classifying this transaction as an operating lease.
Throughout its review process, OMB repeatedly questioned
numerous aspects of the deal in order to press the Air Force to
complete the best possible deal for the taxpayers. In addition
to helping the Air Force to negotiate the price down, OMB,
together with the Office of the Secretary of Defense, also
raised concerns about other aspects of the proposed contract,
including operational restrictions and the lack of adequate
liability protection. As a result, the Air Force went back to
the negotiating table and improved these contractual provisions
to the benefit of the military and the taxpayers.
OMB believes that the lease proposal satisfies Congress's
intent in enacting the legislation authorizing this lease and
represents the best achievable lease. Over the next few months,
we will work with the Department to ensure that the funds
required for the lease are included in the Air Force's fiscal
year 2005 budget and their future plans.
Thank you, Mr. Chairman, for the opportunity to testify on
this important issue. I will be happy to answer any questions
you and the members of the committee may have.
[The prepared statement of Mr. Kaplan follows:]
Prepared Statement by Joel D. Kaplan
Thank you, Mr. Chairman and members of the committee. I am pleased
to be here today to discuss OMB's role in reviewing the Air Force's
planned lease of Boeing KC-767A refueling aircraft. Although I was not
at OMB at the time the decision to proceed with the tanker lease was
made, I will make a brief statement describing OMB's role in that
process and I will be happy to answer any questions you may have.
As with all lease proposals, OMB reviewed the terms of the lease as
they were developed by the Air Force. OMB's role in such transactions
is to ensure that our fighting men and women have the resources they
need, while maintaining fiscal discipline to protect the taxpayer. Both
the Secretary of the Air Force and the Office of the Secretary of
Defense convincingly argued that a modernized tanker fleet, made
available on an expedited basis, was and remains essential to ensure
that our military is adequately supported in the war on terrorism and
other critical missions.
The facts supporting the military necessity for the lease are
discussed at length in the Air Force's report to Congress on the lease
proposal of July 10, 2003, and in Secretary Roche's testimony before
you today. I will not repeat those facts in detail, but simply
highlight the Air Force's strong conviction about the urgent need to
recapitalize the aging tanker fleet. The arguments in support of the
need for new tankers may also have informed the debate in Congress at
the time section 8159 of the Fiscal Year 2002 Defense Appropriations
Act was enacted. In section 8159, Congress expressly authorized the Air
Force to lease Boeing 767 aircraft.
Shortly thereafter, the Air Force proposed a tanker lease that was
extensively reviewed both by OMB and within the Department of Defense.
OMB's unflagging focus during nearly 2 years of review and negotiation
was to ensure that the Air Force entered into the most advantageous
deal possible under the circumstances. The tanker lease proposal was
not without its challenges: the Air Force presented an exceedingly
complex lease proposal that raised many unique issues. During the
review process, and pursuant to its long-standing institutional
responsibilities, OMB posed a number of questions regarding the need
for this aircraft; the business case supporting a lease proposal; and
the aircraft price.
Of all these issues, from OMB's perspective, ensuring that the
price represented the best value for the taxpayer was paramount. As a
result, OMB was aggressive in working to hold down costs while
preserving capabilities. Early on, OMB was concerned that the initial
price of the tanker aircraft was too high, and believed that, through
negotiation with Boeing, the Air Force should and could reduce the
price. By the time negotiations were concluded, the aircraft price had
dropped from an early estimate of $150 million to a final price of $131
million. Reducing the price per plane by $20 million achieved $2
billion in savings for the taxpayer.
The committee has requested that I address the decisions to proceed
with a lease instead of a purchase and to classify the lease as an
operating lease. Both of these issues were challenging, involving
subjective judgments on difficult analytical questions. Under our
Circular A-94, OMB requires a lease vs. purchase analysis from any
agency proposing a lease, and the results are an important part of our
decisionmaking process. OMB worked closely over many months with the
Air Force to understand its business case supporting the lease
proposal, and the give and take of these discussions resulted in
significant improvements to the Air Force's model. While OMB and the
Air Force agreed that leasing, in present value terms, is a higher cost
option than purchase, the magnitude of the difference varies depending
on certain assumptions. The Air Force estimates that the net present
value of the lease proposal is $150 million more than a purchase.
However, the Air Force's Report to Congress also states that the
difference between the net present value of lease and purchase could be
as high as $1.9 billion, depending on a variety of complex assumptions.
The administration decided to approve the lease understanding this
range of financial costs in order to satisfy an important military
requirement in the post-September 11 world: leasing these aircraft will
result in delivery of 60 new 767 tanker aircraft by 2009. There is no
question that without a substantial reallocation of resources that
would have a negative impact on other programs critical to national
security, direct purchase would take much longer to acquire the same
number of aircraft.
Determining whether the proposed lease qualifies as an ``operating
lease'' under OMB Circular A-11 also raised difficult analytical
questions. Of necessity, the assessment of whether or not a lease is an
operating lease under Circular A-11 is based on estimates and
assumptions that can be subject to honest disagreement. Some of the A-
11 criteria contained considerable ambiguity. As a result, capable and
impartial analysts applying those criteria to the same information may
reach different conclusions about whether a lease is a capital lease or
an operating one, especially when the proposal is right at the margin.
In light of the Air Force's conviction that these planes are needed to
meet an urgent military need, and in light of clear Congressional
intent to support a lease, as expressed in legislation, OMB believed it
appropriate to resolve ambiguities in favor of classifying this
transaction as an operating lease.
Throughout its review process, OMB repeatedly questioned numerous
aspects of the deal in order to press the Air Force to complete the
best possible deal for the taxpayers. In addition to helping the Air
Force to negotiate the price down, OMB, together with the Office of the
Secretary of Defense, also raised concerns about other aspects of the
contract, including operational restrictions and the lack of adequate
liability protection. As a result, the Air Force went back to the
negotiating table, and improved these contractual provisions to the
benefit of the military and the taxpayers. OMB believes that the lease
proposal satisfies Congress' intent in enacting the legislation
authorizing this lease, and represents the best possible lease under
the circumstances. Over the next few months, we will work with the
Department to ensure that the funds required for the lease are included
in the Air Force's fiscal year 2005 budget and their future plans.
Thank you, Mr. Chairman, for the opportunity to testify on this
important issue. I would be happy to answer any questions you and the
members of the committee may have.
Chairman Warner. Thank you. We will proceed to a 6-minute
round of questions.
Secretary Roche, this committee and indeed Congress would
never want to ask any uniformed member of the Armed Forces to
take risks as a consequence of aging equipment, such risks
being over and above the normal risks that they all take every
day, whether it is the takeoff or the landing of a brand-new
airplane or an old one. You have in this room as I understand
it several who have experienced the problems with these
aircraft. Could you just summarize the anecdotal evidence that
you present to this committee that it is imperative that we
not, I presume the word would be, continue to require these air
crews to take risks associated with aging equipment?
Secretary Roche. Mr. Chairman, thank you. We would never
ask any pilot or crew to go on an aircraft that ought not to be
flown. The concern is not so much the risk that they would have
been flying. It is the risk of the fleet being grounded or not
being available to be used in a particular operation.
As of today, not counting the aircraft that are in depot,
of the 135 fleet, roughly 78 percent are ready to be used or a
third is not ready to be used. If you count the aircraft that
are in depot, it is something like 35 percent are not
available.
The concern is when you have airplanes that are as old as
they are, we do not know how they will fail. We worry about a
major class problem which would cause us to ground the entire
force because we do not know how they are going to behave as
they get older. We have been surprised on a number of
occasions.
The issue, as we propose it, is to have sufficient number
of newer aircraft to be able to hedge against that happening.
If we had 100 new airplanes and the 59 KC-10s, which are only
about 18 years old now, that 159 number is a dramatic hedge in
any particular scenario to be able to make sure we could
satisfy the requirements of the deployed forces as well as
aircraft overhead.
I have been on a KC-135E and had two of the three
generators go out over the Atlantic, and it gets a little dicey
looking for divert fields in Canada. A second generator came
on, we were fine. Another time, 2 hours west of Honolulu, we
lost all hydraulics on one side of the aircraft, which when we
understood the plane was so old that the hydraulics are really
boosting cables, you can fly without hydraulics on one side of
the airplane, and we went from island to island until we could
get to Okinawa and have an emergency landing.
So it is a third of the time these planes are unavailable.
Chairman Warner. An Air Force economic service life study,
ESLS, of KC-135 tanker aircraft in February 2001 stated that
the tanker fleet was structurally viable to 2040 and there was
no urgent need to replace the KC-135s. Now, what has changed? I
presume that this was a well thought through report.
Secretary Roche. In fact, Mr. Chairman, as we look back on
that report, we would not have submitted it. It used old data
and it just compared the rising costs to maintain as compared
to the budget allocation for maintenance. When we took a look
at that in 2003, the costs assumed to have been in place in
2003 in fact were much higher.
What it did not take a look at was what were the conditions
of the aircraft in the depot, what was the condition of the
corrosion factor.
Chairman Warner. So you think this, frankly----
Secretary Roche. It was a faulty study.
Chairman Warner. A faulty study?
Secretary Roche. Yes, sir.
Chairman Warner. Now, Secretary Wynne and perhaps Mr.
Kaplan, I am sure you are aware of the cost analysis conducted
by the CBO which estimates that a lease of these 100 767s would
be over $5 billion more expensive than outright purchase in
then-year dollars. In the DOD analysis, what was the estimate
of the cost of the lease versus purchase in then-year dollars?
Secretary Wynne. I do not think I have a disagreement in
then-year dollars, sir. I think I have a disagreement as to
whether we should use then-year dollars in comparison. The
better comparison on any financial arrangement is net present
value, and that comes out to be, it ranges between $100 million
and $150 million----
Chairman Warner. Is the CBO estimate accurate in your view,
or are they just using different----
Secretary Wynne. I have not reviewed their thing to
comment. I can take that for the record.
Chairman Warner. Hey, wait a minute. You have not reviewed
the CBO report?
Secretary Wynne. I have not looked at it in depth, sir. I
just have looked at it in very surface amount.
Chairman Warner. I find that somewhat disturbing, that you
have not in your preparation looked at it, because it is a
valuable contribution. We will get testimony on it later.
Do you have any comment on that, Mr. Kaplan?
Mr. Kaplan. Yes, Mr. Chairman, I have had an opportunity to
review the CBO analysis. There are significant differences in
OMB's analytical approach. There are not ultimately significant
differences in the fact that everyone I think who has looked at
this lease ultimately concluded, which is that the lease option
is more expensive in both then-year dollars terms and in terms
of net present value.
The Air Force's discussion in its submission to Congress
did conclude that there was a range, as I said in my testimony,
of between $150 million and $1.9 billion, I believe, in net
present value. Net present value is the criterion that our OMB
Circular requires us to use.
Chairman Warner. Secretary Roche, having had some
experience in a military department as you have had, and you
have been a student of Congress and this committee for many
years, you have professionally had a long association, what is
your understanding of why your predecessors, be they civilian
or uniformed, did not address this question in the depth and
with the conviction that you have addressed it to push the
situation towards what I view as a most extraordinary exception
to the way we do business, Congress and the Department of
Defense?
Secretary Roche. Mr. Chairman, the only conclusion I can
come to is that, given the procurement holiday and given the
low budgets of the 1990s, there were so many other priorities
that the sense was that tankers were not that important.
Second, the planning models that were used assumed two
major conflicts and you plan for those, and I think when they
looked at that they felt they had enough excess capacity in the
tanker force, as compared to looking at the reality of how we
were using AWACS, et cetera, in various contingencies. In July
2001, we could not have predicted a war in Afghanistan and a
war in Iraq that would have required us to go to battle in
landlocked areas, or that our tanker fleet would be used more
than half the time by non-Air Force aircraft, by Navy and
Marine Corps aircraft and coalition partners.
Chairman Warner. Those are operational studies. I have to
presume that in the vast number of studies conducted by the
Department, we had this two major and one minor that somebody
addressed.
But my last question to you is a very simple one, and that
is the magnitude of the added costs being thrust on the
taxpayers by this proposal prompts me to ask: Did you look at,
say, an emergency buy with a lease along these lines of, say,
25 aircraft of the 100 aircraft, thereby giving time for the
traditional process of a budget submission by the President
and, if necessary, a decision by the Secretary of Defense to
create a wedge for the Department of the Air Force to handle
this situation?
Secretary Roche. Mr. Chairman, we did not look at 5, 25, or
50. We looked at the buy of 100 after Congress had passed the
bill that said we had the authority to try to lease 100. So we
used that number.
Chairman Warner. Did you feel that that legislation bound
you?
Secretary Roche. No, sir, no, it did not. It just gave us a
point. We talked about looking at 50 at some point and then
just stuck to the 100 number because it was a good comparison
and a full 100 plus the 59 gave us a full hedge.
The issue was that the up-front budget authority was simply
not available and we did not think it would become available.
There were also procurement rules, like the color of money that
was used for development versus production.
Chairman Warner. Let me ask you quickly: Is it a viable
option? Even though you seized the 100 and Congress may have in
the course of the language put in two bills--and I acknowledge
clearly that Congress in a sense, the full Senate, has acted on
the appropriation and indeed the insertion in the
authorization. I take notice of that.
Secretary Roche. Mr. Chairman, you would be a better
authority than I would as to whether Congress could in fact
give us $5 to $11 billion more over the next 5 years just for
tankers. We were trying to put this in our budget over a longer
period when we in fact could handle the costs of the lease
because our existing expenses for things like C-17 would come
down.
Chairman Warner. I am going beyond my time, but Congress
has to react to the budget request by the President. Initially
the President has to make the decision whether he wants this
wedge for the Department of the Air Force. Then it is up to
Congress to decide.
Senator Levin.
Senator Levin. The CBO has concluded that the use of long-
term leases reduces the ability of our budgets to depict the
government's financial commitments; undermines fiscal
discipline by circumventing controls, including the limits on
deficits and caps on discretionary spending; and allows
agencies to avoid facing the full costs of their purchasing
decisions.
As a matter of fact, the Air Force has stated that the
dominant reason for the lease approach is that it enables the
Department to enable tanker aircraft without requiring
significant up-front funding. So the added costs here that
exist are just delayed, put on the backs of future budgets.
I am wondering, Mr. Kaplan, whether or not you agree or
disagree with the CBO's conclusion that the use of long-term
leases has the effect of weakening fiscal discipline by pushing
costs off into outyear budgets?
Mr. Kaplan. Senator, I think it is fair to say that OMB
shares CBO's institutional skepticism when presented with an
individual lease proposal and, for that matter, whether lease
proposals across the board would be the right way to go. I
think that skepticism is evident in Director Daniels'
correspondence, and his review of the lease. I think the
process that the Air Force and OMB and the Department of
Defense and, for that matter, Congress has undergone for almost
2 years now in review of this lease suggests that this is not
the normal course of events, that this is a unique proposal
that we are looking at in light of unique requirements
identified and recognized more clearly post-September 11.
Senator Levin. Why not lease other DOD assets if we are
going to lease these tankers? There are a lot of other
requirements that are unmet. We have a whole long list of unmet
requirements. Why not use this then as a precedent to lease
cargo ships or cargo aircraft or Navy ships or Army combat
vehicles? We have a lot of unmet requirements.
Mr. Kaplan. We do and the President's budget that he
submitted to Congress and so far has received the support of
Congress I think has gone a long way towards meeting those
requirements. Those requirements have significantly increased,
obviously, post-September 11.
Senator Levin. My question is what is different about this?
We have a lot of unmet requirements.
Mr. Kaplan. We are trying to meet all of those
requirements.
Senator Levin. But we are not.
Mr. Kaplan. Well, but this lease proposal gives us an
opportunity within the FYDP to meet those requirements and meet
this requirement. Some of the alternative proposals that have
been mentioned here today--purchasing, for instance, on the
same delivery schedule--would make it that much more difficult
to meet those requirements.
Senator Levin. This proposal pushes the cost beyond the
future years, the FYDP.
Mr. Kaplan. It does push some of the costs beyond----
Senator Levin. A major part of the costs.
Mr. Kaplan. A major part of the cost, that is true,
Senator.
Senator Levin. You are not answering my question, it seems
to me. We have a lot of unmet requirements. Why not meet those
in the same way through a lease? Those are requirements, they
are unmet, they are significant, and we are not meeting them.
Mr. Kaplan. I think our practice, Senator, is we are going
to try to meet as many of those requirements as possible
through the procurement process. After Congress authorized us
to consider the lease proposal in this individual circumstance,
the Air Force developed a proposal. In light of the needs and
in light of our unwillingness to do a substantial reallocation
that would preclude us from meeting some of those important
needs, we thought this was an acceptable way to go for this
lease.
Senator Levin. Okay, thank you.
Secretary Roche, you indicated that the study which was
referred to by the chairman, which was a 2001 study I believe,
showing that the tankers would be viable through the year 2040,
was not a good study?
Secretary Roche. Sir, I thought it was not based on a
sufficient amount of data. Some of the aircraft will last that
long.
Senator Levin. My question is this: Why not conduct another
comprehensive study, then, to substitute for that? You have not
done that, right?
Secretary Roche. In the course of coming together on this
lease, we have looked at a number of things, including prior
corrosion studies, and also we have reexamined the costs and
projected additional trends.
Senator Levin. Have you made another comprehensive study to
substitute for that one?
Secretary Roche. That was not a comprehensive--we have,
yes, done modifications of that we can clearly give you, sir.
Senator Levin. All right, so you have done a study which is
as comprehensive as the one you disagree with?
Secretary Roche. I would think, yes, sir. I think yes, it
is.
Senator Levin. Thank you. Please send us those subsequent
studies then, if you would, that you say are just as
comprehensive.
[The information referred to follows:]
Senator Levin. You say in your testimony that: ``By 2000,
32 percent of the KC-135 fleet, a significant portion of this
Nation's overall Air Force refueling capability, was
unavailable due to program depot level maintenance and this
reduced the refueling capability of our warfighters and caused
a backlog at the depot facilities, as the average number of
days in depot-level maintenance peaked at over 400 days.'' That
is your testimony.
Secretary Roche. Yes.
Senator Levin. You used 2000 instead of the current depot
level maintenance period. Why did you go back to 2000, since
that period is now significantly better than it was in 2000?
Secretary Roche. The 2000 number was used, as I recall,
Senator, because that was comparable to the prior work, the
2001 study which used data around that time. Subsequent to
that, the depots have become far more efficient. We move things
through. But the amount of the work package that goes to each
135 is still increasing.
Senator Levin. Is it true that in a number of ways there
have been improvements since 2000? Let me just read to you some
of those ways. The number of KC-135s in the depot now stands at
91, which is down from 171 aircraft 3 years ago; is that true?
Secretary Roche. Yes, it is.
Senator Levin. Is it true that the number of KC-135
aircraft are now spending roughly 200 days in the depot on the
average, down from approximately 400, the figure that you used?
Secretary Roche. Yes, it is.
Senator Levin. Is it true that now the aircraft are
requiring roughly 31,000 man-hours of work in depot, down from
a peak of 36,000 man-hours in 1999?
Secretary Roche. Yes, sir. It is a tribute to the depot,
not to the aging of the aircraft.
Senator Levin. All right. Is it true that the mission-
capable rates for the fleet have risen from slightly less than
71 percent in 2000 to more than 79 percent now?
Secretary Roche. Those numbers differ, sir, in terms of
which models. It is roughly 78 percent.
Senator Levin. I mean the total.
Secretary Roche. The standard is higher.
Senator Levin. I talk about the total fleet there.
Secretary Roche. The total 135 fleet.
Senator Levin. Right; is it true that the mission-capable
rate for the total fleet has risen from slightly less than 71
percent in 2000 to more than 79 percent now?
Secretary Roche. It is not 79. I think it is like 78. But
it has risen, and one of the reasons is a lot of spare parts
have been made available.
Senator Levin. Thank you.
My time is up. Thank you.
Chairman Warner. Senator McCain.
Senator McCain. Thank you, Mr. Chairman.
I want to repeat again, no analysis of alternatives was
conducted. The Institute for Defense Analyses, who will testify
later on, who did a study at the request of the Air Force,
concluded that these were overpriced. That, as far as the
authors of that study know, their recommendations were just
disagreed with.
Secretary Roche, if you did another analysis that would
rebut the Extended Service Life Study (ESLS), it has not been
made available to this committee. I would be very interested in
seeing that. In your response to Senator Levin, you said that
an intensive study was done. We have not seen anything of that
nature.
Secretary Roche. I agree, Senator. It is in bits and
pieces, and we tried to go back and see----
Senator McCain. Why did you not just do another analysis?
If you did disagree with the analysis, then you had plenty of
time to do another analysis, a comprehensive one, just like you
refused, apparently at the behest or certainly in keeping with
the objectives of Boeing, to avoid an AOA being conducted. An
AOA was not conducted. It is normal, it is routine, to do an
AOA, and you did not do it.
Secretary Roche. May I address that, Senator?
Senator McCain. Sure.
Secretary Roche. Senator, I have no idea, nor have I seen
anything from Boeing saying they were trying to work against
doing an AOA.
Senator McCain. I would be glad to show you this.
Secretary Roche. No, sir, I am sure what you have is there.
I am telling you that was never communicated to me by Boeing.
There was a discussion of whether or not to do an AOA with the
Under Secretary of Defense for Acquisition, people from Program
Analysis and Evaluation (PA&E), Service Chiefs, the Under
Secretary of Defense. We discussed it as to whether it was
necessary or not. The authority for doing it is not a
requirement. It is a best practice which has emerged and there
are examples where it has not been done.
The authority to decide or not is the Under Secretary for
Acquisition. In this discussion it was felt for the purpose of
this lease there was no reason to do more. However, I think----
Senator McCain. That is remarkable. That is a remarkable
statement and a remarkable decision in view of the magnitude of
this acquisition, and I would argue that no initial acquisition
of this size has ever been done in recent years without an AOA,
and I would be glad to supply that for the record.
[The information referred to follows:]
Senator McCain. Mr. Chairman, I received a letter from Mr.
Daniels, the former Director of the OMB, on August 1, 2002.
First of all, Mr. Kaplan, you state in your previous statement
it will cost more to lease than it is to buy, right?
Mr. Kaplan. That is right, Senator.
Senator McCain. I quote from Mr. Daniels' letter: ``I
believe it would be inconsistent with OMB Circulars and
irresponsible to support any lease proposal which would cost
taxpayers more than direct purchase. While it may seem
appealing to spread out funding, the excess cost will
inevitably crowd out funding for essential warfighting needs.
We would strongly oppose any effort to alter or manipulate
scoring rules and leasing procedures which have served
taxpayers so well.''
What has changed, Mr. Kaplan, besides we have a new
Director of the OMB, since Mr. Daniels wrote me that letter?
Mr. Kaplan. A couple things, Senator, if I may. First of
all, the deal was approved under Director Daniels, not under
the new Director of OMB, although the new Director supports it
as well.
Second of all, the deal has changed significantly since
Director Daniels wrote that letter to you, Senator, in August.
Senator McCain. It will not cost more to lease than to
purchase?
Mr. Kaplan. It will, but by less than $2 billion difference
from when that letter was written.
Senator McCain. Only $2 billion, I see. But Mr. Daniels
said it is irresponsible--by the way, CBO, GAO, and IDA all
disagree with it. They say it is $5 billion. But you are free
to disagree with those numbers.
Mr. Kaplan. I think I just----
Senator McCain. I want to know what has changed since the
objection to any leasing arrangement which costs more than
purchase?
Mr. Kaplan. If I may, Senator, the $2 billion I was
referring to was the reduction in price of the aircraft that
was negotiated in part by Director Daniels', I think
appropriately, skeptical approach to this deal, as reflected in
the letter he wrote to you. So that is the $2 billion decrease
in the price, which is a decrease in the cost to taxpayers.
That is a very significant change from when Director
Daniels wrote that letter, and I think Director Daniels would
not have approved the deal had very difficult negotiations not
achieved substantial cost reductions.
Senator McCain. It is still costing more. So Director
Daniels did not tell me the truth, because he said he would
strongly oppose any leasing arrangement that costs more than a
direct purchase, because that is what he said. That is what he
said to me in the letter. Obviously, we now approve of a lease
which would cost more than a purchase, so either Mr. Daniels--
in other words, Mr. Daniels did not tell me the truth in his
letter.
Mr. Kaplan. I would not characterize it that way, Senator.
Senator McCain. Pardon me?
Mr. Kaplan. I would not be in a position to be prepared to
characterize----
Senator McCain. But when he said he would never approve of
a lease that is more expensive than a purchase, what does that
mean?
Mr. Kaplan. Senator, it means that this was an ongoing,
extended process of negotiations and Director Daniels was in
negotiation----
Senator McCain. It means to me he would have never
approved--I hate to get argumentative, but it says ``I believe
it would be inconsistent with the OMB Circulars and
irresponsible to support any lease proposal which would cost
taxpayers more than direct purchase.'' This costs the taxpayers
more than direct purchase, so Mr. Daniels did not tell me the
truth in the letter that he sent to me.
But let us go on here. ``After analyzing the Air Force's
report and receiving additional information''--this is CBO's
assessment of the Air Force's plan--``about the proposed lease
from the Air Force and Boeing, the Congressional Budget Office
has concluded that the transaction would essentially be a
purchase of the tankers by the Federal Government, but at a
cost greater than would be incurred under the normal
appropriation and procurement process. The special purpose
entity that has been established to buy the aircraft would in
fact be substantially controlled by and act on behalf of the
Federal Government, and its transactions should be reflected in
the Federal budget. Even if one were to view the arrangement as
a lease, CBO's analysis indicates that the proposal does not
meet the guidelines for an operating lease described in the
Congressional scorekeeping guidelines and in OMB Circular A-11
and thus does not comply with the terms of section 8159 of the
Department of Defense Appropriations Act of 2002.''
Now, you are claiming there is some kind of ambiguity. What
is ambiguous here, Mr. Kaplan?
Mr. Kaplan. The ambiguity lies in the criteria, not in
CBO's statement. I think there is ambiguity in how you
determine fair market value. I think there is ambiguity in what
constitutes a general purpose aircraft. There is ambiguity in a
private sector market.
Senator McCain. Is the entity being substantially
controlled by and acting on behalf of the Federal Government
and its transactions being reflected in the Federal budget, yes
or no?
Mr. Kaplan. No, we do not believe the special purpose
entity (SPE) is a part of the Federal Government, and as a
result its transactions should not be reflected in the Federal
budget.
Senator McCain. Is it substantially controlled by and
acting on behalf of the Federal Government?
Mr. Kaplan. It is controlled by the trustee, who is an
employee of the Wilmington Trust Company. The Air Force does
have a seat on the financing board and so as a result does have
a say in the lease terms and the activities. The purpose of the
SPE--and Senator, this is one of the areas where I think OMB
asked a number of questions in order to satisfy itself is to
ensure that there was a lower interest rate achieved on the
bonds, and that translates into a reduced cost to the
taxpayers. So the SPE's purpose is to reduce the cost to the
taxpayers.
Senator McCain. Is it of interest to you that the CBO, the
GAO, the CRS, and every objective observer in the financial
markets agree that this is an entity substantially controlled
by and acting on behalf of the Federal Government? Is that of
any interest to you, Mr. Kaplan?
Mr. Kaplan. Yes, Senator.
Senator McCain. I thank you, Mr. Chairman.
Chairman Warner. Senator McCain, might I suggest that the
letter of Mr. Daniels be copied and given to Mr. Kaplan, so
that he could reflect on it a few minutes and maybe come back
with a response to your important question.
Senator McCain. I would be glad to. I thank you.
[The information referred to follows:]
Chairman Warner. Thank you.
Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman.
Secretary Roche, I am concerned about the maintenance
aspects of the proposed leasing arrangement and also the
implications it would have for the Title 10 requirements. 50-
50, at least 50 percent of maintenance be performed in public
depots. What assumptions were made about tanker maintenance and
the Air Force's long-term strategy?
Secretary Roche. Senator, in terms of the short-term we are
going to use contractor logistics support because there is a
warranty and these are aircraft under lease. Over the long
term, it is our intent, as we are trying to do with the C-17s,
to migrate maintenance to a partnership between one of our ALCs
and the original equipment manufacturer, so that we can
maintain Title 10 capabilities and get the best of both worlds.
Where we have been able to partner with our ALCs and the
company, we have benefited across the board. The ALC has
benefited and the company has been able to participate, and
that has helped us, and that is where we would like to go.
Senator Akaka. If the lease is approved, how valid are
those assumptions?
