Defence PFI’s

We recently produced a quick listing of defence related PFI’s as a precursor to having a more in depth look at defence related Private Finance Initiative (PFI) deals.

PFI’s are simply an extension of a traditional lease or outsourcing contract and intrinsically there is nothing wrong with the concept, organisations all over the world enter into similar arrangements for cars, plant, machinery, photocopiers, super tankers, IT services and plethora of other things that can be ‘financed’ or ‘contracted out’

An example is the Future Strategic Tanker Aircraft (FSTA) that is replacing the VC10 and Tristar in RAF service. The aircraft, servicing, training regime and all other elements are provided to the MoD on a service basis. The RAF will not own the aircraft but will simply contract for services from AirTanker, the winning consortium. The term used is a ‘usage and performance based service delivery contract’

It has been reported that the lead finance provider for the consortium is HBOS with Lloyds TSB and others, the same HBOS and Lloyds TSB that the UK taxpayer now more or less owns.

So that would be the taxpayer owned bank lending to a private company at commercial rates to enable them to lease back to the taxpayer the equipment that we can’t afford to buy, makes sense!

The aim of the PFI system is to harness private sector efficiency and willingness to share risk to provide public sector services in return for long term assured contracts and regular payments. PFI’s are often associated with the current Labour government but the first ones in the UK were introduced by John Major’s Conservative government.

The then opposition (Labour) fiercely attacked the PFI concept, siding with the unions to describe them as privatisation by the back door. In a piece of irony that should not be lost on anyone Alistair Darling, who at the time was a shadow treasury spokesman, was quoted in the Guardian in 1992, saying “apparent savings now could be countered by the formidable commitment on revenue expenditure in years to come”

Since gaining power the Labour Party has fallen on the concept of PFI like the proverbial ‘tramp on chips’ or for our US readers, a ‘bum on fries’

In many ways the PFI is not bad; it has allowed the UK Government and MoD to implement projects that simply would not have been affordable in the short term, at least within the context of a falling defence budget.

But short term gain certainly equals long term pain.

The current Chancellor of the Exchequers words from over a decade ago are coming home to roost and structurally, the PFI has proven to have many disadvantages, made worse by the global financial crisis and unforeseen usage of equipments due to a decade of conflict.

The global economic situation has resulted in a drastic reduction in the available credit supply so the original concept where the private sector carried the finance risk and costs of operation in return for a stable and long term profitable contract has evaporated as the public sector has had to pick up the funding slack. In March of this year the Government announced that it was providing £2billion worth of loans to PFI providers so they could continue with a number of schemes.

This ludicrous situation means that in effect we are lending to the private sector so they can charge us for the privilege.

Returning to the FSTA, the largest ever PFI and so complex it took 10 years to negotiate and finalise the small print, the deal has now been concluded but the cost of finance has inevitably risen and who will cover the cost of that seems unclear.

Vince Cable MP said of PFI’s

“The whole thing has become terribly opaque and dishonest and it’s a way of hiding obligations. PFI has now largely broken down and we are in the ludicrous situation where the government is having to provide the funds for the private finance initiative”

Philip Hammond, Conservative Treasury spokesman, said

“If you take the private finance out of PFI, you haven’t got much left . . . if you transfer the financial risk back to the public sector, then that has to be reflected in the structure of the contracts. The public sector cannot simply step in and lend the money to itself, taking more risk so that the PFI structure can be maintained while leaving the private sector with the high returns these projects can bring. That seems to us fairly ridiculous.”

Putting aside the finance risk issues for one moment it is also interesting to look at other value for money and operational effectiveness issues.

The private sector, when approaching such deals, will deploy its most effective personnel, those with years of experience in the tough commercial environment and these will be teamed with ex MoD employees, both military and civilian.

The MoD will face down these corporate alligators with its own collection of civilian and military staff supplemented with the best external consultants and legal advisers money can buy.

Once the deal has been signed the private sector will ensure that those responsible for the financial running of the deal i.e. profitability, will be of the highest calibre, most experienced and with a degree of long term commitment to the role that is not matched by MoD military and civilian staff on their promotion spines and fast tracks.

On one side, long term continuity and the other, 2 year postings.

One of the core principles of PFI was to bring private sector rigour and efficiency to the traditionally inefficient public sector so that despite accepting that the PFI provider would make a profit, the overall cost would still be less than the traditional public sector method.

This has simply failed to materialise and in its 2007 report the Public Sector Accounts Committee noted.

The Treasury has done little to apply what it has learned from the large number of PFI deals that have now been signed. There has been no improvement in tendering times, significant risks to value for money continue to be taken when public authorities make late changes to deals, and there is a continuing lack of skills and experience in public sector PFI teams. As a result, there are signs that market interest is weakening, with fewer serious bids for recent deals.

