The Referendum on Separation for Scotland: Separation shuts shipyards - Scottish Affairs Committee Contents

2  Shipbuilding in Scotland

4.  There are three major shipyards currently operating in Scotland: Govan and Scotstoun in Glasgow, and Rosyth in Fife, all of which rely on military contracts for their workload.[4] Rosyth is the centre of activity for the Aircraft Carrier Alliance—a joint venture between Babcock Marine, BAE Systems, the Ministry of Defence and Thales—currently building two Queen Elizabeth Class aircraft carriers for the Royal Navy. The yard at Rosyth sustains over 1,000 jobs. Govan and Scotstoun are operated by BAE Naval Maritime and employ near 2,800 people.[5] The Govan and Scotstoun yards have built seven warships since 2004,[6] including six Type 45 destroyers for the Royal Navy. The final one—HMS Duncan—started sea trials in 2012. BAE staff based at Scotstoun are designing the forthcoming Type 26 frigate.

5.  The Queen Elizabeth aircraft carriers, the largest surface ships ever constructed for the UK,[7] have involved shipyards across the UK in building sectional blocks for the carriers. The blocks have been transported by barge from yards in Glasgow, Liverpool, Devon, Tyneside and Portsmouth, to be assembled in a specially constructed dock at Rosyth. The Govan yard received considerable investment in advance and has achieved the largest share of block construction.[8] Research by the University of Strathclyde's Fraser of Allander Institute in 2009 suggested the UK warship building supported 15,000 jobs across the wider supply chain and contributed £600 million a year.[9]

Why the UK builds its own warships

6.  The UK never willingly builds warships outside the UK. Peter Luff MP, the then Minister responsible for procurement in the Ministry of Defence, told us that the UK had not built a warship outside the UK for 200 years except in times of crisis:

We built warships during the Second World War outside these shores. They were not complex warships but simple things like the so-called Landing Ship, Tanks, which were the brainchild of Winston Churchill—a thousand of them were built in the United States of America to enable amphibious attacks on the D-Day beaches, for example—and we built some 200 or 300 wooden minesweepers around the world during the Second World War in bizarre places like Tel Aviv, Bombay, Cochin, Singapore, Burma and Canada; so we have built ships [...] but as to complex warships, I honestly think the answer is not for a couple of hundred years.[10]

7.  This was reiterated by Philip Dunne MP, the new Minister for Defence Equipment, Support and Technology, who said "Other than during the world wars, we have never placed an order for a warship outside the United Kingdom."[11]

8.  The principle reason the UK builds warships at home is that it wants to be able to maintain the ability to do so without having to rely on any other nation. Ian Godden, Chairman of Farnborough International, told us that building a complex warship is comparable to hi-tech construction projects "like the Olympic Village or a new railway line or airport."[12] so maintaining the capability to build these warships means retaining the particular skills. This was recognised in the 2005 Defence Industrial Strategy:

The build of warships extends beyond the simplistic view of steelwork and its assembly, incorporating an amalgamation of skills, facilities, technologies and knowledge. In particular, it is the high complexity, value added aspects of ship build and platform integration that must be maintained under UK sovereignty.[13]

[...] This was necessary to enable the UK to mount military operations from the UK base, and it is not effective to develop advanced, high-value skills needed for specialist hull construction or complex assembly tasks each time.[14]

9.  Scotland has these skills. Importantly, complex warships, such as the Type 45 destroyers or the Queen Elizabeth Class aircraft carriers, are built in the UK because some of the technology involved is militarily sensitive. The Ministry of Defence is, understandably, careful as to who has access to, and knowledge of, the weapons systems on its warships, and keeping such information secret enables the UK to retain military effectiveness. Furthermore, building such warships in the UK contributes to the economy and the wider supply chain and the Treasury benefits from the tax revenue.[15]

EU rules on open competition and Article 346

10.  In general, EU law, under the Treaty on the Functioning of the European Union (TFEU), prohibits action that interferes with open competition across the EU. Signatory countries are required to advertise major contracts and open them to competition across the EU. There are several exceptions, chief of which is the use of Article 346 of the TFEU when a member state decides it is necessary to protect national security interests.[16] Peter Luff MP, the then Minister of State in the Ministry of Defence responsible for procurement, quoted Article 346 to the Committee and explained how it was applied:

