Select Committee on Defence Fourth Report


50. The Private Finance Initiative (PFI) has over the last few years become a significant vehicle for funding defence equipment projects, and that trend is set to continue. The MoD currently has 42 PFI projects in operation, bringing some £2 billion of private sector investment into defence, and is looking at the scope for using the PFI in another 40 projects that collectively would bring in up to £12 billion more private sector investment.[105] While the private sector contractors meet the upfront cost of such investments, the MoD pays them charges over the life of the PFI contracts for the services provided using the assets. For the 50 PFI projects that are under contract or are at (or due to move to) preferred bidder stage, annual PFI charge commitments will reach £835 million by 2007-08, or around 3.5% of the Defence budget. The 40 or so potential PFI projects still at a less developed stage, could if they all materialised as PFI deals, double that total annual commitment.[106]

51. The MoD told us that it was conscious of the fact that PFIs could potentially lock up a large part of the defence budget, and that it keeps score of how much of the future budget is absorbed in existing contractual commitments.[107] A notable example is the recently delayed[108] prospective Future Strategic Tanker Aircraft programme, whose service charges will alone more than double commitments already contracted.[109] In such an environment, CDP highlighted the importance of negotiating PFI contracts that do not lock in the same level of MoD demand at the end of the contract period as at the beginning.[110]

Front-line services, and the role of sponsored reserves

52. The potential financial burden of such schemes is not however the only area that the MoD will have to monitor in regard to its expanding PFI programme. Our predecessors examined the risks of moving PFI projects increasingly into front-line activities, and of the reliance in such schemes on 'sponsored reserves' (contractors' personnel with a liability to be engaged on reserve forces terms while performing their normal duties, but in hostile operational environments) rather than Service personnel. For this inquiry, we sought to explore these issues further, and the boundaries of the potential for PFIs more generally, by examining five projects.[111]

  • The Future Strategic Tanker Aircraft (FSTA), in which two potential contractors are bidding to provide an air-to-air refuelling service, replacing existing RAF aircraft.[112]
  • The Heavy Equipment Transporter (HET), where Fasttrax has been contracted to move the army's heavy armoured vehicles.[113]
  • 'Skynet 5', where Paradigm has been selected as preferred bidder to provide new satellites and to manage a military communications service.[114]
  • The Airfield Support Services Project (ASSP), in which bidders have been asked to consider a range of airfield services including fire services, aircraft fuelling, cargo handling and airfield clearance.[115]
  • Combat Support Vehicles, which has now been abandoned as a PFI.[116]

We also re-examined the Ro-Ro sealift programme, one of the projects examined in our predecessors' inquiries.

53. There was a variety of approaches being adopted in regard to the extent to which sponsored reserves are to be used in the case studies we examined:

  • On the FSTA programme, the MoD will retain responsibility for delivery of military capability, with a mix of sponsored reserve, RAF and contractor staff involved.[117]

  • On the HET programme, the contractor will 'operate' the transporter service with a third of the drivers being sponsored reserves.[118]

  • In the Ro-Ro programme, the ships' crews will all belong to the contractor, and be British seafarers eligible to be called out as sponsored reserves when the ships transit 'war-like zones'.[119]

  • Bidders for the ASSP programme have been asked to submit a range of manning options, including a sponsored reserve component of 25% or more to support overseas' deployments of aircraft (though not for fire services, which will be completely Service-manned on deployments).[120]

54. The HET programme is the first PFI with sponsored reserves, and as such the MoD sees it as a pathfinder for other projects.[121] A contract was placed in December last year, and the service will commence in July 2003 (with the full service in July 2004).[122] It was still too soon, therefore, to arrive at firm conclusions about the practical utility of sponsored reserves, and the Minister acknowledged that the Department were to some extent "feeling our way on this".[123] That fluidity was demonstrated in the FSTA programme. To begin with, the MoD will have a mixed manpower, of which at least 75 per cent will be RAF air and ground crews and 25 per cent may be sponsored reserves. Lord Bach explained why this was a sensible strategy to begin with—