Secretary Roche. Sir, these we believe are policies of the
Air Force and we would go forward with them. These aircraft, if
they were purchased at the end of the lease period by the Air
Force, we would start to migrate those towards one of our ALCs
in a partnership with the original equipment manufacturer. We
have done that with the KC-10 and we have gotten tremendous
results.
In the lease we have a 90-percent mission-capable rate that
is guaranteed. Therefore, the contractor has to do a lot to
ensure that we can make that 90 percent.
Senator Akaka. What changes to planned maintenance would be
required if the lease goes forward? Will workload that was
previously planned to be performed in the private sector have
to be brought into the depots, or will planned areas of
expertise be shifted among depots in order to accommodate other
changes?
Secretary Roche. Senator, I do not see a shift. The
partnership arrangement in fact increases the expertise at the
ALC as well. Because we will be operating some of the 135s well
into their 70s, we expect the demand on the depots by the aging
135s will only increase. The depots have become more efficient,
but these aircraft are aging and we expect the amount of time
spent on corrosion, for instance, to go up by 10 percent just
because of the age of the aircraft.
Senator Akaka. Secretary Roche, I am concerned with the
total costs of this proposal, but I am also very concerned
about, as you mentioned, corrosion and its effect on our
current tanker fleet. What preventive steps will be taken with
regard to corrosion?
Secretary Roche. We are finding across the board, Senator,
especially in the aircraft that are near salt water are
affected much faster than the others, and we rotate aircraft
out of a salt water environment when we can. So for instance,
at McDill Air Force Base we do not keep planes there all the
time. We will have them there 6 months, then put in a new set.
We are inspecting more. We are assuming there is more
corrosion.
As we track it, we are in fact looking at others, and we
have formed an Aircraft Viability Board, which is analogous to
the Navy Board of Inspection Survey, to go tail number by tail
number to get an individual assessment of every single one of
our aircraft and start dealing with them as if they were
patients in the hospital, to keep track of corrosion by tail
number over the long period of time.
Senator Akaka. Mr. Secretary, has the Air Force budgeted
for any other costs that it will incur, for example training
personnel?
Secretary Roche. Yes, sir. In the package that goes along
with the lease there is money for contract logistics support,
as well as initial training, initial spares, and they will
continue.
By the way, just to make sure, sir, we do keep track of
each tail number. This is to be a more in-depth version of
keeping track of each tail number, to my earlier point.
Senator Akaka. Thank you very much, Mr. Secretary.
Thank you, Mr. Chairman.
Chairman Warner. Thank you, Senator Akaka.
Senator Inhofe.
Senator Inhofe. Thank you, Mr. Chairman.
First of all, just for clarification, in the statements you
alluded to something like a flow time for the maintenance of
each KC-135, without distinguishing between E&R, as being
around 400 days, and it is my understanding now that, at least
at Tinker, it is 222 days in the last year. Do you disagree
with that?
Secretary Roche. No, sir. I think the tanker depots have
done a magnificent job.
Senator Inhofe. Thank you very much.
It seems like we talk a lot about the 100 aircraft that are
there and do not really go beyond that. After the lease is
expired, one of two things can happen. You can either return
the planes or you can go ahead and re-order more. I think the
likelihood is very great that they would re-order more.
I would like to get one option off the table and that is of
returning them. Mr. Curtin will be coming up in the next panel
and I want to pursue this with him, but he says: ``If the
aircraft are returned, the Air Force will have to find some way
to replace the lost capability even though lease payments would
have to be paid almost to the full cost of the aircraft.'' He
goes on to say why that would not be a good scenario.
Do you agree with his statements?
Secretary Roche. I do not know the details of the numbers.
I know that we have plenty of time to look to see whether these
are working as well as we think they will work. If not, we can
return them. If so, we would come back to Congress and make
that case that we would like to then have authorization and
appropriation to purchase.
There is a third option, by the way, Senator. In the way
this lease is negotiated, if any time during the construction
period we choose to turn it into a buy, we can. So that if in
fact there is concern with the long-term lease, we could buy
them.
Senator Inhofe. But the point I am trying to get at here is
even the likelihood of stopping at 100--and I would probably be
supportive. If this thing goes through, we are going to have to
be looking for the future and stopping at 100 would not make
sense.
In a memo from Secretary Aldridge to you just a short while
ago, it says: ``It is the intent of the Department to go beyond
the initial 100 aircraft as we begin the recapitalization of
the airborne tanker fleet.'' Then again in Aviation Week, he
reemphasized that, saying: ``We indicated the intent of the
government to begin recapitalization of the tanker fleet so it
would go beyond the 100 aircraft.''
I think that this is realistic, that most likely, that it
would, and I think you would agree with that.
Secretary Roche. Yes, sir.
Senator Inhofe. But with that in mind, why is it that we do
not have a good long-term maintenance and training program that
would go with this?
Secretary Roche. When we come back in November to the Under
Secretary for Acquisition with a long-term strategy, which I
doubt will include additional leases because we believe this is
a one-time thing, we will also reflect how we would intend to
maintain and how we would intend to train.
Senator Inhofe. Senator Akaka brought up this thing on the
50-50 and I understand the response that you gave him. However,
would this not require a change in the law, because if you go
back and you have it in an ALC, but it is actually being done
in a partnership--which have been successful, I might add--
would this not require that you have some type of a change in
the law?
Secretary Roche. Senator, I am not sure. May I turn to a
colleague and ask to answer the question, or may I come back to
you for the record.
Senator Inhofe. Just for the record is fine.
[The information referred to follows:]
No, the law does not have to be changed. The 50/50 law--10 U.S.C.
section 2466--states that not more than 50 percent of the funds made
available in a fiscal year to a military department for depot-level
maintenance and repair workload may be used for the performance by non-
Federal Government personnel of such workload. In applying the 50/50
law, the value of the work performed by ALC personnel pursuant to a
partnership with the contractor will be included in the Government's
share. Therefore, a change to the law is not necessary.
Senator Inhofe. Now, I would like to get into the thing on
which I have been concerned, after having chaired the Readiness
and Management Support Subcommittee for a number of years, in
our lift problem that we have in general. I am talking about
tankers, I am talking about all types of lift vehicles. When
you stop and think of what we did in Kosovo and Bosnia and
Afghanistan and of course now Iraq, it has put a tremendous
strain and we are right at the capacity, and I think everyone
agrees that that is a real serious problem right now.
The reason I bring this up is that when you talk about the
existing KC-135s--and I know people like to talk about how old
they are and it is going to be 80 years old at the end of this,
some of these aircraft, and they will still be in use. That
does not really make that much difference. I have flown
airplanes in the last 2 weeks that were 60 years old. It
depends on how often they are used, how they are rotated. We
have studies to show that they could be used for a long period
of time.
I bring this up, not just to say that there are
alternatives to a lease, but in addition I think we all,
everyone in this room who understands the issues, knows that we
have a tremendous shortage of tankers and lift capacity. Would
you agree with that?
Secretary Roche. Our lift capacity is demonstrating great
progress, and the 767s would also be lift aircraft because they
are good cargo aircraft.
Senator Inhofe. I understand that, but it is today I am
talking about--we have a deficiency.
Secretary Roche. Our plans show, with taking a look at the
C-5s, increasing the life of them, we meet the requirement that
the Joint Staff has given us. This would add to our capacity.
Senator Inhofe. What I am getting around to is the 68 that
you are talking about retiring. It would seem to me that if we
need the capacity out there--let us say the lease goes through.
I would like then to look at this thing and re-evaluate what we
would want to do with the 68 that they are talking about going
into retirement.
We can remember just a short time ago--and I will see if I
can find it in here--that the Air Force testified to us--here
it is, right here--``With proper maintenance and upgrades, we
believe that the aircraft may be sustainable''--we are talking
about Es and Rs here--``for another 35 years.''
I think Senator Warner mentioned a report that would go all
the way to 2040. I think if the need is that great, if this
thing does go through, how receptive would you be to re-
evaluating what you would want to do with some of the existing
KC-135s? I know we are going to have them anyway. I am talking
about the 68 that they are talking about going into retirement.
Secretary Roche. Our sense, sir, is that retiring those 68
could give us quite a savings. We could always look at your
idea, which is different, which is could they be converted to
freighters and used as freighters, and we could take a look at
that.
Senator Inhofe. Then the last thing I want to be sure to
get in the record--I know my time has expired, but--it was
brought up by Senator Levin, the mission-capable rates. I
happen to have a breakdown of the KC-135 Rs and Es, and they
have actually gone up since 2000 or the end of 1999: KC-135Rs
from 78 percent to 82 percent; the KC-135Es from 62 percent to
75 percent. That is in the active service, not counting the
Guard and Reserve.
So would you disagree with those figures?
Secretary Roche. Sir, the Guard and Reserve ones have gone
from 64 percent to 74 percent. It is a matter of what we
average. But they are not the 85 percent total level. I think
the average is near 85 percent or it was in 2003. In terms of
the mission-capable rates of those aircraft, in the last year
with the use, those that we have used in the operating area
have had a higher mission-capable rate, those who have stayed
behind have had a lower mission-capable rate.
Senator Inhofe. I understand that. I understand the
rotation and how that works. But nonetheless, the mission-
capable rate is actually improving and it has over the last 3
years.
Secretary Roche. It has, because of spare parts and depot
work. But it has not made the 85 percent goal.
Senator Inhofe. I think a lot of that is because the depots
have done a very good job; do you not?
Secretary Roche. Absolutely.
Senator Inhofe. Thank you very much.
Secretary Roche. Spare parts. Congress gave us a lot of
spare parts.
Chairman Warner. Senator Inhofe, your question about the
alternate use of these aircraft for airlift other than fuel, I
think it is important that we put into this record today
exactly what--I understand 6 pallets could be placed in there
and up to 200 individuals. Can you give us some rough
parameters?
Secretary Roche. Yes, sir, and I am going to ask my
colleagues to correct me because I am sure I am going to be
wrong.
Chairman Warner. Please do not be wrong. Let us start off
right.
Secretary Roche. That is right. Six pallets on a KC-135.
Chairman Warner. If you want you can just do it for the
record.
Secretary Roche. We will.
Chairman Warner. But it is roughly what?
Secretary Roche. It is 6 on a KC-135, and on a 767 it is
19, but on a KC-10 it is 19 to 27. So this class of aircraft,
although smaller than a KC-10, gives you much more lift
capability in carrying 19 pallets as compared to 6.
Chairman Warner. I think the record should have a reference
to that alternative use. If there were an emergency and we had
to move a significant amount of equipment quickly, they could,
assuming there was not a demand elsewhere.
Now we go to our distinguished colleague here, Mr. Nelson.
Senator Ben Nelson. Thank you, Mr. Chairman, gentlemen. The
question for me is not, Mr. Chairman, whether or not we need
these tankers. I think we do. The question for me is the
question that the Senator from Arizona as my chairman of the
Commerce Committee probed yesterday in the Commerce Committee,
the question of leasing versus the purchase.
So my question would be to you, Mr. Secretary. Yesterday
you sat at a table with three other folks in the Commerce
Committee: someone from GAO, someone from CBO, and someone from
the IDA. They all said that they thought it was a better deal
to purchase than lease. Could you respond to that, please?
Secretary Roche. Briefly, Senator, the same point I made
yesterday, is that it depends on the model that is used. The
net present value calculation has two streams of outflows of
money. One is lease and one is acquiring. How you acquire, what
models, when you can do it, how you can do it, becomes very
important, and the underlying assumptions there are quite
important.
We used the current situation where there was no additional
money and we had to go in the normal acquisition manner, and on
that basis we saw the comparison to be very close, favoring
purchase by $1.5 million per airplane. If you could take some
extraordinary measures for acquisition which we could only
hypothesize, but not really say would be approved by Congress,
then you could in fact favor purchase by as much as $1.9
billion. But it would require such things as a lot of up-front
money we do not see, changes to how, for the rules of when you
can amortize non-recurring and not amortize, colors of money,
other things.
If those all could be put in place, then the purchase is
favored. But under normal acquisition process, you have to
spend all the money up front without getting anything and then
you start to buy airplanes.
Senator Bill Nelson. There was a question, Mr. Secretary,
yesterday about a part that was not competed, a part that
between--okay, it was special purpose entity. Would you respond
to that, why that was not competed?
Secretary Roche. Special purpose entity was a mechanism to
be able to effect a lease and it is a nonprofit entity, so the
sense of someone competing to be that does not feel compelling.
We did look around and agreed with the manufacturer what would
be a sensible third party, detached third party. I can get you
more details as to how that party was chosen and I would be
glad to provide that for the record.
[The information referred to follows:]
The requirements of the Competition in Contracting Act were met
with the Justification and Approval (J&A) for sole source of the
aircraft lease program. The J&A for the Multi-Year Aircraft Lease Pilot
Program was signed by the Assistant Secretary of the Air Force
(Acquisition) on 4 November 2002.
The SPE is not a ``contractor'' under the Competition in
Contracting Act. Rather, the SPE is a legal entity that holds title to
the tanker aircraft and accounts for lease-related funds. The legal
authority and roles of the SPE are expressly set out in the trust
agreement. The SPE benefits the Government by shielding aircraft title
from potential claims by third parties and by assuring lenders of
prompt payments from rents received, thereby lowering the Government's
overall cost of borrowing. The SPE does not make a profit.
Senator Bill Nelson. Thank you, Mr. Chairman.
Chairman Warner. Thank you very much.
Senator Roberts.
Senator Roberts. Yes, sir, Mr. Chairman. Thank you.
I am intrigued by the suggestion by my good friend from
Oklahoma in regards to the 68 tankers that you plan on retiring
and his suggestion that we find some other use for the tankers,
which I endorse. I thought perhaps they could be used for
CODELs and then the members could work on the corrosion
problems as they fly from place to place around the world. Just
a thought.
Mr. Secretary, there is more than one way to skin a cat
than sticking his head in a boot jack and pulling on his tail.
That is just about like what I think we have done in terms of
handling this situation. Good intentions that I do not
challenge or impugn aside, that is what I think is happening
now.
Senator Levin posed a very interesting and good question
about other requirements and why we should go into a leasing
plan on tankers as opposed to other requirements. I am fully
familiar with this, being chairman of the Intelligence
Committee, and that we have quite a bit of infrastructure that
we pay for on a regular basis and then we have to beg, borrow,
or steal from supplementals in regards to get the analytical
product that we need. That is not right, and that is really
basic in terms of our national security.
So I agree with Senator Levin, with the exception that Mr.
Kaplan pointed out this is not a normal course of events. We
are talking about access denial. We are talking about post-
September 11. We are talking about 2 years ago nobody would
have ever thought we would be in Afghanistan or Iraq or
possibly North Korea or possibly Iran, or the Southern
Hemisphere, where we have 31 nations several of which are in
trouble, or Africa. We are talking about access denial of our
troops to get to a place where our national security is
involved and I think that that is the difference.
Let me ask you just a couple of questions if I might. Over
90 percent of your aerial refueling fleet is over 40 years old.
What concerns do you have regarding possible fleet-wide
groundings and access denial that I am talking about, a class
problem, if you will?
Secretary Roche. That has been the concern, sir. As planes
get older, we are not sure how they are going to break. General
Mike Ryan, the prior chief, made a point that we are learning
that airplanes can break in ways we did not understand in the
past, because we are flying them as we did before, with the
same amount of weight, we are using them a lot more. We have
actually had an increase in the use of these aircraft, about 25
percent in the case of the 135s, actually over 70 percent in
the case of the KC-10s because they are newer, and that the
increased use will put greater demands on them and greater
maintenance demands and a class problem could emerge.
It is a hedge against the class problem, given our
projection needs, that leads me to support the notion of
acquiring 100 of these planes in a fast fashion.
Senator Roberts. Some critics of the proposal claim that
the corrosion problems associated with the KC-135 are no worse
than the corrosion problems associated with other aircraft and
we can simply fix them and go on. What is your response to this
claim?
Secretary Roche. In certain aircraft like the F-15Cs that
we have, we are finding that those that are near salt water are
corroding a lot faster. I think we are going to have to retire
aircraft that have been at Kadena Air Base for years. We have
placed restrictions in g-force and restrictions in speed on
these other aircraft because of corrosion problems. So we see
the age and corrosion issue affect the other aircraft as well
and causing us to put limitations on the plane.
Senator Roberts. I have been to McConnell Air Force Base. I
have not been to Tinker. I should go to Tinker. I will go to
Tinker with you, Jim.
Senator Inhofe. Good.
Senator Roberts. I think both depots are doing an
outstanding job, and they now have more spare parts and so
those numbers are increasing. But I viewed first-hand the
corrosion problems now plaguing the tankers as pertaining to
the question of Senator Akaka.
Let me show you what I mean. This [indicating] is the belly
skin of the KC-135E.
[The information referred to follows:]
This is a major problem. If you look on the other side you
do not think that there is a problem, but here is a big-time
problem. This could not be fixed with normal maintenance. It
takes a special plan. It takes a special effort to fix this
problem. Basically, it takes 100 man-hours to fix this problem,
$150 an hour, and that is about $15,000 and weeks and months
that we have to deal with this.
This is a much more common experience than it used to be.
This is the kind of corrosion problem that could lead to a
class problem with all of the tanker aircraft.
I do not want the warfighter fighting in this kind of
plane. I have seen this kind of corrosion at McConnell AFB.
More especially, I do not want to get on the plane. I would
simply close by saying that Mr. Kaplan said this is not a
normal course of events. We do not want this to happen. I was
trying to get a screwdriver so I could punch through this. We
do not have a screwdriver with us. I am certainly not going to
use my fist.
I think that we are slow-dancing with this issue, and I
thank all the witnesses.
Chairman Warner. Does that conclude your questioning?
Senator Roberts. I think it is a pretty good question to
conclude on, yes, sir. Thank you.
Chairman Warner. Senator Chambliss.
Senator Chambliss. Mr. Chairman, I apologize for having to
run back and forth to another hearing. I know that some of my
concerns have been raised already because I have heard parts of
the questions.
Secretary Roche, I am wondering why we have decided to
proceed with the lease as opposed to the multi-year buy that we
are doing so successfully on the C-130 and the C-17. If that
has been asked, I apologize.
Secretary Roche. No, sir, it has not. The multi-year buy in
both of those cases had an aircraft that was produced, looked
at, tested, so that the concerns about it were reduced before
Congress said, all right, now it can be multi-year. We know of
no example where something starts out as multi-year without
having a demonstration aircraft, and that would cost more time.
The issue we are trying to raise is to hedge against time
and to get aircraft in the fleet faster. If we were to try the
normal multi-year, we would have to go through development,
field a plane, demonstrate to Congress that in fact it is a
viable plane to go into production with very little
uncertainty, and then build that out in a multi-year fashion.
Senator Chambliss. Well, it looks like that is a major
problem in and of itself that we ought to try to overcome. I
mean, if the airplane is there and we are going to lease it we
ought to be able to multi-year buy that weapon system.
Secretary Roche. Under the lease that we have, if we had
the funds in budget authority we could buy out the lease at
almost any time.
Senator Chambliss. With respect to depot maintenance, I am
concerned about the fact it appears that we are just, as a part
of the price of the lease, contracting out in effect the depot
maintenance up front. I am concerned about that being in the
best interest of the taxpayer and the best interest of the
warfighter. We have had these philosophical arguments and you
and I have had a number of discussions about that. You know my
concerns and you know my interest.
I do have a serious concern about the fact that we are
just, without any competition whatsoever, all of a sudden
saying we are just going to lease these? Are we going to let
the contractor do the maintenance, because that is in the best
interest of the weapon system?
So if this does come about--and I will be honest; I do not
know where I am yet--but I would hope that, and I have heard
you mention briefly, that there is the potential for a
partnering arrangement not unlike the C-17. Of course, this
does not affect my depot. But, the overall system I think
demands that we continue to provide the availability or the
ability within the depot system to do work on new weapon
systems, and this could be another one of those unintentional
or unintended consequences. It could be a situation where we
have an unintended consequence of removing from the depot the
availability or the ability to do depot maintenance on a newer
weapon system and we continue to be relegated to working on old
systems.
So if this does come about, I know everybody on the
committee is going to want to make sure that we do the right
thing with respect to the depot maintenance.
Secretary Roche. Yes, sir. We have talked in the case of C-
17s of the partnership to have the depot involved. What we
would like to look at in this case is to have the depot partner
earlier during the warranty period with the manufacturer, so
that the depot develops expertise during that same period. If
that is possible, we would like to head in that direction.
Chairman Warner. Senator Reed.
Senator Reed. Thank you, Mr. Chairman, and thank you,
gentlemen. This is a very important issue. It is a complicated
issue. My knowledge of this complicated financial transaction
is only exceeded by my knowledge of materials engineering. So
it is an interesting topic.
Let me just say, though, that it seems to me that in a
commercial transaction you would get a fairness opinion from an
outside objective party. All of the opinions that we are
hearing from CBO and GAO, the ``outside parties,'' seem to be
negative with respect to this proposal. Is there any non-
involved party that has rendered an opinion or an evaluation of
this?
Secretary Roche. Seen from the point of view of the Air
Force, Senator, for the last year and a half we have had
everybody reviewing this. Certainly a number of staff within
the Office of Secretary of Defense, culminating in the creation
of a leasing panel to take a look at it separate from the Air
Force, and then independently the OMB. So we believe our
fairness opinion which would occur in a commercial sense has
been done, both by the Office of the Secretary of Defense for
Secretary Rumsfeld and by the OMB.
Senator Reed. Then there is the argument about how
disinterested these parties are and how insulated they are from
the pressures which we have noted, both political pressures and
other pressures. Frankly, it does not strike me as particularly
independent. The Air Force has been an advocate for replacing
their fleet and doing it in a creative way. The company
certainly is an advocate for selling their aircraft.
Secretary Roche. Yes.
Senator Reed. I think within the Department of Defense
there are some indications that at least initial reviews by
PA&E were similar to CBO and others which were quite negative.
So I guess it would help me tremendously if there was something
out there that was truly independent and a true fairness
opinion about a transaction which in a normal business
proceeding you would--this complicated lease arrangement,
financing, would be accompanied by a bevy of fairness opinions
from hired guns who presumptively do not have anything in the
mix.
Secretary Roche. May I ask Secretary Wynne to comment on
that, because I believe they have come at us from all sides,
where we have had to go back and improve things because it
would not have met their criteria for a fairness opinion.
Secretary Wynne. I will admit in advance, Senator Reed,
that the OSD can hardly be described as a disinterested party.
I think we have as much interest in protecting and preserving
our Armed Forces and doing it in the most timely manner than
anyone else.
That did not deter us, however, from, as Secretary Roche
indicated, questioning them fairly determinedly. In fact, we
considered the PA&E memorandum. They often do financial red
teams on arrangements that we want to do. I myself, for
example, asked for the most favored customer clause, which I am
not going to take credit for its ultimate evolution. I think
Secretary Sambur did a marvelous job of pushing that home. But
it was a very difficult thing to determine best value in a sole
source acquisition sense.
I think, however, we arrived at a conclusion that was
beneficial, and on a net present value basis we see it to be
fair and balanced. $150 million without consideration of the
operations and support costs that we believe is going to be
there is tantamount to being on balance. So I would tell you
that the leasing panel and Dov Zakheim as well did a pretty
thorough review and just on balance we felt that getting these
airplanes sooner, sooner than later, and not disrupting the
ongoing programs, to achieve our goal of program stability, all
merited approval.
Senator Reed. Thank you, Mr. Secretary. I appreciate
certainly your efforts and the energy you put into this. But
still, an observation is that on one side you have agencies
that seem to be removed from the transaction; on your side you
have everyone who is involved in the transaction, and I think
it would favor your position if there was someone more
objective that was rendering an opinion that supported your
position. That is just an observation.
Let me ask, Secretary Roche. It seems to me that critical
to all these different evaluations are the assumptions. Without
going into the detailed analysis, what are the key assumptions
that you have made that makes this deal work for the Air Force?
Secretary Roche. The key assumption, Senator, that we used
was that the procurement side, the purchase side, would be
according to the normal set of rules, regulations put in place,
the fact that you spend the money for a development program,
you then go through a lot of tests of that program, and only
after all that is done you go into limited production, and then
other tests, and then you go into production.
It is a time phasing of it, and the delay of the planes is
the issue.
Senator Reed. It seems to me, Mr. Secretary, that is an
assumption that one could question, since you have an aircraft
that is sitting down, already designed. Boeing did a lot of
that to build the 767, and that you have to make some
modifications. They are not trivial. But if that is the
assumption, again I would question the assumption.
Secretary Roche. We went by the rules, sir. I grant you
that a development program would be a lot shorter because it is
an existing aircraft. But the assumption in following the rules
is that you have to do it that way.
Senator Reed. You seem to be following the rules in one
aspect and asking us to bend the rules considerably to do this
lease job. We are not going to Boeing and saying, build us an
aircraft from scratch and then we will lease it. We are saying,
you have this aircraft--in fact, they are telling us: We have
these aircraft; we can modify them and give them to you.
Again, this goes to the analysis.
Secretary Roche. The second point was the assumption of the
availability of money.
Senator Reed. Yes.
Secretary Roche. We did not assume that there would be $5
to $11 billion additional made available in this period.
Senator Reed. Let me ask a final question, which I am sure
has been covered before. That is, you have done the life cycle
cost comparisons and your conclusion I presume is that the life
cycle cost, the maintenance and the operations and the timing
of the aircraft going into the fleet, favor the lease and
disfavor the purchase. Is that a fair insight?
Secretary Roche. It is a fair insight, especially if you
note that having these planes in earlier has operational
savings, and we would not replace one for one. We do not
believe when all is said and done with new aircraft that we are
going to have a one for one replacement of 544 airplanes for
the needs of the future. We think it will be a much lower
number.
Having 100 and observing what they can do will give us a
very good idea of the total for the long run.
Senator Reed. Again, thank you very much, gentlemen. This
is I find a very important issue, a very complicated issue, and
it has been useful from my perspective to hear your views.
Thank you, Mr. Chairman.
Chairman Warner. Thank you, Senator Reed.
Colleagues, we have a second panel that deserves the
thoroughness with which we have had our exchange of views and
questions with the first. Senator Sessions, you have not had
the opportunity for your first round. It is the desire of the
chair to have you proceed with your first round and then we
will--I have but one question and I hope other members
remaining can limit their second round of questions so that we
can get to the second panel and proceed.
Senator Sessions.
Senator Sessions. Thank you, Mr. Chairman.
Mr. Wynne, you used the phrase I believe earlier that if we
do not use the lease arrangement it will take much longer to
get 100 aircraft. If we utilize the expected expenditure levels
for leasing and applied that to a purchasing system, do you
know how much longer it would take?
Secretary Wynne. Sir, the terms of the lease are so
favorable that it would probably be 7 or 8 years difference
between receipt of aircraft, even if we were to purchase the
airplane outright, as some have indicated, and pay up front the
appropriate amount. But frankly, the cash flow savings that you
get from leasing do not catch up to payments for several years.
That having been said, I think the minimum everybody has
anticipated in delay is 5 years. You would get 12 airplanes
during the Future Years Defense Plan now by purchasing and you
would get 60 airplanes by leasing.
Senator Sessions. In 5 years?
Secretary Wynne. In the Future Years Defense Plan, yes,
sir.
Senator Sessions. Mr. Chairman, I have looked at the KC-
135E, which is the oldest upgrade, which is about $25 million
for that. I guess the question we have in this fleet is just
how big a crisis we are facing, just how quickly it needs to be
brought on line.
I am not happy with creating a lease system that results in
a bow wave down the line, that we now have to alter our budget
to figure out whether we are going to have the money to bring
this on. It seems like to me that in general I would favor the
purchase agreement, the purchase system. So I have some doubts
about that.
Now, we have in the Senate version of this bill a
requirement for an AOA. I do not know what will come out of
this conference. We are talking about changing that, I suppose.
But what would happen if we waited a year and had an AOA? This
may not be technically a purchase, but it is certainly a lease-
purchase and it amounts to the same thing. Why should we not
have an AOA, Secretary Roche?
Secretary Roche. Senator, our sense is that the due
diligence we did in forming the lease package covered what
would normally be covered in an AOA, an informal AOA. Delaying
a year would just delay getting a hedge against any problems of
these aging aircraft.
It would also continue to have us invest in some very old
aircraft. The ones we seek to replace are the E models. A
number of the Rs will in fact be in service until they are 70-
some years old. So there will still be plenty of 135s flying
around. It is trying to get the E models off the books and
substitute aircraft that have more capability and that are far
more reliable.
