16 March 2010

Renegotiating the Long Term Ammunition Agreement

There is an article, Thales contracts in Combet’s sights, by John Kerin in the 15 March 2010 edition of The Australian Financial Review, which can only be described as an ill-informed beatup.

After informing us that:

Defence Materiel Minister Greg Combet has ordered a review of all “poor value for money” long-term Defence contracts with industry as part of a $20 billion drive to cut wasteful spending.

Kerin goes on to tell us that:

Government sources have told The Australian Financial Review that the Defence Materiel Organisation has had the Thales arrangements in its sights since at least 2006, suggesting the contracts were drawn up in the “bad old days” when the plants were transferred from government to private ownership (ADI) and before regular performance-base contracting.

Having been directly involved as Secretary to the Department of Defence in the closing stages of the privatisation of Australian Defence Industries (ADI) I can attest that the form of the contract had nothing to do with the bad old days before Dr Gumley took up the reins at the Defence Materiel Organisation, and everything to do with the Howard Government’s objectives in privatising ADI, namely, to maximise the proceeds of the sale.

By way of background, Australian Defence Industries was the corporate vehicle into which the Hawke Government had gathered up all of the assorted manufacturing and service-providing activities that had been directly owned by the Department of Defence.  Until its privatisation it was a government corporation with its own CEO and Board, but a wholly owned entity of the Department of Defence. Its assets included the Captain Cook Graving Dock at Garden Island, the contract to build six modern minehunters, the ammunition factory at Benalla and the propellant plant at Mulwala, the so-called Long-Term Ammunition Agreement with Defence, and an assortment of smaller plants and businesses.

In one of the first conversations I had with then Defence Minister Ian McLachlan on taking up duty in February 1998, he told me that the Department of Finance (Office of Asset Sales) was complaining that Defence was dragging the chain on completing the provision of the due diligence data required for the privatisation. He told me that I was to have the process completed in four weeks. I told him that I would look into it and get back to him.

On looking into the matter I quickly ascertained that the jewel in ADI’s crown was the Long Term Ammunition Agreement, under which ADI had a contract to provide Defence with certain ammunition natures for a twenty-year period from the date that the munitions factory at Benalla commenced operations in 1995. It was that agreement that put the value into the factories at Mulwala and Benalla. I read the 250-odd pages of the agreement from cover to cover, and came upon the clause that said in effect that Defence could give its wholly owned entity one-month’s notice to terminate the Long Term Ammunition Agreement, would meet all the costs of winding up the relevant operations of ADI, but would not be liable for any other costs.

I went back to Mr McLachlan and said that without a renegotiation of the LTAA, to give the buyer contractual certainty, the Commonwealth would have virtually nothing to sell. Who would pay for a contract that had 17 years to run, but could be wound up without compensation at one month’s notice? He agreed, I said we would complete the matter without delay, and would have all outstanding matters dealt with in weeks, not months, and we did.

The point of this tale is to make the point that the Howard Government’s privatisation strategy for ADI was shaped by its desire to get as much money as it could for the business, as quickly as possible.  It was sold by public tender, and the Transfield-Thomson CSF Joint Venture (the original purchaser) paid a price that reflected what they perceived the LTAA was worth to them. For its part, the Commonwealth capitalised that expected profit stream. If the Commonwealth had placed more stringent performance conditions or less certainty on the contract, that would have been reflected in a reduced price. The Joint Venture got what it paid for, and the Commonwealth was paid the best price it could obtain for what it chose to sell.

Over ten years on, it is entirely appropriate that Defence consider what arrangements it wants to make for the acquisition of the hundreds of ammunition types that it purchases. Everyone has always known that the LTAA was a fixed term arrangement, and that there were no understandings, explicit or implicit, about what would happen after it expired. This is the ordinary course of business and is not a reflection on either Defence or Thales, the current owner of the ammunition facilities and the LTAA.

It is interesting that the only other one of the “older poor value long term contracts” that rates a specific mention relates to the Collins-class submarines:

Another long-term contract under renegotiation is Adelaide-based submarine builder ASC’s $3 billion, 15-year maintenance contract on the troubled Collins-class submarines.

There seems to be a bit of a pattern emerging from this and other reports by Kerin. It seems that nothing that happened in the defence acquisition world prior to the advent of Dr Gumley was quite up to scratch, and similarly, ASC’s performance since he ceased to be the CEO there has been distinctly below par. I wonder where Kerin gets those impressions from?

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