Segment 5 Of 5 Previous Hearing Segment(4)
SPEAKERS CONTENTS INSERTS Tables
Page 887 PREV PAGE TOP OF DOC Segment 5 Of 5
QUESTIONS AND ANSWERS SUBMITTED FOR THE RECORD
March 18, 1997
QUESTIONS SUBMITTED BY MR. BATEMAN
Mr. BATEMAN. DOD collected cost data for interim contractor support, contractor logistics support, and direct support, to private sector sources from organic depots. Why do you think DOD did not include these costs in the future year forecasts of work going into the private sector?
Mr. WARREN. According to DOD officials, the defense authorization committees are aware that these maintenance categories are excluded from the report. In prior years there were discussions about whether or not to include interim contractor support (ICS) and contractor logistics support (CLS) in the 60/40 reporting, and a provision was included in the Senate version of the National Defense Authorization Bill for fiscal year 1997 that would have required these categories to be included in the calculation. The provision was not included in the DOD Authorization Act for fiscal year 1997. According to DOD officials, if Congress had wanted the categories to be included, they would have included the language in the fiscal year 1997 Authorization Act. The officials noted that the information they develop includes the value of workloads each of the services defines as ICS and CLS. They further state that with this information, interested parties can compute the impact of ICS and CLS on the 60/40 requirements.
Page 888 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Your statement noted that 76 percent of the open depot contracts you reviewed were awarded on a sole source basis. Further, 91 percent of the depot maintenance contracts awarded during fiscal years 1996 and 1997 were awarded non-competitively.
What is your assessment of the potential to achieve the level of savings projected from outsourcing depot maintenance given the lack of a competitive market?
Mr. WARREN. Projections of savings are generally based on evaluations of public-private competitions for base support and other commercial activities which have highly competitive markets.
It is unlikely that savings projections can be achieved for depot maintenance to the level projected given the lack of a competitive market for most of these activities. While DOD says it plans to increase the competitiveness of depot maintenance contracts, we have seen a decrease rather than an increase in the amount of competition over the last few years.
Mr. BATEMAN. Is it likely that a more competitive market can be created?
Mr. WARREN. While the Department says it intends to increase the competitiveness of depot maintenance contracts, it is unclear the extent to which they will be successful. In many cases, the government has not acquired sufficient technical data to make available to support a competitive procurement. Additionally, the large capital investment required to establish capability for many military unique items would inhibit potential offerors from getting into the repair business for many items. Finally, other factors such as the unpredictability of the workload, low volume of work, use of older technology, and infrequency of demand also inhibit the development of a competitive market.
Page 889 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Your statement noted that it appears that the support strategy will be contractor support for most new systems. Is it likely this contractor support will be determined on a competitive basis, or will it likely be sole source to the original equipment manufacturer?
Mr. WARREN. Generally, contractor logistics support involves long-term, sole-source arrangements with the original equipment manufacturer. In a few cases in the past, such as with the KC–10 aircraft, the high cost of long-term contractor logistics support prompted the services to develop the capability to compete some of the work. This could be done because the system was a commercial derivative aircraft and multiple private sector repair sources were capable of doing the work. In one case, the Navy competed an aircraft that had previously been awarded on a sole source basis to the original equipment manufacturer, but the competitive awardee was unable to continue the work after a short period of performance and the contract went back to the original equipment manufacturer.
Mr. BATEMAN. What happened to the core concept?
Mr. WARREN. DOD still has a core concept but it has been changed in several ways. First, core is not directly tied to a given system requirement, but rather to a capability. Thus, a workload that otherwise might have been designated core may be determined to be non-core if capability maintained to support other work could also support the workload under evaluation. Second, DOD has introduced a risk assessment process into the analysis to evaluate whether the capability in the private sector is robust and cost-effective enough to support outsourcing the repair of mission essential repair work that otherwise would be performed in a military depot as core work. The services are in the process of identifying core capability requirements using this criteria.
Page 890 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Is DOD not focusing on maintaining core capability in the future?
Mr. WARREN. DOD officials state that core capability will be maintained in military depots, but it is clear that the number and size of core workloads will be greatly reduced in the future. Should the Department decide to use contractor logistics support for all new systems as has been recommended by the Commission on Roles and Missions and the Defense Science Board, the concept of core would eventually go away.
Mr. BATEMAN. How does the risk assessment process work?
Mr. WARREN. The risk assessment process appears to be highly subjective and is not uniform among the services. In general it follows this process. A repair base analysis is performed which identifies this (or similar) capability in other military depots and in the private sector. In the Navy, a non-competitive environment in the private sector would generally result in a capability determined to be core, while the same is not true of the Air Force and Army. If the risk is determined to be not acceptable, the workload is determined to be core. If the risk is determined to be acceptable, the workload is identified as noncore, even though it is mission essential.
Mr. BATEMAN. What evidence is there to support that sole source life cycle support will be more cost-effective than depot support?
Mr. WARREN. We know of no evidence to support this assertion. In fact, for military unique systems, available evidence suggests that long-term contracting to the original equipment manufacturer will be more costly.
Page 891 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Your statement noted that the costs of guidance system repair at the Newark Ohio depot is $13 to $23 million more than the cost of the same workload prior to privatization. Let me get this straight. DOD is telling us that in general, privatization will save 20 to 40 percent. Further, the Air Force is telling us what a success story the Aerospace Guidance and Metrology Center privatization is and that it is saving money, yet you now say it costs more. What is causing the increased costs?
Mr. WARREN. There is not enough actual cost data available to definitively determine the extent of or reasons for the cost increases. The government did not contract for data to be provided in sufficient level of detail to facilitate this kind of analysis. However, available information suggests that increased parts usage, contractor profit, and increased overhead costs appear to be the primary areas causing the increases. With regard to parts usage, the inadequacy of the inventory baseline and the apparent lack of accountability of parts may preclude a thorough understanding of parts usage for the first full year of operations. What the Air Force knows at this time is that the contractor has ordered many more parts since the privatization-in-place occurred. An audit of the parts inventory and the accounting records should provide more information on parts usage before the Air Force and we attempt to analyze costs of operations before and after privatization at this facility, based on a full year of operating resulting results. Finally, given the limited time of contractor operations, there has not been much time for the contractors' management teams to get a clear understanding of the repair processes, identify cost drivers, and implement cost saving initiatives.
Mr. BATEMAN. Are the costs likely to go up even further?
Page 892 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. WARREN. It is too early to tell; costs could go up or they could come down. Available cost information is based on projections, since the facility only completed its first full year of contractor operations in October 1997. When actual cost data is available for the first year, the Air Force and we intend to update our analyses.
Mr. BATEMAN. Your statement noted that the Boeing Guidance and Repair Center (BGRC), the contractor, did not have accountability over government furnished material and that it is unclear how much government furnished material is being used. Have you been able to determine if there are indications that the contractor's parts usage is significantly higher than the usage of the military depot for comparable work?
Mr. WARREN. We know that there are indications of significant increases, based on increases in parts ordered. However, contractor officials stated that errors have resulted in parts being ordered that were not used in the repair process. We have found that increased parts consumption is typical when maintenance work is privatized and most repair parts are provided as government furnished material. Nonetheless, because a complete inventory was not taken to accurately account for all inventory in the Newark facility and an inventory baseline was not established, we may never know about parts usage for the first full year of operations. Air Force Audit Agency is in the process of assessing the inventory situation at BGRC and is expected to report its findings by December 1997.
Mr. BATEMAN. Is government furnished material consumption a problem that has been identified in the past for depot maintenance contracts?
Mr. WARREN. We have found in the past that material consumption is greater for depot maintenance contracts where government furnished material is provided. We have also found inadequate accountability of government furnished material to be a significant problem. For example, we found that the Warner Robins Air Logistics Center experienced a $113.2 million cost overrun on F–15 aircraft contract maintenance work that was directly related to loss of control of government furnished materials.
Page 893 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. According to GAO's analysis of private sector depot maintenance contracts, there is a preponderance of contracts that were awarded sole source. What was the justification for sole source awards?
Mr. WARREN. The justification is often that the government does not have the required technical data to complete a repair workload. Officials also told us that it would take too long to develop and process a competitive contract and the buying commands do not have sufficient manpower to support more competitive acquisitions.
Mr. BATEMAN. Does GAO's prior depot maintenance work show any major pitfalls from extensive use of sole source contracts?
Mr. WARREN. Our work has shown that competition, and sometimes even the threat of competition, can reduce costs, therefore sole-source awards are more costly. We have looked more extensively at the cost reductions that have resulted from competing procurement contracts, but have done some reviews of maintenance and repair contracts and found similar results.
Mr. BATEMAN. The DOD contends that the depot accounting systems are unreliable and that they cannot adequately account for their costs, therefore competitions between the public and private sector are unfair. This was one of the reasons the DOD suspended all depot competitions nearly three years ago. does your analysis show that there are costs which the depots should have accounted for that were not in their bids?
Page 894 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. WARREN. While we recognize that DOD's accounting system needs improvements, we believe the initiatives undertaken by the Department over the past few years have resulted in a system that can track and account for costs. While not perfect, the system appears to be good enough to provide an accurate accounting of costs for competition workloads. What is needed is the discipline to follow through on the initiatives undertaken. Finally, the use of the Defense Contract Audit Agency to review accounting systems and bid proposals for military depot competition offers provides greater assurance that costs can be accurately tracked and accounted for.
Mr. BATEMAN. Does your analysis show that private sector bids were so close that cost increases on the part of the DOD depots would indicate that the lowest private sector bidder could have done the work cheaper?
Mr. WARREN. Our analysis of past public-private competition bids indicates that few, if any of the winning public sector bids had cost increases sufficient to suggest that the government would have saved money if the award had gone to the lowest private sector offeror
Mr. BATEMAN. Your statement says that privatizing in place McClellan and Kelly is likely to be more than $200 million more costly than consolidating workloads in the remaining DOD depots. The Base Realignment and Closure (BRAC) report language suggests that the intent was to consolidate the workload at the remaining depots. Please explain how you derived the $200 million in additional costs by not consolidating the San Antonio and McClellan workloads at the remaining depots.
Page 895 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. WARREN. In doing this analysis, we employed a variety of means to provide us with assurance that our estimating approach and estimates were reasonable. In doing this we worked closely with DOD as we proceeded. For example, to estimate the potential overhead savings from transferring the closing depots' workloads to the remaining depots, we looked at similar evaluations the Air Force performed in evaluating alternatives for consolidating workloads at various locations during its 1995 BRAC process. Much of the data we used was certified as being accurate for use during the BRAC process. We based our analysis on 8.2 million hours of work—or about 78 percent of the projected fiscal year 1999 workload. We did this because the Joint Cross Service Group BRAC distribution would have transferred about 22 percent of the Sacramento and San Antonio workloads to another service's depot or to a private sector firm. While these actions would have generated consolidation savings to other DOD depots or to the private sector, they would not have benefitted the remaining Air Force depots. We believe basing analysis on less than 100 percent of the available workload resulted in a conservative savings estimate.
Further, we basically used a scheme developed for the BRAC 1995 process to identify locations to hypothetically move workloads. However, we modified it slightly to reflect more current workload distribution information that indicated the C–5 would be transferred to Warner Robins rather than Oklahoma City. We provided each Air Logistics Center a breakout of the hypothetical workloads they would receive. We then asked each center to estimate how additional workloads would affect their hourly rates. We asked that they analyze fixed- and variable-cost categories, excluding material, which we assumed would not change. In making their assessments, the three centers used the approach and assumptions developed by executive business planners from the five centers. They used this approach in developing the Air Force downsize-in-place option that was proposed during the 1995 BRAC round as an alternative to closing depots. Air Force officials certified the data developed using this approach to the BRAC Commission.
Page 896 PREV PAGE TOP OF DOC Segment 5 Of 5
We also discussed this methodology with officials at the Air Force Materiel Command. They agreed that our approach was a sound way of assessing the impact of additional workload on a depot's rate structure. We also provided the closing centers with an opportunity to comment on our methodology. San Antonio center officials agreed with the general approach, but commented that increases in variable costs were subjective. Sacramento center officials chose not to comment. Subsequent to our analysis, Air Force Materiel Command personnel provided us a document indicating that they had independently analyzed potential savings from workload consolidation. This document noted that annual savings of $367 million could be achieved through consolidations and an additional $322 million could be saved by relocating workload to depots that already had lower hourly rates. Air Force officials later stated that this information was only one of several excursions developed to determine how our consolidation savings were developed. Air Force officials have stated that they do not agree with our cost analysis, but to this point have not provided specific data or an alternative analysis to support its position.
The cost estimates on which we based our analysis were historical actual costs, which are at an aggregate system level. Since we were dealing with costs at an aggregate level, they should fairly accurately reflect costs incurred in the past and serve as a reasonable basis for analyzing the potential for future savings. Nonetheless, it is important to recognize that our estimates represented a rough order of magnitude, using various aggregate assumptions.
Mr. BATEMAN. Your statement states that privatization-in-place at Newark, McClellan, and Kelly will not save and will probably cost the government more money. Have you also looked at privatization-in-place at Red River, Letterkenny, and other locations?
Page 897 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. WARREN. We have looked at the privatization-in-place at the Navy's depot in Louisville, Kentucky and to a lesser extent at a potential privatization-in-place at Red River and Letterkenny. Our work indicates that privatization-in-place would not be the most cost-effective alternative at either of these locations.
Mr. BATEMAN. What are the implications of privatization-in-place to ever closing any more bases that have large activities such as depots, laboratories, or engineering centers?
Mr. WARREN. Since the concept of privatization-in-place has become more popular as an alternative to closure, it is likely that more and more local communities will attempt to get approval for this type of arrangement as an alternative to closure and relocation of the work and as a means of retaining the work and jobs in the local community.
Excess Capacity
Mr. BATEMAN. DOD's depot maintenance system has substantial excess capacity that includes underutilized facilities, workspace, and equipment. Such excess capacity and the cost of supporting this capacity results in excessive depot maintenance costs. Consolidating workloads into fewer facilities and disposing of excess capacity can result in substantial depot maintenance savings.
What impact will DOD's depot maintenance outsourcing plans, to include contractor logistics support, have on excess DOD depot capacity and the cost of performing work in these depots?
Page 898 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. Large amounts of outsourcing, if not properly managed, would have a detrimental effect—substantially increasing excess depot capacity and therefore increasing the cost of work performed at underutilized facilities.
Mr. BATEMAN. Since outsourcing work from a DOD depot that already has excess capacity will result in more excess capacity and increased labor hour rates for the remaining workloads in the DOD depot, unless the depot is closed altogether, should this cost be considered in public/private competitions; if not, why not?
General WILSON. The potential losses associated with not winning a competition should not be considered for the DOD depots, any more than they should be considered for private sector entities bidding on a workload, because they are costs only if the competition is lost and if nothing else is done to mitigate them. If unused capacity cannot be filled with depot maintenance work, then it must eventually be either declared excess and closed, mothballed, or put into productive use for other than depot maintenance.
Mr. BATEMAN. How does DON plan to reduce costly excess capacity and increase the efficiency of its depots?
General WILSON. I can't answer for all of DOD. The Army Materiel Command, for its part, is embarked on a program of sizing its depot system to perform the workload assigned to it. This includes sizing the workforce, consolidating work where appropriate to minimize equipment and facilities requirements, and innovative programs to partner with the private sector on projects performed in public facilities.
Page 899 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. How does DOD plan to reduce its depot excess capacity resulting from outsourcing and privatizing-in-place workloads?
General WILSON. Again, I can't answer for all DOD. The Army Materiel Command is not generating any substantial amount of additional excess capacity due to outsourcing and privatization-in-place.
Mr. BATEMAN. Do you agree that transferring the workloads at Kelly and McClellan Air Force Bases existing underutilized depots substantially reduce labor hour rates for all the work performed at these depots and do you agree with GAO's estimates that savings would be about $182 million annually?
General WILSON. I defer to the Air Force for an answer.
60/40 Policy, Contractor logistics Support/Interim Contractor Support (CLS/ICS)
Mr. BATEMAN. You have not included CLS and ICS in your 60/40 calculation. My reading of the law reveals no exemption for these categories of maintenance. What is your legal authority for this exclusion?
General WILSON. We submitted the data for the 60/40 calculation, including the depot maintenance portion of the CLS and ICS contracts, to the Department of the Army for consolidation.
Page 900 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. What is the current 60/40 spread for each of the Services? Last year during the hearings you also provided out year projections, would you please do the same this year?
General WILSON. The Army's current projected 60/40 workload is:
Percentages do not include ICS/CLS workload.
Mr. BATEMAN. What are the current ICS/CLS levels for each of the Services?
General WILSON. The Army's current projected ICS/CLS workload is as follows:
NOTE.—These figures represent only the depot maintenance portions of ICS and CLS contracts.
Mr. BATEMAN. If ICS and CLS were calculated into the 60/40 data, would each Military Department be in compliance? What about the projections?
General WILSON. The Army would be in compliance at this time and would be projected to be in compliance whether or not ICS and CLS are included in the calculation.
Page 901 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. What would be the impact of including ICS and CLS in the 60/40 calculations on the Air Force plans for Sacramento and San Antonio?
General WILSON. I defer to the Air Force to answer this question.
Mr. BATEMAN. The Department has announced plans to expand direct vendor delivery. Will this be applied to depot-level reparable? Will this expansion take into account 60/40?
General WILSON. The Department of Defense and the Defense Logistics Agency are interested in expanding direct vendor delivery and premium services. Army's participation in this program will be on a case by case basis. Our items of supply differ in character from those managed by the Defense Logistics Agency. As much as 85% of our requisitions are filled from repairs, not purchase. Also, most of our items have comparatively few demands. Also, very few of our items are commercial items. All of these factors place natural limitations o Army participation in direct vendor delivery. However, where opportunities exist to reduce inventory and improve support to our customers via direct vendor delivery, we will consider its use. The 60/40 rule applies to repair of on-hand inventory and will be considered when we make repair decisions and when we consider use of direct vendor delivery and other stockage alternatives, such as outsourcing.
Mr. BATEMAN. Why are upgrade programs factored into the organic share and not the contractor share of 60/40?
Page 902 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. We have always reported the O&M and AWCF funded portion of upgrade programs for both contract and organic sources in our 60/40 reporting. Separately, we have also reported all organic workload, regardless of funding source, for use in the Defense Depot Maintenance Council Business Plan. This year, DOD has chosen to include all organic work in the 60/40 reporting; because it gives a more complete picture of the organic depots' workloads.
Mr. BATEMAN. Did the internal shift of Army funds from Operations and Maintenance to the procurement accounts in PBD 021 have an effect on 60/40?
General WILSON. The directed changes in FY 98, for M1 to M1A2 tank conversions, for the Apache Longbow program, and for approximately 25% of all software depot maintenance, switched $39.4M that is in-house and $28.7M that is contract. When applied to the total program, this switch of money out of depot maintenance will cause approximately a 1% change in ''60–40.''
Public Versus Private Competition
Mr. BATEMAN. Last year at this time we were told the depots' cost accounting systems weren't adequate enough to make cost comparisons for public versus private competitions. Now, after we rejected your privatization initiative, we're being told all is well and the Department is set to begin a competition program. What's going on here? What's changed? I don't recall any major Departmental initiatives in this area.
Page 903 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. Last year DOD advised the Congress that they were working with the depots to improve internal controls to the point where competition could be resumed. This was done, in part, with the assistance of a Big Six accounting firm. They were sent to depots specifically to fix cost accounting systems, reporting back only when systems were adequate—with no intermediate finger pointing on what they found wrong. As a result of this, and input from the individual Services, an Executive Review Group formed in response to previous Congressional language on the subject of public-private competition has issued, and the Defense Depot Maintenance Council has tentatively approved, a draft policy on public-private competition. I expect, after a full Service review of the policy, that it will be approved and issued by DOD within the next few months.
Mr. BATEMAN. Can you summarize the changes to the Cost Comparability Handbook?
General WILSON. On January 10, 1996 we implemented interim changes to the Cost Comparability Handbook (CCHB) that:
(1) Clarified that a public depot must document and defend proposed costs for a workload when those costs differ from that depot's budget baseline.
(2) Added a cost comparability adjustment which requires that public depots must add a cost for retiree health benefits to their proposals.
On December 4, 1996 we implemented interim changes to the CCHB that:
Page 904 PREV PAGE TOP OF DOC Segment 5 Of 5
(1) Changed the public depots cost comparability adjustment indexing factor for casualty insurance from .0005 to .005, based on a change made by the Office of Management and Budget (OMB). OMB is the determination authority for this factor.
(2) Changed superseded references in the CCHB to the current Financial Management Regulation, DOD 7000.14–R.
Mr. BATEMAN. Were any changes made to the way contractor costs are looked at?
General WILSON. No. The CCHB was developed to identify cost elements and cost comparability adjustments which public depots must include in their proposals to be compliant with public law, cost accounting standards and DOD regulations. Contractors' proposals cannot be changed by the government. Also note that most proposals for these types of workload are fixed price and submitted in where there is price computation. Private industry, under this circumstance, is not required to furnish detailed cost data. Public bidders, however, are required to submit detailed cost proposals, which are fully auditable.
Mr. BATEMAN. What's going to be different from the old public versus private competition program?
General WILSON. There are three basic differences in the program as currently envisioned by DOD. First, they are requiring that the Services remove actual and perceived conflicts of interest in the proposal preparation and evaluation and in the source selection process. Second, they are incorporating relevant aspects of acquisition reform, such as using commercial practices in formulating statements of work and consideration of past performance. Third, depots are being required to demonstrate that their offers accurately identify the total costs of performing a workload, and these costs are charged properly. When the DOD policy is approved, there will be more definition to each of these new aspects.
Page 905 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. When do you plan to start again?
General WILSON. Given that we have definitive policy within the next few months, we could possibly begin competitions during fiscal year 1998. We would need to put implementing guidance in place, and to reestablish the capability to run depot competition programs on our staffs from the depot on up. We gave up much of that capability when competitions were halted in 1994, and many of the experts have since retired or been reassigned.
Mr. BATEMAN. Will all depots be permitted to participate, or will there be restrictions?
General WILSON. In the Army, there would generally be only one depot with the capability to compete on any one program; however, all eligible depots would be allowed to compete within their specialization in accordance with 10 USC 2470 and any other legislation which applies.
Defense Science Board
Mr. BATEMAN. Two years ago, the DSB recommended the Department maintain the core concept. This year they recommended the Department abandon that concept. I notice that there were military advisors connected with both studies. Can you tell us what changed over the past two years that prompted this change in view?
General WILSON. I cannot speak to why the DSB would have two such different positions, however, I do not think so much has changed that such a radical move should be made. I am still a supporter of maintaining a core capability in organic depots.
Page 906 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Some very senior OSD officials have ridiculed the latest DSB report by pointing out that it lacks an analytical foundation. Do you agree with this characterization?
The 1996 DSB Summer Study on Achieving an Innovative Support Structure for 21st Century Military Superiority indicates savings of $30B per year are possible. Are you finding similar results in your QDR studies?
General WILSON. There are valid concerns about the analytical foundation for the 1996 DSB Summer Study. The QDR is a process currently in motion, and it has yet to be completed. However, at this point, more modest savings than those of the magnitude noted by the DSB appear feasible, at least from an Army logistics and infrastructure perspective.
Mr. BATEMAN. The same study calls for a 5 percent per year reduction in civilian workforce and a 2 percent per year reduction in military personnel over the next five years. Can you accomplish these reductions and still stay within 60/40 restriction?
General WILSON. Reductions to the workforce could be accomplished without violating the 60/40 restriction if they are directed at functions which are readily available and potentially less expensive in the commercial world. Examples include computer services, accounting services, audio-visual services, and guards and firefighters. Some of these functions, such as guards and firefighters and any function at Crane and McAlester Army Ammunition Plants, are protected by other legislation.
Page 907 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Can you accept these and still maintain readiness?
General WILSON. Again, if reductions are directed to the right population there should be minimal impact to readiness.
Mr. BATEMAN. Has there been any move, that you know of, to implement these recommendations?
General WILSON. In FY94 and again in FY95 we built our budgets assuming that the legislation protecting specific groups of functions or employees would be repealed. It was not.
Mr. BATEMAN. In your opinion, would there be a violation of the law if the recommendations contained in the DSB Summer study were to be implemented?
General WILSON. I believe the law would have to change in order to implement the recommendations. For example, the recommendation to abandon the concept of core depot maintenance—with which I disagree—would require repealing the law requiring the Secretary of Defense to maintain CORE logistics.
Mr. BATEMAN. It would seem that the people conducting the studies would stand to benefit should the DSB recommendations be implemented. How can this apparent conflict of interest be avoided in the future?
General WILSON. Members of Defense Science Board panels are selected for their subject matter expertise from senior positions in industry, government and from retired senior officials. Their charter comes from the government and recommendations are not binding, but rather must be accepted by the government before they are adopted. Complete policy and legal reviews that take place before recommendations are adopted. I do not know of a way to get the kind of advice we need from experts without involving people in both industry and government who have actual interest and experience in the fields being studied.
Page 908 PREV PAGE TOP OF DOC Segment 5 Of 5
Core Depot Maintenance
Mr. BATEMAN. Your methodology gives the appearance of rigor. However, in actual practice it appears that anything and everything can become non-core at the convenience of the Department. Wouldn't you agree that the core methodology is a sham?
General WILSON. Any method can be manipulated by varying the data you start with. As the DOD methodology has evolved, we have been diligent in applying it honestly and keeping our output traceable to input and assumptions.
Mr. BATEMAN. Have you changed the definition of core from what was reported to us last March?
General WILSON. The basic definition has not changed since November 1993, when OSD issued it in a policy memorandum. The calculation method, however, has evolved from a set of guidelines to a relatively rigorous series of steps which have recently been refined again. When the Services first defined their CORE, in early 1994, we were free to apply the guidelines as we wished. Each Service calculated their CORE independently and there wasn't much common thread. In late 1995, the Services got together and developed the joint methodology. It included a new step called ''assessment of private capability'' which allowed otherwise core work to be assigned to private sector performance. That step has been further defined to be a risk assessment, on which the Services again got together and agreed to a common set of six criteria by which risk must be assessed.
Page 909 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Please provide us with the workloads necessary to sustain core capabilities for each of the Services by commodity, by depot.
General WILSON. I can not do that at this time. There are two major reasons for that. First, we are just completing our first attempt at a rigorous, top-to-bottom application of the joint-Service core methodology as most recently refined—to include the just agreed upon criteria for assessing the risk of privatizing a workload. Second, the very basis for core calculations is what scenarios are defined for us in the Defense Planning Guidance. Since the Quadrennial Defense Review (QDR) in its final form could make some basic changes in the contingencies we prepare for, I wouldn't want to jump the gun by declaring a core requirement that is not based on the most current scenarios. After the GDR, and after we have time to apply any changes to our core evaluation, I could answer this question for the Army.
Mr. BATEMAN. Are new weapon systems considered as core? Are they reviewed for core requirements? Is it still the policy of the Department that new weapon systems will be maintained in the private sector?
General WILSON. New weapon systems will be reviewed in the same way as existing ones for core requirements. Those weapons whose depot maintenance supports a core capability will be maintained in-house. I believe that the current redraft of DOD policy makes it clearer that a core capability will be maintained first, before having any preference for private sector performance of work on new weapons.
Outsourcing Depot Maintenance
Page 910 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. To what extent is the Board's 20–40 percent outsourcing savings estimates dependent on a competitive commercial market and to what extent is there not such a market for depot maintenance activities?
General WILSON. The August 1996 Defense Science Board (DSB) Outsourcing and Privatization study recognized that a competitive market exists for a broad range of DOD commercial activities. The DSB also recognized that there will be functions not well suited for competition. Despite limitations, public-private competitions have produced savings. Theory and history both suggest that a competitive environment drives down cost.
Mr. BATEMAN. To what extent will ownership of data rights by the original equipment manufacturer, plans to rely more on total contractor logistics support and long term contracts, and defense industry consolidations reduce competition for depot maintenance workloads?
General WILSON. All of the things you mention, if not carefully considered and controlled, could severely reduce the existence of competition for depot maintenance. This makes it doubly important that, as part of the core evaluation, the competitive market be evaluated. One of the reasons for retaining core is to establish competitive pressures where they otherwise might not exist.
Mr. BATEMAN. In the absence of a competition, to what extent do you believe outsourcing will achieve savings?
Mr. WILSON. Without competition, or the possibility of competition, I do not believe there can dependably be a savings from outsourcing.
Page 911 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Should DOD retain non-core depot maintenance capabilities for workloads where no competitive market exists?
General WILSON. Yes, and the DOD core methodology allows for this in determining the final ''Total Organic Capability Requirement'' which is the bottom line of the method.
Mr. BATEMAN. Should DOD depots be allowed to compete for outsourced workloads where no competitive market exists?
General WILSON. Yes, and where sources are drying up in the private sector, this can and will happen. Again, the core methodology, properly applied, takes these situations into account.
Mr. BATEMAN. In a non-competitive environment how does DOD plan to assure it is getting the benefits and safeguards of a competitive commercial market?
General WILSON. This is one of the purposes of establishing core capabilities and in having centers for technical excellence in our depots. In the absence of commercial competitive forces, the depots can be the source of the competitive forces.
Public-Private Competition
Mr. BATEMAN. The DOD is changing its policy and using a ''best value'' approach when evaluating bids in a public-private competition, rather than simply evaluating each proposal on a least expensive basis. As the private sector can pick and choose its workload, and the public depots are assigned all types of workload, it is likely that public depots can not run as efficiently as the private sector.
Page 912 PREV PAGE TOP OF DOC Segment 5 Of 5
How will you determine best value in the private sector? How are you going to determine best value in the public depots?
General WILSON. Our evaluation criteria, which will be determined beforehand and included in the solicitation, will be the same for both public and private competitors.
Mr. BATEMAN. If you use a ''past performance'' criteria for determining best value, how will you determine past performance in the public depots when they have had little or no control over the assignment of workload or retention of skilled employees?
General WILSON. The Office of Federal Procurement Policy for the last few years has said that we are to consider past performance in all solicitations. That is what we have tried to do. In regard to the public depots' involvement in public-private competition, our experience tells us that our depots bid generally on goods and services they have successfully maintained in the past. Therefore, we will have a record of performance and be able to judge the degree in which we have confidence in the depots' completing the work successfully, if they win the competition.
Outsourcing Depot Maintenance
Mr. BATEMAN. Since each of the services have been responding to direction to privatize more and more depot maintenance work over the last two years, please provide us with a list of systems and dates regarding the estimated savings resulting from these actions.
Page 913 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. Although we have felt some pressure to privatize more, we have not responded by privatizing for privatization's sake. We do not have a significant amount of additional privatization of depot maintenance over the last two years, and do not have a list of systems or savings to present. If we make a decision for a large scale privatization, we will do complete analyses and file detailed reports as required by law.
Readiness and Sustainment of DOD Forces
Mr. BATEMAN. DOD policy states that ''paramount in all departmental policy considerations are (1) the readiness and sustainability requirements of DOD forces. . . .'' On what do you base the readiness and sustainability requirements of DOD forces?
General WILSON. In our implementation of the Defense Planning Guidance, we define the quantities and types of equipment which our fighting forces need to execute each contingency scenario. Knowing these quantities, the known use of the equipment (operational tempo, probability of damage, etc.) we can determine what is needed to maintain readiness for the contingencies and to sustain the forces in the contingencies. This is the essence of thoughtful application of the core methodology, a core capability to both maintain readiness and sustain the forces in a contingency.
Mr. BATEMAN. Is the optimum use of scarce department resources based on the availability of funds or on employee levels?
Page 914 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. Maintaining readiness and sustainability of DOD Forces is based upon the best mix of all available resources: dollars, manpower, facilities, and the industrial base. It cannot be explained as an either/or option.
Support to Readiness and Sustainment of DOD Forces
Mr. BATEMAN. Over the years, there has been concern voiced with the ability for the private sector to respond during times of national emergencies and concerns for work stoppages due to strikes and/or corporate business decisions. How would you address these concerns?
General WILSON. Work stoppages due to strikes, of course, can be handled under existing laws during a national emergency. The possibility of corporate business decisions interrupting performance of depot maintenance is a real consideration, and this is why I feel the risk assessment for potential privatization and outsourcing of depot maintenance is so important in determining what our core depot maintenance requirements are. Two of the key criteria which all the Services must address when assessing private sector capability concern the existence of alternative sources for performing the work. One looks at the number of commercial sources, and another looks at remaining capacity and capability in the DOD. Between the two of them, these criteria carry a lot of weight in determining whether a workload can be risked to private sector performance.
Mr. BATEMAN. What happens when the private sector makes a business decision to not continue a particular workload and by that time, the public depot previously accomplishing the workload has closed?
Page 915 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. If our criteria for putting work in the private sector works currently, we should not get in this situation. My preference where there are few sources, public and private, to perform a type of work is to maintain a dual system. Where this works, we are able to share workloads between the private sector and the public depot—in the process maintaining both the capability to perform work in both sectors and a somewhat competitive environment.
Mr. BATEMAN. It is DOD policy to place all new weapons systems' depot level requirements with the original equipment manufacturers. How can you maintain your depots if none of the new weapons systems are placed in these depots?
General WILSON. If that were the policy, I would not be able to sustain a viable depot system. The most recent draft of DOD policy, which I concurred in as a part of the Defense Depot Maintenance Council, does show a preference for private sector sources, but only after ascertaining that core capabilities are not eroded by doing so.
Mr. BATEMAN. Is it true that if no new weapons systems are placed in the public depots, they will wither and close in nine years?
General WILSON. I do not know about the figure of nine years, but public depots would wither away as fast as new systems replaced old if all new systems were kept out.
Public Versus Private Competition
Page 916 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. DOD intends to have selective public/private competitions for workloads where adequate competition does not exist in the private sector. For your depots to be a reasonable competitor for these workloads requires that they have the capability and capacity to perform workloads.
What are you doing to ensure that your depots can be realistic competitors for these workloads?
General WILSON. Two things. First of all, we are in the process of reshaping our depots to be as efficient and effective as possible in executing the work that we give them. Second, we give them work on the most modern systems we use, allowing them to maintain the proficiency necessary to keep the competitive edge. This is the essence of the DOD-wide effort to have centers for technical excellence at the depots, always maintaining the technical competence to take in new work of the same type. A side issue, but also important, will be reestablishing the people at the depots, commodity commands, and the headquarters to actually run the competition program.
Mr. BATEMAN. Do you feel that you have the capability to effectively compete for depot workloads?
General WILSON. We definitely have the technical capability to compete. As we complete our reshape of the depots, we will become economically competitive in any areas where we may have lost that edge. As we receive the new guidance from DOD on competition, and reestablish our team to implement the policy, I believe we will be very effective as a competitive force.
Page 917 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Would not the depots be more economically efficient if their workload was closer to their current capacity as opposed to artificially sizing them to core?
General WILSON. The key to the answer to this question is the word ''artificially.'' Core should not be computed in a vacuum, and the core methodology has a place to adjust the organic portion of the workload for economy and efficiency. Sizing the depots, making them efficient and determining the total core and non-core workload assigned to them should be done as one action, not artificially and separately.
Core Depot Maintenance
Mr. BATEMAN. Congress and DOD agree that a core capability should exist in public depots. Have you examined the current core requirements to test for reasonableness and to determine what percent of the maintenance funding will be core?
General WILSON. In our top to bottom application of the joint core methodology that we are just completing, we are definitely examining our core requirements for reasonableness. One of the problems of previous methods of calculating core was that the results, since they were based on pure modeling of the contingency scenario, sometimes were unreasonable in the sense that they were not supportable with actual day-to-day workloads at the depots. The joint methodology, since it is based on maintaining readiness of the contingency equipment with the existing depot system yields results which are manageable and have a direct connection to the day-to-day requirements for maintenance. I cannot at this time state the percent of funding being spent on core requirements; but, as we completed and validate the results of our latest calculation, we will be able to do that. Past methods didn't allow that to be done directly, but this one does.
Page 918 PREV PAGE TOP OF DOC Segment 5 Of 5
Infrastructure Costs
Mr. BATEMAN. It appears to me that DOD wants to eliminate much of the infrastructure cost associated with its depots in order to free up funds for other priorities such as force modernization.
