United States Government Accountability Office

GAO Report to Congressional Committees

DEFENSE 

INFRASTRUCTURE 

Actions Taken to 

Improve the 

Management of Utility 

Privatization, but 

Some Concerns 

Remain 

September 2006 

 

GAO-06-914 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

September 2006

DEFENSE INFRASTRUCTURE 

Actions Taken to Improve the 

Management of Utility Privatization, but 

Some Concerns Remain 

Highlights of GAO-06-914, a report to 

congressional committees 

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 privatization was the 

preferred method for improving 

utility systems, and Congress 

approved legislative authority for 

privatizing DOD’s utility systems 

with Public Law No. 105-85. DOD 

estimates that some utility

privatization contracts will cost 

over $100 million. In a May 2005

report, GAO identified several

management weaknesses in DOD’s 

implementation of the program.

The Fiscal Year 2006 National

Defense Authorization Act required

GAO to evaluate and report on

changes to the utility privatization 

program since May 2005.

Accordingly, this report updates

the status of the program and 

discusses the effect of DOD’s 

changes on the concerns noted last

year. To conduct this review, GAO

summarized program status and 

costs, assessed DOD’s changes to

program guidance and in other

areas, and reviewed the services’ 

implementation of the changes. 

What GAO Recommends

GAO is making seven 

recommendations to improve the 

management of the utility

privatization program. DOD

generally agreed with six and 

indicated disagreement with one 

recommendation. Still, GAO

believes this recommendation 

continues to have merit.

DOD’s progress in implementing the utility privatization program has been 

slower than expected and the estimated completion date has slipped from 

the department’s target of September 2005 to September 2011. DOD 

attributed the delays to the complexity of the program and to the services’ 

decision to suspend and reassess the management of the program between 

October 2005 and March 2006. Since May 2005, the services privatized 14

utility systems under the legislative authority for the program, bringing the 

total number of awarded projects to 81. However, the services have awarded 

no projects since DOD issued new program guidance in November 2005. 

Meanwhile, the services’ total estimated program implementation costs 

through fiscal year 2006 have increased to $285 million, and more funds will 

be required before the program is completed in 2011. 

Since GAO’s May 2005 report, DOD has issued new guidance and required 

changes in procedures. If fully implemented, these changes should result in 

more reliable economic analyses, improved budgetary consideration of 

increased utility costs, enhanced oversight of privatization contracts, and 

reduced instances where contractors recover more than the fair market 

value paid for system conveyances. However, a number of concerns from the 

May 2005 report remain. For example: 

• Although DOD made changes to improve the reliability of project 

economic analyses by requiring independent reviews, GAO reviewed 10 

economic analyses and found reliability issues that had not been 

identified during the independent reviews. 

• DOD directed the services to adequately consider in their budgets the 

increased costs resulting from utility privatization. However, questions 

remain over the availability of the funds needed to complete the program 

because the services estimate that they will need $453 million more than 

is currently programmed to pay costs associated with remaining utility 

systems that might be privatized. 

• Although DOD made many changes to improve contract administration 

and oversight, it may take some time to fully implement the changes as 

new privatization contracts are awarded. GAO’s review of five projects 

awarded prior to DOD’s changes found continuing questions about the 

adequacy of resources provided to perform oversight and the lack of 

required plans for overseeing contractor performance. 

• It is too early in the program’s implementation to know to what extent 

DOD’s efforts will be successful in ensuring equitable periodic contract 

price adjustments and limiting long-term cost growth in the utility 

privatization program. However, GAO found indications that cost growth 

may become a challenge.

• DOD did not change its guidance to require that project economic 

analyses depict the actual expected costs of continued government 

ownership if the systems are not privatized. Therefore, DOD’s reported 

$650 million in long-term cost reductions is unrealistic. 

www.gao.gov/cgi-bin/getrpt?GAO-06-914.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Barry W. 

Holman at (202) 512-5581 or 

holmanb@gao.gov. 
Contents 

Letter 1

Results in Brief 3

Background 6

Utility Privatization Milestones Have Slipped and Implementation 

Costs Continue to Climb 11 

DOD’s Changes to Improve Utility Privatization Implementation 

Have Addressed Many Areas but Have Not Eliminated All 

Program Concerns 14 

Conclusions 32

Recommendations for Executive Action 33 

Agency Comments and Our Evaluation 34 

Appendix I Scope and Methodology 37 

Appendix II Comments from the Department of Defense 39 

Appendix III GAO Contact and Staff Acknowledgments 47 

Tables 

Table 1: Percentage of Systems with Privatization or Exemption 

Decision and Estimated Program Completion Date 12 

Table 2: Status of the Utility Privatization Program as of March 31, 

2006 12 

Table 3: Implementation Costs for the Utility Privatization Program 13 

Table 4: Potential Additional Privatization Contracts and 

Associated Costs 14 

Table 5: Service Estimates of Potential Utility Privatization 

Program Funding Shortfall 20 

Table 6: DOD’s Estimated Cost Avoidance from Utility 

Privatization 29

Page i GAO-06-914 Defense Infrastructure
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Page ii GAO-06-914 Defense Infrastructure
United States Government Accountability Office

Washington, DC 20548 

September 5, 2006 

Congressional Committees 

Department of Defense (DOD) installations have about 2,600 electric, 

water, wastewater, and natural gas utility systems valued at about $50 

billion. These systems consist of the equipment, fixtures, pipes, wires, and 

other structures used in the distribution of electric power and natural gas, 

the treatment and distribution of water, and the collection and treatment 

of wastewater. According to DOD officials, many of these systems have 

become unreliable and are in need of major improvements. To address this 

issue, DOD decided in 1997 that utility privatization was the preferred 

method for improving utility systems and services because privatization 

would allow installations to benefit from private sector financing and

efficiencies. With private sector financing, installations could immediately 

obtain major upgrades to their utility systems and pay for these 

improvements over time. Thus, utility improvements could be achieved 

without going through the traditional budget justification and funding 

process. Under DOD’s program, utility privatization normally involves two 

transactions with the successful contractor—the conveyance of the utility 

system infrastructure and the acquisition of utility services for upgrades, 

operations, and maintenance under a long-term contract of up to 50 years. 

