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Report blasts 767 tanker deal, says Boeing overcharging up to $4.5 billion

By David Bowermaster
Seattle Times aerospace reporter

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As early as today the inspector general of the Department of Defense is expected to release a scathing review of an Air Force proposal to obtain 100 Boeing 767 refueling tankers, congressional sources said.

The report urges the Pentagon not to move forward with the $23.5 billion transaction unless hefty changes are made to remedy procedural and financial flaws that violate federal rules and could cause the government to spend up to $4.5 billion more than necessary, according to a seven-page executive summary reviewed by The Seattle Times.

The report surfaces as the deal enters a critical four-week period that could clear the way for 767 tanker production to proceed at Boeing's Everett plant or cause the government to scrap the existing plan.

Besides the inspector general's report, the Defense Department general counsel, the National Defense University and the Defense Science Board on May 1 are expected to release three additional reviews of the 767 tanker negotiations and the need for the planes.

The outcome will have a major impact on the longevity of Boeing's 21-year-old 767 program.

The $23.5 billion deal A review of the Air Force's proposed deal with Boeing for 100 767 refueling tankers by the Defense Department inspector general details how the money would be spent, and contends many of the figures are too high: $7.9 billion — 100 "green" 767s $1.0 billion — Boeing and Air Force tanker development $4.2 billion — Tanker modifica- tions $4.8 billion — Logistics support $4.3 billion — Lease financing and cost escalation $1.1 billion — Training $200 million — Other costs Source: Seattle Times reporting

Boeing has just 22 767s left in its production backlog, including three refueling tankers for Italy, one for Japan and the first tanker for the U.S. Air Force, which is moving through the assembly line even though a contract has not been signed.

At today's production rate of roughly two 767s every three months, Boeing has only enough 767 orders to keep the line active through the first quarter of 2006.

"We believe the tanker deal is alive and well," Leslie Nichols, a spokeswoman for the 767 program, said earlier this week. "If the U.S. Air Force decides not to go ahead with the deal, that's the time when we would decide about the future of the 767. We aren't going to speculate. It feels premature."

Jim Albaugh, the chief of Boeing's Integrated Defense Systems unit, expressed optimism about the deal at a Washington, D.C., press breakfast Tuesday.

"I think the tanker deal will get done this year," he said. "Supporting the warfighter will come ahead of any other issue that might be out there."

The proposed tanker is not the only military jet that depends on the 767 airframe.

Last May, the Air Force issued a contract for initial development of the E-10A, the next-generation battlefield command-and-control aircraft set to replace the 707-based AWACS planes.

The E-10A, which would be vital in any future war, will be a modified 767-400 with a bulging underbelly containing electronic sensors and communications systems.

Because of that appendage it would be difficult to switch from the 767 to the 7E7 airframe, which has a composite fuselage.

The 7E7 is expected to replace the 767 as a commercial jet when it enters service in 2008.

The first E-10A is expected to be delivered to Wichita for modification in 2005. Unfortunately for Boeing, the $5.3 million initial development funding for the E-10A is also under budget pressure. Stephen Cambone, undersecretary of defense for intelligence, is questioning the project's priority, according to Air Force magazine.

The pipeline's running dry Pending orders for the 767 production line in Everett: All Nippon Airways - 8 Japan Airlines - 5 Ethiopian Airlines - 2 Turkmenistan Airlines - 1 Uzbekistan Airlines - 1 Plus, 5 military tankers will go from Everett to Wichita, Kan., for modification: • 1 for the U.S. Air Force (on hold). • 1 for the Japanese air force, due for delivery in 2007 (needs to leave Everett for Wichita only in 2006). • 3 for the Italian air force, due for delivery in 2006, 2007 and 2008 (next one needs to leave Everett only in 2005). The current production rate is approximately two jets every three months, as slow as is possible without stopping altogether. Excluding the tankers, which are either on hold or for longer-term delivery, the remaining 17 jets could nominally keep the line going for two years, through 2006. However, 13 of those 17 are for delivery to the two large Japanese carriers, which are considered vital prospects for the launch of the 7E7, the successor to the 767 that will go into service in 2008. The more time passes, the stronger the pressure will grow for the Japanese airlines to convert their 767 orders to 7E7s.

On the tanker deal, Inspector General Joseph Schmitz urges in the summary of his report that the Defense Department follow one of three options to fix the deal.

In the best option for Boeing, Schmitz advises the Pentagon to alter 14 aspects of the deal before moving forward with the existing plan to lease 20 767s tankers and purchase 80 planes.

In the worst case, Schmitz advises the Pentagon to start from scratch and "initiate a new major Defense acquisition program based on the results of an analysis of alternatives for military tanker aircraft."

In the third option, Schmitz advises the Pentagon to make the 14 changes and obtain an initial subset of the 100 tankers, but initiate an analysis of alternatives for the balance of the aircraft.

The report is notably critical of the plan to lease 20 aircraft, which has drawn particular criticism from opponents of the deal, including Sen. John McCain, R-Ariz.

According to the report, the lease arrangement as presently structured "did not meet three of six criteria for an operating lease" required by the Office of Management and Budget, and "will increase Air Force costs by at least $560 million more than purchasing the aircraft."

The Air Force would pay $7.9 billion for 100 "green" 767s fresh off the production line in Everett. The list price for a commercial 767-200ER is $101 million to $112 million, according to Boeing's Web site, suggesting a 20 to 25 percent discount for the Air Force.

Yet Schmitz's report asserted even that price "could be overstated from $530 million to $2.4 billion based on an analysis ... of a higher discounted price appropriate for a significant competitive order."

Similarly, the report said the Air Force relied on "questionable comparisons" with other aircraft programs and Boeing engineering data when it agreed to pay $4.2 billion for tanker modifications.

Schmitz said an analysis by the Institute for Defense Analysis using alternative data found that modification price could be "overstated by at least $951 million."

The $4.8 billion cost of logistics support also "included a $465 million error," in the form of misapplied costs from another program, the report added.

Michael Wynne, acting undersecretary of defense for acquisition, is withholding comment on the inspector general's report until the Pentagon studies due May 1 are complete, Schmitz wrote.

Marvin Sambur, the assistant secretary of the Air Force for acquisitions, "nonconcurred" with the inspector general's conclusions.

"We disagree with the assistant secretary's comments and are standing by our findings and recommendations," Schmitz wrote.

Seattle Times aerospace reporter Dominic Gates contributed to this report. David Bowermaster: 206-464-2724 or dbowermaster@seattletimes.com

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