    One of the crucial things that we are trying to do is to remain flexible in the way in which we introduce the concept of sponsored reserves and the way in which we run each of our PFI projects. That will mean doing different things in different cases ... We do not know whether that balance would stay the same as FSTA came on line and we had a few years' experience of it. ... To begin with it is important, as a matter of reassurance, ... that there is a fairly large quantity of Service people.[124]

The FSTA contract will include a mechanism to adjust that proportion of the contractor's workforce that the MoD require to hold a sponsored reserve commitment.[125]

55. The role of sponsored reserves raises wider questions about the place of the PFI in the front-line. The previous Defence Committee commented adversely in its reports on the trend towards introducing PFI schemes into activities increasingly close to the front-line. Most recently, in its report on the MoD's annual reporting cycle, it warned of the dangers of PFIs taking control of war-fighting capabilities out of MoD hands.[126] As part of this current inquiry, the MoD stated that the Department "aims to take PFI as close to the front-line as possible", but not "in circumstances where the operational effectiveness of the Armed Forces would be put at risk".[127] CDP told us that—

    I used to have a very simple rule which is that if it does not move, you can always PFI it. If it moves a bit near the front-line, you can think about it. And if it is in the front-line, you should not do it.[128]

By the 'front-line', he told us he meant "fighting,"[129] and continued that—

    If it is right in the front-line and involves fighting, how do you specify that as a service? You cannot, so we should not waste time trying to pretend that things like nuclear-powered submarines could be provided by a PFI. ... The idea of private contractors being near fighting I think is pretty dodgy."[130]

56. Sir Jock Stirrup considered that the ability to deploy contractors' staff on operations, however, was the essence of having sponsored reserves — "that is the reason why they are sponsored reserves: If they are needed on military operations, they will be called up. They will be military personnel, subject to military discipline and military law. That is the point about having sponsored reserves."[131] There are a number of factors by which the MoD assess the appropriate mix of Service personnel at one end of the scale, through sponsored reserves to, at the other end of the scale, 'contractors on deployed operations' (CONDO),[132] which reflects their relative status—

Sponsored Reserves
  • Remain contractors' personnel at all times, and may decline to be deployed.
  • Reserve forces, who train for military service and are liable to be called out.
  • Subject to some aspects of military law, and disciplined through the military chain or via their employer.
  • When called out, are fully subject to military discipline, and are integrated in military chain of command.
  • Operating in mostly benign environments, and do not bear arms.
  • Potentially operating in hostile operational environments, may bear arms and are 'combatants' under international law.
  • Cheaper than Service personnel and sponsored reserves.
  • With intermittent operations, likely to be cheaper than Service personnel.

57. There is also a wider issue here concerning the increasing operational burden placed on remaining servicemen when their numbers are reduced in some disciplines through PFIs or other forms of contractorisation. In our predecessors' inquiry on the 'Policy for People' they heard how with such pressures the MoD was looking to redress the balance of contractor and Service personnel.[133] Sir Jock Stirrup, with his RAF perspective, told us in our current inquiry that such factors had led to efforts in some disciplines to recruit more Service personnel to redress the balance between servicemen and civilians.[134] Indeed, concern about the burden of having too small a cadre of ground crews for servicing tanker aircraft on deployments was a factor that had been taken into account in deciding the mix of contractors and Service personnel for the FSTA programme.[135]

58. But Sir Jock also reminded us that these tanker aircraft crews provided under the FSTA project — whether service personnel or sponsored reserves — would at times have to operate over "hostile territory", and that during the Kosovo campaign tanker crews had been honoured for their military service and bravery.[136] This is clearly "fighting". It therefore seems to us remarkable that, though founded on the use of sponsored reserves, this is an area not regarded to be sufficiently in the front-line to make a PFI service inappropriate. The MoD needs to produce a clear set of criteria to define what constitutes the 'front-line' for the purposes of assessing the potential for using the PFI. The MoD must make a thorough assessment of how well the sponsored reserve concept works in practice for the Heavy Equipment Transporter 'pathfinder', and be prepared to adjust its usage if any limitations on operational effectiveness are revealed.

