Air Force Utility Privatization Saves Real Money

National Defense Magazine

Albert B. Krachman

Krachman, Albert. B.The Air Force utilities privatization program has realized significant savings for the government, while also encountering some regulatory growing pains. Recent project accomplishments include saving $19.3 million in natural gas costs per year at a $1.1 million transaction cost, reducing water consumption by 28 percent, and reducing electric system outages by almost 40 percent. The program has saved the Air Force an estimated $520 million over the 50-year life cycle of projects, compared to continued government ownership.

With the current Department of Defense focus on energy security, this is good news. But the program still faces some open issues in the areas of labor standards and terminations that will need to be resolved in the future.

There are 270 Air Force utility systems left to evaluate for privatization. Because of the program’s success, the Air Force is adjusting the intake of new systems for evaluation so that it can match procurement resources with the number of systems in review. 

The Air Force has recognized maintenance, operations and upgrades of the four main utility systems, electric, natural gas, sewer and water, are not a core competency and, where appropriate and cost effective, should be privatized.

The Air Force had approximately 159 “privatized” or owned-by-others utility systems before the Congressional utilities privatization authorization, Title 10 U.S.C. § 2688, in 1998. The majority of these legacy systems are with airport authorities where National Guard bases resided or on overseas installations in host nations under Status of Forces Agreements.

Congress enacted Title 10 U.S. Code §2688 to provide statutory authority for the service secretaries to solicit and transfer ownership of Defense Department utility system infrastructure. It allows the Air Force to transfer ownership of existing utility distribution systems to private, municipal, regional, district, or cooperative utility companies or other entities where such conveyance demonstrates long-term economic benefits. Procurement of the underlying commodity is not part of utilities privatization.

Subsequently, DoD issued direction to the service secretaries to privatize utility systems. These directives were based on two premises: Utility system ownership and its associated operation and maintenance is not a DoD core competency, and utility systems on DoD installations must be restored to, and reliably maintained at, industry standards. Using the various policies and guidance, the Air Force has privatized 68 installations.

To reach a decision to privatize, the Air Force uses a two-step process. The first step is a Federal Acquisition Regulation Part 41 contract process. The second part is a decision to convey (transfer ownership permanently) to the successful offeror based upon economics. The question is whether it is cheaper in the long run to privatize, or to maintain government ownership of a utility system.

The key metric used under the privatization program is the government’s “should-cost” estimate. This is the cost the government would incur to restore and maintain the system to industry standards. The should-cost figure is ultimately compared to the offers the Air Force receives after solicitations are issued through the standard Federal Acquisition Regulation process. The Air Force evaluates the received proposals and makes a determination as to whether or not it’s more cost-effective to divest the system.

Currently, there are 64 (out of the 270 left to evaluate) systems in some stage of the privatization analysis. The chart below shows the total number of systems at the various stages of the privatization analysis.

Because of the 2013 budget sequestration, the Air Force has imposed a strategic pause on new utilities privatization starts. The Air Force expects to lift the pause in the near future once funding is realigned to support new awards.

Developing a utilities privatization solicitation is a time-consuming effort because every utility system has unique characteristics totally dependent on where, when and how it was installed.  Also, some state laws may require state-specific terms to be included in a request for proposals. The process starts with creating an inventory list of all the components that make up each system.  This takes about six months. Then, the utilities privatization project management office works with the Defense Logistics Agency Energy, the centralized contracting office for the Air Force and Army programs, to create a request for proposals. DLA Energy distributes the proposal request using FedBizOpps.

After the proposal release, DLA Energy hosts a kickoff meeting at the base to acquaint the potential responders to the systems being privatized, to solicit questions about the inventory and the RFP. DLA will answer those questions as a single reply to all interested parties. The interested parties then decide if they want to submit a proposal.

DLA Energy establishes a proposal submission suspense date. Once proposals are received, it manages the evaluation process with technical support from the utilities privatization office. The agencies then deliver formal presentations to the source selection authority. The SSA is the person responsible for making the final award decision.

Near the end of the evaluation process DLA Energy will ask for final proposal revisions from each respondent. If the SSA decision is to award and the economics are favorable for conveyance, the new system owner, in concert with the base, starts a transition period that can last from six to 18 months. Once a bill of sale is signed, the contract starts and the base and the contractor begin a 50-year relationship to maintain, operate and upgrade the privatized system.

Sometimes, unique issues arise. As the program was beginning, there were unresolved questions on whether the only bidders eligible for privatization awards were holders of the state utility franchises covering the installation’s location. Disputes have also arisen over the government’s responsibility to compensate the contractor for improvements after a termination. Also, most proposals include exceptions or qualifications that must be negotiated.

The competitive acquisition process cantake time before the SSA makes a decision. Since many of these 50-year contracts can be worth over $200 million, the agencies step cautiously through the entire process to ensure best value for the taxpayer.

Historically, the rate of successful awards was only 25 percent of evaluated utilities. Officials are confident that the award rate should go over 60 percent in the next few years. Last year, the Air Force award rate was 50 percent, and it is expected to be the same in 2016.

The application of the Davis-Bacon Act, which requires contractors and subcontractors to pay locally prevailing wages, has been a problem, but efforts are underway to address the issues. The reporting requirements of this law can be a major burden for small entities, such as rural electric cooperatives, resulting in some co-ops having second thoughts about competing.

There are also questions of insurance and liability. Bases have been hit by catastrophic events such as a Hurricane Sandy and Katrina, and responsibility for service restoration or catastrophic loss is an important issue. While privatized utilities have demonstrated faster recovery times from those disasters, working through recovery plans is sometimes a complicated piece of the negotiations.

Termination for convenience exposure is also considered on a case-by-case basis. The Air Force does an upfront cost estimate for convenience terminations based strictly upon the contractual requirements. In case of actual termination due to Base Realignment and Closure or other circumstances, there can be legal issues.

Despite some pre-conceived notions that some contracts may be tailored for the local area utility, there is actually healthy competition in most cases. The Air Force has worked with industry members over the years to improve their processes, and industry has improved their proposals. The Air Force has found that the newer proposals are more realistic and more in line with available budgets, helping to increase the rate of successful awards.

If a competitive award is not made, the Air Force is required to evaluate the local provider for the potential to make a sole source award using a similar FAR-based contract decision and economic conveyance decision.

Capturing data for privatization metrics is a new effort. The Air Force is working on creating metrics to determine improvements in system reliability and evaluate them across the entire Air Force privatized utilities portfolio.

“Air Force Utility Privatization Saves Real Money,” by Al Krachman and Richard Weston was published in the July 2016 edition of National Defense Magazine. To read the article online, please click here.

Al Krachman is a senior partner at Blank Rome LLP, whose practice includes utility privatization transactions and litigation. Richard Weston is the Air National Guard liaison to the Air Force Civil Engineer Center, at Tyndall Air Force Base, Florida. His office evaluates all of the Air Force utility systems for privatization.