DOD estimates that some privatization contracts will cost more than $100 

million over the contract time frames.

To institute the program, at DOD’s request, Congress approved legislative 

authority in 1997 for privatizing utility systems at military installations.1

The authority requires that the military services meet a number of 

conditions to privatize a system including, in part, the following condition: 

the services must demonstrate through an economic analysis that 

privatization of a system would reduce the government’s long-term costs 

for utility services. DOD’s program guidance permits the services to 

exempt systems from privatization when long-term costs will not be 

reduced or for unique security reasons. 

 1

National Defense Authorization Act for Fiscal Year 1998, Pub. L. No. 105-85, § 2812 (1997). 

Page 1 GAO-06-914 Defense Infrastructure
In May 2005, we issued a report that identified management weaknesses in

DOD’s implementation of the utility privatization program.2

 The report 

noted a number of concerns, such as the reliability of the economic 

analyses associated with privatization decisions and the adequacy of 

contract oversight, and made several recommendations to DOD to 

improve the guidance and procedures used to implement and oversee the

utility privatization program. Although DOD initially disagreed with the 

report’s findings and recommendations, after further review of the report, 

the department subsequently reported to Congress that it generally agreed 

with our findings and recommendations and decided to issue new 

guidance on November 2, 2005, to address the key issues in our prior 

report.3

 Among other things, this guidance required the services to 

complete remaining evaluations of utility system potential for privatization 

in a timely and efficient manner, perform an independent review of the 

economic analyses supporting proposed projects, consider and plan for 

increased costs for utility services resulting from potential privatization 

projects, and take steps designed to improve the administration and 

oversight of awarded privatization projects. Even before DOD issued the 

new guidance, the services had implemented several program 

improvements including the requirement for independent reviews of 

project economic analyses. 

In January 2006, the National Defense Authorization Act for Fiscal Year 

20064

 made several modifications to the legislative authority for the utility 

privatization program, restricted the number of utility systems that DOD 

could privatize during fiscal years 2006 and 2007, and required the 

Secretary of Defense to submit a report to congressional defense 

committees by April 1, 2006, addressing program issues and many of the 

concerns noted in our May 2005 report. The act also directed us to 

evaluate and report on the changes made by DOD to the program since 

May 2005 and their effects. Accordingly, this report (1) updates the status 

of the utility privatization program, and (2) discusses the effect of DOD’s 

 2

GAO, Defense Infrastructure: Management Issues Requiring Attention in Utility

Privatization, GAO-05-433 (Washington, D.C.: May 12, 2005). 

3

DOD, Under Secretary of Defense, Memorandum for Secretaries of the Military

Departments and Director, Defense Logistics Agency, Subject: Supplemental Guidance 

for the Utilities Privatization Program (Washington, D.C.: Nov. 2, 2005). 

4

National Defense Authorization Act for Fiscal Year 2006, Pub. L. No. 109-163, § 2823 (2006) 

(codified as amended at 10 U.S.C. § 2688). 

Page 2 GAO-06-914 Defense Infrastructure
changes on the program management and oversight concerns noted in our 

May 2005 report. 

To address these objectives, we summarized program implementation 

status and costs and compared the status to DOD’s past and current goals 

and milestones. To determine the effect of DOD’s changes on the program 

management and oversight concerns noted in our prior report, we 

interviewed DOD and service officials and reviewed pertinent policies, 

guidance, memorandums, and reports to document the changes made, and 

we compared those changes with our previously identified concerns to 

assess whether the issues had been fully addressed. Further, we reviewed 

the reliability of the economic analyses supporting 10 privatization 

projects that were awarded after our prior report and had been subjected 

to the services’ new independent review process. We also visited four 

installations to assess contract administration and oversight issues and 

reviewed contract price changes in six ongoing utility privatization 

contracts. Although we generally relied on program status data provided 

by the services, we confirmed the status data for five utility privatization 

projects and did not otherwise test the reliability of the data. 

We conducted our review from March through July 2006 in accordance 

with generally accepted government auditing standards. A more detailed

description of our scope and methodology is included in appendix I. 

DOD’s progress in implementing the utility privatization program has been 

slower than expected, and implementation costs have continued to climb. 

Since our previous report, the estimated program completion date has 

slipped from the department’s target of September 2005 to September 

2011. DOD officials have attributed delays in program implementation to 

privatization evaluation, solicitation, and contracting processes that were 

more complex and time-consuming than originally anticipated. Service 

officials also stated that additional delays resulted from the services’ 

decision to suspend and reassess the management of the program between 

October 2005 and March 2006. The officials stated that the suspension 

allowed DOD and the services time to review concerns noted in our prior 

report, develop and issue supplemental guidance for the program, and 

implement program changes necessitated by modifications in the 

program’s legislative authority. Between May 31, 2005, and September 30, 

2005, the services privatized 14 utility systems under the legislative 

authority for the program, bringing the total number of awarded projects 

to 81. However, the services have awarded no projects since September 

2005 and, therefore, no projects have been awarded since DOD issued 

Results in Brief 

Page 3 GAO-06-914 Defense Infrastructure
supplemental program guidance in November 2005. With program delays,

the services’ total estimated program implementation costs through fiscal 

year 2006 have increased from $268 million to $285 million and additional 

amounts will be required before the program is projected to be completed

in 2011. Program delays also caused the Defense Energy Support Center to 

cancel solicitations to privatize 42 Army utility systems in May 2006. These 

solicitations had been closed from 1 to 4 years with no award decision and

there were concerns that conditions, such as the accuracy of the inventory

and needed improvements, had changed or might change before an award 

decision would be made. The Army plans to resolicit these systems over 

the next few years. 

