The Air Force KC-767 Tanker Lease Proposal: Key Issues For Congress
Congressional research reportSep 2, 2003
Ask Donna
What actually matters in this document.
Text
Order Code RL32056
CRS Report for Congress
Received through the CRS Web
The Air Force KC-767
Tanker Lease Proposal:
Key Issues For Congress
Updated September 2, 2003
(name redacted), Coordinator
Specialist in National Defense
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress
The Air Force KC-767 Tanker Lease Proposal:
Key Issues For Congress
Summary
The Air Force wishes to replace its KC-135E aircraft by leasing 100 new Boeing
KC-767 tankers. The Air Force indicates that leasing is preferred because it will
result in faster deliveries than outright purchasing. Air Force leaders argue that a
lease will allow them to husband scarce procurement dollars by making a small down
payment. Although Congress authorized the proposed lease in the FY2002 DOD
Appropriations Act, it stipulated that the defense oversight committees must approve
the lease – only the Senate Armed Services Committee has yet to approve. The lease
proposal has been controversial and issues raised thus far include:
Whether there is an urgent need to replace the KC-135 fleet. The Air Force states
that replacing the KC-135 is urgent, citing high costs, aircraft vulnerability to
catastrophic problems, and the imminent closing of the 767 production line.
Opponents of the lease state that operating costs are controllable and will be far lower
than the overall costs of leasing the 767; that the vulnerability is no more than
depicted in a 2-year old study which the Air Force found acceptable; and that the 767
production line is viable until 2006-2008.
Whether the KC-767 is the right airplane. If acquired, the KC-767 may be in
DOD’s inventory for 50 years. The Air Force says that the KC-767 is much more
capable than the KC-135. Opponents say that other aircraft are even better than the
KC-767 in meeting the Air Force’s requirements. The Air Force opposes re-engining
KC-135Es, but opponents say it merits attention, as does outsourcing aerial refueling.
Whether the Air Force cost comparison is authoritative. The Air Force’s report
to Congress calculates that a 767 lease would cost $150 million more than a purchase
on a net present value basis. This calculation, however, is sensitive to many
assumptions. CRS analysis shows that several assumptions built into the calculation,
if treated differently than in the Air Force report, could change the calculation by
hundreds of millions of dollars each. Although some could change the calculation
to favor either the lease or the purchase, others – such as the discount rate used to
calculate net present value and whether to use multi-year procurement for the
purchase option – could be more likely to alter the comparison more in favor of the
purchase option.
Whether this lease has implications for congressional budget oversight. The
proposed lease appears to be an unprecedented method of funding a major new
defense procurement. Critics point out that this approach is coupled with exemptions
from longstanding laws on budgeting and defense procurement. The proposed lease
raises policy issues regarding the visibility of full costs for DoD programs in the
congressional oversight process, including questions concerning locking in budgetary
resources when costs are uncertain, appropriateness of using an operating lease for
this proposal, the impact of a Special Purpose Entity, and the potential for deviation
from full-funding of the government’s contractual liability.
This report will not be updated.
Contents
Introduction and Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Issues for Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Is There an Urgent Need to Replace the KC-135? . . . . . . . . . . . . . . . . . . . . 10
Is the KC-767 the Best Aircraft for the Job? . . . . . . . . . . . . . . . . . . . . . . . . 21
Industrial Base Concerns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Total Costs for Leasing and Procuring the KC-767 . . . . . . . . . . . . . . . . . . . 37
Congressional Oversight and Budgetary Issues . . . . . . . . . . . . . . . . . . . . . . 53
Appendix A. The Law Authorizing the Lease . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
Appendix B. Net Present Value (NPV) Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 75
Appendix C. Multi-year Procurement (MYP) . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
List of Figures
Figure 1. KC-135 Annual Cost Forecast . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Figure 2. KC-135 Projected Aircraft Availability . . . . . . . . . . . . . . . . . . . . . . . . . 4
Figure 3. Cost of Lease Payments and Total Lease Program,
FY2003-FY2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Figure 4. KC-135 Cost Projections from 2001 (ESLS) and 2003 (BCA) . . . . . . 13
Figure 5. DC-10 Availability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Figure 6. Boeing 767 and Airbus A330 Production Backlog . . . . . . . . . . . . . . . 31
Figure 7: Projected 767 Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Figure 8. Boeing Civil Airframe Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Figure 9. Boeing Commercial Airplanes Direct Employment . . . . . . . . . . . . . . . 37
List of Tables
Table 1. Aerial Refueling and Combat in Two Conflicts . . . . . . . . . . . . . . . . . . 21
Table 2: Projected Aircraft Availability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Table 3. KC-767 and Civil 767 Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Table 4. Discount Rates for Lease-vs.-Purchase NPV Comparisons . . . . . . . . . . 45
Table 5. Summary of Variables, Assumptions, and Potential Changes in NPV
Cost Calculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Table 6. Comparison Of Lease vs. Buy Options For The Tanker Lease
Program Using Air Force Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Table 7. How Interest Rates Change 767 Tanker Lease Program Costs . . . . . . . 59
Table 8. Estimated Air Force Termination Liabilities, 2003-2017 . . . . . . . . . . . 66
Table 9. Cost of Lease vs. Multiyear Buy and Alternate Assumptions . . . . . . . . 67
Contributors
Authors
Foreign Affairs, Defense, and Trade Division
(name redacted)
Specialist in Defense Budget
(name redacted)
Specialist in National Defense
(name redacted)
Analyst in National Defense
Ronald O’Rourke
Specialist in National Defense
Specialized Expertise and Advice
(name redacted)
Specialist in Transportation
Resources, Science, and Industry Division
David Fragale
Foreign Affairs, Defense, and Trade Division
Jane Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
The Air Force KC-767 Tanker Lease
Proposal: Key Issues For Congress
Introduction and Background
Introduction
by (name redacted) and Ronald O’Rourke
(707-2577 and 707-7610)
The Air Force is proposing to replace 133 of its oldest Boeing KC-135E aerial
refueling tanker aircraft by leasing 100 new Boeing KC-767 tankers instead of
initially buying them outright.1 The proposed lease was authorized by Section 8159
of the FY2002 DOD Appropriations Act (P.L. 107-117 of January 10, 2002). The
lease, if implemented, would represent a significant shift away from previous Air
Force plans to modernize its tanker fleet, and a significant departure from normal
DOD procedures for major DOD aircraft acquisition programs.
The main issue for Congress is whether to approve or disapprove the lease.
Congress’s decision on this lease could significantly affect DOD aerial refueling
capabilities, Air Force funding requirements, and the U.S. defense industrial base.
Congress’s decision could also set precedents for DOD acquisition practices and have
significant implications for future oversight of DOD acquisition programs.
This report examines the lease proposal and its ramifications by providing
background information on the Air Force’s tanker fleet, the Boeing 767 tanker, and
the proposed lease itself. Then the report analyzes the following potential oversight
issues for Congress relating to the merits of the proposed lease:
! Is there an urgent need to replace the oldest KC-135s?
! If so, is the KC-767 the best replacement aircraft?
! Are there industrial base concerns?
! How the does cost of acquiring 100 KC-767 tankers through a lease compare
to the cost of acquiring them through a purchase (i.e., a procurement)?
! What potential implications might implementing the lease have for
congressional oversight of DOD acquisition programs?
1
See CRS Report RS20941, Air Force Aerial Refueling: Lease, Buy, or Other? by
(name redacted), for a short introductory overview of the subject.
CRS-2
Although the discussions of these four questions are written so that the reader
can proceed from one discussion to the next, the discussions are designed to be fairly
self-contained, so that readers who might be interested in only a particular question
can read the section on that question.
Background
by (name redacted) and Ronald O’Rourke
(707-2577 and 707-7610)
Air Force’s Draft Tanker Roadmap. The Air Force’s tanker fleet currently
consists of 544 aging KC-135E tankers and 59 somewhat newer KC-10 tankers. The
Air Force’s draft Tanker Roadmap of June 18, 2003 – its draft plan for managing and
modernizing the tanker fleet – proposes to begin recapitalizing (i.e., replacing) the
fleet by leasing 100 new Boeing 767 aircraft that have been converted into tankers.
The leased 767 tankers would be used to replace tanker capability now provided by
the 133 oldest KC-135Es in the fleet. The lease on the first group of 767s would
begin in late FY2006.
The draft roadmap also calls for retiring 58 KC-135s in FY2004-FY2005 and
another 68 in FY2006-FY2008, and using the resulting savings to help finance the
lease. A third component of the draft roadmap calls for conducting a new tanker
requirements study and an analysis of alternatives (AOA) to determine future
requirements for the tanker fleet and the tanker characteristics best suited to replace
the remaining aircraft in the tanker fleet.
The June 18, 2003 draft roadmap appears to depart from long-standing Air
Force plans for the tanker fleet, which called for conducting an AOA prior to
acquiring any new tanker aircraft, and for beginning recapitalization in the 2012 time
frame rather than in FY2006.2 The most recent tanker requirements study found that
by the year 2005, the Air Force would need 500 to 600 KC-135R tankers – or their
equivalent – to meet the tanker needs of the national military strategy. The Air Force
study concluded that the current tanker fleet cannot satisfy this requirement because
a portion of the fleet is always in maintenance and is therefore not operational.
KC-135 Cost and Availability – The Economic Service Life Study
(ESLS). The Air Force’s most comprehensive study of the KC-135 fleet is the KC135 Economic Service Life Study (February 2001), which serves as the most
appropriate baseline, and point of departure for considering the urgency of KC-135
recapitalization. The Economic Service Life Study (ESLS) made cost and
availability forecasts for the KC-135 fleet for the years 2001 through 2040. It was
conducted by a team of experts from throughout the Air Force and led by the Air
Mobility Command (AMC). Regarding cost, the ESLS found that the KC-135 fleet
would incur “significant cost increases” between 2001 and 2040, but “no economic
crisis is on the horizon”, “there appears to be no run-away cost-growth,” and “the
fleet is structurally viable to 2040.” (See Figure 1) Following the ESLS publication,
the Air Force planned to wait until 2013 to begin KC-135 replacement.
2
See Guy Norris, “USAF Begins New Tanker Search,” Flight International, November 21,
2000, p. 21.
CRS-3
Constant Year 2000 Dollars - Millions
Figure 1. KC-135 Annual Cost Forecast
3500
3000
Mods
Engine
2500
Airframe
2000
Ind. Support
1500
Fuel
1000
Unit Level
Consumption
500
Personnel
0
01
06
11
16
21
26
31
36
Years
Adapted from: KC-135 Economic Service Life Study. Tanker Requirements Study for FY05. HQ AMX/XPY
Regarding aircraft availability, the ESLS predicted that the number of KC-135s
available would increase between FY01 to FY04, reflecting improvements made in
programmed depot maintenance, but would then decline gradually until 2040. (See
Figure 2.) The ESLS projected three potential trends: the most optimistic trend
(“Upper Bound”) showed between 350 and 375 KC-135s being available from 2005
to 2039, and ending at 349 aircraft available in 2040. The “most likely” trend showed
between 300 and 350 aircraft being available between 2005 and 2035, with aircraft
dipping below 300 and ending around 290 available in 2040. The “worst case” trend
(assumed that the Air Force did nothing to try to arrest the declining trend in
availability) showed aircraft availability gradually and consistently declining from
a high point of approximately 330 in 2004 to only 190 in 2040. The ESLS predicted
that the actual future trend would be somewhere between the upper bound (349) and
the most likely trend (290).
CRS-4
Figure 2. KC-135 Projected Aircraft Availability
Aircraft Available
400
Upper Bound
350
349
Most Likely Trend
300
290
Worst Case
250
200
190
150
00
05
10
15
20
25
30
35
40
Year
Source: KC-135 Economic Service Life Study. Tanker Requirements Study for FY05. HQ AMC/XPY
The Tanker Version Of The Boeing 767. The Boeing 767 has been in
production since the early 1980s. Of the more than 900 that have been built, most
are used in commercial aviation as airliners or cargo carriers. Military applications
for the 767, however, have been envisioned and pursued for at least 10 years.
As early as July 1992, Boeing began publicly exploring the idea of using the
767–200ER version of the 767 design3 as the successor for a variety of existing
combat-support Air Force aircraft that are based on the old Boeing 707 aircraft
design.4 Among the Air Force missions mentioned as being suitable for the 767200ER were airborne early warning, aerial refueling, and electronic reconnaissance
and surveillance. In 1993, Saudi Arabia began exploring the potential purchase of
new or used 767s or other commercial aircraft for use as military tankers. Since then,
Australia, Italy, Japan, Singapore, and the United Kingdom have studied the use of
used or new commercial aircraft, including 767s, as tankers to replace their older
tanker aircraft.
In March 2000, Boeing created a business unit to market the 767 tanker
worldwide. In April 2000, Boeing signed a contract to build four new 767 military
tankers for Italy, with the first to be delivered in 2005. This was followed by a
second contract to build four new 767 military tankers for Japan.
In February 2001, Boeing offered to sell thirty six 767 tankers to the Air Force
as a stop-gap measure for bolstering Air Force tanker capability pending the results
of the Air Force’s projected tanker AOA. At a June 6, 2001, hearing before the
3
767-200ER means the extended-range variant of the 200-series version of the basic 767
design.
4
“Boeing Sees 767 as Heir to 707 in AWACS, Tanking, Other Missions,”Aerospace Daily.
July 14, 1992. P.78.
CRS-5
defense subcommittee of the Senate Appropriations Committee, General Michael
Ryan, then-Chief of Staff of the Air Force, mentioned the Boeing offer in his
response to a question from Senator Ted Stevens on the continued viability of the
service’s KC-135s. General Ryan stated that “we’re looking out in about the next
15-year time frame to begin that replacement.”5
A September 25, 2001, press report stated that Representative Norman Dicks,
a member of the defense subcommittee of the House Appropriations Committee,
planned to “insert an amendment into a defense appropriations bill to jump-start the
Air Force’s purchase of hundreds of Boeing 767 tankers and electronic surveillance
planes.”6 In an October 12, 2001 interview, Air Force Secretary James Roche
expressed support for leasing 100 767s and explained the Air Force’s rationale for
the proposal:
We have a unique business opportunity to get the best pricing possible to address
our critical need for a multimission aircraft that can carry gas and also do all
kinds of other things. ... This is not a bail out, but taking advantage of a buyer’s
market.7
The Proposed 767 Tanker Lease.
Basic Elements of the Lease . Under the proposed 767 lease, the Air Force
would lease each of the 100 767s for a period of 6 years. The 100 aircraft would be
leased in 6 groups. The lease for the first group of four aircraft would begin in late
FY2006 and extend to late FY2012. The lease for the next group of 16 aircraft
would begin at the start of FY2007 and extend to the end of FY2012. The remaining
80 aircraft would be divided into 4 groups of 20 whose leases would begin at the start
of FY2008, FY2009, FY2010, and FY2011, respectively, and extend to the end of
FY2014, FY2015, FY2016, and FY2017, respectively. Figure 3 below illustrates the
relationship between the annual lease payments, the total lease program costs and the
number of aircraft under lease.
5
Hearing of the Senate Appropriations Committee Subcommittee on Defense, June 6, 2001.
6
The Air Force remained reserved. An Air Force spokesman, Capt. Joe Della Vedova, was
quoted as stating, “We believe the 767 could be converted and would be a suitable candidate
for conversion.” See Katherine Pfleger, “Lawmakers Consider Air Force as Boeing
Commercial-Plane Customer,” Associated Press Newswires, September 30, 2001.
7
Vago Muradian, “Roche Seeks Speedy 767 Deal With Boeing to Renew Support Fleet at
Low Cost,” Defense Daily International, October 12, 2001.
CRS-6
Figure 3. Cost of Lease Payments and Total Lease Program,
FY2003-FY2017
Notes: Y1=left axis, $ millions Y2=right axis, number of leased aircraft
* Lease payments reflect the number of aircraft that have been delivered. Each
set of aircraft is available for a six-year lease from the time of delivery.
** Total Lease program cost includes annual lease payments and all support
costs but not purchase of aircraft. If the at the end of the leases, the Air Force
purchases all 100 aircraft, the total program cost would be $29.8 billion, or about
$4.4 billion more. If the Air Force does not buy the aircraft, Wilmington Trust
would sell the aircraft to pay off the bondholders. If the Air Force sells the
planes for more than needed to pay off bondholders, the Air Force would receive
a rebate, estimated at $800 million.
*** Under the Air Force plan, aircraft would be delivered between 2006 and
2011 on the following schedule: 4, 16, 20, 20, 20, 20. Since each aircraft is to
be leased for a six-year period, the number of aircraft leased grows to 100 by
FY2011 when all aircraft are delivered and then declines to zero once all leases
are completed. To continue to retain the full fleet of new aircraft, the Air Force
would need to begin buying the planes starting in 2012.
Source: CRS calculations based on Air Force, Business Case Analysis Model,
“Lease/Return Option,” July 1, 2003.