Secretary Wynne. Senator Sessions, I would tell you, sir,
that an AOA often goes to product, in other words would the
product be appropriate. I think the discussion and the debate
has been about process, i.e., how do you acquire that product.
Going back and looking at an AOA of how do you deliver air
tankerage to note only our forces, but also coalition forces,
probably would determine product content.
We do not see that the Es, which are facing fleet
standdowns and some of whom I believe, Secretary Roche, have
gone over all of the reliability statistics that Boeing
originally did, because they did not believe we would be flying
them this long when they were originally produced and
qualified--it would seem to me that, as I mentioned in my
testimony and I think as we submitted in the report, the
informal AOA to get this product consisted of new aircraft,
consisted of getting a commercial derivative aircraft, and
consisted of re-engining the KC-135s.
The KC-135 re-engining on the Es was determined to be
insufficient to extend their life because of the corrosion
aspect and the price, frankly, even in the strut situation, of
impinging upon our operations and support (O&S) costs.
The idea of whether you go get a commercial derivative was
in fact the Air Force's plan. The cost risk there is whether or
not Boeing could sustain this commercially available derivative
aircraft. If they do not sustain this commercially derivative
aircraft, then we would be paying for essentially the creation
of a brand new airplane, and that cost risk would be between
$150 and perhaps $200 million.
So all of those things I think drove us to the informal
analysis of alternatives to not only do a commercially
available 767, but to get it in the shortest possible time.
Senator Sessions. Just to get the numbers straight, Mr.
Kaplan, your analysis at OMB was that we would come out, the
lease arrangement would cost $150 million to $1.5 billion more?
Was that your analysis?
Mr. Kaplan. Actually, I think the analysis reflects,
Senator, a range of $150 million to $1.9 billion in net present
value.
Senator Sessions. That is the net present value procedure.
CBO used the--what is their standard? They came out with $5
billion.
Mr. Kaplan. Actually, Senator, if I may, I believe what you
are referring to is CBO, as we did and as the Air Force did,
calculated the difference in then-year dollars and then also,
as is required by OMB Circular A-94, presented a net present
value calculation. Under net present value, I believe that
CBO's number is $1.3 billion.
Senator Sessions. What is the best one in this
circumstance? I know you do one and they can do another one.
When applied to these circumstances, what is your opinion of
the best approach and the best figure?
Mr. Kaplan. Senator, because the A-94 analysis requires the
comparison of an actual proposed deal, which is the lease deal,
to a hypothetical purchase, it just depends on the assumptions.
I think the range is right. I think $150 million is on the low
end. I think OMB would include some of the other assumptions,
not necessarily the same ones CBO did, but some assumptions
that would make the net present value higher, somewhere in the
$1 billion and up range.
Senator Sessions. That would run something like 15 percent
or so more at least, would it not, and a lot more than that if
you took the CBO numbers? Your range would be about 15 percent
more expensive leasing?
Mr. Kaplan. In net present value terms, I think that is
right, Senator. I have not done the math. But that is why we
did present the range, the Air Force did present the range in
its report to Congress, so that Congress would have that
information and could make its judgment accordingly.
Senator Sessions. Thank you, Mr. Chairman.
Chairman Warner. Thank you very much.
I will proceed to ask my one question and then recognize
others. I have here the submission by the GAO today, in which
there is a chart showing the bow wave in the out years as a
consequence should this program be approved by Congress. Having
some familiarity with the military departments and these types
of charts, this thing will suck the life's blood right out of
the Department of the Air Force, the magnitude of this bow
wave.
It is also going to have repercussions on the annual, I
call it, scramble between the three military departments to get
their fair share of the budget each year.
Now, I have to say with all due respect, gentlemen, when I
asked the question of whether or not anyone had looked at a 25
buy I recognized, Secretary Wynne, the predicament with the
manufacturer and the possibility his line goes down. I am going
to pursue that a little bit here and take the views of my
committee to possibly see whether or not we can quickly look at
some bifurcated situation where we take part of this proposal,
but then go back to traditional ways of budgeting and planning
for the three military departments.
So I guess I put that in the way of a statement. But I
would have to say, if you want to comment, do you think it is a
reasonably accurate bow wave?
Secretary Roche. Yes, sir, I think that is. The alternative
would be a bow wave that is in the front end if we were to try
and purchase on the same schedule. We were required to take
into account all of the lease payments and possible purchases
if in fact we had an authorization and appropriation into a
modest Air Force budget over time.
What is not reflected there, Mr. Chairman, is that programs
like the C-17 will have ended just before that point. We showed
that it could be accounted for in our budget, but if in fact
there was more money, more budget authority available, we could
buy out the lease and buy down that hill.
Chairman Warner. I have taken my time. Senator Levin, let
us proceed as quick as we can to conclude with this panel.
Senator Levin. Mr. Kaplan, you in answer to Senator
Sessions' question gave us a very critical piece of
information. I want to make sure I understood it correctly. You
said that basically you believe that with the correct
assumptions that the difference in net present value between
leasing and regular purchasing would be somewhat over $1
billion; is that correct?
Mr. Kaplan. I think it would be in the neighborhood, that
is right, Senator.
Senator Levin. Did you say slightly over $1 billion?
Mr. Kaplan. I think I did say $1 billion or slightly over.
I would have to look at the record.
Senator Levin. Is that OMB's best assessment?
Mr. Kaplan. That is my assessment based on what I have
learned. I think that represents a consensus within OMB. There
are different views within OMB.
Senator Levin. Are you speaking on behalf of OMB here
today?
Mr. Kaplan. I am, Senator.
Senator Levin. Okay. So we are going to have to----
Chairman Warner. Let me articulate it for the record. Are
you speaking with your professional personal opinion or on
behalf of the Director and the OMB?
Mr. Kaplan. I am speaking on behalf of the Director and
OMB, Mr. Chairman.
Senator Levin. So that the Air Force presented a $150
million difference, but it is OMB's best judgment that it is $1
billion or slightly more using an apples and apples comparison,
the net present value approach, which is required by I believe
executive order or by OMB regulation; is that correct?
Mr. Kaplan. Actually, Senator, I believe the Air Force in
its report to Congress reflected exactly the range that I have
discussed here today.
Senator Levin. Yes, they expressed a range, the higher part
in a footnote; is that not correct?
Mr. Kaplan. That is correct, Senator.
Senator Levin. As a matter of fact, they did it because OMB
really pressed them to do it; is that not correct?
Mr. Kaplan. I believe there were ongoing negotiations. I
was not there, but I think that was----
Secretary Roche. Correct.
Senator Levin. Secretary Roche is saying ``Correct.''
Mr. Kaplan. That would be consistent with my testimony here
today, Senator.
Senator Levin. You should not be reluctant, if you had to
pressure the Air Force into putting it in there, to say so. The
Air Force is acknowledging that they put it in there because
OMB urged them to put it in there.
But my point is you have tried to give us here a range, it
is somewhere between $150 million and $1.9 billion, but within
that range it is OMB's judgment that it is $1 billion or
slightly more, the difference between leasing and buying, in
apples and apples comparison; is that correct?
Mr. Kaplan. It is OMB's view that, in a range of
assumptions, that is probably the better range of assumptions,
is to take the higher end, roughly in the neighborhood of $1
billion or slightly more.
Senator Levin. That is your view? That is the best estimate
you have? Within that range, that that is the best estimate?
Mr. Kaplan. In comparing an actual lease to a theoretical
purchase which is based on, Senator, a very difficult and
complex range of assumptions----
Senator Levin. Of course.
Mr. Kaplan.--that deal with the discount rate and other
things which are subject to disagreement.
Senator Levin. Of course.
Mr. Kaplan. That is why we presented a range, yes, Senator.
Senator Levin. Look, you might as well give us a direct
answer. Within that range, it is your best estimate that it is
slightly more than $1 billion?
Mr. Kaplan. I believe I said that, yes, Senator.
Senator Levin. I am glad you believe that and I am glad the
record will show that belief.
One last question. On this, Secretary Roche, I gather it is
your intention to ultimately buy these planes; is that not
true? That is your current intention?
Secretary Roche. Our current intention is to lease the
planes and if they work out to consider coming back to Congress
to get authorization and appropriation. But we would want to
take a look at how these planes work out as tankers.
Senator Levin. You want to lease them before you know how
they work out, and you are going to spend about how much on
this?
Secretary Roche. That is because by virtue of a lease we
can always return them.
Senator Levin. How much are you committed to pay under that
lease before you know whether they work out?
Secretary Roche. Senator, that would depend on how many
were available, how we used them in conflict.
Senator Levin. Is it not about 90 percent of the value?
Secretary Roche. That is if you go through to the full
lease.
Senator Levin. That is what you are committed to lease,
right?
Secretary Roche. I would think we would come in much
earlier than that to discuss authorizing and appropriating to
purchase, because you can also purchase out of the lease.
Senator Levin. That is not my question. You said before you
knew whether they work. You are committing to pay about 90
percent of the value under this lease, are you not, before you
know whether they work?
Secretary Roche. No, sir, we will know a lot earlier. We
are committed to paying 90 percent of the lease during the
normal lease terms and then we have a small residual to pay if
in fact we chose to purchase them.
Secretary Wynne. If I could help, I do not think we are
actually committed to accepting those airplanes if they really
do not work at all.
Senator Levin. Of course not.
That is the reason given for the lease, though. A minute
ago we were told we were leasing it because, gee, we do not
know if they work. Now you are saying, gee, if they do not work
we are not committed to lease. I hope we are not committed to
lease if they do not work.
Secretary Roche. I am sorry, Senator. I was using the word
``work'' in a different manner. If they worked out as well as
we expected them to and there were no other alternatives.
Obviously, they would have to meet spec.
Chairman Warner. Work out, are you talking about mission
performance or financial transactions?
Secretary Roche. All of those things, Mr. Chairman.
Chairman Warner. What are you talking about?
Secretary Roche. All of those things. In other words, we
cannot at this point say we definitely would purchase them at
the end, although we have provisions, if we would, that we have
a price----
Chairman Warner. In this 2 years time you did not get a
mockup or borrow one and run a little test on it?
Secretary Roche. No, sir. The first one that is being
developed is being developed for the Italian air force and it
is under development now.
Senator Levin. The reason given for leasing that you just
gave is that we really do not know if they are going to work,
therefore we want to lease them.
Secretary Roche. No, sir, the reason for----
Senator Levin. The reason for leasing is you do not have
the money now to buy them.
Secretary Roche. That is right, that is exactly right.
Senator Levin. Why do we not be just straightforward on
that. You do not have the money now to buy them or else you
would. Why do we not just be straightforward.
Secretary Roche. I am sorry, sir. I think we said that. I
said that earlier. It was whether we should buy them at the
residual.
Senator Levin. Okay. I think it is important, though, that
you be straight on that. If you had the money now you would buy
them, you would not lease them.
Secretary Roche. If we had the money now and we could buy
them, we would.
Senator Levin. Okay, under the usual procurement approach?
Secretary Roche. We would ask that the procurement approach
be changed so we get them at the same schedule, because getting
them earlier is----
Senator Levin. Of course. But under the usual rules of
procurement you would do it with a multi-year; is that correct?
Secretary Roche. If there were all of the things necessary
to get the same number of planes in the same amount of time and
the money were available in the beginning, yes, we would
purchase, because it is less complex.
Senator Levin. Less complex? It also is the way we
ordinarily buy things, for good reasons.
Final question: The CBO letter said the following--Mr.
Kaplan, let me address this to you. It says that: ``The
proposed contract between Boeing and the Air Force, as well as
the financing arrangement, clearly indicates that the statutory
trust exists solely to borrow money on behalf of the Federal
Government to allow the Air Force to acquire an asset that has
been built to its unique specifications.'' Do you agree with
that?
Mr. Kaplan. No, Senator.
Senator Levin. Okay. You do not agree that the contract
between Boeing and the Air Force, as well as the financing
arrangement, indicates that that trust exists to borrow money
on behalf of the Federal Government, to allow the Air Force to
acquire an asset that has been built to its specifications? You
disagree with that?
Mr. Kaplan. I agree with the first portion of it and then
there were other elements of it that I disagree with. First of
all, the Air Force does not acquire the asset. The special
purpose entity acquires the asset. The purpose as I understand
it of the special purpose entity was to achieve a lower
borrowing rate from the bondholders, which would reduce the
cost of the lease to the taxpayers.
Senator Levin. Is this special purpose entity out there
going to be flying planes and carrying out missions, or is it
the Air Force?
Mr. Kaplan. It is the Air Force, Senator.
Senator Levin. This entity is not there to carry out Air
Force missions, is it? It is there to help acquire property
that we cannot pay for now. Why are we not straight on that
issue?
If you had the money now, we would buy it. Let us just be
honest about it.
Mr. Kaplan. Senator, I do not believe I have suggested
otherwise.
Senator Levin. So the purpose of that entity is because we
do not have the money now. We are going to create an entity to
borrow money for the government and we are going to pay more
for it. Your estimate is $1 billion in an apples and apples
basis.
The argument is not--okay, maybe we ought to do that. I can
accept that argument. If we do not have the money now, let us
do it this way because it is such a desperate need to do it,
instead of raising the budget, borrowing money now, pay, borrow
money later and pay more. I may not agree with the argument,
but at least it is an honest argument.
But to suggest that somehow or other we are not acquiring
this property, it is some special purpose entity out there that
is acquiring it, it seems to me is engaging in a fantasy. I do
not want to engage in those kind of fantasies.
Mr. Kaplan. I do not either, Senator. The Air Force does
not acquire these planes at the end of the lease. Congress will
have to----
Senator Levin. It is intended that the Air Force will
acquire these planes. That is the whole purpose of this, is
that we acquire planes without money up front. That is the
purpose of this thing.
Secretary Wynne. But it does presume, sir, on Congress.
Senator Levin. That is the intent, the purpose, that we
acquire these planes, because we are doing it by lease now
because we do not have the money up front. Why not be straight
about it?
Secretary Wynne. As the Inspector General said, he did say
that the Air Force should proceed apace to give the business
case to Congress for purchase. Otherwise we would be presuming
on Congress.
Senator Levin. Last question----
Chairman Warner. Oh, no, you have--another member just came
and we are getting----
Senator Levin. Can I have 30 more seconds? Okay. I will
hold it off and do it later. No, no, that is okay.
Chairman Warner. Take 30 seconds.
Senator Levin. No, that is okay. If I have overstayed, I
will come back again.
Senator McCain. I just have one.
Chairman Warner. Okay, you have one. You have 30 seconds.
We have to get this organized and run along on this railroad
here.
All right, Senator Allard, this is your first round.
Senator Allard. Mr. Chairman, thank you. I apologize, I had
to step out just a moment.
We heard in the Budget Committee yesterday that the lease
is inconsistent with Federal budgetary principles. I have just
a couple questions in that regard for Mr. Kaplan. Would this
proposal bypass the budget process?
Mr. Kaplan. No, Senator. The money for the proposal, the
money for the lease payments in the FYDP, is budgeted and is
accounted for.
Senator Allard. Does it concern you that this future
liability will not be scored and will not be counted in terms
of budgetary resources?
Mr. Kaplan. It is scored, Senator. It is scored as an
operating lease.
Senator Allard. So each year as an operating lease then it
will be brought into the budget; is that correct?
Mr. Kaplan. I believe that is correct, Senator.
Senator Allard. Okay. Then you think it will be accounted
for in the budget process?
Mr. Kaplan. Yes, Senator, ultimately all of the lease
payments will be accounted for in the budget process.
Senator Allard. Okay. Now it is not a lease-purchase?
Mr. Kaplan. No, Senator.
Senator Allard. It is not a lease?
Mr. Kaplan. It is an operating lease, Senator.
Senator Allard. But it does not meet all the requirements
which ordinarily you have for a lease. There are six
parameters. This only meets two of those parameters. The other
four parameters, from what I understand from the testimony
yesterday, are not met.
Mr. Kaplan. That is not my testimony, Senator. My testimony
is, as I stated at the outset, that this is a close call. The
proposal on a number of these criteria is right at the margin.
We recognize that, OMB recognizes that, and in light of the
congressional interest as expressed in legislation and in light
of the compelling need that the Air Force and the Department of
Defense have presented we have concluded that it does satisfy
the criteria for an operating lease.
Senator Allard. Okay. Here are some of the things that have
been brought up by the Budget Committee and I would like to
have you respond to me if you would, please: that CBO reached a
determination that the asset was not a general purpose asset,
which is one of the requirements. Would you respond to that?
They say you have a tanker plane and the only use you can use a
tanker plane is to fly for fuel and you cannot put it out on
the general market and use it. These are requirements for a
lease-purchase.
Mr. Kaplan. Yes, Senator, and Boeing developed the 767
global tanker transport aircraft commercially. It was not
responding to a request from the administration or from the
Federal Government. It markets it commercially. It marketed it
on its Web site before Congress authorized it, I believe. It
has sold it to other governments. It has sold it to the Italian
government. It, I believe, is in final stages of negotiation
with the Japanese government. In its freighter configuration it
expects to have a commercial market, both within governments
and outside of governments.
Senator Allard. Are they sold to these other countries as
refueling planes, or what is their purpose?
Mr. Kaplan. Yes.
Senator Allard. What do they do? Then we have to pay to
take off the retrofit that we did to carry fuel in order to
make them marketable? Is that what has to happen?
Mr. Kaplan. Senator, I believe Italy purchased these in
their tanker configuration. I believe that is Japan's intention
as well.
Senator Allard. Do you believe the Air Force included the
construction loan financing in its assessment of the fair
market value of the aircraft? Is this treatment unusual, and
how do the interest rates affect the fair market value?
Mr. Kaplan. It is certainly the case that the Air Force
included the cost of construction financing in their
calculation of the lease payments and the comparison to fair
market value, and they came up with a number of $138.4 million,
I believe.
The test is whether the sum of the lease payments exceeds
90 percent of the fair market value. This is one of the
difficulties of A-11. We have to establish a fair market value.
If you look at what the Italians paid for these planes in a
similar configuration, it is $175 million. I do not think $175
million is the fair market value. I think something between
$138 million and $175 million is a reasonable place to end up,
and that gets you below 90 percent.
Senator Allard. I want to move on to this trust. I know
there was some discussion earlier. Here is the way that the CBO
report to Congress describes this trust, and I want to know if
you agree with what they say or not: ``The borrowing activities
of the special purpose entity''--that is the trust--``will be
directed by a financing committee composed of the Air Force,
Boeing, and the lease administrator,'' just those three
entities apparently. ``The Air Force has asked Boeing to serve
as the lease administrator. Under the operating guidelines for
the financing committee, the Air Force must approve all of the
terms and conditions of the financing plan and must review and
approve all financing documents. CBO concludes that the action
of that committee will be explicitly controlled by the Air
Force.''
Would you agree with that?
Mr. Kaplan. Senator, I had actually thought that the lease
administrator was not Boeing, but that the trustee was a member
of that financing committee. I will take it for the record and
get with my staff.
[The information referred to follows:]
As with a number of the issues that arose with this very
complicated leasing transaction, reasonable minds can come to different
conclusions. In this case, we do not agree with CBO that the Air Force
will have explicit control over this entity. The SPE benefits the
government by shielding the aircraft title from potential claims by
Boeing's creditors. The SPE will also be able to borrow at a lower cost
than Boeing, which translates into lower lease payments and savings for
the taxpayers. However, the SPE is managed by the trustee (a Wilmington
Trust employee), and its legal authority and roles are expressly set
out in the trust agreement. It is not directed by the financing
committee. Rather, the financing committee has the specific role of
evaluating and executing the financing arrangements required to
conclude the construction and lease of the aircraft to the government.
The committee is comprised of the government, Boeing, and the lease
administrator (a contractor employee). As laid out in the committee's
operating guidelines, it must act with the concurrence of both the
government and the contractor, and any financing plan must be
reasonably acceptable to the contractor, although it must be approved
by the government. The government retained approval authority for
specific financing arrangements to ensure that it will receive the best
possible financing arrangement and will not be forced into an
unfavorable arrangement. Because the committee's authority is limited
to financing arrangements, it will play no role in any sale of the
aircraft.
Secretary Roche. May I help on that point of fact?
Senator Allard. Yes, Mr. Secretary.
Secretary Roche. The lease administrator is really the
lease manager. The trustee is the administrator of the trust.
Two different jobs.
Senator Allard. Okay, thanks for clarifying that.
I want to move on, and I have a question in regard to the
various options. I understand the Air Force has conducted
several analyses on other options to a lease proposal. Some of
these options included re-engining our current fleet of the KC-
135Es, leasing tanker services, or even purchasing commercial
aircraft. I was particularly intrigued by the last option. I
understand the Air Force could purchase these aircraft at
reduced costs. DC-10, for example, is already in the Air
Force's aerial refueling fleet and would not require new
military construction. I have been told that there is from the
commercial side some DC-10s that might be available.
Now, I understand that some of them have a lot of mileage
on them and some of them may not be in good shape. But there
might be some out there that are in good shape. Has there been
any effort to try and see if that option is available?
Where I am driving at in this question is has the Air Force
looked at some interim, bring on some of these planes, buy them
or lease them, whatever, that would be much less expensive, to
work you into a purchasing program for the 767 tanker that you
are wanting to work in as a new plane?
Secretary Roche. Yes, sir. I would like to doublecheck to
make sure we checked on used DC-10s. We certainly looked at
used 767s of the 200ER configuration, which are the freighter
versions, and there were very few of those available and they
had an enormous number of hours.
In the case of the DC-10, it has been out of production as
a commercial plane since the late 1970s and out of production
for the Air Force since the early 1980s. So the infrastructure
supporting it around the world is not that great as compared to
the 767.
Senator Allard. The thing I was bringing up, the 767, that
means you have to have a whole new maintenance line out here.
You may have to build new buildings for that. I do not know
whether it would fit in any of your current buildings or not.
But those are questions that come up. I know the commercial
airlines look at that. In fact, a lot of them are trying to
keep too much diversity in their flight, in their flying
planes, because it creates problems with maintenance because
you have to maintain so many crews that are experts in the
various planes and what-not.
I assume that you have looked at some of that?
Secretary Roche. Yes, sir. At some point you transition,
and our issue is that these planes, these tankers, have to be
recapitalized at some point.
Staff has just provided me, sir: We did look at the DC-10s.
There were very few that were of the configuration needed,
freighter configuration DC-10s, and they had quite a number of
hours on them, about 27 years old. Our experience with taking
old 707s and refurbishing them for Joint Surveillance, Target
Acquisition, and Reporting System (JSTARS) shows that they
really do not start out as new planes; they start out as old
planes.
Senator Allard. Thank you.
Chairman Warner. Now we will proceed to Senator McCain.
Senator McCain. Secretary Roche and Secretary Wynne, you
are familiar with a June 20, 2003, memorandum for Under
Secretary of Defense, Acquisition, Technology and Logistics,
Under Secretary of Defense-Comptroller, ``Subject: PA&E
Analysis, KC-767A lease program''? Are you both familiar with
that?
Secretary Roche. I am, sir.
Senator McCain. Are you familiar with it, Secretary Wynne?
Secretary Wynne. Yes, sir.
Senator McCain. It basically says that ``Our analysis
indicates that the provisions of the lease cost more than the
equivalent purchase. We find that leasing provides no inherent
economic efficiencies relative to direct purchase of tankers,
therefore more expensive in the long run.'' You are familiar
with this, basically a memorandum objecting to the lease
proposal from PA&E?
Secretary Roche. A question of fact, Senator: Does it begin
by saying ``The report to Congress,'' ``The draft report to
Congress''?
Senator McCain. No, it says ``This memorandum provides a
summary of the A-94 and A-11 analysis developed by PA&E in
response to taskings from the leasing review panel and
subsequent leasing working groups. Analysis based on the latest
version leasing contract provided my office on June 17, 2003.''
Secretary Roche. Yes, sir. We both met with Mr. Krieg the
next day.
Senator McCain. Are you familiar with it?
Secretary Roche. Yes.
Senator McCain. Now, then that was on June 20. On June 23
did you have a meeting, Mr. Roche, with Thomas Owens of Boeing?
Secretary Roche. I do not know if I did or not, sir.
Senator McCain. Well, let me say, I have an email here that
is written from Thomas Owens to Jim Albaugh, with a copy to
Andrew Ellis: ``Subject: Roche Meeting 23 June 2003.'' Do you
remember it now?
Secretary Roche. No, sir.
Senator McCain. I tell you what. Maybe I can refresh your
memory. ``Tankers''--this is from the email that he sent.
``Tankers.'' He started with: ``We have a big problem,''
referring to the apparent PA&E question: ``If you need tankers
so bad, why is Air Force retiring KC-135s early?'' Unquote.
``He made reference to Chrissy-Poo several times. He is a
McCain staffer. With regard dialogue reference best price
effort, he seemed to be concerned more for Marv's benefit than
he was himself. Marv having trouble with some over the issue of
$138 million versus $131 million. Ask us to put pressure on
Mike Wynne to convince PA&E to write new letter essentially
undoing the first letter. He said he was not going to answer,
would get in trouble no matter how he answered. Roche said he
was going to talk to Wolfowitz tomorrow. Meanwhile, the report
is stalled until Krieg or someone else figures out the letter
is going to embarrass the SECDEF.''
Do you have any recollection of that meeting?
Secretary Roche. No, sir. I do recollect meeting with Ken
Krieg on a Monday. The letter from PA&E comes to the office on
a Friday afternoon----
Senator McCain. I am asking about a meeting with Thomas
Owens.
Secretary Roche. I do not recall it, Senator. I do not
recall.
Senator McCain. You have no recollection whatsoever of
telling Mr. Owens to put pressure on Mike Wynne to convince
PA&E to write a new letter essentially undoing the first
letter?
Secretary Roche. No, sir. That is Mr. Owens'
characterization of what I may have said. I certainly said to
someone at that time--it could have been Owens; I just do not
remember if he was in the office--that we were working with
Mike Wynne to deal with this. We also met with Ken Krieg that
day, who made it clear that this was more like a red team
letter.
But it was not pressure as much as it was, we have to get
on with this.
Senator McCain. So this email is essentially false? You did
not ask Boeing to put pressure on Mike Wynne to convince PA&E
to write a new letter essentially undoing the first letter?
Secretary Roche. As they----
Senator McCain. Is that true or not, Mr. Secretary?
Secretary Roche. I do not think it is exactly that way,
Senator.
Senator McCain. Did you or did you not----
Secretary Roche. I believe it was a matter that I----
Senator McCain. Secretary Roche, I would like you to
respond to the question.
Secretary Roche.--did suggest that they talk to Secretary
Wynne, yes. But the word ``pressure''----
Senator McCain. Did you or did you not----
Secretary Roche. I did not ask them to put pressure.
Senator McCain. Did you or did you not request Boeing to
put pressure on Mike Wynne to convince PA&E to write a new
letter essentially undoing the first letter? Did you or did you
not?
Secretary Roche. I have no recollection of that, Senator. I
know that we met with Ken Krieg and we decided not to write
another letter, but to work out each of the issues.
Senator McCain. I am asking about a meeting that you had
with Boeing, employees of Boeing----
Secretary Roche. I cannot recollect saying that, Senator, I
am sorry.
Senator McCain. Secretary Wynne, was any pressure put on
you?
Secretary Wynne. No, sir, I reflect no pressure from
Boeing.
Senator McCain. I see, but you had plenty of meetings with
them?
Secretary Wynne. I had a relatively few meetings with
Boeing, sir.
Senator McCain. I have no more questions, Mr. Secretary.
Chairman Warner. I suggest this be part of the record.
Senator McCain. Without objection.
[The information referred to follows:]
Senator Inhofe. Two very short questions. First of all, I
think there might have been a misunderstanding, Secretary
Roche, with my line of questioning concerning the shortage of
tankers. I was not referring to the 68 potentially retired KC-
135s as lift vehicles or something else. I was really referring
to them as tankers.
Do you agree that we have a shortage of tankers today?
Secretary Roche. We meet the requirements today in the
total number of tankers. It is the fact that over time this is
going to become more difficult as we have scenarios that are
around the world. But in fact we do meet all the requirements
of the contingencies we have right now.
Senator Inhofe. Yes, but we do not know what contingencies
we are going to have in the future.
Secretary Roche. That is the point.
Senator Inhofe. Are you personally comfortable? What is
your comfort level with the number of tankers we have right
now?
Secretary Roche. In terms of total numbers, it is not--I am
not uncomfortable. It is in the reliability of the tanker force
that I am uncomfortable.
