Defense Infrastructure:

Management Issue Requiring Attention in Utility Privatization

GAO-05-433: Published: May 12, 2005. Publicly Released: May 12, 2005.

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Department of Defense (DOD) installations have about 2,600 electric, water, wastewater, and natural gas utility systems valued at about $50 billion. In 1997, DOD decided that utility privatization was the preferred method for improving utility systems and services and the Congress approved legislative authority for privatizing utility systems at military installations with Public Law No. 105-85. Because of the costs and long-term implications of DOD's utility privatization program, GAO reviewed the program to determine (1) the program's status, (2) whether the services' estimates of long-term savings from utility privatization projects are reliable, (3) how DOD implements the fair market value requirement for conveyed utility systems, and (4) whether other issues impact the effectiveness of DOD's execution of the program.

DOD's progress in implementing the utility privatization program has been slower than expected, largely because of the complexities of the solicitation and contracting processes. In 1997, DOD initially expected that the services would privatize or exempt all utility systems by January 2000. Yet, after spending about $248 million on program implementation, the services had privatized only 94 systems and exempted 311 systems of the 1,499 utility systems determined to be available for privatization as of December 31, 2004. Although DOD reset implementation target dates and established September 2005 as the current goal for the services to make decisions to privatize or exempt all systems, DOD officials stated that it was unlikely that the services would meet the revised goal. Utility privatization can provide for quicker system improvements than otherwise might be available; however, there are questions about program savings. Although the services' economic analyses estimate that utility systems privatized to date will reduce the government's costs for utility services, GAO questions the estimates because they give an unrealistic sense of savings to a program that increases ongoing government utility costs in order to pay contractors for enhanced utility services and capital improvements. Other base support services could suffer unless budgets are adjusted to reflect these increased costs. Moreover, GAO found that long-term cost comparisons did not depict actual expected costs of continued government ownership in the event that systems were not privatized and DOD had not taken steps to ensure that the estimates were otherwise reliable. As a result, GAO found in the seven cases it reviewed that the services' analyses included inaccuracies that tended to favor the privatization option over continued government ownership. Although the services are permitted latitude in ensuring that the government receives fair market value for systems conveyed to privatization contractors, in some cases implementation has resulted in higher contract costs for utility services. Contractors normally include the full amounts they paid for conveyances in the associated utility services contracts and, therefore, the government will pay back the amounts received over time. In some cases, contractors also include additional amounts in the contracts to cover costs associated with the fair market value payment. Thus, implementing the fair market value requirement in such cases results in higher contract costs because the government will pay back more than it will receive for conveying the systems. Two additional issues of concern identified by GAO related to limited oversight of privatization contracts and DOD's preferred practice of permanently conveying utility systems to contractors rather than using more limited arrangements which, according to DOD consultant reports, is a more prevalent private sector practice and one which may offer greater safeguards to the government.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: In response to our May 2005 report, Defense Infrastructure: Management Issues Requiring Attention in Utility Privatization (GAO-05-433), the Congress modified DOD's utility system conveyance authority and added a reporting requirement on the use of section 2688 of title 10, United States Code, to convey all or part of a utility system. The National Defense Authorization Act for Fiscal Year 2006 requires the Secretary of Defense to submit to congressional defense committees an analysis that demonstrates the economic benefit to the government before entering into a contract for the conveyance of all or part of a utility system. In addition, the act changes the requirement for the Secretary to receive fair market value for each utility system conveyance, limits the contract term to convey utility systems to 10 years unless the Secretary demonstrates that a longer term to be cost effective, and limits the number of systems to be conveyed in fiscal years 2006 and 2007. The act also requires the Secretary issue a report to congressional defense committees on the department's use of the utility system conveyance authority provided in section 2688, title 10. Specifically, the act requires the report to contain a (1) discussion of the methodology used to conduct the economic analyses of proposed utility system conveyances, (2) list of the steps taken to ensure the reliability of the economic analyses, (3) review of the costs and savings resulting from utility system conveyances, (4) discussion of the feasibility of obtaining fair market value, (5) discussion of the effects that permanent conveyance may have on the renegotiate of contracts for utility services, (6) comparison of the value of contracts to permanently convey a utility system versus contracts that include reversion of the system back to government ownership, (7) discussion of the efforts and direction within DOD to oversee implementation and use of the utility system conveyance authority, and (8) discussion of the effect of utility system conveyances on the operating budgets of affected military installations.

    Matter: On the basis of DOD's comments on our recommendations, Congress may wish to consider requiring DOD to address the issues and recommendations discussed in this report before proceeding with further utility privatization efforts.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: In comments on the final report, DOD partially concurred with this recommendation. DOD commented that it is developing the modeling tools needed to more accurately predict long-term program requirements. According to DOD, because these tools will allow DOD to more closely align planned expenditures with requirements, this recommendation will be realized. However, according to DOD, until the tools are mature its estimate of the "should cost" to provide utility services at the appropriate standard is the most accurate measure of the projected long-term requirement for a particular system to be retained by the government. DOD stated that it plans to continue to (1) use the appropriate industry standard in determining the long-term costs to the United States for utility services provided by the utility system concerned, and (2) develop tools for better predicting the requirements for providing adequate utilities services. However, DOD did not change its method for preparing the economic analyses and considers this recommendation closed.