Boeing would begin building each group of aircraft 3 years prior to the start of
the lease for each group. To finance the 3-year construction effort for each group of
aircraft, Boeing would draw down on a bank line of credit (i.e., a bank loan). Upon
completing construction of each group of aircraft, Boeing would sell the aircraft to
a special non-profit entity established specifically for the 767 lease. This entity,
referred to as a Special Purpose Entity (SPE) or Variable Interest Entity (VIE) and
named the Wilmington Trust, would in effect act as a middleman between Boeing
CRS-7
and the Air Force. The SPE would purchase the 767s from Boeing using funds that
the SPE would raise by issuing bonds on the commercial bond market (i.e., funds that
private investors would agree to loan to the SPE in exchange for a promise from the
SPE to eventually repay those funds with a certain amount of interest). The SPE
would then lease the 767s to the Air Force using lease payments that are calculated
to cover (but not exceed) the SPE’s costs, which would include the purchase cost of
the 767s (an average of $138.4 million in FY2002 dollars per plane, including $7.4
million in interest costs on Boeing’s construction loans), the interest return promised
to the bondholders, and the SPE’s minor administrative expenses.
The SPE plans to offer three tranches of bonds, each secured by different assets
and each reflecting different risks. The “G” tranche, estimated to make up about onethird of the total lease cost, will be secured by the Air Force’s lease payments.
Because the Air Force is contractually liable for an additional year’s worth of lease
payments in case of termination, these are essentially low-risk bonds. For that
reason, the Air Force is projecting that rates will be about 1/2% point above the
projected Treasury bill rates from 2006 to 2011.8
The second tranche of bonds, the “A” bonds, covering about half of the
borrowing, would be secured by the value of the aircraft itself and would be the
second claimant in case of termination. The Air Force is projecting that those bonds
would also be relatively low risk, and hence, would require an interest rate 1% above
the projected Treasury rate in each year from 2006 to 2011. Although it could well
be difficult to sell the aircraft for their full value, some would argue that the
likelihood that the Air Force would renege would be low because under the contract,
they would face large, unbudgeted termination liabilities that could be as high as $2.7
billion in current year dollars at the highpoint of lease payments. In addition, the Air
Force sees a compelling need to maintain the size of the tanker fleet.
The third tranche of bonds, the “B” bonds, to cover about 15% of the total cost
of the lease, would be backed by the potential sale of the aircraft to the Air Force at
the end of the lease. This tranche of bonds is a more risky proposition because a
purchase requires Congressional approval, and an additional $4.4 billion in current
year dollars in funding. However, purchase is an attractive option because the Air
Force would already have paid 90% of the cost of the aircraft in its lease payments.
Additionally, the aircraft would only have been used for one-quarter or less of their
normal service lives.9 To reflect potential risks, the Air Force projects that a 10%
interest rate compounded to the end of each lease would be required to attract
bondholders.10
8
Description of the three tranches is based on discussions with and briefings from the Air
Force.
9
Each aircraft would have been used for six years, less than one-quarter of the aircraft’s 25
year service life. In addition, the Air Force is planning to fly the planes for about 750 hours
a year, about one-quarter of typical commercial usage rates.
10
Discussion above based on Air Force briefing to CRS, “KC-767A Report to Congress,
Status Brief”, July 15, 2003, and Boeing briefing, “USAF KC-767A Tanker,” July 24, 2004.
CRS-8
A principal purpose of the SPE is to relieve Boeing of the need to lease the 767s
directly to the Air Force. If Boeing were to lease the 767s directly to the Air Force,
Boeing would have to retain ownership of the 767s and would pay off its
construction loans gradually, using proceeds from the lease payments. This would
require Boeing to carry a significant amount of construction-related debt for an
extended period of time, which might significantly weaken Boeing’s financial
condition.
Upon the conclusion of the 6-year lease period for each group of 767s, the Air
Force would have the option of either returning the 767s to the SPE or purchasing the
767s for an additional payment of $44 million in current year dollars per plane.
Enabling Legislation and Report Language. The authority for the Air
Force to lease 100 767 tankers (and also 4 Boeing 737 transport aircraft) was
provided in the following legislation:
! Section 8159 of the FY2002 Defense Appropriations act (P.L. 107-117 of
January 10, 2002);
! Section 133 of the FY2003 Defense Authorization act (P.L. 107-314 of
December 2, 2002);
! Section 8117 of the FY2003 Defense Appropriations act (P.L. 107-248 of
October 23, 2002);
! Section 308 of the FY2002 Supplemental.
Together, these provisions provide authority for a lease that departs from normal
procedures for major DOD acquisition programs by:
! specifying that a particular acquisition method can be used (i.e., a lease of a
commercial asset, which would make it an operating rather than a capital lease
or a procurement);
! specifying the number and type of aircraft to be leased (100 Boeing 767s and
4 Boeing 737s);
! exempting the lease from requirements and limitations that normally govern
DOD leases of ships and aircraft which are established in 10 USC 2401 and
2401a, including funding of termination liability;
! exempting the lease from a limit established in 31 USC 1553(b)(2) on the
amount of appropriations that, under certain circumstances, may be charged
to closed-out appropriation accounts;
! exempting the Air Force from the “Buy American” requirements of the Berry
Amendment (10 USC 2533a);
! establishing a special congressional approval process for the lease where
approval would be either through authorization and appropriation language,
or through a new start notification to be approved by the four congressional
defense committees at any time.
It should be noted that Section 8159 is not the first provision permitting DOD
to lease aircraft. The FY2000 Defense Appropriations Act (P.L. 106-79 enacted on
October 25, 1999) contained a provision (Section 8133) somewhat similar to section
8159 that permitted the Air Force to lease six aircraft “for operational support
purposes, including transportation of the combatant Commanders in Chief,” (i.e., the
CRS-9
top U.S. officers in charge of U.S. military forces operating in various regions of the
world).
Section 133 of the FY2003 defense authorization act (P.L. 107-314 of December
2, 2002) states that the Air Force may not enter into a lease for the acquisition of
tanker aircraft under Section 8159 of P.L. 107-117 until authorization and
appropriation of funds necessary to enter into the lease are provided by law or until
DOD submits to and the four congressional defense committees approve a new start
reprogramming notification for the lease in accordance with established
reprogramming procedures. This is an unusual if not unprecedented way to approve
a major procurement program since reprogramming or transfers of funds between
appropriations are generally used for minor adjustments to ongoing programs.
Status of Congressional Approval Process. Section 8159 of P.L. 107117 states that the Air Force may not enter into the lease until it submits a report to
the congressional defense committees – the House and Senate Armed Services
committees and the House and Senate Appropriations committees – on its plans for
implementing the lease and until a period of not less than 30 calendar days has
elapsed after submitting the report. The practical effect of this provision is to prevent
the lease from being implemented until the four congressional defense committees
have signaled their approval of the lease.
On July 10, 2003, the Air Force submitted the report required by Section 8159
of P.L. 107-117 to the four defense oversight committees. The 7-page report (plus
a 1-page summary and 4 pages of appendices listing specific lease terms and
conditions) discusses the operational requirement for tankers, alternative tanker-force
investment options, the estimated costs of leasing and procuring the 767s, the Air
Force’s plan for implementing the lease, and basing plans for the 767s.
Following the July 10th report, the Air Force submitted a new start
reprogramming notification for 767 lease mentioned in Section 133 of P.L. 107-314.
Through late August 2003, 3 of the 4 congressional defense committees had
approved the KC-767 new start reprogramming. The Senate Armed Services
Committee has not yet signaled its approval or disapproval. Both the Senate Armed
Services Committee and the Senate Commerce Committee have scheduled hearings
for early September 2003.
CRS-10
Issues for Congress
For congressional policymakers, the merits of the decision to approve or
disapprove the KC-767 lease relate in part to examining the following questions:
! Is there an urgent need to replace the oldest KC-135s?
! Is the KC-767 the best aircraft for the job?
! What are the industrial base concerns?
! Given the uncertainties involved in this unusual acquisition mechanism, are
the costs projected by the Air Force the most authoritative?
! What potential long term implications does this lease present in terms of
budget and congressional oversight?
Is There an Urgent Need to Replace the KC-135?
by (name redacted)
(707-2577)
Much of the Air Force’s argument for leasing 100 KC-767s is based on its
assessment that it has an urgent need to replace the oldest KC-135s: that operations
and support costs are too high, that mission availability is too low, that the aircraft
is wearing out prematurely due to high operations tempo, and that it is vulnerable to
catastrophic problems.11 The Air Force argues that leasing the KC-767 will result in
faster deliveries – under the Air Force’s self-imposed funding limits - than will
purchasing them, which may be important if the need to recapitalize is urgent.
A key judgement for policy makers is whether the need to replace the KC-135E
fleet is urgent enough to justify the leasing procedure. If the need is urgent, then the
higher costs of leasing rather than purchasing new aircraft may be justified. If the
need is not so urgent, then it may be more prudent to delay any action on new
aircraft. In this case, critics of the lease point out that an analysis of alternatives
(AOA) could be performed over the next few years to more accurately determine
what joint aerial refueling requirements may be, prior to embarking on tanker
recapitalization.
Recently, Air Force officials have argued that a number of the ESLS findings
that could be interpreted as supporting a more gradual approach to tanker
11
“Report to the Congressional Defense Committees on KC-767A Air Refueling Aircraft
Muliti-Year Lease Pilot Program.” Secretary of the Air Force. July 10, 2002. “...the urgent
need to begin recapitalization..” Dr. Marvin Sambur, Assistant Secretary of the Air force
told the House Armed Services July 23, 2003: “We urgently need to recapitalize now.” Mr.
Neil Curtin, General Accounting Office: “the Air Force does not make the case that leasing
is cheaper. Instead, the real main argument for the proposal is that there’s an urgent need to
begin replacing the current tanker fleet.”
CRS-11
recapitalization no longer appear accurate or valid. In congressional testimony,
official statements, and numerous press interviews Air Force officials have offered
four general arguments for why replacing the oldest KC-135E models with new
aircraft is urgent:
! New data and analysis show that KC-135 O&S costs will rise faster than the
ESLS predicted;
! KC-135s mission capable rates (MCR) are too low, they spend too much time
being repaired and maintained in depot, and are thus too frequently
unavailable to the warfighter;
! The KC-135 is vulnerable to catastrophic problems that could cause the entire
fleet to be grounded;
! Tanker requirements, and assumptions about KC-135 usage rates, were
formed prior to the terrorist attacks of September 11, 2001. Usage rates have,
and tanker requirements likely will, increase in the new security environment.
Each of these issues will be addressed in the sections below.
New Findings on KC-135 Costs. Air Force and DOD officials argue that
recent estimates of KC-135 costs have been higher, and future costs will also be
higher than the ESLS projected. They say that the ESLS study was “extremely
optimistic,”12 especially in its assumptions and projections on key operation and
support (O&S) cost drivers. For example, depot labor rates have increased much
more quickly than anticipated: from $111 per hour in 2001 to $160 per hour in 2002,
and $210 per hour forecast for 2003. The cost of repairing the engine struts on the
KC-135Es increased from $1 million per aircraft in 2001 to $3 million per aircraft
in 2002.13
The effect of the optimistic projections contained in the ESLS study becomes
evident, DOD officials argue, by comparing ESLS projected 2001 costs to actual
2001 costs. While the ESLS projected 2001 O&S costs to be $2.1 billion, the Air
Force actually spent $2.26 billion, an increase over ESLS estimates by $250 million
or 11.9 percent. Revised Air Force projections now assume that the annual KC-135
O&S costs will escalate from $2.26 billion to $3.4 billion in 2040.14 While the ESLS
predicted 1 percent real cost growth per year and 43 percent cumulative real cost
12
Major General Paul W. Essex, Director, Plans and Programs, HQ Air Mobility Command.
“U.S. Representative Duncan Hunter Holds Hearing on Air Force Tanker Lease Program.”
July 23, 2003 FDCH Political Transcripts. Washington, DC.
13
USAF Need for KC-135 Recapitalization: Operational, Maintenance & Economic
Implications. A September 2002 Reassessment of the KC-135 Economic Service Life Study.
U.S. Air Force.
14
Correspondence from General Richard B. Myers. Chairman of the Joint Chiefs of Staff.
to Senator John McCain. March 13, 2003.
CRS-12
growth by 2040, the new estimates predict 1.5 percent real cost growth per year and
64 percent cumulative cost growth by 2040.15
Many of those opposed16 to the KC-767 lease do not dispute the higher O&S
costs incurred in 2001. Instead, they take issue with the assertion that costs will
continue to rise at the same rate. One year of increased costs, opponents say, does
not amount to a 39 year trend. The Air Force appears to be making a linear
extrapolation from 2001 to 2040. The $3.4 billion figure for 2040 costs is derived by
assuming that costs will continue to increase by 1.5 percent for the next 39 years
rather than the ESLS one percent estimate. The Air Force has provided no analysis
or proof that the increased costs incurred in 2001 aren’t a one-time anomaly,
opponents argue, and thus, the ESLS cost projections to 2040 are still the most
authoritative. The increased costs for 2001, lease opponents argue, are likely caused
by the considerable efforts the Air Force made to “fix the KC-135 depot” (see
availability section below) and now that the depot is running well, it is not a given
that costs will continue to increase at the same rate.
Those opposed to the KC-767 lease also take issue with the Air Force claim that
the ESLS study was optimistic. On the contrary, they say, the ESLS took a
conservative approach in its projections of future KC-135 costs. For example, the
ESLS airframe cost estimates (the largest cost drivers in Figure 1 above) are made
up of programmed depot maintenance, major structural repairs, and structural
investments. The ESLS identified two structural investments that were needed –
KC-135E struts, $1 million per aircraft, and topcoat removal, $500,000 per aircraft.
Recognizing the uncertainty of predicting future repairs, the ESLS estimates included
$6 million per aircraft of notional repairs that may not, in fact, ever be needed: upper
wing skins ($2 million per aircraft), fuselage skins ($2 million per aircraft), and
unknown structures ($2 million per aircraft.) Also, while some costs (notably
programmed depot maintenance, or PDM) have gone up, others have gone down, or
have been eliminated. Depot engineers, for example, have learned how to save
$500,000 per aircraft by conducting periodic inspections and maintenance instead of
removing flaking topcoat (a corrosion preventative material).
Air Force officials state that they have, in fact, gone beyond a linear
extrapolation of 2001 KC-135 O&S costs and conducted a recent analysis of future
costs.17 In this May 1, 2003 study, the Air Force re-evaluated ESLS projections.
The Air Force accepted all ESLS assumptions and data except for PDM estimates,
aircraft modifications and military personnel estimates. By updating these data, and
by using more sophisticated analytical tools, such as compound growth modeling and
15
USAF Need for KC-135 Recapitalization: Operational, Maintenance & Economic
Implications. A September 2002 Reassessment of the KC-135 Economic Service Life Study,
U.S. Air Force.
16
Several members of Congress have expressed their opposition to the lease, as have
academics in newspaper OP-EDs, and a number of not-for-profit organizations, such as
National Taxpayers Union, Council for Livable World, Citizens Against Government Waste,
National Taxpayers Union, National Law and Policy Center, Project on Government
Oversight have voiced their opposition..
17
KC-135 Business Case Analysis. Headquarters, USAF. May 1, 2003.
CRS-13
discounting ESLS constant-year dollars (CY) into net present-value (PV) dollars, the
Air Force projected KC-135 O&S costs to the year 2017 and believes they will be
considerably higher than the ESLS projected two years ago. Figure 4 illustrates the
new projections compared to ESLS projections.18
This new analysis, Air Force officials argue, suggests that KC-1365 O&S costs
6000
5000
BCA
4000
3000
2000
ESLS
1000
20
17
20
15
20
13
20
11
20
09
20
07
20
05
0
20
03
$M (Constant FY03$)
Figure 4. KC-135 Cost Projections from 2001 (ESLS) and 2003
(BCA)
Years
Source: CRS chart based on data from KC-135 Economic Service Life Study. Technical Report. February 9,
2001. P.21, and KC-135 Business Case Analysis. HQUSAF. May 1, 2003. ESLS data inflated from original
Constant FY00$ to to Constant FY03$ using USAF 3400 (Operations & Maintenance) inflation rate of 1.034)
are not just higher today than previously anticipated, but will also likely continue to
exceed projections. These newer, and higher cost estimates, the Air Force says,
support their argument that re-capitalizing the KC-135 fleet sooner rather than later
makes good economic sense.
As a recent study, the Air Force’s most recent projection of future KC-135 costs
has not yet been widely disseminated, and thus, reaction to it has been minimal.
Lease opponents could express dissatisfaction with the newer cost projections on at
least two levels. First, opponents could argue that the Air Force does not fully
explain its rationale for the changes it made in ESLS assumptions and data, and the
effect that these new data have on future cost projections. What changes were made
in the original ESLS projections on military personnel, for example, and what
percentage of the newer, higher cost estimates are attributed to this change? The new
study provides no explanation or rationale. Second, opponents could argue that the
fact that the Air Force has performed two different studies in such a short time period
that produce such different outcomes calls into question the credibility of those
findings. What confidence can readers have in the new projections, opponents could
18
CRS produced this chart based on data from the two studies. For simplicity of
presentation, and to make an “apples-to-apples” comparison, the data are presented in
constant year dollars. The 2003 KC-135 Business Case Analysis provides data in constant
year, then year (TY) and net present-value dollars, but plots the TY dollars only.
CRS-14
argue, when just two years ago, the Air Force presented the ESLS as the definitive
study?