DOD has issued new program guidance and required changes in program 

procedures to improve the management and oversight of the utility 

privatization program since our May 2005 report. For example, DOD 

implemented a requirement for an independent review of economic 

analyses for proposed privatization projects and has imposed greater 

emphasis on contract oversight. If fully implemented, the changes should 

result in more reliable economic analyses supporting proposed 

privatization projects, improved budgetary consideration of increased 

utility costs from privatization, enhanced oversight of privatization 

contracts, and reduced instances where contractors recover more than the 

amounts they paid as the fair market value for system conveyances. 

However, we noted a number of limitations in implementation of the new

procedures. Moreover, a number of concerns noted in our prior report 

remain, at least to some degree, because DOD’s changes to address some 

issues were not implemented effectively, some changes were not sufficient 

to fully eliminate some concerns, and DOD did not make changes to 

address some concerns. For example: 

• First, although DOD made changes to improve the reliability of project 

economic analyses by requiring independent reviews, we found issues 

with the implementation of this change. Specifically, we reviewed the 

economic analyses supporting 10 privatization projects that had been 

subjected to independent review and found reliability issues that had not 

been identified during the independent review. 

• Second, although DOD directed the services to adequately consider in 

their budgets the increased costs resulting from utility privatization, 

questions remain over the availability of the funds needed to complete the 

program. The services have estimated that they will need $453 million 

more than is currently programmed for continuing government utility 

operations to pay implementation and contract costs associated with the 

remaining number of utility systems that might be privatized through 2010 

Page 4 GAO-06-914 Defense Infrastructure
for the Air Force and the Navy and Marine Corps and through 2011 for the 

Army. In view of competing needs and budget priorities, the Air Force 

stated that it will not solicit additional utility privatization contracts until 

further resources are identified to cover the potential increase in costs. 

DOD had not made any decisions on the funding availability issue at the 

time of our review in June 2006. 

• Third, it may take some time to fully implement DOD changes to improve 

utility privatization contract administration and oversight as new 

privatization contracts are awarded. Our review of five projects awarded 

prior to DOD’s changes found continued oversight concerns, including 

questions about the adequacy of resources provided to perform oversight 

and the lack of required plans for overseeing contractor performance. 

• Fourth, DOD reported to Congress in March 2006 that, although 

privatization may limit the government’s options during contract 

negotiations, the department continues to prefer privatization with 

permanent conveyance and believes that safeguards are in place to 

adequately protect the government’s interests. It is too early in the 

program’s implementation to know to what extent DOD’s efforts will be 

successful in ensuring equitable periodic contract price adjustments and 

limiting long-term cost growth in the utility privatization program. 

However, we found cost growth in three of six privatization projects we 

reviewed. In one case, the government’s annual costs for utility service 

were expected to increase by 92 percent as a result of the contract’s first 

periodic price adjustment. 

• Fifth, DOD did not change its guidance to require that project economic 

analyses depict the actual expected costs of continued government 

ownership in the event that the systems are not privatized. Therefore, 

although DOD reported to Congress that the 81 contracts awarded under 

the utility privatization authority will result in about $650 million in longterm cost reductions to the government, the amount is unrealistic because

it was not calculated based on the actual expected cost differences 

between continued government ownership and privatization, and because

privatization generally results in increased, not decreased, utility service 

costs to the government.

We are making a number of recommendations designed to ensure that 

DOD improves the reliability of the economic analyses for proposed utility 

privatization projects, addresses potential program funding shortfalls, 

ensures adequate oversight in utility privatization contracts awarded prior 

to DOD’s program changes, monitors potential contract cost growth, and 

clearly depicts the increased costs resulting from proposed utility 

privatization projects. In comments on a draft of this report, DOD 

generally agreed with six of our seven recommendations and outlined a 

plan of action to address each recommendation. Where it indicated 

Page 5 GAO-06-914 Defense Infrastructure
disagreement, we continue to believe our recommendation has merit. We 

discuss DOD’s comments in detail later in this report. 

At DOD’s request, Congress approved legislative authority in 1997 for 

privatizing utility systems at military installations.5

 In defining a utility 

system, the authority included systems for the generation and supply of 

electric power; the treatment or supply of water; the collection or 

treatment of wastewater; the generation or supply of steam, hot water, and 

chilled water; the supply of natural gas; and the transmission of 

telecommunications. Included in a utility system are the associated 

equipment, fixtures, structures, and other improvements as well as 

easements and rights-of-way. The authority stated that the Secretary of a

military department may convey a utility system to a municipal, private, 

regional, district, or cooperative utility company or other entity and the

conveyance may consist of all right, title, and interest of the United States 

in the utility system or such lesser estate as the Secretary considers 

appropriate to serve the interests of the United States. 

Among other things, the 1997 authority also included two requirements for 

utility privatization. First, DOD was required to submit a report to 

congressional defense committees and wait 21 days before allowing a 

conveyance. For each conveyance, the report was to include an economic 

analysis, based on acceptable life-cycle costing procedures, demonstrating 

that (1) the long-term economic benefit of the conveyance to the United 

States exceeds the long-term economic cost of the conveyance to the 

United States, and (2) the conveyance will reduce the long-term costs of 

the United States for utility services provided by the utility system 

concerned. Second, the Secretary was required to receive as consideration 

for a conveyance an amount equal to the fair market value, as determined 

by the Secretary, of the right, title, or interest of the United States 

conveyed. The consideration could take the form of a lump sum payment 

or a reduction in charges for utility services. 