Article 346 [...] of the Treaty on the Functioning of the European Union, known as article 296 in previous treaties, makes it very clear, and I quote, that "any Member State may take such measures as it considers necessary for the protection of the essential interests of its security which are connected with the production of or trade in arms, munitions and war material; such measures shall not adversely affect the conditions of competition in the internal market regarding products which are not intended for specifically military purposes". In other words, where we think our security depends on this, the Commission does allow us to procure within the United Kingdom.[17]

He explained how the UK Government decided when to exempt defence procurement using Article 346:

The test that we apply as a country is a test of operational advantage and freedom of action. We believe in our ability to maintain an operational advantage and a competitive edge over our enemy. We want to do it ourselves and we want to guarantee that we can actually maintain that action and not depend on foreign countries to maintain that action.[18]

11.  Les Mosco, Director Commercial, Defence Equipment and Support, said that the UK Government does not have to make an application for an exemption under Article 346; it defines its own security requirements and awards the contract as it sees fit:

We satisfy ourselves internally in the MoD that the requirements of 346 are met, under the kind of circumstances described in the European procurement regulations that define when you can and cannot use 346. If we think it is a 346 case, we satisfy ourselves of that internally and then proceed.[19]

12.  So, at the moment, if the UK uses Article 346, it can favour companies within the UK—including Scotland, England, Wales and Northern Ireland. The award of such contracts is open to challenge from another member state, but Mr Mosco could not recall any situation where the UK had been challenged when it had decided to use Article 346.[20]

How does this apply to shipbuilding?

13.  The next big order from the Ministry of Defence is for the Type 26 frigate, also known as the Global Combat Ship. The Type 26 frigates are to replace the Type 23 frigates, which are the current core of the Royal Navy front-line fleet, carrying out a range of tasks such as counter-terrorism, anti-piracy, safeguarding trade routes, and responding to humanitarian and security issues around the world.[21]The Strategic Defence and Security Review proposed there would be 13 Type 26 frigates.[22] They are planned to be built at a rate of one ship a year with the first one coming into service around 2020.[23] The first five are to be basic frigates and the next eight will have additional anti-submarine capability. Each frigate is expected to cost £250-£350 million.[24]

14.  The Type 26 frigate contract represents the final part of the Terms of Business Agreement between BAE Systems and the MoD.[25] (We discuss the TOBA more fully below.) Duncan McPhee, Unite Shop Steward, BAE Systems, Scotstoun, gave evidence to the Committee following a meeting between the shipbuilding unions and Peter Luff MP, Minister responsible for procurement at the MoD. Mr McPhee said:

The specific question that was asked to get the UK Government's position on this was, "In an independent Scotland will we be allowed to tender for the contracts?" It was made quite clear that we would not because we will be a foreign country. I believe that under article 346, if they [the MoD] were considering placing that order in a foreign country, it would have to be opened up EU-wide and possibly worldwide. [...] That, to me, would mean that, unless an independent Scottish Government could provide equivalent-type orders, we would be greatly reduced or completely finished as a shipbuilding industry.[26]

Mr Luff subsequently explained to the Committee what he had told the unions:

When we come to build the new Type 26 frigate—the Global Combat Ship—we will have to apply for an exemption under article 346 to enable us to build it within the United Kingdom without contracting it. That means that, if Scotland is separate, we cannot build it in Scotland.[27]

The new Minister with responsibility for procurement, Mr Philip Dunne MP, reiterated this to the Committee:

Other than during the world wars, we have never placed an order for a warship outside the United Kingdom. It is not our intention to do so with the Type 26.[28]

15.  And as Professor Malcolm Chalmers, Royal United Services Institute, told us:

If Scotland were to become independent before decisions had been made about where to build new Type 26 frigates, for example, I do not understand what political make-up could in those circumstances make the UK Government place those orders in Scottish yards if there were, as there are, alternative places to build them in England.[29]

16.  If, for whatever reason, the UK chose not to apply Article 346 to the Type 26 contract, then it would have to make the contract available through open competition. If this was the case, and if Scotland was a separate country, then Scotland would have to compete internationally.[30] Indeed, witnesses said there would be no advantage to the UK for it to offer the contract to Scotland exclusively, without an open tender, if Scotland was outside the UK. It would open itself to challenge from someone else in the EU, and as Professor Trevor Taylor, Royal United Services Institute, pointed out to us: "Why not compete it? If you are not going to give national preference, you might as well compete it."[31]