If DOD is allowed to do so, what specific steps would be used to eliminate the excess infrastructure?
General WILSON. We would use compliance with core legislation and policy, identification of workload/installation support that could be cost effectively contracted out; further consolidations; elimination of redundancies; and elimination of excess capacity. These steps should work to identify excess infrastructure, allowing the depots to reduce their rates, which would result in additional funding for other priorities.
Mr BATEMAN. Has DOD developed plans and strategies to accomplish a reduction in the depot infrastructure?
General WILSON. Yes, we have, through identification of core capability, BRAC initiatives, privatization/outsourcing, and elimination of redundancies.
Mr. BATEMAN. What would you expect the depot infrastructure to look like after downsizing?
Page 919 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. I would expect the depots to operate efficiently and effectively to provide the maximum support to the specific systems they are responsible for at a minimum cost.
Mr. BATEMAN. If DOD is allowed to size the depot infrastructure to its current definition of core, what depots would be affected? What would employment levels look like?
General WILSON. All depots would be affected. Employment level would probably be somewhat reduced; however, that would be dependent upon realignments, consolidations, and cross servicing initiatives.
Missile Workload at Letterkenny Army Depot
Mr. BATEMAN. It's my understanding that the Army plans to establish a government owned, contractor operated (GOCO) depot maintenance facility for tactical missile maintenance at the Letterkenny Army Depot site rather than transferring work to Tobyhanna Army Depot, as recommended by DOD. The BRAC commission recommended transferring the workload to either Tobyhanna or to the private sector.
How does the Army's plan to establish the GOCO operation meet the spirit and intent of BRAC recommendations which were established to divest the government of unneeded infrastructure?
General WILSON. The BRAC commission's recommendation related to Letterkenny Army Depot states ''change the 1993 commission's decision regarding the consolidation of tactical missile maintenance at Letterkenny by transferring missile guidance system workload to Tobyhanna Army Depot, Pennsylvania or private sector commercial activities''. The Army will move missile guidance system workload that is determined to be core, by the owning services, to Tobyhanna Army Depot. If there is sufficient non-core missile guidance system workload for a cost effective competition the Army will compete the workload and Tobyhanna, as well as the private sector, will be allowed to bid. The core determination will be completed by May 1997.
Page 920 PREV PAGE TOP OF DOC Segment 5 Of 5
The Army does not intend to establish a GOCO operation at Letterkenny Army Depot in response to BRAC 95. Only missile guidance workload could be competed in accordance with BRAC 95 direction. The missile guidance workload that could be competed must be declared by the owning service as non-core. If all the missile guidance workload were declared non-core it would still only amount to approximately 14% of the current workload at Letterkenny Army Depot. This workload is accomplished in facilities that are being retained for other missile workload at Letterkenny and will have no effect on Army infrastructure. If the workload is competed, use of these buildings and equipment at Letterkenny will be offered as an option under the solicitation.
Mr. BATEMAN. Please describe the approach, methodology, and level of documentation that the Army developed for its' risk assessment leading to the proposed GOCO facility at Letterkenny.
General WILSON. The submission to Congress last year, which included a proposal for a GOCO missile assessment of the type now included in the core methodology. Since that time, the proposal to GOCO that facility has been dropped as an option.
Mr. BATEMAN. Please describe the results of the Army's economic analysis supporting the GOCO facility at Letterkenny (LEAD) to include specific options considered, and benefits and savings from GOCO operation compared to the costs and benefits for consolidating at Tobyhanna (TYAD).
General WILSON. As previously stated in the above question, the submission to Congress last year, which included a proposal for a GOCO missile maintenance facility, did not include a formal privatization risk assessment of the type now included in the core methodology. Since that time, the proposal to GOCO that facility has been dropped as an option.
Page 921 PREV PAGE TOP OF DOC Segment 5 Of 5
Modernization Through Spares
Mr. BATEMAN. Please explain your ''Modernization Through Spares'' program. Also, have you provided the report required by section 312 of the Defense Authorization Act for fiscal year 1997 which relates to this program?
General WILSON. The idea behind Modernization through Spares is to generate significant life cycle and support cost savings and to reinvest the savings in modernization of the M109 fleet. This would be accomplished by continuously providing upgraded, more reliable spares. The report you ask about was submitted by the Assistant Secretary of the Army for Research, Development and Acquisition. It deals with competition requirements, core logistics requirements, public-private competition requirements and the Small Business Act.
Base Realignment and Closure (BRAC)
Mr. BATEMAN. General Wilson, as I understand it, the Army's original proposal to the BRAC suggested termination of depot maintenance work at two of the Army's five depots. The Army stationing strategy envisioned retention of the Anniston, Corpus Christi and Tobyhanna facilities and transfer of all depot maintenance workloads from Letterkenny and Red River. If I am not mistaken, a line by line comparison of DOD's proposal to BRAC and the Commission's final recommendation for Letterkenny differs in only one regard—the Commission added language allowing missile work to be sent to ''private sector commercial activities'' in addition to Tobyhanna as the Department originally suggested. Both the DOD recommendation and the Commission recommendation describe the missile workload subject to transfer or privatization as ''missile guidance system workload.'' Based on a recent GAO report, I understand the Army has developed a position whereby an estimated 86 percent of the missile work will likely remain at Letterkenny in a government owned, government operated facility based on the Army's interpretation of what BRAC intended. In addition, GAO states that the Army could save $27 million per year by transferring the entire missile workload package to Tobyhanna, and in the process increase Tobyhanna's utilization rate to 85 percent.
Page 922 PREV PAGE TOP OF DOC Segment 5 Of 5
If you say your initial proposal was to terminate work at Letterkenny, and both the DOD and BRAC Commission recommendations describe the work that was to be sent to Tobyhanna using precisely the same language, what led the Army to establish a plan which retains costly unneeded government owned and operated infrastructure at Letterkenny? Further, why hasn't the Army looked at the cost benefits of transferring the work to Tobyhanna or other private sector commercial activities as recommended by the BRAC and reiterated in GAO's September 1996 report?
General WILSON. The BRAC Commission's recommendation, subsequently passed into law, dealt only with missile guidance systems. This equates to about 14% of the total missile workload performed at Letterkenny. The Army will move missile guidance systems determined to be core workload to Tobyhanna. If there is sufficient non-core missile guidance workload for a cost effective competition, then the Army will compete the workload among the private sector and Tobyhanna. If not, we will also move that workload to Tobyhanna.
Future Plans for Paladin Depot Maintenance
Mr. BATEMAN. In your testimony you indicated that artillery work will be transferred from Letterkenny to Anniston, in compliance with the BRAC Commission's recommendation. I understand the Army is considering a few alternatives that seemingly conflict with that statement. First, GAO's September 1996 report states that the Army was considering establishing a GOCO at Letterkenny for future Paladin depot maintenance work. In yet another proposal, the Army is studying a modernization through spares approach for fleet management of the M109 family of artillery vehicles, which includes the Paladin. Under the fleet management approach, the Army would move the M109 workload capability to Anniston. But, shortly after the work arrives at Anniston, the Army would exercise a contract option to purchase maintenance work from the fleet management contractor.
Page 923 PREV PAGE TOP OF DOC Segment 5 Of 5
What is the Army really planning with regard to future depot maintenance of the Paladin system and the related M109 family of vehicles? What is the utility of transferring workload capability to Anniston, if the long range plan is to have the work done by a private sector contractor? In your view which approach would be most cost effective?
General WILSON. As core workload, Paladin depot maintenance will transition to Anniston Army Depot in accordance with BRAC 95 law. It will not be privatized. We plan to accomplish this transition in FY99.
Paladin production, which is now being done through a teaming arrangement between Letterkenny Army Depot and United Defense Limited Partnership, will continue in place with the present teaming arrangement for its currently planned production run through FY99. We are evaluating how to conduct any future Paladin production after that.
Because Paladin depot maintenance is core, it must be done organically. Therefore, we have done no cost benefit analysis of organic vs private performance.
Transferring of Electronics and Communications
Mr. BATEMAN. Based on the chart included with GAO's statement, I notice the utilization rate for Tobyhanna is quite low in comparison to the other depots. By 1999, Tobyhanna's programmed workload will use only half of the available capacity, and only 35 percent of maximum potential capacity.
Page 924 PREV PAGE TOP OF DOC Segment 5 Of 5
How will the planned transfer of electronics and communications work from the Air Force affect capacity utilization at Tobyhanna?
General WILSON. According to Air Force projections, the workload to transfer from Sacramento Air Logistics Center to Tobyhanna Army Depot as a result of BRAC 95 will total between 1 million and 1.1 million direct labor hours per year. This is a substantial workload, equaling about 20 percent of Tobyhanna's capacity. Although fluctuations in Tobyhanna's other workload will affect Tobyhanna's overall capacity utilization, we currently project a 62 percent capacity utilization in FY00, assuming all of the Sacramento Air Logistics Center workload has transferred by then.
Sincgars
Mr. BATEMAN. Last year the Army calculated a core workload requirement at Tobyhanna of about 4.8 million direct labor hours, of which about 2.0 million hours was applicable to the SINCGARS radio system. According to GAO's statement, this work will not likely materialize. One reason cited in the GAO statement is assignment of SINCGARS repair work to below depot level activities.
What is the utility of decentralized maintenance on this system?
General WILSON. The utility is that the soldiers with the equipment have the ability to do repairs right on the spot saving time and increasing readiness. Tobyhanna Army Depot (TYAD) is the designated centralized maintenance facility for SINCGARS equipment. Although the past estimate of 2.0 million hours was included, the CORE XXI workload requirement has recently been reviewed and analyzed. The current estimate of direct labor hours applicable to SINCGARS equipment a TYAD is 1100. The drastic decline in hours is due to the fact that the model incorrectly included work below depot level. SINCGARS maintainability allows soldiers to easily repair the equipment. Additionally, the total number of reparable circuit card assemblies has been reduced significantly and system reliability has greatly exceeded our expectations.
Page 925 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. What are the pro's and con's of such an arrangement?
General WILSON. The Pro's are: Commanders are more in control of their equipment; less expense to the unit (depot maintenance/transportation costs); an economic analysis shows a reduction in overall maintenance costs at the depot; and it reduces turn around times.
The Con's are: Potential increase in training, manpower, and skill requirements; no Economies of Scale (TMDE usage, batch repairs, repair part prices, skill utilization, etc.); and as the equipment changes, repair program changes must be proliferated to a number of different locations.
Missile Workload at Letterkenney Army Depot
Mr. BATEMAN. Based on the work that the Tobyhanna depot will be receiving from the Air Force, wouldn't it be feasible to also look into transferring the consolidated missile workload package to Tobyhanna? Based on my staff's analysis of the BRAC Commission recommendations, it would appear that both workloads would fit into Tobyhanna depot.
General WILSON. No, it is not feasible to transfer the consolidated missile workload package to Tobyhanna. BRAC 93 directed that tactical missile maintenance be consolidated at Letterkenny Army depot ''as originally planned by the Department of Defense in the Tactical Missile Maintenance Consolidation Plan for Letterkenny Army Depot, January 31, 1992 (revised April 30, 1992). Add tactical missile maintenance workload currently being accomplished by the Marine Corps Logistics Base Barstow, California.'' This direction was only changed by BRAC 95 to the extent that BRAC 95 directed the ''missile guidance workload'' be moved to Tobyhanna Army Depot, Pennsylvania or private sector commercial activities.
Page 926 PREV PAGE TOP OF DOC Segment 5 Of 5
Public Private Partnerships
Mr. BATEMAN. The Anniston depot, over the years, has attempted to better utilize excess infrastructure through a variety of public-private ventures, including partnerships with private industry, work sharing and direct sales of services to private sector firms. Depot officials believe these and similar arrangements could help alleviate some of the costly excess capacity problems evident throughout the current depot maintenance system.
What is your assessment of these programs? To what extent do they provide opportunities to significantly reduce depot maintenance costs?
General WILSON. I believe these programs are extremely useful. In the combat vehicle sector—which lacks somewhat in competitive forces in the marketplace—they have been particularly useful in holding down costs, and in more efficiently using our capacity both at Anniston and at the Lima Tank Plant. If we could do more of these various programs for using otherwise idle capacity, we would significantly reduce costs of depot maintenance by spreading the overhead costs over a large base.
Mr. BATEMAN. Some say the public-private ventures are stymied by legislative impediments. What legislative relief can you suggest that would increase the potential for achieving additional and more cost effective public-private ventures?
General WILSON. Legislation could help in a couple of areas. We have a very successful program in the ammunition production base for leasing out unused capacity which was aided by the Armaments Retooling and Manufacturing Support (ARMS) Act of 1992. Although we have the legal authority to execute similar facilities use contracts at the depots, the marketing assistance that the ARMS act gave us in starting that program would be very helpful if expanded to depots and arsenals. Another change that would give a lot more flexibility to us for entering into partnering arrangements would be if the ''core'' series of legislation (particularly 10 USC 2464, 2466, and 2469) allowed us to count contract employees performing work at government-owned facilities as part of the organic base. This kind of flexible work force, with a government-employee base to perform the long-term, steady work and the potential to bring in private companies to do special and shorter duration work such as modifications and upgrades to existing equipment, could result in a much higher utilization rate on the capacity we own at the depots.
Page 927 PREV PAGE TOP OF DOC Segment 5 Of 5
Many proposed public/private ventures would involve depots performing in the role of subcontractor/supplier to DOD contractors. Any sale by a public activity requires statutory authority. Under existing statutes, 10 USC 2208(j) and 10 USC 4543, Army depots and arsenals have limited authority to offer their capabilities to private industry. These authorities, moreover, are so restrictively conditioned as to make them largely unworkable. Under 10 USC 2208(j), a depot must have been eligible to compete for the prime contract award before it can be a subcontractor. Satisfying this condition is often legally impossible and administratively infeasible. The most frequent complaint about 10 USC 4543 is that a contractor must indemnify the Government for any and all damage resulting from Government performance, even though the contractor has no control over performance at the Government facility. This is not the practice in industry, and prevents industry from utilizing Government facilities even when there is not other industry, and prevents industry from utilizing Government facilities even when there is no other domestic source available. Relief from these restrictions would facilitate public private teaming on a much greater scale than now possible.
Red River Army Depot Closure
Mr. BATEMAN. I understand the Red River depot is aggressively looking at ways to divest the government of unneeded buildings and infrastructure. The plan would reportedly make various buildings, or even parts of buildings, available for use by private sector enterprise.
What is the status and schedule of the Red River closure?
Page 928 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. Red River is not a closure action. It is a realignment action. All maintenance workload other than the Bradley Fighting Vehicle System (BFVS) and Multiple Launch Rocket System (MLRS) will be realigned from Red River. The M113 core workload will transition to Anniston by October 1, 1997. Other minor core workload will transition out in Fiscal Year 1998. Non-core workload will be completely transitioned out not later than the end of Fiscal Year 1999.
Mr. BATEMAN. What problems are envisioned if industrial facilities are shared by both public and private sector user?
General WILSON. As a part of the BRAC 95 action effecting Red River, the Army is declaring excess land and facilities no longer needed as a result of the drawdown in mission. We are working with the Local Redevelopment Authority now in the identification of the excess parcel. There may a point in time that both the community and the Army need access to certain facilities simultaneously as we drawdown our mission, and they attract suitable tenants. We believe these situations can be amiably worked out to further the economic revitalization of the area and ensure that Army readiness does not suffer.
Mr. BATEMAN. Is legislative relief needed to enable more cost effective use of Red River's excess infrastructure?
General WILSON. No. Legislation currently exists under BRAC to enable the Army to adequately dispose of the excess land and facilities.
Impact of Depot Maintenance Outsourcing on Capacity and Savings
Page 929 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. What impact will DOD's depot maintenance outsourcing plans, to include contractor logistics support, have on excess DOD depot capacity and the cost of performing work in these depots?
Admiral STERNER. Currently NAVSEA has no plans to directly outsource ship depot maintenance beyond the current public and private sector mix. As we continue to seek opportunities to reduce the operations and maintenance costs of our systems, we will employ support concepts such as Contractor Logistics Support (CLS) and Direct Vendor Delivery (DVD) that may place support functions, including depot level repairs to systems, in the private sector. We expect to employ these concepts for our systems where it makes good business sense.
Mr. BATEMAN. Since outsourcing work from a DOD depot that already has excess capacity will result in more excess capacity and increased labor hour rates for the remaining workloads in the DOD depot, unless the depot is closed altogether, should this cost be considered public/private depot competitions, if no why not?
Admiral STERNER. Since we are not planning to directly outsource additional ship depot maintenance, we do not foresee an increase in excess capacity and associated costs. We will consider the impact on excess capacity when making any decisions relative to outsourcing depot level repairables.
Mr. BATEMAN. How does DOD plan to reduce excess capacity and increase the efficiency of its depots?
Page 930 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral STERNER. From a NAVSEA perspective, the primary mechanism to reduce excess capacity in the public sector ship depot maintenance industrial base is the Base Realignment and Closure (BRAC) process. For example, by the end of FY97 we will have closed four of eight Naval Shipyards (Philadelphia, Charleston, Mare Island, and Long Beach) with a resultant reduction of personnel from 72,000 in FY87 to approximately 21,000 by the end of FY97 (a reduction of 71%).
Other efficiency efforts ongoing in the Naval Shipyards include participation in Regional Maintenance; demolition of excess facilities; consolidation of shipyard effort; reduction in late deliveries and cost overruns; Strategic Planning to identify and improve customer satisfaction with quality, cost, and schedule performance; elimination of Cumbersome Work Practices; implementation of new technologies; and teaming with the private sector to identify best practices in the planning, management, and execution of aircraft carrier availabilities, and to share specialized resources in nuclear propulsion work.
Similar efforts are ongoing at the Naval Undersea Warfare Center (NUWC) which reduced Torpedo Depot personnel by 35% during FY97 and 51.4% overall since FY94. They consolidated the Torpedo Production organization at Naval Undersea Warfare Center Division, Keyport; reduced Torpedo Depot facilities (buildings) by 50%; and re-engineered depot processes to share common facilities and to capitalize on most efficient material flow, industrial processes, common testing equipment, and transportation pathways.
Mr. BATEMAN. How does DOD plan to reduce its depot excess capacity resulting from outsourcing and privatizing-in-place workloads?
Page 931 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral STERNER. From a NAVSEA perspective we already have many initiatives underway to reduce excess capacity. As we continue to look for the best business solution for our depot level repairables, we will consider its impact on our depot maintenance organizations.
60/40 Policy, Contractor Logistics Support/Interim Contractor Support (CLS/ICS)
Mr. BATEMAN. You have not included CLS and ICS in your 60/40 calculation. My reading of the law reveals no exemption for these categories of maintenance. What is your legal authority for this exclusion?
Admiral STERNER. It is the Navy's understanding that it is DOD policy that CLS and ICS are not to be included in the ''60/40'' calculation.
Mr. BATEMAN. What is the current 60/40 spread for each of the Services? Last year during the hearings you also provided outyear projections. Would you please do the same this year.
Admiral STERNER. The 60/40 spread for the Department of the Navy for the period FY 1996–2002 is as follows:
Mr. BATEMAN. What are the current ICS/CLS levels for each of the Services?
Page 932 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral STERNER. The ICS/CLS levels for the Department of the Navy are as follows:
Mr. BATEMAN. If ICS and CLS were calculated in the 60/40 data, would each Military Department be in compliance? What about the projections?
Admiral STERNER. The Department of the Navy would be in compliance with the law, for both current and future projections, if ICS and CLS were included in the 60/40 calculation, as demonstrated on the previous two charts.
Mr. BATEMAN. The department has announced plans to expand direct vendor delivery. Will this be applied to depot-level reparables? Will this expansion take into account 60/40?
Admiral STERNER. The Navy is pursuing expanding the Direct Vendor Delivery (DVD) concept, which may include depot-level repairables. We, at NAVSEA, have not received guidance regarding application of ''60/40'' to DVD.
Mr. BATEMAN. Why are upgrade programs factored into the organic share and not the contractor share of 60/40?
Admiral STERNER. The guidance for calculating 60/40 was provided to the Navy by the Office of the Secretary of Defense, under which we are directed not to include upgrade programs in the contractor share of 60/40. I74Privatization of Louisville
Page 933 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. The GAO indicated last July that they didn't agree with the Navy analysis of costs on Louisville. Now the GAO has issued a draft report indicating that the Navy could have saved $72M by transferring workload to other depots. Do you have an explanation for this apparent waste of taxpayer dollars?
Admiral STERNER. DoD is in the process of responding to the GAO draft report. Our analysis indicated that the taxpayer will avoid spending $60M in the first five years in this area of work by privatizing versus relocating the work. In addition, BRAC savings will be achieved sooner than would have been achieved by transferring the workload to other depots.
Mr. BATMAN. I'm told the Navy did not take into account the effect this workload would have had on the overhead of the existing workloads had the Louisville work been transferred to other organic deports. Is that true? Would you please provide a copy of the original cost analysis to this committee?
Admiral STERNER. We believe that is not true. We believe the effect on overhead for existing workload at a receiving activity has already been accounted for in the BRAC calculations and is reflected in the cost analysis. A copy of the cost analysis will be provided under separate cover.
Mr. BATEMAN. Can you explain why the Department's plan for privatization of the Louisville depot did not address the 10 U.S.C. 2469 requirement that public vs. private competition be used?
Page 934 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral STERNER. The Navy's actions in implementing the BRAC recommendations for Louisville as explained in our letter to you of July 19, 1996, are consistent with 10 U.S.C. 2469 in the context of the BRAC Act of 1990 (10 U.S.C. 2687 Note).
Mr. BATEMAN. The Department concurred with the GAO's recommendation that, before exercising any contract options for the Louisville depot maintenance workloads, the Navy use competitive procedures to ensure the cost-effectiveness of the Louisville privatization-in-place initiative. What is the status of the competition?
Admiral STERNER. The Department of Defense stated ''FAR provides that before exercising a contract option, the contracting officer must determine that the exercise of the option is the most advantageous method of fulfilling the Government's needs; price and other factors considered.'' We have and will continue to follow that direction. The next option will be the FY98 option. The FY98 option is designed to receive, primarily, FY98 funding.
Mr. BATEMAN. In making its recommendation to the BRAC Commission, the Department proposed transferring Louisville's workloads to Norfolk Naval Shipyard, Crane and Port Hueneme to make their operations more efficient by utilizing their excess capacity. Since that transfer did not take place, what other steps has the Department taken to address this problem?
Admiral STERNER. In order for the Louisville workload to be transferred to Norfolk Naval Shipyard, Crane and Port Hueneme all three sites would have had to add construction and/or facility alterations to accommodate transferred or new equipment and people, increasing their existing capacity. In an effort to reduce existing capacity, we are consolidating like functions and demolishing excess facilities.
Page 935 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. How do the prices the Department is paying for the Louisville workloads being accomplished by United Defense Limited Partnership and Hughes Missile Systems Company compare to the costs that were incurred previously?
Admiral STERNER. It is too early in the privatized effort to look for definitive cost comparisons; however, recent information from the privatization contractors indicates that cost of performance is being reduced and productivity efficiency is improving. We expect to continue a relationship with the privatized facility as long as the Navy needs the work, the product quality is acceptable and the price is competitive.
Mr. BATEMAN. At the time of the award of contract for Louisville, both United Defense Limited Partnership and Hughes Missile Systems Company had excess capacity in their own facilities. Has either firm moved any of the work that has resulted from these contracts to the company's sites?
Admiral STERNER. No contract work has moved from Louisville to other sites. United Defense has placed work (55 workyears) that could have gone to its other site in Louisville. Both companies plan to move more work from their other sites to Louisville. Both companies have indicated the potential of using the Louisville site for work other than that originally contracted for is advantageous to both them and the Navy.
Mr. BATEMAN. How does the size of the workload currently being done by both contractors compare with that which was being done previously?
Page 936 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral STERNER. The workload for legacy systems is declining and is expected to continue to decline.
Mr. BATEMAN. How do the overhead rates of both contractors compare with that which was experienced previously?
Admiral STERNER. A comparison of actual rates will not be possible until the individual work elements are completed and costs are audited. Based on the limited data to date, projections are that the overhead rates of the contracted work at Louisville will be within 10% + or– of the Navy Louisville rates.
Mr. BATEMAN. How does the contractors' performance, in terms of repair cycle time, compare with that which was delivered previously?
Admiral STERNER. A typical repair cycle time for a complex gun system is between 8 and 15 months. Since it has only been 7 months since privatization and because much of the work transferred to the contractors was work in process, it is too early to make cycle time comparisons. Early indications are that repair time has been shortened. We have recently been informed by one of the contractors that they are not experiencing production efficiency, on average, 20% better than standards established before privatization. Further reductions are anticipated as the contractors continue to implement process improvements.
Mr. BATEMAN. One of the basic tenets of the Departments theory on outsourcing is competition. Yet the Navy awarded Louisville on a sole source basis. Can you comment on this apparent departure from Departmental policy?
Page 937 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral STERNER. Many factors went into the decision to privatize in place including the specific BRAC recommendation, cost of privatization versus relocation, ability to provide a specialized technical capability to the Sailors and Marines at sea, minimization of risk, community redevelopment, and the reduction of Navy infrastructure. A key factor was that the work being performed at Louisville was unique and not performed at any other location, DoD or private. The Navy entered into a lease with the Local Redevelopment Authority (LRA) for the facilities and equipment necessary to perform the workload. LRA considered sublease proposals from three defense contractors. The LRA entered into subleases with UDLP and Huges. The Navy awarded workload contractors to UDLP and Hughs. Therefore, given the unique circumstances at Louisville, we do not view privatization in place for the workload as being synonymous with elective outsourcing.
Public Versus Private Competition
Mr. BATEMAN. Last year at this time we were told the depots' cost accounting systems weren't adequate enough to make cost comparisons for public versus private competitions. Now after we rejected your privatization initiative, we're being told all is well and the Department is set to begin a competition program. What's going on here? What's changed? I don't recall any major Departmental initiatives in this area.
Admiral STERNER. The Navy is aware that the Office of the Secretary of Defense has drafted guidance to reinstitute public/private competition. That guidance has not yet been promulgated; therefore, we are not in a position to comment.
Page 938 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Can you summarize the changes to the Cost Comparability Handbook? Were any changes made to the way contractor costs are looked at?
Admiral STERNER. The Navy is aware that OSD may recommend changes to the Cost Comparability Handbook in connection with their public/private competition guidance. However, since that guidance has not been promulgated, we do not know the final details.
Mr. BATEMAN. What's going to be different from the old public versus private competitive program?
Admiral STERNER. As stated previously, the Navy does not yet know the final details of OSD's public/private competition guidance.
Mr. BATEMAN. When do you plan to start again?
Admiral STERNER. The Navy does not know when OSD's public/private competition guidance will be finalized. The Navy, while recognizing the potential benefits to public/private competitions, anticipates few, if any opportunities to use this acquisition methodology. As a result, the Navy has no plans to participate in public/private competitions in the foreseeable future.
Mr. BATEMAN. Will all depots be permitted to participate, or will there be restrictions?
Admiral STERNER. As stated above, the Navy does not plan to participate in public/private competitions in the foreseeable future.
Page 939 PREV PAGE TOP OF DOC Segment 5 Of 5
Defense Science Board
Mr. BATEMAN. Two years ago, the DSB recommended the Department maintain the CORE concept. This year they recommend the Department abandon that concept. I notice that there were military advisors connected with both studies. Can you tell us what changed over the past two years that prompted this change in view?
Admiral STERNER. I have not been advised of what specific changes in the past two years affected the recommendations of the November 1996 DSB Report.
Mr. BATEMAN. Some very senior OSD officials have ridiculed the latest DSB report by pointing out that it lacks analytical foundation. Do you agree with that characterization?
Admiral STERNER. In my position as a Systems Commander, I have not assessed or analyzed the DSB report in detail and therefore cannot provide a fully informed opinion regarding the adequacy of the report's analytical foundations.
Mr. BATEMAN. The 1996 DSB Summer Study on Innovative Support Structure for the 21st Century Military Superiority indicates savings of $30B per year are possible. Are you finding similar results in your QDR studies?
Admiral STERNER. The QDR studies are still in a preliminary stage and it would therefore be premature to quantify savings which may be identified in that review.
Page 940 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. The same study calls for a 5 percent per year reduction in civilian workforce and a 2 percent per year reduction in military personnel over the next five years. Can you accomplish these reductions and still stay within the 60/40 restriction? Can you accept these and still maintain readiness? Has there been any move, that you know of, to implement these recommendations?
Admiral STERNER. I have been advised that the Navy has not analyzed the impact of the Defense Science Board recommendations and that there has been no direction to implement these recommendations. In any event, the results of the Quadrennial Defense Review should be assessed before any reductions are made.
Mr. BATEMAN. In your opinion, would there be violation of the law if the recommendations contained in the DSB Summer Study were to be implemented?
Admiral STERNER. I have been advised that full implementation of the DSB recommendations may require relief from, or revision of, existing statutes, such as 10 U.S.C. 2466.
Mr. BATEMAN. It would seem that the people conducting the studies would stand to benefit should the DSB recommendations be implemented. How can this apparent conflict of interest be avoided in the future?
Admiral STERNER. The Defense Science Board is a Federal Advisory Committee established to provide independent advice to the Secretary of Defense. Therefore, matters concerning its membership and activities should be addressed to the Secretary of Defense.
Page 941 PREV PAGE TOP OF DOC Segment 5 Of 5
CORE
Mr. BATEMAN. Your methodology gives the appearance of rigor. However, in actual practice it appears that anything and everything can become non-CORE at the convenience of the Department. Wouldn't you agree that the CORE methodology is a sham?
Admiral STERNER. The DoD CORE policy provides a sound basis for identification of the depot maintenance capabilities required to ensure a ready and controlled organic source of technical competence. We would like a stable workload base so we can have a static workforce. This would make for a streamlined industrial base planning and execution process. However, many factors drive the composition of our workloads necessary to sustain CORE capabilities, and these factors are not static. For example, force structure changes drive the size of our requirements. The introduction of new technologies will change the skills that are required. Changes to operational scenarios will drive both the skill requirements and the size of the CORE requirement. In this ever-changing environment, we need to have a responsive process that allows us to adapt to these changes.
Mr. BATEMAN. During BRAC 95 a significant portion of the workload performed at Louisville was certified as core and yet was contracted out. Are we contracting core? Was a risk assessment performed on the workload? If so will you provide us a copy of that assessment.
Admiral STERNER. We followed the DoD's proposed Policy Regarding Performance of Depot-Level Maintenance and Repair (March 1996) CORE methodology. Based on this methodology the work at Louisville was not CORE. Our assessment of the private sector's capability to perform this work was based on the fact that we were providing the facility, equipment and personnel that had previously provided Navy with that capability. A risk assessment was performed as part of the Navy BRAC process. The BRAC commission provided two alternatives for maintaining the technical capability.
Page 942 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Have you changed the definition of CORE from what was reported to us last March?
Admiral STERNER. No, the definition remains the same.
Mr. BATEMAN. Please provide us with the workloads necessary to sustain core capabilities for each of the Services, by depot.
Admiral STERNER. CORE has been developed at the total activity group level and at the product level, but not at the indvidual depot level. CORE quantities are expressed in direct labor hours (DLHs). Total Navy DLHs are 37.659M, broken out as follows:
There are two principal reasons for this difference. First, a substantial proportion of the Air Force force structure is common to commercial equivalents. For example, the KC–10 is common to the widely-used DC–10 commercial aircraft. In many cases, the relatively small AF force structure is a fraction of the commercial fleet that is well supported for maintenance and supply world wide. Dependence on that commercial base for support precludes the heavy capital expense of organic depot establishment and represents a sound business practice. The Navy, with its carrier operational requirement and the Army, with its unique vehicle requirements supporting combined arms maneuver, have a smaller opportunity to capitalize on the economies of scale of large commercial activities.
Secondly, initial support for new AF weapon systems is typically provided by contractors while production is on-going and the normal, organic support structure has not yet been established.
Page 943 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. If ICS and CLS were calculated into the 60/40 data, would each Military Department be in compliance? What about the projections?
General VICCELLIO. As in the past, the ICS and CLS data reported reflects an estimate of the depot maintenance content of these programs. Before a definitive answer to this question could be provided, a thorough analysis of current USAF ICS/CLS expenditures would be required, since more than depot activity is included for a number of weapons systems. Such activities as intermediate maintenance, organized maintenance, materiel management, system management, base level supply support, and in-service engineering are also sometimes included.
Mr. BATEMAN. What would be the impact of including ICS and CLS in the 60/40 calculations on the Air Force plans for Sacramento and San Antonio?
General VICCELLIO. If the outcome of the public/private competition processes underway today to determine disposition of selected non-core Kelly and McClellan workloads were to award workload to the public offerors, there would be no effect, since this would not change current ratios. If the outcome of the competitions were to award workload to a private offeror, the amount of work awarded to the winning bidder could be constrained due to reduced ''headroom.'' The degree of this constraint would require an analysis of current ICS/CLS contracts to determine what portion is for depot maintenance and what portion is for other types of activity.
Mr. BATEMAN. The department has announced plans to expand direct vendor delivery. Will this be applied to depot-level reparables? Will this expansion take into account 60/40?
Page 944 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. Up to this time direct vendor delivery (DVD) has applied to piece part support for maintenance activities. It is an initiative championed by the Defense Logistics Agency which, in tests, has shown it can improve responsiveness, eliminate ''middleman'' materiel management overhead, and reduce costs. At this time, there has been no move to apply this concept to depot-level reparable reprocurements. This approach to supply support does not necessarily change the source of supply; it just improves the process.
Mr. BATEMAN. Why are upgrade programs factored into the organic share and not the contractor share of 60/40?
General VICCELLIO. Depot maintenance upgrade programs are included in both the organic and contract components of the computation for 60/40. This is based upon where the work is accomplished and who is doing it. Most of the Air Force upgrade programs are accomplished organically, but contractor activity, such as field teams are sometimes used and are included in the contract side of the computation.
Mr. BATEMAN. Did the internal shift of Army funds from Operations and Maintenance to the procurement accounts in PBD 021 have an effect on 60/40?
General VICCELLIO. The Air Force has no visibility on the effect of PBD 021 on Army depot maintenance operations.
Public Versus Private Competition
Page 945 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Last year at this time we were told the depot's cost accounting systems weren't adequate enough to make cost comparisons for public versus private competitions. Now after we rejected your privatization initiative, we're being told all is well and the Department is set to begin a competition program. What's going on here? What's changed? I don't recall any major Departmental initiatives in this area?
General VICCELLIO. Current public/private competition procedures have been refined from those used in the early 1990s to better ensure all relevant costs and technical requirements are considered and to further enhance equity and fairness.
The Air Force has requested DCAA validate cost systems at the San Antonio, Sacramento, Warner-Robins, Ogden, and Oklahoma City ALCs. The audits will review the accuracy of systems' outputs and any workarounds required to ensure reliable information is used in the evaluation process.
Mr. BATEMAN. Can you summarize the changes to the Cost Comparability Handbook? Were any changes made to the way contractor costs are looked at?
General VICCELLIO. Since the Cost Comparability Handbook was updated and released on 10 August 1993, there have been two releases of interim changes (21 December 1995 and 4 December 1996). The 21 December 1995 release was implemented on 10 January 1996.
The 21 December 1995 Interim Change had two main purposes. The first purpose was to add a Comparability Adjustment to cover Retiree Health Benefits. A Retiree Health Benefit factor of 4.7% of annual salary costs was developed by the Office of Personnel Management (OPM). The second purpose of this release was to define the budget as the baseline from which all cost estimates must be defended and documented.
Page 946 PREV PAGE TOP OF DOC Segment 5 Of 5
The 4 December 1996 Interim Change has two main purposes. The first purpose was to change the factor used to calculate a Comparability Adjustment for casualty insurance from .0005 to .005 based on a decision from the Office of Management and Budget (OMB) and second, revise the text to add references to the Financial Management Regulation, DOD 7000.14–R.
In addition to the Cost Comparability Handbook (which is used by all Services), the Air Force provided additional public/private depot competition cost guidance in a 20 December 1996 Memorandum, to better ensure competition equity and fairness and enhance our ability to arrive at decisions that provide the best overall value to the government. This additional guidance directs comparability adjustments for transition costs, federal income tax, the cost of money, overhead cost savings to other workloads, and other adjustments that the SSA will use when comparing proposals.