Before and after approval of the specific authority for privatizing utilities, 

the services have used other authorities for utility privatization. For 

example, the Army had privatized some systems after obtaining 

congressional authority for each specific case. Also, the services have

privatized systems by modifications to natural gas services agreements 

Background 

 5

Pub. L. No. 105-85, § 2812 (1997). 

Page 6 GAO-06-914 Defense Infrastructure
administered by the General Services Administration and by conveyances 

of some systems on the basis of authorities related to base realignment 

and closure and the military housing privatization program. 

DOD’s Office of the Deputy Under Secretary of Defense for Installations 

and Environment provides overall policy and management oversight for 

the utility privatization program. However, primary management and 

implementation responsibility for the program is delegated to the 

individual services, their major commands, and individual installations. In 

addition, Defense Logistics Agency’s Defense Energy Support Center is 

responsible for providing the military services with utility privatization 

contracting, technical, and program management support. 

In December 1997, DOD issued Defense Reform Initiative Directive 

Number 9, which made utility system privatization a DOD policy.6

 The 

directive instructed the military departments to develop a plan that would 

result in privatizing all installation electric, natural gas, water, and 

wastewater utility systems by January 1, 2000, unless exempted for unique 

security reasons or if privatization would be uneconomical. Under the 

program, privatization normally involves two transactions with the 

successful contractor—the conveyance of the utility system infrastructure 

and the acquisition of utility services for upgrades, operations, and 

maintenance under a long-term contract of up to 50 years. Normally, the 

conveyances do not include title to the land beneath the utility system 

infrastructures. 

A year later, in December 1998, DOD issued another directive to establish 

program management and oversight responsibilities and provide guidance 

for performing economic analyses for proposed projects, exempting 

systems from the program, and using competitive procedures to conduct

the program.7

 The directive also stated that the objective was for DOD to 

get out of the business of owning, managing, and operating utility systems 

by privatizing them and that exemptions from privatization should be rare.

DOD Made Utility 

Privatization a Department 

Policy 

 6

DOD, Deputy Secretary of Defense, Memorandum for Secretaries of the Military

Departments and others, Subject: Department of Defense Reform Initiative Directive 

#9—Privatizing Utility Systems (Washington, D.C.: Dec. 10, 1997). 

7

DOD, Deputy Secretary of Defense, Memorandum for Secretaries of the Military

Departments and others, Subject: Department of Defense Reform Initiative Directive 

#49—Privatizing Utility Systems (Washington, D.C.: Dec. 23, 1998).

Page 7 GAO-06-914 Defense Infrastructure
The directive reset the privatization implementation goal to September 30, 

2003. 

In October 2002, DOD issued revised program guidance and again reset 

implementation goals.8

 The guidance noted DOD’s contention that many 

installation utility systems had become unreliable and in need of major 

improvements because the installations historically had been unable to

upgrade and maintain reliable utility systems due to inadequate funding 

caused by the competition for funds and DOD’s budget allocation 

decisions. DOD officials stated that owning, operating, and maintaining 

utility systems was not a core DOD function and the guidance stated that

privatization was the preferred method for improving utility systems and 

services by allowing military installations to benefit from private sector 

financing and efficiencies. The revised implementation goals directed the 

military departments to reach a privatization or exemption decision on all 

systems available for privatization by September 30, 2005. The October 

2002 guidance also reemphasized that utility privatization was contingent

upon the services demonstrating through an economic analysis that 

privatization will reduce the long-term costs to the government for utility 

services. The guidance included details for conducting the economic 

analyses, stating that the services’ analyses should compare the long-term 

estimated costs of proposed privatization contracts with the estimated 

long-term costs of continued government ownership assuming that the 

systems would be upgraded, operated, and maintained at accepted 

industry standards, as would be required under privatization.

In May 2005, we issued a report that identified management weaknesses in

DOD’s implementation of the utility privatization program.9

 The report 

noted that utility privatization implementation had been slower than 

expected, the services’ economic analyses supporting utility privatization 

decisions provided an unrealistic sense of savings to a program that 

generally increases government utility costs, DOD’s funding obligations 

would likely increase faster than they would under continued government 

ownership, DOD did not require that the services’ economic analyses be 

Implementation Goals 

Reset and Program 

Guidance Revised 

GAO Report Identified 

Weaknesses in Program 

Implementation 

 8

DOD, Deputy Secretary of Defense, Memorandum for Secretaries of the Army, Navy, and 

Air Force and Director, Defense Logistics Agency, Subject: Revised Guidance for the 

Utilities Privatization Program (Washington, D.C.: Oct. 9, 2002). 

9

See footnote 2. 

Page 8 GAO-06-914 Defense Infrastructure
subjected to an independent review for accuracy and compliance with 

guidance, implementation of the fair market value requirement in some 

cases resulted in higher contract costs for utility services, the services had 

not issued specific contract administration guidance for the program, and 

DOD’s preferred approach of permanently conveying utility system 

ownership to contractors may give the contractor an advantage when 

negotiating service contract changes or renewals. The report made several

recommendations for DOD to address these concerns. 

The National Defense Authorization Act for Fiscal Year 2006,

10 enacted in 

January 2006, made several modifications to the legislative authority for 

the utility privatization program. The act did the following: 

Program Legislative 

Authority Modified 

• Reinstated a requirement that the Secretary of Defense must submit to 

congressional defense committees an economic analysis and wait 21 days 

after the analysis is received by congressional defense committees, or 14 

days if in electronic form, before conveying a utility system.11 The 

economic analysis must demonstrate among other things that the 

conveyance will reduce the long-term costs to the United States of utility 

services provided by the utility system. The report and wait requirement 

had been replaced with a requirement for a quarterly report of 

conveyances by the National Defense Authorization Act for Fiscal Year 

2004.