KC-135 Mission Availability. Air Force officials argue that as aircraft age,
the oldest KC-135's mission capable rates (MCR) will decline, and that the aircraft
spends too much time in maintenance depots. These two factors will combine to
reduce the number of available aircraft to unacceptably low levels. The Air Force
needs, they argue, to recapitalize the KC-135 fleet with new aircraft that will satisfy
mission availability requirements.
The Air Force has a goal of an 85 percent mission capable rate (MCR) for tanker
aircraft. The MCR is the percent of time that an aircraft is available to perform its
assigned mission. Making judgements on the adequacy of KC-135 MCR is
complicated because the MCR appears highly dependent on the time period
considered and whether the aircraft is in the active or reserve component.
Air Force officials have testified that over the last five years, KC-135Rs have
averaged a 78 percent MCR and the KC-135Es a 71.9 percent MCR, well below the
85 percent goal.19 This testimony appears to roughly correlate with a 2002 Air Force
study that showed active duty KC-135Rs with an MCR above 80 percent for
FY1997, 1998, 1999, 2001 and 2002. The active duty “R” models MCR’s fell
slightly below 80 percent in 2000. KC-135Rs in the reserve fleet had generally
higher MCRs than KC-135Es, which fluctuated between the low 60s and high 70s.
The 2002 study, also states, however, that “Mission capable rates are holding steady”
which appears to contradict some KC-767 lease proponents’ assertions that the MCR
is getting worse.20
The General Accounting Office (GAO) has also written that the KC-135 rates
are holding steady – “...there has been no indication that mission capable rates are
falling or that the aircraft cannot be operated safely.”21 Also, the GAO asserts “KC135s in the active duty forces are generally meeting the 85-percent goals for mission
capable rates.”22 Moreover, a January 2003 Air Force study also shows the MCR for
19
Major General Paul W. Essex, Director, Plans and Programs, HQ Air Mobility Command.
“U.S. Representative Duncan Hunter Holds Hearing on Air Force Tanker Lease Program.”
July 23, 2003 FDCH Political Transcripts. Washington, DC.
20
KC-135 Tanker Aging Aircraft Story. General Handy, CINCTRANSCOM. General Lyles,
Commander AFMC. August 2, 2002. The MCR data in this briefing were expressed in barchart format, so the exact data was unavailable. Estimates are based on visual inference of
the chart.
21
“Military Aircraft: Considerations in Reviewing the Air Force Proposal to Lease Aerial
Refueling Aircraft.” Statement of Neal P. Curtin, Director Defense Capabilities and
Management. GAO-0301048T. July 23, 2003. p.7
22
“Military Aircraft: Considerations in Reviewing the Air Force Proposal to Lease Aerial
Refueling Aircraft.” Statement of Neal P. Curtin, Director Defense Capabilities and
Management. GAO-0301048T. July 23, 2003. p.3
CRS-15
both the KC-135E and the KC-135R as 85%.23 The study did not give a time period
for this MCR estimate.
Because of the GAO and Air Force studies, some debate has focused on the
time, or duration of MCR estimates and the impact that these factors might have on
the applicability of estimating over the long term. For example, the Air Force has
discounted some GAO MCR estimates, noting that they were for short time periods,
and that even aircraft with low MCRs can have “spikes” of higher availability. The
KC-135's performance during Operation Iraqi Freedom is an example of this
phenomenon, KC-767 lease supporters say. The KC-135's 86.4 percent MCR during
this conflict has not been sustained over the long term, lease supporters argue.
Lease opponents would agree that short term MCRs might not be the most
reliable of an aircraft’s long term MCR. But, lease opponents argue, “when the chips
were down,” the KC-135 fleet did achieve, and actually exceeded MCR goals. Also,
the KC-135's 86.4 MCR was higher than the MCRs for many other aircraft that
participated in the Iraq war: A-10, B-1B, B-2, B-52, E-3B, E-8C, F-117, F-15 (all
models), F-16 (all models), KC-10, U-2, and Predator and Global Hawk UAVs.
Lease opponents concede that the KC-135's 86.4 percent MCR is higher than normal
and likely due to extraordinary wartime efforts. But that is also likely the case for the
13 other aircraft types that had lower MCRs than the KC-135. This comparison
shows, opponents argue, that KC-135 availability can be on par with, if not superior
to other aircraft, and claims about low MCR are not a compelling reason to retire the
fleet prematurely.
The MCR is only calculated for those aircraft not otherwise unavailable due to
depot maintenance or training requirements. Few KC-135Rs and no KC-135Es are
used for training. Therefore, the number of aircraft in depot, and the amount of time
they spend there are also important factors that affect aircraft availability.
The KC-135's maintenance history is well established. As the aircraft has aged
and as age-related problems have become more acute, it has taken more effort to
complete scheduled maintenance, called Programmed Depot Maintenance (PDM).
The KC-135's maintenance problems appeared at their worst in 1999, when 176
aircraft (32 percent of the fleet) were in depot at the same time. It was at this point,
both the Air Force and KC-767 lease opponents agree, that the Air Force had to make
a concerted effort to improve depot maintenance and processes. According to one Air
Force study, the Chief of Staff of the Air Force directed his staff and the Air Force
Mobility Command to “fix the depot.”24 The result was a marked improvement in
aircraft availability from FY2001 to FY2003. By some estimates, KC-135s are today
spending 45 percent less time in depots than they were two years ago,25 and 100
23
White Paper on KC-767A. The Aircraft to Begin Our Tanker Recapitalization. HQ
AMC/XPR January 10, 2003. Table 3 “Combat Capability Comparison (Logistics), p. 5.
24
25
“KC-135E Business Case Analysis.” Headquarters, USAF. May 1, 2003. p.15.
Rep. Duncan Hunter. “U.S. Representative Duncan Hunter Holds Hearing on Air Force
Tanker Lease Program.” July 23, 2003 FDCH Political Transcripts. Washington, DC.
CRS-16
more aircraft are now available to the warfighter than in July 2000.26 Where the Air
Force and KC-767 lease opponents diverge, however, is what this recent
improvement in availability implies for the future.
The Air Force acknowledges that fewer KC-135s are in depot. However, this
doesn’t mean that less work is being done to maintain the KC-135, officials say. In
fact, the opposite is true; more work is being done on them while they are in depot.
KC-135 depots added a second shift, and PDM man-hours have doubled from
16,000 to 33,000 despite the improvement in the number of aircraft in depot.27
Reducing the number of KC-135s in depot to a manageable level is a real success
story, Air Force officials say. However these improvements have come at a real
monetary cost, and aren’t expected to get any better. According to one Air Force
official, “we mined all the gold we can there.”28
Lease opponents say that Air Force assertions that depot maintenance can’t
further improve are unproven. When the Air Force projects the future costs of
acquiring new aircraft (such as the F/A-22) it often banks on “future savings” that
will result from manufacturing improvements that don’t exist today, but are expected
to emerge in the future. Why are depot maintenance improvements a dead end, lease
opponents ask, when manufacturing improvements for new aircraft are projected to
occur as an article of faith? For example, depot workers discovered how to save
$500,000 per aircraft by conducting 60-hour fuel filter checks and scrubbing fuel
tanks rather than engaging in topcoat removal procedures. KC-135 depots improved
their processes by paying heightened attention to critical path management, and
“kitting” major structural repair parts.29 Current workers at Tinker, AFB – one of
three KC-135 depots -- report that present flow time for aircraft in and out of PDM
is still decreasing thanks to process improvements.30 What is prohibiting, lease
opponents ask, depot workers from “climbing the learning curve,” and discovering
new maintenance improvements?
Corrosion and Fleet-Wide Grounding. The Air Force has recently said
that the need to replace the KC-135 fleet is urgent because the aging aircraft is prone
to mechanical or structural problems that could result in a fleet-wide grounding. The
July 10th Air Force report to Congress on the KC-767 lease argued that there were
“...increasing possibilities that this 43-year-old aircraft could encounter a fleetgrounding event, crippling our combat forces.” (p.2.) Former acquisition chief Pete
Aldridge, for example, remarked, “‘We cannot continue to fly the KC-135s forever,
26
KC-135 Tanker Aging Aircraft Story. General Handy, CINCTRANSCOM. General Lyles,
Commander AFMC. August 2, 2002.
27
KC-135 Tanker Aging Aircraft Story. General Handy, CINCTRANSCOM. General Lyles,
Commander AFMC. August 2, 2002.
28
Major General Paul W. Essex, Director, Plans and Programs, HQ Air Mobility Command.
“U.S. Representative Duncan Hunter Holds Hearing on Air Force Tanker Lease Program.”
July 23, 2003 FDCH Political Transcripts. Washington, DC.
29
“Fact Sheet.” Office of Legislative Liaison. USAF. August 13, 2003.
30
Conversation between CRS and Tinker AFB employees. August 19, 2003.
CRS-17
and the longer you wait to recapitalize, the more you run the risk...of a fleet of those
aircraft being grounded for some reason.’”31
Much of the Air Force’s concern over the prospects of fleet-wide grounding is
based on the KC-135's problems with corrosion. The KC-135 is particularly
susceptible to corrosion. The materials and manufacturing techniques used to
produce this aircraft in the 1950s did not reflect modern corrosion prevention
techniques. The Air Force cannot accurately predict the extent or cost of corrosion,
Air Force officials now say, and currently lacks mature diagnostic tools that could
help safely and economically extend the life of the KC-135 fleet.32 Because of
corrosion’s unpredictability, the Air Force is concerned that it has little idea if, when,
or how badly the next big corrosion problem will appear.
Air Force officials say they have recently experienced a “wake up call”
regarding the viability of the KC-135 fleet, and it is prudent to take heed of this
warning. On January 13, 1999 a KC-135 crashed in northwestern Germany, killing
all four crew members onboard. Investigating the cause of this accident, Air Force
officials found problems with the aircraft’s stabilizer trim actuators. Between
September 1999 and February 2000, 139 aircraft (24% of the total fleet, 40% of the
aircraft available) were grounded for repair.33 If this grounding had happened during
an important operation, such as, Operation Iraqi Freedom, the Air Force’s ability to
project power would have been diminished, and the conflict could have been
prolonged, possibly resulting in higher casualties. The bottom line for the Air Force
is, in the words of acquisition chief Marvin Sambur that “we have no confidence in
the Es right now.”34
Lease opponents do not dispute the fact that the KC-135 is old or that is has
corrosion problems. They take issue however, with the Air Force’s depiction of the
problem.
The KC-135 fleet clearly suffers from corrosion, and this causes noteworthy
maintenance problems. However, lease opponents say, the Air Force makes
observations about corrosion that appear out of sync with the experience of other
military services. The Navy and Marine Corps have had to deal with the effects of
corrosion since the inception of naval aviation because their aircraft operate in much
more corrosive environments that the Air Force typically does. Engineers at the
31
John Tirpak. “100 Tankers” Air Force Magazine. August 2003.
32
USAF Need for KC-135 Recapitalization: Operational, Maintenance & Economic
Implications. A September 2002 Reassessment of the KC-135 Economic Service Life Study.
U.S. Air Force.
33
Frank Wolf. “Air Force Conducting KC-135 Systems Assessment. Defense Daily.
November 18, 1999. and “Point Paper on Fleet Wide Grounding of Aircraft.” Office of
Legislative Liaison, USAF. August 14, 2003.
34
Dr. Marvin Sambur, Assistant Secretary of the Air Force (Acquisition). “U.S.
Representative Duncan Hunter Holds Hearing on Air Force Tanker Lease Program.” July
23, 2003 FDCH Political Transcripts. Washington, DC.
CRS-18
Navy’s Naval Air Systems Command remark that “corrosion is a known problem that
the Navy takes proactive steps to manage.”35
As far back as 1965, the Air Force recognized that corrosion was a problem that
it would increasingly face in the future. One study recognized that the Navy had
instituted effective corrosion protection and prevention measures and recommended
that the Air Force emulate Navy procedures and initiate additional procedures to
better mitigate corrosion problems.36 Why, lease opponents ask, is corrosion difficult
for the Air Force to predict, and why are its diagnostic tools “immature,” when this
problem has been known for 40 years? Current claims that corrosion is difficult to
predict also appear in conflict with Air Force statements in the ESLS of just two
years ago that appear quite predictive: “Aging-related structural repairs due to
corrosion will continue to increase at a manageable rate.”37
Lease opponents also say that the Air Force appears to be exaggerating the risks
and potentially the consequences of a fleet-wide grounding of the tanker fleet. Many
note that “By having 90 percent of its refueling fleet in one aircraft type, the Air
Force for some years now has been accepting the risk of fleet-wide problems that
could ground the entire fleet.”38 If the Air Force has been living with this risk for
many years, why, lease opponents ask, has concern only been voiced recently?
The Air Force claims that the September 1999-to-February 2000 grounding of
24% of the KC-135 fleet was a serious warning that similar groundings could happen
in the future, and that such events could threaten U.S. power projection capabilities.
If true, lease opponents ask, why has the Air Force only begun discussing this
recently? The 2001 ESLS study did not mention concern over fleet-wide grounding.
No Air Force congressional testimony included discussion of this event until June
2003, and no Air Force or DOD official was reported in the press to have expressed
any concern about fleet-wide grounding prior to April 2002.39 If the Air Force were
concerned about the risks of fleet-wide grounding, lease opponents say, it would have
made this case soon after the four-month event. Waiting until the KC-767 lease was
being debated diminishes the strength of the Air Force’s argument, lease opponents
say. Furthermore, critics say, the Air Force appears to be overstating the
consequences of the four-month KC-135 grounding episode. The United States
successfully prosecuted Operation Allied Force (the air war over Kosovo), with 40%
of the fleet unavailable. This conflict saw the largest deployment of air assets and
aerial refueling aircraft since the 1991 war in Iraq, proving, critics say, that the Air
35
Conversation between CRS and Navy officials at the Naval Air Systems Command (Naval
Air Station Pax River). August 13, 2003.
36
Lieutenant Colonel (USAF) Robert C. Drebelbis. “Corrosion as a Problem to the Air
Force.” RAND. Santa Monica, CA. March 1965. P-3080.
37
KC-135 Economic Service Life Study. Technical Report. February 9, 2001. p.vi.
38
“Military Aircraft: Considerations in Reviewing the Air Force Proposal to Lease Aerial
Refueling Aircraft.” Statement of Neal P. Curtin, Director Defense Capabilities and
Management. GAO-0301048T. July 23, 2003. p.7
39
Vago Muradian. “Air Force Sees Merit In Mixed Boeing-Airbus Tanker Fleet.” Defense
Daily International. April 12, 2002.
CRS-19
Force was clearly able to make do with their diminished assets. Furthermore, the
United States also participated in far-flung stabilization and humanitarian operations
in Venezuela and East Timor at the same time as forces were engaged in Kosovo.
Aircraft are frequently grounded to address new-found mechanical problems40, critics
say. Moreover, there’s nothing to say that the KC-135 fleet is any more prone to a
catastrophic event than many other aircraft in the Air Force and Department of Navy
inventories.
Post 9/11 KC-135 Usage and New Military Strategy. The Air Force has
recently argued that another factor contributing to the urgency of replacing the KC135 fleet is the unanticipated increase in KC-135 flying hours. Relatedly, the
Defense Department revised its military strategy in light of post September 11th
security requirements, and this new strategy will put increased strains on a force that
already falls short of tanking needs.
Since September 11, 2001, Air Force officials say, the tanker fleet has been key
to protecting the U.S. homeland (Operation Noble Eagle), and prosecuting the global
war on terrorism (Operations Enduring Freedom and Iraqi Freedom). While
performing admirably, Air Force officials say “...the KC-135's...are beginning to
show real signs of wear and are being used at a steady state tempo over the last two
years that were never forecast or even imagined before September 11, 2001.”41 Flying
hours for the KC-135s averaged about 300 hours per year between 1995 and
September 2001. Since then according to the GAO, employment is averaging about
435 hours per year.42 This unanticipated use, KC-767 lease proponents say, is
wearing out the 42 year old aircraft even faster than anticipated just 3 years ago.
Lease opponents recognize the upturn in flight hours, but challenge that the
consequences are as negative as the Air Force contends. Corrosion, lease opponents
point out, is the limiting problem with the KC-135, and increased use does not make
corrosion worse. If the KC-135's limiting factors were flying hours, or metal fatigue,
for example, the increase in flying hours could have a noteworthy detrimental impact
on the KC-135's remaining life. Increased flying hours, however, have less impact
on the aircraft’s corrosion problems, they say. Lease advocates concede that
increased flying hours do not directly make corrosion worse. They point out
however, that increased flying hours may lead to deferred depot maintenance, where
corrosion problems would be addressed. Thus, increased flying hours can indirectly
exacerbate corrosion problems.
The Air Force also argues that today’s tanker fleet is facing a new set of
requirements that is more challenging than past requirements – and that the fleet
40
David Fulghum. “EADS Fuels Tanker Challenge.” Aviation Week & Space Technology.
August 4, 2003 p. 25.
41
Dr. Marvin Sambur, Assistant Secretary of the Air Force (Acquisition). “U.S.
Representative Duncan Hunter Holds Hearing on Air Force Tanker Lease Program.” July
23, 2003 FDCH Political Transcripts. Washington, DC.