17.  Putting out such a contract to international tender has a precedent. The Ministry of Defence put the initial contract to build the Military Afloat Reach and Sustainability fleet—commonly known as MARS tankers—out to international tender in 2007. The programme originally consisted of six tankers and five support and logistical vessels.[32] Crucially, the Ministry of Defence took the decision to open the contract to competition as it did not classify the MARS tankers as warships. The contract, with a value of £596 million, was awarded to Daewoo Shipbuilding and Marine Engineering in South Korea.[33]

18.  The UK has consistently built its own warships. It wants to retain the capability to design, build and maintain such warships in this country, keep the skills and industry to do so, maintain freedom of action over its own navy, and because of the sensitivities around some of the equipment involved.

19.  EU law requires major procurement contracts to be offered for open competition. Member states can use various exemptions to place contracts with preferred suppliers. One such exemption, Article 346, allows countries to exempt defence procurement on the grounds of national security. The UK has consistently excluded the construction of complex warships from open competition using Article 346. If Scotland was a separate country, then the Ministry of Defence could not use Article 346 to favour shipyards in Scotland because they would no longer be within the UK.

20.  In those instances in which the Ministry of Defence has decided not to exempt contracts on the grounds of national security, it has then been obliged to offer the contract for tender internationally. In such a situation, any shipyards in Scotland would have no preferential status and would have to bid for the contract on the same basis as other international yards.

The Terms of Business Agreement

21.  The previous Government's Defence Industrial Strategy, 2005, set out that it was necessary to retain the capability to build warships in the UK because of the need to "develop and support military capability throughout its life; and the ability to mount operations from the UK base."[34] This need to retain that capability, so the UK was not reliant on anyone one else for warships, contributed to the Ministry of Defence developing the Terms of Business Agreement, or TOBA, with BAE Systems. As Vice Admiral Andrew Mathews, Chief of Materiel (Fleet), Defence Equipment and Support, put it:

The purpose of the deal was to get them [BAE] to a place where we had an affordable shipbuilding industry, high performing and benchmarked across world class, that delivered us the future warships that we wanted without getting that loss of capability. That was the purpose of the deal.[35]

22.  The TOBA guarantees BAE a minimum level of surface ship build and support activity from 2009 to 2024 worth £230 million each year.[36] In return, BAE has to retain the capability to design and build complex warships within the United Kingdom—the TOBA is with BAE Systems, not just BAE and the Scottish yards. The need for this commitment, as Professor Taylor, said, came out of the experience leading up to building the Astute Class submarines, "where we left too big a gap and allowed a skill run-down to occur in Barrow", and the realisation that a work force needs to have continuous work to keep a satisfactory skill base.[37] BAE found that it could not interchange the skills between surface ships and submarine yards. Dr John Louth, Royal United Services Institute, told us:

There is quite a strong evidence base that BAE Systems could not just raid surface competencies and skills because they were not a neat enough fit. They had to have time to develop, plan and refresh the skills and competence base for the Astute programme. Indeed, much of the cost overruns and the delays with Astute were in some ways associated with the regeneration of that skills base.[38]

23.  So, in trying not to repeat these mistakes, the TOBA was introduced to manage the workforce and skill requirements for the three surface ship programmes (Type 45 destroyers, Queen Elizabeth Class aircraft carriers, and the Type 26 frigates), and was based on the understanding that the workforce size would vary because, as Mr Dunne said: "you don't need as many people to build a frigate as you do an aircraft carrier".[39] Vice Admiral Mathews, explained the numbers involved:

When we let the terms of business agreement with what was then BVT, which was a joint venture between BAE Systems and Vosper Thornycroft, the deal was predicated on the fact that we were building the Type 45 destroyers, so around 2,000 people would be employed in shipbuilding. We were then going to go up to between 5,000 and 5,500 employed in shipbuilding during the carrier phase, and then come down to the Type 26 frigate, which would employ about 1,500 people.[40]