Mr. BATEMAN. What's going to be different from the old public versus private competition program?
General VICCELLIO. Current public/private competition procedures have been refined from those used in the early 1990s to better ensure all relevant costs and technical requirements are considered and to further enhance equity and fairness. The following are some changes from the old competition process which have strengthened the current process:
1. The DOD Cost Comparability Handbook has been updated to include additional cost comparability adjustments and to better represent costs for various comparability categories.
Page 947 PREV PAGE TOP OF DOC Segment 5 Of 5
2. Implementation of additional Air Force guidance (SAF/FM/AQ, 20 Dec 96 memo) regarding cost comparability adjustments and evaluation procedures.
3. Public bids will be based on information from accounting systems and management procedures that DCAA has validated as adequate for competition purposes.
4. The competition Source Selection Authority is organizationally separated from any of the competing interests.
Mr. BATEMAN. When do you plan to start again?
General VICCELLIO. Acquisitions for selected workloads have already begun based on a refined strategy announced in Aug 96. The C–5 Business Area Request for Proposal (RFP) was released 11 Feb 97, with proposals due 14 April 1997. The Sacramento Consolidated Workload maintenance RFP is scheduled for release in July 1997.
Mr. BATEMAN. Will all depots be permitted to participate, or will there be restrictions?
General VICCELLIO. All depots are generally eligible to participate. Air Force Materiel Command has designated a single Air Force depot to be the lead in preparing the public bid for each of the two solicitations under consideration. These two depots were selected based on capacity and capability. Other depots are permitted to team with them, where appropriate. Other Service's depots may also participate.
Page 948 PREV PAGE TOP OF DOC Segment 5 Of 5
Defense Science Board
Mr. BATEMAN. Two years ago, the DSB recommended the Department maintain the core concept. This year they recommend the Department abandon that concept. I notice that there were military advisors connected with both sides. Can you tell us what changed over the past two years that prompted this change in view?
General VICCELLIO. The Department of Defense clearly recognizes the continued need for a core concept and reflects this position in its Defense Depot Maintenance Policy submitted to the Congress in March 1996. Since the end of the Cold War, several groups and reports have called for wholesale outsourcing of all depot work. Air Force Materiel Command has consistently supported the maintenance of a core capability and recognized the inevitability of ''last source'' workload (i.e., workload, regardless of its core status, for which there is either no commercial capability or lack of a competitive market).
Mr. BATEMAN. Some very senior OSD officials have ridiculed the latest DSB report by pointing out that it lacks an analytical foundation. Do you agree with that characterization? The 1996 DSB Summer Study on Achieving an Innovative Support Structure for 21st Century Military Superiority indicates savings of $30B per year are possible. Are you finding similar results in your QDR studies?
General VICCELLIO. The DSB is comprised of recognized leaders in the field of logistics and maintenance activities. While the report may exhibit some analytical shortcomings, many of the assumptions used could be valid. In any case, it is too early in the analysis of the DSB recommendations to validate any potential savings. Likewise, it would be premature to comment on the possible outcome of the Quadrennial Defense Review. Many initiatives which could affect the size, shape and philosophy of the Department's infrastructure and its sustainment, including some going well beyond depot maintenance, are still under review.
Page 949 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. The same study calls for a 5 percent per year reduction in the civilian workforce and a 2 percent per year reduction in military personnel over the next five years. Can you accomplish these reductions and still stay within the 60/40 restriction? Can you accept these and still maintain readiness? Has there been any move, that you know of, to implement these recommendations?
General VICCELLIO. Reductions similar to those contained in the Defense Science Board study are currently underway as a result of the National Performance Review, downsizing and other initiatives. Through a number of force-wide actions, the USAF has been able to accommodate these and sustain its mission performance. Air Force Materiel Command has combined Acquisition Reform initiatives such as The Air Force Lightning Bolts, a consolidation of its laboratory overhead structure, the outsourcing of selected base operating support activities, realignment of test and evaluation activities and initiatives within the depot maintenance area to sustain needed manpower and remain within compliance with applicable statutes. There has been no direction to implement the DSB's recommendations in addition to initiatives currently underway. -Subformat:
Mr. BATEMAN. In your opinion, would there be violation of the law if the recommendations contained in the DSB Summer study were to be implemented?
General VICCELLIO. The letter transmitting the final report of the 1996 DSB Summer Study to the Deputy Secretary of Defense identifies the two key recommendations in the report:
Page 950 PREV PAGE TOP OF DOC Segment 5 Of 5
(1) Dramatically restructure DoD support, utilizing modern information technology and management principles, and maximizing the use of the competitive private sector . . .; and,
(2) Create a new planning and budgeting process that will institutionalize incentives to more effectively align overall resources with DOD's mission require- ments. . . .
The first recommendation calls for a fundamental change in how the Department supports the warfighters. The Department could begin to implement this change within existing law. In many areas, there are no legal impediments to fully implementing this recommendation. The recommendation cannot be fully implemented, however, because of 10 U.S.C. Section 2466, which provides that not more than 40% of the funds made available to a military department or a Defense Agency for depot-level maintenance and repair workload can be used to contract for the performance of such workload by the private sector. This requirement can only be waived if the Secretary of a military department or the Secretary of Defense determines the waiver is necessary for reasons of national security and notifies Congress regarding the reasons for the waiver.
We see no inherent legal impediments to implementing the second recommendation.
Mr. BATEMAN. It would seem that the people conducting the studies would stand to benefit should the DSB recommendations be implemented. How can this apparent conflict of interest be avoided in the future?
Page 951 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. We do not perceive a conflict of interest arising out of the Government appointing special government employees as consultants highly knowledgeable in their fields, including representatives from industry, academia, and former military officials. The individuals conducting the studies are participating at such a macro level that any recommendations or conclusions are so indirect to any individual participant or organization that there is no apparent conflict of interest in this case.
The Department of Defense Standards of Conduct Office conducted their normal procedures in educating members of this study. Since all members are special government employees, they were required to file an Office of Government Ethics (OGE) Form 450. Prior to the first meeting, all members received one hour of ethics materials to review. At the first briefing all members received a fifteen minute ethics briefing from a qualified ethics instructor and a one page summary of the ethics rules including he name and phone number of the ethics counselor.
Core
Mr. BATEMAN. Your methodology gives the appearance of rigor. However, in actual practice it appears that anything and everything can become non-core at the convenience of the Department. Wouldn't you agree that the core methodology is a sham?
General VICCELLIO. Efforts to standardize the quantification of post-Cold War core requirement began in 1993. The current methodology was developed by a joint service working group during 1995–1996. It incorporates an assessment of private sector capability and provides for ''best value'' and ''last source'' items. The methodology was briefed through the services and subsequently approved by the DDMC. Responding to Congressional and GAO recommendations, the methodology was revised to better standardize and strengthen the assessment of private sector capability. The improved core determination process was approved by the DDMC in December 1996.
Page 952 PREV PAGE TOP OF DOC Segment 5 Of 5
Core capability requirements, as applied to any wartime scenario, may change as a result of such factors as force structure modifications, changing threats, introduction of new weapon systems, retirement of old ones, or a change in battle doctrine. For these reasons, it is necessary to review core capability requirements on a recurring basis, or whenever a changing situation dictates. Just as the capability requirements change, the workloads required to sustain those capabilities will also change.
Mr. BATEMAN. Have you changed the definition of core from what was reported to us last March?
General VICCELLIO. No. Depot maintenance core is the logistics capability maintained within organic Defense depots to meet readiness and sustainability requirements of the weapon systems that support the JCS contingency scenario(s). Core capabilities exist to minimize operational risks and to guarantee required readiness for these weapon systems. Organic depot maintenance facilities comprise the facilities, equipment and skilled personnel necessary to ensure a ready and controlled source of required technical competence. Depot maintenance for designated weapon systems will be the primary workloads assigned to DOD depots to support core depot maintenance capabilities.
The DOD Core Methodology was revised in 1996 to include an assessment of the private sector's depot repair capability. Additionally, a ''Best Value'' requirement was included in the Core Methodology to determine the source for non-core workloads. The DDMC approved this new methodology in December 1996.
Page 953 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Please provide us with the workloads necessary to sustain core capabilities for each of the Services by commodity, by depot.
General VICCELLIO. Core is the organic capability (in terms of personnel/skills, equipment, and facilities) required to support readiness and sustainability for essential weapon systems required in JCS contingency scenarios. Core is not workload based, rather, it is the capability required to sustain the weapon systems used in these JCS contingency scenarios. Core is determined from a DoD perspective not a Service perspective. Mission essential weapon system workloads sustain these core capabilities.
A workload breakout will only be available following the completion of a core determination process on all USAF depot workloads. Since workload disposition at Sacramento and San Antonio ALCs is being driven by the BRAC 95 timeline, those workloads are being evaluated first. Subsequently, determinations will be made as necessary to accommodate changing conditions (operational changes, force structure modifications, emerging or retiring systems, proposals from the commercial sector, etc.). Until such time as all workload has been evaluated, workloads previously rated as core will remain so for reporting purposes. With this in mind, USAF core capability projections are as follows:
Mr. BATEMAN. Are new weapon systems considered as core? Are they reviewed for core requirements? Is it still the policy of the Department that new weapon systems will be maintained in the private section?
General VICCELLIO. Only weapon system maintenance that is not required to sustain core capabilities will be considered for assignment to the private sector under DODD 5000.2R. As in the case of other systems, new systems are reviewed for core requirements as a part of the source of repair assignment process called for in DOD, Air Force and Air Force Materiel Command Guidance. It is policy that new workloads will be assigned to organic or contract sources based on the results of a core determination using the DDMC approved core methodology. Sources for workloads not required to sustain core will be determined based on a competitive, best value assessment.
Page 954 PREV PAGE TOP OF DOC Segment 5 Of 5
Outsourcing Depot Maintenance
A recent report by the Defense Science Board states savings of 20 to 40 percent would result from outsourcing DOD commercial activities to include depot maintenance. The report calls for DOD personnel to rely on ''robust, competitive private sector'' to provide maintenance and logistics support. The Board believes that private sector competition already exists or would quickly develop to meet virtually all of DOD's support requirements. However, GAO states in its testimony that 90 percent of the depot maintenance contracts it sampled were awarded non-competitively.
Mr. BATEMAN. To what extent is the Board's 20 to 40 percent outsourcing savings estimates dependent on a competitive commercial market and to what extent is there not such a market for depot maintenance activities?
General VICCELLIO. While we have not validated the Board's estimates, any prediction of potential savings associated with outsourcing depends on assumptions of a competitive, qualified commercial market. While there are some depot workloads for which DOD would be the ''last source'' (i.e., limited or no commercial capability, or competitive potential), there are also workloads for which the opposite is true. For example, the Sacramento/San Antonio workloads currently undergoing public/private competition were selected and are being competed only after a determination that there is a viable and competitive commercial market. This was determined by an examination of commercial sector capabilities, capacities and levels of interest.
Page 955 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. To what extent will ownership of data rights by the original equipment manufacturers, plans to rely more on total contractor logistics support and long term contracts, and defense industry consolidations; reduce competition for depot maintenance workloads?
General VICCELLIO. We do not anticipate any significant impact to competition due to the cited concerns. Under our public/private competition strategy, all of the workloads to be competed are currently performed in an organic depot (as opposed to a contractor depot where proprietary rights could be more of a concern). In addition, we have worked extensively with private industry and organic depot representatives to address issues and concerns which might hinder a successful competitive process. At this time there appears to be no significant issues along the lines of this question.
Mr. BATEMAN. In the absence of competition, to what extent do you believe outsourcing will achieve savings?
General VICCELLIO. The Air Force strongly believes in competition, which is viewed by most observers to be the strongest motivating force to reduce costs. In general, the introduction of public/private competition to the DOD has been beneficial to both public and private sector depot maintenance providers. Competition has caused the public depots to focus objectively on their labor and material costs. There is greater management incentive to improve production methods, reduce costs, cut overhead, and improve accounting methods and systems. As the depth of competition declines, so does the potential for savings. A risk assessment process involving careful analysis of commercial sector capabilities, and capacities is conducted prior to considering any offers to industry.
Page 956 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Should DOD retain non-core depot maintenance capabilities for workloads where there is not a competitive commercial market?
General VICCELLIO. Yes, the Services recognize that some organic capacity can be required to provide a ''Last Source'' for some percentage of the mission requirements. This is generally the case where little or no commercial capability exists, or where there is a limited competitive market.
Mr. BATEMAN. Should DOD depots be allowed to compete for outsourced workloads where no competitive market exists?
General VICCELLIO. Outsourcing competitions are intended to determine best value sources. These competitions can use merit based procedures for competitions among public depots, or competitive procedures for competitions among public and private entities. The depth of the competitive market affects the decision to consider commercial performance, but it does not define the process.
Mr. BATEMAN. In a non-competitive environment how does DOD plan to assure it is getting the benefits and safeguards of a competitive commercial market?
General VICCELLIO. Contracting officers can use price analysis based on commercial catalogs or market analysis to determine and negotiate a reasonable contract price. Further, the government can award contracts which contain beneficial commercial terms and conditions for performance of work effort. This work effort is described in performance based terms which allows contractors to perform in accordance with their best practices. The use of commercial best practices and processes enables us to maximize and evaluate the benefits we receive from contractors—even in a non-competitive environment. DOD has held training and issued guidance to help negotiators use commercial methods more effectively. This initiative is a major part of the current acquisition reform efforts in DOD.
Page 957 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Does DOD have a plan for how it will manage outsourcing where there is not a robust competitive commercial market?
General VICCELLIO. In accordance with the Air Force Public-Private Competition (PPC) Procedures, Air Force acquisition planning and strategy development will follow established procedures. Each strategy will be individually tailored to best meet operational needs and the acquisition environment. If adequate competition does not exist, public sources will be determined.
A primary goal in developing an appropriate acquisition strategy shall be to minimize the time and cost of outsourcing with common sense and sound business judgment. Essential elements in this process include, but are not limited to, sources, risk management, cost control, quality control measures, contract approach, and management approach. An example of a major initiative critical to the success of PPC is the avoidance of large capitalization costs. It is also the policy of the government to provide maximum opportunities for small businesses at both the prime and subcontract level in contracts awarded by the Government. PPCs will adhere to normal contracting policy and utilize the source selection processes best suited for the specific acquisition and in accordance with FAR, DFAR and AFFARS guidance.
Additional Questions
The DOD is changing its policy and using a ''best value'' approach when evaluating bids in a public-private competition, rather than simply evaluating each proposal on a least expensive basis. As the private sector can pick and choose its workload, and the public depots are assigned all types of workload, it is likely that public depots cannot run as efficiently as the private sector.
Page 958 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. How will you determine best value in the private sector?
General VICCELLIO. The acquisitions will be conducted as public/private competition source selections. Awards will be determined based on an integrated assessment of all offeror proposals to determine which provides the overall best value to the government and taxpayers. Along with cost, best value includes an integrated assessment of technical and management approach, past performance, risk, and other factors. Current public/private competition procedures have been refined from those used in the early 1990s to better ensure all relevant costs and technical requirements are considered and to further enhance equity and fairness.
Mr. BATEMAN. If you use a ''past'' performance criteria for determining best value, how will you determined past performance in the public depots when they have had little or no control over the assignment of workload or retention of skilled employees?
General VICCELLIO. Workload assignments are made based on center technology base expertise, resource capability and center capacity. Center business planners work with HQ AFMC to make these decisions. Past performance data on comparable past workloads will be provided for assessing performance risk. Data will include cost, schedule, quality and other management indicators. In addition, our Depot Maintenance Performance Tracking System (DMPTS) tracks previously competitively awarded depot workloads through their work cycles, comparing actual contract performance against proposed performance.
Page 959 PREV PAGE TOP OF DOC Segment 5 Of 5
Depots winning '90s competition committed to a level of performance at a given price. Their performance against those standards is relevant, since they were ''assigned'' that workload competitively. Our experience with previous competition generated a net cost avoidance of 25 percent. As for retention of skilled employees, private and public offerors alike face the same personnel management challenges.
Mr. BATEMAN. Since each of the services have been responding to direction to privatize more and more depot maintenance work over the last two years, please provide us with a list of systems and dates regarding the estimated savings resulting from these actions.
General VICCELLIO. Over the past two years, the AF depot maintenance focus has been on implementation of the BRAC directed closure of SM–ALC and the realignment of SA–ALC. At this time, we do not have a list of systems or estimated savings from these actions because we are just beginning to enter into the acquisition process. Seven workload areas for these logistics centers, e.g. SA–ALC's C–5, SM–ALC's hydraulics, software, electrical accessories, instruments, KC–135, A–10, have completed their repair base analysis and core risk assessments, which now will allow us to compete these workloads.
The Air Education and Training Command (AETC) has extensive experience with privatized maintenance activities. Although this occurred at base level (vice depot) and compared a precompetition uniformed organic workforce against contractor costs, savings of up to 40 percent were achieved. Much of AETC's outsourcing experience has been under A–76 procedures and therefore inappropriate to use as a baseline from which to predict depot outcome, however, AETC has experienced their greatest outsourcing savings in areas where the workload was most technically demanding.
Page 960 PREV PAGE TOP OF DOC Segment 5 Of 5
DOD policy states that ''paramount in all departmental policy considerations are (1) the readiness and sustainability requirements of DOD forces, (2) the optimum use of scarce departmental resources, and (3) exploitation of the strength of United States commercial industries''.
Mr. BATEMAN. On what do you base the readiness and sustainability requirements of DOD forces?
General VICCELLIO. The readiness and sustainability requirements of DOD's armed forces reflect those investment levels and maintenance capabilities required to keep the requisite force levels modern and ready. This includes both supply expense and maintenance efforts at organizational, intermediate and depot levels. Selected metrics are used by both program managers and field operators to measure readiness and sustainability. Among others, they include: Aircraft availability—current and projected; spares stockage—particularly contingency stocks; and depot performance—timeliness, quality, surge capability and cost.
Mr. BATEMAN. Is the optimum use of scarce department resources based on the availability of funds or on employee levels?
General VICCELLIO. It is based on the availability of funds, although the two factors are definitely interrelated. Any manpower in excess of what is needed to meet mission requirements drains funds from other, high priority needs such as modernization, and represents suboptimum use. On the other hand restricted manning levels builds production backlogs and drives costs higher as short term contractor efforts are used to supplement organic resources. AFMC has adopted a flexible manning strategy which includes permanent and temporary manpower as well as allowing local management flexibility in overtime usage.
Page 961 PREV PAGE TOP OF DOC Segment 5 Of 5
Over the years, there has been concern voiced with the ability for the private sector to respond during times of national emergencies and concerns for work stoppages due to strikes and/or corporate business decisions.
Mr. BATMAN. How would you address these concerns?
General VICCELLIO. The continuity of depot support to the operational forces is vital to the mission. The impact of a labor strike, contract breach, default or other circumstances that cause a production disruption can affect readiness and contingency operations. In conducting risk assessments, the Air Force considers the likely impact if depot repair is disrupted and the likelihood of alternative sources. In a contingency, the Air Force would use existing DOD capabilities and/or move the requirements to another commercial source, factors which are considered in the risk assessment process. During Desert Shield/Desert Storm, DOD vendors were, for the most part, very responsive. One example was GE's Aircraft Engine Group effort to provide critically needed turbine blades for the Blackhawk helicopters.
Mr. BATEMAN. What happens when the private sector makes a business decision to not continue a particular workload and by that time, the public depot previously accomplishing the workload has since closed?
General VICCELLIO. Before any given organic workload is competed, residual DOD capability is addressed. It is important to retain enough DOD capability to provide maintenance for contingency requirements and technical competence to oversee the transition of workload from contract to organic or from one contracted source to another. It is far more common for a commercial performer to lose the workload to a better competitor than to discontinue the workload as part of a business decision. In the current environment of a declining defense business base, most companies' behavior reflects strong commitment to do what's necessary to retain the customer's confidence and business.
Page 962 PREV PAGE TOP OF DOC Segment 5 Of 5
It is DOD policy to place all new weapons systems depot level requirements with the original equipment manufacturers.
Mr. BATEMAN. How can you maintain your depots if none of the new weapons systems are placed in these depots?
General VICCELLIO. Only maintenance of those weapon systems that is not required to sustain core capabilities will be considered for assignment to the private sector under DODD 5000.2R. As in the case of other systems, new systems are reviewed for sustaining core requirements as a part of the source of repair assignment process called for in DOD, Air Force and Air Force Materiel Command guidance. It is policy that new workloads will be assigned to organic or contract sources based on the results of a core determination. For workloads not required to sustain core capabilities, sources will be determined through an assessment of best value.
Mr. BATEMAN. Is it true that if no new weapons systems are placed in the public depots, they will wither and close in nine years?
General VICCELLIO. Only maintenance of new weapon systems and equipment not required to support Core capability requirements may be assigned to the private sector in accordance with the Department's policy. The three remaining USAF depots will not be lacking in work. On the contrary, we expect to have a vigorous and efficient organic depot system. Regardless of the outcome of current workload disposition deliberations concerning those depots affected by BRAC, we anticipate substantial workloads will relocate to the remaining depots. Should the public offeror(s) be successful in competition, the already substantial workload transfer from closing to non-closing depots would increase.
Page 963 PREV PAGE TOP OF DOC Segment 5 Of 5
DOD intends to have selective public/private competitions for workloads where adequate competition does not exist in the private sector. For your depots to be a reasonable competitor for these workloads requires that they have the capability and capacity to perform the workloads.
Mr. BATEMAN. What are you doing to ensure that your depots can be realistic competitors for these workloads?
General VICCELLIO. OSD policy makers and the Source Selection Authority for ongoing public/private competitions have, through policy development acquisition strategy formulation, and the issuance of innovative Requests for Proposals (RFPs), done much to overcome any reality and/or perception of inequities in the process as it was executed in the early 1990s.
The RFPs are performance-based, allowing both public and private offerors more flexibility in their approach.
Teaming flexibility can allow offerors to broaden both the geographical and technical basis of performance to exploit strengths and lower costs.
Depot accounting systems used as the basis for bid development will be validated by Defense Contract Audit Agency as adequate for competition.
Commercial accountant assistance is provided to public offerors for proposal preparation.
Page 964 PREV PAGE TOP OF DOC Segment 5 Of 5
Funding is being provided to assist public (and private) offerors in studying the SM–ALC workload to enable innovative and low cost/risk proposals to be provided.
Mr. BATEMAN. Do you feel that you have the capability to effectively compete for depot workloads?
General VICCELLIO. Yes. We have thoroughly assessed our depot capabilities including technology base, resources and facilities and are fully prepared to compete for those workloads. Our depots have a proven track record of quality and mission support and are currently developing detailed strategies to support the competed workloads if awarded.
Mr. BATEMAN. Would not the depots be more economically efficient if their workload was closer to their current capacity as opposed to artificially sizing them to core?
General VICCELLIO. The AF is opposed to artificially sizing industrial capacities to some given level. Such an approach may not be the most economical. The Air Force is striving to increase the capacity utilization of non-closing facilities through the consolidation of core depot and other workloads, through competition for the non-core workloads, and through making excess organic capacities available to the commercial sector through partnering arrangements.
Mr. BATEMAN. Congress and DOD agree that a core capability should exist in public depots. Have you examined the current core requirements to test for reasonableness and to determine what percent of the maintenance funding will be core?
Page 965 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. OSD policy states that core determinations will be made periodically in accordance with procedures developed by a 1996 cross-service working group and approved by the Defense Depot Maintenance Council in December. The Air Force is undertaking this process with workload at Sacramento and San Antonio ALCs due to their closure via the BRAC 95 process. Subsequent core determinations will be made as required by policy, or by changing operational requirements or the emergence/retirement of weapons systems.
It appears to me that DOD wants to eliminate much of the infrastructure costs associated with its depots in order to free up funds for other priorities such as force modernization.
Mr. BATEMAN. If DOD is allowed to do so, what specific steps would be used to eliminate the excess infrastructure?
General VICCELLIO. The AF is committed to retaining the required infrastructure for a viable public depot support system operating at efficient levels. Long range planning efforts are in work to ensure that we can effectively sustain AF warfighting capability at best value. Elements of this plan include: Identifying workloads at closing ALCs that support core capability and move to remaining depots (the closure/realignment of two of the five Air Force Air Logistics Centers will drive the consolidation of workload into the remaining depots); holding public/private competitions and moving work won by our public depots; developing strategies, plans, and policies to foster partnering with industry at the remaining depots (reduce AF operating costs through shared overhead); and converting excess facilities to alternate uses and eliminating facilities and equipment no longer needed.
Page 966 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Has DOD developed plans and strategies to accomplish a reduction in the depot infrastructure?
General VICCELLIO. The AF is committed to retaining the required infrastructure for a viable public depot support system operating at efficient levels. Long range planning efforts are in work to ensure that we can effectively sustain AF warfighting capability at best value. Elements of this plan include: Identifying workloads at closing ALCs that support core capability and move to remaining depots; holding public/private competitions and moving work won by our public depots; developing strategies, plans, and policies to foster partnering with industry at the remaining depots (reduce AF operating costs through shared overhead); and converting excess facilities to alternate uses and eliminating facilities and equipment no longer needed.
Mr. BATEMAN. What would you expect the depot infrastructure to look like after downsizing?
General VICCELLIO. The Air Force envisions its depot structure of the early 21st Century as one that is consolidated, more robust, heavily committed to operational as well as support activities, and much leaner and efficient in its repair activity. The depots will be predominately organic, but today's nearly 8,000 private contractor personnel working on-base will be substantially larger as partnering opportunities are exploited.
Mr. BATEMAN. If DOD is allowed to size the depot infrastructure to its current definition of core, what depots would be affected? What would employment levels look like?
Page 967 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. The Air Force does not believe that sizing depots to core is either practicable or advisable. As explained in answers to earlier questions, ''last source'', competitively awarded, and other organic, non-core workloads will continue to be present at our depots. We expect our three post-closure depots to be larger, busier, more diversified and more efficient than they are today.
Privatization and Outsourcing
Mr. BATEMAN. At one point all of the work performed at AGMC was considered core and yet the Air Force contracted it out. Was there a risk assessment performed? If so, would you please provide a copy to this committee.
General VICCELLIO. During the 1993 BRAC deliberations and before the Air Force decided to award contracts for the work at AGMC, the risk of either moving the work to another depot or transferring it to the private sector was evaluated. Before awarding the contracts, the Air Force concluded that awarding the contracts to the private sector provided the best value at an acceptable risk.
Mr. BATEMAN. A December 1994 GAO report stated that the privatization in place of AGMC would not save money. The Air Force chose to privatize any way. Now the GAO, as I understand it, has done a line by line review of the MINUTEMAN and PEACEKEEPER missiles and found that it's costing far more than it did at AGMC. Has the Air Force performed a similar analysis? Is it true? If this is true, doesn't it give serious pause to the Air Force plans at Sacramento and San Antonio?
Page 968 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. At the GAO's request, Ogden, ALC analysts initiated a cost comparison of missile guidance unit repair at Newark, Ohio, comparing data on initial three months of contractor performance (annualized for FY97) to actual costs of organic performance, adjusted to 1997. The cost comparison was completed by a team of Ogden/AFMC analysts on 16 Mar 97 and released to the GAO the same day. Although showing a possible range of variation of projected FY97 contractor performance at $1.5M less than organic to $19.5M more than organic, the mid-point of a more probable range of variation showed projected contractor costs at $6.8M above organic for missile work only.
The Newark missile component repair analysis needs to be understood for what it is (and isn't). It is a projection of first year's performance based on initial three months of data. It reflects the effect of many ''moving parts,'' particularly during contractor's ''learning curve'' period. The contractor's cost variance, although above programmed early on, is showing consistent improvement. A visit to Newark indicated that better accountability of parts consumption through the Air Force material management system is needed. A baseline parts audit and data systems changes are both underway in response to the team's findings.
Furthermore, this analysis needs to be viewed in proper perspective. It only touched on recurring costs at Newark, and only covered half of Newark workload . . . aircraft navigation system and metrology analyses are underway, to provide a better across-the-board picture.
The non-recurring costs (transition costs) are running at about 2/3 of predicted as end of transition approaches, and may well come in $10M+ below what was expected. Moreover, the cost avoidance of $300M for relocation of Newark work to another DOD depot dwarfs other cost factors.
Page 969 PREV PAGE TOP OF DOC Segment 5 Of 5
The relevance of Newark experience to ongoing Kelly/McClellan competitions is limited. Newark was a large, pre-acquisition reform repair contract. The RFP was heavy in MIL-SPECS and repair process standards . . . ''do it our way.'' It called for Government Furnished Material (GFM) on most supply items needed for repair, forcing USAF/DLA to carry materiel management costs. It was Cost Plus Award Fee, with the contractor incentivized for accountability, but less so for cost reduction. There were frequent contract option points, driving contractor insecurity and perceived risk.
In contrast, Kelly/McClellan competitions have been built around various additional acquisition reform initiatives, using performance-based RFPs. Contractors must propose ''our way,'' but may also propose and cost out alternative commercial processes. Contractors may provide depot-specific pieceparts, with USAF/DLA relieved of associated material management costs. The contracts are anticipated to be fixed price, with the contractor incentivized for both accountability and cost reduction. Extended performance periods drive contractor security and perceived confidence.
It is the Air Force's position that this analytic effort should be represented as predictive of steady-state Newark contractor performance this early in the game. Likewise, this should not be used to pre-judge public/private competitions for Kelly and McClellan. Although Kelly/McClellan represented initial attempts at ''reformed' acquisition of large-scale repair efforts, we are confident that successes experienced in ''reformed'' weapon system manufacturing/modification acquisitions will be repeated.
Mr. BATEMAN. If a study has been done, would you please furnish it to this committee?
Page 970 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. The recent AFMC cost comparison study accomplished for missile guidance repair is attached.
[See attachment A in the appendix on page 1194.]
Mr. BATEMAN. Do you think AGMC is the success story it's been held out to be in light of the GAO report. Are there lessons to be applied elsewhere.
Sacramento and Kelly ALC Closures
Mr. BATEMAN. What is the current utilization rate of the open ALCs?
General VICCELLIO. The FY 96 and FY 97 Utilization Rates are as follows:
Mr. BATEMAN. The GAO report on the Air Force privatization in place plans show, that based on certified BRAC 95 data, the Air Force maintenance depots have an average excess capacity of 45 percent. How can you possibly defend privatizing the workloads from Sacramento and San Antonio rather than sending that workload to the remaining ALCs?
General VICCELLIO. The Air Force is not defending a privatization plan, but rather is pursuing a public/private competition process to ensure mission readiness and obtain best value. The costs and cost avoidance associated with consolidation of workload will be analyzed and compared to the same factors related to other options. Capacity is one of several factors affecting the outcome.
Page 971 PREV PAGE TOP OF DOC Segment 5 Of 5
The BRAC 95 certified data was based on a measure of capacity known as Maximum Potential Capacity which was the capacity at a point in time where each ALC's depot maintenance workload and the number of workstations to accomplish that workload was at its peak. The certified BRAC data showed that the depots are and were operating at a much lower level of capacity than peak and that there was a large amount of available/excess capacity.
The depot maintenance activities have experienced much lower levels of workload since the Maximum Potential Capacity peak and have taken measures to reduce capacity. The elimination of workstations, equipment, and facilities has left the remaining AF depots with a much lower capacity than the Maximum Potential Capacity used in BRAC 95.
Mr. BATEMAN. The overwhelming majority of the work done at San Antonio and Sacramento was certified by the Air Force as core during the BRAC 95 deliberations. Now we're being told that it's not. Is it? Was it? What has changed that turned core into non-core?
General VICCELLIO. For BRAC 95 data, core was quantified based on organic requirements to support weapon systems tasked for the 2 MRC contingency scenario. In FY 96, an assessment of private sector repair capabilities was added to the DOD Core Methodology. As part of the core determination methodology the Services evaluate the commercial sector's capability to support workloads that are under consideration for possible outsourcing. If there are adequate capabilities and capacities in the commercial sector to assure depot repair for a given requirement—at an acceptable risk for mission support, the Service can compete the requirement for non-core work. While the definition of core workload has not changed from the Cold War era, the core determination process has been updated to reflect the national security strategy.
Page 972 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Will the organic depots be allowed to ''team'' when competing for the San Antonio and Sacramento workloads? Will the contractors? Will the organic depots be allowed to team with contractors?
General VICCELLIO. Current public-private competition policy allows the organic depots to team with other organic depots, where appropriate. This includes teaming with other service (Army & Navy) depots to optimize the use of specialized capabilities, capacity and existing DOD depots. Private contractors can team with other private contractors. However, public depots cannot team with a private contractor beyond normal support relationships. This is prescribed to maintain the integrity of pubic versus private competition.
Mr. BATEMAN. If the depots are not allowed to team, will they be big enough under the ''Big Bang'' strategy to do the work?
General VICCELLIO. The current public-private competition policy allows the organic depots to team with other organic depots, where appropriate.
Mr. BATEMAN. Wouldn't competing smaller workloads result in additional competition and thus a lower cost to the Government?
General VICCELLIO. Smaller workload packages may induce additional contractors to bid. Larger workload packages, however, bring the advantages of economy of scale, workforce cross-utilization, fewer contract actions and less complex contract administration. We believe the larger workload packaging enhances competition, while allowing greater potential for savings and increased mission support.
Page 973 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. It appears that by bundling the work packages so large that the only viable proposals will have to use privatization in place. Won't this distort any conclusions to be drawn from these competitions since other viable options will be precluded? Doesn't this artificially limit competition?
General VICCELLIO. Offerors are not limited to in place performance. Other options are open including performance at a contractor facility and teaming between public depot bidders. During acquisition strategy development to include Industry Days, potential offerors discussed the possibility of basing bids on performance at locations other than the closing depots. We believe the consolidated workload strategy provides many advantages: Leverages workload/workforce/facility commonalities; enhances competition; earlier awards facilitate closure schedule—reduced costs; permits more efficient acquisitions and follow-on administration; and minimizes workforce disruption.
Such a strategy provides best value to the government without risking critical depot support to our combat forces by taking advantage of full and open public/private competition for non-core activities.
Mr. BATEMAN. The recent GAO study cites an internal Air Force study wherein the Air Force could save $689M by consolidating the San Antonio and Sacramento at other ALCs. Does the Air Force have that kind of money to waste?
General VICCELLIO. True costs/savings will be determined through competition using offeror proposals. The Air Force analysis of costs and cost avoidance (savings) associated with specific workload consolidation is being accomplished as part of the public/private competition process. The cited ''Air Force Study'' was an illustration of overhead and materiel rate adjustments using GAO methodology, which bears little resemblance to what would happen if workloads were transferred to other depots.
Page 974 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. You say you haven't performed a detailed comparative analysis for potential savings. Don't you think that for the amounts of money involved a detailed comparative analysis would be prudent? How can you embark upon this strategy without performing such an analysis?
General VICCELLIO. True costs/savings will be determined through competition using offeror proposals. The Air Force analysis of costs and cost avoidance (savings) associated with specific workload consolidation is being accomplished as part of the public/private competition process.
Mr. BATEMAN. The GAO states, and there has been no dispute, that the transfer of communications and electronics workload from Sacramento to Tobyhanna would save $24M annually, why are we waiting? Does the Air Force have that much money that they can afford to waste $24M?
General VICCELLIO. The joint Army-Air Force plan to transfer common-user communications/electronic workload from Sacramento to Tobyhanna Army Depot was approved by the DDMC on 13 March 1997, and is now in the implementation phase.
Mr. BATEMAN. Given the dramatic underutilization of the other ALCs, doesn't that cry out for another round of BRAC to eliminate this excess capacity that has been caused by the Air Force refusal to move work out of Sacramento and San Antonio?
General VICCELLIO. The Air Force is not refusing to move work out of Sacramento and San Antonio ALCs. Through a process of public/private competition, the Air Force will analyze and compare costs, savings, capabilities and risks of various alternatives, to include the consolidation of specific workloads at the three remaining Air Force depots.