42
“Military Aircraft: Considerations in Reviewing the Air Force Proposal to Lease Aerial
Refueling Aircraft.” Statement of Neal P. Curtin, Director Defense Capabilities and
Management. GAO-0301048T. July 23, 2003. p.2
CRS-20
could not satisfy the old requirements. Rather than defeat two major regional
adversaries (the old strategy), the new strategy (outlined in the Defense Planning
Guidance FY04-09) requires the military to 1) defend the United States, 2) deter
aggression and coercion in four critical regions, 3) swiftly defeat aggression in two
overlapping major conflicts, and 4) upon the President's direction, win decisively
against one of the two major conflict adversaries. According to Air Force documents
the new strategy “...coupled with anti-access/area denial challenges show increasing
importance and reliance on a viable, sustainable, effective tanker fleet.”43 These
increased requirements argue strongly, the Air Force says, for recapitalizing the
tanker fleet as soon as possible.
Those skeptical of the KC-767 lease challenge the Air Force assertion that the
new strategy will automatically result in increased tanking requirements. Opponents
challenge this assumption first, because the Air Force has not conducted a tanker
requirements study since the new strategy has been declared. When asked how the
Air Force could be so sure of its future requirements considering the lack of analysis,
one Air Force official replied:
Because we're convinced that the requirement for air refueling is large and will
continue to be very large. As we talked just a moment ago, the requirement is
growing, actually, although I can't give you a specific number right here for how
much it's grown, based on the new Defense Planning Guidance, yet. But we
know it's growing, we know it's going to continue to be very large...44
Lease opponents agree that conventional wisdom suggests that the new military
strategy could demand increased tanker capabilities. However, they say,
conventional wisdom is often wrong. Determining future tanker capabilities is very
complex, and really requires serious analysis. The Air Force does not know what its
requirements are going to be 10, 20, 30, or 40 years hence, and it certainly does not
know what future Navy or Marine Corps tanker requirements will be. What will be,
opponents ask, the net effect on tanking of more aggressive and pervasive fielding
of unmanned aerial vehicles (UAVs)? Will these more fuel efficient platforms
reduce requirements as they replace manned aircraft in the inventory? Or will UAVs
continue to augment, rather than replace manned aircraft, and thus add to tanker
requirements? Many suggest that air ships (blimps) and unmanned tethered balloons
(aerostats) will likely replace AWACS for a variety of surveillance missions in the
future; such as homeland defense. If this transition occurs, and when, may have
implications for future tanker requirements.
Lease opponents also note that dramatic improvements in targeting and weapon
miniaturization is translating into fewer combat sorties, which, in turn, means fewer
refueling sorties. Although a simple comparison, lease opponents say one can
compare airpower in the last two wars with Iraq and conclude that, the Air Force can
43
White Paper on KC-767A. The Aircraft to Begin Our Tanker Recapitalization. HQ
AMC/XPR January 10, 2003. p.2.
44
Major General Paul W. Essex, Director, Plans and Programs, HQ Air Mobility Command.
“Hearing of the Projection Forces Subcommittee of the House Armed Services Committee.”
2118 Rayburn House Office Building. June 24, 2003. Federal News Service, Inc.
CRS-21
already do “more with less.” How much more effective will tomorrow’s air
operations become as current R&D programs reach fruition, and what effect will this
have on tanking needs? These questions, lease opponents argue, require a study to
answer, and it cannot be assumed that tomorrow’s aerial refueling needs will exceed
today’s.
Table 1. Aerial Refueling and Combat in Two Conflicts
1991
Desert Storm45
USAF Tankers Deployed
2003
Iraqi Freedom46
224: (30 KC-10)
(194 KC-135)
182: (33 KC-10)
(149 KC-135)
USAF Tanker Sorties
11,024
6,193
Combat Sorties (All Services)
57,631
18,695
Finally, lease opponents ask why the Air Force is planning to prematurely retire
68 KC-135E models. If the current fleet is deficient today, and tomorrow’s
requirements are to be even more difficult to satisfy, why doesn’t the Air Force want
new tankers in addition to, rather than in lieu of, the 68 KC-135Es, lease opponents
ask. Premature retirement of 68 KC-135Es, they say, reduces the strength of the Air
Force’s argument that recapitalization is required to satisfy growing tanker
requirements.
Air Force officials recognize that, on one level, retiring 68 KC-135Es can
appear inconsistent with the stated concern over increasing tanker requirements.
Also, Air Force studies, such as the May 1, 2003 BCA, do indicate that early
retirement does incur a small amount of risk in terms of reduced tanker capabilities
between the years FY03 and FY14. However, the O&M costs of maintaining the
oldest KC-135Es is so onerous, the Air Force says, that cost savings achieved from
retirement more than make up for this slight decrease in capability. Furthermore,
savings from retiring the 68 aircraft can be reinvested in the remaining fleet to
increase its availability, and also help fund tanker recapitalization efforts.47
Is the KC-767 the Best Aircraft for the Job?
by (name redacted)
(707-2577)
If the Air Force need to replace the KC-135E fleet is urgent, then the number
of replacement options is narrowed. Those options that can be implemented more
quickly become more attractive than those that take longer to implement. The Air
45
Gulf War Air Power Survey. Statistical Compendium and Chronology. Vol. V.
Washington, DC. 1993. P.232.
46
Operation Iraqi Freedom – By the Numbers. USCENTAF. Assessment and Analysis
Division. April 30, 2003. p.7-8.
47
“KC-135E Business Case Analysis.” Headquarters, USAF. May 1, 2003.
CRS-22
Force presents the KC-767 lease as the most timely solution to its recapitalization
problem, and the KC-767 airframe as the most effective way to improve aerial
refueling capabilities.
It is important to understand how well KC-767 attributes match Air Force needs
because if leased and then purchased, these 100 aircraft could likely be in the
inventory for at least 50 years. Also, many believe that if the Air Force is successful
in leasing and purchasing these 100 aircraft, it will attempt to lease and/or purchase
some additional number of KC-767s, perhaps up to another 100.48 Former defense
acquisition chief Pete Aldridge, for example, was reported to have said that DOD
plans to purchase more than the initial 100 KC-767s. Aldridge said that DOD was
successful in negotiating a lower price for the KC-767 by promising follow-on
purchases.49 Boeing officials deny any government commitment for anything but the
number of aircraft in the current KC-767 lease.50
Five comparisons can be made when considering the KC-767 aircraft and its
ability to satisfy the aerial refueling mission needs:
! How does the KC-767 compare to the aircraft it will replace?
! How well does the KC-767 meet operational requirements?
! How does the KC-767 compare to surplus aircraft available on the commercial
market?
! How does acquiring the KC-767 compare to re-engining the KC-135Es?
! How does acquiring the KC-767 compare to leasing aerial refueling services?
KC-767 vs KC-135. The Air Force compares the KC-767 to the KC-135, and
says that the new aircraft is clearly superior to the old. The KC-767 is more flexible
and more capable than the KC-135, supporters argue. All KC-767's for example, like
the KC-10, will be aerial refuelable. The KC-767 can carry 108 patients in its
Aeromedical role, compared to the KC-135's 24 patients. The KC-135 can only
refuel Navy and coalition aircraft after maintenance personnel spend six-to-24 hours
attaching a temporary drogue to the refueling boom. The KC-767's drogue is integral
to the aircraft. Furthermore, the KC-767 can use either the boom (to refuel Air Force
aircraft) or the drogue (to refuel Navy, Marine Corps, or allied aircraft) on the same
mission. The KC-135 can use either the boom or the drogue on the same mission,
48
John Tirpak. “100 Tankers.” Air Force Magazine. August 2003. “...he (Donald Rumsfeld)
blessed language stating the intent of the Defense Department to ‘go beyond the first 100
767s’ with additional acquisitions.”
49
John Donnelly. “Tanker Deal is ‘Unmatched,’ Advocates Say.” Defense Week. August 4,
2003.
50
If the Air Force does lease or purchase of an additional number of KC-767 aircraft beyond
the currently discussed 100, it would appear to contradict the Air Force’s current Tanker
Roadmap, which calls for conducting an AOA after the lease is established, to determine the
best tanker capabilities and characteristics to recapitalize the remainder of the KC-135 fleet.
CRS-23
but not both. The KC-767's cargo carrying capacity is over twice as large as the KC135s: 77,000 lbs on 19 pallets compared to 36,000 lbs on 6 pallets. 51 Also, the KC767's ability to operate from shorter runways (8,000 feet) than the KC-135 (12,000
feet) will provide greater flexibility and options. There are approximately 8,000
airfield world wide from which the KC-767 will be able to operate compared to 228
for the KC-135.52
In addition to being more capable, the KC-767 should also be much more
available than the KC-135, the Air Force says. As demonstrated by Table 2 below,
the KC-767 is estimated to be more available to the warfighter than the KC-135.
Over a six-year period, a given KC-135E aircraft can be expected to be available only
60 percent of the time. The 870 days of unavailability (out of a total number of 2,190
days in six years) is caused by the maintenance activities and modifications described
below. Flight line and scheduled depot maintenance cause the bulk unavailability.
Table 2: Projected Aircraft Availability
(Days not available to the warfighter in a 6-year period per aircraft)53
KC-135E*
KC-135R*
KC-767**
Scheduled Depot
325
288
48
Unscheduled Depot
19
19
31
Mods
62
62
0
Flight Line Maintenance
464
346
95
Total Not Available
870
715
174
Bottom Line Available
60%
67%
92%
* Based on actual data extended over a 6-year operational time frame
** Based on FY12 fleet projections extended over a 6-year period.
KC-767 versus Operational Requirements. In many ways, lease
opponents admit, the KC-767 does compare favorably to the KC-135. However,
lease opponents say, the Air Force does not make the most important comparison
between the aircraft, which is maximum fuel capacity. Despite its modernity, the
KC-767 only carries 1 percent more fuel (2,000 lbs) than the KC-135. The KC-767's
cargo and aeromedical capabilities, for example, are second order issues for
consideration, lease opponents say. These aircraft are being acquired to provide fuel,
51
Tanker Roadmap (Draft). Colonel Scott Wuesthoff. Chief, Global Mobility Panel.
AF/XPPM. June 18, 2003. P.10.
52
White Paper on KC-767A. The Aircraft to Begin Our Tanker Recapitalization. HQ
AMC/XPR January 10, 2003. P.3.
53
Adapted from Tanker Roadmap (Draft). Colonel Scott Wuesthoff. Chief, Global Mobility
Panel. AF/XPPM. June 18, 2003. P.10. Emphasis of text in bottom row added by CRS.
CRS-24
and when comparing total fuel carrying capability, the KC-767 represents almost
negligible improvement over the KC-135.
Another more meaningful evaluation of the KC-767's performance is how it
compares to Air Force requirements. Air Force aerial refueling requirements are
expressed in the Operational Requirements Document (ORD) (HQ AMC/XPR,
October 22, 2002). Lease opponents say that the KC-767, while looking good
compared to the KC-135, does not measure up in many important areas to the ORD
yardstick.
The ORD requires, for example, that the KC-135's replacement be able to refuel
two aircraft simultaneously with the hose-and-drogue system. The KC-767 variant
being considered in this lease cannot satisfy this requirement. It can only refuel one
aircraft at a time with the hose-and-drogue which considerably reduces, opponents
say, its operational capabilities.
Another KC-767 shortcoming, opponents say, is the aircraft’s inability to
offload multiple types of fuel on the same mission. The ORD lists this objective
because it would greatly enhance the aircraft’s ability to simultaneously fuel both Air
Force and Navy and Marine Corps aircraft. Both service’s aircraft can operate on the
same fuel if necessary. However, to minimize the hazard of shipboard fires, Navy
and Marine Corps aircraft regularly use a type of fuel less prone to ignition than the
standard Air Force fuel. Carrier-based Navy and Marine Corps aircraft will only use
Air Force fuel infrequently, because their tanks must be emptied prior to landing, and
their fuel systems must be flushed clean to avoid contaminating the carrier’s fuel
supply with the Air Force’s more combustible fuel. Thus, a KC-767 able to offload
only one type of fuel on a single mission is much more limited in the types of aircraft
it can service, contend lease opponents.
Some of the capabilities that the Air Force and Boeing tout sound attractive,
opponents say, but they aren’t required by the ORD. This brings into question how
important these capabilities really are. The ability to operate from runways less than
12,000 feet is one example. The Air Force also reportedly wanted the KC-767 built
in a “combi” configuration that would permit it to carry passengers and cargo at the
same time. This configuration, however, would have required building a special
bulkhead, and would have presumably increased the cost of the aircraft, so the plan
was dropped.54 The loss of this capability, opponents say, is another example of how
the KC-767 might look good compared to a 42 year-old aircraft, but still might not
have the attributes most attractive in a new aerial refueling aircraft.
The Air Force and other lease supporters could counter these criticisms by
pointing out that the KC-767 does satisfy the majority of ORD requirements. It is
unrealistic to expect an aircraft to satisfy all of the requirements, and the many that
the KC-767 does satisfy more than make up for the one or two that it does not. The
ability to offload more than one type of fuel on a single mission is an ORD objective,
lease supporters argue, not a requirement. Also, supporters point out, provisions
54
John Tirpak. “100 Tankers.” Inside the Air Force. August 2003.
CRS-25
have been made to add hose-and-drogue wing pods – which would enable
simultaneous refueling of two aircraft – if future needs warrant.
KC-767 versus Other Aircraft. Another way to determine if the KC-767 is
the best aircraft for the job is to compare it to other available aircraft. The Air Force
says that it evaluated 747, 757, 767, 777, and A330 aircraft, and found the 767 the
best candidate for the aerial refueling mission.55 These aircraft are not the only
alternatives to be considered, critics argue. Lease opponents note that there is
currently a glut of excess commercial airliners on the market, and the Air Force could
more cheaply buy some number of these unwanted aircraft and convert them into
tankers. Some estimate that over 700 surplus commercial airliners are in long-term
storage facilities in the American southwest alone.56
Surplus Boeing DC-10 aircraft, for example, appear to be excellent candidates
for conversion into tankers and for recapitalizing some portion of today’s KC-135
fleet, lease opponents say. The Air Force already operates 59 converted DC-10s –
called KC-10 Extenders. These aircraft have almost twice the maximum fuel
capacity of both the KC-135 and the KC-767. Using the Air Force’s own
comparative metrics, the KC-10 is a 1.95 KC-135 equivalent – in other words, it has
195 percent of the KC-135's fuel carrying capabilities. Thus, 50 KC-10s have
roughly the same tanker capabilities as 100 KC-135s. Also, lease opponents point
out, the KC-10 can use the refueling boom and the hose-and-drogue systems on the
same mission. The KC-10 also has a much larger cargo carrying capacity (170,000
lbs) than either the KC-135 or the KC-767. This large capacity would also be a boon
to the Air Force’s strategic airlift capabilities, which are currently hard pressed to
meet the requirements established in the Air Force’s latest requirements study.57
In addition to these operational advantages, lease opponents point out that
buying and converting surplus DC-10s into KC-10s offers significant financial
advantages over the KC-767. Surplus DC-10s are being offered for sale for $600,000
to $10.3 million each.58 If 50 surplus DC-10s could be purchased for $10 million
each, and if the tanker conversion cost another $40 million59, the Air Force could
replace the oldest 100 KC-135s with 50 tankers that are twice as capable for a only
$2.5 billion, lease opponents say. Just as important, the Air Force has already
invested in KC-10 training, O&M, and military construction. These investments
would have to be borne anew for a KC-767 fleet. Between 42 and 57 DC-10 aircraft
55
KC-767A Report to Congress Status Brief. Headquarters U.S. Air Force. July 15, 2003.
P. 14-16.
56
Edward Wong. “Airlines’ Unwanted Fleet Grows in Desert.” New York Times. June 7,
2003.
57
See CRS report RS20915, which points out that the current strategic airlift fleet is
approximately 10 million ton miles per day (MTM/D) short of the 54.5 MTM/D
requirement.
58
59
“Semi-Annual Jet Aircraft Value Listing.” Aircraft Value News. July 28, 2003.
The cost of the aerial refueling components of the KC-767 is roughly estimated to be
approximately 30 percent of the cost of the 767 ($138 million), or $40 million. Source: CRS
meeting with Boeing representatives, July 30, 2003.
CRS-26
were available for sale or lease between September 2002 and August 2003.60 At least
twenty five of these aircraft were equipped with the same CF6-50C2 engines as the
Air Force’s KC-10 fleet.61
The Air Force could counter the arguments above with several points. First,
surplus DC-10s are used aircraft. Used aircraft conditions vary widely, and not all
may be in acceptable condition. How much life is left in each aircraft? Commercial
airlines put many more flight hours annually on their aircraft than does the military.
How well has the aircraft been maintained? The Air Force has purchased and
converted surplus commercial aircraft before, it says, and has run into difficulties.
The Air Force’s first two E-8A JSTARS development airplanes were 20-year-old
commercial Boeing 707s. Conversion difficulties and questions of remaining service
life convinced the Air Force that it needed to design and implement a more robust
inspection and verification program to ensure the that surplus aircraft being
considered actually have the capabilities and characteristics advertised. Relatedly,
the Air Force could argue, the DC-10 is yesterday’s technology. While the Air
Force’s 59 KC-10s are very capable tankers, their future is limited. The DC-10's
1980s-era design and components do not offer all the opportunities represented in a
brand new aircraft. The KC-767 will offer room for technological growth that the
KC-10 can’t match.