24.  The TOBA would require BAE Systems to manage the workforce reduction from over 5,000 to 1,500 for the Type 26 frigate build, but without the loss of skills that occurred with Astute. In effect BAE would come down to "the equivalent overhead of one complex warship building yard".[41] The Royal Navy, with the budget available to it, cannot provide work for all the yards currently at BAE's disposal—Govan, Scotstoun and Portsmouth.[42]

25.  The issue is not just one of reducing the size of the workforce, but also the time between the carrier build phase finishing and the Type 26 build phase starting. The workforce for the carrier programme steeply tails off after 2015 but the Type 26 frigate is still in the design stage, with the main gate decision, "currently" scheduled for "the middle of the decade".[43] Professor Taylor told us that dealing with the combination of a fluctuating workforce and a period between major contracts has created a problem for BAE and the MoD:

It seems fairly self-evident that there is overcapacity in the UK as a whole for shipbuilding. There is a very clear programme of work with a gap in it that includes the Carrier and then the F26 [Type 26]. The decision, which seems to be both a political and programme decision, is where that new ship will be essentially manufactured. There is a choice of three plants and two sites: the Clyde and Portsmouth. [44]

The timing of the Type 26 decision and the TOBA

26.  The conversation between BAE and the MoD, and the timing of the decision as to where the Type 26 would be built is important, as Dr John Louth pointed out:

The programmatic problem is that the people concerned with the design and development of the F26 [Type 26] are, at some time in the very near future, going to have to have some kind of certainty around where it is going to be constructed. Unfortunately, these sorts of programmes have to take into account location of manufacture and fit because the facilities aren't identical. That could complicate the programmatic considerations.[45]

Mr Dunne made it clear that it was for BAE to propose how to manage this:

In relation to the flow between the carrier cessation of build and the commencement of the Type 26, we anticipate there will be a gap. The company is working on how to best manage that, and we are leaving it to the company to come forward with proposals. We will consider those proposals and we will then be in a position to respond and move forward.[46]

27.  BAE has been considering how to manage the problem, and it commissioned LEK Consulting to research how it might best use the three yards while balancing the needs of the TOBA. Reports in the media suggest that BAE favour Govan and Scotstoun over Portsmouth. Indeed, most of the Type 23 frigates were built in the Scotstoun yard when it was known as Yarrow Shipbuilders.[47] The Clyde yards have already received considerable investment in plant and facilities over the last ten years, whereas Portsmouth would require "several tens of millions of investment" to enable the consolidation of a Type 26 vessel, and lacked some of the skills to manage the whole of the Type 26 programme.[48] These are encouraging reports, and given what we have heard about the need to retain capability within the UK, we remain concerned that one of the options open to BAE Systems would be to close the shipyards on the Clyde and keep Portsmouth open, as there is no risk of Portsmouth leaving the UK in the foreseeable future.

28.  If the Type 26 build contract is given to the Clyde yards, then the assumption is that Portsmouth's capability to build warships would be run down. This would leave the UK unable to rely upon an English yard to build a warship without considerable investment and re-skilling.

29.  One way to reduce impact of the gap and keep the workforce occupied would be to order the construction of smaller ships that did not require substantial investment in either Scotland or England—to maintain the 'drum beat' of work. There is the possibility of a £150 million contract to build two Offshore Patrol Vessels (OPVs) in Portsmouth to fill the post Carrier gap and help maintain the numbers and skills employed in shipbuilding in Britain,[49] and we understand the proposal was being discussed but had not been accepted.[50] A similar contract could be placed in the Clyde yards. It was also suggested to us that the workforce could diversify and use their engineering capability in other ways that could keep the skills in Scotland.[51] This may provide alternative employment in the long term, but without firm proposals it is not clear how many jobs might be created and how quickly those who currently build ships would be able to retrain and successfully find alternative employment.