Senator Inhofe. Second, one thing that has just been left
out of this discussion has been the idea of centralized
training. We have used centralized training on the C-141, C-5,
C-17, and KC-135. It has been a successful program. Do you feel
if this lease should go through or if any of the other
arrangements that have been discussed here today should occur,
that centralized training is desirable?
Secretary Roche. In the long run it most certainly is, sir.
We typically take a new plane and train where they are first
deployed and then migrate to a centralized position, and we
would intend to do the same thing.
Senator Inhofe. In the case of the C-17s, I think the
original purchase was 120. That decision was made I think when
the 40th one was delivered. Does that time frame sound
reasonable?
Secretary Roche. I would have to take a look and discuss
with others. It is somewhere between there and 100, or maybe it
is beyond 100. It depends on the aircraft and the amount of
training that is being done, for instance, where we would like
to go.
Senator Inhofe. Why would it be different with, say, a 767
and a C-17?
Secretary Roche. It may not necessarily be different,
Senator. It may not necessarily be different.
Senator Inhofe. In retrospect, was not the C-17 program
pretty successful?
Secretary Roche. It was very successful.
Senator Inhofe. All right, sir. Thank you very much.
Chairman Warner. Thank you very much.
Senator Allard. Just one question, Mr. Chairman?
Chairman Warner. We actually will go to Senator Levin for
his 30 seconds, and 30 seconds with you, because I am very
anxious to move to this next panel.
Senator Levin. Thank you, Mr. Chairman.
I want to just pursue something that Senator Allard asked.
He read a long paragraph from the CBO report and the answer was
that there was some confusion between the lease administrator
and the trustee. I do not think that is the point this
paragraph makes and so I am going to re-read it: ``Under the
operating guidelines for the financing committee,'' the CBO
writes, and this is the financing committee of this trust,
``the Air Force must approve all of the terms and conditions
for the financing plan and must review and approve all
financing documents. CBO concludes that the actions of that
committee will be explicitly controlled by the Air Force.''
My question of you, I think, Mr. Kaplan first, would be: Do
you disagree with that?
Mr. Kaplan. Senator, the SPE will continue to own this
aircraft. For purposes of the A-11 analysis, the relevant
question is whether the ownership remains with the lessor
throughout the term of the lease. The answer in this case is
that the lessor is the SPE.
Senator Levin. I understand. I know what you are saying.
That is not my question. I am not asking you for a legal
technicality. I am asking you for actual control. I think you
know what I mean.
The question is, is CBO wrong in concluding that the
actions of the committee will be controlled by the Air Force?
Mr. Kaplan. Some of the actions of the committee, I think
is the right answer, Senator.
Senator Levin. The important actions, the relevant actions,
the key actions?
Mr. Kaplan. Not for purposes of the A-11 analysis, Senator.
I believe that refers to the financing terms of the
transaction. It does not, for instance, refer to the sale of
the aircraft at the end of the lease. That is, for the purposes
of the A-11 criteria, determining whether this is an operating
lease or a lease-purchase, it is the retention of ownership
that is important.
Senator Levin. Is it not true that if in fact the Air Force
decides to buy these that that financing committee must
purchase?
Mr. Kaplan. The Air Force has the option, yes, under the
contract. The Air Force has the option, if Congress approves,
to purchase the planes, absolutely.
Senator Levin. Right, and then the financing committee must
buy; is that not correct? It must arrange to buy the aircraft?
Mr. Kaplan. Yes, there is a contractual provision that
there is an option to buy.
Senator Levin. Of course. Is it not true that the Air Force
has a veto over any action of the financing committee?
Mr. Kaplan. I would have to check. I think that is the
case, but again the area of responsibility of the financing
committee I believe is limited to the terms and conditions of
the lease itself.
Senator Levin. So you do not agree with the statement of
the CBO?
Mr. Kaplan. As I said I think at the outset, there were
parts of it I agreed with and parts that I did not, Senator.
Senator Levin. Just the one I read at the end, that the
actions of that committee will be explicitly controlled by the
Air Force? You just disagree with that statement?
Mr. Kaplan. The financing committee I believe will be
controlled by the Air Force in conjunction with the other
members of the committee.
Senator Levin. Thank you.
Chairman Warner. Senator Allard, a quick wrap-up.
Senator Allard. Mr. Chairman, I just want to make clear
that I do think we have a need for new tankers and I want to
see it done. I just have some concerns about how we are going
to handle this from a budget point of view.
So my last question is that the trust that we have set up
here--is this the first time this mechanism has ever been used?
I asked this question yesterday of the CBO and he thought it
was. Does OMB know whether this is the first time this process
has ever been used in the budgeting process?
Mr. Kaplan. Senator, I think it is fair to say that this
very complex transaction is unique in many respects. As to
whether a special purpose entity has ever been used, I cannot
say. But there is no question that this is an extremely unique
lease transaction.
Senator Allard. I am wondering. I wonder if you would
confirm that and see as to whether it is the first time this
has been used or not and get something back to me and the
committee in that regard.
Mr. Kaplan. We will do that, Senator.
[The information referred to follows:]
Trusts have been used as part of lease arrangements in the past.
For example, the Veterans Administration has used trusts in at least
eight building leases since 1986. In 1989, the Architect of the Capitol
entered into a similar trust arrangement to finance the construction of
the Federal Judiciary Office Building. The National Archives and
Records Administration did the same in constructing the Archives II
facility.
Senator Allard. Thank you.
Chairman Warner. We will now proceed to the second panel.
But before you depart, I would say to our witnesses that I feel
that in a period of 3 hours we have had a very intense period
of questioning here and I think the members of this committee
are to be commended for the fairness of the questions and the
sincerity to try and reach what, I cannot predict the
conclusion, but would be a solution to a problem that is in the
best interests, security interests, of this country and the
taxpayers.
So we will now proceed to the second panel.
Secretary Wynne. Thank you, Senator.
Secretary Roche. Thank you very much, Senators.
Chairman Warner. We thank the witnesses of the second panel
for their patience, but I believe that, and I hope you concur,
that we had a very thorough exchange of viewpoints with the
first panel.
This second panel will provide independent views on the
specifics of the lease proposal. I want to welcome: Neal
Curtin, Director, Defense Capabilities and Management at the
GAO; Robert Sunshine, Assistant Director for Budget Analysis at
the Congressional Budget Office; and Dr. Richard Nelson,
Assistant Director, Cost Analysis and Research Division,
Institute for Defense Analyses.
I thank you, gentlemen, for your willingness to appear
today and express your views. We will place into the record
your statements and the chair requests that you summarize your
statements and then we will proceed to questions.
Mr. Curtin.
STATEMENT OF NEAL P. CURTIN, DIRECTOR FOR DEFENSE CAPABILITIES
AND MANAGEMENT, U.S. GENERAL ACCOUNTING OFFICE
Mr. Curtin. Thank you, Mr. Chairman and members of the
committee.
About a year ago we provided this committee a report on our
preliminary observations on the Air Force's negotiation as it
stood at that time, and you asked us to take another look at
this when the Air Force presented its proposal to Congress,
which it did on July 10. So we have reviewed the Air Force
proposal, and I appreciate the opportunity to be here today to
present GAO's observations on issues that we hope are useful to
the committee in its deliberations on this.
I will be very brief since my full statement is in the
record. I will summarize a couple key points.
Chairman Warner. I would like to ask you to draw up the
microphone because there are a number of people in the
audience, particularly those in the back, that are anxious to
hear your statements.
Mr. Curtin. Thank you.
First, the Air Force report acknowledges that leasing is
more expensive, but its analysis indicates that a net present
value difference of only $150 million favoring purchase out of
a total program estimate of about $17 billion. Since this type
of analysis is so sensitive to the assumptions used--and you
went into great depth on that with the first panel--we reviewed
some of those same analyses that the other panelists have.
The sensitivity analysis that we did shows that the cost
difference in favor of purchase could be as much as $1.9
billion in net present value. That is an extra cost of over 10
percent for leasing versus the 1 percent shown in the Air Force
report. We think that is a better reflection of the real
difference between lease and purchase.
Second, the Air Force really does not make a case that
leasing is cheaper. Instead, their main argument is that there
is an urgent need to begin replacing the current tanker fleet
and that leasing provides the aircraft earlier and completes
the deliveries more quickly than purchase under the current
budget constraints. Leasing would provide the first planes in
August 2006, whereas under the current procurement plan in the
Air Force budget they would not receive the first planes until
fiscal year 2009.
In our view, the urgency of the need is really a matter of
how much risk the Air Force and Congress are willing to accept.
Now, the Air Force has not made replacement of the tanker fleet
a procurement priority in past years. We pointed out as far
back as our 1996 report that the Air Force needed to start
planning to replace the aging fleet of KC-135s. At that time
they were already 35 years old, and the Air Force said at that
time in response to our report, and has continued to say up
until about 18 months ago, that the tankers were a lower
priority and replacement could wait until later in this decade.
KC-135s are increasingly difficult and expensive to
maintain, there is no question about it. The Air Force has been
able to meet the heavy demands of the past 2 years with the
existing fleet. The risk is that the aging planes would incur
some fleet-wide problem in the intervening years that would
jeopardize the overall mission, and there is no way to predict
how likely that is or how serious such a fleet-wide grounding
might be.
The third point: Congress also needs to be aware that as
part of the lease agreement DOD plans to contract with Boeing
for logistics support that will total over $5 billion during
the period of the lease, or an average of about $6.4 million
per year per aircraft in fiscal year 2002 dollars. Boeing would
handle all maintenance above the flight line level.
We do not know at this point to what extent the Air Force
considered other options for maintenance. There was some
discussion this morning that they are looking at public-private
partnerships and things like that. But there was no competition
of this contracting provision for maintenance and there are
many private contractors out there who perform maintenance now
on commercial 767s.
We asked the Air Force for documentation on how they
arrived at the maintenance agreement with Boeing and agreed on
the price, but the documents the Air Force provided really did
not shed much light on their basis for how they arrived at the
price.
Fourth, there are some issues that Congress needs to
consider when these leases expire, and there was some
discussion of that earlier as well. At the end of these 6-year
terms, the agreement says the aircraft are supposed to be
returned to the owner. At that point the Air Force would have
made lease payments of about 90 percent of the value of the
aircraft, maybe more than 90 percent under different analysis
there, and the Air Force would actually incur additional cost,
estimated at about $778 million, to return the aircraft to this
special purpose entity in the maintenance condition specified
in the lease.
More importantly, if the Air Force in fact returns those
airplanes they would be losing tanker capacity that would have
to be replaced somehow. So in other words, if the Air Force
really leases these planes for 6 years and turns them back in
this proposal really does not make much sense at all,
financially or militarily. So the very strong likelihood is
that the Air Force will seek authority and funding to purchase
the tankers at the expiration of the lease. So Congress should
be aware that the full cost of this program should really
include an additional $4 billion to account for the purchase
cost at the end of the program.
Moreover, the tanker fleet consists of over 500 KC-135s,
which all must be replaced eventually, or at least some portion
of that 500, as the Secretary said. It may not be all 500. If
the Air Force continues procurement beyond these first 100, the
leasing proposal complicates the Air Force's budget situation
in future years. Because leasing results in deferring payments
until future years, the Air Force will still be making large
lease payments on the first 100 aircraft at the same time it
will need to commit funds to follow-on procurements, and that
is the chart you showed earlier, Mr. Chairman.
In that chart it shows that at the peak of the lease
payments you would also be reaching one of the peaks in your
follow-on procurement of the second batch of airplanes. In that
analysis, the Air Force could need as much as $6 billion per
year in the 2012 to 2014 time frame just for tankers.
Chairman Warner. That procurement you refer to is a capital
acquisition----
Mr. Curtin. Absolutely, yes.
Chairman Warner.--vice lease.
Mr. Curtin. Absolutely.
Just to sum up the key points: The lease proposal in our
view is clearly more expensive than outright purchase, and by a
greater amount than the Air Force analysis shows. So from a
purely economic standpoint the proposal really does not provide
the best return for the taxpayer. It really comes down to a
judgment then of whether other factors outweigh the extra cost.
There is a need for new tankers, but the urgency of
proceeding more quickly through this tanker proposal has really
not been made strongly to us, because the problems of the KC-
135s have been known for some time and yet the Air Force has
not made tankers a priority for procurement funding.
I will stop there. My statement does raise additional
issues that I would be glad to go into in the questions period
and be glad to take whatever other questions you have.
[The prepared statement of Mr. Curtin follows:]
Prepared Statement by Neal P. Curtin
Mr. Chairman and members of the committee: I appreciate the
opportunity to appear before you today to discuss the Air Force's
report on the planned lease of 100 Boeing 767 aircraft modified for
aerial refueling. Aerial refueling is a key capability that is
essential to the mobility of U.S. forces. Section 8159 of the
Department of Defense Appropriations Act for Fiscal Year 2002
authorizes the Air Force to lease up to 100 Boeing 767 aircraft; the
leased aircraft would be known by a new designation, KC-767A. The act
also requires the Air Force to report to Congress with a description of
the proposed lease terms and conditions and any expected savings before
proceeding. The Air Force sent its report to Congress on July 10.
Last year, we provided you with information on the Air Force plan
to lease KC-767A aerial refueling aircraft.\1\ For this hearing, you
asked for our analysis of the Air Force's business case and our views
on the proposed lease arrangement. In my statement today, I will: (1)
summarize the proposed lease as presented in the Air Force's recent
report to Congress, (2) present our observations on the Air Force's
lease report and its justification for the lease, and (3) identify
related issues and costs that we believe Congress will want to consider
as it assesses the Air Force's proposal.
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\1\ Air Force Aircraft: Preliminary Information on Air Force Tanker
Leasing. GAO-02-724R. Washington, DC: May 15, 2002.
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To summarize and analyze the report of the proposed lease, we
reviewed the report to Congress, examined the draft lease (which is
still in negotiation and is subject to change), and reviewed documents
and briefings from the Office of the Assistant Secretary of the Air
Force for Acquisitions, Air Mobility Programs, to identify issues and
costs that are material to the contract. We also reviewed the Air
Force's analysis and data used in its analysis of the lease versus buy
comparison as required by Office of Management and Budget (OMB)
Circular A-94. Finally, we used data gathered for our ongoing review of
tanker requirements being conducted for the House Armed Services
Committee's, Subcommittee on Readiness.
BACKGROUND
Aerial refueling is critical to carrying out our national security
strategy because it allows other aircraft to fly further, stay airborne
longer, and carry more weapons, equipment, and supplies. While numerous
military aircraft provide refueling services, the bulk of U.S.
refueling capability lies with the Air Force's fleet of 59 KC-10 and
543 KC-135 aircraft. These are large, long-range aircraft that have
counterparts in the commercial airlines but have been modified to turn
them into tankers. The KC-10 is based on the DC-10 aircraft, and the
KC-135 is similar to the Boeing-707 airliner. Because of their large
numbers, the KC-135 is the mainstay of the refueling fleet, and
successfully carrying out the refueling mission depends on the
continued performance of the KC-135. Thus, recapitalizing the fleet of
KC-135s will be crucial to maintaining aerial-refueling capability, and
it will be a very expensive undertaking.
There are two basic versions of the KC-135 aircraft, designated the
KC-135E and KC-135R. The R model aircraft has been refitted with modern
engines and other upgrades that give it an advantage over the E model.
The E model aircraft on average is about 2 years older than the R
model, and the R model provides more than 20 percent greater refueling
capacity per aircraft. The E model is located in the Air National Guard
and Air Force Reserve. Active Forces have only the R model. Over half
the KC-135 fleet is located in the Reserve components.
The rest of the Department of Defense's (DOD) refueling fleet
consists of Air Force HC-130 and MC-130 aircraft used by Special
Operations Forces, Marine Corps KC-130 aircraft, and Navy F-18 and S-3
aircraft. However, the bulk of refueling for Marine Corps and Navy
aircraft comes from the Air Force KC-10 and KC-135. These aircraft are
capable of refueling Air Force and Navy/Marine aircraft, as well as
some allied aircraft, although there are differences in the way the KC-
10 and KC-135 are equipped to do this.
The Air Force's Report on the KC-767A Aircraft Lease
Section 8159 of the Department of Defense Appropriations Act for
Fiscal Year 2002,\2\ which authorized the Air Force to lease the KC-
767A aircraft, specified that the Air Force could not commence lease
arrangements until 30 calendar days after submitting a report to the
House and Senate Armed Services and Appropriations Committees that
would (1) outline implementation plans and (2) describe the terms and
conditions of the lease and any expected savings. At about the same
time that the Air Force submitted the required report (on July 10,
2003), it submitted a New Start Notification \3\ and stated that it
would not proceed with the lease until it received approval from all of
the committees. The House and Senate Appropriations Committees and the
House Armed Services Committee approved the new start in July. We
previously testified before the House Armed Services Committee and its
Subcommittee on Projection Forces, and we issued a briefing report in
2002 on the status of the proposed lease to date (see our Related GAO
Products page for a complete list of products to date related to
refueling requirements and the proposed lease).
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\2\ Department of Defense and Emergency Supplemental Appropriations
for Recovery from and Response to Terrorist Attacks on the United
States Act, 2002, Pub. L. No. 107-117, Sec. 8159, 115 Stat. 2230, 2284-
85 (2002).
\3\ The New Start Notification, submitted to the Armed Services and
Appropriations Committees on July 11, 2003, was required by section 133
of the Bob Stump National Defense Authorization Act for Fiscal Year
2003, and is being used by the Air Force as the trigger for executing
the lease. Pub. L. No. 107-314, Sec. 133, 116 Stat. 2458, 2477 (2002).
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The key elements of the Air Force's proposal, as presented in the
report to Congress, are summarized below:
The Air Force proposes to lease 100 KC-767A aircraft
for 6 years each; the first aircraft would be delivered in
August 2006 and the final ones by the end of 2011. Leases on
the final group of aircraft would terminate in 2017. The report
indicates that the total program for the leased aircraft would
cost about $17.2 billion in net present value over the lease
period.\4\
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\4\ When costs and benefits are evaluated over time, a net present
value calculation is used to account for the time value of money
through an interest rate called a ``discount rate.''
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The Air Force's report includes an analysis required
by OMB Circular A-94 comparing the net present value of the
lease approach against that of purchasing the aircraft. The Air
Force acknowledges that its analysis indicated that purchase
would be cheaper than leasing by about $150 million in net
present value terms. Nevertheless, it proposes to use the
leasing approach because it allows the Air Force to take
delivery of the aircraft more quickly than it could through
purchase (and avoid creating major disruptions to other
procurement programs for which funding has already been
identified in the Future Years Defense Program). Specifically,
the Air Force said that if the aircraft were purchased at the
same rate as planned under the lease, it would need $5 billion
more funding through fiscal year 2006 and more than $14 billion
more for the 6 years reflected in the Future Years Defense
Program. Under the procurement budget plan that the lease would
replace, the Air Force would not begin acquiring new tankers
until fiscal year 2009 and would not have 100 new tankers until
2016, 5 years later than planned through the lease.
The key justification for the lease, according to the
Air Force, is an urgent need to replace the current fleet of
KC-135 aircraft. The Air Force has stated that the KC-135 is
aging and becoming increasingly costly to operate owing to
corrosion, the need for major structural repair, and increasing
rates of inspection to ensure air safety. Moreover, the report
indicates that the Air Force believes it is incurring a
significant risk by having 90 percent of its aerial-refueling
capability in a single, aging airframe and that a ``fleet
grounding'' event could jeopardize the tanker's mission.\5\
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\5\ A fleet grounding event would involve some systemic problem or
equipment failure affecting all aircraft of the same type and would be
serious enough to require replacement before the aircraft could resume
normal operations.
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The Air Force plans to award a contract to a special
purpose entity (SPE), a trust to be created under the laws of
Delaware, that will issue bonds to raise sufficient capital to
purchase the new aircraft from Boeing and lease them to the Air
Force.\6\
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\6\ The special purpose entity would pay the interest on the bonds
using lease payments it receives from the Air Force and would pay off
all the bonds at the conclusion of the lease term.
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The entity is to issue bonds on the commercial market
based on the strength of the lease and not the creditworthiness
of Boeing. The lease is part of a three-party contract between
the Air Force, Boeing, and the SPE. Figure 1 depicts the
relationships of the three parties to the contract and the
transactions that are to take place under the contract, once it
is signed.
Office of Management and Budget Circular A-11 requires
that an operating lease meet certain terms and conditions,
including a criterion that the net present value of the lease
payments not exceed 90 percent of the fair market value of the
asset at the time that the lease is initiated. The report to
Congress states that DOD believes the proposed lease meets
those criteria and that payments over the life of the lease
will be equal to 89.9 percent of the fair market value of the
aircraft. At the same time, the report points out that the
percentage is based on the cost to buy the aircraft--$131
million plus the cost of construction financing of $7.4
million, for a total of $138.4 million. If the fair market
value is assumed to be the cost to buy the aircraft, then the
lease payments represent about 93 percent of the fair market
value and would not meet the requirement.
If Boeing sells up to 100 comparable aircraft during
the term of the contract to another customer for a lower price
than that agreed to by the Air Force, the government would
receive an ``equitable adjustment.'' The report also states
that Boeing has agreed to a return-on-sales cap of 15 percent
and that an audit of its internal cost structure will be
conducted in 2011, and that any return on sales exceeding 15
percent would be reimbursed to the government.
According to the report, if the government were to
terminate the lease, it must: (1) do so for all of the
delivered aircraft, and any aircraft for which construction has
not begun, (2) give 12 months advance notification prior to
termination, (3) return the aircraft, and (4) pay an amount
equal to 1 year's lease payment for each aircraft terminated.
If termination occurs before all aircraft have been delivered,
the price for the remaining aircraft would be increased to
include unamortized costs incurred by the contractor that would
have been amortized over the terminated aircraft and a
reasonable profit on those costs.
The government will pay for and the contractor will
obtain commercial insurance to cover aircraft loss and third-
party liability as part of the lease agreement. Aircraft loss
insurance is to be in the amount of $138.4 million per aircraft
in calendar year 2002 dollars. Liability insurance will be in
the amount of $1 billion per occurrence per aircraft. If any
claim is not covered by insurance, the Air Force will indemnify
the special purpose entity for any claims from third parties
arising out of the use, operation, or maintenance of the
aircraft under the contract.
At the expiration of the lease, the Air Force can
return the aircraft to the SPE after removing, at government
expense, any Air Force-unique configurations added by the Air
Force after delivery of the aircraft from the SPE.
Alternatively, the Air Force also has the option to purchase
the aircraft at residual value (the estimated value of the
aircraft after the lease term ends). However, the purchase can
take place only if it is authorized and funded by Congress at
or before the expiration of the lease.
The contractor will warrant that each aircraft will be
free from defects in materials and workmanship and that the
warranty will be of 36 months' duration and will commence after
construction of the commercial Boeing 767 aircraft but before
they have been converted into aerial-refueling aircraft. Upon
delivery to the Air Force, each KC-767A aircraft will carry a
6-month design warranty, 12-month material and workmanship
warranty on the tanker modification, and the remainder of the
original warranty on the commercial components of the aircraft,
estimated to be about 2 years.
Our Analysis of the Air Force's Report and Lease Proposal
I will now present our observations on the Air Force's lease report
to Congress and on some of the details of the lease proposal. We
believe there are a number of aspects of the report and lease that
Congress needs to be aware of in considering the Air Force's proposal,
including the following:
The cost differential between leasing and purchasing
was presented by the Air Force as about $150 million favoring
purchase in net present value terms, although the differential
can rise to $1.9 billion favoring purchase, depending upon the
assumptions used. For example, according to the Air Force
report to Congress, had Congress provided multiyear procurement
authority and had DOD been able to accommodate that while
preserving ``program stability,'' the net present value could
favor purchase by up to $1.9 billion.
The Air Force report states that there is an urgent
need to begin tanker replacement 3 years earlier than
previously planned, but until recently, recapitalization of the
fleet has not been a high enough priority in the Air Force
budget to successfully compete for funding.
The Air Force proposal may not meet all the criteria
specified by OMB to qualify as an operating lease since the Air
Force would pay 93 percent of the fair market value of the
aircraft if construction financing were not assumed to be
included in the fair market value of the aircraft.
As required by section 8159 of the fiscal year 2002
Defense Authorization Act, the Air Force report to Congress was
limited to the costs of leasing the aircraft. However, the
report does not present the total costs of this program,
including the costs to acquire the aircraft at the expiration
of the lease or to maintain the aircraft during the period of
the lease.
Net Present Value Analysis
OMB Circular A-94 specifies that whenever a Federal agency needs to
acquire the use of a capital asset, it should do so in the way that is
least expensive to the government as a whole and further specifies how
a lease versus purchase analysis should be conducted. Specifically, the
circular directs a net present value comparison between the proposed
lease and a hypothetical purchase on the basis of the same delivery and
return profile. This approach permits an accounting for the time-value
of money.
In its report to Congress, the Air Force's net present value
calculations between the proposed multiyear lease and a hypothetical
purchase indicate that purchasing the aircraft would be cheaper than
leasing by about $150 million; however, the report contains a footnote
indicating that the net present value could favor purchase by an
additional $1.7 billion (for a total of $1.9 billion less in costs
compared with leasing). The $1.7 billion is based on four assumptions
(all in net present value terms). First, the Air Force assumes that
using a multiyear contract \7\ for purchasing the aircraft would lead
to $900 million in savings. Second, the Air Force assumes that using a
shorter span of time for the period when progress payments \8\ are made
would lead to another $200 million in savings. Third, it assumes that
if a shorter span of time for calculating inflation for progress
payments is used, then savings of $500 million will occur. Fourth, it
assumes that if a 30 percent discount on the imputed cost of insurance
is included (since the government self-insures), savings of $100
million will occur.
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\7\ In multiyear procurement, all items are bought under one
contract as opposed to a series of annual contracts.
\8\ Progress payments, which are made to contractors before they
deliver items, reduce contractors' financing costs and in turn result
in a lower purchase price for the government.
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The net present value analysis is also sensitive to the appropriate
discount rate and other expected inflation. The Air Force followed OMB
guidance contained in Circular A-94 in doing its analysis, to include
using the discount rate of 4.1 percent. Our analysis shows that a 1-
percentage point change in the discount rate can cause a change of over
$660 million in the net present value results. Table 1 shows the
sensitivity of the net present value analysis to different discount
rates, including the discount rate of 4.2 percent that we would use on
the basis of the July 10, 2003, date on which the report to Congress
was issued.\9\
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\9\ The Air Force used a 9-year discount rate from Appendix C of
Circular A-94, which is revised annually. The date of the revision used
by the Air Force was January 2003. GAO policy for determining a
discount rate is that it should be the interest rate for marketable
U.S. Treasury debt with maturity comparable to the term of the project
being evaluated. On the basis of the date the report was issued, the
discount rate that we would use would be 4.2 percent.
TABLE 1: SENSITIVITY ANALYSIS OF DISCOUNT RATES FOR THE A-94 ANALYSIS
[In millions of dollars]
------------------------------------------------------------------------
Net present value of
Discount rates in percentages leasing minus purchase
------------------------------------------------------------------------
3.5........................................... $567.6
4.1 (Air Force discount rate)................. 154.7
4.2 (GAO discount rate)....................... 89.5
4.5........................................... -100.4
------------------------------------------------------------------------
Sources: Air Force (data); GAO (analysis).
The assumptions being used for the analysis regarding rates of
expected inflation for construction of the aircraft, for military
construction of facilities, and for operation and maintenance are
reasonable; however, if the actual cost increases for the construction
of the aircraft are higher than the assumed cost increases in the Air
Force analysis, the cost of leasing will be higher than the cost
presented in the report to Congress. The reverse could also be true.
Urgency of Tanker Replacement
In its report to Congress, the Air Force stated that ``our National
Security Strategy is unexecutable without air refueling tankers'' and
that ``the risks involved with indefinitely operating a fleet of aging
aircraft are unacceptable.'' These statements indicate that tankers
are, or should be, a very high priority; however, the Air Force has for
many years faced the issue of an aging KC-135 fleet and yet has not
planned, until recently, to begin replacing them.
After reviewing a wide variety of Air Force reports and documents
as well other documents, we have concluded that neither the Air Force
nor DOD have been willing to make the difficult decision to reallocate
procurement funds from other programs in the near term. For example,
the Air Force put a replacement tanker program (known as the ``KC-X'')
in its submission for the President's fiscal year 2004 budget. But in
view of ``affordability constraints'' in the near term, the program
would not begin to be funded until fiscal year 2006, and the first
aircraft would be delivered in fiscal year 2009.