Third-party revenues

59. The feasibility of several of the PFI projects that we examined hinges on the contractors' ability to generate third-party income when the equipment is not required to support the services provided to the MoD. Our predecessors examined the MoD's arrangements for securing access to the services of the Ro-Ro ships during military operations, particularly for the fifth and sixth vessels that would for most of the time be used by the contractor for commercial third-party work. The FSTA contractors envisage the internal main spaces in the tanker aircraft being able to be readily switched between fuel carriage for the MoD and cargo carriage for third-party customers.[137] In these and other cases, the contractors will be responsible for generating their third-party revenues. The MoD appeared to have a more interventionist role, however, in the Skynet 5 programme. CDP explained that although the onus was on the contractor to acquire third-party customers,—

    to help allies to take advantage of this third-party commercial opportunity, we have a number of memoranda of understanding in place with allies already. They want to know that their information will be looked after properly when it is travelling over the commercial military satellite service. We are doing our bit on the government side to facilitate commercial deals between our supplier, Paradigm, and other allied governments ... Having invested all the money to develop a Skynet 5 satellite effectively, Paradigm will have defrayed all the non-recurring costs of that satellite design, so it should be able to offer that design of satellite very competitively to NATO when NATO wants to replace its existing satellite.[138]

60. The Skynet 5 programme is somewhat unusual in that it also envisages circumstances in which the assets provided under the PFI will be insufficient to support the service to the MoD. Some military communications capacity will be met through commercial alternatives or arrangements agreed with other nations,[139] and the prospective contract will provide for retaining clauses to have access to commercial capacity.[140] CDP pointed out that "the United States is quite happy to rely on commercial satellite support for military operations. We should be too. We should not just confine ourselves to military satellites for all our traffic."[141] We assume of course that Sir Robert does not have in mind the sorts of satellite services that recently made US surveillance video footage from Bosnia inadvertently available to the amateur satellite enthusiast.

61. This minimal-provision philosophy is carried over into the number of satellite launches planned. The programme will involve the launch of only two satellites, as opposed to three in previous MoD satellite programmes (Skynet 5 will supplement and then replace the existing MoD-owned Skynet 4 system). Whereas the MoD in previous conventional satellite programmes acquired three satellites to guarantee against failure, the two new satellites will be "fully insured against failure".[142] CDP explained how the contractors (and indeed the MoD) anticipate that a satellite failure could be accommodated without jeopardising the service delivered to the MoD. He told us that the third satellite in previous programmes was included against the possibility that one might be lost on launch—the single most likely cause of total loss—or would not deploy or work properly when placed in orbit. Having constructed three, he told us, it made sense to launch and use all three. Under the PFI, however, the private finance provider will build two satellites and take out an insurance policy on both successfully achieving orbital performance. It will have to launch the first and second satellites soon enough to give itself time, if needed, to assemble and launch a possible third satellite to maintain the contracted operational capability (based on a combined constellation of Skynet 4 and Skynet 5 satellites—the total signal throughput of Skynet 5 is about two-and-a-half times greater than the present Skynet 4 system).[143] This was less of a risk than it might once have been, though, because Skynet 4 satellites have had operational lives of 6-10 years, which has been longer than previously expected (Skynet 5 satellites will have an expected life of around 15 years).[144] So, while the full Skynet 5 service provision is planned only from 2008 (with an initial operational capability from 2005),[145] at the beginning of the programme there will be capacity on remaining Skynet 4 satellites.[146]

62. We welcome the assurance that Sir Robert Walmsley was able to give us, against that background, about the capability that Skynet 5 will deliver