12

• Added a requirement that the economic analyses incorporate margins of 

error in the estimates, based upon guidance approved by the Secretary of

Defense, that minimize any underestimation of the costs resulting from 

privatization or any overestimation of the costs resulting from continued 

government ownership. 

• Eliminated the requirement that DOD must receive as consideration for a 

conveyance an amount equal to the system’s fair market value. 

• Limited contract terms to 10 years, unless the Secretary concerned 

determines that a longer term contract, not to exceed 50 years, will be 

cost-effective and provides an explanation of the need for the longer term 

 10Pub. L. No. 109-163, § 2823 (2006). 

11Prior to November 2003, section 2688 of title 10 stated that the Secretary of Defense was 

not permitted to make a conveyance until he submitted a report that demonstrated two 

specific factors and a period of 21 days had elapsed from the date at which the analysis was 

submitted. 

12National Defense Authorization Act for Fiscal Year 2004, Pub. L. No. 108-136, § 

1031(a)(32)(2003). 

Page 9 GAO-06-914 Defense Infrastructure
contract, along with a comparison of costs between a 10-year contract and

the longer term contract. 

• Placed a temporary limitation on conveyance authority stating that during 

each of fiscal years 2006 and 2007, the number of utility systems for which 

conveyance contracts may be entered into under this authority shall not 

exceed 25 percent of the total number of utility systems determined to be 

eligible for privatization under this authority as of January 6, 2006. 

• Required DOD to submit, not later than April 1, 2006, to congressional 

defense committees a report describing the use of section 2688 of title 10, 

United States Code (10 U.S.C. 2688), to convey utility systems. The report 

was to address several specified aspects of the utility privatization 

program. 

Although DOD initially disagreed with our May 2005 report, after further 

review of the report, it subsequently reported to Congress that the report

had brought some significant issues to light and that the department had 

decided to issue new guidance to address the key issues in the report in 

order to improve program management. On November 2, 2005, DOD 

issued the new guidance, which among other things required the services

to complete the remaining evaluations of utility system potential for 

privatization in a timely and efficient manner, perform an independent 

review of the economic analyses supporting proposed projects, consider 

and plan for increased costs for utility services resulting from potential 

privatization projects, and take steps to improve the administration and 

oversight of awarded privatization projects.13 DOD issued additional 

supplemental guidance14 on March 20, 2006, to implement the 

modifications to the legislative authority made by the Fiscal Year 2006 

National Defense Authorization Act; and on March 31, 2006, DOD 

submitted to congressional defense committees the utility privatization 

report required by the act.15 Even before DOD issued new guidance to 

improve the program in November 2005, the services had implemented 

several program improvements, including the requirement for independent 

reviews of project economic analyses. 

DOD’s Response to GAO’s 

Report and Modifications 

to the Program’s Authority 

 13See footnote 3. 

14DOD, Under Secretary of Defense, Memorandum for Secretaries of the Military

Departments and Director, Defense Logistics Agency, Subject: Supplemental Guidance 

for the Utilities Privatization Program (Washington, D.C.: Mar. 20, 2006). 

15DOD, Deputy Under Secretary of Defense (Installations and Environment), Report to 

Congress on Use of Utility System Conveyance Authority and Temporary Suspension of

Authority Pending Report (Washington, D.C.: Mar. 31, 2006). 

Page 10 GAO-06-914 Defense Infrastructure
DOD’s progress in implementing the utility privatization program has been 

slower than expected and implementation costs have continued to climb. 

None of the services met DOD’s September 2005 implementation goal and 

the program’s estimated completion date has now slipped to September 

2011. In addition to increasing implementation costs, program delays have 

also resulted in the cancellation of privatization solicitations because of

concern that conditions had changed or might change before a decision 

would be made whether to privatize.

None of the services met DOD’s goal of making a privatization or 

exemption decision on all systems available for privatization by September 

30, 2005. Since the program began, DOD officials have attributed delays in

program implementation to privatization evaluation, solicitation, and 

contracting processes that were more complex and time consuming than 

originally anticipated. Service officials stated that additional delays 

occurred because the services decided to suspend the program between 

October 2005 and March 2006. According to the officials, the suspension 

was provided to allow DOD and the services time to review concerns 

noted in our May 2005 report, develop and issue supplemental guidance 

for the program, and implement program changes necessitated by 

modifications in the program’s legislative authority made by the National 

Defense Authorization Act for Fiscal Year 2006. The services now estimate 

that their program completion dates—the date when a privatization or 

exemption decision has been made on all available systems—are October 

2007 for the Navy and Marine Corps, December 2008 for the Air Force, and 

September 2011 for the Army. Among other things, the Army attributed the 

extension in its completion date to the privatization process being more 

complicated than envisioned and a recognition that the Army’s past 

estimates for completing the program were unrealistic. Table 1 shows 

progress as of March 31, 2006, compared to DOD’s goal, as well as the 

current estimated program completion dates.16 

Utility Privatization 

Milestones Have 

Slipped and 

Implementation Costs 

Continue to Climb 

Services Did Not Meet 

Program Implementation 

Milestone 

 16Although this report includes Defense Logistics Agency program status information, the

report does not include any additional Defense Logistics Agency program information

because the agency has few systems available for privatization compared to the military 

services and has awarded no utility privatization contracts.

Page 11 GAO-06-914 Defense Infrastructure
Table 1: Percentage of Systems with Privatization or Exemption Decision and

Estimated Program Completion Date 

Component 

Goal for

September 30,

2005 (percent)

Actual as of 

March 31, 2006

(percent) 

Estimated

completion 

date

Army 100 75 September 2011

Navy and Marine Corps 100 78 October 2007 

Air Force 100 82 December 2008

Defense Logistics Agency 100 86 December 2007

Source: DOD. 