Until the authority to lease tanker aircraft was established by
section 8159 of the fiscal year 2002 Department of Defense
Appropriations Act, we did not perceive that concern within the Air
Force about the condition of its KC-135 fleet was serious enough to
successfully compete with other programs for funding. Instead, the Air
Force has expressed belief in the necessity of continuing to operate
and sustain the 540-plus aircraft fleet for several more decades, and
it has also expressed confidence in its ability to do so, as
illustrated in the following:
In our 1996 report on aging tanker aircraft,\10\ we
stated that procurement of a commercial-derivative aircraft
could take as long as 4 to 6 years and that development of a
new aircraft could take up to 12 years. Therefore, we stated,
the Air Force will need to quickly initiate studies to develop
a replacement strategy for mobility aircraft and should
consider a multirole aircraft that could be used for air
mobility as well as aerial refueling. In response, DOD stated
that ``while the KC-135 is an average of 35 years old, its
airframe hours and cycles are relatively low. With proper
maintenance and upgrades, we believe the aircraft may be
sustainable for another 35 years.'' Thus in 1996, the Air Force
was planning to continue to rely on the KC-135 aircraft until
about 2030. The Air Force's comments notwithstanding, we
pointed out at the time of our report that the long-term
serviceability of the aircraft was questionable and we continue
to believe it.
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\10\ U.S. Combat Air Power: Aging Refueling Aircraft Are Costly to
Maintain and Operate, GAO/NSIAD-96-160 (Washington, DC: August 8,
1996).
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The KC-135 Aircraft Sustainment Master Plan (1997), an
Air Force strategic guide for investment, repair, and
modification decisions, concluded that ``with continued
aggressive maintenance, the KC-135 will fly safely well beyond
the fiscal year 1997-2002 time frame.'' The report added that
the aircraft can continue to be a safe and affordable weapon
system that will meet the operational requirements well into
the next century ``if there is a consistent investment in
maintenance and the aging aircraft programs.''
The Air Mobility Command's Air Mobility Strategic Plan
for 2002 (October 2001) established a time frame of fiscal year
2008-2013 to begin fielding an updated fleet of refueling
aircraft. However, the report also identified additional
problems hampering operations, including tanker aircraft and
aircrew shortfalls, an increase in the number of KC-135
aircraft in the depot, and a decrease in mission capable rates.
The strategic plan acknowledged that the KC-135 Programmed
Depot Maintenance Improvement Plan had been developed to reduce
the number of aircraft in the depot. In addition, the strategic
plan indicated that an Analysis of Alternatives would be
conducted over the next 2 years to determine the most effective
solution set to meet the Nation's future air-refueling
requirements, although, to our knowledge, the analysis has not
been done yet.
In the Mission Need Statement: Future Air Refueling
Aircraft (AMC 004-01, November 2001), the commander of the Air
Mobility Command (AMC) stated that the ``Air Mobility Command's
priority is to continue with C-17 acquisition and C-5
modernization in the near term. As the airlift priority is met,
AMC will begin to shift resources to address the next air
refueling platform in the mid- to long-term. Air Mobility
Strategic Plan 2000 envisions KC-135 aircraft retirement
beginning in 2013 with the concurrent fielding of a replacement
air refueling platform.'' The mission need statement also
stated that ``definition of future air refueling mission needs
and examination of opportunities for technology enhancement
must begin in the near-term.''
In a May 2002 response to our briefing on our
preliminary analysis to the Senate Armed Services Committee of
the planned tanker lease, the Air Force stated that while it
had programmed funds for a traditional replacement tanker since
2001, the first new aircraft would not enter the fleet until
fiscal year 2009. The Air Force maintains an aggressive program
of inspection and repair to keep the KC-135 fleet operational
and to meet mission requirements. Consequently, while the KC-
135 fleet was built from 1957 through 1965, significant
portions of the aircraft have been upgraded or modified in the
intervening years.
From 1975 through 1988, the Air Force replaced about
1,500 square feet of the aluminum skin on the underside of the
wings of most KC-135 aircraft with an improved aluminum alloy
that was less susceptible to fatigue. In addition, engine strut
fittings were replaced.
Beginning in the mid-1980s, the Air Force began to
replace the engines of the original KC-135A aircraft. Over 410
KC-135 aircraft have been converted to the R model by
installation of fuel-efficient, quiet F108 (CFM-56) engines
that enhanced the aircraft's performance and capability. In
addition to new engines, this modification includes 25 other
changes per plane, including reinforced floors, new and
strengthened landing gear, reinforced wing structures, new
engine struts, and over 12 miles of wiring.
The Air Force modernized the cockpits on all of its
KC-135 tankers through a program called PACER CRAG (compass,
radar, and Global Positioning System receiver) to enhance
reliability, maintainability, and capability.
In addition to specific large-scale, fleet wide
upgrade programs such as those that I described above, most
aircraft have had major structural components replaced as
necessary. Moreover, if--as KC-135 aircraft undergo their
periodic programmed depot maintenance--trend analyses indicate
the potential for fleet wide problems, some major components
may be replaced on all aircraft. Examples of some of these
major structural repairs include segments of fuselage skins,
floor beams, fuselage bulkheads, and upper wing skins. As
components such as these are replaced, the use of new and
improved materials, fabrication, and corrosion prevention
techniques are designed to solve problems and to last for the
remaining life of the aircraft. In the case of the upper wing
skins, for example, the Air Force reported, ``as we work
through the fleet, this level of replacement will decrease as
most of the bad skins have been or shortly will be replaced.
Replaced skins are installed with attention to corrosion
prevention and should last more than 40 years.''
Despite the Air Force's aggressive maintenance and upgrade programs
to keep the KC-135 mission capable, since 2001, the Air Force has come
to believe that the condition of the fleet has deteriorated to the
point where replacement has become more urgent. For example, Air Force
officials have cited the Air Force's Economic Service Life Study, which
showed that program depot maintenance has become increasingly costly on
the KC-135. Air Force officials told us that the E-model of the KC-135
is currently operating under flight restrictions owing to corrosion.
The KC-135 fleet averages over 40 years in age, but the aircraft
have relatively low levels of flying hours. Flying hours for the KC-135
averaged about 300 hours per year from 1995 through September 2001.
Since then, utilization is averaging about 435 hours per year. The Air
Force projects that E and R models have lifetime flying hour limits of
36,000 and 39,000 hours, respectively--according to the Air Force, only
a few KC-135 aircraft would reach these limits before 2040, at which
time some of the aircraft would be about 80 years old.
The KC-135 fleet has not been meeting its mission capable rate
goal. Mission capable rates measure the percentage of time on average
that the aircraft are available to perform their assigned mission. The
Air Force has a goal of an 85-percent mission capable rate for the KC-
135 fleet. As shown in figure 2, KC-135 aircraft have not met the 85
percent mission capable rate in any of the last 3 fiscal years,
although aircraft in the Active component have consistently reached a
mission capable rate of over 80 percent.
By most indications, the fleet has performed very well during the
past few years of high operational tempo. Operations in Kosovo,
Afghanistan, Iraq, and here in the United States in support of
Operation Noble Eagle were demanding, but the current fleet was able to
meet the mission requirements. Approximately 150 KC-135 aircraft were
deployed to the combat theater for Operation Allied Force in Kosovo,
about 60 for Operation Enduring Freedom in Afghanistan, and about 150
for Operation Iraqi Freedom.\11\ Additional KC-135 aircraft provided
``air bridge'' support for the movement of fighter and transport
aircraft to the combat theater, for some long-range bomber operations
from the United States, and to help maintain combat air patrols over
major U.S. cities since September 11, 2001.
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\11\ Air Force officials told us that combat commanders refused to
permit the E-model of the KC-135 to be deployed to recent combat
theaters.
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According to Air Force projections, the KC-135 operating and
support costs will increase substantially in the coming years. The
costs for the current fleet totaled about $2.4 billion in fiscal year
2002 (2002 dollars). The Air Force projects that the cost will total
about $3.5 billion (2002 dollars) in fiscal year 2012 for a fleet of
510 aircraft. According to Air Force officials, increased programmed
depot maintenance costs were a significant cause of the increase. The
officials said that, based on historical experience, programmed depot
maintenance costs are expected to increase about 18 percent per
aircraft per year. By the same projections, the operating and support
costs for the fleet of 100 KC-767A aircraft will total about $808
million.\12\
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\12\ The projections assume that the KC-135Es and KC-135Rs will fly
308 and 368 hours per year while the KC-767A will fly 750 hours per
year.
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The concept of an aging KC-135 fleet, and the problems and costs
associated with operating and sustaining old aircraft, is not a sudden
manifestation, but rather a fact of life that the KC-135 support
infrastructure has had to deal with for years. Many of the problems
currently being reported as reasons to begin tanker recapitalization
immediately--including corrosion, increasing operating and support
costs, and reduced aircraft availability--are not new and were issues
that the Air Force was addressing in the mid-1990s, when we last
examined aerial-refueling matters and when the Air Force concluded that
recapitalization was not urgent.
Operating Lease Requirements
OMB Circular A-11 provides certain criteria that must be met for an
operating lease:
Ownership must remain with the lessor throughout the
term of the lease and is not to transfer at or shortly after
the end of the lease period.
No bargain price purchase option is allowed.
The lease term may not exceed 75 percent of the
asset's economic lifetime.
The present value of the minimum lease payments cannot
exceed 90 percent of the fair market value of the asset at the
beginning of the lease term.
The asset must be a general-purpose asset and not
government-unique.
The asset must have a private-sector market.
The Air Force report says that the proposal complies with all of
the criteria.
However, the report also points out that, depending on the fair
market value used, the net present value of the lease payments in the
case of the KC-767A may exceed the 90 percent of initial value
threshold. On the one hand, if the fair market value is considered to
include the cost of construction financing of $7.4 million per aircraft
(or $740 million for all 100 aircraft),\13\ then the lease payments are
estimated to represent 89.9 percent. This is the formula that the Air
Force used to document compliance with the circular and which the Air
Force cited in its report to Congress; it results in a cost of $138.4
million per aircraft. On the other hand, if the fair market value
excludes construction financing, it totals $131 million per aircraft,
and the lease payments represent 93 percent, thus exceeding the 90
percent threshold. According to the Air Force report, construction
financing, however, must be included to meet the OMB Circular A-11
requirement.
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\13\ Construction financing will be raised by the special purpose
entity through borrowing in order to make progress payments.
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However, it is not clear that including the construction financing
represents the fair market value of the aircraft. The SPE will borrow
money on the commercial market to raise funds to pay Boeing to finance
construction of the aircraft and will repay the banks up to $7.4
million in interest on the loans per aircraft. Once constructed, the
aircraft will be delivered to the SPE, and the SPE will pay Boeing $131
million less the amount of financing already paid to Boeing for the
aircraft. The Air Force will then lease the aircraft for up to $138.4
million per aircraft over the life of the lease. Consequently, the $7.4
million (reported by the Air Force as construction financing)
represents interest on the loans to the SPE, and it is not clear that
interest should be included in the fair market value of the aircraft.
Total Cost of the Program
While the Air Force report includes the cost of leasing and other
government costs such as training, as well as operations and support,
the report does not include the costs of buying the tankers at the end
of the lease.\14\ At the end of each 6-year lease, the aircraft are to
be returned to the owner, the SPE, or they can be purchased by the Air
Force for their residual value, estimated at about $44 million each in
then-year dollars. If the aircraft are returned, the Air Force tanker
fleet will be reduced, and the Air Force will have to find some way to
replace the lost capability. In other words, the lease payments will
have paid almost the full cost of the aircraft, and then the capability
would be lost. Thus, the total cost of this 100-aircraft program should
include the eventual acquisition cost. In addition to the cost to lease
and subsequently purchase the aircraft, Air Force operations and
support costs range from $4.6 billion to $6.8 billion, depending on
which dollar calculation is used. The Air Force also plans to construct
new facilities and would incur other costs ranging from $1.2 billion to
$1.5 billion. Table 2 summarizes total cost in three different dollar
calculations--then-year (or current) dollars, constant fiscal year 2002
dollars, and net present value.\15\
---------------------------------------------------------------------------
\14\ The Department of Defense and Emergency Supplemental
Appropriations for Recovery from and Response to Terrorist Attacks on
the United States Act, 2002, Pub. L. No. 107-117, Sec. 8159, 115 Stat.
2230, 2284-85 (2002) required that the Air Force report on the costs to
purchase or lease the aircraft but did not require that other costs be
reported.
\15\ Current dollars or then year dollars are the dollar value of a
good or service in terms of prices at the time the good or service is
sold. These contrast with constant dollars, which measure the value of
purchased goods or services at price levels that are the same as those
for the base year. Constant dollars do not contain any adjustments for
inflationary changes that have occurred or are forecasted to occur
outside the base year. When costs and benefits are evaluated over time,
a net present value calculation is used to account for the time value
of money through an interest rate called a ``discount rate.''
TABLE 2: ESTIMATED COST OF THE CONTRACT TO LEASE, MAINTAIN, AND PURCHASE
100 KC-767A AIRCRAFT UNDER THREE DIFFERENT TYPES OF ANALYSIS
[In billions of dollars]
------------------------------------------------------------------------
Constant
Net fiscal Then-year
Category present year 2002 dollars
value dollars
------------------------------------------------------------------------
Lease payments with aircraft return. $11.4 $12.3 $16.3
Aircraft purchase and other costs... 3.1 3.4 5.2
-----------------------------------
Subtotal.......................... 14.5 15.7 21.5
Operations and Support.............. 4.6 5.7 6.8
Military construction and other 1.2 1.3 1.5
costs..............................
-----------------------------------
Lease-buy Total................... $20.3 $22.7 $29.8
------------------------------------------------------------------------
Sources: Air Force (data). GAO (analysis).
In addition, the Air Force will have to pay an additional estimated
$778 million if the entire 100 aircraft are returned, to ensure that
the aircraft are returned in the maintenance condition specified in the
lease. For these reasons, returning the aircraft would probably make
little sense, and Congress will almost certainly be asked to fund the
purchase of the aircraft at their residual value as the lease expires.
Related Issues and Concerns
Our preliminary analysis indicates that certain other costs
associated with the lease may deserve further examination by Congress.
Specifically, we have concerns related to contractor logistics support,
the extent of Boeing's profit margin, and the impact of the lease on
follow-on tanker acquisitions.
Contractor Logistics Support
The Air Force estimates that the maintenance agreement with Boeing
will cost between $5 billion and $5.7 billion during the lease period.
It has negotiated a noncompetitive agreement with Boeing as part of the
lease negotiations, covering all maintenance except flight-line
maintenance, which is to be done by Air Force mechanics. This
represents an average of about $6.4 million per aircraft per year in
fiscal year 2002 dollars. We do not know how the Air Force determined
that this was a reasonable price or whether competition might have
yielded savings because the Air Force did provide sufficient documents
on a timely basis for us to evaluate its price analysis. A number of
commercial airlines and maintenance contractors already maintain the
basic 767 commercial aircraft and could possibly do some of the
required maintenance if given the opportunity to compete for the
contract.
Profit Margin
The Air Force report indicates that Boeing can earn no more than a
15-percent profit on the Boeing 767 aircraft and that an audit will be
conducted after the final planes are delivered to ensure that the
company's profit does not exceed that amount. However, since this
aircraft is basically a commercial 767 with modifications to make it a
military tanker, it is not clear why the 15-percent profit should apply
to the full cost. One financial analysis published recently states that
Boeing's profit on commercial 767 aircraft is in the range of 6
percent.\16\ If the Air Force negotiated a lower profit margin on that
portion of the cost, with the 15-percent profit applying only to the
military-specific portion, this could lower the cost by several million
dollars per aircraft. For example, assuming the commercial tanker
portion of the cost is about $80 million, the difference between
profits of 6 percent and 15 percent would be about $7 million per
aircraft, or $700 million for all 100 aircraft.
---------------------------------------------------------------------------
\16\ See Morgan-Stanley, Does 767 Tanker Equate to 700+ Comml
Orders?, (May 30, 2003).
---------------------------------------------------------------------------
Effect on Follow-on Tanker Acquisitions
One of the key advantages of leasing is that it enables the Air
Force to take delivery of aircraft without the large, up-front
obligation of funds required for purchase; thus by the end of fiscal
year 2011, the Air Force will have received 100 new tankers. The flip
side of this, however, is that payments are spread out over many years
and represent an obligation that must be met throughout the term of the
lease. The Air Force will be making lease payments on the leased
aircraft through fiscal year 2017, and will likely pay about $4.4
billion (in then-year dollars) in fiscal years 2012-2017 to purchase
the aircraft at the expiration of the lease. Funds spent during those
years on these 100 aircraft are therefore funds that are not available
for the procurement of additional tanker aircraft that will be needed
to replace the remaining 400-plus aircraft in the KC-135 fleet. If the
Air Force wants to procure additional tankers starting in this 2012-
2017 period, it will need an even larger budget during those years to
accommodate both the continuing lease payments and new procurement.
Figure 3 illustrates the annual outlays that would be required to lease
the aircraft as proposed and the additional outlays needed to purchase
an additional block of 100 aircraft. This assumes that delivery of the
additional aircraft would begin after the first 100 had been delivered.
If additional aircraft are to be obtained before the planned end of
delivery of the first 100 leased aircraft in 2011, then the additional
funds for the second block of aircraft would be needed even sooner.
Mr. Chairman, this concludes my prepared statement. I would be
happy to answer any questions that you or members of the committee may
have.
Contacts and Staff Acknowledgments
For future questions about this statement, please contact me at
(757) 552-8111 or Brian J. Lepore at (202) 512-4523. Individuals making
key contributions to this statement included Kenneth W. Newell, Tim F.
Stone, Joseph J. Faley, Stephen Marrin, Kenneth Patton, Charles W.
Perdue, and Susan K. Woodward.
related gao products
Military Aircraft: Observations on the Air Force's Plan to Lease
Aerial Refueling Aircraft. GAO-03-1143T. Washington, DC: September 3,
2003.
Military Aircraft: Considerations in Reviewing the Air Force
Proposal to Lease Aerial Refueling Aircraft. GAO-03-1048T. Washington,
DC: July 23, 2003.
Military Aircraft: Information on Air Force Aerial Refueling
Tankers. GAO-03-938T. Washington, DC: June 24, 2003.
Air Force Aircraft: Preliminary Information on Air Force Tanker
Leasing. GAO-02-724R. Washington, DC: May 15, 2002.
U.S. Combat Air Power: Aging Refueling Aircraft Are Costly to
Maintain and Operate. GAO/NSIAD-96-160. Washington, DC: August 8, 1996.
Chairman Warner. Mr. Sunshine.
STATEMENT OF ROBERT A. SUNSHINE, ASSISTANT DIRECTOR FOR BUDGET
ANALYSIS, CONGRESSIONAL BUDGET OFFICE
Mr. Sunshine. Thank you, Mr. Chairman. I would like to
start by expressing the regrets of our director, Dr. Holtz-
Eakin, who would have liked to be here to testify this morning.
He is a very capable fellow, but he could not be in two places
at one time, and he had to testify before the House Budget
Committee on our new economic analysis.
I would also like to acknowledge the fine work of our
analyst who did our analysis of this transaction, David Newman,
who is here with me.
CBO's analysis was performed at the request of Senator
Nickles, chairman of the Budget Committee. It is presented in
my written testimony, which I will summarize this morning. That
analysis is pretty limited in its scope. CBO has not analyzed
the need for new tankers. It has not analyzed possible
alternatives to acquiring new tankers or the impact on our
defense capabilities of this tanker acquisition decision.
Our analysis and my testimony address only the proposed
financing mechanism, its long-term costs, and its budgetary
treatment. In that regard, I would like to make three major
points this morning.
First, the objective of the proposed transaction is to get
new tankers into the hands of the Air Force as quickly as
possible while avoiding any significant budgetary impact in the
next few years. However, CBO believes that if this transaction
is treated properly in the budget, it should be shown as a
purchase of the tankers by the Government and therefore would
require substantial up-front budget authority.
Second, the proposed transaction will result in costs to
the government over the next 14 years that are $5 billion to $6
billion more than would result from a straightforward purchase
of the same aircraft with the same delivery schedule, using a
multiyear procurement arrangement. Discounted to this year's
dollars and depending on the exact methodology one uses to do
so, the additional cost is between $1 billion and $2 billion in
net present value terms. There seems to be a broad consensus on
that.
Third, these types of transactions have ramifications
beyond the defense budget and beyond national security
concerns. Each year in its budget resolution, Congress sets a
limit on discretionary budget authority, and it allocates that
sum among various functions. Sometimes, Congress sets these
limits in law for a number of years. Presumably, those figures
represent Congress' best judgment as to the amount of
discretionary obligations that it believes the government
should enter into during that time period.
Transactions that create obligations of the government that
are not recorded as obligations of the government make these
budgetary limits less meaningful and less effective.
I will elaborate briefly on each of these points. When one
steps back from the technical and financial intricacies of this
proposal, it becomes clear, at least to us, that the
arrangement is simply a governmental purchase of the tanker
aircraft. The purchase is being made by the special-purpose
entity created specifically to borrow money on behalf of the
government in order to buy aircraft for the government. These
borrowing arrangements will be overseen by and must be approved
by the government, and the trust has no other function.
Thus, as you can see in this chart, which you have all
seen, we view the trust as an instrument of the government, and
we think that the budget should reflect the transactions of the
trust as transactions of the government.
[The information referred to follows:]
That would require about $17 billion in budget authority
over the 2004 to 2008 period and would result in outlays of a
similar amount from 2004 to 2011.
In our view, the lease payments from the Defense Department
to the trust are essentially intragovernmental, basically the
government paying itself. The real budgetary transaction here
is the government's purchase of the aircraft through the trust.
It does not look like the administration is going to treat
the transaction this way. The Air Force plans to treat the
trust as an independent private-sector entity and to record
these transactions as an operating lease. That would mean
recording the lease payments in the budget year by year as they
were paid. Such a treatment would have the effect of deferring
the budgetary impact of buying these aircraft for several
years. Instead of $17 billion in budget authority over the 2004
to 2008 period, the agency will need less than $2 billion, and
that in fact is the stated objective of the proposal.
But even if one does not accept our view that the trust
should be treated as an instrument of the government, we find
it difficult to see how this could be considered an operating
lease. We have discussed and members have pointed out that
there are six criteria specified in OMB Circular A-11 for an
operating lease. This arrangement meets hardly any of them.
For example, the asset is supposed to be a general-purpose
asset that is not built to the unique specification of the
government and for which a private-sector market exists.
Basically, operating leases are intended to apply to widely
used, commercially available assets like automobiles and
commercial office space. Aircraft refueling tankers are very
different. They are highly specialized assets, used almost
always for governmental purposes, and there is very little, if
any, private-sector market for them.
In addition, the asset is not supposed to be transferred to
the government at or shortly after the end of the lease term,
and the lease is not supposed to contain a bargain-price
purchase option. Under this proposal, the Air Force is planning
to buy the aircraft after the 6-year leases expire and would be
able to do so at a pretty low price.
Therefore, we believe that if the trust is to be considered
nongovernmental, which is not what we think it should be, then
this financing arrangement should be treated in the budget as a
lease-purchase, which would require up-front budget authority
and outlays similar to those for a direct purchase. So whether
the trust is viewed as governmental or not, we believe that if
the government's standard budgetary principles are properly
applied, the proposed arrangement would not accomplish its aim
of deferring the budgetary impact of the aircraft purchases.
My second point is that this transaction will cost more
than a straightforward purchase. We estimate that the
transaction as it is structured will cost taxpayers between $5
billion and $6 billion more between now and 2017 than a
straightforward purchase through the appropriations process of
the same planes with the same delivery schedule and the same
maintenance and operating costs.
The second chart in your handout, with the three sets of
numbers, displays how we think these figures play out over
time. The first set of numbers describes our estimate of the
transaction if it is treated as a purchase or a lease-purchase,
in other words, the proposed transaction as we believe it
should be treated. The second set of numbers shows how we think
it would be treated if it is recorded as an operating lease.
The third set of numbers shows what we think it would be as a
direct purchase of the tankers up front under the same
timetable.
[The information referred to follows:]
As we have also discussed at some length, when you have
different flows of money over time, it is useful to do a
present-value calculation to try to capture the differences in
the timing of payments. Our estimate of the difference in cost
is between $1 billion and $2 billion, or 10 to 15 percent,
depending on exactly what assumptions are used.
The administration or the Air Force had talked about a $150
million difference. The biggest difference between our estimate
and theirs is the difference in the assumptions about what a
direct purchase would look like. We assumed that if Congress
was willing to engage in this leasing agreement, it also ought
to be willing to provide the kind of multiyear procurement
authority that has sometimes been exercised for some weapons
systems.
The Air Force in calculating its present value added 7.4
percent to the cost of the aircraft under the assumption that
that kind of multiyear procurement authority would not be
available. That accounts for close to $1 billion of the
difference between our estimate and theirs.
If you were to compare this leasing arrangement with a
purchase assuming multiyear procurement authority, even under
the administration's numbers you would get a number in the
vicinity of $1 billion or a little bit more. There are other
differences, but that looks to me to be the major difference
between those two sets of numbers.
Why is it more costly? It is more costly because, instead
of borrowing at Treasury rates, which are the lowest possible
rates, the government via the trust will be borrowing at higher
rates. The Air Force estimates some of the borrowing at 50 to
100 basis points above Treasury rates but expects that some
will be at junk bond rates, hundreds of basis points above
Treasuries. The government will have to bear those costs
through its lease payments.
Finally, we have a broader concern, namely, how this
transaction and others like it could affect the government's
overall budget process. Federal budgeting is generally based on
the principle that spending decisions are best made if the full
costs of the programs and commitments are recognized explicitly
up front when the spending decisions are being made. Through
its budget resolution, Congress specifies the amount of
discretionary budget authority and outlays for each year and
then goes through a very painful process of allocating those
funds among competing national needs and priorities.
When an agency of the government enters into transactions
that involve significant obligations of the government but that
are not fully reflected in the budget figures, those figures
become less meaningful, and making trade-offs on a level
playing field among competing demands for scarce resources
becomes more difficult. Programs with a special non-budgetary
treatment have a clear advantage over other programs in
obtaining funding, regardless of their relative merits.
We at CBO cannot predict how much budget authority will be
available over the next few years and how much of that will be
for defense procurement. We cannot judge how easy or hard it
would be to allocate through the regular appropriations process
sufficient funds to make a straightforward purchase of the new
tanker aircraft, either by drawing upon funds that would have
been used for other purposes or by simply adding to the total
pot of money. You are in a much better position than we are to
make that judgment.
The key question, it seems to me, is whether the Air Force
needs to acquire these aircraft as quickly as it proposes and,
if so, whether the proposed transaction is the best way to do
so. If it is determined that the aircraft need to be acquired
and if it is possible to find the funds to finance a
straightforward purchase, the taxpayers would save some money
and the budget process would be more meaningful and effective.
Thank you, Mr. Chairman. I will be happy to answer any
questions.
[The prepared statement of Mr. Sunshine follows:]
Prepared Statement by Robert A. Sunshine
SUMMARY
The Department of Defense Appropriations Act, 2002 (Public Law 107-
117), authorized the Air Force to pursue a pilot program for leasing as
many as 100 Boeing 767 aircraft for up to 10 years and directed the
service to describe its plan to Congress before entering into such a
lease. The Air Force, Boeing, the Office of the Secretary of Defense,
and the Office of Management and Budget (OMB) reached an agreement in
May 2003 for the service to acquire 100 Boeing KC-767A aerial refueling
aircraft through a complex financing arrangement. The Air Force
submitted the required report to Congress on July 11, 2003. In that
report, the Air Force concludes that the proposed leasing arrangement
meets all requirements of the Department of Defense Appropriations Act,
2002, which specified that the terms had to be consistent with the
criteria for an operating lease as defined in OMB Circular A-11,
Preparation, Submission, and Execution of the Budget. The report
further concludes that, while leasing would cost about $150 million
more (expressed in net present value terms) than an outright purchase,
leasing is the preferred approach because of the ``advantage it affords
for quickly delivering needed tankers to our warfighters without
requiring significant up-front funding.''
After analyzing the Air Force's report and receiving additional
information about the proposed lease from the Air Force and Boeing, the
Congressional Budget Office (CBO) has concluded that the transaction
would essentially be a purchase of the tankers by the Federal
Government but at a cost greater than would be incurred under the
normal appropriation and procurement process. The special-purpose
entity that has been established to buy the aircraft would, in fact, be
substantially controlled by and act on behalf of the Federal
Government, and its transactions should be reflected in the Federal
budget.