    There is no satisfaction in having the money in the bank, but not having the satellites. We need the communications and we are quite satisfied that this arrangement will provide a seamless transfer from Skynet 4 to Skynet 5.[147]

    By launching Skynet 5 early enough, taking account of the possibility of failure of the first or second satellite, I am absolutely confident that there is plenty of life left in Skynet 4 to provide a seamless transition.[148]

63. The opportunities for third-party revenues, however, or rather the lack of them, has led the MoD to cancel at least one PFI project. In March 2001, the MoD abandoned a prospective PFI for Combat Support Vehicles, and in its place sought a traditional procurement route for each of the programme's main components—a Future Fuel Vehicle, Future Cargo Vehicle and Future Wheeled Recovery Vehicle. The MoD concluded that a PFI contractor would have limited potential for managing the vehicle fleets innovatively or for generating third-party revenue from them.[149] The vehicles would be widely and thinly dispersed when they are on operations, making it difficult for a contractor to use them for third-party purposes.[150]

64. The Chief of Defence Procurement explained that a number of issues slowly became clearer as the MoD engaged with the companies, particularly on specifying the military features of the vehicles "which actually started to look more specialised the longer we ran the procurement".[151] The Department's appreciation of the limited opportunities for PFI became particularly apparent six months before it pulled the plug, with the fuel distribution crisis of September 2000. In regard to the Fuel Vehicle element of the programme, that episode "taught us all a lot about the elasticity of the petroleum products supply arrangements in this country" and highlighted that "the commercial market does not want tankers some of the time, but it wants absolute access to commercial tanking transport fleets, 24 hours a day, seven days a week."[152] It is remarkable that it took three years of developing proposals and discussions with industry for the difficulties about generating third party income on the Combat Support Vehicles PFIs to become apparent to the MoD.

65. The Combat Support Vehicle PFI was abandoned, despite it seems the availability of capable potential contractors, when the MoD had doubts that contractors could have offered it good value for money terms because of uncertainties about the opportunities for them to manage the vehicle fleets innovatively and to generate third-party income. The position in another PFI programme under our examination—the Ro-Ro ships—is almost the opposite in every way, and despite its difficulties it is still being pursued by the MoD and its prime contractor.

66. Following the SDR, the MoD is acquiring the sealift services of six Ro-Ro ships under a PFI project, to replace the two vessels currently chartered by the MoD. After a competition, the MoD selected AWSR Shipping in October 2000 as its preferred PFI contractor, who would base their sealift service on four new Ro-Ro ships to be built in a German shipyard, and two to be built at Harland &Wolff in Belfast. The MoD and AWSR agreed in December 2000 that the full sealift service would be available from 2003.[153] However, difficulties emerged with the detailed commercial arrangements for the two vessels to be built in Belfast. As a result, the MoD had to take over the shipbuilding contract with Harland & Wolff in March 2001, and the PFI contract itself was only signed late last month[154]—a year later than previously planned. When the two vessels are delivered to the MoD they will be transferred to AWSR for use in the PFI programme.

67. When we challenged CDP about the successfulness of the Ro-Ro programme as a PFI, he was unequivocal — "It is an absolute benchmark of innovative contracting."[155] He pointed out that "it was not us who picked Harland & Wolff. ...AWSR picked Harland & Wolff..."[156] And when problems arose at Harland & Wolff—

    Sitting at the back of this was the fact that we had had a proposition from AWSR which had proved very attractive for us because it had got the service quickly. If you start to consider bids from somewhere else, all that would have been thrown out of the window and there would then have been the question whether we had to reopen the whole competition. ...We found ourselves looking at a proposition which we thought we could make work by a different way and deliver all the benefits of the AWSR bid. That is what Ministers decided to do...[157]

    ...the shipbuilding content of this [programme] is about 20 per cent of the value. The value was going to be provided by a shipping company that had the imagination to see how they could secure commercial deals on ships five and six which would offset the cost of the service to us.[158]

