Magazine

Power Play

June 1, 2002

By Shane Harris and George Cahlink

ir Force Lt. Col. Alberto Armesto, who oversees the service's efforts to privatize utilities at its bases, has a folder bulging with glossy, spiral-bound sales brochures from an energy company in his office filing cabinet. The brochures tout "unlimited possibilities" and offer big savings to the Air Force if it turns over its electricity, natural gas, water and wastewater operations to the company. Facing a Pentagon mandate to privatize all utilities by 2003, Armesto was all ears when the firm came knocking in 1998. Defense is well aware of the problems. Indeed, last fall the Pentagon created a utilities and energy office to manage utilities privatization and develop common contracting practices. Previously, no single manager was charged with overseeing the effort. "There are some ugly stories, but that's not where [utilities privatization] will be going in the next 12 months," says Get Moy, who was appointed Defense's director of utilities and energy last fall. Each of the services has pursued different approaches to privatization. The Army is hiring different utility companies to operate systems at each of its bases, while the Navy and Marine Corps are looking for utility providers to oversee systems at multiple bases. The Air Force is testing several approaches to find the one that works best. "Nobody knew what did or did not work, so they tried a lot of different things," says Rick Tempchin, director of energy efficiency and transportation policy for the Edison Electric Institute, a trade association for the electric industry in Washington. The services, prodded by Moy, have taken steps in recent months to improve their utilities privatization efforts. Tempchin says they have made great strides in giving utility companies greater flexibility in bidding on work. Whether the services have turned the corner will be decided in next few years as hundreds of privatization deals valued at hundreds of millions of dollars are made. John Nerger, the Army's director of facilities and housing, says the service will no longer focus on solely privatizing one base at a time, but will allow multiple bases to package their systems together to get the best privatization deals. In at least one case, the Army has joined with the Air Force to privatize systems at neighboring bases in Alaska. More than 20 National Guard bases will be competed as one contract, as well. "Where it makes sense we will bundle work," he says. The lessons are being incorporated into current and future RFPs, award decisions and contracts, Armesto says. He acknowledges that privatization efforts have thus far moved more slowly than expected, but argues that the Air Force ultimately will run better competitions and get better deals because it is not being rushed.

"They were promising great things," says Armesto, noting the aggressive evangelism even caught the attention of the Air Force's top civilian leaders. But ultimately, he says, the Air Force did not accept the company's unsolicited proposal for a utilities takeover because a closer look showed the savings and other financial data were "soft at best." The Air Force's decision proved to be fortuitous. Last fall, the company making the pitch-Enron Inc. of Houston-filed the largest corporate bankruptcy claim in U.S. history.

The Air Force's experience with Enron illustrates the problem all the military services have faced in trying to privatize billions of dollars worth of utilities systems by 2003. On the surface, privatization appears to be an easy way for the Defense Department to save money and upgrade aging electric, water, wastewater and gas systems at the same time. But in practice, turning utility systems over to contractors has proven as confusing as reading one of Enron's financial statements.

The Defense Department spends $5 billion to $6 billion annually buying electricity, gas and water, and hundreds of millions more to operate and maintain systems to deliver them. Not surprisingly, Defense has sought ways to cut its utility bills for years. The military services typically do not generate their own power, but they do own, operate and maintain 2,660 utility systems, including substations, pipes and wires on bases, that carry gas, electricity and water onto and around the bases from outside sources. Those systems are worth about $50 billion, but Defense has woefully underfunded efforts to maintain them for decades.

Five years ago, Defense officials decided there was no need for the services to own the systems and that the department could save money, modernize the systems and free up management resources by privatizing them. The services were ordered to privatize about 1,600 systems by 2003. Other systems were exempted because they didn't appear to offer savings or needed to be kept in-house for security reasons.

The services are privatizing the systems by transferring ownership of them to utility companies, granting the companies access to the land on bases where the systems are located and then paying them to operate and maintain the systems for up to 50 years at fixed rates. Each contract has provisions that allow for the systems to be returned to the government if the contractor does not provide acceptable service. Since most of the utility companies bidding for the work are regulated utilities, federal, state and local officials tightly monitor companies' performance.

Since the Pentagon flipped the switch on privatization, only 29 systems have been turned over to utility companies, little money has been saved and only a handful of systems have been modernized. "There have been more hang-ups than you can count in privatizing Defense utilities. It's been a demonstration in how not to do it," says Ken Beeks, a lobbyist for Business Executives for National Security, a Washington group representing companies that support a strong military.

Several factors have caused the delays, according to Defense and industry officials, including:

The services' lack of a coordinated approach to privatizing the systems.
The complexity of the energy marketplace.
Poor communications between the military services and utility contractors.
The services' strict adherence to federal acquisition methods for awarding and writing contracts.
Traditional military resistance to outsourcing, which has been heightened in the case of utilities by the California energy crisis and the collapse of Enron.

Already, Moy has moved to reshape the utilities privatization effort. The services' privatization managers now hold meetings every two weeks to share best practices and coordinate acquisition strategies. Additionally, Moy has addressed a key concern of industry by allowing contractors to charge Defense interest on money they borrow to upgrade utility systems.

More changes are in store. The biggest will come in June, when Moy says he will extend the deadline for requiring the services to privatize utilities from September 2003 to at least 2004-and possibly 2005. As a result, the pressure on the services to write requests for proposals and make awards quickly will be eased, while industry will no longer have to make dozens of bids at the same time. "Our effort is not to dump utility systems," says Moy.