Even if one were to view the arrangement as a lease, CBO's analysis
indicates that the proposal does not meet the conditions for an
operating lease described in the Congressional Scorekeeping Guidelines
and in OMB Circular A-11 and thus does not comply with the terms of
section 8159 of the Department of Defense Appropriations Act, 2002.
Finally, CBO concludes that implementing the Air Force's proposed
arrangement would be more expensive than the service has estimated.
While the Air Force estimates that its proposal would cost $150 million
more than an outright purchase, CBO's analysis indicates that the
proposal would cost $1.3 billion to $2 billion more in present-value
terms, or 10 percent to 15 percent more than an outright purchase. On
average, the Air Force would spend $161 million per plane in 2002
dollars to lease and then purchase the aircraft, compared to a cost of
$131 million per plane for an outright purchase.
THE AIR FORCE'S PLAN TO ACQUIRE 100 BOEING TANKERS
The Air Force plans to sign a single multiyear contract that will
include leasing 100 KC-767A aerial refueling aircraft from a special-
purpose entity, called the KC-767A USAF Tanker Statutory Trust 2003-1
(the Trust). The tankers will be delivered to the Air Force in six
groups--four aircraft in 2006, 16 aircraft in 2007, and 20 planes
annually over the 2008-2011 period. The Air Force will use each
aircraft for 6 years and pay the Trust an average of $126 million a
plane, in 2002 dollars, during that period. At the conclusion of each
6-year period, the Air Force can return the aircraft to the Trust or
purchase them for a price to be set when the contract is signed. The
Air Force currently estimates the purchase price at an average of $35
million per plane in 2002 dollars. Thus, according to its estimate, the
Air Force will pay an average of $161 million per plane to lease and
then purchase the tankers.\1\ The Air Force has not negotiated to
purchase the planes directly, but on the basis of the leasing
arrangement, CBO estimates that given multiyear procurement authority,
the service could negotiate a contract for 100 tankers at an average
price of $131 million per plane in 2002 dollars.
---------------------------------------------------------------------------
\1\ Payments under the Air Force's proposal are based on a
negotiated purchase price of $131 million in 2002 dollars. Payments
will be adjusted for inflation using a combination of the Employment
Cost Index and the Industrial Commodities Index.
---------------------------------------------------------------------------
The Air Force will be able to terminate the deal prior to the
completion of the contract by notifying the Trust one year in advance.
However, that termination would be costly because the Air Force would
have to make an additional payment equal to an annual lease payment on
each aircraft and would have to reimburse the Trust for any additional
costs that resulted from the decision to terminate.
FINANCING ARRANGEMENTS FOR THE PROPOSAL
Boeing and the Air Force have established the special-purpose
entity to execute the leasing arrangement and to finance the
acquisition of the aircraft. Under the financing plan established by
the Air Force and Boeing, the Trust will buy 100 KC-767A tankers from
Boeing at an estimated average price of $131 million per aircraft (in
2002 dollars) and will borrow money to make progress payments to Boeing
during the construction period for each group of aircraft.
As Boeing completes construction of each group of tanker aircraft,
the Trust will issue bonds in the commercial bond market. Boeing and
the Air Force estimate that the proceeds from the bonds will need to
equal $138.4 million per aircraft (in 2002 dollars), enough to pay
Boeing for the remainder that it is owed for the aircraft, repay the
principal on the construction loans, and pay interest on the
construction loans, which the Air Force estimates at an average of $7.4
million per aircraft.
Press reports indicate that there will be three classes of bonds.
The Trust, which will technically own the aircraft, will use the Air
Force's annual lease payments to pay principal and interest on two of
the three classes of bonds. If the aircraft are sold at the end of the
lease term, the proceeds will be used to pay off principal and interest
on the last class of bonds. The price the Air Force may pay to acquire
title to the tankers will be established for all 100 planes at the time
the contract is awarded. That amount will be equal to the principal and
interest owed on the third class of bonds. Under the terms of the
agreement, if the Air Force should choose to forgo purchasing the
aircraft and the aircraft are then sold to another purchaser for more
than the amount owed on the bonds, any profits from the sale will be
returned to the U.S. Treasury.
According to the Air Force and Boeing, the credit rating on the
bonds will be based on the strength of the cash flow from the Air
Force, rather than on Boeing's credit rating. For that reason, the Air
Force expects that the Trust will be able to issue bonds at interest
rates that are only slightly greater than Treasury rates. Interest
rates on the bonds must compensate investors for the risk that the Air
Force might terminate the contract early or might decline to purchase
the aircraft at the end of the lease. CBO believes that the small risk
premium estimated by the Air Force on borrowing by the special-purpose
entity indicates that the Air Force assumes the market will perceive
the debt as being backed by the Federal Government. (See Figure 1 for a
graphic display of the financing arrangements.)
THE RESULTS OF CBO'S ANALYSIS
CBO reviewed the information contained in the Air Force report,
sections of the proposed contract, and the economic analysis prepared
to support the Air Force's decision to lease. CBO found that the
financing plan envisioned for acquiring the tankers constitutes Federal
borrowing and spending under standard government accounting
principles.\2\ CBO also concludes that the proposal does not meet the
conditions for an operating lease described in OMB Circular A-11 and
thus does not comply with the terms of section 8159 of the Department
of Defense Appropriations Act, 2002. While the Air Force acknowledges
that acquiring the aircraft with this financing method is more
expensive than purchasing them outright, its estimate of the extra
cost--at $150 million--is much less than CBO's analysis indicates. CBO
concludes that the Air Force would pay $1.3 billion to $2 billion
(expressed in net present value terms) more to lease and then purchase
the tankers than it would to purchase them outright.
---------------------------------------------------------------------------
\2\ The 1967 Report of the President's Commission on Budget
Concepts suggests a broad definition of Federal budget activities, with
a few narrow exclusions. It observes that ``providing for national
security . . . obviously constitutes activities of the Federal
Government which should clearly be in the budget.'' Consistent with
other recommendations by the Commission, CBO believes that when the
government owns a significant part of an entity's assets or exercises
substantial control over the entity's operations, that entity should be
included in the Federal budget.
---------------------------------------------------------------------------
The Tanker Financing Plan Constitutes Federal Borrowing and Spending
In its report to Congress, the Air Force indicates that the
administration will record the tanker contract as an operating lease in
the Federal budget once the contract is signed. Consequently,
obligations and outlays will be recorded on a year-by-year basis,
reflecting the lease payments due each year to the Trust. CBO believes
that recording the transaction as such would be at odds with standard
government accounting principles because the proposed financing
constitutes Federal borrowing and spending. Therefore, the borrowing,
resulting aircraft purchases, and interest payments by the special-
purpose entity established specifically for this purpose should be
recorded in the budget at the time the Trust makes those transactions.
The proposed contract between Boeing and the Air Force, as well as
the financing arrangement, clearly indicates that the KC-767A USAF
Tanker Statutory Trust 2003-1 exists solely to borrow money on behalf
of the Federal Government to allow the Air Force to acquire an asset
that has been built to its unique specifications. The borrowing
activities of the special-purpose entity will be directed by a
financing committee composed of the Air Force, Boeing, and the lease
administrator. (The Air Force has asked Boeing to serve as the lease
administrator.) Under the operating guidelines for the financing
committee, the Air Force must approve all of the terms and conditions
for the financing plan and must review and approve all financing
documents.\3\ CBO concludes that the actions of that committee will be
explicitly controlled by the Air Force.
---------------------------------------------------------------------------
\3\ Boeing provided CBO with a summary of the operating guidelines
for the financing committee. It is available upon request.
---------------------------------------------------------------------------
Because the government will both direct and benefit from the
Trust's financing activities (see Figure 2), the Trust will be acting
on behalf of the government. Therefore, its borrowing and spending
should be treated as Federal borrowing and spending and recorded
appropriately in the budget.\4\ The parties to the lease portion of the
contract are the Air Force and the Trust. Since the Trust is an
instrument of the government, the government will effectively be buying
the aircraft (via the Trust) and then leasing them to itself. To
accurately reflect the nature of that arrangement, the Federal budget
should report the transactions between the Trust and Boeing, and
between the Trust and its bondholders, not the essentially
intragovernmental transfers between the Trust and the Air Force. Thus,
when the Trust pays Boeing for the aircraft, those payments should be
reflected as Federal outlays. Subsequent interest payments on the
Trust's borrowing should also be reflected as outlays when those
payments are made. (Federal borrowing is not counted as a governmental
receipt, and the repayment of principal is not counted as an outlay.)
---------------------------------------------------------------------------
\4\ The Universal Service Fund is another example of a Federal
program administered by a private agency for the Federal Government.
The Universal Service Access Company (USAC), an independent
organization that is regulated by the Federal Communications
Commission, collects ``contributions'' from telecommunications service
providers and makes payments to other service providers to ensure
universal access to telecommunications services. Even though the
collections and disbursements are not handled by the Treasury, USAC's
transactions are included in the Federal budget. In 2002, the agent
recorded revenue collections of $5.5 billion and expenditures of $5.1
billion in the Federal budget.
---------------------------------------------------------------------------
Table 1 displays how that budget authority and the associated
outlays should be recorded in the budget compared with how CBO believes
the department might reflect the contract in the budget. The table also
shows CBO's estimate of the cost to purchase the tankers directly using
traditional procurement methods. For budget purposes, all amounts are
shown in current dollars.
The two budgetary treatments of the financing plan differ
substantially. If the proposed transaction is recorded as a purchase,
budget authority over the first 5 years would total $17.3 billion, and
outlays would sum to $10.1 billion. If the transaction is recorded as
an operating lease, only $1.5 billion in budget authority would be
shown over the first 5 years, and outlays during that period would also
total only $1.5 billion, because most of the aircraft would not be
available for leasing until 2009.
In total, by CBO's estimates, acquiring the tankers through a lease
would cost $21.5 billion over the next 14 years. In contrast, CBO
estimates, a direct purchase of 100 tankers would cost $15.9 billion
over the same period--but with all of the outlays recorded by the end
of 2011.
Budget authority and outlays for the Air Force's proposed lease
have two components: the purchase price of the aircraft and the
interest costs from the financing arrangement. (Those costs include the
additional expense of borrowing money at rates that exceed Treasury's
normal borrowing rates.) If the Air Force's proposal is recorded in the
budget as a purchase, the purchase price of the aircraft would appear
in the first few years when the planes were being constructed, and
interest would be recorded annually as the lease payments were made. Of
the $21.5 billion shown in Table 1, $17.1 billion is for the purchase
price of the aircraft, while budget authority for the imputed interest
would total $4 billion over the 2006-2017 period. The remaining $0.4
billion would pay for insurance and other lease costs. Outlays for the
purchase price, which would occur over the 2004-2011 period, would
reflect progress payments during the construction period and final
payments when the planes were delivered. Outlays for imputed interest
charges would coincide with lease payments and would equal the annual
budget authority for those charges.
Alternatively, if one chooses not to view the special-purpose
entity as an instrument of the government, CBO concludes the
arrangement should be reflected in the budget as a lease-purchase, not
an operating lease as suggested by the Air Force and Boeing. In that
case, the budgetary treatment would be similar to that of the financing
plan treated as a purchase (shown in Table 1).\5\
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\5\ For a more in-depth discussion, see Congressional Budget
Office, The Budgetary Treatment of Leases and Public/Private Ventures
(February 2003).
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The Proposal Does Not Meet the Criteria for an Operating Lease
After reviewing the details of the proposal, CBO concludes that it
does not meet the conditions for an operating lease described in OMB
Circular A-11 and thus does not comply with the terms of section 8159
of the Department of Defense Appropriations Act, 2002.
To comply with section 8159 and to be treated as an operating lease
in the budget, the lease must meet the following six criteria:
The asset must be a general-purpose asset, not built
to unique government specifications.
There must be a private-sector market for the asset.
The present value of the lease payments cannot exceed
90 percent of the asset's fair market value at the start of the
lease.
The lease cannot contain a bargain-price purchase
option.
Ownership of the asset must remain with the lessor.
The lease term cannot exceed 75 percent of the asset's
useful life.
CBO has concluded that the arrangement between Boeing and the Air
Force fails to meet the first four of these criteria and complies with
the letter but not the spirit of the fifth.
The Lease Must Be For a General-Purpose Asset. Operating leases
must be for a general-purpose asset, not one that is built to the
unique specifications of the government. An aerial refueling tanker is
not a general-purpose asset. Although the tanker is based on Boeing's
commercial 767-200 model, the Air Force has specified several
significant modifications such as auxiliary fuel tanks, a refueling
boom, a refueling receptacle, more powerful generators, and heavier
wiring to accommodate unique military requirements. The tanker's aerial
refueling capability serves a uniquely governmental purpose.
There Must Be a Private-Sector Market. A private-sector market must
exist for any asset obtained through an operating lease. The Air Force
and Boeing assert that the lease meets this criterion because Boeing
has offered the tanker, called the Global Tanking and Transport
Aircraft (GTTA), for public sale. However, the only customers for the
GTTA so far are the U.S. Air Force, the government of Japan, and the
government of Italy, all of which plan to use the aircraft to refuel
their military aircraft. Boeing states that there are a number of
private companies that might purchase GTTA aircraft--Omega Air and the
Tanker and Transport Service Company Ltd., in particular. CBO does not
believe that those companies would buy more than a few of the tankers.
Boeing also points out that some long-haul commercial air carriers
may be interested in acquiring the capability for aerial refueling, but
none currently employs the technique. CBO believes it unlikely that
aerial refueling would make economic sense for commercial
transportation companies because they already have access to
groundbased refueling services at airfields worldwide. Finally, while
Boeing cites many potential customers for the freighter capability
inherent in the tanker, how many of the 100 tankers reconfigured as
freighters the private market would be able to absorb is unclear.
There are only about two dozen outstanding orders for all Boeing
767 variants. The KC-767A is derived from the Boeing 767-200C variant,
for which Boeing has no commercial orders. In fact, according to
Boeing, the last delivery of any commercial version of 767-200 aircraft
occurred in 2002, and Boeing has no future orders because it now
produces 767 models that are superior to the 767-200. Thus, while there
may be a private-sector market for a few of the aircraft that the
government is acquiring, there is no evidence of such a market for 100
tanker aircraft.
Lease Payments May Not Exceed 90 Percent of the Fair Market Value.
To qualify as an operating lease, the net present value of the lease
payments may not exceed 90 percent of the fair market value of the
aircraft. The Air Force report indicates that the lease payments under
the proposed financing arrangement will account for 89.9 percent of the
fair market value of the aircraft, which the Air Force calculates at
$138.4 million (in 2002 dollars) when the cost of the construction loan
financing ($7.4 million per aircraft) is included. CBO believes that
including the cost of that financing as part of the aircraft's fair
market value is inappropriate because that cost is additional to any
interest that would be capitalized in the price of the aircraft in the
purchase option. When the financing cost is excluded from the
calculation, the net present value of the lease payments accounts for
93 percent of the fair market value.
CBO also notes that, even using the Air Force's methodology, there
is a significant possibility that the threshold of 90 percent of the
fair market value could be exceeded for at least some of the groups of
leased tankers. The lease payments are based on the Air Force's
estimate of bond interest rates. If the rates for Treasury bonds are
higher than the predicted value used by the Air Force, or if the spread
on the interest rates for the bonds issued by the Trust is greater than
predicted, lease payments will increase accordingly. Since the Air
Force already estimates that the present value of the lease payments
will be 89.9 percent of the fair market value, it has no margin for
error on its estimate of interest rates.
The Lease Cannot Contain a Bargain-Price Purchase Option. The lease
cannot contain an option to purchase the aircraft at a bargain price.
The agreement gives the Air Force the option to purchase the aircraft
at any time during or at the end of the lease. The Air Force estimates
that it could purchase the aircraft at the end of the lease for an
average $35 million apiece (in 2002 dollars), or 28 percent of the cost
to purchase new tankers. Since the aircraft should last at least 30
years, the aircraft should have 80 percent or more of their life
expectancy remaining after 6 years. While it is difficult to establish
the fair market value of used tanker aircraft, CBO believes that paying
28 percent of the cost of a new tanker for a used aircraft with 80
percent of its life left constitutes a bargain purchase price.
Ownership Must Remain With the Lessor. Under the operating lease,
ownership must remain with the lessor, and title may not transfer to
the government at or shortly after the end of the lease term. CBO
believes the Trust is an instrument of the government, given the level
of control the government exercises over its operations. Thus, the
Trust is effectively purchasing the tankers for the government.
However, if one chooses not to view the Trust as an instrument of
the government, the financing arrangement technically complies with
this criterion since the purchase option is contingent upon subsequent
authorization and appropriation by Congress. It seems clear for several
reasons, however, that the Air Force fully intends to acquire the
tankers during or at the end of the lease term.
First, the Air Force and Boeing plan to negotiate a purchase price
for each group of planes when the contract is awarded. The Air Force
has the right of first refusal on the disposal of the aircraft at the
end of the 6-year term. The Air Force has also stated its intention to
earmark funds to purchase the aircraft.
Second, senior Department of Defense officials have stated on
several occasions that the department has a long-term requirement for
tankers and that the department plans to replace the entire fleet of
KC-135 aircraft over the next 30 years. It seems implausible that the
Air Force would return the 100 leased tankers to the Trust since the
Air Force plans to retire 68 KC-135E tanker aircraft over the 2004-2006
period regardless of whether the lease is approved and will retire all
131 KC-135E aircraft by 2008 if the lease is approved. Moreover, it
would have to accept a significant reduction in its aerial refueling
capability if it chose not to purchase (or continue to lease) the KC-
767 tankers at the end of the 6-year term.
Finally, the Air Force's basing plan for the tankers includes more
than $600 million in construction projects to support the permanent
basing of the aircraft. Spending those funds would be uneconomical if
the Air Force was seriously considering returning the aircraft at the
end of the lease term.
The Proposed Financing Approach Is More Costly Than an Outright
Purchase
The proposed financing arrangement to acquire the tanker aircraft
is significantly more expensive than an outright purchase by the
government because of the anticipated interest rates (which are higher
than U.S. Treasury rates) and other costs that are unique to the
leasing option. By CBO's estimates, total costs for a direct purchase,
including the estimated costs for self-insurance, would be about $16
billion (see Table 2). The Air Force reports that it will pay $17
billion to lease the aircraft for 6 years and more than $4 billion to
purchase them at the end of the lease term. Those payments include the
interest expense on borrowing by the special-purpose entity. The Air
Force will also pay about $400 million for insurance and other expenses
related to the lease transactions. Thus, the Air Force estimates that
the costs of acquiring the aircraft under the financing arrangement
will total almost $22 billion in current dollars. On a present value
basis, the leasing approach would cost $1.3 billion more than an
outright purchase, CBO estimates. (The administration uses a
discounting methodology specified in OMB Circular A-94, Guidelines and
Discount Rates for Benefit-Cost Analysis of Federal Programs, which,
CBO estimates, would result in a greater cost difference of $2 billion
relative to a purchase.)
The Air Force's Economic Analysis Understates the Cost Difference
In its report to Congress, the Air Force indicates that leasing 100
air-refueling aircraft will cost $150 million more than an outright
purchase in net present value terms (see Table 3). CBO's analysis
indicates that the estimate significantly understates the additional
cost associated with the Air Force's plan. The Air Force, in fact, does
not rule out that possibility, stating that ``had Congress chosen
instead to provide multiyear procurement authority and had the
Department of Defense been able to accommodate that execution while
preserving program stability, the [net present value] could favor
purchase by up to $1.9 billion.'' \6\ The Air Force's report notes that
this type of analysis is ``highly sensitive to the underlying
assumptions'' but that ``in no case approved by OMB did the financial
analysis indicate that the net present value of the lease option as
being less than that of a traditional purchase.''
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\6\ The Air Force appears to attribute the large difference to the
effects of multiyear procurement alone. In fact, CBO's analysis
indicates that the assumption of multiyear procurement accounts for
only $970 million of the $1.9 billion difference.
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Multiyear Procurement. For the lease, the Air Force and Boeing
negotiated a price for the aircraft as delivered to the Trust on the
basis of the assumption that the Air Force would ultimately lease and
acquire 100 airplanes. That assumption allows Boeing to make
investments in facilities and equipment that will reduce the total
costs of production. It also allows Boeing to purchase parts and
components in large quantities to get price breaks from suppliers. For
its analysis of the purchase option, however, the Air Force assumed
that each lot of aircraft would be bought on an annual basis (that is,
with no assurances of subsequent purchases). Thus, no price breaks or
production efficiencies were included in the estimated purchase prices.
For the purchase option, the Air Force increased the price of each
aircraft by 7.4 percent relative to the price that it used for the
lease. CBO believes that estimating the purchase cost under the
assumption that a multiyear contract would be granted is warranted
because, under section 8159, Congress has already granted authority for
the lease and would likely grant such authority for an acquisition
program of that size. The Air Force's statement that it did not assume
a multiyear procurement in its analysis of a purchase because it did
not currently have that authority is inconsistent with its budgetary
practices for other major acquisition programs. The department does not
currently have multiyear procurement authority for either the F-22
fighter or the Joint Strike Fighter programs but assumes multiyear
procurement in estimating the future purchase costs of those aircraft.
CBO estimates that the cost to acquire 100 KC-767A tankers under
the proposed financing arrangement would exceed the cost of purchasing
the aircraft under a multiyear contract by $1.1 billion (expressed in
net present value terms), an increase of $970 million relative to the
Air Force's results. Although Congress has already granted multiyear
authority for the lease, in traditional procurement programs, that
authority is frequently provided after several years of production
prove that the program is stable. If Congress waited until the third
lot to grant the authority, then, by CBO's estimates, the lease would
cost $920 million more than the purchase, an increase of $765 million
relative to the Air Force's estimate.
Inflation of Progress Payments. The Air Force's method for applying
inflation to progress payments is another factor that affects the
purchase price in its analysis. During the construction period, a
contractor is continually paying for materials and labor. If the
government paid the contractor for the full price of the asset at the
time of delivery, the contractor would have to borrow money to cover
those expenses and include the full costs of that borrowing in the
purchase price. Progress payments reimburse the contractor for the
costs the company incurs during the construction period and reduce the
requirement for the contractor to borrow the money to cover expenses--
resulting in a lower purchase price for the government. The government
usually limits progress payments to a percentage of the actual costs
incurred at the time the request for payment is made.
In its analysis of the cost of a straightforward purchase, the Air
Force estimated progress payments as a percentage of the tanker's
price, which it inflated to the year of delivery. CBO believes that
that method overstates both the amount of the progress payments and the
total cost of the aircraft since inflation would affect the cost of
material and labor only up to the time those costs were paid. The
method also conflicts with the DOD Comptroller's guidance on inflation,
which calls for inflating costs to the year the order is made, using an
inflation index that takes into account the fact that outlays will
occur incrementally between the date the order is placed and the date
the asset is delivered. CBO estimates that if the cost of progress
payments were inflated only to the time those costs were paid, then the
cost of the leasing arrangement would exceed the cost of a
straightforward purchase by an additional $640 million (in net present
value terms).
Schedule for Progress Payments. The schedule for making those
progress payments is also a factor that affects the purchase price in
the Air Force's analysis. For the option of purchasing the aircraft,
the Air Force assumed that progress payments would begin approximately
4 years before the aircraft were delivered. The assumed payment
schedule seems protracted for several reasons. First, the schedule is
longer than that of other major aircraft procurement programs. For
example, the budget for the C-17 transport program provides advance
procurement funding just 2 years before the delivery date. Other
procurement programs, like that for the F-22 fighter, assume that the
majority of the progress payments are made over 3 years.
Second, the Air Force's aircraft procurement programs spend, on
average, about 90 percent of budget authority within 3 years after
appropriation. In contrast, the progress-payment schedule that the Air
Force used in calculating the costs of purchasing tankers would expend
only 75 percent of budget authority in 3 years, with the last 25
percent of the payments in the fourth year. That progress-payment
schedule does not appear to reflect the Air Force and Boeing's plan to
deliver the first KC-767A tanker approximately 34 months after lease
approval and to deliver subsequent aircraft on an even faster schedule.
Using a 4-year progress payment schedule increases the cost of the
purchase option in net present value terms because it brings forward a
large portion of the payments into a period in which the discount
factors have less impact. The method appears to conflict with the
Department of Defense's Financial Management Regulation, which limits
progress payments to a percentage of incurred costs, because it would
make payments before work commences. Using a 3-year schedule for
progress payments (one more in line with historical outlay rates for
procuring aircraft) would defer some payments for 1 year relative to
the schedule used in the Air Force analysis and would reduce the cost
of the purchase by about $210 million in net present value terms.
Discount Rates and Interaction Among The Factors. The results of
any economic analysis are sensitive to changes in the discount rate
selected. Changes in the discount rate also affect the costs associated
with assumptions made about multiyear procurement and progress
payments. CBO has calculated the present value of cash flows associated
with the planned acquisition of tanker aircraft by discounting the
estimated cash flow for each year using the interest rate on a
marketable zero-coupon Treasury security with the same maturity from
the date of disbursement as that cash flow. That method--often referred
to as the ``basket of zeros'' discounting approach--is used by both CBO
and OMB for calculating estimates of loan subsidies under the Federal
Credit Reform Act. Although the tanker acquisition plan does not
explicitly involve a direct loan or Federal loan guarantee, the
financing of tankers would result in a series of annual cash flows that
have to be matched by the trust's borrowing (on behalf of the
government). Using the basket of zeros to discount that stream of cash
flows most accurately reflects the time value of money. Under CBO's
approach, the acquisition plan would cost about $1.3 billion more--in
present value terms--than an outright purchase would.
In contrast, the Air Force's analysis relied on the simplified
discounting method provided in OMB Circular A-94, which advises using a
single discount rate (as opposed to the ``basket of zeros''). In
implementing the guidelines, the Air Force used a 9-year Treasury rate,
based on a 3-year construction period and a 6-year lease term, to
discount the lease payments. CBO estimates that this assumption would
result in an additional cost to leasing of $1.7 billion.
However, CBO believes that if a single discount rate is used, the
relevant period of analysis should be 6 years, since the Trust will
issue bonds that mature in no more than 6 years. CBO estimates that
using the administration's method with a single 6-year discount rate
would yield an even larger present value difference--a greater cost of
about $2 billion for the Air Force's plan.
OTHER CONSIDERATIONS
Termination Liability
Under the terms of the agreement, the Air Force can terminate the
lease prior to the completion of the lease term for its convenience.
However, exercising that option would be expensive for the Air Force
because of the requirement to pay penalty payments, unamortized costs
of the development of the tankers, and additional costs that would
arise from its decision to terminate. If it terminates the lease, the
Air Force might take delivery of the tankers under construction, make 1
year's lease payment, and within a year, return them to the Trust along
with the penalty payment. Alternatively, it might choose to pay Boeing
for the costs of work performed before the decision to terminate. CBO
estimates that termination liability could be as high as $5 billion to
$7 billion in some years. Under the authority in section 8117 of the
Department of Defense Appropriations Act, 2003, the Air Force does not
intend to set aside budget authority to cover this contingency and
therefore would need an appropriation from Congress to do so. Given the
potential size of the liability and the fact that the Air Force does
not intend to budget for it, CBO believes it is extremely unlikely that
the Air Force will terminate the lease.
The Long-Term Affordability of Leasing and Then Purchasing Tankers
The Air Force states that its primary reason for choosing this
financing arrangement is the favorable budgetary treatment that it will
receive. This treatment would allow the service to get the tankers
today without displacing other programs from its budget. However, the
budget will eventually have to reflect the Air Force's decision to
acquire the tankers. When those obligations are eventually recorded,
mostly over the 2008-2017 period, they will create additional budgetary
pressure in those years.
The Air Force report acknowledges that the lease is a more costly
method to acquire the tankers, but the Air Force believes that its
decision to pursue the method is justified by lower up-front costs.
Total costs to the government are higher under the lease (almost $5.7
billion in current dollars, according to CBO's estimate), however, so
rather than eliminating difficult budgetary decisions, the lease merely
postpones them.