Page 975 PREV PAGE TOP OF DOC Segment 5 Of 5
The need for additional BRAC legislation and action will be decided between the administration and Congress.
Mr. BATEMAN. How can you support declaring the hydraulic workload at Sacramento as non-core when there is no residual capability residing in the Navy and no similar capability within the other Services?
General VICCELLIO. In conducting the risk assessment for the hydraulics workload, data from visits to ten commercial sources and three DOD depots, including the Army and the Navy, was evaluated. Capabilities evaluated included capacity, facilities, equipment, skills/training, strike history, and ability to perform the workload.
Core is based on DOD capability—not the individual service capability. The hydraulic workload at SM–ALC represents only approximately 38 percent of DOD's capability at the commodity level. A DOD hydraulic core capability is retained even without the SM–ALC workload. Outsourcing the workload with an existing commercial source is a relatively low risk to the Air Force mission, based on other DOD capability. The Navy has stated that, because their current workload in the Naval Aviation depots is sized to core, they could only support the Air Force hydraulics workload to the capacity available through surge and only if the required resources were made available.
Mr. BATEMAN. If the hydraulic workload does not meet the risk test for core, can you name an Air Force workload that does?
Page 976 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. With the end of the Cold War, core calculations which recognize the potential of qualified commercial activities to participate to an appropriate level has been recognized. In a December 1996 study, the GAO recommended that a risk analysis be made part of the core determination process, a recommendation which has been subsequently implemented. There are numerous workloads which, because of their nature, would probably remain core under any scenario.
Mr. BATEMAN. I understand that the Air Force has contract employees at San Antonio performing 2 level maintenance on the F100 engine. Can you explain how this fits into your core policy?
General VICCELLIO. In the past San Antonio has used contract personnel to accomplish F100 engine workload which has exceeded their current capacity or capability. Such actions are normal to support short term capability or workload fluctuations. During these periods core capability is still retained through the remainder of the organic F100 program.
The concept fits our core concept and allows us greater flexibility in the near term.
Mr. BATEMAN. Two years ago, the Air Force ''certified'' to the BRAC Commission that most of the workloads at Kelly and McClellan Air Logistics centers were required to be accomplished by public depots in order to sustain CORE depot maintenance capabilities. What has changed that would now allow this CORE workload to be accomplished in the private sector?
Page 977 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. For BRAC 95 data, core was quantified based on organic requirements to support weapon systems tasked for the 2 MRC contingency scenario. In FY96, an assessment of private capability requirement was added to the DOD Core Methodology. The Services determine commercial capability with regard to workloads that were previously done in-house to maintain a core capability. If there are adequate capabilities and capacities in the commercial sector to assure depot repair for a given requirement—at an acceptable risk for mission support, and the work does not need to be performed in-house to maintain a core capability—the Service can compete the requirement. I11Mr. BATEMAN. It is my understanding that the reason the BRAC Commission recommended the closure of many of the departments industrial facilities was because of a large amount of excess capacity in these facilities. In fact, the BRAC process closed half of all Navy Aviation Depots and Naval Shipyards. Similar reductions were made in the Army's structure. As I remember it, the workloads of these Navy and Army facilities was to be redistributed to the remaining facilities to solve their excess capacity problems. When the BRAC Commission recommended the closure of Kelly and McClellan Air Logistics Centers, excess capacity in all of the Air Force logistics centers was the reason. Under the current proposal to leave the workload at Kelly and McClellan, how will you solve the excess capacity problems at the remaining three logistics centers?
General VICCELLIO. The air Force does not have a proposal to leave the workload at Kelly and McClellan. The Air Force is conducting a public/private competition to determine the best plan for workload disposition. The closure/realignment of these depots will drive the consolidation of workload into the remaining depots. Should the public offeror(s) be successful in competition, the already substantial workload transfer from closing to non-closing depots would increase. Beyond the ongoing competitions, the Air Force has looked hard at capacity utilization at our remaining depots and we are working long range strategies to improve the utilization. These strategies include partnering with industry, workload transfers, divestiture of unneeded facilities and equipment and potential to win public-private competitions.
Page 978 PREV PAGE TOP OF DOC Segment 5 Of 5
The AF is committed to retaining the required infrastructure for a viable public depot support system operating at efficient levels. Long range planning efforts are in work to ensure that we can effectively sustain AF warfighting capability at best value. Elements of this plan include: Identifying workloads at closing ALCs that support core capability and move to remaining depots; holding public/private competitions and moving work won by our public depots; developing strategies, plans, and policies to foster partnering with industry at the remaining depots; reduce AF operating costs through shared overhead; and converting excess facilities to alternate uses and eliminating facilities and equipment no longer needed.
Mr. BATEMAN. The 1995 BRAC Commission estimated that the closure of McClellan Air Force Base and the realignment of Kelly Air Force Base would allow the Air Force to achieve a net savings of $151.6 million during the 6 year implementation period allowed by law. This estimate was based, in part, on the assumption that closure and realignment actions would begin in fiscal year 1996 and be completed by year 2000. However, due in part to concerns about the high cost of closing the two bases' Air logistics Centers, current plans call for many closure and realignment actions to be delayed until the year 2001. What impact will this delay have on the net savings that can be achieved during the 6 year implementation plan?
General VICCELLIO. The AF is not delaying closure-related actions until 2001. The AF is working with the Army to establish timelines for movement of the ground communications workload at SM–ALC. The AF is developing a strategy for movement of all workloads that will not be competed. This plan will be finalized after the effects of the Quadrennial Defense Review are analyzed and incorporated. The timeframe for movement of the competed workloads is in part, dependent upon the outcome of the competition process.
Page 979 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. The General Accounting Office has stated that the Air Force is missing the opportunity to save several millions by consolidating depot maintenance workloads in its three remaining depots rather that privatizing these workloads in place. Air Force officials tell us the GAO is wrong and it will not be known what the more cost-effective option is until the San Antonio and Sacramento competitions are completed. The GAO says that the contractor costs will likely be higher than the evaluated offers because the projected costs will grow at Sacramento and San Antonio just as they have grown at the privatized facilities at Newark, Ohio and Louisville, Kentucky. GAO states that the cost at these privatized activities are significantly higher than the costs before privatization. While Air Force officials have told staff they disagree with the GAO, they have provided the Congress no substantive support that their general conclusion that privatization-in-place is the more cost-effective alternative. Further, the GAO cites Navy data that supports their conclusion—based on what the Navy is experiencing as a result of its depot consolidations.
General, you've said that the GAO is wrong. Is the Navy also wrong in its assessment that it will lower its depot overhead costs by $130 million annually by consolidating the depot maintenance workloads from its three closing depots to its three remaining depots?
General VICCELLIO. The Air Force cannot comment on the Navy assessments. As a part of ongoing public bid preparation and subsequent source selection activity, however, the effect of workload consolidation on overhead rates at prospective gaining depots will be analyzed and included as cost avoidance in the public offers. This analysis will be conducted on a commodity-by-commodity basis, and responds to one of the four recommendations contained in the GAO's December 96 Study on AF Depots.
Page 980 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. The Air Force has touted its privatization of AGMC and the savings it is achieving as a result of that privatization as key support that privatization-in-place is the most cost-effective approach for the Sacramento and San Antonio workloads. Staff informs me that recent information you provided Congress stated that the AGMC privatization is saving $15 million annually. However, GAO states that it projects the costs are 25 to 35 percent higher than the costs prior to privatization. Furthermore, costs have grown so much that funds budgeted for the entire year have already been expended for the Newark contract although it is less than six months into the fiscal year.
Would you care to comment on this?
General VICCELLIO. The Air Force has not pre-judged that privatization-in-place is the most cost-effective approach for Kelly and McClellan workloads. That will be determined by the on-going public-private competitions. At the Gao's request, Ogden ALC analysts initiated a cost comparison of missile guidance unit repair at Newark, Ohio, comparing data on initial three months of contractor performance (annualized for FY97) to actual costs of past organic performance, adjusted to 1997. The cost comparison was completed by a team of Ogden/AFMC analysts on 16 Mar 97 and released to the GAO the same day. Although showing a possible range of variation of projected FY97 contractor performance at $1.5M less than organic to $19.5M more than organic, the mid-point of a more probable range of variation showed projected contractor costs at $6.8M above organic for missile work only.
The Newark missile component repair analysis needs to be understood for what it is (and isn't). It is a projection of first year's performance based on initial three months of data. It reflects the effect of many ''moving parts,'' particularly during contractor's ''learning curve'' period. The contractor's cost variance, although above programmed early on, is showing consistent improvement. A visit to Newark indicated that better accountability of parts consumption through the Air Force materiel management system is needed. A baseline parts audit and data systems changes are both underway in response to the team's findings.
Page 981 PREV PAGE TOP OF DOC Segment 5 Of 5
Furthermore, this analysis needs to be viewed in proper perspective. It only touched on recurring costs at Newark, and only covered half of Newark workload . . . aircraft navigation system and meteorology analyses are underway, to provide a better across-the-board picture.
The non-recurring costs (transition costs) are running at about 2/3 of predicted as end of transition approaches, and may well come in $10M+ below what was expected. Moreover, the cost avoidance of $300M for relocation of Newark work to another DOD depot dwarfs other cost factors.
The relevance of Newark experience to ongoing Kelly/McClellan competitions is limited. Newark was a large, pre-acquisition reform repair contract. The RFP was heavy in MIL–SPECS and repair process standards . . . ''do it our way.'' It called for Government Furnished Material (GFM) on most supply items needed for repair, forcing USAF/DLA to carry materiel management costs. It was Cost Plus Award Fee, with the contractor incentivized for accountability, but less so for cost reduction. There were frequent contract option points, driving contractor insecurity and perceived risk.
In contrast, Kelly/McClellan competitions have been built around various additional acquisition reform initiatives, using performance-based RFPs. Contractors must propose ''our way,'' but may also propose and cost out alternative commercial processes. Contractors may provide depot-specific pieceparts, with USAF/DLA relieved of associated materiel management costs. The contracts are anticipated to be fixed price, with the contractor incentivized for both accountability and cost reduction. Extended performance periods drive contractor security and perceived confidence.
Page 982 PREV PAGE TOP OF DOC Segment 5 Of 5
It is the Air Force's position that this analytic effort should not be represented as predictive of steady-state Newark contractor performance this early in the game. Likewise, this should not be used to pre-judge public/private competitions for Kelly and McClellan.
Although Kelly/McClellan represent initial attempts at ''reformed'' acquisition of large-scale repair efforts, we are confident that successes experienced in ''reformed'' weapon system manufacturing/modification acquisitions will be repeated.
Mr. BATEMAN. General Viccellio, it is my understanding that at the Newark depot, the contractor has ordered repairable spares to support its repair and overhaul operations at the 200 percent increase above the amount ordered by the depot prior to privatization. They also stated that the contractor did not have accountability over these parts, which are being furnished as government furnished material, and that this is a common condition identified in their review of depot maintenance contracts. GAO says that the contractor is being measured on reducing repair time and that he can reduce his repair time and use fewer employees if the doesn't repair reparable components, but rather he turns broken ones into the supply system and orders a new one.
Is it possible that your enthusiasm for privatization is based upon a lack of understanding of the repair process and the various trade-offs which must be evaluated in order to achieve the most cost-effective repair solution?
General VICCELLIO. As part of AFMC's analysis of costs associated with contractor operations at Newark, a joint Ogden ALC/AFMC team visited the contractor plant to review cost performance and materiel usage. Among other findings, the team determined: Materiel orders did not reflect consumption of parts; much of what has been ordered was to establish working stock levels; and contractor materiel management data was not flowing as needed into the Air Force G009 system.
Page 983 PREV PAGE TOP OF DOC Segment 5 Of 5
AFMC and DCMC are conducting a joint zero-based audit that will aid in systems interface fixes and clarify inventory baseline from which parts utilization can be more accurately reported.
It is also useful to note that while most audit activity has focused on costs at Newark, the effectiveness side of the performance equation shows that the contractor is producing approximately 25 percent more parts than did the previous organic repair, and doing so at a faster response time as well.
Mr. BATEMAN. The GAO told us this morning that the loss of accountability for government furnished material is a fairly typical problem with DOD contractors. For example, they mentioned a situation where one of your air logistics centers allowed government furnished materiel provided to the contractor to exceed the estimated amount by over $100 million. Such examples point out the fact that DOD managers who are emphasizing the benefits of privatization and projecting to save billions of dollars by privatizing depot maintenance really have no idea what some of the hidden cost impacts of increased privatization may be.
Now for my questions. First, why should this committee take seriously your proposals for increasing the privatization of depot maintenance when we hear these horror stories about lack of accountability and cost growth subsequent to privatization?
General VICCELLIO. The condition mentioned occurred at one center and on one contract because of personnel turnover, lack of training and some data system shortfalls. We have addressed these and consider our actions corrective and lasting. This occurrence should not be used to characterize all competition efforts that may result in privatization.
Page 984 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Have you been informed about this condition in the past, and if not, why not, and if so, what did you recommend for dealing with it?
General VICCELLIO. As indicated above we were aware of the incident and took corrective action. Training was provided to the Production Management Specialists who are responsible for management of the contract from initiation through closeout. A training course for the command has been developed, an informal version tested at two centers and will soon be released to the field. We have revised our command instructions for contract management and data systems are currently being reengineered to assure we have accurate and timely visibility of contract costs.
I understand that the Air Force paid twice as much per B–1 aircraft on contract in fiscal year 1995 and 1996 as the cost of doing similar programmed depot maintenance on the same type aircraft repaired by Boeing (formerly Rockwell). GAO says the Air Force paid an additional $9.9 million in fiscal year 1996 to repair five aircraft on contract rather than in the assigned military depot. In these days of austere funding conditions, I have no idea why you would do that, and I trust that you will be able to enlighten us as to why in your response.
Mr. BARTEMAN: Nonetheless, given that you did pay $20 million more than you needed to get these repairs done, why would the Air Force reject a program office proposal to bring this work in-house rather than to continue this costly sole-source arrangement?''
General VICCELLIO. The Air Force does not believe more money than needed was paid to accomplish programmed depot maintenance (PDM) on the B–1 aircraft. Exact apples-to-apples cost comparisons between government and private sector efforts are very difficult to evaluate because items such as infrastructure costs are not included in government prices. However, the Air Force consistently attempts to maintain the proper balance between total program costs, maintaining appropriate core organic capabilities, and operational needs.
Page 985 PREV PAGE TOP OF DOC Segment 5 Of 5
In the 15 Jun 96 response to a similar inquiry by Senator Nickles, the Air Force responded: ''In Sep 90, Rockwell was awarded a sole source contract to perform PDM on an average of five aircraft per year for FY91–95. Facility constraints (limited dock spaces) and a shortage of certified technicians to work on the egress system were the principal reasons for this contract. Although these personnel constraints have been resolved, additional contracts have been planned for other reasons. In Sep 95 another one year contract for five aircraft was awarded (for FY 96 effort) to mitigate schedule risks associated with the uncertainties surrounding potential results of the Congressional Bomber Study (increased B–1B requirements & workload) and BRAC results (possible OC–ALC) closure or picking up additional workload from other base closures).''
Secretary Widnall, in her 15 Oct 96 response to another inquiry (related to the FY97 and FY98 PDM contracts) by Senator Nickles stated: ''* * * cost was not the only consideration in our decision to extend the Palmdale PDM line. Maintaining Rockwell as a second source for two more years sustains engineering support that has proven invaluable in the past, and gives us flexibility to adapt to pending decisions on workloads at the closing depots to support core capabilities, and the results of public/private competitions for non-core activities. We believe maintaining PDM capability for five aircraft per year at Palmdale protects both the taxpayer's dollars and the Air Force's need for flexibility in an uncertain period.''
Mr. BATEMAN. What is the Air Force's fiscal year 1997 programmed depot maintenance costs for the B–1 aircraft repaired by the contractor and how does this amount compare to estimated depot costs?
Page 986 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. There is a net savings to the government by performing the FY 97 programmed depot maintenance (PDM) on five aircraft at Boeing (formerly Rockwell). The PDM cost for five aircraft at Boeing is $14.4 million; the estimated cost to perform the same work at Oklahoma City Air Logistics Center is $10.55 million. However, these figures do not reflect the entire picture. By continuing work at Boeing the government avoids an estimated overhead cost reallocation of $4 million to other programs located both at the site and elsewhere, thus offsetting the higher PDM costs.
Mr. BATEMAN. Has the Air Force determined the potential for reducing maintenance costs by relocating this workload to the Oklahoma City Air Logistics Center?
General VICCELLIO. Yes, the Air Force is constantly looking for ways to reduce overall costs without significant operational impacts. In the 15 June 96 Congressional response to a similar inquiry by Senator Nickles, the Air Force responded: ''As a cost saving measure the B–1B program has also been able to extend the required interval between PDMs from four years to five years beginning in FY99 which will reduce the annual requirement from 23 aircraft to 18 aircraft, saving approximately $4.5 million per year. Thus, this plan [of continuing to perform five PDMs at Boeing during FY97 and FY98 has the additional benefit of stabilizing the B–1B work flow at OC–ALC. Rather than driving a ramp up to 23 aircraft per year for a two year period and then a drawdown to 18 when PDM is extended to the five year interval, a stable B–1B PDM workflow is maintained.''
Mr. BATEMAN. Would the potential reduction in overhead costs and other related costs from relocating the B–1 workload to Oklahoma City Air Logistics Center be sufficient to offset the projected cost increase to other government programs at Boeing?
Page 987 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. In 1996 the Air Force reexamined the earlier plan to move all B–1B Programmed Depot Maintenance (PDM) to Oklahoma City Air Logistics Center beginning in FY97 in light of the privatization policy and continued uncertainty surrounding projected workload distribution at the various Air Force depots. The Air Force decided it was in the best interest of the government to continue performing the work in the private sector while maintaining an appropriate balance of work in the Air Force depots.
Relocating B–1 workload to Oklahoma City Air Logistics Center would not reduce FY97 costs, but there would be a potential FY97–98 total cost reduction to approximately $730,000. However, as Secretary Widnall stated in her 15 Oct 96 response to Senator Nickles: ''. . . we stand by our position that the cost of performing this work at Rockwell's Palmdale, CA facility is not ''excessive.'' We also continue to stress that factors other than cost weighed heavily in our decision to extend PDM at Palmdale through 1998.''
Mr. BATEMAN. What is the status of these negotiations? When does the Air Force plan to transfer the workloads and how much work is anticipated to be transferred?
General VICCELLIO. The joint Army-Air Force plan to transfer common-user communications/electronics workload from Sacramento to Tobyhanna was approved by DDMC on 13 March 1997, and is now is the implementation phase.
Mr. BATEMAN. What success has the Air Force had in developing public-private ventures within the ALC community? Also, can you suggest additional legislative relief to further facilitate these practices?
Page 988 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLO. The Air Force has had limited practice in developing partnerships with the private sector, owing primarily to the lack of reimbursement authority for use of depot facilities. This is not to imply that there is a lack of interest on the part of the commercial sector. Successful partnering arrangements are in place at Warner Robins ALC today, with discussions underway at all three non-closing depots. While each commercial enterprise has its own particularities, ideas under discussion range from small-repair operations through composite manufacturing to system-wide logistics support.
Mr. BATEMAN. Why has the Air Force chosen to pursue privatization-in-place, given the huge amounts of excess capacity at the remaining depots?
General VICCELLIO. The Air Force is not pursuing privatization-in-place although that is one of various possible outcomes to the public/private competitions that are currently underway to determine ''best value'' disposition of selected Kelly/McClellan workloads. The Commission did indeed state that consolidation would increase capacity utilization at the remaining depots, and costs and savings associated with that alternative will be evaluated as a part of the source selection process. The Commission also identified both organic and private sector workload disposition alternatives, and the public/private competition process will provide a side-by-side comparison of the capabilities, risks, capacities, costs and cost avoidances associated with each of these alternatives.
Mr. BATEMAN. Is a strong, efficient and responsive organic depot system considered a core competency of the Marine Corps? Would it be accurate to describe depot maintenance and logistics support as the backbone of readiness for Marine Corps combat equipment?
Page 989 PREV PAGE TOP OF DOC Segment 5 Of 5
Genral STEWART. Yes, a strong, efficient and responsive organic depot maintenance system is a core competency of the Marine Corps. The core competencies postulated by the Commandant focus our need to ''Make Marines'' and ''Win Battles''. Clearly, our Marine Corps Maintenance Centers support our ability to win battles. Our doctrine states that to provide the forces necessary for expeditionary warfare, the Marine Corps must possess certain core logistics capabilities that cut across the strategic, operational and tactical levels of war. As such, the supply and maintenance systems of our core logistics capabilities provide a critical element of combat equipment materiel readiness to our warfighters when and where needed. The depot maintenance activities enable our logistics support structure to perform that mission.
There are many factors outside the depot maintenance arena that affect the readiness posture of our combat equipment. However, there is a correlation of the depot maintenance activities support to equipment readiness. For a complete assessment of combat equipment readiness, one must look at all elements affecting equipment readiness, such as supply, maintenance, transportation, manpower, operational tempo, etc.
Excess Capacity
Mr. BATEMAN. DOD's depot maintenance system has substantial excess capacity that includes underutilized facilities, workspace, and equipment. Such excess capacity and the cost of supporting this capacity results in excessive depot maintenance costs. Consolidating workloads into fewer facilities and disposing of excess capacity can result in substantial depot maintenance savings. What impact will DOD's depot maintenance outsourcing plans, to include contractor logistics support, have on excess DOD depot capacity and the cost of performing work in these depots?
Page 990 PREV PAGE TOP OF DOC Segment 5 Of 5
General STEWART. The Marine Corps capacity utilization rate is averaging 92% a year and it is anticipated to continue at that level for the next five years. Current outsourcing plans to include any contractor logistics support will minimally impact our capacity utilization.
Mr. BATEMAN. Since outsourcing work from a DOD depot that already has excess capacity will result in more excess capacity and increased labor hour rates for the remaining workloads in the DOD depot, unless the depot is closed altogether, should this cost be considered in public/private depot competitions, if not why not?
General STEWART. The Marine Corps labor rates are minimally impacted due to excess capacity. The Marine Corps capacity utilization rate is averaging 92% and will continue at that level for the next five years. Excess capacity costs should be included if both public and private industry includes the costs.
Mr. BATEMAN. DOD's depot maintenance system has substantial excess capacity that includes underutilized facilities, workspace, and equipment. Such excess capacity and the cost of supporting this capacity results in excessive depot maintenance costs. Consolidating workloads into fewer facilities and disposing of excess capacity can result in substantial depot maintenance savings. How does DOD plan to reduce costly excess capacity and increase the efficiency of its depot?
General STEWART. The Marine Corps does not have costly excess capacity; but is continuously initiating smart business practices to improve the efficiency of our depots.
Page 991 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. DOD's depot maintenance system has substantial excess capacity that includes underutilized facilities, workspace, and equipment. Such excess capacity and the cost of supporting this capacity results in excessive depot maintenance costs. Consolidating workloads into fewer facilities and disposing of excess capacity can result in substantial depot maintenance savings. How does DOD plan to reduce its depot excess capacity resulting from outsourcing and privatizing-in-place workloads?
General STEWART. The efforts of BRAC 93 and BRAC 95 have resulted in reduction of excess capacity by downsizing, realigning, and closing depots. Even though the Marine Corps has not closed either of its depots, it is continuously improving its business practices, resulting in improved efficiency and reduced customer costs. Currently, the Marine Corps has no plans in place to privatize and will outsource only when it makes sound business sense and does not preclude the Marine Corps from accomplishing its mission.
Contractor Logistics Support/Interim Contractor Support (CLS/ICS)
Mr. BATEMAN. You have not included CLS and ICS in your 60/40 calculation. My reading of the law reveals no exemption for these categories of maintenance. What is your legal authority for this exclusion?
General STEWART. It is in the legislative history. In 1994 during the mark up for the FY95 Defense Authorization Act, specific provisions were included that would have added interim contractor support (ICS) and contract logistics support (CLS) (and other provisions) to the calculation of ''60/40''. These provisions were discussed during conference and were deleted prior to final passage. The Department concludes that since the inclusion of ICS/CLS was discussed and specific action was taken to remove them from the scope of the 60/40 metric, it was the intent of Congress that they not be included.
Page 992 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. What is the current 60/40 spread for each of the Services? Last year during the hearings you also provided out year projections, would you please do the same this year?
General STEWART. The Marine Corps 60/40 spread is reflected in the charts below:
Mr. BATEMAN. What are the current ICS/CLS levels for each of the Services? Why are the Air Force levels so much higher than the other Services?
General STEWART. The Marine Corps does not use the concept of ICS/CLS for depot level maintenance.
Mr. BATEMAN. If ICS and CLS were calculated into the 60/40 data, would each Military Department be in compliance? What about the projections?
General STEWART. The Marine Corps does not use ICS or CLS for depot maintenance; therefore, there is no impact on our compliance with 60/40.
Mr. BATEMAN. The department has announced plans to expand direct vendor delivery. Will this be applied to depot-level reparable? Will this expansion take into account 60/40?
Page 993 PREV PAGE TOP OF DOC Segment 5 Of 5
General STEWART. The Marine Corps is committed to shifting our logistics focus from managing materiel to managing the materiel support we receive. The concepts of direct vendor delivery and vendor owned/managed inventory are being explored as supply support solutions throughout the Marine Corps. Using direct vendor delivery for depot level reparables has not yet been investigated, but consideration will be given to the possibility, and, where feasible, the concept will be implemented.
This expansion would not be calculated into the 60/40 for depot maintenance because this is a supply function, not a maintenance function. If the vendor performed the depot level maintenance on the reparable, then it would become part of the 60/40 calculation.
Mr. BATEMAN. Why are upgrade programs factored into the organic share and not the contractor share of 60/40?
General STEWART. Marine Corps upgrade programs are factored into the organic and contractor share of 60/40.
Public Versus Private Competition
Mr. BATEMAN. Last year at this time we were told the depot's cost accounting systems weren't adequate enough to make cost comparisons for public versus private competitions. Now after we rejected your privatization initiative, we're being told all is well and the Department is set to begin a competition program. What's going on here? What's changed? I don't recall any major Departmental initiatives in this area.
Page 994 PREV PAGE TOP OF DOC Segment 5 Of 5
General STEWART. Last year, we advised you that we were working with the depots to improve internal controls to enable competition. This was done, in part, with the assistance of a Big Six accounting firm. They were sent to the depots with instructions to help them fix the cost accounting systems as well. To ensure results, and not finger-pointing, we arranged for this to be done not with reports back to headquarters on what was wrong, but rather with a report of when the systems were considered to be adequate.
Mr. BATEMAN. Can you summarize the changes to the Cost Comparability Handbook? Were any changes made to the way contractor costs are looked at?
General STEWART. We are assessing whether the Cost Comparability Handbook should be modified to address Federal Income Taxes and the Cost of Facilities Capital. Our objective is to ensure that the adjustments to cost proposals used for depot maintenance competitions, which are necessary to make the public and private sector bids comparable, are consistent with those used for competitions involving other types of support activities (e.g., those under OMB Circular A–76). Our guidance will not specify how these factors are to be treated in the CCH. The JPCG–DM will be tasked to determine this.
Mr. BATEMAN. What's going to be different from the old public versus private competition program?
General STEWART. There will be three differences. First, we are requiring that actions be taken by the Services to remove actual and perceived conflicts of interest in the proposal preparation and evaluation, and source selection processes. Second, we are incorporating relevant aspects of acquisition reform—such as use of commercial practices when formulating statements of work and consideration of past performance in source selection—wherever practical into the acquisition strategy. Third, we are requiring a series of actions necessary for public depots to demonstrate that their offers identify accurately the total costs of performing the workload, and that actual costs are charged properly. These are weaknesses in past competitions that were strongly criticized.
Page 995 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. When do you plan to start again?
General STEWARD. That will depend on the Service. Those that are already effectively at the 60/40 limitation (e.g., Navy) will not be holding any PPCs unless the law is changed. Those with some remaining flexibility (e.g., Army and Air Force) can be expected to start holding PPCs as soon as they have published requisite implementing procedures (Army does not intend to begin before FY98, Air Force has PPCs ongoing).
Mr. BATEMAN. Will all depots be permitted to participate, or will there be restrictions?
General STEWART. The guidance published by OSD will be in compliance with 10 U.S.C. 2470.
Defense Science Board
Mr. BATEMAN. Two years ago, the DSB recommended the Department maintain the core concept. This year they recommend the Department abandon that concept. I notice that there were military advisors connected with both studies. Can you tell us what changed over the past two years that prompted this change in view?
General STEWART. While both DSBs focused on saving money with higher performance, their approaches were quite different. The DSB two years ago was broken into eight functional areas from health to training, to supply, to maintenance, with in-depth analytical reviews. The 1996 DSB did no analytical review. The 1996 DSB's vision focused on DoD personnel preparing for, and conducting combat operations and managing crises (their core competencies) and moving the support activities not deployed to competitive private sector (their core competencies).
Page 996 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Some very senior OSD officials have ridiculed the latest DSB report by pointing out that it lacks an analytical foundation. Do you agree with that characterization?
General STEWART. Yes. The published report only identified ''opportunities'' for savings without providing the supporting analysis.
Mr. BATEMAN. The 1996 DSB Summer Study on Achieving an Innovative Support Structure for 21st Century Military Superiority indicates savings of $30B per year are possible. Are you finding similar results in your QDR studies?
General STEWART. The QDR studies are still in a preliminary stage and it would therefore be premature to quantify savings which may be identified in that review.
Mr. BATEMAN. The same study calls for a 5 percent per year reduction in civilian workforce and a 2 percent per year reduction in military personnel over the next five years. Can you accomplish these reductions and still stay within the 60/40 restriction? Can you accept these and still maintain readiness? Has there been any move, that you know of, to implement these recommendations?
General STEWART. The DSB identifies this reduction in personnel against the O&S People Reduction Opportunities and not specifically against depot maintenance. The Marine Corps would examine where the best opportunity for personnel reduction within O&S was and weigh it against the risk factors which could endanger its mission. If it was decisioned that the Marine Corps could reduce the personnel within the depot maintenance program, it would only be to a level which made sound business sense and to maintain the 60/40 restriction. To date, we are not aware of any move to implement this recommendation.
Page 997 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. In your opinion, would there be violation of the law if the recommendations contained in the DSB Summer study were to be implemented?
General STEWART. Yes, The recommendation for deleting the requirement for retention of organic depot maintenance CORE capabilities and to contract out the workload is predicated on legislative action to repeal the 60/40 requirement.
Mr. BATEMAN. It would seem that the people conducting the studies would stand to benefit should the DSB recommendations be implemented. How can this apparent conflict of interest be avoided in the future?
General STEWART. This apparent conflict of interest can be minimized if the DSB included analytical data to substantiate their recommendations. As an added measure, the DSB recommendations could also be subjected to an independent audit.
CORE
Mr. BATEMAN. Your methodology gives the appearance of rigor. However, in actual practice it appears that anything and everything can become non-core at the convenience of the Department. Wouldn't you agree that the core methodology is a sham?
General STEWART. No, we don't agree that the core methodology is a sham. The core methodology allows each Service the flexibility to identify the core capability needed to sustain its institutional expertise. We would like to have a stable workload base so we could have a static workforce, resulting in a streamlined industrial base planning and execution process. However, many factors drive the composition of our workloads necessary to sustain core capabilities and these factors are not static. For example, force structure changes drive the size of our requirements. The introduction of new technologies will change the skills that are required Changes to operational scenarios will drive both the skill requirements and the size of the core requirement. In this ever-changing environment, we need to have a responsive process that allows us to adapt to these changes.
Page 998 PREV PAGE TOP OF DOC Segment 5 Of 5
Previous responses indicated the need for risk assessments based on Best Value analysis. Workload that was deemed core in the past may be determined as non-core in the future because of the factors involved with the risk assessment. The Marine Corps would not deem certain workload as non-core because of convenience. Rather, it would be decisioned as core or non-core based on an assessment of the risks. Given the limited financial resources, identification of the minimum viable capability required for retention is necessary.
Mr. BATEMAN. Have you changed the definition of core from what was reported to us last March?
General STEWART. No, the definition has not changed.
Mr. BATEMAN. Please provide us with the workloads necessary to sustain core capabilities for each of the Services by commodity, by depot.
General STEWART.
595
The Marine Corps does not divide the capability requirement to sustain CORE by depot. This allows us to maintain our flexibility in assignment of workload to this capability.
Mr. BATEMAN. Are new weapons systems considered core? Are they reviewed for core requirements? Is it still the policy of the Department that new weapon systems will be maintained in the private sector?
Page 999 PREV PAGE TOP OF DOC Segment 5 Of 5
General STEWART. Depot maintenance workloads resulting from new weapon systems will be reviewed under the same process that all other workloads are reviewed. Those that are determined to be necessary to sustain core capability requirements will be performed by the organic depots.
DoD policy has been rewritten to clarify that new technologies support will be analyzed for Core capabilities requirement and risk assessment. If it is decided that the Marine Corps has a requirement to maintain a depot capability, that workload will be retained organically.
Outsourcing Depot Maintenance
A recent report by the Defense Science Board states savings of 20 to 40 percent would result from outsourcing DOD commercial activities to include depot maintenance. The report calls for DOD personnel to rely on ''a robust, competitive private sector'' to provide maintenance and logistics support. The Board believes that private sector competition already exists or would quickly develop to meet virtually all of DOD's support requirements. However, GAO states in its testimony that 90 percent of the depot maintenance contracts it sampled were awarded non-competitively.
Mr. BATEMAN. To what extent is the Board's 20 to 40 percent outsourcing savings estimates dependent on a competitive commercial market and to what extent is there not such a market for depot maintenance activities?
Page 1000 PREV PAGE TOP OF DOC Segment 5 Of 5
General STEWART. There was no analysis done to support the DSB's recommendations; the report only identified ''opportunities'' for savings. Consequently, the Marine Corps cannot determine how much of the savings were dependent on a competitive commercial market. There is very limited commercial depot maintenance activity in the private sector due to the size and mix of the Marine Corps depot workload and the inability of private industry to meet completion schedules based on the Marine Corps mission.
Mr. BATEMAN. To what extent will ownership of data rights by the original equipment manufacturers, plans to rely more on total contractor logistics support and long term contracts, and defense industry consolidations reduce competition for depot maintenance workloads?
General STEWART. The Marine Corps does not foresee any impact on competing ground equipment workload at the present time.
Mr. BATEMAN. In the absence of a competition, to what extent do you believe outsourcing will achieve savings?
General STEWART. We believe competition is crucial to achieving savings. In the absence of competition, savings will be achieved through sound business practices.
Mr. BATEMAN. Should DOD retain non-core depot maintenance capabilities for workloads where there is not a competitive commercial market?
General STEWART. If there is not a competitive commercial market for non-core depot maintenance workload, the organic capabilities and workload should be retained by DOD. If current organic capabilities exist, then it would not make sound economic sense to establish a capability in the private sector just to move the non-core workload out of DOD.
Page 1001 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Should DOD depots be allowed to compete for outsourced workloads where no competitive market exists?
General STEWART. Yes, DOD depots should be allowed to compete for outsourced workloads where no competitive market exists.
Mr. BATEMAN. In a non-competitive environment how does DOD plan to assure it is getting the benefits and safeguards of a competitive commercial market?
General STEWART. The Marine Corps will continue to make sound business decisions to ensure we are getting the best product for every dollar being expended through process improvements.
Additional Questions
Mr. BATEMAN. The DOD is changing its policy and using a ''best value'' approach when evaluating bids in a public-private competition, rather than simply evaluating each proposal on a least expensive basis. As the private sector can pick and choose its workload, and the public depots are assigned all types of workload, it is likely that public depots can not run as efficiently as the private sector.
How will you determine best value in the private sector?
How are you going to determine best value in the public depots?
Page 1002 PREV PAGE TOP OF DOC Segment 5 Of 5
If you use a ''past performance'' criteria for determining best value, how will you determine past performance in the public depots when they have had little or no control over the assignment of workload or retention of skilled employees?
General STEWART. Best value will be determined in the same manner for both private and public depots. Criteria include ability to meet cost, schedule, and quality of the completed product. ''Past performance'' will be an element of the ''best value'' analysis. ''Past performance'' of organic depots again will be judged on the ability to meet the cost and schedule, and on the quality of the product. The Marine Corps depots' ability to adjust to changing customer demands is their strength.