Figure 5. DC-10 Availability
60
[http://www.airtrading.com. August 4, 2003].
61
[http://www.speednews.com. August 1, 2003].
CRS-27
KC-767 versus Re-Engining KC-135Es. Another contentious debate has
arisen over re-engining KC-135E aircraft – essentially turning them into KC-135Rs.
KC-767 lease critics say that re-engining the KC-135E has many merits that should
be considered as an alternative to leasing 100 new aircraft. Upgrading the E’s
engines will increase the aircraft’s takeoff power, cruise speed and other performance
parameters. Despite their old age, the KC-135Es have only used approximately half
their flying hours. Re-engining them to improve their performance over their
remaining lifetime, perhaps 35 more years, would be a cost-effective and prudent
step, many argue.
A major advantage of this approach, lease critics say, is timeliness. If the need
for improved tanker capabilities is urgent, as the Air Force argues, then upgrading the
“E” fleet to R models may be the quickest solution.62
The second advantage of this approach is cost. The GAO estimates that reengining 127 KC-135Es would cost $3.6 billion, a much lower figure, lease
opponents say, than the Air Force’s $17.2 billion estimate for leasing the KC-767,
or the $24.6 billion total program cost (plus the $4.4 billion likely spent at the end
of the lease to purchase the aircraft.)63 Not only is the cost of the re-engining
procedure low, compared to the 767 lease, but this approach also saves money by
avoiding projected maintenance on the old engines that will be replaced. Much of the
increased cost projections for the KC-135 from 2001 to 2040 have to do with engine
maintenance. According to the ESLS study: “E-model per A/C Engine Costs are 20
times the R-Model.”64 Thus, the out-year maintenance costs avoided by this reengining will help finance the $3.6 billion initial investment, lease opponents argue.
A third advantage of re-engining is that it will eliminate one of the KC-135E’s
most challenging maintenance problems: corrosion of the engine strut. Corrosioninduced maintenance and repair of the KC-135E engine struts have recently been
estimated at $3 million per aircraft.65 Concerns over the effects of corrosion on this
key structure have also led the Air Force to impose flight restrictions on the Emodels. Eliminating these problems, in addition to the cost savings and performance
improvements, argues strongly for re-engining, lease opponents say.
The Air Force is strongly opposed to re-engining the KC-135E fleet. According
to the GAO, the Air Force has not requested funds for re-engining E-models since
1993. Congress or DOD have added funds to upgrade approximately 2 E Models per
62
“Preliminary Information on Air Force Tanker Leasing.” Neal Curtin. Director, Defense
Capabilities and Management. GAO-02-724R. May 15, 2002.
63
John Tirpak. “100 Tankers” Air Force Magazine. August 2003.
64
KC-135 Economic Service Life Study. Tanker Requirements Study for FY05.
HQAMC/XPY. P.13 “Engine Cost Growth.”
65
USAF Need for KC-135 Recapitalization: Operational, Maintenance & Economic
Implications. A September 2002 Reassessment of the KC-135 Economic Service Life Study.
U.S. Air Force. P.6
CRS-28
year to R Models at a cost of about $29 million per aircraft.”66 The Air Force makes
a number of arguments against re-engining. First, only 100 of the E-models are
candidates for re-engining.67 So, if re-engined, the final number of R-models in the
inventory would be at least 27 fewer than advocates of this approach believe. Second,
re-engining will improve some of the KC-135E’s capabilities, but it does nothing to
address the underlying issue of the aging aircraft fleet. According to former DOD
acquisition chief Pete Aldridge, the upgrade from E-models to R-model “will not buy
you any lifetime, and that’s what we need to buy: additional life.”68
The third argument the Air Force makes against re-engining the KC-135Es is
one of immediate and longer-term availability. Re-engining the Es would remove
them from the active inventory for at least six months. Re-engining, the Air Force
argues, would decrease the availability of air refueling tankers when the Air Force
has the highest demand on tankers – now, during a war. Re-engining the KC-135E
fleet would leave “tired iron” in the inventory that would degrade mission capable
rates relative to a new aircraft.
Fourth, the Air Force says, while re-engining may obviate corrosion problems
with the engine strut, it will not address any of the numerous remaining problems
such as the wing attachment fittings, electrical wire replacement, and body skin
replacement that will continue to plague the KC-135R fleet.
The final Air Force argument against re-engining the E-fleet is economic. KC135Es have approximately 80 percent the capability of a KC-135R. If the Air Force
were to re-engine and convert the E-model to an R-model, it would gain a 20 percent
increase in capability for the $38 million investment. This is a poor deal, the Air
Force argues. Also, according to Air Force studies, converting E-models to R-models
exacerbates the recapitalization problem considerably, because it does not satisfy
recapitalization requirements, it only postpones them. Furthermore, it postpones
recapitalization with a significant investment ($3.87B for 100 aircraft) that will take
decades to pay for itself, the Air Force argues.69
KC-767 versus Leasing Tanker Services. Those critical of the proposed
767 lease also say that there are other alternatives to purchasing or leasing an aircraft.
Instead, the Air Force could reduce the KC-135's workload and buy time to explore
other recapitalization options by leasing tanker services. The U.S. Navy, for
example, has signed a five-year deal with a private company to refuel Navy and
Marine Corps aircraft participating in exercises or flying from Atlantic to Pacific
Coasts. The Navy does not own, or even lease the aircraft. It contracts to have tanker
66
Air Force Tanker Leasing. General Accounting Office. GAO-02-724R. May 15, 2002.
p.14.
67
Major General Paul W. Essex, Director, Plans and Programs, HQ Air Mobility Command.
“U.S. Representative Duncan Hunter Holds Hearing on Air Force Tanker Lease Program.”
July 23, 2003 FDCH Political Transcripts. Washington, DC.
68
John Tirpak. “100 Tankers” Air Force Magazine. August 2003.
69
“KC-135E Business Case Analysis.” Headquarters, USAF. May 1, 2003. p.E-2.
CRS-29
services provided. The Navy is reportedly satisfied with the company’s cost – about
half that of military aerial refueling – and reliability.70
The United Kingdom is also soliciting bids from private firms to provide its
military with aerial refueling services. As a private finance initiative the source of
refueling services would provide the Royal Air Force (RAF)with both the tanker and
the support services. The RAF will own the services of the fleet – 10 aircraft for 27
years – but not the aircraft. The vendor would technically own the aircraft (which
appear likely to be 767s) and would also make them available for third-party usage
when not demanded by the RAF.71
Leasing tanker services would be more advantageous than leasing or buying
KC-767's, lease opponents argue, for several reasons. Leasing tanker services could
augment the Air Force’s tanking quickly, thereby satisfying the Air Force’s stated
urgent need. Also, leasing service would avoid any kind of cost associated with
recruiting, training and paying an aircrew. The Air Force currently suffers from very
high operations tempo (OPTEMPO), as it deals with the unanticipated strains of
fighting the global war on terrorism, lease opponents point out. This high
OPTEMPO exacerbates a long standing problem the Air Force has had with too few
KC-135 crews. Leasing tanker services could immediately ameliorate this problem.
The current DOD leadership has a consistent track record of promoting outsourcing
and privatization. Why not apply the same principles to recapitalizing the aerial
refueling fleet, critics of the 767 lease ask?
Unlike the Navy, the Air Force has not yet hired private refueling services to
support exercises or training. Supporters of the proposed 767 lease may argue that
such services are inherently limited in their application: companies have a difficult
time getting insurance for aircraft that fly into war zones. Also, it would be difficult,
they argue to get private pilots to fly into contested areas. During Operation Iraqi
Freedom the Air Force aggressively flew tankers well into Iraqi airspace. Would
private pilots balk if asked to do the same? The number or companies willing to
engage in such business is limited, lease supporters argue, and it is unlikely that
companies currently in this line of work could provide the Air Force with the number
of aircraft required to meet anticipated needs. So, while there may be some niche
applications for leasing tanker services, most believe it is no replacement for fleet
recapitalization. Also, most private companies can refuel Navy and Marine Corps
aircraft, but not Air Force aircraft, so their application may be limited in that
dimension as well. Outsourcing and privatization do have their applications, lease
supporters agree, but Air Force tanker aircraft are combat systems, not a commissary
or depot. To be effective and reliable, combat systems must be operated by, and
controlled directly by the military, who are trained and disciplined to deal with
combat situations.
70
Paul Lewis. “USAF and Omega Feud Flares Up.” Flight International. August 20, 2002.
and Ron Laurenzo. “Private Aerial Tanker Earns Navy’s Praise.” Defense Week. April 22,
2002.
71
“Marshall Aerospace to Perform 767 Conversion For TTSC's FSTA Bid” Defense Daily
International. June 6, 2003. (Unattributed)
CRS-30
Industrial Base Concerns
by Dan Else
(707-4996)
In addition to the operational urgency arguments outlined above, the Air Force
and lease supporters say that two industrial base concerns argue strongly for
immediately implementing the KC-767 lease: leasing the 767 before its production
line closes, and supporting the Boeing Company during a period of unusual economic
hardship.
Viability of the 767 Production Line. The Air Force argues that the KC767 lease should be implemented immediately because a lack of business may force
Boeing to shut down this production line in the near future. In essence, if the Air
Force does not act now, it may not have this opportunity again.72
A review of publically available information on the 767's business suggests that
the 767 production line is not in imminent danger of being shut down. The backlog
of production orders on the 767 line as of mid-August 2003 appears to be sufficient
to sustain minimum-rate production through at least February 2006.73
Boeing’s 767 production line has been able to maintain a production rate of 20
aircraft or less per year (less than two per month), and industry analysts estimate that
the minimum sustainable rate for Boeing’s commercial aircraft lies at approximately
one aircraft per month.74 At the end of 2002, thirty nine 767s had been ordered but
not delivered. During 2003, 19 of these aircraft were completed and delivered, and
another 11 were put on order. This means that, as of mid-August 2003, there is a
production backlog of 31 commercial 767s. At the minimum sustainable production
72
Michael Wynne, Acting Undersecretary of Defense. “...Congress gave us pilot program
authority to lease, this allowed the department to aggressively pursue a tanker design based
on the 767 airframe before its commercial production lined ended, an option which might
not have been available in FY’06.”July 23, 2003 FDCH Political Transcripts. Washington,
DC. An Air Force briefing offered in late 2002 stated that “Leasing replacement tankers is
feasible today; USAF may not get an opportunity like this again.” During May 2003, the
then-Under Secretary of Defense for Acquisition, Edward C. “Pete” Aldridge stated “We’ve
got to have a new tanker, and here’s a chance to do it sooner. If it (767) goes out of
production, who do you turn to? Airbus? I don’t think so.” See USAF Need for KC-135
Recapitalization: Operational, Maintenance & Economic Implications. A September 2002
Reassessment of the KC-135 Economic Service Life Study. U.S. Air Force. p. 23; and Les
Blumenthal, “Boeing Deal Worth Billions,” The News Tribune (WA), May 24, 2003, p. A1.
73
This projection assumes that the production line will be maintained at the minimum
sustainable rate. Should Boeing maintain a higher rate of production, the production line
could be closed out much sooner. For example, if Boeing maintained a production rate of
3 aircraft per month, the current backlog could be depleted by July of 2004.
74
See James Wallace, “Boeing Looks At One Line For Two Models,” Seattle
Post-Intelligencer, December 20, 2002, p. A1; and Helen Jung, “Boeing’s 767 Tanker Deal
a Boon to Ailing Line,” Associated Press Newswires (May 23, 2003, 20:31.
CRS-31
rate of 1 aircraft per month, therefore, Boeing’s production line for the 767 could
possibly operate until February 2006 without any additional orders being placed.75
Beyond February 2006, the viability of the 767 production line is less certain.
Commercial market demand for the 767 appears weak and shows few signs of future
strength. The aircraft has steadily lost ground to its near-peer competitor, the Airbus
A330, since 1998. (See Figure 6 below.) Boeing is in the late developmental stages
of a new aircraft, the 7E7 Dream Liner, that will be offered for sale in 2004 and is
expected to enter service in 2008.76
Figure 6. Boeing 767 and Airbus A330 Production Backlog
250
200
A330
150
100
50
767
0
1996
1997
1998
1999
2000
2001
2002
Source: CRS Chart based on data from Aerospace Industries Association
Some analysts have predicted that Boeing’s alleged lack of commitment to
marketing and improving the 767, coupled with the introduction of the 7E7, will not
add many new sales to the current backlog, and could kill the civil airliner version
75
This assumes that none of the outstanding orders will be canceled. During the first half of
2003, Uzbekistan Airlines placed two 767s on order. In July, Turkmenistan Airlines ordered
an additional 767, and an undisclosed customer ordered an additional eight. Without these
new orders, the production line might have shut down as early as August 2004. Production
backlogs are the result of company production plans, marketing strategies, and customer
demand.
76
The 767 (in its -300 version) carries 218-269 passengers up to 4,020 nautical miles (7,450
km). The A330-300 carries 295-335 passengers up to 5,600 nautical miles (10,400 km). The
7E7 is being designed to use 15 to 20 percent less fuel than other comparable multi-aisle
aircraft and will carry 200-250 passengers on routes between 7,200 and 8,000 nautical miles
(13,334-14,816 km). Boeing expects to begin offering the 7E7 for sale in late 2003, with the
first firm offers being made to airlines in early 2004. Boeing expects to begin production in
2005. First flight is expected in 2007 with certification, delivery, and entry into service
occurring in 2008. Sources: Teal Group, Boeing, Airbus.
CRS-32
of the aircraft.77 The production of the civilian 767 is now projected (See Figure 7
below) to continue at the rate of 12-15 aircraft per year only through mid-2008.78
Figure 7: Projected 767 Production
Lease opponents are likely to point to these current and future business
projections and argue that there is no urgency to leasing the KC-767. It could be
available to the Air Force until at least 2006 and perhaps until 2008. Lease
supporters, however, may say that these projections prove that the Air Force must
move more quickly than its previous plan, which was to begin recapitalization in
2012. No one expects the 767 to remain in production that long, they may argue.
Furthermore, supporters may argue, there is no guarantee that the line will stay open
until 2006. The profit margin realized from building 767s at the minimum sustaining
rate (one aircraft per month) is likely to be very small. Boeing could decide that in
light of dwindling business, it may be more profitable in the long term to shut down
the line sooner than 2006.79
77
See Helen Jung, “Boeing’s 767 Tanker Deal a Boon to Ailing Line,” Associated Press
Newswires, May 23, 2003, 20:31
78
See Teal Group Corp., “Boeing 767,” World Military and Civil Aircraft Briefing, August,
2003.
79
A recent New York Times article discussing the proposed Air Force arrangement
estimates that the production of all models of the 767 could continue as late as 2011. This
projection is based on the assumption that the initial lot of 100 tankers is ordered and
delivered. In the face of no new commercial orders, a subsequent Air Force procurement
would be needed to further delay a shutdown. See Leslie Wayne, "Air Force Lease With
Boeing Seen Adding Billions to Cost," New York Times, August 27, 2003.
CRS-33
The Need to Help Boeing. Some critics have portrayed the leasing
arrangement as somewhat of a financial boost for a company in difficulty,80 and other
analysts have speculated on the benefits of the number of jobs the construction and
deployment of 100 new airplanes are likely to preserve and create.81
Boeing is the largest manufacturer in the U.S. aerospace industry, directly
employing 166,000 workers and generating more than $54 billion in sales during
2002 that was split almost exactly in half between its two major divisions,
Commercial Airplanes and Integrated Defense Systems. In addition, it provides work
for many thousands of employees in companies that supply parts, components, and
services to its operations. Boeing is ranked No. 15 in the most recent Fortune 500
and No. 104 in the Financial Times Global 500 lists of corporations. It is included
in both the Standard & Poor’s 500 index and the Dow Jones industrials index.82 In
the civil aviation industry, Boeing has traditionally dominated world sales in large
commercial jet aircraft, but is facing strong competition from rival Airbus. In the
defense sector, Boeing and Lockheed Martin compete for the number one spot in
world sales.
Perhaps because of the recent softening in general worldwide demand for
commercial aircraft, Boeing recently restructured its corporate organization, moving
its headquarters from the Seattle, Washington, area (where its principal commercial
aircraft manufacturing facilities lie) to Chicago, and combined what had been its
military aircraft and space and communications units into Integrated Defense
Systems. One analyst has characterized this as a “controlled de-emphasis” of the
company’s traditional focus on commercial air transports in order to concentrate on
areas such as satellite communications, space-imaging, flight services, and unmanned
aerial and unmanned combat aerial vehicles (UAVs and UCAVs respectively).83
The impact of a 100-aircraft order on Boeing’s Overall Production
Output. The delivery of 100 new 767 Tankers to the United States Air Force over
a six-year period would represent a relatively small addition to existing and
80
One news article quoted Sen. John McCain as stating, “This is a great deal for the Boeing
Company that I’m sure is the envy of corporate lobbyists from one end of K Street to the
other. But it’s a lousy deal for the Air Force and the American taxpayer.” See Leslie Wayne,
“Unusual Pentagon-Boeing Deal Is Attacked,” New York Times, June 10, 2003.