There is no reason to believe that the Air Force itself will have
more budgetary flexibility 10 years from now than it has today. In
2012, for example, the Air Force will be making lease payments on the
tankers that were delivered over the 2007-2011 period--about $2.9
billion (in current dollars) a year in payments. It will also have to
begin purchasing the leased tankers at an estimated cost of $4.4
billion over the 2012-2017 period. Finally, the Air Force will have to
decide how to replace the rest of its KC-135 fleet. Should the Air
Force choose to buy more than 100 KC-767s, it would need to start
purchasing those additional tankers in 2011 to keep the Boeing 767-200
production line in operation. Procuring 20 tankers annually would cost
about $3 billion each year in current dollars, CBO estimates. Designing
and building a new tanker would probably cost more and taker longer.
But the Air Force will not just be buying tankers with its aircraft
procurement funds over this period. Other Air Force programs will
require significant sums also. According to the administration's
published plans and cost estimates, by 2012 the Air Force will be
buying 110 Joint Strike Fighters annually at a cost of almost $7
billion per year. Together, those two programs would consume about 70
percent of estimated funding for procuring aircraft. Thus, CBO
concludes that the Air Force will likely be faced with making difficult
budgetary decisions over the longer term also.
Chairman Warner. Dr. Nelson.
STATEMENT OF J. RICHARD NELSON, PH.D., ASSISTANT DIRECTOR, COST
ANALYSIS AND RESEARCH DIVISION, INSTITUTE FOR DEFENSE ANALYSES
Dr. Nelson. Thank you. Mr. Chairman and members of the
committee: I am pleased to come before you today to talk about
IDA's estimate for the unit purchase price of the KC-767A
tanker/combi aircraft. I will present a summary in the interest
of time.
Before beginning, however, and with all due respect to the
committee, I need to clarify an impression I was getting from
some remarks this morning. I testified for this work, IDA,
yesterday and for the record I did not testify for or against
the lease, and I do not intend today to testify for or against
the lease. I am here to testify on the unit direct purchase
price estimate for 100 KC-767A tanker/combi aircraft.
In January 2003 the IDA was tasked by the Office of the
Under Secretary of Defense, Acquisition, Technology, and
Logistics, and the Office of the Director, Program Analysis and
Evaluation, to estimate the unit purchase price for the KC-767A
tanker/combi aircraft. The tanker/combi designation which we
examined indicates that the aircraft can serve as an air
refueling tanker or carry freight or carry passengers or
combine freight and passengers, and that is the configuration
that we assessed.
The objective of our task was to estimate the unit purchase
price for the 100 KC-767A aircraft. We did not investigate the
condition of the KC-135E/R fleet or the requirement for a
tanker replacement, and we were not asked to evaluate any other
aspect of the proposed acquisition nor address provisions of
the lease, the financing, suitability of leasing, or any
alternatives for that proposal. The unit purchase price for the
aircraft is what we addressed and that is what I am prepared to
discuss.
Our methodology and data sources are as follows. To
estimate the KC-767A tanker/combi purchase price, we separated
the acquisition into several segments that included the basic
767-200ER, the enhanced features that the Air Force required
from other Boeing 767 family members, the combi modifications
for freight and passenger or combined, the auxiliary fuel tank,
and the other USAF-unique modifications pertaining to the
tanker and the avionics equipment that the Air Force needed. We
also looked at the development cost for the program.
The proposed KC-767A program would use FAR Part 12
guidelines written for the acquisition or lease of commercial
items. The establishment of a reasonable price under these
rules would normally rely largely on prices for the same or
similar items in the commercial marketplace. The market for
larger tanker aircraft is of course limited and of little value
for rigorous determination of reasonable prices under such
conditions.
Consequently, while our analysis made use of commercial
pricing wherever possible, we relied on traditional cost
analysis techniques where estimation by commercial pricing was
not practical. Our analysis relied on data from a variety of
public sources, some of whom you have heard today, including
other sources and the analysis of consultant organizations
familiar with the airline industry hired by IDA, internal IDA
proprietary data and models, data supplied by Boeing, data
provided by other aerospace suppliers who supply to Boeing, and
data supplied by the USAF.
Chairman Warner. We are assuming that you pursued a very
careful methodology and that is in your statement. We are quite
interested in receiving your conclusions.
Dr. Nelson. We feel the evolution of the task through the
time period from January to May is a methodologically
conservative approach. We estimate, summarized according to the
segments in the final testimony--there is a table that will
show the breakdown. We believe that $120.7 million is a
reasonable unit purchase price for the proposed 100 KC-767A
aircraft.
[The prepared statement of Dr. Nelson follows:]
Prepared Statement by Dr. J. Richard Nelson
Mr. Chairman and members of the committee, I am pleased to come
before you today to talk about IDA's estimate of the purchase price of
the KC-767A Tanker/Combi Aircraft.
INTRODUCTION
In January 2003, the Institute for Defense Analyses (IDA) was
tasked by the Office of the Under Secretary of Defense Acquisition
Technology and Logistics and the Office of the Director, Program
Analysis and Evaluation to estimate the purchase price of the KC-767A
Tanker/Combi aircraft. The Tanker/Combi designation indicates that the
aircraft can serve as an air-refueling tanker or carry freight or carry
passengers or combine freight and passengers.
Description of Proposed Aircraft as Assessed by IDA
The KC-767A Tanker/Combi aircraft is to be based upon the
commercial B767-200ER. Modifications would include the addition of
features available on other Boeing 767 models, as well as changes
required for the military application. In the tanker role, total fuel
capacity is to be just over 200,000 pounds, including up to 41,000
pounds carried in added auxiliary fuel tanks. The KC-767A would have
the capability to perform refueling by both the hose/drogue and boom
methods (not simultaneously) from the aircraft centerline and would
also be able to receive fuel from other tanker aircraft. The cabin of
the KC-767A is to be convertible to three configurations. In the
passenger configuration, the KC-767A would accommodate up to 190
passengers and 10 crewmembers. The freight configuration would allow
carriage of up to 19 cargo pallets and 10 crewmembers. The combination
(so-called ``Combi'') configuration is to have the capacity for
simultaneous carriage up to 10 pallets, 10 crewmembers, and 70
passengers.
OBJECTIVE AND SCOPE OF THE TASK
The objective of the IDA task was to estimate a unit purchase price
for 100 KC-767A aircraft. We did not investigate the condition of the
KC-135E/R fleet or the requirement for a tanker replacement. We were
not asked to evaluate any other aspect of the proposed acquisition and
therefore did not address provisions of the lease, financing,
suitability of leasing, or any alternatives to this proposal.
Consequently, the purchase price for the fleet of KC-767A aircraft is
what I am prepared to discuss today.
METHODOLOGY AND DATA SOURCES
To estimate the KC-767A Tanker/Combi purchase price, we separated
the acquisition into several segments:
Basic 767-200E/R--the commercial aircraft upon which
the KC-767A design would be based.
Enhanced B767 Features--the features from other B767
models that would be added to the basic B767-200E/R design to
build toward the KC-767A.
Combi Modifications--the modifications to the B767-
200E/R that would allow the carriage of passengers, freight, or
both simultaneously.
Auxiliary Fuel Tanks--the lower fuselage fuel tanks,
pumps, and installation materials required for additional fuel
capacity in the KC-767A.
Tanker and Other USAF-Unique Modifications--the
changes required to give the KC-767A its refueling, fuel-
receiving, and military-unique capabilities.
Development Costs--the investment required to create
and certify the KC-767A design.
The proposed KC-767A program would use FAR Part 12 guidelines
written for the acquisition or lease of commercial items. Under these
guidelines, the contractor is not required to provide cost estimates,
or any other data not normally supplied to commercial customers. The
establishment of a reasonable price under these rules would normally
rely largely on prices for the same or similar items in the commercial
marketplace. However, the KC-767A Tanker/Combi aircraft acquisition
involves modifications that do not easily lend themselves to this
approach, particularly in the area of military aerial refueling
capability. The market for large tanker aircraft is limited and of
little value for rigorous determination of reasonable prices.
Consequently, while our analysis made use of commercial pricing
wherever possible, we relied on traditional cost analysis techniques
where estimation by commercial pricing was not practical.
Our analysis relied on data from a variety of public sources,
including other government sources, the analyses of consultant
organizations hired by IDA, internal IDA proprietary data and models,
data supplied by Boeing, data provided by other aerospace suppliers,
and data supplied by the USAF.
TASK RESULTS
The analysis examined the proposed aircraft in detail, and
incorporated information provided by Boeing during and after briefings
at their facility in Wichita, Kansas. We feel that the evolution of our
task through the January to May time period has resulted in a
methodologically conservative approach that has produced a high quality
unit price estimate. We also performed an internal rate of return (IRR)
analysis on an estimate of Boeing's initial investment and found that
our price estimate would provide Boeing with an attractive IRR for the
time-period, and considering the risks involved. We believe that $120.7
million is a reasonable unit purchase price estimate for the proposed
100 KC-767A aircraft. Our estimate is summarized in the following table
according to the segments identified in the methodology.
SUMMARY OF KC-767A TANKER/COMBI PURCHASE PRICE ANALYSIS
[In millions of dollars]
----------------------------------------------------------------------------------------------------------------
IDA Unit Price
Taxonomy Element Estimate (Fiscal Primary Analysis Primary Data Sources
Year 2002) Technique
----------------------------------------------------------------------------------------------------------------
Basic B767-200ER...................... 72.1 Commercial Pricing...... Consultants, Department
of Transportation data
Enhanced B767-200ER Features.......... 1.6 Commercial Pricing...... Consultants, Boeing,
USAF data, IDA models,
vendor quotes
Combi Modifications................... 9.5 Commercial Pricing...... Consultants, public data
Auxiliary Fuel Tanks.................. 6.3 Cost analysis........... Vendor quotes, IDA
models
Tanker and Other Modifications........ 20.3 Cost analysis........... IDA models, USAF, Boeing
Development Costs..................... 10.9 Cost analysis........... USAF, IDA models
----------------------
Total............................... 120.7
----------------------------------------------------------------------------------------------------------------
Mr. Chairman and members of the committee: Due to the proprietary
information agreement that IDA has signed with The Boeing Company, I
cannot divulge any proprietary data that we have obtained under this
agreement. IDA and the OSD sponsors have provided a redacted version of
our report, and the privileged information version can be read in the
Pentagon.
Mr. Chairman and members of the committee: Thank you for your
attention. I am available for comments/questions.
Chairman Warner. You said reasonable unit price for
purchase.
Dr. Nelson. Yes, sir.
Chairman Warner. You meant that vice lease. So I mean, you
carefully used the word ``purchase.''
Dr. Nelson. Yes, sir, right.
IDA has executed a proprietary information agreement with
Boeing. Boeing has given IDA permission to discuss proprietary
information in a closed hearing if needed. IDA and the OSD
sponsors have provided a redacted version of our report and the
privileged information version can be read in the Pentagon.
Thank you for your attention. I am available for your
questions.
Chairman Warner. Thank you.
We will proceed to questions. First, Dr. Curtin, you said
you did not have--I think you made effort, but did not
receive--facts to support, ``the urgency to proceed along these
lines,'' vice to go through a normal procurement process.
Mr. Curtin. Yes, sir. We got the same kind of answers that
you got from the panel this morning, that, yes, there are
corrosion problems and, sure, it is always better to have a
shiny new plane than an old one. But the real urgency----
Chairman Warner. The threat of some block----
Mr. Curtin. Nothing specific. There is nothing that anybody
can say is going to happen.
Chairman Warner. I made reference to an earlier KC-135
study on which presumably the Air Force relied in its judgment
with budget submissions to Congress, and the Secretary said, we
just felt it was all wrong. Did you ever look at that analysis?
Mr. Curtin. Yes, and we have been using that. The Air Force
pointed us to that when we first started looking at tankers as
a well-documented study, and I was not aware that there is
anything more current than that, that had gone into that
detail.
Chairman Warner. In your own professional judgment, was it
a carefully prepared study and was it of value?
Mr. Curtin. It looked to us like a very valuable study,
yes, sir. It was a joint study with Boeing and Air Force
personnel involved.
Chairman Warner. That answers my question.
Quickly, Mr. Sunshine, what impact might this transaction,
if it is approved by Congress, have on the other military
departments in the annual allocation of budgets in those out
years where this bow wave is due to occur?
Mr. Sunshine. This transaction pushes the need for
budgetary resources from the next 2 years out into future
years.
Chairman Warner. That is correct.
Mr. Sunshine. So it eases pressures in the next few years.
Chairman Warner. On one military department.
Mr. Sunshine. Or on the whole Defense Department. Congress
has to make those tradeoffs.
Chairman Warner. But each year the Secretary of Defense
sits down with the service secretaries, service chiefs, and
works through--you know all about it, the Program Objective
Memorandum (POM) process, what do you need. Then finally those
numbers are struck for the military departments, and by and
large service secretaries and service chiefs work within that
framework in the Department. It is salute and march off. That
is the way that building runs.
But this thing is a very skillful, really a Hail Mary pass,
an end run around that process. Then the Air Force is stuck
with this thing in the out years, and the Secretary, he cannot
just ignore it. Therefore, it seems to me it is going to
impinge on that annual allocation between the three military
departments. Am I correct?
Mr. Sunshine. That is correct, it is a ``pay me now or pay
me later'' or a ``pay me something now or pay me more later''
proposal.
Chairman Warner. But I do not see this as a little, narrow
Air Force problem, unless the Secretary of Defense said, you
are going to have to eat all of this and go into your budget,
in which case then there are going to be serious perturbations
in other items.
Mr. Sunshine. That is correct. CBO recently did an analysis
on long-term defense needs, and the pressures are not going to
diminish as we get out into those later years.
Chairman Warner. Let me ask first Mr. Curtin and then the
same question to Mr. Sunshine and Dr. Nelson, if you care to
opine. I am concerned that if this matter is approved as
submitted to this committee and three others it will establish
a precedent and we can see a reoccurrence of this type of end
run, I call it a Hail Mary pass, around the budget process in
the out years.
Having had some modest experience with shipbuilding
acquisition, I would love to get a hold of this thing and start
building some Navy ships on this program. Believe me, I would
throw the all-time Hail Mary that will go over and through the
end zone. But there would be an obligation on the people in the
military departments: Hey, the Air Force won out; let us give
it a try.
Is this wild speculation?
Mr. Curtin. No, I think you are exactly on point there. The
enticing part of this lease is pushing it back to the out years
and it is somebody else's problem down the road.
Chairman Warner. We will have three-star tours in the
Pentagon, got the distinguished Pentagon service, go on back to
industry. Hey, I have been there, done that.
What do you think, Mr. Sunshine?
Mr. Sunshine. I agree. I think it is a very legitimate
fear.
Chairman Warner. Thank you.
Dr. Nelson?
Dr. Nelson. Very definitely there is a difficulty there
with long-term implications that are not anywhere near known at
this time.
Chairman Warner. Now, lastly. I assume full responsibility
for this, without any adequate consultation with colleagues.
But again having some experience with the Department of
Defense, and I try, as well as all of the members of this
committee and others, to keep abreast of military problems and
so forth, we are in a bind, I think, because of--I am not
pointing fingers for any reason, but mismanagement,
miscalculation, by previous Air Force secretaries or something,
not addressing this problem. I will just say that for the
record.
What do we do at this juncture? We have three committees of
Congress that have approved this. We are the holdouts. As I
said, I am very impressed with the thoroughness with which this
committee is performing its responsibility. Is there any merit
in asking them to come back with a 25 buy to help alleviate the
pressures on Boeing----
Senator McCain. A 25 lease.
Chairman Warner. A 25-unit lease, aircraft unit lease. Then
try and require the Department to accept this emergency fix and
move into the orderly procurement process. Do you think that
has any merit, Mr. Curtin?
Mr. Curtin. I was intrigued when you raised that earlier,
Mr. Chairman.
Chairman Warner. I am sure there is intrigue in the back
halls right now figuring it out.
Mr. Curtin. Yes, there is, exactly. My sense is that the
Air Force and DOD have invested so much time and energy in this
lease that they are pretty well focused on that and they are
not thinking about alternatives like that. But I think that is
probably exactly what is needed, is let us really think through
the need and how urgent it is, what we can do in the short term
versus long term, what we can do that is fiscally responsible.
I think it is worth a look at it.
The other thing you could do, and I am raising this not as
a GAO recommendation, but it is one that we have talked about,
is that there is a provision in the lease agreement here that
the Air Force can buy these out before the end of the lease. If
you feel we need to start on replacing this fleet, you could
begin with the lease, get the production line running, and buy
yourself some time that way to rejigger the budget over the
next couple years, to do the studies they need to do, and you
may have only leased the first 20 or 30 at that point and you
can make a buy decision at that point. That is another option.
Chairman Warner. There is only so much we can do, given the
constraints of the very short period of time.
Mr. Curtin. Yes.
Chairman Warner. But I am concerned when the final
questions were propounded here by my colleagues the Secretary
of the Air Force said: ``We have to figure out that this thing
is going to work, if it is mission-capable to the expectations
that we have of this aircraft.'' I am sitting back here saying
to myself: Whoa, there is really some front-end work on this
thing that either has not been done or could not have been
done, and I have to explore that.
So I am just trying to look at something that might take
the pressure off Congress, the pressure off the Air Force, to
begin to address the needs, and take a 25-unit buy and try it,
lease.
Mr. Curtin. It strikes me that this is really----
Chairman Warner. Not buy. I said ``lease''. I am trying to
move quickly so I can give you gentlemen time.
Mr. Curtin. This is a very----
Chairman Warner. In other words, lease just 25 aircraft.
Mr. Curtin. It strikes me that this is a very substantial
decision and I think the members of the committee have been
asking all the right questions. I have the sense that the
administration pretty much thought that they had a clear
direction to go in a leasing direction and they really did not
fully explore the other options for getting the aircraft
quickly.
I do not know, I do not have the expertise myself to judge
what those other options are. But it seems to me very
worthwhile to explore what other options we have for getting
either some or all of those aircraft quickly, assuming that
there is a need to have them.
Chairman Warner. It is predicated on the basis, that they
desperately need to do this. Lease 25 now and then go into the
normal procurement cycle.
Mr. Curtin. Actually, Mr. Chairman, I do not mean to
interrupt you, but that is actually pretty close to a proposal
we raised at a hearing earlier this summer with the House Armed
Services Committee. We have not explored that in detail, but we
did raise the option of just leasing a first portion to buy
yourself a few years to do the AOA that should have been done.
So yes. I thought you were talking purchase the first 25--
--
Chairman Warner. No, I misspoke in trying to move along
quickly.
Mr. Curtin. Leasing 25, I think that is----
Chairman Warner. Clearly I said in my initial statement
that, let us look at a 25-unit lease program at this juncture.
Mr. Curtin. I think it makes a lot of sense, yes.
[The information referred to follows:]
Chairman Warner. Now, Senator Levin.
Senator Levin. Thank you, Mr. Chairman.
The CBO wrote in August that the tanker lease fails to meet
four of the six criteria, as has been indicated here this
morning, that are required in OMB Circular A-11. It stated that
the recording lease payments on a year-to-year basis would,
``be at odds with standard government accounting principles.''
I think you said the same thing here this morning, Mr.
Sunshine.
You indicated in that letter and here today, that purchase
costs should be recorded as Federal expenditures at the time
the aircraft are delivered.
However, I am told that if this lease is approved by this
committee and goes into effect that CBO would then plan to
score it as an operating lease despite what you have told us
here; and that you would record the lease payments on a year-
to-year basis. I have trouble understanding that. Is that true,
first of all?
Mr. Sunshine. There is a difference between the scoring of
legislation when legislation is being considered or being
enacted and the actual budget implementation. This authority,
if the committee approves this, will have been provided and
there will in fact be no legislation for CBO to score. What
will happen is this: the Defense Department will get
appropriations for 2004 and later for 2005 and so on, and the
administration will decide how it is going to record the
obligations it makes for this transaction against the budget
authority that is provided. It has indicated that it is going
to record obligations under the criteria for an operating
lease, not as if the transaction is a purchase.
Senator Levin. You are saying prospectively it should not
be scored that way, but when you get down to scoring you are
going to score it that way?
Mr. Sunshine. It has moved from the legislative arena,
where we do scoring of bills, to the budget implementation
arena, where ultimately OMB decides how to record actions
actually in the budget itself.
Senator Levin. If OMB decides to proceed that way, you
would not disagree with them at that time?
Mr. Sunshine. If OMB says that outlays in fiscal year 2004
are $2 point whatever trillion, CBO is not going to say, well,
no, they are not really $2 point something trillion; they are
more than that. Once we get to the point of actual budget
implementation, that is in the domain of the administration. We
have told you how we think they should do it, but the time at
which the budget is implemented is beyond the point where we
can do something about that.
Senator Levin. Dr. Nelson, you have indicated that you have
determined that $120.7 million would be a reasonable unit
purchase price for the aircraft. The Air Force, however, is
stating that the unit price that they have negotiated, upon
which they base either a purchase or a lease, is $138 million.
The GAO has said that the actual price is going to be $173
million per aircraft if, as expected, the Air Force exercises
its option to purchase the aircraft at the end of the lease.
Now, I am not here talking about the $1 point plus billion
difference which has been described to us by the OMB Deputy
Director this morning. I think we finally have taken that range
of $150 million to $1.9 billion and, at least as far as my
thinking is concerned, I am going to assume it is about $1
billion plus in additional costs on an apples to apples basis,
using net present value, if we lease instead of purchase in the
ordinary course.
But that $1.1 billion does not include what Dr. Nelson has
said should be the cost of this plane in his best judgment,
which is $120.7 million a unit, versus the price which has been
negotiated, which is $138 million per unit. Are you with me so
far?
Mr. Curtin. I think so.
Senator Levin. So let me ask both of you, because this is
no longer a question for you. You have done your work. You have
given us your best estimate. It is $120.7 million and that is
what we have to go on. Is what I have said accurate, Mr.
Curtin, that there is also then a difference between that
negotiated price per unit and what Dr. Nelson has said should
be the reasonable price of the purchase?
Mr. Curtin. Yes. As far as I can tell, you have described
it pretty well. The reason the price--the $131 million is the
starting point versus the $120.7 million, and you add on
interest and you add on the price or the cost of paying the
final residual value afterwards. So yes, it is $120 million
versus----
Senator Levin. But the interest and the residual value
piece is included in the $1.1 billion, if I am correct; is that
correct or not? You know what I am saying?
Mr. Curtin. Yes, I think that is probably a good way of
looking at it.
Senator Levin. Which is the net present value difference.
Mr. Curtin. Yes, that is fine, that is a good way.
Senator Levin. So I want to remove those items because we
have already included those in the difference in net present
value between purchase versus lease, which is the $1 billion
plus.
Now I want to talk about something in addition to that
which we are now being confronted with, which is that if Dr.
Nelson's projections are correct that this should cost us $120
million per plane if we were just buying it right now, that the
negotiated price upon which that lease is based or the purchase
would be based is approximately $17 million more per plane than
it, ``should'' be based on his assessment of what parts cost
and inflation and the cost of labor and everything else that I
assume goes into whatever proposal he made.
Mr. Curtin. Yes, I think that is right on, yes.
Senator Levin. All right. What is their explanation for
that? I do not know whether you have talked to the Air Force
about that or to the OMB about that.
I do not think that was in your domain, was it, Dr. Nelson,
or was it, to ask them, how come you have negotiated $138
million when you say it should be----
Dr. Nelson. We were not part of the negotiation process.
Senator Levin. Then let me ask the CBO, then the GAO. My
time is up.
Just quickly, have you raised that question with the Air
Force?
Mr. Curtin. This whole IDA situation, it took us a long
time before we finally got a copy of the IDA report and we were
not sure whether the Air Force was ever going to actually give
us that or not. So we were not able to get into much detail on
that. But I think there was testimony yesterday at the Commerce
Committee hearing from Secretary Roche, who said, yes, they had
that, but it was advice, and they came up with a different
number. They used that as part of their bargaining, but they
did not use that number.
Senator Levin. All right. Mr. Sunshine?
Mr. Sunshine. That is not an area that we have explored.
Dr. Nelson. If I might, our role was to provide our best
information--objective, independent--to our sponsors. Our
sponsors were USD AT&L, and OSD PA&E. But we did have meetings
with Air Force on issues of difference. We tried resolving data
and sources, interpretation of data, analogies application, as
best we could. But we were not part of the final negotiation.
Senator Levin. Thank you.
Mr. Chairman, if there is an urgent requirement here it
seems to me we ought to try to find a way to meet it. I think
we have to meet it in a way which is direct, straightforward,
does not shift costs, more costs yet, to the future, that does
not create this conflict in the future where huge amounts of
money are going to be needed for the refueling tankers that are
going to have to be purchased after this first 100. That is
going to be a huge part of the Air Force budget, creates the
problem which the chairman has talked about in terms of the
overall budget.
I am willing to consider meeting an urgent requirement if
that is what is concluded. But I think we have to do it in a
way which is much more responsible, much more straightforward
in terms of the present cost, and avoid hiding costs and avoid
this uneven playing field which has been so very clearly
described this morning by our witness.
Thank you.
Chairman Warner. Thank you, Senator. We will work together
on that.
Senator McCain.
Senator McCain. Thank you, Mr. Chairman, and I thank you
and Senator Levin. Obviously, there is some thinking out loud
going on here, and I would like to say that I think that both
the chairman and the ranking member have come up with at least
a concept that I think we ought to pursue.
I also would emphasize, and I think that my friends would
agree, we do need an AOA. This may not be the best way to go.
We need an intense study as to how serious these corrosion
problems are, so that that would give us a better idea of the
urgency and the schedule that is necessary for the replacement
of the existing tanker fleet. I think both of those have to be
key elements of any proposal or scheme that the chairman, the
ranking member, and others may come up with.
But I do think that what the chairman has said is really
something worth pursuing seriously. I appreciate Mr. Curtin's
view that this might be on the surface of it--I know it is not
an official position of yours, but it might be an option worthy
of pursuit.
Would you agree it might be worth looking at, Mr. Sunshine?
Mr. Sunshine. Yes, I think we ought to explore ways, the
various alternatives we have, for getting the airplanes
quickly.
Senator McCain. Dr. Nelson, I want to apologize if I
misportrayed your position. I guess what I was trying to say is
that the best estimate of cost per airplane that IDA could come
up with was $120 million per copy and the Air Force's version
is considerably more under the lease proposal. So I would like
to correct the record if I misportrayed any of your position.
Does that take care of that?
Dr. Nelson. Thank you very much, Senator.
Senator McCain. Thank you, Dr. Nelson. I know that you are
in a difficult position here and I appreciate that.
Let me just discuss for 1 additional minute this issue of
the lease-purchase. Mr. Curtin and Mr. Sunshine, if this were a
lease-purchase it would be illegal, right?
Mr. Curtin. It would not be an operating lease, yes. It
could not fit under the current rules for an operating lease.
Senator McCain. Right. But under the present setup we are
going to pay 90 percent of the price of the airplane over a 6-
year period, which has a lifespan of 30, 40 years roughly. So
it would be almost insane to pay 90 percent of the cost of an
airplane over the first 6 years of its, say, 30-year life--that
is a conservative estimate--and then not purchase it. That
would be the worst kind of economics that anybody could
consider.
So really, it walks like a duck and it quacks like a duck,
and everybody knows that they are not only talking about 100,
they are talking about 200, in some cases 400 or 500 more. So I
guess that that is a disturbing kind of element here in this
whole scenario, because I think all of us on the committee
would feel better by saying, as in response to previous
questioning, we intend to buy it, this is the best way that we
can do it without disturbing the Air Force's budget and their
other priorities. I can understand that argument. I may not
agree with it.
But I would just like your comments on, would it make any
sense whatsoever to pay 90 percent of the cost of anything that
has a 30- or 40-year life period and then not purchase it at
the end of that period of time? Mr. Curtin?
Mr. Curtin. No. I think that is the point I made in my
opening remarks, is that you have really thrown money down the
drain if you turn those planes back after 6 years, because they
do have a long life. If they are not the right plane, you have
spent an awful lot of money on the wrong plane already, so
turning them back at that point does not accomplish much.
You are acquiring these for their full life cycle.
Mr. Sunshine. It is not that the need is a temporary need.
The need is a permanent need, and it is probably a growing
need. You do not have anything to replace them with if you turn
them back after 6 years, and you have just exacerbated the
problem. So if someone comes along 5 years into the lease and
says let us do an analysis and let us decide whether it is
worth keeping these aircraft or not, the analysis almost
certainly has to conclude that we have to keep them because we
have already paid for most of them.
Senator McCain. I thank you, Mr. Chairman. I thank the
witnesses.
Chairman Warner. This has been very helpful testimony,
gentlemen, and I commend each of you. I thank my ranking member
and you, Senator McCain, you have spent a lot of time on this
issue, and this committee. I am just very impressed with the
depth, the sincerity, the commitment, and the attendance we had
today to address this important issue.