Mr. BATEMAN. Since each of the services have been responding to direction to privatize more and more depot maintenance work over the last two years, please provide us with a list of systems and dates regarding the estimated savings resulting from these actions.
General STEWART. The Marine Corps has not privatized any of its current weapon systems workloads.
Mr. BATEMAN. DOD policy states that ''paramount in all departmental policy considerations are (1) the readiness and sustainability requirements of DOD forces, (2) the optimum use of scarce department resources, and (3) exploitation of the strength of United States commercial industries''. On what do you base the readiness and sustainability requirements of DOD forces? Is the optimum use of scarce department resources based on the availability of funds or on employee levels?
Page 1003 PREV PAGE TOP OF DOC Segment 5 Of 5
General STEWART. The Combat Development Process (CDP) develops the requirement for the Fleet Marine Forces based on the Defense Planning Guidance (DPG) and its Illustrative Planning Scenarios (IPS). Sustainment requirements are developed from the Combat Active Replacement Factor Model which is developed using the guidance in the DPG. The timeframes are based on the phase-in of forces, the scenario developed rate of attrition, and the intensity of action (i.e., assault/sustained and armored heavy/infantry heavy threats.
Optimum use of scarce department resources is based on analysis which allows the Marine Corps to achieve maximum benefit with limited available funding and the mission to be accomplished. Employee levels are then based on this analysis.
Mr. BATEMAN. Over the years, there has been concerned voiced with the ability for the private sector to respond during times of national emergencies and concerns for work stoppages due to strikes and/or corporate business decisions. How would you address these concerns? What happens when the private sector makes a business decision to not continue a particular workload and by that time, the public depot previously accomplishing the workload has since closed?
General STEWART. The Marine Corps would build incentives into the contract as well as penalties if cost, quality, and schedule were not met. If the private sector makes a business decision to not continue a particular workload, a decision would have to be made whether to buy a new asset or reestablish the maintenance capability in an organic depot. However, either decision would result in an increased cost to DoD.
Page 1004 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. It is DOD policy to place all new weapons systems depot level requirements with the original equipment manufacturer. How can you maintain your depots if none of the new weapons systems are placed in these depots? Is it true that if no new weapons systems are placed in the public depots, they will whither and close in nine years?
General STEWART. It has not been our practice to place all new weapons systems depot level requirements with the original equipment manufacturer. The policy in DOD 5000.2 states ''It is DoD policy to retain organic core depot maintenance capability to meet essential wartime surge demands, promote competition, and sustain institutional expertise * * *'' In this light, the Marine Corps does not plan to place new weapon systems with the original equipment manufacturer, nor do we anticipate closing depots.
Mr. BATEMAN. DOD intends to have selective public/private competitions for workloads where adequate competition does not exist in the private sector. For your depots to be a reasonable competitor for these workloads requires that they have the capability and capacity to perform the workloads. What are you doing to ensuring that your depots can be realistic competitors for these workloads? Do you feel that you have the capability to effectively compete for depot workloads? Would not the depots be more economically efficient if their workload was closer to their current capacity as opposed to artificially sizing them to core?
General STEWART. The Marine Corps will continue to make sound business decisions through process improvements to ensure our depots can be realistic competitors. Yes, the Marine Corps feels it has the capacity to effectively compete for depot workloads. Our workload is close to our capacity; therefore, we are not artificially sizing to core.
Page 1005 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Congress and DOD agree that a core capability should exist in public depots. Have you examined the current core requirements to test for reasonableness and to determine what percent of the maintenance funding will be core?
General STEWART. Yes, The Marine Corps continuously reviews its Core capability requirement. As part of the review, sound business sense is applied along with risk analysis of outsourcing the workload. The current FY98 funding level for depot maintenance will cover workload which is core capability-related.
Mr. BATEMAN. Marine Corps has escaped the difficulties resulting from depot closures. Employment, workload and capacity utilization have remained fairly stable over the years. What accounts for this anomaly?
General STEWART. As the President's ''911'' force, our mission requires us to maintain the depot structure as a core competency. The size of our depots and workload does not lend itself to the benefits of savings from downsizing, privatizing or closure. The Joint Cross-Service Work Group, in support of BRAC 95, concluded there was not a substantial benefit to close, downsize, or privatize either of our depots. The Marine Corps program equates to less than one percent of the total DoD investment for depot maintenance. Additionally, the strategic location keeps both Marine Corps Logistics Bases filled with workload.
QUESTIONS SUBMITTED BY MR. ORTIZ
Page 1006 PREV PAGE TOP OF DOC Segment 5 Of 5
Depot Maintenance Decrements
Mr. ORTIZ. When your staff briefed my staff last month, one chart they used showed ''congressional decements'' in addition to the funding moved out of FY96 and FR97 O&M accounts for Bosnia operations. Please specify these additional congressional decrements that you say have occured.
General WILSON. We received the following congressional decrements ($000) in FY96 for depot maintenance:
We received the following congressional decrements ($000) in FY97 for deport maintenance:
Civilian Personnel Policy
Mr. ORTIZ. If given the necessary funding required to eliminate your depot maintenance backlog and to meet all unfunded depot maintenance requirements, what constraints would you still face in terms of civilian personnel policy and regulations that would prevent you from accomplishing this?
General WILSON. There are no personnel constraints. We size our workforce to match funded workload.
Page 1007 PREV PAGE TOP OF DOC Segment 5 Of 5
Corpus Christi Army Depot Skilled Workforce
Mr. ORTIZ. Why would Major General Sinn say, as he did during a Subcommittee O&M budget briefing earlier this month, that engine work at Corpus Christi Army Depot is being privatized because there is no skilled workforce?
General WILSON. Corpus Christi Army Depot (CCAD) has consistently overhauled and/or repaired the Navy T700 for the Seahawk, the Air Force T700 for the Pavehawk, and the Army T700, T53, T55 and T63 family of engines. There is also selected work done on the AGT 1500 tank engine for Anniston Army Depot and CCAD overhauls the Navy TF40–B hoovercraft engine. A skilled workforce is in place at CCAD to perform this workload and there is no current plan to privatize this work in the future.
Defense Depot Maintenance Policy
Mr. ORTIZ. We are very concerned that depot maintenance policy appears to send all depot-level maintenance for new weapons systems to the private sector through application of acquisition and procurement policies and such documents as PBD (Program Budget Decision) 21, which we believe are meant to circumvent 60/40. How will the depots remain ready to support the warfighters if they no longer have aches to new weapon systems?
General WILSON. If that were the policy, to send all new weapon system maintenance to the private sector, I would not be able to sustain a viable depot system, and the depots could not remain ready to support the warfighters. The most recent draft of DOD policy, which I concurred in as a part of the Defense Deport Maintenance Council, shows a preference for private sector sources, only after ascertaining that core capabilities are retained.
Page 1008 PREV PAGE TOP OF DOC Segment 5 Of 5
Management/Capitalization Efforts
Mr. ORTIZ. What management and capitalization efforts are under way to modernize the Army's depots so that they can become more efficient and be competitive?
General WILSON. The FY 1998/1999 President's budget includes $23M in FY 1998 and $4.3M in FY 1999 for capital projects that will improve operational efficiency.
Mr. ORTIZ. What management and capitalization efforts are under way to modernize the Army's depots so that they can become more efficient and be competitive?
General WILSON. We are supporting Army Power Projection requirements and modernizing our industrial capacity through the Army Strategic Mobility Program (ASMP), Capital Investment Program (CIP) and ''Right-sizing'' our facilities through Base Realignment and Closure (BRAC).
The following represent the most significant examples of our efforts to modernize our industrial facilities and improve customer service. There are numerous other efforts either in the planning stage or being implemented to improve our infrastructure and operations.
1. The Army Strategic Mobility Program (ASMP) provides for the upgrade of our real property assets to improve our efficiency in accomplishing current workload and enhance the Army's Ammunition Logistics Power Projection mission. Ongoing improvements (including estimated project funding) follow.
Page 1009 PREV PAGE TOP OF DOC Segment 5 Of 5
a. Increase Crane Army Ammunition Activity through-put of container cargo from 215 per day to 310 per day ($15.5M), upgrade of railroad ($10.4M) and ammunition storage facilities ($2.1M).
b. Increase Anniston Army Depot thru-put of container cargo from 65 per day to 120 per day ($3.9M).
c. Increase McAlester Army Ammunition Plant through-put of container cargo from 50 per day to 400 per day ($11.2M), upgrade railroad ($8.5M), improve loading docks ($0.2M), and roads ($5.5M).
d. Increase Tooele Army Depot through-put of container cargo from 120 per day to 310 per day, and improve ammunition container complex ($5.0M), and improve railroads ($8.4M).
e. Increase Blue Grass Army Depot through-put of container cargo from 74 per day to 300 per day and improve ammunition container complex and container surveillance facility ($5.2M), improve railroads ($3.0M) and roads ($4M), and improved ammo container handling facility ($9.1M).
2. Capital Investment Program (CIP) for Facilities Improvement. The following CIP initiatives are ongoing in FY 97.
a. Rock Island Arsenal building to house the All Angle Simulator (AAS) to permit the AAS to operate in all weather conditions.
Page 1010 PREV PAGE TOP OF DOC Segment 5 Of 5
b. Rock Island Arsenal altering curve radius of railroad track to allow the larger, modern cars to transit the distance to the shipping and receiving area in building 299.
c. Anniston Army Depot improvement of hardstand staging and storage area for combat vehicles. Project facilitates the loading and unloading of large items in support of the depot's partnering with industry efforts.
d. Corpus Christi Army Depot sheet metal cutting station. Project allows consolidation of welding shop and cutting operations, eliminating the time now required to transport work between the two locations.
e. Corpus Christi Army Depot construction of storage building for flight test components. New facility reduces the delivery time for flight test components to the test site and increases efficiency of aircraft repair.
f. Letterkenny Army Depot X-ray facility. Consolidation of missile system workload has resulted in a greatly increased need for X-ray quality. New facility will significantly reduce cycle time for inspections, and eliminate the current backlog of work, improving the timeliness of deliveries and improving customer service.
g. McAlester Army Ammunition Plant. Currently establishing a new flexible small cast cure explosive loading facility to better meet customer needs and be able to respond to the trend towards insensitive munitions warheads.
Page 1011 PREV PAGE TOP OF DOC Segment 5 Of 5
3. Base Realignment and Closure (BRAC).
a. Mission functions have been realigned and consolidated among nine depots/depot activities. The excess real and personal property at the losing installations is being transferred to other Government agencies or Local Redevelopment Authorities.
b. The resulting minimum essential structure provides support to our mission workload with a considerably smaller infrastructure, producing significant reductions in the Army's base operations support cost requirements. The mission customer is able to obtain their workload with a smaller overhead, and a smaller total cost.
Defense Depot Maintenance Policy
Mr. ORTIZ. Is the Army currently including all sources of depot maintenance funding in its calculation of the percent for contracting? For example, are all workloads and dollars associated with R&D, procurement, weapons systems for peace-keeping operations, weapons systems for testing, and the maintenance of spares included in the 40 percent?
General WILSON. No. AMC reports the O&M and AWCF funded portion for both contract and organic sources in our 60/40 reporting. Separately, we also report all organic workload regardless of funding source, for use in the defense Depot Maintenance Council Business Plan. For this year, DOD chose to include organic work in the 60/40 report.
Mr. ORTIZ. Do all the reports to Congress clearly identify all the appropriations which support depot maintenance? If not, what is excluded and what is the basis for excluding the maintenance relative to the 40 percent constraint?
Page 1012 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. The reports to Congress clearly identify the funds that are appropriated for depot level maintenance and repair work. However, in accordance with DOD policy, the Army does exclude ICS/CLS workload from 60/40 reporting.
Mr. ORTIZ. What is the total funding level of Army contract maintenance proposed in the President Budget for FY98? How does this change over the Future Years Defense Program? Do these levels include the maintenance for all weapons systems upgrades, maintenance that is included in life-cycle maintenance associated with new procurement, and other maintenance workload provided from the private sector to include maintenance on test equipment, R&D equipment, weapons support equipment (generators, compressors, laboratory equipment, commercial utility vehicle equipment regardless of whether it is direct funded or leased) and jet-engine maintenance for all weapons systems?
General WILSON. The FY 98 President's Budget reflects a funding level for depot maintenance contract workload of $213M. At this time, the contract level appears to be about the same in the outyears. The funding levels include only the O&MA funds that are appropriated for depot level maintenance and repair workload.
Trends Toward the Private Sector
Mr. ORTIZ. What have been the Army trends for the past five years in moving maintenance to the private sector? Has it increased or decreased? What have been the total funding levels for all maintenance (all appropriations) that has been competitively contracted and sole-source contracted for the past five years: What are the levels planned for the Future Years Defense Program?
Page 1013 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. Although the contact/organic split for Army depot maintenance has fluctuated over the last five years, there has been no trend towards either contracting more work or putting more work into organic depots. The organic portion of the Army's depot maintenance program has stayed between 64 and 69 percent. Similarly, we have made no effort to increase the relative proportion of either sole-source or competitive contracts.
Depot Maintenance Overhead
Mr. ORTIZ. Are depot maintenance overhead levels acceptable?
General WILSON. No, not at all installations. A certain amount of overhead is necessary and in some cases good, e.g., computer systems that are treated as indirect costs. However, we have some sites where overhead levels in relation to the direct labor hour base are excessive.
Mr. ORTIZ. If not, what has contributed to the excessive overhead levels: reduced workload funding levels, increased depot maintenance hourly rates, and/or surcharges on each depot maintenance hour?
General WILSON. Overhead levels have increased for many reason: (1) maintenance of some weapons systems have fallen in priority, resulting in reduced funding levels; (2) at BRAC locations our experience has been that overhead reductions lag behind realignment of direct workload causing a temporary imbalance between direct and overhead ratios; (3) reorganization may also result in an increased overhead level for a time as personnel are trained to operate new equipment or perform work on a new or different weapon system.
Page 1014 PREV PAGE TOP OF DOC Segment 5 Of 5
Production Planning Requirements System
Mr. ORTIZ. Does the Army maintain a detailed production planning requirements system to support the efficient execution of depot maintenance programs?
General WILSON. The Army has a workload prioritization system which identifies the type of weapon system, type of maintenance required, unit cost, number of costs, and funds required and available.
Mr. ORTIZ. Does that system provide an accurate set of production requirements for each depot prior to budget-year execution?
General WILSON. Workload prioritization occurs at least twice a year. Once for budget formulation/rate establishment and once to reflect execution year adjustments, e.g., appropriation levels.
Mr. ORTIZ. Are there inefficiencies introduced in the ''planning process'' for the execution of the depot maintenance programs?
General WILSON. Yes, there are inefficiencies.
Mr. ORTIZ. If so, what are they and do they contribute to the current depot maintenance rates required to support the depot maintenance programs?
Page 1015 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. The factors that contribute to inefficiencies are changing priorities, contingencies, and funds do not materialize. These inefficiencies increase the rates to the extent that if there is no replacement workload available, the direct labor hour rate would increase.
Mr. ORTIZ. Would additional flexibilities granted by the Congress improve the efficiency of the depot maintenance system?
General WILSON. Yes.
Mr. ORTIZ. If so, what are they and which rate would they have the most positive impact on?
General WILSON. Additional flexibility would allow the installations to explore contracting out of some functions that are currently protected. If the contracting out is cost effective, reductions to costs, and reductions to rates could occur.
Workload Management Programs
Mr. ORTIZ. The Committee commended AMC two years ago for its commitment to correcting workload management programs. What is the status of your effort to correct these problems?
General WILSON. We have two efforts underway. Our Management Engineering Activity (MEA) has completed a survey of our command and has established a major subordinate command (MSC) unique baseline relationship of workload and manpower. As Phase II to this baseline, we will engage in comparative analysis/improvement studies across MSC's focusing on ''high impact'' functional areas. Over the next several years MEA will refine this baseline or benchmark to similar activities across the command. In a complimentary approach, we are adopting a Navy shipyard workloading system which we are prototyping at Corpus Christi Army Depot.
Page 1016 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. ORTIZ. When can the Committee expect you to complete the AMC-wide installation of the new workload system?
General WILSON. We do not yet have a firm completion date for AMC-wide implementation.
Mr. ORTIZ. When will this support budget submissions to Congress?
General WILSON. Possibly for FY 2000.
Mr. ORTIZ. Please provide use with a copy of audit reports on workload management and also an accounting of AMC effort to address these recommendations.
General WILSON. Subject audit is attached. The AMC comments to the recommendations start on page 26.
[See attachment B in the appendix on page 1236.]
Breakdown of Hourly Rate
Mr. ORTIZ. Please provide us with a complete breakdown of the depot hourly charge including overhead categories and surcharges for BRAC, JLSC, and other additions to the depots' core labor charges.
Page 1017 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. The break out for the FY98 composite rate for depot maintenance is as follows:
Depots and Arsenals Bidding or Competing on Work
Mr. ORTIZ. Have the depots and arsenals been prevented from bidding or competing on any work? If so, please provide all instances, amounts and finding source of the work.
General WILSON. Because of legal restrictions such as 10 U.S.C. 4543 and U.S.C. 2208(j), Government Owned-Government Operated facilities are unable to team with the private sector for government work. Installations have given accounts of receiving calls and requests for manufacture of defense items, but being unable to assist. The following are examples for McAlester AAP where they have lost business opportunity because of this situation.
(1) Prevented from loading warheads with McDonnel Douglas in the amount of $540,000. Funds would have come indirectly from the U.S. Navy.
(2) Prevented from undertaking contracts with Olin Ordnance to perform demil work in the amount of $375,000. Funds would have come from Olin Corporation through the Army demil account.
(3) Prevented from manufacturing pallets for Olin Ordnance in the amount of $950,000. Funds would have come from Olin via the Army.
Page 1018 PREV PAGE TOP OF DOC Segment 5 Of 5
(4) Prevented from undertaking contracts with ICI, a demil contractor, in the amount of $400,000. Funds would have come from ICI, through the Army demil account.
(5) Will be prevented from entering into a contract with General Dynamics to load the New Advanced Unitary Penetrator (AUP), for the Air force. McAlester completed loading the test round, but will be prevented from loading the production quantity of 1500. The contract would have been through General Dynamics by way of the Air Force. Estimated program value is $1,959,000.
Removing the restrictive conditions in these statutes would facilitate teaming arrangements.
Funded Workloads
Mr. ORTIZ. Will depots and arsenals be permitted to increase funded workloads if they can import additional funded workloads to achieve efficiencies?
General WILSON. Yes, although they must ensure they are complying with core policy. Additional workload should be considered if it would achieve greater efficiency.
Core Depot Maintenance
Mr. ORTIZ. How do the Army and the Navy define and determine care and how do you apply the 60/40 law in that determination? How do you assess risk? How do you determine best value?
Page 1019 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. The Army uses the jointly developed DOD core methodology to determine core. Within the methodology there is a step where ''last source and other non-core workload'' is added into the organic base. In the instructions for this step, it is explained that this is where work is added to core if necessary to comply with ''60/40'' or other laws. Best value analysis, another step in the methodology, is done after work has been determined to be non-core, and is where the final decision is made whether to go to a private sector source or to a government depot. If this requires a formal competition, then the analysis is one according to formal and preset rules of source selection.
Depot Maintenance Privatization and Outsourcing
Mr. ORTIZ. What are the Army's and Navy's concerns regarding the Air Force's plan to privatize in place whole workloads at two closing air logistics centers? What impact will this plan have on the Army's and Navy's ability to stay within the 60/40 depot maintenance requirement?
General WILSON. Assuming the workload transfers from SMALC to TYAD as agreed upon, the Army has no direct concerns with the Air Force's plan, and there will be no impact on 60/40.
Mr. ORTIZ. How do the Army and the Navy define and determine core and how do you apply the 60/40 law in that determination? How do you assess risk? How do you determine best value?
Page 1020 PREV PAGE TOP OF DOC Segment 5 Of 5
Admiral LOCKARD. We identify our total core requirements every two years, as required by the Defense Depot Maintenance Council. Prior to award to the private sector we review our public/private workload balance to ensure we stay in compliance with the law.
To assess risk the Naval Air Systems Command uses the six risk criteria incorporated in the DOD CORE Methodology which were developed by the Services.
Mr. ORTIZ. What are the Army's and Navy's concerns regarding the Air Force's plan to privatize in place whole workloads at two closing air logistics centers? What impact will this plan have on the Army's and Navy's ability to stay within the 60/40 depot maintenance requirement?
Admiral LOCKARD. Some of the work done at the closing air logistic centers supports our CORE capability requirements. We are currently performing risk assessments and plan to posture that work in accordance with the outcome of the CORE methodology. We are also analyzing the impact on 60/40 and will posture our work to stay within the legal constraints.
QUESTIONS SUBMITTED BY MR. HANSEN
Depot Maintenance and Logistics Support as a Core Competency
Mr. HANSEN. Is depot maintenance and logistics support a core competency of the Army and do you believe a strong organic depot system is critical to the readiness of the Army?
Page 1021 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. I believe depot maintenance is a core competency of the Army. The reason for maintaining a viable government-operated, depot system is that the depots support pre-deployment, deployment, and reconstitution of the equipment used by the Army in conjunction with the total Army's force projection capability. Therefore, I believe a strong organic depot system is indeed critical to the readiness of the Army.
In order to retain the basic capability to provide essential depot maintenance support during contingency operations, the Army must sufficiently workload maintenance depots.
Mr. HANSEN. Is depot maintenance a core competency of the Air Force and are organic depots critical to maintaining readiness?
General VICCELLIO. Yes. As a part of ''Agile Combat Support,'' one of the six U.S. Air Force core competencies, both organic and contracted depot maintenance is critical to maintaining readiness. Accordingly, the Department of Defense subscribes to the concept of sustaining an appropriate level of organic capability so as to ensure mission accomplishment and the maintenance of technical competence.
Mr. HANSEN. Is the Newark AGMC contract costing us more money and has the Air Force in any way included these higher costs in the rate structure of the remaining depots through the Air Force business operating fund?
General VICCELLIO. Yes, our analysis shows that, at least initially, one of the contracts at Newark is showing recurring costs in excess of those projected from previous organic performance of the same workload. However, contractor performance is improving and costs are decreasing rapidly. It is simply too early to tell when the contractor's costs will stabilize and whether or not the privatization of AGMC will save us money. In non-recurring expenses, however, the contract has avoided substantial costs. Transition costs, originally estimated to be in excess of $60M, may total only two-thirds of that amount, and relocation costs estimated in excess of $300M have been totally avoided.
Page 1022 PREV PAGE TOP OF DOC Segment 5 Of 5
Since customer prices related to contract repair are determined separately from those associated with organic repair, rate structures at other depots will not be affected by Newark costs.
Mr. HANSEN. Has any administration official at any time directed you or anyone under your command to pursue a privatization-in-place strategy at Kelly and McClellan Air Logistics Centers? Has any administration official established employment goals for these locations? What are they? Do you have them for any other locations?
General VICCELLIO. The Air Force was given the latitude by the BRAC recommendations to explore suitable opportunities for privatizing workload at Kelly and McClellan. While in-place performance could well be the basis of a given commercial offer, that decision would be up to the offeror. As for employment goals, at the time that the President approved the 1995 Base Closure recommendations, the President requested the Secretary of Defense to evaluate a plan for the closure of Kelly and McClellan so that jobs at Kelly and McClellan could be retained through the closure period. These goals were general in nature, expressed as fractions of the total base population at the time of the BRAC decision, and regarded as just what they are . . . goals. The Air Force and DoD has evaluated various options in attempting to balance closure considerations such as tenant relocation, workload transfer and transition, and public-private competition, to implement BRAC recommendations and minimize impacts to force readiness, workforce management, and the base closure communities.
Mr. HANSEN. Has any administration official in any case overruled a recommendation from you or any other Air Force commander with respect to the privatization of Kelly and McClellan workloads?
Page 1023 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. No. As we have progressed from early considerations of basic closure options through the acquisition strategy for selected workloads, both Air Force and DoD leadership have supported plans as recommended.
Mr. HANSEN. Will the competition as currently structured give preference, or require, in any way all of the work to be done in a single location? Are commercial bidders free to consolidate work to their own significant excess capacity if that would move workload from McClellan or Kelly?
General VICCELLIO. As currently structured, competitions for the workloads at McClellan and Kelly do not require the work to be done at a single location. Commercial bidders are free to offer performance of the work at any location.
Mr. HANSEN. Are you aware of any analysis done within the Air Force that suggests that privatization-in-place at Newark, Kelly or McClellan is not the most effective solution for the Air Force? Are you aware of any Air Force analysis that recommends against privatization of any specific workloads? Are you aware of any Air Force analysis that recommended specific workloads as core which are being considered for privatization?
General VICCELLIO. Althought privatization-in-place of selected workloads may offer such advantages as reduced readiness risks, no relocation costs, and continued utilization of ''sunk cost'' resources such as facilities, equipment and a trained workforce, there are start-up costs to pay which can only be analyzed once formal proposals are offered. Similarly, transferring workload to underutilized, non-closing installations may offer some advantages through reduced overhead rates per production unit and other economies of scale, but also involve considerable transition costs in areas such as equipment teardown, transportation, buildup at the receiving end, facility construction or reconfiguration and workforce training. Only Air Force workloads determined as not necessary to be performed in house to sustain a core capability are being considered for competition.
Page 1024 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. HANSEN. Please provide a detailed breakdown by workload of what the Air Force considers to be core maintenance at each of the five Air Logistics Centers.
General VICCELLIO. Core is the organic capability (in terms of personnel/skills, equipment, and facilities) required to support readiness and sustainability for essential weapon systems required in JCS contingency scenarios. Core is not workload based, rather, it is the capability required to sustain the weapon systems used in these JCS contingency scenarios. Core is determined from a DoD perspective not a Service perspective. Mission essential weapon system workloads sustain these core capabilities.
A workload breakout will only be available following the completion of a core determination process on all USAF depot workloads. Since workload disposition at Sacramento and San Antonio ALCs is being driven by the BRAC '95 timeline, those workloads are being evaluated first. Subsequently, determinations will be made as necessary to accommodate changing conditions (operational changes, force structure modifications, emerging or retiring systems, proposals from the commercial sector, etc.). Until such time as all workload has been evaluated, workloads previously rated as core will remain so for reporting purposes. With this in mind, USAF core capability projections are as follows:
Mr. HANSEN. Is there any analysis completed by the Air Force regarding the relocation of the F–117 SPO? What was the recommendation of the current Air Force program office? Were any of these decisions overruled by any Air Force acquisition official? If so on what basis? Is the F–117 SPO planned to be sole source to Lockheed Martin?
Page 1025 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. Following the BRAC '95 decision to close McClellan Air Force Base and the Sacramento Air Logistics Center, AFMC conducted a review of affected workloads and produced a preliminary disposition plan called Integrated Weapon System Management (IWSM) II. This effort did not consider contractor options (by design). In early 1996, a separate team reviewed a ''white paper'' submitted by Lockheed-Martin that suggested an expanded contractor role in the areas of system and material management. That team recommended that the warehousing function be contracted, the systems management function be relocated to Wright-Patterson AFB, Ohio, and that further study be pursued in the area of materiel management. Subsequently, the program office has worked with the contractor to further develop what could (but as yet has not) become a formal proposal. In March 1997 the Air Force Audit Agency, as part of a broad review of logistics support contracts, reviewed the F–117 management options being explored and concluded that if competitive procedures were pursued for program office support functions, up to 25% cost savings could occur. Throughout this period, the F117 program office was involved in both reviews and deliberations with Lockheed-Martin, the system contractor. We believe greater savings can be achieved by considerably reducing the size of the program office and by increasing the contractor's responsibility for F–117 logistics support.
The issue of a sole source contractual arrangement will not be decided until later this year when the contractor's concept and proposal is formally offered and analyzed in more detail.
Mr. HANSEN. In the course of your work is it standard protocol for cost data and other requested information from field units, individual bases, program offices, or contract offices to be vetted through Service headquarters prior to release to GAO? Are you experiencing any difficulty or irregularities in gathering requested information from the Air Force regarding the cost and criteria of Air Force privatization efforts?
Page 1026 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. WARREN. Generally we receive requested information directly from field activities without first routing the information through a headquarters organization. This procedure, if used would delay our access to information. We have experienced some difficulties in getting information from the Air Force regarding the San Antonio, Sacramento, and Newark closures and privatization efforts. These difficulties have on some occasions included denial of information that we believe we should have access to.
Mr. HANSEN. In general terms, if DOD pursues a strategy of privatization of excess capacity, without consolidation of workloads, aren't we likely to see increased costs to the Department? Is there any evidence of this increase in costs?
Mr. WARREN. The privatization of excess capacity will likely result in higher costs for remaining workloads. By consolidating workloads from closing depots into underutilized facilities, the fixed overhead costs at these locations can be spread among larger numbers of units, reducing the average cost of all workload. The Navy has demonstrated the validity of this concept by closing 3 of 6 naval aviation depots and improving the efficiency and cost-effectiveness of the remaining depots through this process.
Mr. HANSEN. Newark AGMC is often touted by the Air Force as an example of successful privatization where millions of dollars can be transferred to underfunded modernization accounts. Can you tell us how much this success story is costing the Air Force? How is the Air Force paying for these increased costs? What effect do these increased costs have on the remaining organic depots? And what does your analysis show regarding what are the main factors causing these increased costs?
Page 1027 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. WARREN. The costs of guidance system repairs at the Newark Ohio depot are estimated to be $13 to $23 million more than the cost of the same workload before privatization. The increased costs must be paid by increasing the cost of other depot maintenance work to make up the loss. There is not enough actual cost data available to definitively determine the extent of or reasons for the cost increases. The government did not contract for data to be provided in sufficient level of detail to facilitate this kind of analysis. However, available information suggests that increased parts usage, contractor profit, and increased overhead costs appear to be the primary areas causing the increases.
Mr. HANSEN. Your report states that the Air Force retains over 50% excess capacity. Can you tell us what the most accurate measure for capacity is? Is this the measure BRAC used? How does industry measure capacity? And what percent of capacity utilization do you believe would represent an efficient level for DOD depots to operate at?
Mr. WARREN. Excess capacity is the difference between the capacity of a facility to perform work, usually measured in direct labor hours, an the amount of work that is actually performed in that facility. We refer to maximum potential capacity that is derived by determining what is the potential for doing more work after the programmed work is accomplished, assuming the production capacity will be used to the maximum extent, which would require the availability of additional trained personnel. DOD normally measures capacity by an analysis that constrains facility and equipment availability by the availability of trained personnel and the organization of work stations, assuming an 8-hour workday, for 5 days a week. The BRAC Commission used maximum potential capacity to identify the potential for consolidating like workloads to improve capacity utilization of underutilized facilities and reduce redundancies that existed among depots. Private industry also uses the maximum potential capacity approach for measuring facility utilization. Capacity utilization of 75 to 85 percent, using at least a two shift operation is generally considered optimal for commercial contractors. However, we have not made a specific analysis of what is likely achievable in DOD.
Page 1028 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. HANSEN. Can you tell us what the Department's core methodology is and have any of the Services completed the detailed determination of core capability by weapon systems as required by the Committee and the other body during last year's hearings?
Mr. WARREN. The services have not completed their reassignments of core requirements using new DOD criteria for determining core. The services are taking a different approach to their core assessment processes and it is not clear when these assessments will be completed. Service officials have stated that these processes take time and use resources which must be diverted from other tasks.
Mr. HANSEN. Your testimony states that through closure of 3 out of 6 aviation depots, and consolidation of that workload, the Navy reduced its excess capacity significantly and reduced operating rates by over $10/hour for annual savings of more than $130 million. How does this plan compared to the Air Force plan for depot closures? What was the effect of consolidation on excess capacity in the Navy depots? What do you believe the effect of consolidation of Air Force workloads would be on depot rates and how much would the annual savings be?
Mr. WARREN. The Navy quickly closed the shipyards and aviation depots identified for closure during the 1993 BRAC process and consolidated much of the workload from these facilities with similar workloads in remaining shipyards and aviation depots. By accomplishing the closures quickly, the Navy started achieving the closure savings sooner. Further, by consolidating most of the closing depots' workloads in remaining underutilized Navy depots, the Navy also achieved significant consolidation savings that resulted from improved utilization of remaining facilities. The DOD is delaying the completion of the closure of McClellan Air Force Base and the realignment of Kelly Air Force Base until 2001. These delays will reduce the closure savings over what was projected by the BRAC Commission, since the BRAC savings were computed based on a more aggressive closure schedule. Further, to the extent McClellan and Kelly workloads are privatized in place, the Air Force will forego achieving the workload consolidation savings that could be achieved if the workloads were consolidated in remaining underutilized Air Force depots. We estimate that consolidation savings of over $182 million can be achieved by transferring the Kelly and McClellan depot maintenance workloads to remaining Air Force depots. This is in addition to the $24 million which is expected to be saved when the McClellan ground communications workload is transferred to the Tobyhanna Army depot as mandated by the BRAC Commission. It is also in addition to non-depot maintenance savings projected to be saved by the McClellan Air Force Base closure and the Kelly Air Force Base realignment.
Page 1029 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. HANSEN. Your testimony states that the executive branch cites readiness concerns and the up front costs as reasons for their privatization in-place decision. Is there any evidence, readiness analysis or risk assessment to support this claim? What are your estimates of the up front costs? What would the pay back period be? And are these costs included in the BRAC decision to close these facilities?
Mr. WARREN. We have observed that relocating depot maintenance workloads is complex and requires extensive planning and coordination as well as effective implementation. Nonetheless, relocating workloads among military depots has been done many times in the past, including movements of all workloads from an entire depot as a part of a base closure situation, without adversely impacting unit readiness. Relocations within a single service's depot system generally run more smoothly, while we have observed that relocations are more difficult if they involve transfers from one service depot to another or from a military depot to the private sector.
Regarding the cost and payback of relocating San Antonio and McClellan workloads, Air Force financial management officials estimate that all workloads from these locations could be relocated at a cost of about $475 million to absorb all of the estimated 10.5 million direct labor hours of work at these locations. Comparing this cost estimate to our $206 million projected annual savings indicates that net savings would occur within 2 1/2 years of the consolidation. Transition costs for moving only 78 percent of the workload (the amount we used in our consolidation savings analysis) would be less; therefore projected net savings would occur in even less time. Moreover, $318 million of the projected $475 million are associated with the release or movement of depot maintenance personnel, and these costs are about the same for either option. DOD will incur these costs regardless of whether the workload is moved to other military depots or privatized-in-place. Using this analysis, the Air Force could recoup the remaining $157 million cost in less than one year if the workloads were consolidated at other Air Force depots.
Page 1030 PREV PAGE TOP OF DOC Segment 5 Of 5
Finally, the BRAC Commission did consider estimated relocation costs in determining that the San Antonio and Sacramento depots should be closed.
Mr. HANSEN. In your work is there any evidence that DOD is continuing to ignore the prohibition against managing by end strength, or FTE (full time equivalent) instead of funded workload? If so, what is the likely effect on cost and competition?
Mr. WARREN. To some extent, DOD is not complying with the prohibition against managing by end strength. Cuts are being made even though there is funded workload available that would require the use of personnel being reduced. However, according to DOD personnel, Congress also has mandated large DOD personnel reductions, and it would be difficult, if not impossible to comply with both edicts. Officials concede that they could make all personnel cuts in non-industrial activities that are not covered by the funded workload provision, but they have determined the required cuts in the non-industrial fund areas would be too severe.
Mr. HANSEN. Is depot maintenance a core competency of the Air Force and are organic depots critical to maintaining readiness?
General VICCELLIO. Yes. As a part of ''Agile Combat Support,'' one of six U.S. Air Force core competencies, both organic and contracted depot maintenance is critical to maintaining readiness. Accordingly, the Department of Defense subscribes to the concept of sustaining an appropriate level of organic capability so as to ensure mission accomplishment and the maintenance of technical competence.
Page 1031 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. HANSEN. Is the Newark AGMC contract costing us more money and has the Air Force in any way included these higher costs in the rate structure of the remaining depots through the Air Force business operating fund?