81
See, for example, Marc Selinger, “Lawmakers Renew Push for Boeing to Build AF
Tankers,” Aerospace Daily, March 22, 2002; and Dan Voorhis, “767 Tanker Work Takes
Off,” Wichita Eagle, August 5, 2003, p. 1.
82
83
Hoover’s Company Profiles, August 1, 2003.
Ibid. The communications satellite and launch services units within Integrated Defense
Systems have recently faced difficulties of their own. Because of an incident involving the
appearance at Boeing of competitor Lockheed Martin proprietary documents, the Air Force
canceled or barred the company from competing for approximately $1 billion in military
launch contracts. This came on top of unexpected commercial satellite launch cancellations
due to the weakened space communications market. See Caroline Daniel, "Boeing Probe
Gets To Grips With Ethics," London Financial Times, August 25, 2003; and Anne Marie
Squeo, J. Lynn Lunsford and Andy Pasztor, "Boeing's Plan to Smooth Bumps of Jet Market
Hits Turbulence," Wall Street Journal, August 25, 2003, p. 1.
CRS-34
anticipated production. However, some analysts expect the profit accruing to the
company upon the sale of each 767 Tanker to exceed that of a comparable
commercial jet, exerting a positive influence on corporate profits.
Boeing Commercial Airplanes delivered 379 aircraft of various models worth
approximately $25 billion during 2002 (this was down from the 526 aircraft delivered
during 2001). Of these 379 airframes, 35 were 767s. Figure 8 illustrates Boeing new
aircraft deliveries from 1998 through 2002 and projects production through 201184
with 767 and KC-767 production highlighted.
Figure 8. Boeing Civil Airframe Production
Without the KC-767, Boeing will have built 5,308 civil aircraft during these
fourteen years, including 293 767s. This represents 5.5% of the airframes
manufactured. If 86 KC-767s are added (the remaining 14 are scheduled for 2012
delivery), the total 767 production accounts for 7.0% of Boeing production.
Therefore, it appears that the KC-767 program is not critical to Boeing Commercial
Aircraft, but is critical to one of the company’s six existing civil aircraft assembly
lines.85
A May 2003 report prepared by Morgan Stanley Research calculated and
compared the expected profit of the sale of Boeing’s KC-767 with other Boeing
84
Data are provided by the Aerospace Industries Association and Teal Group Corp. The
projection is not carried through 2012, the last production year of the proposed KC-767
acquisition, because overall projection figures are not available for that year.
85
The smallest of Boeing’s commercial jet models, the 717, is expected to cease production
in 2005.
CRS-35
commercial jet aircraft.86 The report finds that the sale of each Boeing KC-767 under
the conditions announced publicly by Boeing and the U.S. Air Force would generate
approximately seven times the profit of a single Boeing 737, the company’s most
popular commercial airplane.
A comparison such as this is more valid if the KC-767 is compared with a
commercial sale of the civil 767. If the assumptions published in the report are used
to calculate and compare profits on the 767, it seems that the KC-767 may generate
company profits equal to approximately three to four 767s. Table 3 illustrates how
this number was generated.
Table 3. KC-767 and Civil 767 Profits
KC-767
Low
767
High
Average
10.0%
15.0%
6.0%
Sale Price ($mil)**
138
138
82
Operating Profit/Aircraft ($mil)
13.8
20.7
4.9
280.5%
420.7%
100.0%
Operating Profit Margin*
Profit vs. 767***
Data Source: Morgan Stanley
* Boeing has agreed to cap its operating profit margin at 15% of the converted tanker sale price.
** Boeing’s advertized list price for the 767-200ER is $101.0-$112.0 million in 2002 dollars. The
actual price of a given aircraft depends on the configuration and special features selected by the
customer. Price quotes are available on the World Wide Web at
[http://www.boeing.com/commercial/prices/]. Aircraft prices are negotiable, though, and airline
customers can often win substantial discounts.
*** Profit calculation: CRS
The KC-767 as a Jobs Program. An order for 100 767 aircraft and their
conversion to tanker configuration is likely to increase the number of workers that
would otherwise be employed by Boeing’s Commercial Airplanes unit and by the
company’s second-tier and below suppliers.87 In an October 2002 letter to the White
House Chief of Staff, Secretary of the Air Force James Roche quotes Boeing as
estimating that the program would create 11,000 new jobs at Boeing itself and
86
Heidi Wood, Aayush Sonthalia, and Myles A. Walton, Does 767 Tanker Equate to 700+
Comml Orders?, Morgan Stanley Research, May 29, 2003.
87
Defense industry companies are traditionally divided into tiers. Prime contractors such as
Boeing, Lockheed Martin, General Dynamics, etc., are referred to as first-tier companies.
Companies that supply prime contractors with major subcomponents, such as aircraft
engines, radar systems, etc., comprise the second tier. Companies lying further down the
chain constitute third-and fourth-tier suppliers and below. See CRS Report RL30720, The
U.S. Defense Industrial Base: Trends and Current Issues, by Daniel Else.
CRS-36
another 28,000 at its component makers, for a total of approximately 39,000 new
positions.88
In order to gain an appreciation of what this means, it should be viewed in the
context of Boeing’s recent job losses, which have been significant since 1997 (See
Figure 8). That year, the year after Boeing acquired McDonnell Douglas, the
Commercial Airplanes unit employed more than 108,000 workers. This rose in 1998
to more than 117,500 as the company increased the pace of its jet deliveries. During
1999, however, Commercial Airplanes employment fell by more than 22,000, to
94,700, mirroring a slowdown in the deliveries of both single- and multi-aisle
aircraft. Employment continued to decline through 2000 and 2001 until, at the end
of that year, the unit employed 89,400, or more than 28,000 workers below the 1998
employment peak. Near the end of 2001, the company announced that the postSeptember 11 effect on the airline industry would require the layoff of approximately
30,000 workers.
By the end of 2002, Commercial Airplanes unit employment stood at 66,500
workers, a loss of 22,900 during the year and an overall loss of more than 59,000 jobs
from the peak year of 1998. Assuming an average of $49,700 in annual wages per
production position, with approximately 2.5 supplier jobs linked to each Boeing job,
this 5-year decrease in employment represents as much as $10.4 billion in wages in
209,000 jobs nationwide, and $2.9 billion in wages at Boeing, that have been either
diverted to other employment within the aviation industry, moved to positions
outside the aerospace sector, or eliminated.89
If the 11,000 anticipated direct employment positions at Boeing’s Commercial
Airplanes unit had materialized during 2002, the limiting best case, they would have
reinstated slightly less than half of the positions actually lost during that year. Figure
9 presents Boeing’s Commercial Airplanes employment history in graphic form. The
thick line on the right of the graph represents the addition of 11,000 hypothetical jobs
during 2002.
88
At about the same time, Commercial Airplanes unit head Alan Mulally indicated that
workers on the 767 at the Everett production site would face imminent layoffs due to the
slow pace of 767 sales. The Seattle Post-Intelligencer estimated that approximately half of
the 767 workforce would be cut. California would be expected to receive the greatest
number of jobs, estimated at 9,200, from a 100-aircraft 767 tanker order. The states with
large Boeing facilities, Washington and Kansas, could expect 8,000 and 4,400 jobs
respectively. Other states with significant anticipated employment include Maryland (2,100
jobs), Connecticut (1,600 jobs), Texas (1,400 jobs), Michigan (1,400 jobs), Florida (1,000
jobs), and Arizona (1,000 jobs). The remaining 8,900 jobs would be spread over an
additional 29 states. These projections were repeated in press reports. See James Wallace,
“Boeing Plans Job Cuts On 767 Line,” Seattle Post-Intelligencer, October 31, 2002 p. A1;
and Helen Jung, “Boeing’s 767 Tanker Deal a Boon to Ailing Line,” Associated Press
Newswires, May 23, 2003, 20:31.
89
Boeing’s estimated 11,000 direct and 28,000 supplier jogs created by t he KC-767,
yielding a ratio of approximately 1:2.5. Average airplane manufacturing worker wage date
is taken from U.S. Census Bureau, Statistics for Industry Groups and Industries: 2001:
Annual Survey of Manufacturers, U.S. Department of Commerce, January 2003; see,
[www.census.gov/prod/2003pubs/mO1as-1.pdf]
CRS-37
Figure 9. Boeing Commercial Airplanes Direct
Employment
However, it is not clear whether all of these jobs will be new, or whether some
might be transferred from the 747 production line, which is also facing difficulties.
Should the 747 production line be shut down or its workforce cut back, this skilled
labor would presumably be available for use on the 767 production line, potentially
reducing the number of new or rehired workers.90
Total Costs for Leasing and Procuring the KC-767
by Ronald O’Rourke
(707-7610)
If there is an urgent need to acquire tanker aircraft, and if tankers based on the
Boeing 767 are the best aircraft to acquire, then a follow-on question is how the cost
of acquiring these aircraft through a lease compares to the cost of acquiring them
through a purchase (i.e., procurement).
Estimated Total Cost and Factors That Can Change The
Calculation. The Air Force report presents estimates for the total cost of the
leasing and procurement options that have been calculated on a net present value
90
In fact, at the end of 2002, Boeing reportedly considered combining 767 and 747
production into a single line. Boeing produces its larger aircraft, the 747, 767, and 777, at
its plant in Everett, Washington, and its smaller 737 and 757 in nearby Renton. The 717 is
built at a plant inherited from McDonnell Douglas in Long Beach, California. See James
Wallace, “Boeing Looks At One Line For Two Models,” Seattle Post-Intelligencer,
December 20, 2002, p. A1.
CRS-38
(NPV) basis (see Appendix B for a description of NPV analysis). The report states
that when calculated on an NPV basis, leasing the 767s would be about $150 million,
or about 1%, more expensive than purchasing (i.e., procuring) them. Specifically,
the report states that leasing would have an NPV of $17.2 billion while purchasing
would have an NPV of $17.1 billion. These two NPV figures are rounded to the
nearest tenth of a billion. When the difference between them is measured more
precisely, it becomes $150 million.91
Although the Air Force report presents this $150-million difference as a single
answer to the question of the comparative total costs of leasing vs. purchasing the
767s, the cost comparison, as the report notes, can be significantly affected by
decisions one makes on certain key variables or assumptions involved in the
calculation. Included among these variables and assumptions are the following:
! Should a multi-year procurement (MYP) arrangement be used in calculating
the cost of the procurement option?
! How much would using MYP arrangement reduce the cost of the procurement
option?
! What is the correct discount rate to use in performing the NPV cost
comparison?
! What progress payment schedule should be used in estimating the cost of the
procurement option?
! How should inflation be used in calculating the cost of the progress payments
under the procurement option?
! What interest rate should be used for the bonds floated by the Special Interest
Entity (SPE)?
! What interest rate should be used on the construction loans that the SPE
would take out under the leasing arrangement to finance the building of the
767s?
! What estimate should be used for the imputed government self-insurance cost
included in the cost of the procurement option?
Each of these questions is discussed below. Several of these factors could
individually shift the result of the NPV analysis by hundreds of millions of dollars.
In combination with one another, they could shift the result by an even greater sum.
Use of MYP Arrangement For Procurement Option. In calculating the
costs of the 767 leasing and procurement options, the Air Force assumed that the
procurement option, like most major DOD acquisition programs, would use annual
contracting. If the calculation had instead assumed the use of multi-year procurement
91
Air Force report, pages 4-5.
CRS-39
(MYP) for the procurement option (see Appendix C for a discussion of MYP), the
NPV analysis could have favored the procurement option by several hundred million
additional dollars.92
The Air Force states that it used annual contracting rather than MYP for the
procurement option for the following reasons:
! MYP has never before been used at the start of a DOD aircraft procurement
program.
! Using MYP at the start of a procurement program would not be consistent
with the statutory requirement that weapons and platforms being considered
for MYP have a stable design (i.e., a design that has been in production for
several years and been proven through actual use, and is thus unlikely to need
to be altered during the period covered by the MYP due to the discovery of
design problems).
! Congress passed a provision authorizing a lease of 767s and did not pass a
provision authorizing a multi-year procurement of 767s. If Congress had been
open to considering an MYP arrangement for the 767s, it would have passed
legislation granting such authority.93
Those who support the idea that the Air Force should have assumed the use of
MYP in calculating the cost of the procurement option might argue the following:
! The leasing arrangement approved by Congress inherently involves
making a multi-year commitment to the 767 program. Leasing opponents
may maintain that since the leasing option is inherently a multi-year option,
it should have been compared to a multi-year procurement option to ensure an
apples-to-apples comparison of costs.
! Supporters of the lease have argued that it constitutes an innovation in
defense acquisition. Using MYP at the start of a 767 tanker procurement
would equally represent an innovation. Opponents may argue that although
DOD has leased aircraft in the past, the 767 lease is precedent-setting in
several regards, including the larger number of aircraft involved, the large
total cost of the lease, and the use of a relatively short-term operating lease for
92
A footnote in the Air Force report (footnote 1 on page 4) can be read as implying that the
use of MYP would by itself have enlarged the cost advantage of the procurement option
from $150 million to as much as $1.9 billion on an NPV basis – a shift of as much as $1.75
billion. Discussions with the Air Force officials clarified that the use of MYP would have
been responsible for about $900 million of this estimated shift, and that three other
variables, if treated differently, together would have been responsible for shifting the
calculation by roughly another $800 million. (One of these other variables – the inclusion
of an imputed self-insurance cost in the cost of the procurement option – is discussed
elsewhere in this CRS report.)
93
The Air Force report states “that neither multi-year procurement authority, nor related
funding authorities were made available and, therefore, was not a viable option for the
Administration’s analytical consideration.” Air Force report, op cit, footnote 1 on page 4.
CRS-40
an asset that the Air Force will likely continue to require for a much longer
period of time. In addition, the legislation setting up the lease exempted the
Air Force from a requirement to include the full amount of funding that the
government would be liable for in case of cancellation, and established a
special congressional process for approving the lease. Leasing opponents may
assert that Congress arguably sent a signal in passing the legislation setting up
the lease that, in the case of the 767s, it is prepared to consider highly novel
acquisition approaches. From their perspective, using MYP for the 767s
would be no more irregular, and possibly less irregular, than the leasing
arrangement. The fact that Congress approved one kind of authority (leasing)
and not another (MYP) does not prove lack of congressional interest in
approaches other than leasing. They might maintain that it is the role of
Congress, not the Air Force, to decide what options Congress would be
willing to consider.
! There is precedent for Congress granting DOD a multi-year contracting
authority similar to MYP at the start of a major DOD acquisition
program involving a platform with a complex design: Congress, in acting
on the FY1998 defense budget, passed a provision granting the Navy a special
block-buy contracting authority for the first four Virginia-class nuclearpowered attack submarines. This authority was similar to MYP authority in
that it permitted the Navy to sign a single contract covering 4 submarines that
were to be procured over the 5-year period FY1998-FY2002. These 4
submarines have a combined estimated procurement cost of more than $10
billion. In terms of design and engineering, nuclear-powered submarines are
at least as complex, if not more complex, than tanker aircraft, and Congress
passed this legislation in 1997, before construction of the first Virginia-class
submarine had even started.
! There is precedent for a service requesting MYP authority for a program
that has not yet produced a single completed unit and consequently has
not demonstrated design stability through the traditional means of
successfully testing one or more fully built units in their intended
operating environment: The Navy, as part of its FY2004 budget submission,
requested that Congress grant full MYP authority for a group of 7 Virginiaclass submarines to be procured during the 5-year period FY2004-FY2008.
The Navy requested this authority even though construction of the first
Virginia-class boat is still not complete. (It was about 85% complete at the
time the Navy submitted its proposed FY2004 budget to Congress in February
2003.) Instead of demonstrating the stability of the Virginia-class design in
the traditional manner – by completing construction of at least one boat and
showing, through real-world operations, that the boat’s design does not need
to be changed to fix previously undiscovered design problems – the Navy is
advancing the novel argument that the relatively small number of design
changes that have occurred during the lead ship’s construction (compared to
the number of design changes that occurred during construction of the lead
ships of previous classes of U.S. submarines) is sufficient to demonstrate that
the Virginia-class design is stable.
CRS-41
! There is precedent for a service assuming the use of a precedent-setting
MYP in a major defense acquisition program when making an important
cost calculation that was forwarded to Congress: In estimating projected
cost growth in the Virginia-class program – a projection that the Navy
forwarded to Congress – the Navy this year assumed the use of MYP in the
Virginia-class program for FY2004-FY2008. The Navy made this assumption
even though Congress has not yet approved the MYP arrangement for the
Virginia class, and even though approving it would set a precedent because
the first boat has not yet been completed, let alone tested. If the Navy had not
assumed the use of MYP in its cost calculation, the projected amount of cost
growth in the program would have been substantially higher, and would have
triggered the Nunn-McCurdy provision (10 USC 2433), a law under which a
defense program reporting more than 25 percent projected unit cost growth is
to be terminated unless the Secretary of Defense submits to Congress certain
certifications about the program’s importance and management.