So I will consult with my ranking member and members of the
committee and we will probably have further statements on
behalf of the committee as to our procedures we are going to
follow as we address our responsibility under this request.
Senator McCain, I did get from the Inspector General a
reply. It tracks pretty well what you had said, with no
reference to the word ``criminal'' at this point in time. I
will place this into the record. I will actually read it for
those who are following the hearing: ``Dear Chairman Warner:
You have inquired as to whether or not I am investigating
someone in connection with the Air Force tanker proposal.
First of all, it is Inspector General policy generally not
to comment publicly on the incidents of ongoing investigative
activities. However, when others have already publicly
commented on the IG investigative activities''--and there has
been some press coverage and so forth--``in an inaccurate
manner, it is appropriate and sometimes necessary for the
Inspector General to set the public record straight.''
``As indicated to you''--that is Warner--``yesterday, my
investigative staff has received information from another
Senator's staff that we are currently reviewing to determine
whether or not we should open an investigation. Procedurally,
we are still conducting a `preliminary inquiry', which is
standard operating procedure for my staff on the receipt of any
such information. We may or may not determine to open an
investigation. In the course of this preliminary inquiry, we
determine whether the information is credible, whether it
alleges violation of a prescribed standard, and whether the
information is sufficient to enable a focused investigation.
Although we generally hope to complete preliminary inquiries
within 10 days, that aspirational standard depends upon the
complexity and quantity of the information we are reviewing.''
``The enclosed memorandum, dated May 1, 2003, describes our
standard operating procedures,'' and so forth.
That is in response.
[The information referred to follows:]
Senator Levin. Mr. Chairman, I have a request to make if it
is appropriate. We have this issue about the cost, the purchase
price for the plane, and there is quite a difference here
between $120 million and the $137 million which has been
negotiated. The GAO has not had an opportunity to really look
at the IDA analysis as I understand Mr. Curtin's testimony. I
would like them to look at that analysis because as part of the
approach which we have talked about and you outlined here I
think we have to address that issue in some way.
That is actually, I believe, a larger number than the $1
point plus billion delta in the net present value approach. So
I do think, if it is appropriate, Mr. Chairman, that we ask the
GAO to give us a report on that narrow issue to supplement
their testimony here today.
Chairman Warner. I would suggest that a letter be prepared
for our joint signatures and it will be sent out this
afternoon.
[The information referred to follows:]
Chairman Warner. I will be consulting with my colleague
regarding my proposal where we look at a unit of 25 leased
aircraft for the present time.
Thank you very much. The hearing is concluded.
[Questions for the record with answers supplied follow:]
Questions Submitted by Senator James M. Inhofe
TANKER MAINTENANCE COSTS
1. Senator Inhofe. Secretary Roche, can you explain the 767
maintenance costs indicated in the July GAO report of $8 million?
Secretary Roche. The GAO stated, ``The Air Force estimates that the
maintenance agreement with Boeing will cost between $5 billion and $5.7
billion during the lease period. It has negotiated an agreement with
Boeing as part of the lease negotiations, covering all maintenance
except flight-line maintenance to be done by Air Force mechanics. This
represents an average of about $50 million per aircraft, with each
aircraft being leased for 6 years, or over $8 million per year.''
2. Senator Inhofe. Secretary Roche, how can the annual maintenance
costs of a new aircraft be double the cost of the KC-135?
Secretary Roche. It is not. Comparing the costs based on actual
utilization planned, the KC-767 is much more cost effective. The
support cost-per-flying hour (calendar year 2002 dollars) for the KC-
767 is $10,800 per hour. The support cost-per-flying-hour for the KC-
135E is $27,000 and $17,700 for the KC-135R. These are the estimated
costs for operations in 2012 (expressed in calendar year 2002 dollars)
when 100 KC-767s will be in the inventory. If the flying hours for KC-
135 were increased to 750 flying hours per year (the projected flying
hour for the KC-767), the support cost-per-flying-hour for the KC-135E
would be $16,300 and $10,600 for the KC-135R.
3. Senator Inhofe. Secretary Roche, did the annual maintenance
costs of the KC-135 mentioned in the GAO report include any one-time
modifications such as the Pacer CRAG (Compass, Radar, and Global
Positioning System)?
Secretary Roche. The Air Force contacted the GAO analysts
responsible for the July 2003 report. The GAO analysts advised that the
costs mentioned in the July 2003 GAO report do include one time
modification costs.
4. Senator Inhofe. Secretary Roche, if the costs did include any
one-time modification costs, what are the normal, annual maintenance
costs of the KC-135E and KC-135R without the one-time costs?
Secretary Roche. The aggregate data in the July 2003 GAO report is
insufficient to answer this question. The annual operating costs
referenced in the GAO report include the costs of personnel, unit level
consumption and depot maintenance. After discussions with the
responsible GAO analyst, we received some additional information used
by the GAO to support the cost data referenced in their report. The
additional GAO data shows that after removal of all avionics
modifications, remaining fiscal year 2001 operating costs are $3.7
million per aircraft for the KC-135D/E and $3.0 million per aircraft
for the KC-135R/T. These costs are in constant year 2000 dollars.
TRAINING AND MAINTENANCE
5. Senator Inhofe. Secretary Roche, in your testimony you said you
would be back in November with a training and maintenance plan. What
happens between now and November that would precipitate a training
plan?
Secretary Roche. A Training System Requirements Analysis (TSRA) was
scheduled for completion in the late-November 2003 timeframe. The TSRA
will provide a comprehensive analysis of our KC-767 training
requirements, how training devices can best be utilized, and
recommended locations for training activities. That activity, however,
is currently suspended pending ``new start'' approval.
6. Senator Inhofe. Secretary Roche, does the Air Force currently
have a long-term, centralized training plan for the 767?
Secretary Roche. Yes, KC-767 training is included in the lease
contract with Boeing. As tanker fleet recapitalization continues beyond
the initial 100 new tankers and should the decision be made to procure
additional KC-767s, the Air Force will look again at the advantages of
centralized training for the larger fleet. Boeing, as part of the
training service, will provide the simulators and Boeing will own the
simulators. The Government has the option to purchase the devices from
Boeing at any time during the lease.
______
Questions Submitted by Senator Elizabeth Dole
SPECIAL EQUIPMENT
7. Senator Dole. Secretary Roche and Secretary Wynne, as part of
the Boeing 767 tanker lease proposal, Boeing has designated many of the
components and systems of this aircraft for foreign procurement as part
of a foreign procurement offset plan. Arguably, some global tanker
transport aircraft will be designed for foreign customers; however,
these aircraft will not share the same special mission requirements as
the KC-767. As part of the lease, has the Air Force imposed any special
restrictions on Boeing for U.S. specific features such as auxiliary
fuel systems and other special mission equipment?
Secretary Roche. The Air Force has not directed Boeing to any
particular U.S. subcontractor to fulfill a specific requirement such as
the auxiliary fuel system or other special mission equipment. The Air
Force typically does not give such direction thus avoiding the
potential argument that the Government is guaranteeing subcontractor
performance. The lease does, however, include DFARS 252.225-7001, Buy
American Act and Balance of Payments Program and Boeing has certified
that it is providing end products manufactured in the United States.
Secretary Wynne. The Air Force has not required that Boeing fulfill
a specific requirement such as the auxiliary fuel system or other
special mission equipment only through domestic sources. The lease
includes DFARS 252.225-7001, Buy American Act and Balance of Payments
Program, and Boeing has certified that it is providing end products
manufactured in the United States.
ECONOMIC BOOST
8. Senator Dole. Secretary Roche and Secretary Wynne, if approved,
this lease plan will provide a huge economic boost for Boeing. Berry
Amendment provisions for military specific aircraft, if applied
correctly in this deal, could also provide an economic boost for
subsystem suppliers as well. What U.S. military-only modifications are
being included in the creation of the KC-767 and how many of these
systems are foreign produced?
Secretary Roche. The Fiscal Year 2002 Supplemental Appropriations
Act 107-206, Section 308, dated 12 Aug 2002, exempts the KC-767A Tanker
Program from Berry Amendment application under Section 2533a of Title
10 U.S.C. The KC-767A is a commercial tanker aircraft equipped to meet
Air Force requirements. There are a very limited number of USAF
specific military avionics components, and all are procured or are
projected to be procured from domestic sources.
Secretary Wynne. Section 308 of the 2002 Supplemental
Appropriations Act, P.L. 107-206, exempts the KC-767A Tanker Program
from the provisions of section 2533a of title 10, United States Code
(commonly referred to as the Berry Amendment). The KC-767A is a
commercial tanker aircraft equipped to meet the requirements of the
USAF. There are very few pieces of military avionics specific to the
requirements of the USAF, and all are procured or are projected to be
procured from domestic sources.
9. Senator Dole. Secretary Roche and Secretary Wynne, are
comparable systems or materials made in the U.S.?
Secretary Roche and Secretary Wynne. The 767 tanker is a
commercially offered aircraft. All systems are procured from domestic
sources or are projected to be procured from domestic sources.
10. Senator Dole. Secretary Roche and Secretary Wynne, the Boeing
767 tanker lease proposal brings to light a new aspect of weapons
systems acquisition. This proposal continues the trend toward the use
of commercial off-the-shelf (COTS) technology as a means of reducing
often exorbitant research and development costs. The Berry Amendment
requires the Department of Defense to purchase U.S. sourced and
manufactured specialty metals, clothing, and textiles. This law, re-
codified by Congress in 2001, preserves the ``warm industrial base''
that provides the items our military needs in times of both war and
peace. The 100 proposed airframes will be manufactured on the
commercial line then modified to fill the specific military tanker
mission. Technically, this lease plan bypasses the Berry Amendment
specialty metals requirements due to the dual use of commercial and
military manufacturing lines. Boeing has agreed to a deal with the
House Armed Services Committee to purchase the same amount of American
titanium in the proposed Air Force tanker lease deal as would have been
required under traditional defense procurement guidelines. Has the Air
Force written this agreement into the leasing contract?
Secretary Roche. Section 308 of the Fiscal Year 2002 Supplemental
Appropriations Act for Further Recovery From and Response to Terrorist
Acts on the United States, P.L. 107-206, 116 Stat. 841, provides that
10 U.S.C. 2533a (Berry Amendment) does not apply to the Boeing tanker
lease. Therefore, the tanker lease properly does not include any
clauses implementing the Berry Amendment. The Air Force was not party
to any agreement between the House Armed Services Committee and Boeing
nor is the Air Force clear on the terms of any such agreement. If
Congress changes the application of the Berry Amendment to the tanker
lease, the Air Force will negotiate changes to the lease to comply with
the new law.
Secretary Wynne. Section 308 of the 2002 Supplemental
Appropriations Act, P.L. 107-206, 116 Stat. 841, provides that section
2533a of title 10, United States Code (commonly referred to as the
Berry Amendment) does not apply to the Boeing tanker lease. Therefore,
the tanker lease properly does not include any clauses implementing the
Berry Amendment. The Air Force was not party to the agreement between
the House Armed Services Committee and Boeing, and thus has not
memorialized the agreement as a requirement of the proposed lease
contract.
11. Senator Dole. Secretary Roche and Secretary Wynne, how does the
Department of Defense plan to meet the Berry Amendment's requirements
for other COTS items modified for military use?
Secretary Roche. The Berry Amendment (10 U.S.C. 2533a) applies to
both military and commercial items acquired with appropriated funds or
funds otherwise made available to the Department. Nevertheless, many
COTS items are manufactured without regard to Berry Amendment
requirements. The Department will examine the feasibility of
incorporating Berry Amendment compliant materials and components into
COTS items manufactured for military use on a case-by-case basis. If
the Air Force determines that it is not feasible to incorporate Berry
Amendment compliant materials and components into the manufacturing
process for these items, the Air Force will consider exercising the
statutory authority to grant waivers in appropriate cases.
Secretary Wynne. The Department will have to assess each COTS case
independently. In anticipation of Congress' consideration of the
National Defense Authorization Act for Fiscal Year 2004, we sent a
legislative proposal to Congress, with the goal of clarifying and
streamlining the requirements in section 2533a of title 10, United
States Code (often referred to as the Berry Amendment). The House of
Representatives and the Senate each passed its own version of the Act,
and each version proposes changes to the Berry Amendment. The House
version has additional provisions, including those dealing with machine
tools and the requirement to procure specified items from manufacturers
that are part of the national technology and industrial base. Because
the resulting legislation will have a significant impact, the
Department is keenly interested in the results of the work of the House
and Senate conferees. We hope that whatever changes are enacted will
result in a statute that can be efficiently applied and enforced, will
protect the defense industrial base, and will be consistent with the
principles established in negotiated agreements with our counterparts
in other countries regarding mutual cooperation in defense procurement.
______
Questions Submitted by Senator Carl Levin
USEFUL SERVICE LIFE REMAINING
12. Senator Levin. Secretary Roche, as late as February 2001, the
KC-135 Economic Service Life Study, found that ``the fleet is
structurally viable to 2040,'' and that none of the KC-135Es and only
six of the KC-135Rs would reach the end of their fatigue life (36,000
hours and 39,000 hours, respectively) by 2040. Based on that
assessment, the Air Force intended to: (1) continue to convert KC-135E
aircraft to the KC-135R configuration; and (2) wait until 2013 to begin
KC-135 replacement. What is your latest assessment of the fatigue life
remaining for the KC-135E aircraft?
Secretary Roche. Assessments of the KC-135 service life agree that
fatigue alone will not be the driving factor for retirement; rather
degradation of the aircraft structure due to corrosion is the life-
limiting factor. One of our greatest concerns is a potential fleet-wide
grounding event that could emerge with little or no warning because of
unknown unknowns in regards to what corrosion does to aircraft. The Air
Force feels that we cannot accept the risk of unknown systematic
failures that could ground the tanker fleet.
DISADVANTAGES OF LEASING
13. Senator Levin. Director Kaplan, earlier this year, the CBO
provided us with a report on the budgetary treatment of leases. In that
report, CBO concludes that the use of long-term leases reduce the
budget's ability to fully depict the Federal Government's financial
commitments, undermine fiscal discipline by circumventing controls such
as limits on deficits and caps on discretionary spending, and allow
agencies to avoid facing the full costs of their purchasing decisions.
Indeed, the Air Force has stated that the ``dominant reason'' for the
lease approach is that it enables the Department to obtain tanker
aircraft ``without requiring significant up front funding.'' Do you
agree or disagree with CBO's conclusion that the use of long-term
leases has the effect of undermining fiscal discipline by pushing costs
off into outyear budgets?
Director Kaplan. OMB agrees that leases can be abused in some
instances in the way feared by CBO. When the Air Force first brought
this proposal to OMB, we had a number of questions about it. Pursuant
to congressional authorization, and after nearly 2 years of discussions
that ultimately involved a reduction of over 12 percent in the price
per plane, the administration decided to pursue a lease because of the
price reduction and the advantages it provides for urgently
recapitalizing the tanker fleet. The Boeing lease does not represent an
endorsement of leasing as a preferred method for acquiring military
equipment or other critical assets. OMB expects agencies to know the
full costs of their programs, and to conduct the appropriate analyses
under OMB Circulars A-11 and A-94. OMB will review any lease proposal
to ensure that appropriate analyses have been conducted, and will
approve such a proposal only when leasing is the most appropriate
structure in light of all the circumstances.
14. Senator Levin. Director Kaplan, what standards will you use to
ensure that the Boeing lease does not become a precedent for other
long-term leases of expensive capital equipment by the Department of
Defense and other Federal agencies?
Director Kaplan. As mentioned in the previous response, the Boeing
lease is the result of exhaustive efforts to understand the
implications of the transaction and to negotiate the best possible
price. OMB will review any lease proposal to ensure that the agency has
conducted appropriate analyses under OMB Circulars A-11 and A-94, and
will approve such a proposal only when leasing is the most appropriate
structure in light of all the circumstances. The Boeing lease does not
represent an endorsement of leasing as a preferred method for acquiring
military equipment or other critical assets. Instead, OMB anticipates
that long-term leases of capital equipment will remain the exception
rather than the rule.
URGENCY OF THE REQUIREMENT
15. Senator Levin. Secretary Roche, whatever we believe about the
various cost estimates, it is clear that the Air Force is willing to
pay a premium to lease the KC-767 tankers. The Air Force states that it
is willing to pay this premium because the urgency of obtaining new
tanker aircraft overwhelms the added costs. However, the Air Force's
most comprehensive study of its existing tanker fleet--the February
2001 KC-135 Economic Service Life Study (ESLS)--concluded that ``the
fleet is structurally viable to 2040'' and that although the cost of
aircraft maintenance would increase significantly during that time,
``there appears to be no run-away cost growth.'' On this basis, the Air
Force planned to wait until 2013 to begin KC-135 replacement. Since the
time of that study, the amount of time the KC-135 has spent in the
depot has declined, the number of aircraft in the depot at any one time
has declined, and the mission capable rates for the aircraft have
increased. Also, in the fiscal year 2004 budget, the Air Force proposed
reducing its tanker capacity by retiring more than 60 KC-135E tankers
without any immediate replacement. This hardly seems to describe a
situation so urgent that the Air Force must pay a premium to obtain new
tankers early. During the hearing, you indicated that the ESLS was a
faulty study. Could you provide the committee with the better studies
upon which the Air Force based its decision that the requirement to
replace the KC-135E tankers was so urgent as to require pursuing the
leasing proposal now?
Secretary Roche. The Deputy Secretary of Defense, in his 22 Sep
2003 letters to Senators Warner and Levin, confirmed that structural
degradation due to corrosion is the life-limiting factor. Our major
concern is a potential fleet grounding event due to the unforeseen
nature of corrosion. This would cripple global reach--we cannot accept
the risk. This drives the Air Force to begin a rapid recapitalization
of the aging KC-135 tanker fleet. Since the ESLS study release, average
annual costs have increased by $250 million per year. The ``KC-135E
Business Case Analysis,'' dated 1 May 2003, updates the cost
projections of the ESLS. This document was provided to SASC staff on 18
July 2003.
16. Senator Levin. Secretary Roche, what new information has the
Air Force obtained since February 2001 that has caused it to reverse
its position and determine that it is urgent to begin fielding new
tanker aircraft as soon as possible?
Secretary Roche. The comprehensive report and briefing, ``KC-135E
Business Case Analysis,'' dated 1 May 2003, documents the cost
avoidance and strategy for retiring the KC-135E. This report and
briefing was provided in July to SASC members and staff. In addition,
the Air Force provided ``The KC-135 Aging Aircraft Story,'' dated 2 Aug
2002.
SOLE-SOURCE LOGISTICS SUPPORT CONTRACT
17. Senator Levin. Secretary Roche, most of our focus in the
discussion in the hearing was related to the issue of the lease versus
purchase comparisons of the proposed deal. However, the proposed
agreement between Boeing and the Air Force also includes a sole-source
logistics support contract of roughly $6 billion. Although Boeing is
undoubtedly capable of providing this support, there appear to be other
organizations in the public and private sectors that could have
effectively competed for this work, had they been permitted to do so.
Indeed, I understand that Boeing is not now providing logistics support
for any of the 767s that it has sold in the commercial marketplace.
Wouldn't the Air Force have been able to save a considerable amount of
money if it had conducted a competition for logistics support, instead
of awarding the contract on a sole-source basis to Boeing?
Secretary Roche. Our contract terms with Boeing require them to
cover the costs of parts obsolescence and diminishing manufacturing
sources (for both green a/c and modification) to ensure aircraft
availability. These are two areas that the original equipment
manufacturer is best prepared to address due to their relationship with
the vendor base and availability of data. In addition, for the tanker
unique aspects of the KC-767, the data required for support is Boeing
proprietary.
18. Senator Levin. Secretary Roche, some Air Force officials have
told us that some aspects of logistics support could not be awarded to
a contractor without Boeing's approval, because of Boeing's proprietary
data in the refueling system. If this is the case, couldn't the sole-
source award have been limited to those aspects of the system?
Secretary Roche. Breaking the support of the aircraft into smaller
``pieces'' would drive the cost for general and administrative support
higher to carry multiple contractors. For these reasons, the Air Force
justified a sole source justification and approval for the lease and
support of the KC-767A tanker.
BOEING'S ROLE IN DRAFTING THE REQUIREMENT
19. Senator Levin. Secretary Roche, an article in U.S. News and
World Report earlier this month states that the Air Force allowed
Boeing to help draft the requirements for the tanker aircraft to be
leased. The article states that an unnamed Pentagon panel later
``chastised the Air Force for tailoring its requirements to the Boeing
767 and concluded that the document `should not be written for a
specific aircraft.' '' In fact, Senator McCain has provided us with a
Boeing document in which company officials refer to an objective of
``establish[ing] clearly defined requirements for the USAF tanker
configuration that results in an affordable solution that meets the
USAF mission needs and will prevent an [Analysis of Alternatives] from
being conducted.'' Did Boeing in fact participate in drafting the Air
Force's requirement for tanker aircraft? If so, isn't this inconsistent
with DOD acquisition regulations?
Secretary Roche. The Air Force did share the draft operational
requirements document with Boeing as the legislation was being
finalized (i.e. prior to Dec 2001). However, working with industry
early in the acquisition process is encouraged by DOD acquisition
regulations. In fact, according to the Chairman of the Joint Chiefs of
Staff Memorandum 3170.01, ``The intent is to share capstone
requirements documents with allies and industry wherever possible.
Early collaboration should be encouraged wherever possible.''
LOGISTICS SUPPORT COSTS
20. Senator Levin. Secretary Roche, Mr. Curtin's prepared testimony
on page 16 states that the total operating and support cost including
logistics support and flying hour costs for the KC-767 tanker fleet of
100 aircraft would be $808 million in constant fiscal year 2002
dollars, or $8.08 million per aircraft. The statement also quotes an
Air Force prediction that the KC-135 fleet of 510 aircraft would
require a total operating and support cost expenditure of roughly $3.5
billion in fiscal year 2002 dollar terms, or an average of about $6.4
million per aircraft per year. As I understand it, within that total
KC-135 expenditure, the Air Force is predicting that the KC-135R
aircraft would require roughly $2.7 billion, or $6.5 million per
aircraft and the KC-135E aircraft would require $773 million or roughly
$8.3 million per aircraft. I note that one of the reasons that the Air
Force wants to retire the KC-135E aircraft is because they are
expecting increasing maintenance costs. However, based on these
estimates, it would not appear that the KC-767 logistics support costs
will be greatly reduced from those of the current fleet of tankers. Do
you have any reason to believe that operating and support costs for the
KC-767 tanker will not increase over time?
Secretary Roche. The Air Force has negotiated a fixed price
contract for integrated fleet support for the duration of the KC-767
lease. The cost per year in constant year dollars will remain static
throughout this contract and will not increase. More importantly, the
more capable KC-767 will fly twice as many hours as a KC-135 and thus
will be less expensive to operate. The support cost per flying hour
costs (calendar year 2002 dollars) for the KC-767 is $10,800 per hour.
The support cost per flying hour for the KC-135E is $27,000 and $17,700
for the KC-135R. These are the estimated costs for operations in 2012
(expressed in calendar year 2002 dollars) when 100 KC-767s will be in
the inventory. If the flying hours for KC-135 were increased to 750
flying hours per year (the projected flying hour for the KC-767), the
support cost-per-flying-hour for the KC-135E would be $16,300 and
$10,600 for the KC-135R.
21. Senator Levin. Secretary Roche, if the cost per year is already
at roughly $8.1 million per aircraft per year for the KC-767, and as
the Air Force points out, support costs for any aircraft are likely to
grow over time, do you have any estimate of how these costs might
increase beyond the current estimate in later years?
Secretary Roche. The Air Force has negotiated a firm fixed price
contract for integrated fleet support (IFS) for the duration of the KC-
767 lease. The cost per year in constant year dollars will remain
static throughout this contract and will not increase. When this
contract expires, the Air Force has many options for this IFS contract.
They include competing the IFS contract and performing IFS by the
government. The aircraft industry has made many corrosion prevention
improvements in metallurgy as well as coatings over the years between
KC-135 production and KC-767 production. We anticipate lower
sustainment costs for the KC-767 as it ages compared to the KC-135.
LOGISTICS SUPPORT COST ASSUMPTIONS
22. Senator Levin. Secretary Roche, all of the Air Force
assumptions about the logistics support contract costs assume an annual
flying hour total of 750 hours per aircraft. The Air Force is now
flying the KC-135Es and KC-135Rs at a rate closer to 300-400 hours per
year. I would note that one of the reasons that the Air Force has
claimed that it needed to retire roughly half of the KC-135E fleet (68
aircraft) in the Future Years Defense Program is that you do not have
enough crews to keep up with the current flying hour program. Isn't
this assumed utilization rate too optimistic for the KC-767?
Secretary Roche. No, the KC-767 utilization rate is based on the
planned crew ratio of 2.0 as compared to the current 1.3 crew ratio for
the KC-135 fleet. As a result, the KC-767 is envisioned being used
similar to the KC-10 and should fulfill the projected 750 hours per
aircraft. 600 of the projected flight hours are required during
peacetime to ensure adequate experience levels throughout the crew
force. The additional 150 hours are provided for contingency
operations.
23. Senator Levin. Secretary Roche, what would be the cost
difference in total support costs from assuming a more reasonable 400
hours-per-year rate?
Secretary Roche. Our warfighters established 750 flying hours per
year as the expected utilization rate, in line with how AMC operates
the KC-10. The IFS contract has the flexibility to adjust for changes
in OPTEMPO scaling the level of support based on need. As such, fleet
cost estimates provided by the KC-767 System Program Office for 100 KC-
767 operating at 400 annual flying hours is $679 million (calendar year
2002 dollars) and at 750 annual flying hours is $808 million. Cost per
flying hour for 400 annual flying hours is $17,000 while for 750 flying
hours is $10,800.
LIFE CYCLE COST ANALYSES
24. Senator Levin. Secretary Roche, in response to a question from
Senator Reed during the hearing, you indicated that the Air Force had
completed life cycle cost analyses of the tanker situation, presumably
including life cycle costs of the current KC-135E force and of the
proposed KC-767 force. Could you provide those analyses for the record?
Secretary Roche. As I stated to Senator Reed during the hearing,
the earlier we have these new aircraft in place, the more operational
savings we will be able to realize. The support cost-per-flying-hour
(calendar year 2002 dollars) for the KC-767 is $10,800 per hour. The
support cost-per-flying-hour for the KC-135E is $27,000 and $17,700 for
the KC-135R. These are the estimated costs for operations in 2012
(expressed in calendar year 2002 dollars) when 100 KC-767s will be in
the inventory. Cost avoidance of accelerating retirement of KC-135Es by
5 years is $6.3 billion (then-year dollars). The details of this cost
avoidance is included in the comprehensive report and briefing, ``KC-
135E Business Case Analysis,'' dated 1 May 2003. This report and
briefing were provided in July to SASC members and staff. If the flying
hours for KC-135 were increased to 750 flying hours per year (the
projected flying hour for the KC-767), the support cost-per-flying-hour
for the KC-135E would be $16,300 and $10,600 for the KC-135R.
PROFITS IN THE CONTRACT
25. Senator Levin. Secretary Roche, a CRS report assesses that
Boeing is making roughly 6 percent return on sales for its commercial
sales of B-767 aircraft. The proposed Air Force leasing deal would cap
Boeing profits at no more than 15 percent return on sales for the
commercial aircraft (so-called ``green aircraft'') and 15 percent
return on sales for the refueling modification. There may be some
additional risk in modifying the aircraft to tanker configuration that
would merit a potentially higher return, but why would the Air Force
agree to pay a potential premium for an unmodified aircraft above what
Boeing is apparently receiving on its commercial orders?
Secretary Roche. Boeing has assumed tremendous risk in this program
in both undertaking a firm fixed price development of $1.4 billion and
in the first-time manufacturing of the tanker. Because of this high
risk, a high ``potential'' reward is merited. Although it may be argued
that the ``green'' component of the tanker is low risk and has been
``assumed'' to deliver a 6-percent profit, it is important to recognize
that we have both a profit cap and a most favored customer clause.
Since the Air Force is getting the best, most favored price, Boeing's
profit will be, at best, at the 6-percent level. The profit level is a
cap and not a mandate of profit. By allowing a higher cap, we
incentivize Boeing to be as efficient as possible so as to get a better
price for future commercial 767 derivatives.
[Whereupon, at 1:15 p.m., the committee adjourned.]