General VICCELLIO. Yes, our analysis shows that, at least initially, one of the contracts at Newark is showing recurring costs in excess of those projected from previous organic performance of the same workload. However, contractor performance is improving and costs are decreasing rapidly. It is simply too early to tell when the contractor's costs will stabilize and whether or not the privatization of AGMC will save us money. In non-recurring expenses, however, the contract has avoided substantial costs. Transition costs, originally estimated to be in excess of $60M, may total only two-thirds of that amount, and relocation costs estimated in excess of $300M have been totally avoided.
Since customer prices related to contract repair are determined separately from those associated with organic repair, rate structures at other depots will be affected by Newark cost.
Mr. HANSEN. Has any administration official at any time directed you or anyone under your command to pursue a privatization-in-place strategy at Kelly and McClellan Air Logistics Centers? Has any administration official established employment goals for these locations? What are they? Do you have them for any other locations?
General VICCELLIO. The Air Force was given the latitude by the BRAC recommendations to explore suitable opportunities for privatizing workload at Kelly and McClellan. While in-place performance could well be the basis of a given commercial offer, that decision would be up to the offeror. As for employment goals, at the time that the President approved the 1995 Base Closure recommendations, the President requested the Secretary of Defense to evaluate a plan for the closure of Kelly and McClellan so that jobs at Kelly and McClellan could be retained through the closure period. These goals were general in nature, expressed as fractions of the total base population at the time of the BRAC decision, and regarded as just what they are . . . goals. The Air Force and DoD has evaluated various options in attempting to balance closure considerations such as tenant relocation, workload transfer and transition, and public-private competitions, to implement BRAC recommendations and minimize impacts to force readiness, workforce management, and the base closure communities.
Page 1032 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. HANSEN. Has any administration official in any case overruled a recommendation from you or any other Air Force commander with respect to the privatization of Kelly and McClellan workloads?
General VICCELLIO. No. As we have progressed from early considerations of basic closure options through the acquisition strategy for selected workloads, both air Force and DoD leadership have supported plans as recommended.
Mr. HANSEN. Will the competition as currently structured give preference, or require, in any way all of the work to be done in a single location? Are commercial bidders free to consolidate work to their own significant excess capacity if that would move workload from McClellan or Kelly?
General VICCELLIO. As currently structured, competitions for the workloads at McClellan and Kelly do not require the work to be done at a single location. Commercial bidders are free to offer performance of the work at any location.
Mr. HANSEN. Are you aware of any analysis done within the Air Force that suggest that privatization-in-place at Newark, Kelly or McClellan is not the most effective solution for the Air Force? Are you aware of any Air Force analysis that recommend against privatization of any specific workloads? Are you aware of any Air Force analysis that recommended specific workloads as core which are being considered for privatization?
General VICCELLIO. Although privatization-in-place of selected workloads may offer such advantages as reduced readiness risks, no relocation costs, and continued utilization of ''sunk cost'' resources such as facilities, equipment and a trained workforce, there are start-up costs to pay which can only be analyzed once formal proposals are offered. Similarly, transferring workload to underutilized, non-closing installations may offer some advantages through reduced overhead rates per production unit and other economies of scale, but also involve considerable transition costs in areas such as equipment teardown, transportation, buildup at the receiving end, facility construction or reconfiguration and workforce training. Only Air Force workloads determined as not necessary to be performed in house to sustain a core capability are being considered for competition.
Page 1033 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. HANSEN. Please provide a detailed breakdown by workload of what the Air Force considers to be core maintenance at each of the five Air Logistics Centers.
General VICCELLIO. Core is the organic capability (in terms of personnel/skills, equipment, and facilities) required to support readiness and sustainability for essential weapon systems required in JCS contingency scenarios. Core is not workload based, rather, it is the capability required to sustain the weapon systems used in these JCS contingency scenarios. Core is determined from a DoD perspective not a Service perspective. Mission essential weapon system workloads sustain these core capabilities.
A workload breakout will only be available following the completion of a core determination process on all USAF depot workloads. Since workload disposition at Sacramento and San Antonio ALCs is being driven by the BRAC '95 timeline, those workloads are being evaluated first. Subsequently, determinations will be made as necessary to accommodate changing conditions (operational changes, force structure modifications, emerging or retiring systems, proposals from the commercial sector, etc.). Until such time as all workload has been evaluated, workloads previously rated as core will remain so for reporting purposes. With this in mind, USAF core capability projections are as follows:
Mr. HANSEN. Is there any analysis completed by the Air Force regarding the relocation of the F–117 SPO? What was the recommendation of the current Air Force program office? Were any of these decisions overruled by any Air Force acquisition official? If so on what basis? Is the F–117 SPO planned to be sole sourced to Lockheed Martin?
Page 1034 PREV PAGE TOP OF DOC Segment 5 Of 5
General VICCELLIO. Following the BRAC '95 decision to close McClellan Air Force Base and the Sacramento Air Logistics Center, AFMC conducted a review of affected workloads and produced a preliminary disposition plan called Integrated Weapon System Management (WSM) II. This effort did not consider contractor options (by design). In early 1996, a separate team review a ''white paper'' submitted by Lockheed-Martin that suggested an expanded contractor role in the areas of system and materiel management. That team recommended that the warehousing function be contracted, the systems management function be relocated to Wright-Patterson AFB, Ohio, and that further study be pursued in the area of materiel management. Subsequently, the program office has worked with the contractor to further develop what could (but as yet has not) become a formal proposal. In March 1997 the Air Force Audit Agency, as part of a broad review of logistics support contracts, reviewed the F–117 management options being explored and concluded that if competitive procedures were pursued for program office support functions, up to 25% cost savings could occur. Throughout this period, the F117 program office was involved in both reviews and deliberations with Lockheed-Martin, the system contractor. We believe greater savings can be achieved by considerably reducing the size of the program office and by increasing the contractor's responsibility for F–117 logistics support.
The issue of a sole contractual arrangement will not be decided until later this year when the contractor's concept and proposal is formally offered and analyzed in more detail.
QUESTIONS SUBMITTED BY MR. RILEY
Page 1035 PREV PAGE TOP OF DOC Segment 5 Of 5
Three Viable Core Depots
Mr. RILEY. General, in our meeting last week you indicated to me that you believe that the Army needs to maintain three viable core depots. Your testimony is somewhat vague on this subject. Could you please tell the committee what in fact your position is on this issue.
General WILSON. The 1995 Base Closure and Realignment Commission, in its report to the President, expressed the judgment that our Army Stationing Strategy, which had envisioned an aggressive minimization of our depot maintenance infrastructure, assumed too great a risk in readiness. We had proposed three commodity-oriented depots; the Commission recommended that we retain limited capability in two additional depots, for a total of five.
We intend to implement the commission recommendations fully, both in their letter and their intent. That is, we will make a real effort to workload Red River Army Depot and Letterkenny Army Depot sufficiently to make them viable industrial assets, despite their limited missions and despite the overall decline in Army depot maintenance work.
BRAC 95 Work From Letterkenny to Anniston
Mr. Riley. General Wilson, in your testimony, you indicate that the Army is going to follow through with the BRAC requirements to move certain work from Letterkenny and Red River to Anniston. I would like you to provide me with a specific time line of when Anniston can expect this work. Could you also provide me with a detailed response concerning the Army's plans for the Paladin. The BRAC was very clear on this issue, yet the Army seems to be sending mixed signals on this program. I want to know if in fact the army is going to comply with the BRAC requirements on the Paladin.
Page 1036 PREV PAGE TOP OF DOC Segment 5 Of 5
General WILSON. The 1995 Base Closure and Realignment Commission recommended transferring the Letterkenny Army Depot towed and self-propelled combat vehicle mission to Anniston Army Depot. We are carrying out those recommendations. All towed artillery will be transferred to Anniston by the end of 1997. All self-propelled artillery, including Paladin sustainment overhaul and repair, will be transferred to ANAD by early 2000. Paladin production, which is now being done through a teaming arrangement between Letterkenny Army Depot and United Defense Limited Partnership, will continue in place with the present teaming arrangement for its currently planned production run through FY99. We are evaluating how to conduct any future Paladin production after that.
Core Depots Efficient and Modern
Mr. RILEY. General Wilson, what are you doing to ensure that we keep our core depots efficient and modern?
General WILSON. I've described the efforts we are making to increase efficiency; that is, the reshaping of the workforce, resizing the depot facilities, and mothballing, excessing or reusing facilities that are beyond the needs of depot maintenance. To remain modern, we are keeping our depots proficient in maintaining the most modern weapon systems, the ones which will go to war first. That means Anniston's principal jobs for the future will be repairing Abrams tanks, the newest upgrades to the M113 family, and the modern artillery pieces that will be on the front lines.
BRAC 95, ATCOM
Page 1037 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. RILEY. General Wilson, the 1995 BRAC approved an Army consolidation plan to move the U.S. Army Aviation and Troop Command, otherwise known as ATCOM, from St. Louis to Redstone Arsenal in Huntsville. Does the Army intend to comply with the BRAC on this matter? As you know compliance with the BRAC requirement is very important to me and my colleagues from Alabama. Could you please provide me and the Committee with a specific time line of the Army's plan to move the Aviation component to Huntsville.
General WILSON. The Army is currently in the process of complying with the BRAC decision on ATCOM. New facilities at Redstone Arsenal are largely complete. Permanent Change of Station (PCS) orders are being distributed to the workforce at St. Louis. The vast majority of personnel will arrive in the summer 1997, in order to accommodate families and children. All actions associated with the realignment will be completed not later than December 31, 1997, in accordance with the directive from Mr. West, the Secretary of the Army.
NAVAL PETROLEUM RESERVES
House of Representatives,
Committee on National Security,
Military Readiness Subcommittee,
Washington, DC, Wednesday, May 7, 1997.
Page 1038 PREV PAGE TOP OF DOC Segment 5 Of 5
The subcommittee met, pursuant to call, at 10:05 a.m. in room 2212, Rayburn House Office Building, Hon. Herbert Bateman (chairman of the subcommittee) presiding.
OPENING STATEMENT OF HON. HERBERT H. BATEMAN, A REPRESENTATIVE FROM VIRGINIA, CHAIRMAN, MILITARY READINESS SUBCOMMITTEE
Mr. BATEMAN. The subcommittee will come to order. The Subcommittee on Military Readiness meets today to receive information concerning the Naval Petroleum Reserves. Our interest today centers on a progress report from the Department of Energy on the sale of Naval Petroleum Reserve No. 1, commonly known as Elk Hills, CA, and to receive information on a report provided by the Department of Energy on their recommendations for the disposition of the other oil and oil shale—shale reserves that make up the Naval Petroleum Reserves.
In the National Defense Authorization Act for fiscal year 1996, Congress mandated that the Department of Energy divest its interest in NPR No. 1 by a process that would offer the reserve for sale to the public within 2 years of enactment. That 2-year process will end on February 10, 1998. As we are just over the halfway point in this process, I believe it prudent to review the actions taken to date by the Department of Energy.
The legislation requiring this sale includes specific dates by which several necessary actions were to be accomplished. As this sale is extremely complicated, I understand that many of the action completion dates have needed to be adjusted. The Department of Energy has kept Congress notified of these changes as they have occurred. And for that, I compliment the Department.
Page 1039 PREV PAGE TOP OF DOC Segment 5 Of 5
The questions I would like to address today are: Is the sales process on track? How confident is the Department that it will be able to complete the sale by the mandated deadline? Because much of the specific information concerning the sale of Elk Hills is considered sensitive to the sales process, I have asked our witnesses to not answer or—to not address or answer any questions that they believe would be prejudicial to that process. I have asked that these responses and statements be provided to the committee under separate cover.
At the same time the Congress mandated the sale of Elk Hills, we also asked the Department of Energy to conduct a study and provide recommendations for the disposition of the other oil and oil shale reserves that comprise the entire Naval Petroleum Reserves. These other reserves include two other oil reserves, one in California, one in Utah; and three oil shale reserves, one in Wyoming and two in Colorado. The Department of Energy recently completed this study and provided its recommendations to Congress. Our purpose today is to have our witnesses review these recommendations for the subcommittee.
A bill was recently introduced in the house, H.R. 1163 by the gentleman from Colorado, Mr. Hefley, that recommends specific actions concerning the two oil shale reserves located in Colorado. H.R. 1163 has been referred to the subcommittee—this subcommittee, and we have asked a sponsor to appear today concerning his proposal.
[The bill, H.R. 1163, can be found in the appendix on page 1410.]
Our witnesses today are Hon. Joel Hefley from the State of Colorado and a senior member of the National Security Committee; Mr. Martin Fitzgerald, Associate General Counsel of the General Accounting Office; and, last, Hon. Patricia Fry Godley, Assistant Secretary of Energy for Fossil Energy. We welcome all of our witnesses.
Page 1040 PREV PAGE TOP OF DOC Segment 5 Of 5
And before I begin, I will yield to the gentleman from Virginia, Mr. Sisisky, the Ranking Democrat on the subcommittee for any comments he may have.
STATEMENT OF HON. NORMAN SISISKY, A REPRESENTATIVE FROM VIRGINIA, RANKING MEMBER, MILITARY READINESS SUBCOMMITTEE
Mr. SISISKY. Thank you, Mr. Chairman. I would like to take this time to welcome and add my thanks to our witnesses for their attendance at this hearing today.
In the 1996 National Defense Authorization Act, we address the sale of the largest active producing part of the reserve, Elk Hills, and ask for recommendations for divesting the remaining parcels. I remember the discussions at that time focused on removing the Government from the business of producing and selling oil and natural gas and maximizing the return on the taxpayers' investment. We also knew that the proposed legislation would resolve a long-standing dispute with the State of California. I look forward to hearing your report on the progress being made to implement the legislation regarding the sale.
I am also interested in hearing more about your discussions of the options and recommendations for disposition of the remaining parcels that make up the rest of the reserves. While there are issues associated with the disposition of the remaining oil and shale reserves, I think we can all agree that the final decisions regarding these parcels must pass the good government test. And I trust that, as a result of this hearing, we will be able to develop legislation that will enable the Government to achieve the best bargain for the taxpayers.
Page 1041 PREV PAGE TOP OF DOC Segment 5 Of 5
I thank you for coming today. Your testimony will help us understand more about the issues associated with those dispositions. And I look forward to hearing your testimony and your responses to the questions.
Mr. BATEMAN. Thank you, Mr. Sisisky.
And before I recognize Mr. Hefley as our first witness, let me welcome to our subcommittee Mr. Rodriguez, who will shortly be officially a part of our happy little family. Welcome. And we look forward to working with you and your participation in the activities in the subcommittee.
With that, Mr. Hefley, the floor is yours.
STATEMENT OF HON. JOEL HEFLEY, A REPRESENTATIVE FROM COLORADO
Mr. HEFLEY. Mr. Chairman, thank you. And this is a little change in role for me. I am usually sitting where you are in this room, and I have Mr. Sisisky sitting there to my left, instead of having to face him head on here. You will understand a little fear and trepidation, Mr. Chairman.
Mr. SISISKY. I am really a nice guy.
Mr. HEFLEY. That is what you keep telling all of us, Mr. Sisisky.
Page 1042 PREV PAGE TOP OF DOC Segment 5 Of 5
But I appreciate the opportunity to be before you, and I will try to be relatively brief because I know you have a busy schedule.
Mr. Chairman, I would like to thank you for the opportunity to testify on behalf of H.R. 1163. The bill will transfer administrative jurisdiction over the Naval Oil Reserves 1 and 3 from the Department of Energy to the Bureau of Land Management. It would allow leasing of oil and natural gas rights on the two reserves and outright sale of some existing equipment. And I think this is an issue we will talk a little more about later, the lease as opposed to the sale. It embodies four points of agreement between the two agencies. The two fail to agree on who would pay for the cleanup of 50 acres on the reserve. As we discussed—as you and I have discussed previously, this was apparently the result of some oil shale experimentation the Department conducted, and we have assigned this cleanup to DOE since the pollution happened on its watch.
The oil shale in Colorado—I have lived in Colorado for something over 30 years. And I can remember, before I moved to Colorado, when I was out there on vacation on the western slope near Grand Junction, they would point to these mesas and bluffs, and they would say, boy, that is oil shale country. There is going to be a gigantic boom there.
I can remember when I was in the State legislature, we planned our highway construction, our infrastructure around this great oil shale boom. We had, I think, Chevron and Conoco and Occidental, all kinds of people in there doing things with the oil shale out there.
Well, clearly, there has never been a boom. And I think probably the greatest potential we have now is for the production of natural gas. And that is mainly what we are talking about here. I would love it if someone could figure a way to get the enormous quantities of oil—in fact, at one point they called this the American Saudi Arabia.
Page 1043 PREV PAGE TOP OF DOC Segment 5 Of 5
But if we could figure an economic way that made sense to get the oil out—and they have tried numerous things, including atomic detonation—and we haven't figured out a way to do it at this point.
We are recommending in this bill leasing, not sale, of these reserves. The advantage over sale is that it would allow a continuing revenue stream to the United States. Sale of reserves would result in a one-time revenue shot of between—and there are different estimates, we are not sure exactly—but between $7 and $20 million.
On the other hand, transfer and leasing would, at worst, result in no loss to the Treasury and has the potential to rake in as much as $126 million in Federal revenues over the next 10 years.
I understand the chairman has some questions about the range of revenues that has been given for leasing, and I admit that that range is large. Therefore, I would like to submit for the record data presented by the State of Colorado during last year's budget negotiations. This data was compiled by the State Department of Natural Resources and by the Colorado Oil and Gas Conservation Commission, the State agency that is charged with overseeing the oil and gas industry in Colorado.
I would also like to enter into the record letters of support from Governor Roy Romer, to the then Department of Energy, Secretary Hazel O'Leary; from the Executive Director, James Lochhead, to the then Senator Hank Brown; and Commission Director Rich Griebling, to the CBO budget analyst, Kathy Gramp.
Page 1044 PREV PAGE TOP OF DOC Segment 5 Of 5
[The information referred to can be found in the appendix on page 1401.]
Mr. HEFLEY. You know, these are about as authoritative estimates as I think we can find. One way you find out how much the reserves are in a case like this, and what they are worth, is, you lease land and you let people explore and drill. I grew up in Oklahoma and grew up working in the oil fields, and that is—you know, that is what you found. And that is why a lease, I think, would be preferable to a sale. Here, I would have some nervousness about a sale.
The State data appears to show that the Federal share of royalty revenues through the first 5 years of a leasing program could total up to $53.1 million. Later, revenues could run that total to $126.6 million. These State agencies have indicated their willingness to share their methodology with the subcommittee if you would like.
Leasing under this bill would be conducted under the Mineral Leasing Act of 1920. Precedent has been set for a 50–50 royalties split under that act. And I think the major precedent for that was the Alaska settlement agreement where they settled on a 50–50 split on that. This royalty share is not as much of a windfall to Colorado as it may seem, because the dollar amounts are greater because of the greater percentage of public land in the West. By law, 40 percent of the State's share must be paid into a reclamation fund. Administration takes up another 10 percent, so the real split is something like 75–25.
Further, this does not make up for the real estate taxes forgone on public land or for the infrastructure cost the State must bear to support leasing operations, supposed to be reimbursed by Federal payments in lieu of taxes, but these have rarely, if ever, been sufficient. And all of us who have public lands in our areas, I think, are aware of that.
Page 1045 PREV PAGE TOP OF DOC Segment 5 Of 5
I would also like to have entered into the record a chart compiled by the Colorado Oil & Gas Conservation Commission that details the distribution of funds from Federal mineral leases in Colorado.
[The information referred to can be found in the appendix on page 1408.]
Mr. HEFLEY. Resources apparently has no problem with inclusion in Defense authorization, although reserves the right to hold hearings on this. And I frankly don't think we will hold hearings over in Resources, but we could.
In conclusion, this is an issue that has been around for at least 8 years. Ben Campbell first introduced it over here, and I had a bill the past two Congresses. This appears to be an opportunity to benefit the State, private industry and the Federal Treasury, and that is a rare opportunity when it is a win-win for all of these, and therefore, I ask inclusion of this in this year's Defense authorization bill.
[The prepared statement of Mr. Hefley can be found in the appendix on page 1374.]
Mr. BATEMAN. Thank you very much. We appreciate your coming and testifying today on something that is very important and has its very unique complexities to it. For my part, I am not well-versed in oil and gas law and leasing and those kind of transactions. They are somewhat esoteric to this Easterner's experience. I am charged, however, with learning as much as I can about it in order that we may try and make the wisest decision in the public interest of all the people of the United States; and, of course, in a way that is equitable to the State and to the people of Colorado.
Page 1046 PREV PAGE TOP OF DOC Segment 5 Of 5
Your bill addresses the two oil shale reserves in Colorado. We also have, of course, the oil shale reserves in Wyoming, UT, and oil reserves that remain in California in addition to Elk Hills; and our charge is to really inquire into a better means of disposition of all of those resources.
I appreciate the documentation that you are providing for the record. I think it is going to be very helpful to the committee, and I look forward to going through it.
You are making a strong case for the desirability of the option of leasing as opposed to outright sale of these Naval Petroleum Reserves and Oil Shale Reserves. I haven't reached any—any judgment on that question as to lease versus sale that is entirely satisfactory to me, but I think there is great merit to your suggestion that the best interest of the taxpayers, the people of the United States, may well be in leasing rather than outright sale. But that is the very heart of the question that is before the subcommittee.
The issue remains, we assume, that leasing—leasing is the preferred public policy option. The issue then presented is the methodology or the way the leasing argument is structured and the equities as between the people in the State of Colorado and the people of the greater United States.
I would welcome you to extend your remarks or to provide us additional information on the equity of Colorado sharing in the leasehold revenues that might be generated if we go that route. Certainly, if you followed the norm of the Department of Interior in leasing arrangements—I am aware of the 50–50 split in revenues that has occurred traditionally and as a standard under normal Department of Interior ownership of Federal lands. On the other hand, the oil shale, the Naval Petroleum Reserves, when established, were specifically established and exempted from the norm of those leasing arrangements.
Page 1047 PREV PAGE TOP OF DOC Segment 5 Of 5
We have to make a judgment as to whether that norm of the Naval Petroleum Reserves should remain or whether or not the norms as to the general provisions dealing with leasing by the Department of Interior should prevail.
We need all of the arguments marshaled for us to look at in terms of what is the soundest public policy decision that we can recommend, and move legislation accordingly. With that, I turn to Mr. Sisisky.
Mr. SISISKY. Thank you, Mr. Chairman. You pretty well set it up.
You know, the main question is, why does Colorado deserve 50 percent? That is a good government question. And I won't ask you that now, because I see you every day. And the other witnesses—and we have many; and I would just pass and welcome you here. And, you know, you can always put it on the base closing list if you need it. I had to say that.
Mr. HEFLEY. That is the reason I was a couple of minutes late. I was held up by the reporter in the hall. Everyone wants to talk about base closure right now.
Mr. SISISKY. I know they do.
Mr. HEFLEY. I think we do.
Mr. SISISKY. I am only kidding. Thank you.
Page 1048 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Mr. Pickett.
Mr. PICKETT. Thank you, Mr. Chairman. Our colleague has made such a detailed and convincing statement, I don't have a single question I have to ask.
Mr. BATEMAN. Gee whiz. Now Mr. Taylor.
Mr. Taylor.
Mr. TAYLOR. Not unless he wants to talk about subvention.
Mr. HEFLEY. I would yield my time so you could talk about that.
Mr. BATEMAN. Mr. Rodriguez, do you have anything?
Mr. TAYLOR. Well, for those folks that came out from Colorado, he does great work looking out for the military retirees and their access to health care. I hope we can make it the law of the land this year.
Mr. BATEMAN. Well, with that, Mr. Hefley, it looks like you got off very lightly. We would be happy to have you remain and join the next panel of witnesses if your schedule and desires are consistent with doing so.
Mr. HEFLEY. Thank you, Mr. Chairman. You are very gracious, and I appreciate being with you this morning.
Page 1049 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. SISISKY. I told you I was a nice guy.
Mr. BATEMAN. The next panel of witnesses consists of Mr. Martin J. Fitzgerald, Associate General Counsel, U.S. General Accounting Office. And we look forward to hearing from Mr. Fitzgerald. Joining him will be Jackie Goff. And then our third panel member or witness will be the Assistant Secretary for Fossil Energy, the Hon. Patricia Fry Godley.
Mr. Fitzgerald, we are pleased to hear from you now.
STATEMENT OF MARTIN J. FITZGERALD, ASSOCIATE GENERAL COUNSEL, ACCOMPANIED BY JACKIE GOFF, OFFICE OF GENERAL COUNSEL, U.S. GENERAL ACCOUNTING OFFICE
Mr. FITZGERALD. Thank you, Mr. Chairman. Good morning to you, Mr. Sisisky and the other members of the subcommittee. Thank for you introducing Jackie Goff. She is a senior in the Office of General Counsel at GAO, and she has been principally responsible for following this issue in our office.
I should mention I heard your opening statement, Mr. Chairman, about the discussion about Elk Hills. The purpose of our testimony is not to discuss the sale of Elk Hills, the process that the Department is following. We are speaking only regarding Oil Shale Reserves Nos. 1 and 3.
I should also say, by way of apology, that I couldn't resist yesterday the opportunity to go through my testimony, my prepared statement which had already been submitted to the committee and make some changes. If it is okay with the Chairman and the committee, I would like to submit an amended version for inclusion in the record.
Page 1050 PREV PAGE TOP OF DOC Segment 5 Of 5
I believe some of my scribbled notes are available to you and to Mr. Sisisky, and I would like to read that. It is a fairly short statement; I would like to read through it.
Mr. BATEMAN. We would be happy to have the statement in whatever form you wish to submit it at this point.
Mr. FITZGERALD. Thank you. Well, I will try the oral form first.
We do appreciate the opportunity to provide our views on the Department of Energy's recommendation to transfer Oil Shale Reserves Nos. 1 and 3 to the Department of the Interior for leasing and for surface management under the Mineral Leasing Act and the Federal Land Policy Management Act.
The Petroleum and Oil Shale Reserves were established by executive orders in the early 1900's when the government began setting aside large sections of public land that are favorable for hydrocarbon production. These lands, as you have noted, are located in California, Colorado, Wyoming and Utah.
Although these reserves were originally intended as a source of petroleum for the Nation's military, the Naval Petroleum Reserves are now produced primarily for commercial purposes. By contrast, the naval oil shale reserves have remained largely undeveloped.
Page 1051 PREV PAGE TOP OF DOC Segment 5 Of 5
Naval Oil Shale Reserve No. 1 is located in western Colorado and has shale resources of about 2.5 billion barrels of shale oil. However, extraction of this resource may be technologically feasible only with a high enough sales price to make recovery economically attractive.
In addition, in 1994, the U.S. Geological Survey estimated in excess of 500 billion cubic feet of natural gas reserves that are continuous throughout the region in which Shale Reserves 1 and 3 are located. No natural gas is produced at Shale Reserve No. 1.
Shale Reserve No. 3 stretches along the eastern and southern flanks of Shale Reserve 1. And unlike Shale Reserve 1, it is essentially devoid of oil reserves within its boundaries. However, DOE has conducted protective gas drilling and production since 1985 to prevent depletion of government resources due to gas production on adjacent lands. This production totaled approximately 10 million cubic feet of natural gas a day during 1996. This gas was sold competitively and generated approximately $3.1 million in revenues for the Federal Government in fiscal year 1996.
As you know, section 3416 of the 1996 National Defense Authorization Act requires the Secretary of Energy to retain an independent petroleum expert to conduct a study to determine which of four options or combination of options would maximize the value to the United States of the five naval petroleum and oil shale reserves. This mandate excluded the Naval Petroleum Reserve at Elk Hills, which is to be sold specifically pursuant to another provision of that same statute.
The four options specified in the act for DOE's consideration and recommendation to the Congress are, first, retention and operation of the naval petroleum reserves by the Secretary of Energy under chapter 641, title 10, of the United States Code, which is commonly referred to as the naval petroleum reserve law and which is the current statutory authority for managing and operating the reserves.
Page 1052 PREV PAGE TOP OF DOC Segment 5 Of 5
Two, a transfer of all or part of the reserves to the jurisdiction of another Federal agency for continued administration under chapter 641 of title 10.
Third would be a transfer of all or part of the reserves to the Department of Interior for leasing in accordance with the Mineral Leasing Act and for surface management in accordance with the Federal Land Policy and Management Act.
And fourth would be a sale of the interests of the United States in these reserves.
Based on its analysis of the consultant's report, the DOE is recommending to the Congress that NOSR's 1 and 3 be transferred to the Department of the Interior and leased under the Mineral Leasing Act. Whether to enact legislation in accordance with DOE's recommendation is a matter of policy for the Congress to determine, and we at GAO have no position to offer with respect to that determination. Our comments today are merely for the purpose of making sure the subcommittee is well aware of another available option as it considers the DOE recommendation.
In its report to the Congress, DOE assumes that transfers of NOSR's 1 and 3 to Interior for leasing under the Mineral Leasing Act would result in 50 percent of the lease revenues accruing to the State of Colorado. It is our understanding that DOE has not yet provided to the Congress proposed legislation mandated by section 3416, which would implement these recommendations. I understand from the Assistant Secretary that that legislation is currently being considered by the lawyers at both Interior and the Department of Energy.
Page 1053 PREV PAGE TOP OF DOC Segment 5 Of 5
Accordingly, we assume that DOE proposes to structure the transfer in such a way that NOSR's 1 and 3 would lose their identity as naval oil shale reserves. This, in turn, would result in the reserves losing their unique status under current law whereby all of those receipts from those reserves are and would continue to be retained by the Federal Government.
Instead, as envisioned by DOE, if NOSR's 1 and 3 are transferred to the Secretary of Interior to be administered in the same manner as the Secretary of Interior is obligated to administer other leases under the Mineral Leasing Act, 50 percent of the lease revenues will be paid over to the State of Colorado.
While DOE's recommendation to transfer these two reserves to Interior is one option, there is another option which, with some technical conforming statutory revisions, would allow the Secretary of Energy to retain those reserves and operate them by leasing them in a manner consistent with normal commercial practices. Revenues from such leases would be paid into the miscellaneous receipts account in the Treasury, and all of the proceeds, not just 50 percent, would accrue to the U.S. Government.
The Secretary of Energy currently has the authority to lease these two shale reserves, although there are some limitations on the use of that authority.
In the Mineral Leasing Act of 1920 and the Naval Appropriations Act for fiscal year 1921, the authority to do that was originally reserved to the Secretary of the Navy. The Navy's authority was later transferred to the Secretary of Energy in 1977 under the statute which created the Department of Energy.
Page 1054 PREV PAGE TOP OF DOC Segment 5 Of 5
An exemption to authorize the United States to retain all of the proceeds generated from the naval petroleum reserves and the shale reserves is delineated, as I said, in the Mineral Leasing Act.
Moreover, when the act was amended in 1981 to allow States to receive 50 percent of revenues from minerals on lands acquired for military purposes, the specific exception for these reserves was repeated. As the House Armed Services Committee report on that legislation indicated, the Interior Department supported that exception—the continuation of that exception. We have been advised by a DOE official that disposition of revenues from various reserves over the years has been consistent with this position.
As I previously mentioned, protective drilling is performed at NOSR–3 by DOE resulting in revenues of $3.1 million in fiscal 1996. According to DOE, all of those revenues were deposited into the Treasury and retained by the United States. In addition, Naval Petroleum Reserve 2 in Buena Vista, CA, was originally leased by the Secretary of Interior in 1923 and managed by Interior until the 1970's when the Secretary of Energy assumed responsibility for Buena Vista. DOE officials has told us that the U.S. Government has retained all the proceeds from those leases since 1923.
Mr. Chairman, we, I think, outlined the options available—one of the options available to this committee. There are a lot of options available to this committee.
That does conclude my prepared remarks, and we would be happy to address the questions of you and Mr. Sisisky and the other members of the committee.
Page 1055 PREV PAGE TOP OF DOC Segment 5 Of 5
[The prepared statement of Mr. Fitzgerald can be found in the appendix on page 1380.]
Mr. BATEMAN. Thank you very much, Mr. Fitzgerald. That is very helpful.
Somewhere in my reading of this increasingly large file I read about a reference to the transfer of a naval petroleum reserve in Alaska sometime in the 1970's or 1980's. Are you familiar with that development?
Mr. FITZGERALD. Mr. Chairman, I believe the transfer of Naval Petroleum Reserve No. 4 in Alaska occurred in 1976.
Mr. BATEMAN. Do you recall the basis on which that transfer took place?
Mr. FITZGERALD. I don't have a distinct recollection. It was—it was by separate statutory provision, and it did provide that the sharing of revenues from oil leases on Petroleum Reserve No. 4 would be shared with the State of Alaska, 90 percent going to the State of Alaska and 10 percent to the Federal Government.
Mr. BATEMAN. Was there some other trade-off involved in that that you are aware of?
Page 1056 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. FITZGERALD. I frankly haven't researched the legislative history of that provision carefully enough to give you an answer, so I won't hazard a guess.
Mr. BATEMAN. Thank you.
The Oil Shale Reserve No. 3, the one in Colorado, that is the one where there has been protective drilling for natural gas?
Mr. FITZGERALD. Yes, sir.
Mr. BATEMAN. And it generated, in 1996, $3.1 million in revenue to the Treasury?
Mr. FITZGERALD. Yes. That is according to the consultant's report, the consultant—the report of the consultant hired by DOE pursuant to the statute.
Mr. BATEMAN. Now, the consultant's recommendation was to sell, outright sale of that tract of land; is that correct?
Mr. FITZGERALD. That is correct.
Mr. BATEMAN. And its estimated valuation or market value was assigned what number?
Mr. FITZGERALD. I don't recall specifically, but it was considerably higher than the leasing value.
Page 1057 PREV PAGE TOP OF DOC Segment 5 Of 5
Do you have it?
Maybe Jackie has a better answer.
I am advised it was $5.5 million for sale and about half that for leasing.
Mr. BATEMAN. Why would it be half that for leasing if it generated, just through protective drilling in 1996, as much as $3.1 million? The numbers don't seem to jive.
Mr. FITZGERALD. Well, the DOE report is very explicit about how the consultant assumed that 50 percent of these revenues would be paid over to the State of Colorado. And, therefore, the consultant did not consider those revenues in the valuation process. DOE did not concur with that aspect of the consultant's report and did take into account in its recommendation the proceeds that would go to State of Colorado.
Mr. BATEMAN. The consultant in terms of his projection of leasing revenue as an option did or did not take into account a 50–50 split between the Federal Government and Colorado?
Mr. FITZGERALD. He took into account the 50–50 split and therefore excluded from his calculations approximately $2.8 million——
Mr. BATEMAN. OK.
Page 1058 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. FITZGERALD [continuing]. Of leasing revenues that would be paid over to the State of Colorado.
Mr. BATEMAN. So if you assume the Federal Government kept 100 percent of the leasing revenues, the leasing revenues would be something like 5-plus, a little over $5 million——
Mr. FITZGERALD. The sale option—I am sorry.
Mr. BATEMAN [continuing]. And that would be his projected revenue from leasing if we kept all of the lease revenue?
Mr. FITZGERALD. The DOE report, I think, indicates that under that scenario, the sale option and the lease option would be about the same value to the government.
Mr. BATEMAN. Does that seem consistent with the norm in commercial oil and gas transactions?
Mr. FITZGERALD. Well, like I said, Mr. Chairman, I am not an oil and gas lawyer, but I think your question raises an issue about the interpretation of the phrase ''the United States'' in section 3416—the mandate under which DOE conducted this study and issued this report.
Page 1059 PREV PAGE TOP OF DOC Segment 5 Of 5
There is no definition of the term ''the United States'' in the 1996 legislation, nor is there a definition in the Naval Petroleum Reserve law, which is chapter 641 of title 10, nor is there one in the Mineral Leasing Act. But we have taken a look at what the definition of ''the United States'' is and other statutory provisions, and we have found that it does appear quite frequently—for example, in other parts of title 10, referring to the military; in other parts of title 30, relating to mining and mining law, mineral lands; as well as title 5, relating to Federal personnel; title 7, relating to agriculture; and title 29, just to name a few.