! There is precedent for a service requesting MYP authority for an air-
vehicle program that has not demonstrated design stability through the
traditional means of completing testing and having multiple production
copies completed and in the operational inventory: The Navy, as part of
its FY2004 budget submission, requested that Congress grant MYP authority
for 1,748 Tactical (Block IV) Tomahawk cruise missiles to be procured during
the 5-year period FY2004-FY2008. The Tactical Tomahawk is a reengineered
(redesigned) version of the older Tomahawk cruise missile (the Block I
through Block III version) that ended procurement in FY1999. The Tactical
Tomahawk was reengineered to be built at roughly half the cost of the older
Tomahawk and differs in many ways from the older Tomahawk at the piecepart level. The first Tactical Tomahawks meant for operational use were
procured in FY2002. Construction of these missiles is to begin at the
subcontractor level in 2003, and assembly of the missiles is scheduled for
2004. The Navy requested an MYP arrangement for the Tactical Tomahawk
program even though testing of the Tactical Tomahawk is still underway, and
even though the first production missiles procured in FY2002 have not yet
been completed, are being built following a two-year (FY2000-FY2001)
interruption in procurement of new-built Tomahawks, and are not scheduled
to enter the operational inventory until May 2004. In addition, a DOD
decision on whether the Tactical Tomahawk program is ready to proceed to
full-rate production is not to be made until May or June 2004.94
! The 767 tanker will have as much, if not more, design stability than the
Virginia-class submarine or Tactical Tomahawk cruise missile. The 767
94
The developmental phase of testing, which included four test flights, began in August 2002
and was completed on July 20, 2003. The follow-on operational phase of testing is to
include another four test flights. The initial low-rate production contract for the weapon was
awarded in October 2002. Manufacturing at the subcontractor level was to begin in 2003,
and missile assembly is to begin in 2004. (Sources: U.S. General Accounting Office.
Defense Acquisitions[:] Assessments of Major Weapon Programs. Washington, 2003.
(May 2003, GAO-03-476) p. 61; Hodge, Nathan. Tactical Tomahawk On Track: Navy.
Defense Week, July 28, 2003: 3.)
CRS-42
tanker design is based on the airframe for the Boeing 767 commercial airliner.
Boeing has considerable experience building this airframe: It delivered the
first 767 airliner in 1982 and has delivered a total of 908 through June 2003.
The equipment that is to be added to the basic 767 airframe to convert the
plane into a tanker is not new technology. And the task of integrating these
components into the basic 767 design will be done to sell the 767 tanker
design to the governments of Italy and Japan, which are in line to acquire four
767 tankers each before 767 tankers are to be delivered to the Air Force.
! The start of the MYP arrangement could in any event be delayed until
sometime after the start of the procurement option. As noted in the
August 26, 2003, Congressional Budget Office (CBO) report on the 767 lease
proposal, Congress in any event could wait until the third 767 production lot
(i.e., the 21st plane) to grant MYP authority, and use the first two production
lots (totaling 20 planes) to demonstrate design stability in the program. Such
an option, CBO stated, would still capture roughly 80% of the cost-reduction
benefits of using MYP for the procurement option.95
Air Force officials have stated that the issue of whether to assume MYP in the
procurement option is in any event moot, because the Air Force budget is insufficient
over the next few years to meet the near-term funding requirements of a 767
procurement program without requiring undue reductions in other Air Force
programs. Indeed, they could argue that using MYP would require even more nearterm funding than an annually contracted procurement program, due to the need to
fund the MYP’s economic order quantity (EOQ) purchase (i.e., up-front batch order)
of selected 767 tanker components.96
Those who believe that an MYP arrangement should be used in calculating the
cost of the procurement option could argue that the issue is not necessarily moot,
because it is possible to structure a 767 tanker procurement option using MYP that
features reduced near-term funding requirements. Specifically, they could argue, the
Air Force could procure the 767s under an approach that combined MYP,
incremental funding, and possibly a delayed EOQ purchase or no EOQ purchase at
all. Such an approach, they could argue, would (through MYP) reduce the total
procurement cost of the 767s below what the Air Force estimated in its report and
defer (through incremental funding) portions of the procurement cost of the 767s into
future years, so as to address the Air Force’s requirement to minimize near-term
funding requirements.
Deferring the EOQ purchase (and thereby applying it only to later planes in the
100-plane effort, rather than to all 100 aircraft) would reduce the amount of savings
achieved through the MYP (since EOQ purchases are a significant contributor to
overall MYP savings), but it would also defer the funding requirements of the EOQ
to a later year and reduce the scope and cost of the EOQ when it does occur,
95
U.S. Congressional Budget Office. Assessment of the Air Force’s Plan to Acquire 100
Boeing Tanker Aircraft. Washington, 2003. p. 14 (With cover letter dated August 26,
2003)
96
For more explanation of EOQ payments, see Appendix C.
CRS-43
addressing the Air Force’s need to minimize near-term funding requirements.
Completely eliminating the EOQ purchase would further reduce the savings achieved
by the MYP, but still permit some MYP-related savings to be achieved (through
work force optimization and investment in improved production equipment at the
final assembly plant) while eliminating the EOQ purchase as a possible source of
near-term funding pressure.
Opponents of an incrementally funded MYP could argue that it would not only
set a precedent by using MYP at the start of an aircraft procurement program, but
also violate the full funding policy governing defense procurement. In acting on the
FY2003 budget request, they can argue, Congress altered the Air Force’s proposed
funding profile for the C-17 program and passed other legislation specifically to
reinforce the principal that procurement programs using MYP are no less subject to
the full funding policy than annually contracted programs.97
Supporters of an incrementally funded MYP with a delayed or eliminated EOQ
purchase could argue that although Congress, in acting on the FY2003 budget,
reinforced the application of the full funding policy to MYP programs, this was
intended to send a general signal on defense budgeting procedures that need not apply
to the 767 program because Congress, in passing the legislation setting up the 767
lease, indicated that, in the case of the 767s, it was prepared to consider highly novel
and irregular acquisition approaches. An incrementally funded MYP with a delayed
or eliminated EOQ purchase, they could argue, would be no more irregular, and
possibly less irregular, than the leasing arrangement. Supporters of the lease have
argued that it constitutes an innovation in defense acquisition. Supporters of an
incrementally funded MYP could argue that it, too, would represent an innovation.
As recent precedents for the use of incremental funding in a major DOD acquisition
program, they could cite the following examples:
! Congress, in the FY2000 and FY2001 defense appropriation bills, directed
the Navy to use incremental funding to procure an amphibious assault ship
called LHD-8 – a relatively expensive ($2.0 billion) ship that, if fully funded
in a single year, could have required reductions in other Navy programs that
year.
! The Navy, through use of advanced procurement funding in FY2001-FY2006
and so-called split funding in FY2007-FY2008, plans to procure a new aircraft
carrier called CVN-21 in FY2007 using a funding profile that amounts to a
form of incremental funding, even though this ship is nominally subject to the
full funding provision. CVN-21 is a very expensive ($8.6 billion) ship that,
if fully funded in a single year, could require significant reductions in other
Navy programs that year.
97
For a discussion of the full funding policy and Congress’ action on the FY2003 budget in
connection with the C-17 aircraft program, see CRS Report RL31404, Defense
Procurement: Full Funding Policy – Background, Issues, and Options for Congress, by
Ronald O’Rourke and (name redacted). Washington, 2002. (Updated November 22, 2002)
p. 7-8, 17-21.
CRS-44
! DOD in the 1990s in effect used a form of incremental funding to acquire
military sealift ships called Large, Medium-Speed, Roll-on/Roll-off ships
(LMSRs) that were procured through the National Defense Sealift Fund
(NDSF). The NDSF is a DOD revolving fund that is not subject to the full
funding provision because it is outside the procurement title of the DOD
appropriation act. Future ships procured through the NDSF, including Navy
Lewis and Clark (TAKE-1) class auxiliary cargo ships, could be built using
a similar funding approach.
Supporters of an incrementally funded MYP for the 767s could argue that
procurement of 767s, if necessary, could be moved to a DOD budget account that is
outside the procurement title of the defense appropriations act and therefore not
subject to the full funding policy. Past congressional action, they could argue,
establishes some precedent for this: As part of its action on the FY2001 defense
appropriation bill (H.R. 4576/S. 2593), Congress established a National Defense
Airlift Fund (NDAF) – a revolving fund outside the procurement title of the DOD
appropriations act that was analogous to the NDSF – and directed that C-17 airlift
aircraft be procured through this fund rather than in the Air Force’s aircraft
procurement account.98 Although Congress directed that C-17 procurement in the
NDAF conform to the full funding policy, supporters of an incrementally funded
MYP for the 767s could argue that Congress, in passing the legislation setting up the
767 lease, signaled that, in the case of the 767s, it was prepared to consider new
approaches, such as incremental funding.
Amount of Savings From Using MYP In Procurement Option. The
Air Force’s estimate that using MYP for the procurement option would reduce the
cost of the procurement option by about $900 million on an NPV basis was derived
by reducing the estimated cost of the procurement option by 7.4%. The 7.4% figure
was taken from a 2001 report from the RAND Corporation that examined the
estimated savings of 12 previous actual or proposed uses of MYP in DOD
procurement programs.99 The 7.4% figure was an average obtained by excluding the
highest and lowest estimated savings rates in the programs examined (more than
14.3% for the Army Javelin anti-tank missile and 3.9%-4.7% for the Air Force F-22
fighter, respectively). Including these two cases would produce an estimated savings
rate of 7.7%. The remaining 10 cases varied between 5.4% and 10%.
98
The NDAF was established by report language on the FY2001 defense appropriations bill
(H.R. 4576/S. 2593. (See pages 136-137 of the Senate Appropriations Committee’s report
[S.Rept. 106-298 of May 18, 2000] on S. 2593 and page 284 of the conference report
[H.Rept. 106-754 of July 17, 2000] on H.R. 4576.) The NDAF was disestablished as part
of Congress’ action on H.R. 3338, the FY2002 defense appropriations bill (see page 261 of
the House Appropriations Committee’s report on H.R. 3338 [H.Rept. 107-298 of November
19, 2001]), and procurement of C-17s reverted to the Air Force’s aircraft procurement
account.
99
Lorell, Mark A., and John C. Graser. An Overview Of Acquisition Reform Cost Savings
Estimates. RAND Corporation, 2001. (MR-1329-AF) 142 p. MYP is discussed in Chapter
6 of the report.
CRS-45
If applying MYP to the 767 procurement option produce savings of as little as
5.4% or as much as 10%, then MYP might reduce the cost of the procurement option
on an NPV basis by as little as about $660 million (using the 5.4% figure) or as much
as about $1.2 billion (using the 10% figure). Using a delayed (and thus reduced)
EOQ, or no EOQ at all, would result in a smaller amount of cost reduction.
Discount Rate Used in NPV Analysis. OMB circular A-94 provides
guidance to executive branch agencies on what discount rates to use in calculating
the NPVs of leasing and purchasing options. These rates are based on the yields (i.e.,
interest rates) on U.S. Treasury notes and bonds of specified maturities. As set forth
in the most recent (January 2003) version of Circular A-94, those rates are as follows:
Table 4. Discount Rates for Lease-vs.-Purchase NPV
Comparisons
(Appendix C, OMB Circular A-94, revised January 2003)
Discount
Rate
Maturity Periods
3-year
5-year
7-year
10-year
30-year
Nominal
3.1%
3.6%
3.9%
4.2%
5.1%
Real
1.6%
1.9%
2.2%
2.5%
3.2%
Section 8(c) of Circular A-94 further instructs agencies, in choosing a discount
rate, to use “the Treasury borrowing rate on marketable securities of comparable
maturity to the period of analysis.” In selecting a rate to use from the table above,
OMB and the Air Force considered at least three alternatives that might qualify as
being “of comparable maturity to the period of analysis” – a 6-year rate (which would
cover the 6-year lease period for each aircraft), a 9-year rate (which would cover both
the 3-year construction period and 6-year lease period for each aircraft) and a 15-year
rate (which would span the entire period from the start of construction of the first
aircraft through the end of the lease of the 100th aircraft). OMB and the Air Force
settled on using a 9-year rate, which was then calculated by interpolating between the
7-year and 10-year rates shown on the above table.100
100
In response to questions submitted by CRS, the Air Force stated the following regarding
the selection of the 9-year discount rate:
QUESTION: Please explain the two-step discount rate shown in the slide on the financial
analysis of a lease vs. purchase. Was that option rejected by the lease panel and if so, why?
ANSWER: The two-step was developed to inject analytical consistency into the analysis
and to resolve analytical differences between the Air Force and OMB. It was developed and
then rejected. Initially, the OMB noted that the planned leases for this program involved six
years of lease payments. Therefore, it was appropriate to consider the use of a six-year
discount rate in this analysis. However, the Air Force noted that actual lease payments
would not start until 2006 and would continue as leased aircraft are delivered through 2011.
(continued...)
CRS-46
Was a 9-year Treasury bond rate the correct rate to use as the discount rate in
the NPV calculation?101 CRS analysis indicates that a different Treasury bond rate
should have been used.
Specifically, CRS analysis indicates that the NPV
calculation should use the Treasury bond rate for bonds having an average maturity
equal to the bonds that the U.S. government would likely use to raise the funds
needed for the cash flows involved in the lease arrangement. In the case of the 767
lease, CRS calculates this average maturity at something between 3.5 and 4 years.102
Using a 4-year discount rate instead of the 9-year rate in the Air Force report would
100
(...continued)
The issue was how to calculate the present value of the lease payments since the lease
involved different key dates – the date of the contract and the various dates from 2006
through 2011 when the aircraft were to be delivered. The two-step discounting took this
variety of dates into account. The process involved: 1) The first step was to discount each
of the respective lease streams back to the year of lease option using the OMB forecasted
treasury yields for the year of lease. Similarly, the stream of lease payments starting with
the 2007 lease option would be discounted to 2007 using the forecasted yield on treasuries
in 2007, and so on; 2) The values from step 1 would then need to be further discounted to
the contract award date. The lease panel decided not to use this approach because it was
unconventional. Our understanding is that they did not want to diverge too far from existing
policy on discounting. It should be noted however, that OMB acknowledged that existing
guidance was not set up to handle such a complex lease versus buy analysis[.]
QUESTION: Please explain the rationale for selecting a nine-year discount rate.
ANSWER: The nine-year discount method was the result of the resolution of the
consideration of the two-step discounting process. OMB guidance clearly stated that the
discount rate should be used that is commensurate with the period of analysis. However,
the Air Force's period of analysis was 15 years from the start of the contract until the last
lease payment is made. OMB decided that a 9-year discount rate was appropriate in that it
matches the 6 years for a given lease plus three years of construction for a given plane. By
agreeing to the nine-year discount rate, OMB agreed that the Air Force did not have to use
the 6-year discount rate while the Air Force agreed to eliminate the 2-step discount approach
or the 15-year discount rate. Again, the nine-year discount rate is based on the assumption
that there is a 3-year tanker construction period plus a 6-year lease.
(Source: Questions 9 and 10 from Air Force Fact sheet dated August 13, 2003 and sent to
CRS on that date responding to CRS questions on the 767 tanker lease.)
101
The paragraph and the following one are based on consultations with Jane Gravelle,
Senior Specialist in Economic Policy, Government and Finance Division, Congressional
Research Service.
102
This is a rough calculation based on the following assumptions: A 3-year construction
period, a 15/30/30/25 progress payment schedule during construction, 6 equal lease
payments paid in advance of each year equating to about 90% of the cost of the aircraft, and
a final residual payment at the end of the sixth year to pay off the remaining 10% cost of the
plane. (A 15/30/30/25 progress payment schedule means that the government would make
progress payments to Boeing for the construction of each aircraft on the following schedule:
15% three years before delivery, 30% two years before delivery, another 30% one year
before delivery, and 25% at delivery. This is the progress payment schedule used by the Air
Force in its cost comparison.) This rough calculation ignores a compounding issue that
would not significantly alter the outcome of the calculation.
CRS-47
favor the procurement option by an additional $520 million.103 Using a 3.5-year rate
instead of the 9-year rate would favor the procurement option by an additional $610
million.104
It is possible that the interest rates shown in Table 5, particularly the rates for
the shorter-term bonds, are too low. The Congressional Budget Office is projecting
10-year government borrowing rates that are higher than those shown in Table 5105
Using higher interest rates than shown in Table 5, particularly for shorter-term bonds
(such as a bonds with a 3.5- or 4-year maturity) would by itself favor the leasing
arrangement by some additional amount of money. If government borrowing rates
shift up from the rates shown in Table 5, however, corporate borrowing rates would
likely also shift up, offsetting some portion (possibly all) of the relative advantage
gained by the leasing option of assuming an upward shift in Treasury bond rates.
Progress Payment Schedule For Procurement Option. In estimating
the cost of the procurement option, the Air Force report used a 15/30/30/25 progress
payment schedule, meaning that the Air Force under the procurement option would
provide Boeing progress payments during the construction of each aircraft (or group
of aircraft) as follows: 15% of the cost of the aircraft three years prior to delivery,
30% two years prior to delivery, another 30% one year prior to delivery, and 25% at
delivery. The Air Force states that it used the 15/30/30/25 schedule in modeling the
cost of the procurement option because this is the schedule that has been used in
discussions of the lease option under which Boeing would draw on the SPE’s bank
line of credit (i.e., the construction loan) to finance the construction of the planes for
sale to the SPE. Using this same schedule for modeling the progress payments under
the procurement option, Air Force officials argue, ensures a more apples-to-apples
cost comparison.