The timing of the Type 26 decision, the gap and the referendum

30.  The proposed statutory timetable for the referendum requires it to be held before the end of 2014. At the moment, the Type 26 main gate decision is due in "the middle of the decade". This further complicates the dilemma as to where to build the Type 26, as Professor Taylor, told us:

It seems that the political and programmatic decision is entwined with the referendum. It seems very difficult to decouple the two. [...] One thing we do know is that the UK has to rationalise its shipbuilding. It must make a decision on where it will anchor tomorrow's shipbuilding.[52]

Dr Louth observed that a scenario where a contract had been signed to build the Type 26 frigates in Scotland, and then Scotland became a separate country would create: "a number of hoops that perhaps we have never really had to jump through before".[53] Philip Dunne said that these complications were not influencing the Type 26 timetable:

The date of the referendum is not influencing the date of the placing of the contract for the Type 26. That is being determined by the maturity of the design, and that is being driven by the defence operational requirements, not the political requirements of the Scottish Government.[54]

While he said his personal view was "the shorter the period to the referendum, the better", he was adamant that the decision was separate from the referendum timetable.[55] It was for the BAE come forward with proposals, at which time the MoD "will consider at that time how those proposals fit in with our plans." Furthermore:

One of the considerations at that time, depending on whether we have or have not had the referendum and which way it goes, will be the consequences in the event of a change in circumstance of the Scottish yards, in the event that that is where the company proposes to build the ships.[56]

Legal implications, contracts and options

31.  This timescale raises the question of the legal implications if a decision is taken to build the Type 26 frigate in Scotland before the referendum date. As we explained earlier, the UK does not build its warships outside the UK and we have been told that it would use Article 346 to exempt the Type 26 build from open competition. If it had already taken the decision to build the Type 26 on the Clyde, and then Scotland became a separate country, the TOBA would remain, and the sovereign state whose capital is London would still want the capacity to design, build and support warships.[57] Scotland would no longer be in the UK and:

Clearly, in the event of separation, that will be a new factor that we will have to take into account. We will be looking at all MoD contracts at that point that are in existence and all those that are in the planning phase, and we will decide what to do about them.[58]

32.  When asked whether the Type 26 contract could have a clause defining where the build must take place, including being moved to stay within the UK, Mr Dunne replied:

There are a great many conditionalities within that. We have to take these things a step at a time. Sitting here today in December 2012, we are not in a position to be able to predict precisely when we will have those contractual negotiations and therefore what the terms of those clauses will be.[59]

33.  The MoD would consider whether contracts should be terminated and the work relocated back to the residual UK,[60] or whether it was prudent to continue some contracts until they were due to end as "it may then be inefficient to remove them."[61] It would be standard practice to include break clauses in contracts, and we are confident that the MoD would include clauses in such large contracts as for building warships. But this would still incur costs, and the concern remains as to how expensive it would be for the Ministry of Defence to withdraw its business from Scotland.

34.  Mr Dunne said that a consideration would be "the capability and the security sensitivity of each contract."[62] And he made it clear that the decision as to how to proceed with some contracts could entail some costs, and that these costs would be factored into the separation negotiations:

As to those contracts that are in progress at that point, it would be a matter for negotiation with an independent Scottish Government as to what would happen to those contracts, the financial implications, who would bear them and where completion would take place.[63]

35.  He conceded that, if a contract had already been signed, that the best value deal might include continuing to build the Type 26 on the Clyde even if Scotland was outside the UK.[64] These considerations argue against a decision on the Type 26 build being made before the referendum date, but there is a cost associated with that "delay" that would be very visible as it would extend the gap without work that the TOBA was designed to avoid.[65] Similarly, there would be a cost to allocating the contract to the Clyde and then having to terminate it.

36.  It would appear that holding the referendum, and importantly the timing of the referendum, is becoming more relevant for the defence industry. Ian Godden said the big defence companies had been thinking about the impact of separation for about a year.[66] Professor Taylor said it would be good practice for companies to carry out risk assessments and look how they might mitigate those risks, and if a company was prudent they would be aware of separation and would be doing some scenario planning.[67] Dr Louth said that it was unrealistic to think they would be doing otherwise.[68]

37.  We are confident that the MoD, despite what it say in public, has been doing the same and, as a result, we find it inconceivable that it would make a decision on the Type 26 frigate build before the referendum outcome is known, because the consequences of a yes vote in the referendum are too complicated and expensive.

38.  The Type 26 frigate will be built in either Scotland, on the Clyde, or in England at Portsmouth. The decision as to where the Type 26 will be built will be announced in 'the middle of the decade'. The referendum is to be held before the end of 2014. If a decision was made before the referendum date and the contract was awarded to the shipyards on the Clyde, and thereafter Scotland became a separate country, there would be considerable consequent legal and contractual difficulties for the UK. The Ministry of Defence has said that, in the event of separation, it would reassess all its relevant contracts. There would be enormous pressure, because of security considerations, for the Type 26 build to be relocated to remain within the UK. However, this would entail considerable financial costs and these would be factored into the separation negotiations. The lower risk alternative, to give Portsmouth the contract, would incur extra investment costs and the relocation of skilled staff (the design team are in Scotstoun), which would increase the cost of the Type 26.