Most of these definitions of the term ''the United States'' say that it means the several States, the District of Columbia, and the various territories and possessions of the United States. And some of these definitions even clarify that the term includes Federal agent—individual Federal agencies and federally owned corporations. But the point is that all these definitions are written in such a manner as to describe the Federal Government as an entity distinct from the individual States; and these definitions are generally consistent with the Constitution itself, which distinguishes between the Union of the United States and the several States.
In fact, I think it is the 10th amendment to the Constitution reiterating this distinct—the distinction reads, and I have a quote here:
The powers not granted to the United States by the Constitution or prohibited by it to the States are reserved to the States respectively or to the people.
So, as a result, I think we have a little difficulty ascribing a meaning to the term ''the United States'' for which value is to be maximized to reserve to a sovereign entity other than the sovereign entity of the Federal Government.
Page 1060 PREV PAGE TOP OF DOC Segment 5 Of 5
But that is the interpretation, as I read the DOE testimony, that they have come to—they have come to a different interpretation. They would include revenues going to the State of Colorado or another State as if it were revenues to the United States.
Mr. BATEMAN. Mr. Hefley made reference to estimates of the Oil & Gas Commission, or some Colorado State agency, that the potential natural gas resources would amount to as much as $120 million-plus. Does your investigation include any appraisal as to the quantity of the gas reserves that might be there and their economic value if exploited?
Mr. FITZGERALD. No, sir. GAO did not undertake to do an independent evaluation or appraisal. We have familiarized ourselves with the DOE report, the consultant's report, which does go into evaluation and estimates quantities, but we have not done an independent appraisal of that.
Mr. BATEMAN. Would it strike you as being important that the committee be able to deal with some measure of confidence as to the accuracy of those, the estimated reserves?
Mr. FITZGERALD. Well, I think as I read the consultant's report and the DOE report and recommendations there is, as Congressman Hefley said, quite a wide range of estimates. I believe that some of those estimates are very narrow and some are very liberal, if you will.
I have read Congressman Hefley's testimony. I see that at the upper end of the range there are some figures that are rather large. But I don't think that—I don't think that I can answer your question. I do think it is important for the subcommittee to obtain some answers to those questions, though.
Page 1061 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Thank you for that. As a reformed lawyer, I enjoyed your discourse on the meaning and definition of the phrase ''the United States.'' I want you to go beyond that, oh, perhaps narrow and, some might say, esoteric discussion to what are the practical equities here? Is there something that, in equity, would entitle the State of California to a share in these revenues? And if there is, what are those equities? And how would we quantify them?
Can you offer any suggestions?
Mr. FITZGERALD. Well, I think my first suggestion is a nonsuggestion, which is that the consideration of the equities on both sides of that issue are really for this committee and for the Department of Energy, between and among themselves, to debate and for the Congress finally to determine.
But there are, of course, some general considerations from a legal standpoint, and I do return to the legal issue. That is that you have a general rule that there is a 50–50 sharing between the States and the Federal Government for revenues that are derived from leases on Federal lands.
On the other hand, there is a more than 75-year-old exemption for the naval petroleum reserves and for the oil shale reserves, an exemption that it was—as recently as 1981, again confirmed by this very committee. And that was after the transfer of Naval Petroleum Reserve No. 4 in Alaska to—to Alaska.
Page 1062 PREV PAGE TOP OF DOC Segment 5 Of 5
So one of the considerations may be, was there ever any expectation on the part of the various States that they would at some point in the future derive revenues from these? The argument can be made on one side that after such a long history, there really couldn't be such an expectation.
On the other hand, I heard Congressman Hefley explain how in his career in Colorado there was a lot of planning that the State went into in terms of roads and other infrastructure improvements that apparently took that into account. I don't have any independent knowledge about that. I heard his statement. Those are the kinds of equities that I think could be debated.
Mr. BATEMAN. You have not made any investigation of what investments or expenditures the State of Colorado has undertaken that would be beneficial to anyone who is going to exploit these resources?
Mr. FITZGERALD. No, I haven't. Although I noticed that Interstate 70 runs fairly close to Rifle, CO, which is the nearest town. On the other hand, the interstate highway system is largely paid for out of the Federal Highway Trust Fund.
Mr. BATEMAN. Well, I assume it goes somewhere beyond the borders of Colorado also.
Mr. FITZGERALD. It does. It starts east and heads west, or vice versa, depending on where you sit.
Page 1063 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. OK. With that, Mr. Sisisky.
Mr. SISISKY. I am almost not ready to ask my questions. Let's get back to the figures Mr. Bateman talked about. Producing—by leasing, you have got $3,100,000?
Mr. FITZGERALD. That is for Naval Reserve No. 3, and that was for protective drilling production.
Mr. SISISKY. No. 3. OK. And if we sold it, it would bring how much?
Mr. FITZGERALD. It was sold. That gas was sold in 1996.
Mr. SISISKY. I am talking about, if we sold the whole field.
Mr. FITZGERALD. The sale for Reserve No. 3, the estimate of the consultant was $5.5 million.
Mr. SISISKY. $5.5 million and you took in $3 million? That doesn't make good sense.
Mr. FITZGERALD. In other words, that was $3.1 million in revenues. As I recall the consultant's report, there were considerable costs associated with that. It was a very controlled kind of production, which is all that DOE can do under the current law.
Page 1064 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. SISISKY. That is not a net sale of it?
Mr. FITZGERALD. It was not a large scale; it was for protective purposes. So the costs that were incurred were rather substantial. I think it was somewhere in about the same range as the revenues. I think it was pretty much offset, if slightly more than offset.
Mr. SISISKY. Do I understand correctly that the current law prohibits full development of No. 3 natural gas resources, while we fear that privately owned properties adjacent to this are draining the reserves? Is that a fair statement?
Mr. FITZGERALD. Yes, the law does currently limit the DOE authority to lease for certain purposes.
Mr. SISISKY. And if we do what DOE says to do, transfer it to the Department of the Interior, that automatically under the law gives Colorado 50 percent; is that a——
Mr. FITZGERALD. If it is an estimate——
Mr. SISISKY. The Mineral Rights Act automatically gives it to them?
Mr. FITZGERALD. We haven't seen the legislation being drafted by the Departments of Energy and Interior at this point. Our concern, as I think I alluded to in the statement, was if you assume under the legislation that these reserves lose their character as reserves, they would no longer qualify for the treatment that they have always enjoyed under the Mineral Leasing Act. And title 10 of the United States Code.
Page 1065 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. SISISKY. But other States benefit under the 50 percent, I think, in your statement.
With all the beauty out there, ecological beauty, because I know we always have to answer, does it really make sense to mine this field?
Mr. FITZGERALD. Well, you already have at the southern border on NOSR–3, I think it is, 56 producing natural gas wells and associated transportation equipment and facilities. So there is already some development. And those are the protective wells, as I understand it.
There is, I understand, considerable scenic beauty in that part of the State of Colorado. But I think consideration of ecological and scenic and recreational values is something that the committee could take into consideration. I understand from the report that some of this land is used for grazing purposes and for recreation purposes presently.
The surface of both of these shale reserves is managed from the Department of Energy under memoranda of agreement with the Bureau of Land Management at Interior. So Interior's Bureau of Land Management is already managing the surface area of this land.
I think, to answer your question, some of those values might actually be better addressed by the Bureau of Land Management since they have on-scene familiarity with that.
Mr. SISISKY. Thank you, Mr. Chairman.
Page 1066 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Mr. Pickett.
Mr. PICKETT. Thank you, Mr. Chairman. Is all of this acreage that we are speaking of here in the—was it four different parcels, five different parcels?
Mr. FITZGERALD. There are—there are two reserves, Oil Shale Reserves, No. 1 and No. 3. They are located adjacent to each other in Garfield County, so there are two parcels of land. Although if you look at the DOE report, they have, as part of their recommendation, included the notion that the land that is currently under production on NOSR–3 would be held back for a year and continued to be administered by DOE, even though the rest of the land would be administered by the Department of Interior. So, in a sense, you have kind of carved a separate tract out of NOSR–3. But for my purposes, I think it was two tracts of land.
Mr. PICKETT. And they are adjacent?
Mr. FITZGERALD. Yes.
Mr. PICKETT. Contiguous with each other?
Mr. FITZGERALD. Yes.
Mr. PICKETT. Is there some reason why they are not dealt with as a single unit for purposes of considering for sale or——
Page 1067 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. FITZGERALD. I think it goes back to history. The executive orders under which those lands were reserved for naval petroleum purposes, for military purposes, were issued at different times. I think No. 1 was issued in 1916, and the executive order for Shale Reserve No. 3 was issued in 1923 or 1924, somewhere in there.
Mr. PICKETT. The issue about adjoining property on this possibly being able to draw off some of the gas and possibly oil under these tracts is a concern. And that has been the reason for the drilling of these what they call ''protective wells''?
Mr. FITZGERALD. Yes. In the last 10 years or so—last 20 years, I guess it is—DOE noticed the development of natural gas fields, I think essentially to the south of Shale Reserve No. 3 and, in 1985, began this program of protective drilling, which is conducted, I might say, on a cooperative basis with some of the industries that are located there.
Not all the wells are owned by DOE. I think DOE owns 29 of the 56 wells, 24 or 29, and the others are owned kind of jointly. They have agreements with industry about the management of those protective wells.
Mr. PICKETT. And does the United States Government own the fee simple interest in this property or just the mineral rights to it?
Mr. FITZGERALD. I believe except for a tract within Shale Reserve No. 1, all the ownership interests are in the United States. I could be wrong about that; and Secretary Godley could correct me if I am wrong. There is a tract within Shale Reserve No. 1 which has some private ownership interest in it.
Page 1068 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. PICKETT. Well, you have got the surface rights, whatever that may be, the beauty and use, grazing, and what have you. You have got the shale that is not going to go anyplace, and nobody can disturb that, because I take it you have got property rights on the surface that would preclude it. And then you have got the gas and oil that is below the surface that are really the problems, a problem in a sense that something needs to be done to protect the interest of the U.S. Government.
Mr. FITZGERALD. It is the natural gas that has had a tendency to migrate, does have a tendency to migrate. You have to have something in liquid form essentially for migration. And I think you are probably correct, Congressman Pickett, that the oil shale is not—is not vulnerable to that.
Mr. PICKETT. So we are really speaking here about selling or leasing mineral rights or doing something with the oil and gas and not with the surface and not with the shale; is that what I understand?
Mr. FITZGERALD. There is an option, I think it is the option that we have called to the subcommittee's attention, under which—if DOE continued to operate these under the current law with some—there would be some required statutory changes to authorize DOE to operate and produce more fully and more competitively and more commercially than it is now. But in any event, the memoranda of agreement regarding surface administration with the Bureau of Land Management could continue.
We didn't address that in our testimony, but there is no reason why that couldn't continue.
Page 1069 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. PICKETT. But there is nothing here to indicate that there is an intent to proceed with the description of anything other than oil and gas below the surface.
Mr. FITZGERALD. That is my understanding.
Mr. PICKETT. Thank you.
Thank you, Mr. Chairman.
Mr. BATEMAN. Mr. Taylor, any questions?
Mr. TAYLOR. Mr. Chairman, only to follow up on Mr. Pickett's line of thought.
Do you feel like, in addition to Mr. Hefley's proposal, that there is a better way for the government to manage what we have now in order to prevent the migration of this gas, in order to hang on to that resource that we have?
Mr. FITZGERALD. There is another way. It is not my determination to make, and I don't have any recommendation to make about whether that is a better way.
Mr. TAYLOR. Why not?
Page 1070 PREV PAGE TOP OF DOC Segment 5 Of 5
I am serious. This is an extremely valuable resource. I would think it would be the job of those who were entrusted to protect that resource to be thinking of ways to best protect it and best utilize it.
Mr. FITZGERALD. I think—I think that the——
Mr. TAYLOR. You know, the old ''It is not my job, man,'' hopefully went out of style in the early 1970's.
Mr. FITZGERALD. I am not saying it is not our job. We haven't done that kind of work to make that kind of an assessment. We were interested, when we saw the DOE report because it related to some other work that we were doing, to see that there was a difference between the consultant's recommendation and the DOE recommendation.
There is, as you know, legislation pending before this subcommittee and the House Resources Committee to authorize the transfer which would essentially effectuate what DOE is recommending with respect to Oil Shale Reserves 1 and 3. There is no legislative proposal yet available from the Department.
And so we thought, before—there was a hearing scheduled here, before we let the opportunity pass, we would discuss this matter with the committee, and we did. And we are addressing ourselves simply to the question about the options that are available, without reaching a value judgment.
For GAO to reach a value judgment, I think we would have to essentially go with great depth into the questions that you are raising, the committee is raising, the chairman has raised about valuation, quantities, and things of that sort. We are taking at face value what we read in the DOE report and the consultant's report.
Page 1071 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. TAYLOR. But if I may, I have seen the very detailed and, I thought, excellent work you did—for example, comparing the F18 CD's—CD to the ENF. You went into a great deal of detail, and you did make a recommendation.
This is obviously something else that is very expensive. This is obviously something else that is very important. Why in that instance do you go to the trouble of making a recommendation when in this instance you choose not to? And again I am fairly new to the subcommittee, but I think it is a fair question.
Ms. GOFF. If I may, if I can, sir, I believe that the reason we didn't with this specific Oil Shale Reserve is in the legislation, the Defense Authorization Act of 1996 that contains this provision, most of that act has to do with the sale of Elk Hills and that process. And GAO has actually written into that part very specifically about addressing the Secretary's actions about the sales process.
Then, at the end of the act, was this one section, and we were specifically not included. We interpreted that to mean that we were not a part of reviewing that process. If, however, this committee obviously feels that that is important to help them reach that decision, we would be happy to do so. But that is why, until recently, we did not have an independent analysis of these reserves.
Mr. TAYLOR. Mr. Chairman, if I may, I am making a request of you as the chairman. I just think in order to make—Mr. Hefley, you know, is making a fairly sizable request, in order for at least for this member to make a decent judgment on that request, I would sure like to know what the alternatives are.
Page 1072 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Well, certainly, we need all the assistance that we can get——
Mr. TAYLOR. Thank you, Mr. Chairman.
Mr. BATEMAN [continuing]. We can get in terms of determining which of the several options are in the consultant's recommendations and the Department of Energy recommendations. And you have given us at least an additional option this morning. There may be even other options. And we want to know all of them and make sure we select the one which represents the soundest public policy.
As I understand it, you are officially charged as a part of our legislation to monitor and advise with regard to the processes through which Elk Hills is being disposed of.
Mr. FITZGERALD. That is correct, Mr. Chairman.
Mr. BATEMAN. And what you have given us today is not subject to any specific charge that anyone in the Congress has put before you, but simply as an adjunct to what you were doing in connection with Elk Hills?
Mr. FITZGERALD. That is correct.
Mr. BATEMAN. Well, can you give me a time line on when you might be able to give us a report, if we specifically ask for one, and the evaluation and recommendations with respect to sound public policy options.
Page 1073 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. FITZGERALD. Let me consult with some of the people who might be required to do some of that work.
Mr. BATEMAN. Yes. Excuse me.
Mr. FITZGERALD. I am advised—by the way, these people are not lawyers, so they are not tarred with the same brush, although you and I did go to the same law school. On the question of sale versus lease, I am told we could get back to the committee pretty quickly on that issue.
With respect to the leasing options, I think we would probably want to sit down and speak with you more to get an idea of what the scope of the work required for the committee and to address Mr. Taylor's interest would be.
Mr. BATEMAN. Well, on the record, I think I need to ask that you give us, as quickly as you can, recommendations as—on the question of sale versus lease. And I would be happy to meet with whomever you suggest in order to scope out whatever further study and investigation reporting might need to be done and the time line within which it could be done.
Mr. FITZGERALD. We will be available to the subcommittee, Mr. Chairman.
Mr. BATEMAN. OK.
Page 1074 PREV PAGE TOP OF DOC Segment 5 Of 5
Oh, yes, Mr. Rodriguez. No questions?
Well, I suspect we will have some further discussions concerning this, Mr. Fitzgerald. We thank you and Ms. Goff for being with us this morning, and we look forward to further discussions in trying to make sure we arrive at the right decision.
Mr. FITZGERALD. We look forward to it, too, Mr. Chairman. Thank you very much.
Mr. BATEMAN. Thank you.
Ms. Godley, we are pleased to have you and look forward to your testimony. Your written statement will be made a part of the record, and you may proceed in whatever manner you choose.
STATEMENT OF PATRICIA FRY GODLEY, ASSISTANT SECRETARY FOR FOSSIL ENERGY, U.S. DEPARTMENT OF ENERGY
Secretary GODLEY. Great. Thank you very much. I thought I would make some very brief remarks orally and submit the written testimony for the record. And the remarks I will make really will be more contextual in nature.
The Department of Energy manages the three naval petroleum reserves and the three naval oil shale reserves under the naval petroleum reserves law. The reserves, as you know, were originally established in the 19-teens or so for the purpose of national defense, to provide a secure source of fuel for our Navy at that time back in the 19-teens and the 1920's when we were actually fueling our ships with oil.
Page 1075 PREV PAGE TOP OF DOC Segment 5 Of 5
After the Iran oil embargoes in the 1970's, the naval petroleum reserves law was amended to show the development of the three naval petroleum reserves for commercial leasing and sale of produced hydrocarbons. The law has never been amended to authorize the full development of the three naval oil shale reserves, the oil shale reserves, two of which, as you have heard, are located in Colorado, one in the State of Utah.
While the naval petroleum and oil shale reserves has played an important role, over its long history, since, again, the 19-teens, providing a secure source of oil for national security and national defense purposes, it no longer serves a national defense or national security purpose.
And this committee, you, Mr. Chairman, in a letter from the Department of Department of Defense in March 1995, the Department of Defense so advised this committee, it no longer looks to these reserves as a source of fuel for the military.
Moreover, the production of oil and gas for sale in competition with our private sector oil and gas producers is not, in our view, a uniquely Federal function. Accordingly, in 1996, the administration agreed with us and Congress authorized the Department of Energy to sell naval petroleum reserves No. 1, which is the Elk Hills field in California. And this, of course, is by far the most productive and valuable of the six Naval Petroleum and Oil Shale Reserves.
In response to your question, Mr. Chairman, that sale is going swimmingly.
Page 1076 PREV PAGE TOP OF DOC Segment 5 Of 5
In accordance with the requirements of the 1996 Defense Authorization Act, we have hired all of the experts and advisors as required by that act. They are all on board. A huge amount of work has been done in a record period of time in connection with that sale. And I am extremely optimistic that the Department will be able to meet the February 1998 sales date mandated in that action.
I should note that one important piece of that work, which includes the negotiations with our co-owner in that field, which is Chevron of U.S.A., Inc. with respect to the winding up of our relationship under our unit plan contract with Chevron are ongoing. There are some very difficult issues relating to or involved in those negotiations, pertaining to ownership interests in the field, and we are continuing to make very good progress, although we have not completed those negotiations.
Congress in the 1996 Defense Authorization Act also authorized the Department, or directed the Department, rather, to retain an independent petroleum consultant to conduct a study to determine which of four specified options or combination of options would—and I will quote—''Maximize the value to the United States of the five other Naval Petroleum Oil and Shale Reserves,'' those other than the Elk Hills field in California.
DOE, in accordance with the statute, hired the consulting firm of John Gustavson and Associates to perform the study required by Congress, and in that work DOE asked Gustafson Associates to assess the economic value of the options specified in the Defense Authorization Act.
The firm conducted its—completed its study in December of 1996. In March of 1997, DOE submitted its report to Congress describing the results of the Gustavson study, and that report contained DOE's recommendations regarding the disposition of these five other reserves.
Page 1077 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. PICKETT. Mr. Chairman, can I ask a clarifying question?
Mr. BATEMAN. Sure.
Mr. PICKETT. When you say ''reserves,'' are you speaking of the underground reserves of the oil and gas reserves only?
Secretary GODLEY. No, sir. It is the—we own that—the United States Government owns those properties in fee simple. So the direction, for example, with respect to the sale of Elk Hills would transfer title in fee simple to the lands as well as the minerals, its surface as well as mineral rights.
Mr. BATEMAN. Clarifying this, I think I am correct that prior to the time, by Executive order, these areas were designated as naval petroleum reserves, it was property of the United States, which had never been granted to private ownership.
Secretary GODLEY. Sorry. I am advised that they were withdrawn from the public domain. They were Federal lands prior to that time.
Mr. BATEMAN. They had never been under private ownership? They had always been owned by the United States Government?
Secretary GODLEY. That is my understanding.
Page 1078 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. By executive order, these specific Federal lands were made naval petroleum reserves?
Secretary GODLEY. Yes.
Mr. BATEMAN. And the fee simple title to the land is included in that executive order designating them as naval petroleum reserves?
Secretary GODLEY. Right. And, yes, the interest in the Federal—the United States interest in those properties is fee simple title to all of the land surface as well as the mineral rights.
Mr. SISISKY. But there is some disagreement on who owns some of the land; is there not? The California teachers, aren't they involved in this in some way?
Mr. PICKETT. That is Elk Hills.
Mr. SISISKY. I thought you were talking about Elk Hills.
Secretary GODLEY. I think the statements I made pertain to all of the reserves, including Elk Hills.
Mr. PICKETT. The question, well, do you want to wait for the question, because I was following up on Mr. Sisisky's comments.
Page 1079 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Let me ask Ms. Godley, would you prefer to take questions or complete your statement?
Secretary GODLEY. I just had a couple of other remarks, again, to set the context. And if you don't mind, I would like to finish that.
Mr. BATEMAN. Why don't we do that?
Secretary GODLEY. In summary, again, just to make sure we are all starting from the same point, the Gustavson report found that the United States Government, or United States, would receive the greatest economic benefit by selling the three naval oil shale reserves as well as Naval Petroleum Reserve No. 2, which is in Buena Vista, California—it's the Buena Vista field in California adjacent to Elk Hills. So the Gustavson report would have us sell all three of the NOSR's, as well as the Buena Vista field in California.
But it also recommended that the Department of Energy retain and continue to operate Naval Petroleum Reserve No. 3, which is that famous Teapot Dome field in Wyoming. And the reason for that is, it is a stripper field now. It is nearing the end of its productive life probably, projected to be in about the year 2003. And it basically would cost the government more to sell it than it would to keep it and produce it to depletion and then abandon it.
The Department of Energy, taking into full consideration the economic valuations in the Gustavson report but, in addition, some other noneconomic public interest values, determined that—or recommended the transfer of the three NOSR's, the three naval oil shale reserves, to the Department of Interior for leasing under the Mineral Leasing Act and for surface management under all of the applicable laws, as in—as well as, we would also transfer the Buena Vista field to DOE for management of the current leasing arrangements in that field.
Page 1080 PREV PAGE TOP OF DOC Segment 5 Of 5
But we agreed with the Gustavson assessment that it would be more—accrue to the economic benefit of the United States more to retain the Teapot Dome field and continue to operate that until depletion.
With these summary comments, Mr. Chairman, I will—I will be happy to respond to any additional questions.
Mr. BATEMAN. All right. Thank you very much Secretary Godley.
[The prepared statement of Secretary Godley can be found in the appendix on page 1389.]
Mr. BATEMAN. The Department of Energy charge from the Congress in the 1996 legislation was to examine options as to the disposition of these naval petroleum reserves which would produce the maximum value to the United States.
Explain to me how the Department came to a conclusion that if you are going to maximize the value to the United States, you changed the legal status of these properties in a way in which 50 percent of the revenue would redound to someone other than the United States.
Secretary GODLEY. Right. I think that our focus on the word ''value'' to the United States programs accords a broader definition to the word ''value'' than just the economic value to the United States, and we considered both the economic value as well as the noneconomic value.
Page 1081 PREV PAGE TOP OF DOC Segment 5 Of 5
When you look at the leasing options, for example—and I will focus on NOSR–3, although the same concerns, I think, pertain to the other NOSR–1 in Colorado as well as NOSR–2 in Utah—that when the Gustavson firm performed its economic valuation of the properties, it did so very appropriately under the market condition also at the time of its assessment.
And when you look at the development of these properties, again looking at NOSR–3, very little development has occurred with respect to oil and gas and with respect to NOSR–3. Again, just that southern portion of the property has been drilled again to prevent drainage from Federal property by development and adjoining private property.
So the vast majority of NOSR–3, just as an example, is undeveloped. We have very little geological or petrophysical data that would tell us with any degree of certainty what kind of oil and gas resources underlie the undeveloped portions of that property. There has been virtually no development on NOSR–1, so we have even less geological petrophysical data with respect to NOSR–1.
So again, what the Gustavson report concluded was the principal current market value, again looking at NOSR–3, is determined by the developed portion of that property only, because the market, just like we don't have sufficient or significant information, again, that would allow us to predict the reserves under the undeveloped portion of the property, the private sector companies therefore would risk and highly discount that undeveloped acreage.
Again, the Gustavson report looked at or determined that the sale value, the current net present value of that property under existing market conditions, when it did its study, would be about the same as what the private sector would pay if—for example, in a lease bonus, for the right to lease the property.
Page 1082 PREV PAGE TOP OF DOC Segment 5 Of 5
You heard some testimony before that, as a result, the Gustavson estimate of the sale value of the property was about equivalent to the total value that would accrue from the Department of the Interior's leasing of the property under the Mineral Leasing Act, the difference being—and I am actually getting to your point—that the Gustavson interpretation of value to the Federal Government meant economic value to the Federal Government, 50 percent of which from the leasing would go to the Federal Government, 50 percent to the State of Colorado.
When, in our discussions with the Department of the Interior, we also were looking at, again, since this property has no further national defense value to the Government, we are looking at, you know, what agency is it in the United States charged with the management of Federal lands? And that agency is the Bureau of Land Management in the Department of Interior. And the Bureau of Land Management is charged with the Federal lands by a number of laws passed by Congress, in the wisdom of Congress, that set the rules and the regulations for the management of Federal lands. That includes the Mineral Leasing Act in the 1920's.
In that act, as you know, that ''50 percent to the States'' provision is there presumably because that brings some value to the Nation. I mean, that is a provision in Federal law that is implemented by a Federal agency. So presumably, again, the provision of giving 50 percent of those revenues to the State must be in the Federal interest, presumably, or it wouldn't be in that law.
So it wasn't so much a parsing of the words or seeking a definition of the United States but, again, looking at which agency is charged with and has the experience to manage Federal lands, what is the menu of laws that applies to that agency, that would include the Mineral Leasing Act of 1920.
Page 1083 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Well, if I could try and paraphrase, make sure I fully understand the Department's position, you are saying that if these petroleum reserves were no longer necessary for national defense purposes as a direct requirement, then they ought to be treated in the same manner that any other Federal lands are treated and, under existing generic law, Department of Interior, through the Bureau of Land Management, leases the property and the revenues derived from it are divided between the State and the Federal Government.
Secretary GODLEY. Right.
Mr. BATEMAN. So you are saying, if you are going to follow the norm, if you are getting rid of these properties as the defense has such, then that is the way it should be. You have not approached it from the standpoint of, if you don't follow the norm, what would maximize the economic value to the Treasury of the United States.
Secretary GODLEY. That is correct.
I will add that another reason for recommending transfer to the Department of Interior, again, is in the Bureau of Land Management—or their management would be to protect or to further the multiple use of this property. It is a very scenic area; it has a high recreational use.
In addition, for example, with respect to Naval Oil Shale Reserve No. 2 in Utah, the Ute Nation owns 40 percent of the surface of that, and Native American cultural interests, historic, anthropological interests are very key in that area as well. So these, again, are issues we think that are more appropriately managed in the experience and under the laws applicable to the Department of Interior.
Page 1084 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Well, for my part, I find no difficulty in these properties remaining assets of the U.S. Government in terms of the surface and under management of the Bureau of Land Management. I don't know of anyone that is better qualified to deal with the surface of property rights. That, however, leaves the question of the—whatever—the autumn of economic value the mineral rights may have.
Clearly, if the Congress determined it was in the best interest and the sound public policy of the United States to dispose of these properties or have them leased under an arrangement or a program where all of the revenues remain revenues of the United States, it has the authority to do that if it chooses to do so. There is no question in your minds as to that?
Secretary GODLEY. That the Department of Energy would have the authority—I am sorry?
Mr. BATEMAN. No; that the Congress of the United States.
Secretary GODLEY. Absolutely.
Mr. BATEMAN [continuing]. If it chooses to change the status quo, can change it in a way that would still retain 100 percent of the revenues for the Treasury.
Secretary GODLEY. Yes, sir.
Mr. BATEMAN. If it chooses to do that.
Page 1085 PREV PAGE TOP OF DOC Segment 5 Of 5
Secretary GODLEY. Yes, sir.
Mr. BATEMAN. OK.
Mr. Sisisky, do you have any questions?
Mr. SISISKY. Just a little one.
Gus—Gustavson and Associates, they are a reputable firm? I mean, I say reputable; they are obviously reputable. But highly regarded firm?
Secretary GODLEY. Very highly regarded. And I think, if I could say for the record, we believe they did a superb job in this very——
Mr. SISISKY. Do they agree with your assessment—I am talking about the Department of Energy's assessment—that it should be leased?
Secretary GODLEY. Again, in their report looking strictly at the economic values of these properties, they recommended the sale of all but the Teapot Dome Field. And again, we do not disagree with their economic assessments of those properties. We added to their assessment certain noneconomic considerations. And one other piece of that—I don't want to be lost in the shuffle—and that is again a market analysis, which is again what we charged the Gustavson firm to do and they performed on that request. And the market would significantly discount the value of the undeveloped properties.
Page 1086 PREV PAGE TOP OF DOC Segment 5 Of 5
We believe that by transferring or by leasing these properties and holding continuing Federal ownership of these lands and leasing those properties so that development can occur, we will learn more about the resources in those undeveloped lands and be able to more accurately value them in the future, so that we don't give up potential future value of these undeveloped lands but we just don't have enough geologic and petrophysical data today to be able to value it.
Mr. SISISKY. I think, Mr. Chairman, in all accounts we should probably hear from the consultants on the economic value if we can make a judgment on it. I don't mean tomorrow, but I think we really should hear from them.
Concerning California, now, you say you are coming along fine in the—how many companies have you hired in that respect?
Secretary GODLEY. Well——
Mr. SISISKY. Because that was always my biggest fear.
Secretary GODLEY. In accordance with the specific direction of the national—I mean the Defense Authorization Act of 1996, we did retain an investment banking firm to advise us in connection with the sales process. We hired an engineer, petroleum engineering firm, to perform an independent reserve report. That report has been completed. We have hired five independent petroleum engineering firms to perform the assessment of the value of the property under continued government ownership. And we have retained a number of other experts to provide additional advice with respect to the legal separation of title from the property.
Page 1087 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. SISISKY. OK. Good.
When this land—did the U.S. Government own this land and turn it over to the Navy, or how did this history go? I am going to try to make a point.
Secretary GODLEY. Well, I don't have sufficient knowledge of the early history of these properties to answer your question.
Mr. SISISKY. The reason I asked the question is, you know, this is the National Security Committee.
Secretary GODLEY. Yes, sir.
Mr. SISISKY. And we are faced with many dollar problems. And I would just hate to see, if the sale goes on, that the money goes into some other agency or to the General Treasury when it probably could come into the national defense budget——
Secretary GODLEY. Right.
Mr. SISISKY [continuing]. In some way to——
Secretary GODLEY. I believe——
Mr. SISISKY. And particularly the Navy, if they can have it.
Page 1088 PREV PAGE TOP OF DOC Segment 5 Of 5
Secretary GODLEY. The Department of Energy could use it, too, sir. But I believe by specific direction, the 1996 Defense Authorization Act requires the revenues from the sale to be deposited into the U.S. Treasury.
Mr. SISISKY. I guess we can change that. We can.
Thank you very much.
Mr. BATEMAN. Mr. Pickett.
Mr. PICKETT. Thank you, Mr. Chairman.
Just to follow up on a question that Mr. Sisisky raised while you were giving your opening statement, there are title difficulties with the Elk Hill tract of property. But are there title problems with these Oil Shale Reserve 1 and 3?
Secretary GODLEY. No, sir.
Mr. PICKETT. Well, I must say, I am really, Mr. Chairman, quite astounded, and here we are talking about disposing of the surface property here, I don't have any quarrel with disposing of the oil and gas, but the Naval Oil Shale Reserve No. 1 in Colorado and the—here is the description: The terrain includes canyons that range from generally rolling on the east end of the property to very deep and steep-sided as they traverse the property to the west, creating spectacular scenery. Numerous streams and creeks are located in canyon bottom.
Page 1089 PREV PAGE TOP OF DOC Segment 5 Of 5
I have not been there. But that is a fairly attractive description of something, and we are out here scrambling to add acreage in many cases to existing Federal Government park facilities, and it appears that we are about to get rid of something here at a fairly nominal price that should have a great value to the United States, to the people of the United States, as a recreational kind of an asset.
What is going on? Am I missing something here?
Secretary GODLEY. We would agree absolutely with you, sir. In fact, that is why we recommend not the sale of these properties and; instead, the Department of Energy recommends that they be transferred to the Department of Interior, and the Bureau of Land Management in particular, for surface management in accordance with the Federal Land Policy and Management Act as well as mineral development under the other applicable laws to the BLM.
So we would agree absolutely with you, sir.
Mr. PICKETT. Let's get to the fundamental issue, that you are talking in terms of disposing of the subsurface oil and gas and leaving the surface alone and retaining the surface as owned by the United States of America.
Secretary GODLEY. Under our proposal, the United States would retain ownership of all of the property. They would simply be planning the surface in accordance with the applicable——
Page 1090 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. PICKETT. But I don't like the proposal of transferring the property around. I don't see any need for that. But I am trying to distinguish between what we are going to keep for the people of this country and what we are going to be getting rid of because it is a commercially oriented asset.
Secretary GODLEY. Under our proposal, we would not be getting rid of any of the property, sir, with the single exception of the Teapot Dome Field, again, in Casper, which we would propose to produce to its depletion in about the year 2003, abandon the oil wells on that property, restore the property, and then sell or otherwise dispose of that property to achieve its maximum value to the Government.
But with respect to all of the NOSR's, including the NOSR–2, where the Green River does run through it, those lands would not be transferred out of Federal ownership.
Mr. PICKETT. OK. Well, that clarification helps, Mr. Chairman. I hope we can adhere to this general principle as we go through this process.
Mr. BATEMAN. Thank you, Mr. Pickett.
Mr. Taylor.
Mr. TAYLOR. Ms. Godley, I don't claim to know a great deal about oil and gas. I do know a little bit about shipbuilding. I can tell you, just about every shipbuilder I know is building offshore supply boats, which, seeing that, makes me think there is getting ready to be a resurgence in the oil and gas exploration, which makes me think someone is anticipating making enough money in that business to buy these boats, which makes me think that the price of oil and gas is probably getting ready to go up.
Page 1091 PREV PAGE TOP OF DOC Segment 5 Of 5
When the accounting group made the recommendation to sell these mineral deposits, did they in their study include a basement or a ceiling where they decided with what price range for oil and gas would it be reasonable to sell this and what price range would it be a bad deal for the people of the United States to sell this? Was that included?
Secretary GODLEY. Yes, sir. Under the statute that required the study, the statute specified four specific options that the firm was required to value under four—value the United States interest in these reserves under four specific options. One was a direct sale, one was transfer to Interior for lease, one was for retention by the Department of Energy and continuing management under the current law, and one was transfer to another agency for continued management under the existing law. So in accordance with that specific direction from the statute, the engineering firm did exactly that.
I might mention that in projecting or estimating the net present value of an oil and gas producing property—and you may know all this, and please stop me, but one of the issues is, that is very difficult, to assess the oil and gas reserves that underlie these very rugged properties that you know you can't see it from the surface. That is more of an art than a science. It is a very informed art but a very difficult one. So it is reserves—estimating the reserves underlying the land.
Another is the point that you make, that you also need to project oil prices over the life that these reserves might be found into the future 30, 40 years from now.
A third element is how much money would be available to invest in the development of these oil and gas reserves over the life, 30, 40 years of life of these reserves, and then again, once you calculate all that out, you bring it back to a net present value by the application of a discount rate.
Page 1092 PREV PAGE TOP OF DOC Segment 5 Of 5
For example, 10 percent is one that is typically used in reserve reports, although if you are using a market value assessment, you can use a broad range of discount rates.