    Recommendation: As long as savings are expected to be a key factor in utility privatization decision making, the Secretary of Defense should direct the Deputy Under Secretary of Defense (Installations and Environment) to revise the guidance for preparing economic analyses so that the analyses compare the cost of a proposed privatization contract with the cost of continued government ownership on the basis of the actual planned expenditures and the timing of these expenditures.

    Agency Affected: Department of Defense

  2. Status: Closed - Implemented

    Comments: On November 2, 2005, DOD issued supplemental guidance for its utilities privatization program to address the issues raised in our report. Specifically, the supplemental guidance requires DOD components to ensure that independent reviews are conducted of all economic analyses supporting proposed utility privatization projects. At the minimum, the reviews are to verify that all relevant guidance has been met and that the privatization option is in the best interest of the government. The guidance further specifies that for the reviews to be considered independent they are to be performed by personnel with the appropriate analytical expertise and who are independent from the team that conducted the original economic analysis for the source selection authority.

    Recommendation: The Secretary of Defense should direct the Deputy Under Secretary of Defense (Installations and Environment) to require an independent review, perhaps by DOD headquarters or the services' audit agencies, of the economic analyses supporting proposed privatization projects.

    Agency Affected: Department of Defense

  3. Status: Closed - Implemented

    Comments: On November 2, 2005, DOD issued supplemental guidance for its utilities privatization program to address the issues raised in our report. Specifically, the supplemental guidance requires DOD components to consider and plan for increased costs for utility services contracts resulting from potential privatization projects and system conveyance and to prepare operation and maintenance budgets based upon the expected costs under utilities privatization.

    Recommendation: The Secretary of Defense should direct the Deputy Under Secretary of Defense (Installations and Environment) to provide general program guidance emphasizing the need to consider increased utility costs under privatization as the military services prepare their operation and maintenance budget requests.

    Agency Affected: Department of Defense

  4. Status: Closed - Implemented

    Comments: On November 2, 2005, DOD issued supplemental guidance requiring each procurement contracting agency to publish standard operating procedures that incorporate the military department's guidance for establishing fair market value of utility systems being considered for privatization.

    Recommendation: The Secretary of Defense should direct the Deputy Under Secretary of Defense (Installations and Environment) to place greater scrutiny on the implementation of the fair market value requirement in proposed contracts to minimize cases where contractors recover more than the amounts they paid for system conveyances.

    Agency Affected: Department of Defense

  5. Status: Closed - Implemented

    Comments: On November 2, 2005, DOD issued supplemental guidance for its utilities privatization program to address the issues raised in our report. Specifically, the supplemental guidance requires the Defense Energy Support Center--the DOD contracting center of expertise for utility privatization--to develop specific pre-award and post-award procurement procedures for the effective management of utilities services contracts resulting from utilities privatization. In addition, the guidance requires the Center, in coordination with the Defense Acquisition University, to develop a training program for all contracting officers and DOD components involved in utilities privatization.

    Recommendation: The Secretary of Defense should direct the Deputy Under Secretary of Defense (Installations and Environment) to issue program guidance, specific to utility privatization, emphasizing the importance of contract oversight.

    Agency Affected: Department of Defense

  6. Status: Closed - Implemented

    Comments: DOD concurred with this recommendation and stated that it had reassessed this issue since our prior report on utilities privatization. Consequently, most utility services contracts resulting from a utility conveyance includes a contract clause that provides an option for the government to purchase the system at the end of the contract period. According to DOD officials, where conveyance with a full title transfer is uneconomical, the DOD components have been encouraged to consider conveyance of a lesser estate if it will reduce long-term costs to the government.

    Recommendation: The Secretary of Defense should direct the Deputy Under Secretary of Defense (Installations and Environment) to reassess whether permanent conveyance of utility systems should be DOD's preferred approach to obtaining improved utility services.

    Agency Affected: Department of Defense

  7. Status: Closed - Implemented

    Comments: On November 2, 2005, DOD issued supplemental guidance directing DOD components to prepare operation and maintenance budgets based upon the expected costs under utilities privatization. If significant shortfalls are anticipated that will impact utilities privatization, the components are required to notify the Deputy Under Secretary of Defense (Installations and Environment) during the annual program review or earlier, as appropriate.

    Recommendation: The Secretary of Defense should direct the Secretaries of the military departments to ensure that installation operations and maintenance budgets are adjusted as necessary to reflect increased costs from utility privatization projects.

    Agency Affected: Department of Defense

  8. Status: Closed - Implemented

    Comments: On November 2, 2005, DOD issued supplemental guidance for its utilities privatization program to address the issues raised in our report. Specifically, the supplemental guidance requires the Defense Energy Support Center to develop specific pre-award and post-award procurement procedures for the effective management of utilities services contracts resulting from privatization. DOD's supplemental guidance also requires that the procedures for transferring contract administration from the Procuring Contract Office to a Contracting Administration Office follow the Federal Acquisition Regulations and be coordinated with the DOD component soon after the source selection authority decision. The guidance also directs the Contracting Administration Office to coordinate with the Procurement Contracting Officer and the DOD component to ensure that contract administration efforts are adequately resourced.

    Recommendation: The Secretary of Defense should direct the Secretaries of the military departments to issue specific utility privatization contract administration guidance including the clear assignment of responsibilities and ensure that resources are provided to perform adequate contract oversight.

    Agency Affected: Department of Defense

 

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