An alternative view is that regardless of the line of credit draw-down schedule
that was used in discussing the lease option, the procurement option should be
modeled using a progress payment schedule that reflects actual progress payment
schedules used in previous Air Force aircraft procurement programs involving
aircraft built over a 3-year construction period. An example of such a schedule,
based on part programs, would be 10/24.5/43.5/22. This alternative schedule has
been referred to by some observers as a “compressed” schedule. Others, however,
might view it as a traditional or typical schedule for a procurement program
involving aircraft that take 3 years to build. Compared to the 15/30/30/25 progress
payment schedule, this alternative schedule would shift a portion of the progress
payments into later years, with the result that they would be discounted more heavily,
reducing the NPV of the procurement option. The Air Force states that using this
alternative progress payment schedule for the procurement option would favor the
procurement option by an additional $200 million.
103
This figure is a rounded off version of the result ($521.8 million) provided by the Air
Force cost model.
104
This figure is a rounded off version of the result ($612.7 million) provided by the Air
Force cost model.
105
For CBO’s projected interest rates on 10-year Treasury bonds, see
[http://www.cbo.gov/showdoc.cfm?index=4032&sequence=11].
CRS-48
Treatment Of Inflation In Progress Payments For Procurement
Option. In estimating the cost of the procurement option, the Air Force calculated
each progress payment to include an amount of inflation that would result as if all
four progress payments for a given aircraft (or groups of aircraft) were made at the
time of delivery, even though three of the progress payments would actually be made
in earlier years. The Air Forces states that it calculated the progress payments for the
procurement option this way because this was the same basis for calculating the lease
cost of the aircraft under the lease option. Using this same method, Air Force
officials argue, ensures a more apples-to-apples cost comparison.
An alternative view is that procurement programs in the past have calculated
progress payments in one of two ways – by including inflation through the year of
delivery on all the payments, as described above, or by including an amount of
inflation on each progress payment sufficient to cover inflation up to the point in time
when each payment is made. The Air Force states that using the second method
would favor the procurement option by an additional $500 million.
Interest Rates For Bonds Floated By SPE. Comparing the costs of the
leasing and procurement options involves making an assumption, for the leasing
option, about the interest rates of the bonds that would be floated by the Special
Purpose Entity (SPE) to raise the cash needed to purchase the 767s from Boeing.
The higher (or lower) these interest rates are, the higher (or lower) the lease payments
would need to be to cover the SPE’s borrowing costs, and thus the higher (or lower)
the total cost of the lease option.
Under the proposed approach for implementing the 767 lease, the SPE would
float three kinds of bonds called G bonds, A bonds, and B bonds. These bonds
would present different amounts of risk for the bondholders and would thus carry
different interest rates.
In the Air Force report, the assumed interest rate for the G bonds was derived
by taking the January 2003 OMB forecast for 5-year Treasury Bonds and then
increasing it by 56 basis points (i.e., 56 hundredths of a percentage point).106 The
result was that the interest rates for the G bonds were assumed to be 5.70%-5.91%
during the period FY2006-FY20011 (the period during which the bonds would be
floated).
The assumed interest rate for the A bonds was derived by taking the January
2003 OMB forecast for 2-year Treasury bonds and then increasing them by 100 basis
points (i.e., a full percentage point). The result was that the interest rates for the A
bonds were assumed to be 5.84%-6.04% during the period FY2006-FY2011.
The assumed interest rate for the B bonds was based on expected (i.e.,
forecasted) rates for high-yield corporate bonds, which resulted in a 10% interest rate
for the period FY2006-FY2011.
106
A basis point is 1/100th of a percentage point. An interest rate of 5.01%, for example, is
1 basis point higher than an interest rate of 5.00%
CRS-49
The actual interest rates for all these bonds will not be known until the SPE
actually floats them in the bond market. These actual rates could be higher or lower
than the rates assumed in the Air Force report. If the actual rates turn out to be higher
(or lower) than assumed in the Air Force report, then the cost of the lease will be
higher (or lower) than shown in the Air Force report.
As a means of illustrating the sensitivity of the NPV cost calculation to any
difference between the assumed and actual interest rates for the SPE bonds, it can be
noted that if the actual interest rates for all three kinds of bonds turn out to be 50
basis points higher (or lower) than assumed in the Air Force report, then the total cost
of the lease, when calculated on an NPV basis, would be about $270 million higher
(or lower) than the cost shown in the Air Force report.107 This figure of about $270
million can be used as a rough yardstick for estimating changes in the cost of the
lease resulting from a difference between assumed and actual rates that is different
than 50 basis points.108
Potential questions for Congress arising out of the issue of the assumed SPE
interest rates include the following:
! What was the analytical basis for the approach that was used in the Air Force
report to derive the estimated interest rates for the SPE bonds? Was this
approach reasonable? What other approaches might have been used to
estimate these interest rates?
! Given changes in various economic factors since January 2003, including
projected federal borrowing needs, what is the likelihood that the interest rates
forecasted by OMB in January 2003 will turn out to be higher or lower than
actual rates?
! Historically, in situations where similar estimates had to be made about future
bond interest rates, how much of a difference did there turn out to be between
projected and actual interest rates, and was the difference more likely to be in
one direction than another?
Interest Rates for Construction Loans Taken Out By SPE. Comparing
the costs of the leasing and procurement options also involves making an assumption,
for the leasing option, about the interest rates of the construction loans that the SPE
would take out from banks to finance the construction of the 767s prior to Boeing
selling them to the SPE. The higher (or lower) these interest rates are, the higher (or
lower) would be the construction-financing cost that is included in lease price for
each airplane, and thus the higher (or lower) the lease payments would need to be to
cover the lease cost of the airplanes.
107
Source: Based on Air Force calculations of 50- and 150-basis-point changes in interest
rates provided to CRS, August 22, 2003.
108
The figure of more than $200 million for a 50-basis point difference between assumed and
actual rates does not scale up and down in a precisely linear fashion, but the difference is
small enough that the 50-basis-point figure can be used for making rough estimates of the
change resulting from differences greater or lesser than 50 basis points.
CRS-50
The Air Force report assumes that the SPE will be able to borrow money for 767
construction loans at an interest rate that would result in an average of $7.4 million
in construction-financing costs for each plane. This $7.4-million cost is added into
the lease price of each 767, bringing the average lease price to $138.4 million per
plane.
The actual interest rates for the construction loans will not be known until
Boeing takes out these loans. These actual rates could be higher or lower than the
rates assumed in the Air Force report. If the actual rates turn out to be higher (or
lower) than assumed in the Air Force report, then the cost of the lease will be higher
(or lower) than shown in the Air Force report.
As a means of illustrating the sensitivity of the NPV cost calculation to any
difference between the assumed and actual interest rates for the construction loans,
it can be noted that if the actual interest rates turn out to be 50 basis points higher (or
lower) than assumed in the Air Force report, then the total cost of the lease, when
calculated on an NPV basis, might be several tens of millions of dollars higher (or
lower) than the cost shown in the Air Force report.109 This potential degree of change
can be used as a rough yardstick for estimating changes in the cost of the lease
resulting from a difference between assumed and actual rates that is different than 50
basis points.
Inclusion of Imputed Self-Insurance Cost in Procurement Option.
The total cost of the 767 lease option includes a cost for private insurance policies
that the SPE would take out to protect bondholders against events such as the
accidental crash and loss of one or more of the 767s. In the event of such a loss, the
proceeds from the insurance policy would be used to pay off the bondholders.
If the 767s were procured rather than leased, no such insurance policy would be
taken out by the government. Instead, the government would simply bear the risk of
such a loss (i.e., employ self-insurance). Bearing this risk incurs no immediate
additional cost to the government. OMB Circular A-94, however, instructs agencies,
when comparing the costs of leasing and purchasing options, to include in the cost
of the procurement option an imputed (i.e., synthetic or virtual) self-insurance cost.
OMB Circular A-94 instructs agencies to include such a cost because there is a risk
that one or more of the 767s would be lost during their years of operation, and the
government, in the case of the procurement option, would have to bear the cost of
such a loss either operationally (due to the reduced capacity of the remaining 767
fleet) or financially (due to the need to spend additional funds to procure replacement
aircraft). For this reason, OMB believes, including an imputed self-insurance cost
ensures a more apples-to-apples comparison of costs between leasing and purchasing
options.
109
Source: CRS rough order-of-magnitude (ROM) estimate based on the contribution of the
construction-financing costs ($7.4 million) to the average total price of each aircraft ($138.4
million), a rough proportional relationship between the $138.4-million figure and the total
net present value of the lease, and the approximate amount of change that might occur in the
$7.4-million figure as a result of a 50-basis-point change in the interest rate of a bank line
of credit that is drawn down over a 3-year construction period to finance the construction
of a 767.
CRS-51
The cost comparison in the Air Force report, as instructed by Circular A-94,
includes an imputed self-insurance cost for the procurement option. The Air Force
report estimates this cost at $100 million on an NPV basis.
The question is whether $100 million figure is a reasonable estimate of the
government’s self-insurance cost. The government’s self-insurance cost would likely
be lower than the cost of private insurance, since the cost of private insurance
includes, among other things, a profit for the insurance company. The government’s
self-insurance cost would also likely be greater than zero, since there is a risk greater
than zero of losing one or more of the 767s during their years of operation. Beyond
these two bounding observations, however, calculating the cost of self-insurance
poses methodological uncertainties that could lead to results either higher or lower
than $100 million on an NPV basis. If alternative estimates put the cost of selfinsurance at something higher than $100 million, this would make the cost
comparison more favorable to lease option. If they put it at something lower than
$100 million, thus would make the comparison more favorable to the procurement
option.
The table immediately below summarizes the potential effect of the above
variables and assumptions on the outcome of the cost comparison.
CRS-52
Table 5. Summary of Variables, Assumptions, and Potential
Changes in NPV Cost Calculation
Variable or
assumption
Treatment
in Air
Force
report
Potential
alternative
treatment
Potential change in NPV
calculation resulting from
alternative treatment of that
one variable or assumption
Use MYP
for the
procurement
option?
No
Yes
Could favor procurement option
by several hundred million
additional dollars (see next item)
How much
savings
would result
from using
MYP for the
procurement
option?
7.4% –
about $900
million in
NPV
Anywhere
from 5.4% to
10% – or
less, if
economic
order
quantity
(EOQ) is
delayed or
not used
MYP might reduce the cost of
the procurement option by as
little as $660 million (5.4%) or
as much as $1.2 billion (10%),
respectively, in NPV (rather than
$900 million as stated in the Air
Force report). Delaying or
eliminating the EOQ would
result in a smaller amount of cost
reduction.
Discount rate
used for
NPV
analysis
9-year
Treasury
bill rate
from OMB
Circular A94
3.5- or 4-year
Treasury bill
rate from
OMB
Circular A94
Could favor procurement option
by an additional $520 million
dollars (4-year rate) to $610
million dollars (3.5-year rate)
Progress
payment
schedule for
procurement
option
15/30/30/
25
schedule
used,
reflecting
draw-down
rate for
lease
10/24.5/43.5/
22 schedule
used,
reflecting
past Air
Force
procurement
programs
Could favor procurement option
by an additional $200 million.
Treatment of
inflation in
progress
payments for
procurement
option
Include
inflation
through
year of
delivery
for all
payments
Include
inflation
through point
in time for
each payment
Could favor procurement option
by an additional $500 million
CRS-53
Variable or
assumption
Treatment
in Air
Force
report
Potential
alternative
treatment
Potential change in NPV
calculation resulting from
alternative treatment of that
one variable or assumption
Interest rates
for bonds
floated by
SPE
Based on
OMB
forecasts of
certain
market
rates
Actual rates
could turn
out to be
higher or
lower
If the actual rates are higher (or
lower) than the forecasted rate,
the lease would be more (or less)
expensive than shown in the Air
Force report. A half-point (i.e.,
50-basis-point) difference
between the forecasted and
actual rates could shift the NPV
of the lease option by about $270
million.
Interest rates
for SPE
construction
loans
Current
projected
corporate
borrowing
rates
Actual rates
could turn
out to be
higher or
lower
If the actual rates are higher (or
lower) than the forecasted rate,
the lease would be more (or less)
expensive than shown in the Air
Force analysis. Each half-point
(i.e., 50-basis-point) difference
between the forecasted and
actual rates might shift the NPV
of the lease option by several
tens of millions of dollars.
Imputed selfinsurance
cost
Estimated
at $100
million
Other
estimates
could be
higher or
lower
Source: Congressional Research Service.
Could favor leasing (if higher) or
procurement (if lower).
Congressional Oversight and Budgetary Issues
by (name redacted)
(707-7627)
A final set of questions addresses implications of the tanker lease for
Congressional oversight of defense programs and long-term budget plans. If all four
congressional committees approve the $720,000 new start notification submitted on
July 11th, the Air Force will sign a contract with Boeing Aircraft that will commit the
Air Force to a $24.6 billion program over the next fifteen years. Approving a major
weapons system program with substantial funding over a long period through a new
start notification, rather than through approval of funds in DOD’s annual
CRS-54
appropriation and authorization bills, appears to be unusual if not unprecedented.110
The Air Force and others argue that the lease is attractive because it allows the
Air Force to acquire 100 tanker aircraft with relatively little money spent up front.111
On the other hand, the proposed lease appears to be, in many ways, an unprecedented
method of undertaking a major new defense procurement and is at odds with
longstanding laws and regulations that apply to budgeting and procurement of
defense systems. The proposed tanker lease raises a number of broader policy issues,
particularly, the visibility of full cost of planned defense programs in the
Congressional oversight process. The chief issues raised are the following.
! Locking in substantial budgetary resources when long-term budgets are
uncertain. If Congress approves the new start notification, the Air Force will
make a contractual commitment that ”locks-in” an estimated $24.6 billion or
more between 2003 and 2017 for the Boeing tanker lease. These funds have
not been included in the Air Force budget. And while the lease approach
reduces Air Force budget requirements in the short-term, it does so only by
pushing costs out into future years when potentially necessary trade-offs with
other defense programs are less visible to policy makers but may be no less
difficult.
! Locking in funding when program costs are uncertain. By proposing to
lease rather than purchase the aircraft, the Air Force adds considerable
uncertainty to the cost of the program that might not be experienced in a
straight purchase. In this proposed lease, the Air Force would make itself
subject to the volatility of the bond markets. Because of the high cost of
termination liabilities, the Air Force would be unlikely to cancel the lease
even if financing costs increased substantially. The total cost of the program
is also likely to be higher because, according to many observers, the Air Force
is likely to purchase the aircraft at the end of each six-year lease.
! Does the proposed lease comply with the statutory requirements and
OMB rules for operating leases? Some observers have questioned whether
the K767 tanker proposal is appropriately categorized as an operating lease.
Budget rules provide that payments for operating leases are to be counted or
scored in agency budgets on an annual basis as payments are made. If the
tanker deal is categorized as a capital lease, then OMB would require that
DOD budget $11.6 billion up front to cover the full cost of the lease in present
value terms.112 Those rules are designed to ensure that the full scope of the
110
The multi-year lease of six 737 operational support aircraft that was authorized in the
FY2000 Defense Appropriations Act, P.L. 106-79 was for a small defense program.
111
In the cover letter to the Air Force report, “Report to the Congressional Defense
Committees on KC-767A Air Refueling Aircraft Multi-Year Lease Pilot Program,” July 10,
2003, Secretary of the Air Force James Roche states “The dominant reason for proposing
the lease is the advantage it affords for quickly delivering needed tankers to our warfighters
without requiring significant upfront funding.”
112
OMB, Circular A-11,Appendix B-1, “Scoring Lease-Purchase and Leases of Capital
(continued...)
CRS-55
government’s obligations are visible to policymakers in order to foster costeffective decisions.
! Use of a Special Purpose Entity decreases visibility. The Air Force plan to
rely on a Special Purpose Entity (SPE) or Variable Interest Entity (VIE) to
float the bonds to finance the program creates additional uncertainties and
reduces visibility about likely cost. Some observers have suggested that using
an SPE also masks the financial commitment of the government because the
full government liability is not scored or counted in terms of budgetary
resources.
! Is the proposed lease a good deal for the government? The dollar value of
the proposed lease is predicated on covering 90% of the “fair market value”
of the aircraft in order to minimize the amount of funding that would be
considered risky - and hence command a larger premium - by bondholders.
That pricing does not reflect either the length of the lease or the wear and tear
on the aircraft. Some have also questioned whether the “fair market value” of
the aircraft is the best price for a tanker particularly since the Air Force
negotiated both the lease and support contract without competition.
! Deviation from full-funding of the government’s contractual liability.
The statutory language applying to the multi year tanker lease exempts the Air
Force from the requirement to budget for its potential termination liability, i.e.
penalty payments for cancellation of the contract. Congress has thus
exempted this Air Force action from the longstanding Anti-Deficiency Act
which requ
This text is long and has been trimmed here. Open the source document for the complete record.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.