68. The MoD recognised that the division of construction between two yards made the bid more expensive (though still, we were told, cheaper than a traditional MoD procurement[159]), but "the benefit we get is the service sooner, and that is what we want."[160] Despite the difficulties concerning AWSR's contract with Harland & Wolff, the vessels were now under construction (one had been floated) and the two yards had indicated to the MoD that they would be delivered on time, or early, against the contracts.[161]

Conclusions on PFI

69. The MoD is putting a lot of faith (and money) in the PFI, to provide capabilities and services for which it would otherwise buy the necessary equipment outright, including areas that could be regarded as front-line tasks. In such a contentious area we sought some clarity from the MoD, asking it to set out the guidance that Ministers give their officials to help them judge how value for money should be assessed in potential PFI projects. The Department told us that—

70. It is indeed right that 'operational effectiveness' and 'quality of service' should be taken into account. Whether PFI delivers value for money should depend not just on a purely financial balance of costs and benefits, but also on whether risk is managed more efficiently. In the defence field, getting the balance of risks wrong does not just undermine the calculation of the cost-benefit of particular projects; it can have profound consequences for the operational readiness and effectiveness of our Armed Forces, and ultimately for the safety of our Service personnel operating in hostile environments. It is in that context, and despite the Department's guidance, that we remain concerned about the lack of clarity in the use of PFI, particularly its further encroachment into front-line areas. These risks are present in several of the projects that we have examined in this inquiry and are perhaps most glaring in the case of the Future Strategic Tanker Aircraft. In another—for combat support vehicles—we have been able to see the boundary of the potential for PFI, at least on the economic front. In the fundamentally restructured and delayed Ro-Ro ship project, we see the MoD rather than the contractor taking over the risk of the acquisition of some of the vessels—which undermines the supposed advantages and fundamental principles of the PFI.

105   Q 289 Back

106   Ev 144, para 11.1 Back

107   Q 362 Back

108   HC Deb, 17 June 2002, c7 Back

109   Q 367 Back

110   Q 364 Back

111   Ev 78-83 Back

112   Ev 79 Back

113   Ev 80 Back

114   Ev 81 Back

115   Ev 82 Back

116   ibid Back

117   Ev 79, para 12 Back

118   Ev 80, paras 17, 20 Back

119   Ev 89, para 8 Back

120   Ev 143, para 9.2 Back

121   Ev 80, paras 16, 20 Back

122   Q 289 Back

123   ibid Back

124   QQ 290, 292 Back

125   Ev 142, para 8.1 Back

126   Eighth Report, Session 2000-01, The MoD's Annual Reporting Cycle, 2000-01, HC 144, para 23 Back

127   Ev 79, para 6 Back

128   Q 340 Back

129   Q 347 Back

130   QQ 349, 352 Back

131   Q 327 Back

132   Ev 142, paras 9.1-9.11 Back

133   Second Report, Session 2000-01, Strategic Defence Review: Policy for People, HC 29-II, Ev 205 (QQ 656, 657) Back

134   Q 358 Back

135   Q 360 Back

136   Q 328 Back

137   Ev 79, para 11 Back

138   Q 303 Back

139   Ev 81, para 21 Back

140   QQ 298, 299 Back

141   Q 299 Back

142   Ev 81, para 23 Back

143   Q 296 Back

144   Q 305 Back

145   Q 304 Back

146   Q 305 Back

147   Q 297 Back

148   Q 305 Back

149   Ev 83, para 38 Back

150   Q 295 Back

151   Q 331 Back

152   Q 332 Back

153   Ev 88 Back

154   HC Deb, 27 June 2002, c1038w Back

155   Q 46 Back

156   QQ 52, 53 Back

157   Q 56 Back

158   Q 53 Back

159   Q 61 Back

160   Q 60 Back

161   QQ 48, 58, 62 Back

162   Ev 144, paras 10.1-10.2 Back

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