Another core principle was that of competition, with lots of work on offer it was argued that the public sector would be falling over themselves to provide the lowest bid, obviously an advantage for the public purse. Alas, this has also failed to materialise with large merged consortia bidding for PFI contracts, some PFI’s have attracted little interest. Our Example, the FSTA was competed by only two bidders and the Heavy Equipment Transporter attracted 2 bids

Real data on PFI value for money is hard to come by because of our old friend, commercial confidence, so the true picture is difficult to determine. It may be that PFI offers fantastic value for money but does anyone think that if this were the case the underlying data would be available for scrutiny?

In 2005 the MoD produced the Private Finance Unit Operational Report that assessed how it’s PFI’s had performed to date. In a manner of asking a child to mark their own exam papers it concluded that they substantially deliver projects on time, on budget, performing well, delivering the services required and finally, that long term PFI’s retain the flexibility to accommodate changes. We will have a look at the flexibility to accommodate changes theme later in this post.

The report is full of pie charts, references to ‘good or very good’ and a plethora of other tractor manufacturing statistics.

Well that’s all right then, move along, nothing to see here!

Interestingly, no successor report has been published.

There had been a thinly disguised zeal for the PFI concept from the Labour government, so much so that it is obvious that the bidding process has been distorted to such a degree that no PFI = no project.

On the Military Suppliers and News website in March 2006 the Combining News Newsletter quoted David Ruff (a former MoD PFI Team Leader)

We have also seen a shift from the dogma of “PFI is the answer, now what is the question,” to a much more confident approach to procurement, as much intent on ensuring the UK’s defence industrial base, as securing very best value for money

In its 2008 report, the National Audit Office provides some information on the true scale of MoD PFI’s payments. The NAO is a very trustworthy organisation providing rigorous analysis but is limited to the financial and project management aspects, it does not and of course should not look at military need or effectiveness, this is the role of the House of Commons Defence Select Committee but they rarely look at PFI as a self contained issue meaning that effective oversight across a range of financial and operational aspects is lacking.

However, the report concluded that the despite the MoD being praiseworthy in many aspects of PFI management the 8 projects it examined as case studies; Heavy Equipment Transporter, Field Electrical Power Supplies, Medium Support Helicopter Aircrew Training Facility, Armoured Vehicle Training Service, Main Building Refurbishment, Defence Animal Centre, Defence Fixed Telecommunications Service and Tidworth Water & Sewerage would be at moderate to significant risk of failing to deliver value for money.

Take a look at the detail contained in the report, especially starting from Page 26.

It is well known that variations or VO’s are loved by the contracting industry the world over, deviations from contract arrangements are leapt on with zeal by any contracts manager worth his salt.

The NAO report states that repairs needed to the equipment in the case of the Heavy Equipment Transporter will be funded by the MoD should temperatures fall outside agreed parameters, road surfaces vary from the contract, or should weights of carried equipment vary from contract.

Oh dear, you know whats coming next don’t you…

The superlative road infrastructure in Afghanistan and the up armouring of Challenger and Warrior weren’t in the contract so the word I am looking for here is kerching…

How about the ‘stealth generators’ of the Field Electrical Power Supplies contract, ah, they only worked up to 45 Degrees C so should the temperature in Iraq and Afghanistan ever go beyond that and impair functionality, that might impose undue wear and tear and need repairs. Who would have thought when the contract was awarded in 2002 (ten years after Op Granby in, err, Iraq) that we would be operating in hot and dusty places. yes, you guessed it, kerching…

The MoD guaranteed CAE, HSBC and Serco that the Medium Support Helicopter Aircrew Training Facility (MSHATF) would be used for a minimum number of hours up to the contract end in 2037 (yes, the MoD can see that far ahead) but as at the date of the report that target was not met. Paying for something that has not been used is bad enough but should the MoD need more, that will be £250 per hour please. How the Merlin MK3a, Puma modifications and other changes to the helicopter fleet recently announced impact this PFI is yet to become public.

These are just three examples where one might argue that the potential for poor value for money could be easily realised or be at risk.

The MoD has over 50 active PFI’s many that dwarf those three case studies.

Of course, things have moved on since the report was published but significantly it did not examine the large projects like the FSTA, Skynet satellite service or the massive accommodation projects.

It is one thing engaging a PFI for long term infrastructure projects but using PFI as a vehicle for warlike equipment, transport and tanker aircraft, combat engineering plant or tank transporters is simply nonsense and represents very poor value for money.

The justifications are often skewed in the favour of PFI and the real cost is often under reported because it is so complex to do so or shrouded in commercial confidence. To stretch out the payment profile and improve attractiveness we enter into decades long contracts often making operational or usage commitments in contract that fly in the face of the MoD’ s financial short termism.

The bow wave of PFI payments is going to dramatically decrease the available spend and ability of the MoD to react to a changing strategic landscape.

The real winners are the banks, lawyers and consultants.

The losers, well, you decide.

Tags: PFI