After spending about $268 million on program implementation costs 

through fiscal year 2005, the services had awarded contracts for a fraction

of the 1,496 utility systems available for privatization. Between May 31, 

2005, and September 30, 2005, the services privatized 14 utility systems 

using 10 U.S.C. 2688 authority bringing the total number of awarded 

projects to 81. However, the services have awarded no projects under this 

authority since DOD issued supplemental program guidance in November 

2005. In addition to the projects awarded under 10 U.S.C. 2688 authority, 

DOD privatized 36 systems under other programs, such as DOD’s housing 

privatization program. The services also have exempted 147 additional 

systems, bringing the total systems exempted from privatization to 458. 

Table 2 shows program status as of March 31, 2006. 

Services Have Awarded 

Contracts for a Fraction of 

the Total Systems 

Available for Privatization 

Table 2: Status of the Utility Privatization Program as of March 31, 2006 

Component 

Systems 

available for 

privatization

Systems pending 

solicitation or under 

reassessment

Systems in

solicitation

Systems 

exempted

Total contract 

awards 

Contract awards

using 10 U.S.C. 

2688 authority

Army 320 0 202 38 80 70

Navy and Marine 

Corps 

645 13 411 200 21 1

Air Force 502 4 262 220 16 10

Defense Logistics 

Agency 

29 0 29 0 0 0

Total 1,496 17 904 458 117 81

Source: DOD. 

Page 12 GAO-06-914 Defense Infrastructure
With program delays, the services’ estimated program implementation 

costs have increased from about $268 million through fiscal year 2005 to 

about $285 million through fiscal year 2006. Additional implementation 

funds will be needed before the services complete their programs between 

October 2007 and September 2011. According to service officials, the funds 

used to implement the program primarily paid for consultants hired to 

help the services in conducting an inventory of their utility systems, 

assessing the systems’ condition, preparing economic analyses, and 

soliciting and contracting for proposed projects. Program implementation

costs did not include funds used to pay the costs of awarded privatization

contracts. Table 3 shows program implementation costs by service and the 

Office of the Secretary of Defense. 

Program Delays Have 

Resulted in Increased 

Implementation Costs 

Table 3: Implementation Costs for the Utility Privatization Program 

Dollars in millions 

Component 

Implementation 

costs for fiscal 

years 1998 

through 2005

Estimated 

implementation 

costs for fiscal 

year 2006

Total estimated

implementation 

costs through

fiscal year 2006

Army $62.5 $4.0 $66.5

Navy and Marine Corps 109.7 4.4 114.1

Air Force 92.6 8.0 100.6

Office of the Secretary of 

Defense 

3.6 0.3 3.9

Total $268.3 $16.8 $285.1

Source: DOD. 

Note: Totals may not add due to rounding. 

Program delays also caused the Defense Energy Support Center to cancel

solicitations to privatize 42 Army utility systems in May 2006. These 

solicitations had been closed from 1 to 4 years with no award decision and

there were concerns that conditions, such as the accuracy of the inventory

and needed improvements, had changed or might change before an award 

decision would be made. The Army plans to resolicit these systems over 

the next few years. Further, Defense Energy Support Center officials 

stated that program delays and the resulting decrease in assistance 

requested by the services have made it difficult to retain qualified staff to 

support the utility privatization program. Consequently, the center will 

need to train new staff once the program’s pace begins to increase again. 

Page 13 GAO-06-914 Defense Infrastructure
In addition to revising their program completion dates since our previous 

report, the services also estimated the additional number of systems that 

might be privatized by the completion of their programs and the funds 

needed to pay the costs of these anticipated contracts. The Army 

estimated that 41 additional systems might be privatized with the 

associated contract costs totaling about $212 million; the Navy and the 

Marine Corps estimated that 40 additional systems might be privatized 

with the associated contract costs totaling about $139 million; and the Air 

Force estimated that 210 additional systems might be privatized with the 

associated contract costs totaling about $602 million (see table 4). Air 

Force officials stated that its estimated 210 additional systems was a 

“worst case” estimate used to determine the maximum funding needed for

possible additional privatization contracts. The officials stated that the 

more likely number of systems that might be privatized was about 105 

systems. However, the officials did not provide an estimate of the contract

costs associated with the smaller number of systems. 

Table 4: Potential Additional Privatization Contracts and Associated Costs 

Dollars in millions 

Component 

Number of additional 

systems that potentially 

could be privatized

Potential program

 costs if the additional 

systems are privatized

Army 41 $212.4

Navy and Marine Corps 40 139.3

Air Force 210 602.0

Total 291 $953.7

Source: DOD. 

DOD has made many changes to improve the management and oversight 

of the utility privatization program since our May 2005 report. To improve 

the reliability of the economic analyses supporting privatization decisions, 

DOD now requires that the analyses undergo an independent review to 

assess the inputs and assumptions, ensure that cost estimates for the 

government-owned and privatization options are treated in a consistent 

manner, and verify that all relevant guidance has been met. Also, in 

supplemental program guidance issued in November 2005, DOD reminded 

the services to consider and plan for increased costs for utility services 

contracts resulting from potential privatization projects and prepare 

operation and maintenance budgets based upon the expected costs under 

privatization. The guidance also emphasized the importance of contract 

Services Have Estimated 

the Number and Cost of 

Potential Privatization 

Contracts

DOD’s Changes to 

Improve Utility 

Privatization 

Implementation Have 

Addressed Many 

Areas but Have Not 

Eliminated All 

Program Concerns 

Page 14 GAO-06-914 Defense Infrastructure
oversight and directed a number of actions designed to ensure adequate 

contract administration and oversight. Among other things, the guidance 

directed the Defense Energy Support Center to develop specific preaward 

and postaward procurement procedures for the effective management of 

utilities services contracts, directed contracting agencies to adequately 

train and prepare personnel involved in the utility privatization contracts,

noted that DOD components are responsible for ensuring that the 

acquisition plan adequately addresses cost growth control, and stated that 

DOD components are responsible for ensuring that resources required to 

properly administer the contracts have been identified and provided. In 

March 2006, DOD also issued guidance implementing modifications in the 

program’s legislative authority made by the Fiscal Year 2006 National 

Defense Authorization Act, which among other things addresses our 

concern that some utility privatization contracts had allowed contractors 

to recover more than they paid as the fair market value for system 

conveyances. If fully implemented, the changes should result in more 

reliable economic analyses supporting proposed privatization projects, 

improved budgetary consideration of increased utility costs from 

privatization, enhanced oversight of privatization contracts, and reduced 

instances where contractors recover more than the amounts they paid as 

the fair market value for system conveyances. 