I am going into this lengthy explanation in an attempt to assist the committee in, when you look at these very broad range of values that were mentioned by the GAO witness that had been ascribed to these properties, you are talking at four—at least four very significant variables, a lot of which involve projections or estimates, best estimates, of future oil prices, of how much reserves actually lie underneath the ground and you can't see them, as well as the amount of money that would be made available for investments.
So again, it is a bit of a cautionary piece that, when you are looking at these estimates, a lot of it is very formed application of judgment and knowledge but there are a lot of variables that could play in and explain the reason why there is a broad range of estimates of the value of these properties.
Mr. TAYLOR. Let me go back to your first point then. In addition to the uncertainties of what the price will be, you are telling me that the United States of America owns vast tracts of land for which we have drilled no test wells to know what is down there?
Secretary GODLEY. We have——
Mr. TAYLOR. And let me draw the analogy. If you own 40 acres of timberland in Pearl River County, MS, and someone comes wanting to lease your mineral rights, you may not be able to afford to know exactly what you are leasing. I would think the United States of America ought to be able to make a more informed decision than that. You are telling me that no one has taken the time to drill the test wells to see what exactly we are about to either sell or give away.
Page 1093 PREV PAGE TOP OF DOC Segment 5 Of 5
Secretary GODLEY. We actually have, again, in the—the naval petroleum reserves law which authorizes the activities that we undertake on these properties forbids us from doing that by law. It allows——
Mr. TAYLOR. How old is that law?
Secretary GODLEY. It is—well, 1920's, but then it was amended in 1970 to allow us to develop the petroleum reserves. Under that law, though, we have not been allowed to develop for commercial purposes, for full purposes, the Naval Oil Shale Reserves.
Mr. TAYLOR. Mr. Chairman, if I may, because my memory is so short, I would sure request of you as the chairman of this committee that prior to any sort of a transfer, be it to another governmental agency, be it to make it available for sale, I just think it would be a very sound business practice that at least some test wells would be drilled so we have some idea what we are talking about. I would sure hate to find out that we have, in effect, sold or leased billions of dollars' worth of oil for pennies on the dollar. I just don't think the public would be very well served by that. Obviously, someone who thought there was a reserve there in the first place must have had a reason to think so.
Mr. BATEMAN. The chairman appreciates very much the gentleman's point of view, and I think it is of critical importance that we come to some degree of comfort into what we are dealing with and what its value is. I do not have that level of comfort at this point.
Page 1094 PREV PAGE TOP OF DOC Segment 5 Of 5
Let me say, while we are discussing this aspect of it and seeking guidance for the future, that we have the data submitted by Mr. Hefley that comes to us from the State of Colorado Gas and Oil Commission, or whatever its formal name is. We have what, to me, appears to be a significant fact that with regard to Oil Shale Reserve No. 3, just with protective drilling, we are at least grossing—I am not sure what the gross or the net is, but $3.1 million in 1 year. That is just from protective drilling under a statutory regimen that doesn't allow exploitation of the resources.
Certainly it would seem to me that we need to thoroughly consider whether or not we need to take off the wraps and allow commercial exploitation of the resource and then, having done so, have a much better feel for what the lease value or the sale value of the properties might be.
I think you are exactly right, that we need to know a great deal more information to I feel like I am at all comfortable with this. And I will cooperate with you, and I will seek—and will consult with the members of the subcommittee on where do we go in order to get the level of comfort that is going to be necessary.
Mr. TAYLOR. Mr. Chairman, not to belabor the point, but I think a reasonable place to start would be Mr. Steffes or someone from the staff deciding the jurisdictional boundaries of at least changing that language, so that our Nation can at least take a look and see what it owns before it decides to sell it or lease it.
Mr. BATEMAN. The gentleman's point is well taken, and it will not be overlooked.
Page 1095 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. TAYLOR. Thank you, sir.
Secretary GODLEY. Mr. Chairman, may I correct a misstatement that I made in respond to your question, Mr. Taylor.
Mr. BATEMAN. Sure.
Secretary GODLEY. We do have authority under existing law to drill exploratory wells, which is your direct question, so I misspoke. In fact, we have drilled a small number of exploratory wells in the northern part of NOSR–3. We have not drilled any in NOSR–1.
But we have requested funds with which to do that exploratory drilling from Congress, and those funds were denied to us. So I think that is another issue of, where are the priorities with which we will expend—where is the greatest return on the Federal dollars? And it has been determined that that is not an investment that would—compared to all the other Federal investments of Federal money, money was not made available to our program by Congress through appropriations to do additional exploratory drilling.
Mr. BATEMAN. Could you share with us any of the data that came from the exploratory wells that were undertaken?
Secretary GODLEY. Yes, certainly.
Page 1096 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Mr. Gibbons, we need a western point of view. I call on you.
Mr. GIBBONS. Thank you, Mr. Chairman. In fact, probably out west and a lot farther away from this subject than you are, even as a geologist, I understand some of the problems with projecting oil reserves and gas reserves as well.
What is the current cost to the U.S. Government to maintain these properties in the current production status? What is the cost to the Federal Government?
Secretary GODLEY. Sorry for the delay. Our operating costs for all 3 NOSR's is about $1.4 million a year. And I want to stress that that is operating costs. It doesn't include any capital cost investment that might be needed, for example, to improve the natural gas delivery facilities, pipeline facilities, and so forth. That is strictly O&M costs.
Mr. GIBBONS. So what is the net from your leases today with your operating cost, capital investment, that the U.S. Government is realizing from this oil field?
Secretary GODLEY. It varies from year to year, of course. In 1996 we grossed $3.1 million, as I think you have heard earlier in testimony, but our expenditures in that year were $3.7 million, which would include operating costs. But we also made significant capital investment costs in that year to extend the pipeline for delivery of gas, natural gas. So it varies from year to year, but—excuse me.
Page 1097 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. GIBBONS. No; excuse me for interrupting you. I had one just very uncertain question, if I may. Strategic reserves like this played an important role in this Nation, and that is to ensure in the long range a secure source of energy, of oil and gas, for strategic purposes, whether that is for the defense of this Nation or some other basis.
Help me understand what has changed in our need for this secure strategic reserve that now makes us or mandates that we sell this property or lease it out or dispose of it. What has changed in our strategy picture? If you could help me with that.
Secretary GODLEY. Sure. And again, in a 1995 letter from the Department of Defense to this committee, the Department of Defense walked through some of the things that have changed, and that is that when these properties were first put into a reserve, they were done so because the Navy could actually use oil produced virtually out of the ground. It required some refining for purposes of fueling its naval vessels.
Right now, for example, certainly in Teapot Dome, Elk Hills, and of course we are producing natural gas from the NOSR's that are—and I am basically doing this from memory from the letter, but the military now requires highly refined products. The producing rate from Elk Hills and certainly Teapot Dome—and I can't address the natural gas because the military doesn't use natural gas for military purposes—the producing rates are much lower than they were in the early years. So that by the time you produce the oil and refine the oil into products that can be used by the military, the military, instead, is dealing in the world market in obtaining its fuel on the world—its refined products on the world market.
So I am paraphrasing, or trying to, the Department of Defense rationale for why this field is no longer having military or defense value to the Government.
Page 1098 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. GIBBONS. It seems to me that what has happened here is that the Navy is driving its budget with a strategic strategy over the reserve component. By that I mean, instead of having a reserve, a secure source out there for future demand, it is looking at what its budget may be today in terms of acquisition of oil need—or needed for its service ships, and seeking the utilization of this resource in today's dollars versus keeping it out there in the strategic sense.
I guess my question was: Have they done away with the strategy that says, 20 to 30 years from now we will be relying on these reserves or commercial sources? And that would be the first thing. Have they done away with that strategy?
And the second thing is, what is going to be the probable cost to the Navy for utilization of this oil once it is leased out to a private company or some other source for their acquisition? Are they really going to save money from it, or will it cost them more when it goes through some private production hands when the cost will rise?
Secretary GODLEY. Uh-huh. Uh-huh. And I of course cannot speak for the Department of Defense or what the Navy's plans are in the budgetary or otherwise, but I would mention that the oil, for example, that is commercially produced and sold is sold into the marketplace. It is not purchased by or given to the Department of Defense or the Navy right now; it is sold into the marketplace.
Mr. GIBBONS. So this money is simply going into the U.S. Treasury.
Page 1099 PREV PAGE TOP OF DOC Segment 5 Of 5
Secretary GODLEY. Correct. Absolutely.
Mr. GIBBONS. So it is a Treasury demand rather than a Navy demand?
Secretary GODLEY. The money does go into the U.S. Treasury. If I could offer an opinion though, I believe that if we want to look at the most economic and best development of these domestic oil and gas resources, we would ask the private sector to do that. They have the ability to do that, I think, more so than the Federal agency would have the ability to do that, maximize the resources for availability into the marketplace.
Again, I can't comment on what the Navy's or the military's purchasing strategies are, but if we were really looking to make those—develop those domestic resources for availability in our marketplace, my personal view would be that the private sector is the best person to do—or people to do that, whether it be indirect ownership of those lands or if those lands are leased, so that ownership remains in the Federal Government and the Government gets the benefit of the royalties while those properties are being fully and efficiently developed.
Mr. GIBBONS. Thank you.
Mr. Chairman, I still am uncertain about military strategy and disposing of the property and resources, and I will reserve, of course, the point now, and I will save the discussion for a later time.
Page 1100 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Thank you, Mr. Gibbons. And I am going to ask that we obtain a copy of the Department of Defense 1995 letter that addresses the question whether the petroleum reserves are any longer really necessary.
But I also ask, Secretary Godley, if you would provide us for the record with a breakout of the cost of the administration management, all the costs associated with each of these reserves and the revenue itself generated from each of the reserves.
Secretary GODLEY. Yes, sir.
Mr. BATEMAN. If that is already a part of this report that I have read, I won't need to duplicate it, but I don't recall having seen it put out that way. But I would like to see it in that form, if you would.
Secretary GODLEY. Yes, sir.
[This information is available in the subcommittee offices.]
Mr. BATEMAN. I have a communication from the Honorable Bill Thomas, Member from California, asking that his statement be made a part of the record. And with unanimous consent, that would be done.
[The prepared statement of Mr. Thomas can be found in the appendix on page 1399.]
Page 1101 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Madam Secretary, anything further?
Secretary GODLEY. No, sir. Thank you for the opportunity to appear before you.
Mr. BATEMAN. Thank you very much for doing this. We appreciate you being here and the testimony.
With that, the subcommittee will be adjourned.
[Whereupon, at 11:45 a.m., the subcommittee was adjourned.]
[The questions and answers can be found in the appendix beginning on page 1415.]
"The Official Committee record contains additional material here."
QUESTIONS AND ANSWERS SUBMITTED FOR THE RECORD
May 7, 1997
Page 1102 PREV PAGE TOP OF DOC Segment 5 Of 5
QUESTIONS SUBMITTED BY MR. BATEMAN
Mr. BATEMAN. Mr. Fitzgerald, DOE says in its prepared statement that it ''interpreted Congress' direction in section 3416 of the 1996 Defense Authorization Act to 'maximize the value of the reserves to the United States' as a direction to consider the full value of both Federal and State revenues in the leasing option.'' Do you agree with the view that DOE can consider payment of fifty percent leasing revenues to a state as fulfilling the Secretary's obligation pursuant to section 3416 to maximize value of the reserves to the ''United States?'' If not, why not?
Mr. FITZGERALD. No. We don't agree with DOE. We consider the DOE statement in its report and testimony to be a strained interpretation of the words ''the United States.'' First, I'd like to point out that in the beginning of DOE's description for NOSR–3 in its report, DOE uses the term ''the United States'' to refer to the federal government as a whole when it noted that gas from its wells sold competitively in 1996 for about $3.1 million in revenues ''for the United States in fiscal year 1996.'' Second, with respect to the term ''value'' in section 3416, there is nothing in that section, or indeed the rest of the 1996 Defense Authorization Act or its conference report, that suggests Congress ascribed any other meaning to the term than ''revenues.''
More importantly, however, the Congress has repeatedly defined ''the United States'' to mean the federal government representing the nation as a whole, not the individual states. The phrase ''the United States'' is not specifically defined in the 1996 Defense Authorization Act, chapter 641 of title 10, United States Code (commonly referred to as the Naval Petroleum Reserve Law) or the Mineral Leasing Act. However, it is defined in other chapters of title 10 relating to the military, title 30 relating to mineral lands and mining, as well as titles 5, 7, and 29, to name a few.
Page 1103 PREV PAGE TOP OF DOC Segment 5 Of 5
Most of the definitions say that ''United States'' means ''the several states, the District of Columbia, and the various territories and possessions of the United States.'' Some definitions also clarify that federal agencies and corporations are included in the term. The point is that the definitions are written in such a manner as to describe the federal government as an entity which represents the Nation as a whole and is distinct from the individual states. These definitions are consistent with the Constitution which distinguishes between the union of the United States and ''these several States.''
In fact, the Tenth Amendment reiterates this distinction. It reads ''The powers not granted to the United States by the Constitution, nor prohibited by it to the States, are reserved to the states respectively, or to the people.'' Consequently, we believe the most natural meaning of this term in section 3416 is that it refers to the sovereign entity of the entire country.
Mr. BATEMAN. Mr. Fitzgerald, if DOE retains control of NOSRs 1 and 3 and leases them, would the Mineral Leasing Act have to be amended for the government to retain all of those proceeds?
Mr. FITZGERALD. No. As I mentioned in my testimony, the law already authorizes DOE to retain all proceeds from leases of these properties. An exemption to authorize the United States to retain all of the proceeds generated from the NPRs and NOSRs is delineated in the Mineral Leasing Act of 1920. Moreover, when the Act was amended in 1981 to allow states to receive 50 percent of revenues from minerals on lands acquired for military purposes, the specific exception for these reserves was repeated. As the House Armed Services Committee's report on that legislation indicated at that time, the Interior Department supported this exception.
Page 1104 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Mr. Fitzgerald, are you aware of any legislative or regulatory requirement that requires the leasing of the minerals rights on any of the Naval Reserves under the Mineral Leasing Act?
Mr. FITZGERALD. No.
Mr. BATEMAN. Mr. Fitzgerald, in your opinion, would there need to be changes to any laws if DOE were to lease NOSRs 1 and 3? If so, what changes would you recommend?
Mr. FITZGERALD. Yes, several conforming amendments to the Naval Petroleum Reserve Law would be necessary. For example, it contains a provision which limits production to the ''maximum efficient rate.'' This provision historically has been interpreted by DOE to mean ultimate recovery of petroleum, not hydrocarbon or gas which is the resource constituting the primary value of NOSRs 1 and 3. Additionally, chapter 641 contains a provision that precludes commercial development and operation of the reserves in a way that would be competitive with private industry. In order to fulfill the requirement of section 3416 of the Defense Authorization Act that the value of NOSRs 1 and 3 to the United States be maximized, these and any other impediments could be removed by amending chapter 641 in a manner that directs DOE to lease the NOSRs under terms that result in the maximum financial return to the United States ''notwithstanding any other provisions of chapter 641.''
Sale of Elk Hills
Page 1105 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Is the process for the sale of Elk Hills on track for completion by February 10, 1998, and do you believe the current process will allow the government to receive maximum value for the reserve?
Secretary GODLEY. At the present time, the process for the sale of Elk Hills is on tract for completion by February 10, 1998. On May 21, 1997, the Department announced the start of a four-month marketing and sale process that will culminate with the submission of offers by October 1, 1997.
The Department, in conjunction with our investment banker advisors, has designed a marketing strategy and sales process that we believe will create the greatest possible interest in the sale of Elk Hills and, consequently, the greatest possible competition. This competition, in turn, will ensure the maximum return from the sale of Elk Hills.
Mr. BATEMAN. The FY 96 National Defense Authorization Act, which authorized the sale of Elk Hills, requires that all equity interests be finalized between DOE and Chevron in October 1996. In March 1995, you testified before this subcommittee that equity at Elk Hills should not take too long to be finalized because it is a mature field. You subsequently notified Congress in July 1996 that it would take until May 1997 to finalize equity interests. We are now in May.
a. How close are you to finalize equity?
b. Why is it taking so long to finalize equity?
Page 1106 PREV PAGE TOP OF DOC Segment 5 Of 5
Secretary GODLEY. The Department expects to issue the preliminary decisions on final equity for the Dry Gas Zone and Carneros Zone by August 1997, and the Stevens Zone by May 1998. The Shallow Oil Zone, which has been the subject of dispute between the parties for some time, has been delayed and is not likely to be resolved before December 1998. Final decisions will be issued in all the zones after the technical teams from both sides have an opportunity to comment on the preliminary decisions. The agreement executed by Chevron U.S.A. Production Company and the Department permits the sale to continue uninterrupted, notwithstanding the equity finalization schedule.
Equity finalization is taking so long because of its technical complexity and the magnitude of its dollar value impact. Because an adjustment in equity is retroactive to November 20, 1942, literally hundreds of millions of dollars are at stake. As a result, both the Department of Energy and Chevron U.S.A. Production Company are committed to a careful technical analysis, as is Netherland, Sewell & Associates, the firm hired to serve as the Independent Petroleum Engineer.
Mr. BATEMAN. An issue that has come to the attention of the committe is the question of data rooms. I understand that it is standard commercial practice to establish data rooms when selling oil and gas fields. As I understand the proposed process, you will not have data rooms, but rather you would provide individual boxes of data to various bidders and hold briefings for different groups to answer questions.
a. Why are you not following the standard commercial practice?
b. Are you concerned about the possibility that different bidders might receive unequal information through such a process or, at least, some bidders might have such perception?
Page 1107 PREV PAGE TOP OF DOC Segment 5 Of 5
c. What effect could this have on the bidding and on the value of the government would receive?
Secretary GODLEY. In order to stimulate the greatest possible competition for Elk Hills, the Department has solicited offers form all interested and qualified bidders. This approach will produce many more interested bidders than in a private commercial sale. Therefore, because of the greater number of companies likely to participate in the sale of Elk Hills, use of the typical data room was not viewed as optimal. Use of the typical data room process would allow each bidder only 3–5 days in the data room according to when they signed up for entry to the room. Some potential bidders would get entry very late in the process and have a limited amount of time to review relevant data.
In lieu of the more standard data room process, the Department will provide all interested and qualified bidders with the same data that normally would appear in a data room. This data will be provided to all potential bidders within a two-week period, thus affording all potential bidders approximately the same amount of time to analyze the information. Because they will have their own copies of the data, bidders will have the ability to review the data extensively—much more than in a typical process. In addition, the Department will conduct a series of technical briefing sessions for all interested and qualified bidders. The presentations will be the same for each session so that all attendees will receive the same information.
This process was recommended by the Department's investment banker advisors. We believe that this process will allow bidders to have more information for a longer period of time than the standard practice, and will result in the maximum return to the government from the sale of Elk Hills.
Page 1108 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. I understand that the plan is to let for bid a fair amount of Elk Hills in 2% shares. Was this aimed at trying to encourage more bidding from the smaller players?
Secretary GODLEY. Approximately one quarter of the government's share of Elk Hills will be offered in two percent segments. This approach will permit small and mid-sized independent producers and refiners, either alone or in consortia, to obtain interests in Elk Hills. At the same time, this strategy will increase the number of entities capable of bidding on Elk Hills, thereby increasing competition and resulting in a higher return to the government from the sale.
Mr. BATEMAN. Let me ask you point blank: Do you believe that you can complete this sale by February 10, 1998 and receive maximum value for the government or do you think you need more time to do it and do it right? If you need more time, how long do you think you need?
Secretary GODLEY. At this time, I am confident that the Department can complete the sale of Elk Hills by February 10, 1998, and receive the maximum value for the government. On May 21, 1997, the Department announced the start of the formal solicitation process with bids due by October 1, 1997. This should allow ample time to evaluate the bids, submit the Department's recommendation of the highest offer to Congress for the required 31-day ''lie-before'' period, and complete the sale by February 10, 1998.
Disposition of the Other Petroleum Reserves
Page 1109 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Could you explain why DOE did not accept the recommendations of the independent review for the disposition of the remaining oil and oil shale reserve?
Secretary GODLEY. DOE concurs with the independent consultant's recommendation that the United States retain its interest in NPR–3 (Teapot Dome). However, with respect to the remaining four Reserves, DOE's recommendations are different than those recommended by the independent consultant. The independent consultant recommended the outright sale of the other four Reserves, whereas the DOE recommendation for their disposition is primarily through transfer to the Department of the Interior for leasing. The DOE rationale for transfer for leasing rather than outright sale as recommended by the independent consultant is unique to each property and is explained in the following paragraphs. These DOE recommendations reflect the recommendations that were presented to Congress in our March 1997 Report.
NPR–2
DOE does not concur with the independent consultant's recommendation to sell all of the United States' interest in NPR–2. The difference in the net present value estimated by the independent consultant for sale as compared either to retention by DOE or transfer to the Department of the Interior is about $1 million. The estimated sale value, however, assumed that the sale of NPR–2 would cost only $300,000, based on costs that would be typical in a private sector sales transaction. Based on its experience in conducting the sale of NPR–1 (Elk Hills), the DOE estimates that the actual transaction cost would more likely be in the range of $500,000 to $800,000, depending on the costs of environmental assessments, reserve report requirements, and other sale preparation activities. DOE therefore is unconvinced that the sale of NPR–2 would result in a significantly greater economic benefit to the United States than would continued Government ownership.
Page 1110 PREV PAGE TOP OF DOC Segment 5 Of 5
Furthermore, NPR–2 is a significant habitat for a number of endangered or threatened animal and plant species protected under the Endangered Species Act (ESA). A transfer of ownership of the property to a private sector buyer would carry with it the responsibility of compliance with the ESA and consultation with the U.S. Fish and Wildlife Service for the continued protection and management of endangered and threatened species at NPR–2. However, the Department of the Interior has expressed its deep concern that ESA values would be lost if NPR–2 were sold, noting that ESA obligations incurred by a Federal agency are of a higher magnitude than those incurred by private owners. Continued Government ownership of NPR–2 would provide for the continued rigorous protection of endangered species on the property.
DOE does, however, recommend the sale of the United States' interest in the 16.7 acres of town lots within Ford City. The independent consultant assigned no value to any mineral interests underlying the town lots, but assigned a fair market value of $288,000 to them if sold for residential or commercial use. These lots hold no uniquely Federal value, and should be divested through sale or other appropriate disposition.
NOSR–1 and NOSR–2
With respect to NOSR–1 and NOSR–2, DOE does not concur with the independent consultant's recommendation. DOE believes that NOSR–1 and NOSR–2 have intrinsic value to the Nation which, together with their potentially large, long-term economic value, outweighs any near-term financial gain that may be realized through a sale of these properties. DOE therefore recommends the transfer of NOSR–1 and NOSR–2 to the Department of the Interior for leasing under the Mineral Leasing Act and surface management under the Federal Land Policy and Management Act.
Page 1111 PREV PAGE TOP OF DOC Segment 5 Of 5
There are unproved yet potential substantial natural gas deposits within both NOSR–1 and NOSR–2. And although the independent consultant assigns little or no value to that resource under continued Government ownership, DOE believes sale of NOSR–1 and NOSR–2 should not be considered until more information and a fuller understanding of the potential mineral resources is obtained. The Department of the Interior could develop that information and understanding through leasing and other activities under the Mineral Leasing Act.
Additionally, although sale of the NOSR–1 and NOSR–2 properties might produce the greatest immediate fiscal benefit, DOE believes that benefit is not substantial enough to outweigh the value of public access to the substantial recreational, scenic, and biological values associated with public surface management opportunities at these sites. The transfer of NOSR–1 and NOSR–2 to the Department of the Interior for surface management under the Federal Land Policy and Management Act would retain the properties in the public domain for multi-purpose usage.
Furthermore, with respect to NOSR–2 only, DOE recommends, in particular, consideration of the inclusion of the Green River Area within the national wild and scenic river system. Transfer of NOSR–2 to the Department of the Interior would also allow full consideration of the claims and request of the Ute Indian Tribe Protection of Native American petroglyphs and burial sites on the reserve is a real concern. Claims of the Ute Indian Tribe, which already maintains surface ownership of 40 percent of the reserve, need to be resolved. All of these issues can be addressed in a systematic manner, if the Reserve is maintained in the public domain for the foreseeable future under management by the Department of the Interior. Transfer of NOSR–1 and NOSR–2 to the Department of the Interior therefore would ensure public access to the properties and secure the opportunity for the United States to maximize the full value of their mineral rights in the future, as mineral prospects are further explored and evaluated.
Page 1112 PREV PAGE TOP OF DOC Segment 5 Of 5
NOSR–3
In regard to NOSR–3, DOE disagrees with the independent consultant's recommendation to sell the United States' interest. The independent consultant estimated the net present value of the option of transferring NOSR–3 to the Department of Interior for leasing under the Mineral Leasing Act to be only $2.8 million, as compared to $5.5 million under sale option. The difference was attributed primarily to the fact that, under the provisions of the Mineral Leasing Act, half of the revenues resulting from leasing activities would be paid to the State of Colorado. The independent consultant therefore concluded that an outright sale of the property would generate the greatest revenues to the Federal Government.
However, the Mineral Leasing Act's requirements of payment of 50 percent of leasing revenues to the State in which the Federal land is located is based on the apparent determination by Congress that such assignment carries value to the Nation as a whole. DOE therefore believes that the total estimated value of the leasing option, including the share that would go to the State of Colorado, should be considered in determining the disposition of NOSR–3. According to the independent consultant, the market value of a bonus that would be paid to lease the developed acreage of NOSR–3 would be close to what the property would sell for outright (royalty burden considered), or approximately $4.2 million. Other revenues generated by leasing, after cost offsets, totaled about $5.46 million, an amount nearly the same as the estimated sales value of $5.54 million. As estimated by the independent consultant, therefore, the total value that the United States and Colorado, together, would realize under the lease option is nearly equal to the estimated sale value.
Page 1113 PREV PAGE TOP OF DOC Segment 5 Of 5
In addition, as with NOSR–1 and NOSR–2, the sale of NOSR–3 would forfeit significant potential value in future, currently unknown minerals development potential. In this connection, the independent consultant heavily discounted the value of the potentially large, but as yet undeveloped, natural gas reserves. DOE believes that, after transfer of the undeveloped acreage to the Department of the Interior for leasing in accordance with the Mineral Leasing Act, even a marginal leasing program on the undeveloped acreage would ultimately ensure royalty revenues to the United States that would exceed the independent consultant's estimated difference between sale and transfer to the Department of the Interior. Minerals leasing on NOSR–3 property also would eliminate Government operation of a purely commercial activity, and return this property to the private sector for commercial development of the minerals.
Finally, and again similar to NOSR–1 and NOSR–2, there is significant intrinsic value in maintaining public access to the recreational, scenic, and biological values associated with public surface management opportunities at NOSR–3. The transfer of NOSR–3 to the Department of the Interior would retain the property in the public domain for multi-purpose usage.
Accordingly, DOE recommends the transfer of NOSR–3 to the Department of the Interior for leasing and surface management in accordance with the Mineral Leasing Act, Federal Land Policy and Management Act, and other applicable statutes. DOE's recommendation would result in nearly the same net present value as the sale option as estimated by the independent consultant; secure the opportunity for the United States to maximize the full value of the mineral rights in the undeveloped acreage in the future, as mineral prospects are further explored and evaluated; and ensure public access to the property. Because the Department of the Interior has expressed concern about possible environmental contamination on portions of NOSR–3, however, the transfer of NOSR–3 would be subject to a prior determination of the appropriate allocation of responsibility for environmental restoration and remediation. Pending such determination, DOE would retain and continue to operate NOSR–3 under the Naval Petroleum Reserve law.
Page 1114 PREV PAGE TOP OF DOC Segment 5 Of 5
To expedite the development of the potential value of the acreage from which natural gas currently is produced after a transfer to the Department of the Interior, DOE recommends that the Department of the Interior conduct a lease sale of the mineral interests underlying such acreage with one year from the effective date of legislation authorizing the transfer and leasing of NOSR–3 property. The lease sale would include the 56 wells, the gathering lines, and related equipment owned by the United States and suitable for use in the exploration, development, or production of hydrocarbons on such acreage.
To ensure that the operation and generation of revenues from the natural gas wells on NOSR–3 continues uninterrupted pending the lease sale, and to avoid costs and administrative burdens associated with transferring management of the operation of the producing properties twice (once to the Department of the Interior and then to the lessees after leasing occurs), DOE would propose to continue to manage and operate this portion of NOSR–3 in accordance with the provisions of the Naval Petroleum Reserve law until such time as the property is leased.
Mr. BATEMAN. In your personal and professional opinion, how could the Federal Government realize the maximum return to the treasury if Congress decides to allow leasing of the mineral rights on the Naval Petroleum Reserves?
Secretary GODLEY. The recommendations that DOE made in its March 1997 Report, with respect to leasing these other petroleum and oil shale reserves, will maximize return to the U.S. Treasury. However, if Congress does not agree with DOE's interpretation of considering benefit to the State as a benefit to the U.S. Treasury, then maximum value could only be realized if it were clear that the Department of the Interior was required to deposit 100 percent of the leasing revenues in the Treasury (i.e., Congress authorized leasing without being subject to the Mineral Leasing Act (MLA)). The MLA's requirement of payment of 50 percent of leasing revenues to the State in which the Federal land is located is based on the apparent determination by Congress that such assignment carries value to the Nation as a whole. DOE therefore believes that the total estimated value of the leasing option, including the share that would go to the State, should be considered in determining the disposition.
Page 1115 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Please explain exactly what your plans for NPR–2, Buena Vista, California would be under DOE's recommendation. Are there any special environmental concerns with this property?
Secretary GODLEY. DOE's recommendation for the disposition of NPR–2 is outlined in our response to a previous question, above. That response, which includes a discussion of environmental concerns, is repeated here in its entirety.
DOE does not concur with the independent consultant's recommendation to sell all of the United States' interest in NPR–2. The difference in the net present value estimated by the independent consultant for sale as compared either to retention by DOE or transfer to the Department of the Interior is about $1 million. The estimated sale value, however, assumed that the sale of NPR–2 would cost only $300,000, based on costs that would be typical in a private sector sales transaction. Based on its experience in conducting the sale of NPR–1 (Elk Hills), the DOE estimates that the actual transaction cost would more likely be in the range of $500,000 to $800,000, depending on the costs of environmental assessments, reserve report requirements, and other sale preparation activities. DOE therefore is unconvinced that the sale of NPR–2 would result in a significantly greater economic benefit to the United States than would continued Government ownership.
Furthermore, NPR–2 is a significant habitat for a number of endangered or threatened animal and plant species protected under the Endangered Species Act (ESA). A transfer of ownership of the property to a private sector buyer would carry with it the responsibility of compliance with the ESA and consultation with the U.S. Fish and Wildlife Service for the continued protection and management of endangered and threatened species at NPR–2. However, the Department of the Interior has expressed its deep concern that ESA values would be lost if NPR–2 were sold, noting that ESA obligations incurred by a Federal agency are of a higher magnitude than those incurred by private owners. Continued Government ownership of NPR–2 would provide for the continued rigorous protection of endangered species on the property.
Page 1116 PREV PAGE TOP OF DOC Segment 5 Of 5
DOE does, however, recommend the sale of the United States' interest in the 16.7 acres of town lots within Ford City. The independent consultant assigned no value to any mineral interests underlying the town lots, but assigned a fair market value of $288,000 to them if sold for residential or commercial use. These lots hold no uniquely Federal value, and should be divested through sale or other appropriate disposition.
Mr. BATEMAN. Are you aware of any legislative or regulatory requirement that requires the leasing of the minerals rights on any of the Naval Reserves under the Mineral Leasing Act?
Secretary GODLEY. The DOE is not aware of any existing legislative or regulatory requirement which mandates that the mineral rights on any of these reserves must be leased under the Mineral Leasing Act.
Mr. BATEMAN. Is it your understanding that the DOE currently has the authority to lease lands in the Naval Petroleum Reserves?
Secretary GODLEY. The DOE currently has authority to lease lands in the Naval Petroleum Reserves, however that authority is severely limited. DOE is not authorized to develop the oil shale reserves. Production may only take place to protect its resources from drainage to private wells located off of the reserves or in the event production is required for national defense purposes. Due to this restriction, leasing by DOE, without the authority to develop the reserves, is not a viable option.
Page 1117 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. Have you been able to estimate what the potential revenue would be if the viable lands in the NPR were leased for mineral development? If not, could you provide these estimates to the committee when they are available.
Secretary GODLEY. According to the independent consultant, the market value to the U.S. Treasury that would be achieved if each of the other Naval Petroleum and Oil Shale Reserve properties were leased for mineral development by the Department of the Interior, after cost offsets, would be as follows:
As determined by the independent consultant, leasing is assumed to take place subject to the Mineral Leasing Act, therefore these values reflect the sharing of all leasing revenues with the particular State that each property is located within. These values are dependent upon the leasing assumptions utilized, and thus would change as assumptions are redefined.
Sale of Elk Hills
Mr. BATEMAN. Can you please explain to us the agreement that will allow you to proceed with the sale without finalizing equity and yet not compromise value? How can that happen?
Secretary GODLEY. On May 19, 1997, DOE and Chevron entered into an agreement (termed the ''Decoupling Agreement'') which fixes DOE's and Chevron's (1) future interests in respective participation percentage shares of production from each of the unitized zones (Dry Gas, Shallow Oil, Stevens, and Carneros) and the currently non-unitized Asphalto Zone and (2) respective ownership interest in the facilities and equipment. These matters are fixed for purposes of the sale and future operations unless modified by the parties after closing. This agreement was necessary to provide certainty of ownership to the bidders so as to assure that maximum value is received by the U.S in the sale.
Page 1118 PREV PAGE TOP OF DOC Segment 5 Of 5
Because final equity may differ from the sales equity used in the Decoupling Agreement, the agreement contains provisions which address the financial adjustment which will occur between the DOE and Chevron. The adjustment for the prospective value will be based on winning bid(s), and the retrospective adjustment will be based on historical product sales prices. We believe the agreement will ensure that the U.S. receives maximum value for its ownership interests and that the bidders have the certainty they need to bid aggressively for the asset.
Mr. BATEMAN. I understand that you have been considering possible inclusion of language in the contract for bids allowing for a requirement to set aside a percentage of the oil for small refiners. As you know, there is no provision for such a set-aside in the authorizing sale legislation. Wouldn't such a set-aside lead to lower bids because it will constrain the buyer(s) flexibility to use their oil? Why do you want to include such set-aside language?
Secretary GODLEY. Before any provision is included in the purchase agreement which establishes a small refiner set aside, the Department will assure itself that the provision does not negatively affect the U.S. sales proceeds. This, in part, could be achieved by limiting the duration of the set aside and by requiring that small refiners pay market value for the crude oil.
DOE has explored the possibility of such a provision due to the reliance by small refiners on access to the light Elk Hills crude oil and the importance of such refiners to the local economy. These policy considerations are evident in the naval petroleum reserves Production Act of 1976, Pub. L. 94–258, which opened up Elk Hills for maximum efficient rate production and contained a small refiners set aside provision.
Page 1119 PREV PAGE TOP OF DOC Segment 5 Of 5
Mr. BATEMAN. What's there to prevent small refiners from bidding on Elk Hills? I mean can't they as well as anyone else bid straight out for some share of Elk Hills? Or, alternatively, can't they get together with other folks, form a consortium for the express purpose of bidding on Elk hills?
Secretary GODLEY. The Elk Hills sales strategy that the Department has developed in conjunction with out investment banker advisors, CS First Boston/Petrie Parkman, consists of offering approximately three quarters of the government's share of the field in a segment large enough to constitute an ''operatorship interest'' in Elk Hills. The remainder of the field will be offered in two percent segments of non-operating working interests to allow small companies, alone or in consortia, the opportunity to obtain interests in the field. This sales strategy has been designed to maximize the value of the assets, allow all qualified bidders to compete on an equitable basis, and create a sales process that does not preclude small and mid-sized independent producers and refiners from bidding. While small refiners could, alone or in concert, bid on Elk Hills, even a 2% segment will command a price that may be out of reach for such a group.