DIFFERENT APPROACHES

David Sykes, federal corporate account manager for the Southern Co., a large regional utility provider in Atlanta, says different approaches have left the utility industry confused about how to bid for utility work. For example, the Army often requires contractors to prepare separate bids for systems on the same base. The Navy and Air Force are encouraging bidders to form partnerships with other companies to win work on multiple bases. "There does not have seem be any commonality between the services," says Sykes.

Several industry representatives say the services underestimated-or didn't understand-the utilities market before requesting bids. The Army attracted only one bidder for all utility work at Fort Hamilton, including electric, gas, water and wastewater operations, because it did not fully understand the difference between regulated and unregulated utilities. Some small Air National Guard bases attracted no bidders because their contracts were not large enough for industry to spend the time and money it would take to win. The Air Force, meanwhile, has made more than 20 amendments to a single RFP to privatize utilities at seven bases in Texas. Each RFP causes two to three months in delays before the contract can be awarded. That's now scheduled for this summer, Air Force officials say.

The procurement process used by all of the services has also drawn barbs from industry. Tempchin says the bidding process is "needlessly inefficient and complex" and the dissatisfaction registered by those who won the initial contracts has kept some other firms from bidding on future work. Congress requires fair and open competition before systems are privatized, but has offered few other guidelines for how the services should privatizetheirutility infrastructure. Contractors have complained that Defense gives them too little time to examine facilities to assess their condition before bidding on work and requires highly complex bids that can cost more than $1 million to write.

"The government wants to know the name of the guy who will fix your system when it breaks at 12:30 in the morning. It's micromanaged," says Sykes, noting that bids can sometimes be as long as 500 pages because of all of Defense's requirements. Tempchin says the services need to develop more consistency in their RFPs and that for smaller systems, such as those at National Guard bases, far less information should be required from bidders.

Industry representatives also say the services have failed to consider the time and money companies must spend to make bids. Currently, Defense has a total of 767 solicitations pending for running utility systems. In April, Sykes said he had two dozen bids due before the end of June. Companies cannot bid on all the work they want because there is not enough time to prepare their proposals, he says. "There's been no coordination [among the services] for when the bids are issued and when they are due."

LIGHT OF DAY

Nerger says future awards should go more smoothly now that the service has gained some experience in privatizing utility systems. "We now no longer have to be the water works department," says Joe Sicuranza, chief of maintenance at the Army's Fort Lee, Va., where the service recently turned over its drinking water distribution system to a public utility company, Virginia American Water Co. The company will upgrade the systems and save the Army a projected $1.4 billion over the next 25 years in reduced operating costs.

Andrew Bennett, energy coordinator at Fort Sill, Okla., says the base's effort to privatize more than 100 miles of natural gas pipeline over the next 25 years will pave the way for future utilities privatization. Already, the base is seeking bids from industry to run its water, wastewater and sewer systems. "We did not have a road map before, but we do now," he says.

The Navy and Marine Corps will bundle work regionally. Mark Bellis, the service's utilities privatization chief, says the Navy and Marine Corps are using an "open ended" bid process that will allow companies to bid on all or only pieces of the bundled work. That encourages companies only to go after the work they do best, and Navy and Marine Corps officials also expect it will spur partnerships. "Some companies may think that bidding on a small base is the best way to go. Others may want to bid on all the bases to get the best economies of scale. We are not prescribing a process for privatization," says Bellis.

The Navy is seeking innovative deals like the one the Norfolk Naval Shipyard struck with a regional firm, the Southeastern Public Service Authority, in 1999. For years, the Navy purchased trash from the company that was then converted to fuel at a shipyard power plant. Under the privatization deal, the service transferred ownership of the plant to the firm and agreed to buy power generated at the facility for 50 years. The Navy expects it will save $6 million annually in reduced operating costs and through fixed and discount power rates set under the 50-year deal. Meanwhile, the Southeastern Public Service Authority will earn money by selling off power it generates at the plant that is not needed by the Navy.

The Air Force is experimenting with bundling utilities work at multiple bases, as well, but is also privatizing systems at individual bases. "Privatization is complex even before you go to the street [for bids]," says Armesto. The Air Force has collected more than 50 lessons learned about utility privatizations, despite only having turned two small systems over to contractors. Another 80 deals are now being negotiated and an additional 200 systems are up for bid.

Some of the lessons learned include:

Allowing for flexibility from contractors in responding to RFPs.
Doing thorough reviews of contractor proposals (as the experience with Enron showed).
Allowing prospective bidders to visit sites and examine systems.
Sharing information with contractors and among bases via the Web.

Each of the services is also taking other steps to ensure the privatization process goes more smoothly. The Army and Air Force are using the Defense Energy Support Center (DESC), a Defense organization already responsible for negotiating and writing contracts for energy commodities, to solicit, award and administer utility privatization contracts. By using the support agency, Army and Air Force officials say, they'll develop common procurement practices. For example, DESC has drawn up standard RFPs for utilities privatization, which can be modified to meet unique service requirements. The Navy and Marine Corps have centralized most of their contract writing operations within the Naval Facilities Engineering Command.

Randall Yim, who oversaw the Clinton administration's utilities privatization effort as undersecretary of Defense for installations, says there is no "single cookie-cutter" approach to the issue. But, he says, the services should continue to seek common ground wherever possible and are wise to continue with what has been a cumbersome process because of the long-term payoffs. "The United States has the most efficient utility operators in the world," Yim says. "Why should Defense do it?"

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