Although DOD has made many changes to improve implementation of the 

utility privatization program, the changes have addressed some concerns 

but have not eliminated all concerns noted in our prior report, such as 

ensuring the reliability of project economic analyses and ensuring 

effective contract oversight. We found that changes to address some 

issues have not been effectively implemented, some changes were not 

sufficient to totally eliminate the concerns, and DOD did not make 

changes to address some concerns causing continued questions about the 

reliability of the economic analyses, the availability of funds to pay for the 

remaining projects that might be privatized, the adequacy of contract 

oversight in projects awarded prior to DOD’s changes, and the control of 

long-term cost growth in utility privatization contracts. We also have 

concerns that the program may continue to provide an unrealistic sense of 

savings and decision makers may have incomplete information on the 

financial effect of privatization decisions. 

Page 15 GAO-06-914 Defense Infrastructure
Although DOD has made changes to improve the reliability of the analyses 

supporting proposed utility privatization projects, we found issues with 

the services’ implementation of the changes. In November 2005, DOD 

issued supplemental program guidance requiring DOD components to 

ensure that independent reviews were conducted for all economic 

analyses supporting a proposed conveyance. The guidance stated that the 

independent review should verify that all relevant guidance has been met 

and that privatization is in the best interest of the government. In March 

2006, DOD reported to Congress that the independent review included 

procedures to review the general inputs and assumptions, verify that the

inventory in the economic analysis is identical to the inventory in the 

solicitation, and ensure that the government and the contractor treat the 

renewal and replacement cost estimates in a consistent manner.17 Even 

before DOD issued the guidance requiring independent reviews, Army and 

Air Force officials stated that they had implemented such reviews to help 

ensure reliability of their project analyses. The officials stated that 

independent reviews were performed on the analyses supporting 12 utility 

privatization projects that were awarded in September 2005—after our 

previous report—but before DOD’s issuance of the guidance requiring 

independent reviews. 

DOD Has Taken Steps to 

Improve the Reliability of 

Project Economic 

Analyses but 

Implementation Is a 

Concern 

As an additional step to help ensure reliable economic analyses, DOD’s 

March 2006 report to Congress stated that the services must conduct 

postconveyance reviews that compare actual project costs with the 

estimated costs included in the projects’ economic analyses. DOD stated 

that the postconveyance reviews are conducted 2 to 3 years after contract 

award, or 1 year after the first periodic price adjustment, whichever is 

later, and that the results of these reviews will be compiled until such time 

as the analysis of all conveyances is complete. DOD stated that the 

reviews are to include an analysis of the system’s inventory, changes in

requirements and contract costs, and a comparison of actual contract 

costs with estimates from the economic analyses. 

Although DOD’s changes are key steps in the right direction to improve the 

reliability of the economic analyses, we found issues with the 

implementation of the changes. First, we reviewed the analyses associated 

with 10 Army and Air Force projects awarded in September 2005. 

 17Renewals and replacements is a term used to describe the normal replacement of, or 

repairs to, a system’s components or parts as needed to keep the system functioning in

accordance with industry standards. 

Page 16 GAO-06-914 Defense Infrastructure
Although these analyses were prepared prior to the issuance of DOD’s 

supplemental guidance, the services had already implemented an 

independent review process and these analyses underwent an independent 

review. Service officials noted that the independent reviews had just 

begun and expected that the thoroughness of the reviews would improve 

as experience was gained and DOD’s supplemental guidance was 

implemented. We found that the reviews did identify some questionable 

items and that some changes were made to improve the reliability of the 

economic analyses. Yet, we also found questionable items in each analysis 

that were not identified during the independent review. For example: 

• The economic analysis for the natural gas system privatization at Minot Air 

Force Base did not treat estimates of renewal and replacement costs for 

the government-owned and privatization options in a consistent manner. 

The analysis estimated that the Air Force would spend $7.1 million on 

renewals and replacements during the first year of continued government 

ownership. Under the first year of privatization, the analysis estimated that 

the contractor would spend about $0.2 million on renewals and 

replacements. When we asked about this difference, Air Force officials 

stated that the contractor is not required to perform the same renewals 

and replacements identified in the government estimate and that the 

government found the contractor’s proposal to be acceptable. Because the 

analysis was not based on performing the same work, the cost estimates 

were not consistently developed and resulted in favoring the privatization

option. This issue was not identified in the independent review. 

• The economic analyses for the water and wastewater privatization 

projects at Andrews Air Force Base were based on the systems’ inventory 

(i.e., the wells, pumps, water treatment equipment, valves, fire hydrants, 

water distribution mains, meters, storage tanks, reservoirs, and other 

components that constitute the systems) and condition 2 years prior to 

contract award. The Air Force stated that adjustments to the contract 

could be made after contract award, if needed, to reflect changes in the 

inventory. However, because the analyses were not updated to reflect 

inventory changes before contract award, the reliability of the analyses is 

less certain. This issue was not noted in the independent review. 

• The economic analyses for privatization of the electric distribution system 

at Fort Leavenworth and the water and wastewater systems at three Army 

installations in the Tidewater Virginia area incorrectly included financing

costs under the government option. Although this favored the privatization 

option, the amount was not enough to change the outcome of the analyses. 