39.  Essentially, the timing of the referendum is driving decisions for the shipbuilding industry for the wrong reasons, and this is not good news for Scotland. A gap is emerging between the construction phase of the Carrier programme ending and the construction phase of the Type 26 frigate starting. However, the announcement which, though likely to be held in October 2014, could go as late as December 2014.

40.  We are convinced that the MoD will not award the Type 26 contract until after the outcome of the referendum is known. If the result is a 'No' vote, we believe that the work will be carried out on the Clyde, whereas a 'Yes' vote will result in the work being carried out in Portsmouth. The sooner the referendum takes place, the sooner the decision will be made and the sooner there will be an end to the uncertainty.

4   Q 115 Back

5   BAE Systems employs 4,000 people in Portsmouth, 1,500 on shipbuilding; and over 4,000 people in Barrow, Cumbria, on submarines.  Back

6   Scotland Office, Scotland and Defence, March 2010 Back

7   Aircraft carrier: A mind boggling building job, 7 April 2011,, HMS Queen Elizabeth is expected to begin sea trials in 2017. Back

8   Solving the UK's shipyard and skills conundrum, Jane's Defence Weekly, April 2012 Back

9   Solving the UK's shipyard and skills conundrum, Jane's Defence Weekly, April 2012 Back

10   Q 420 Back

11   Q 2016 Back

12   Q 1951 Back

13   Ministry of Defence, Defence Industrial Strategy, CM 6697, December 2005, B2.21-B2.25 Back

14   Ibid., B2.24 Back

15   RUSI, The Destination of the Defence Pound, January 2012 Back

16   Ministry of Defence, February 2012, National Security Through Technology: Technology, Equipment, and Support for UK Defence and Security, Cm 8278 Back

17   Q 380 Back

18   Q 380 Back

19   Q 2041 Back

20   Q 2041 Back

21  Back

22   Q 2012 Back

23   Britain's Future Frigates: Type 26 & 27 Global Combat Ships, Defence Industry Daily, 9 September 2012 Back

24   Naval Technology, Type 26 Global Combat Ship (GCS) Programme, United Kingdom, Back

25   Q 2017 Back

26   Q 113 Back

27   Q 384. See also Q 113 Back

28   Q 2016 Back

29   Q 219 Back

30   Qq 389-396  Back

31   Qq 1949-1950 Back

32   HC Deb 7 January 2013, Col 49W. Scottish Affairs Committee, Sixth Report of session 2007-08, Employment and Skills for the Defence Industry in Scotland, HC 305  Back

33   Q 405 Back

34   Ministry of Defence, Defence Industrial Strategy, CM 6697, December 2005, B2.21-B2.25 Back

35   Q 2022 Back

36   PAC, The Major Projects Report 2010, Supplementary written evidence from the Ministry of Defence, February 2011 Back

37   Q 1951 Back

38   Q 1968 Back

39   Q 2015 Back

40   Q 2022 Back

41   Q 2022 Back

42   Q 1951 Back

43   HC Deb 22 Oct 2012, col 686 Back

44   Q 1941 Back

45   Q 1954 Back

46   Q 2015 Back

47 Back

48   Solving the UK's shipyard and skills conundrum, Jane's Defence Weekly, April 2012 Back

49   HC Deb, 22 October 2012, Col 686 Back

50   Q 1952 Back

51   Q 1951 Back

52   Q 1941 Back

53   Q 1943 Back

54   Q 2018 Back

55   Q 2021 Back

56   Q 2032 Back

57   Q 1942 Back

58   Q 2026 Back

59   Q 2032 Back

60   Q 2028 Back

61   Q 2026 Back

62   Q 2026 Back

63   Q 2028 Back

64   Q 2024 Back

65   Q 1955 Back

66   Q 1890 Back

67   Q 1895 Back

68   Q 1891 Back

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© Parliamentary copyright 2013
Prepared 20 January 2013