This issue was not identified in the independent review. However, Army 

officials told us that they would ensure that this did not occur in future 

analyses. 

Page 17 GAO-06-914 Defense Infrastructure
Second, although DOD noted in its March 2006 report to Congress the 

importance of postconveyance reviews as an additional measure to help 

ensure reliable economic analyses, DOD has not issued guidance that 

requires the services to perform the reviews. Service officials stated that 

they had performed only a limited number of postconveyance reviews and 

do not have plans to perform the reviews in the manner or frequency 

described in DOD’s report to Congress. Also, DOD’s report cited seven 

Army Audit Agency postconveyance reviews, four additional Army 

postconveyance reviews, and one Air Force postconveyance review. 

However, only three of the Army Audit Agency reviews included a 

comparison of actual contract costs with estimates from the economic 

analyses. 

Although DOD has taken steps to help ensure that the services adequately 

consider the increased costs from utility privatization projects during 

budget preparation, questions remain over the availability of the additional 

funds needed to complete the program. The services estimate that they 

potentially will need $453 million more than is currently programmed for 

continuing government utility operations to pay implementation and 

contract costs associated with the remaining number of utility systems 

that might be privatized through 2010 for the Air Force, the Navy, and 

Marine Corps, and through 2011 for the Army. As a result, in view of 

competing needs and budget priorities, the Deputy Assistant Secretary of 

the Air Force (Installations) stated in an April 2006 memorandum that the 

Air Force could not afford to award further utility privatization contracts 

unless additional resources are provided. 

Our May 2005 report noted that installation utility costs under privatization 

typically increase significantly above historical levels because the systems 

are being upgraded and the contractors recoup their investment costs 

through the utility services contracts. Essentially, under the privatization 

program, the services leverage private sector capital to achieve utility 

system improvements that otherwise would not be feasible in the short 

term because of limited funding caused by the competition for funds and 

budget allocation decisions. The services pay for the improvements over 

time through the utility services contracts, which are “must pay” bills. As a 

result, if an installation’s funds were not increased sufficiently, then funds 

provided for other installation functions where there was more discretion 

in spending might be used to pay the higher utility bills. This, in turn, could 

negatively affect those other functions, such as the maintenance of 

installation facilities. We recommended that DOD provide program 

guidance emphasizing the need to consider increased utility costs under 

DOD Has Taken Steps to 

Address Some Funding 

Issues but Concerns 

Remain 

Utility Costs Increase with 

Privatization 

Page 18 GAO-06-914 Defense Infrastructure
privatization as the military services prepare their operation and 

maintenance budget requests and that DOD direct the service Secretaries 

to ensure that installation operations and maintenance budgets are 

adjusted as necessary to reflect increased costs from utility privatization 

projects. 

In November 2005, DOD issued supplemental program guidance that 

reminded DOD components to consider the increase in utility costs from 

privatization. Specifically, the guidance directed the components to 

consider and plan for increased costs for utility services contracts 

resulting from potential privatization projects and system conveyance and 

prepare operation and maintenance budgets based upon the expected 

costs under privatization.

DOD’s guidance addresses the recommendations from our May 2005 

report and, if implemented, should result in the increased costs from

utility privatization projects being adequately considered during budget

preparation. However, in view of competing needs and budget priorities, 

questions remain over availability of the additional funds needed to 

complete the program. To illustrate, DOD’s November 2005 supplemental 

guidance also directed DOD components to advise the Deputy Under 

Secretary of Defense (Installations and Environment) if significant 

shortfalls are anticipated that will affect utilities privatization efforts. In 

response to that direction, each service estimated the remaining number 

of utility systems that might be privatized, calculated the associated 

implementation and contract costs, compared these costs with the funds 

already programmed for continued government operation of the systems 

that might be privatized, and determined whether any potential funding 

shortfalls existed. The Army’s estimate was through fiscal year 2011 and 

the other services’ estimates were through fiscal year 2010. As a result of 

this review, each service determined that funding shortfalls existed to pay 

for potential future privatization contracts (see table 5). 

Funds Not Programmed for All 

Potential Utility Privatization 

Projects 

Page 19 GAO-06-914 Defense Infrastructure
Table 5: Service Estimates of Potential Utility Privatization Program Funding 

Shortfall 

Dollars in millions 

Component 

Number of 

systems that 

potentially

could be

privatized

Potential program 

costs if the 

systems are 

privatized

Total funds

programmed

Total unfunded

requirement 

(shortfall)

Army 41 $212.4 $90.3 $122.1

Navy and Marine 

Corps 

40 139.3 103.2 36.1

Air Force 210 602.0 306.9 295.1

Total 291 $953.7 $500.4 $453.3

Source: DOD. 

Air Force officials stated that the increased costs from potential future 

utility privatization contracts had reached a critical point. The officials 

stated that because funds are limited and funding needs for some Air 

Force programs are greater than the funding needs for utility upgrades, the 

Air Force has concluded that it will not solicit new utility privatization 

contracts until additional resources are identified to specifically cover any 

potential increase in future costs. Air Force officials further explained that

privatization results in improving utility systems to an industry standard 

level by creating “must pay” contracts. However, without additional 

resources, funding these contracts must come from other base operating

support funds, which would result in diverting critical resources from 

remaining facilities and infrastructure. Also, the officials noted that the 

utility privatization program drives system recapitalization to an industry 

standard level that may be questionable when compared to historical Air 

Force requirements and, furthermore, reflects a funding level that is not 

affordable in light of current fiscal constraints and differing Air Force 

modernization priorities. 

When we questioned a cognizant DOD official in June 2006 about the 

potential funding shortfall, the official stated that each service has 

competing priorities and the cost of awarding contracts to privatize utility 

infrastructure is just one of many. However, the official also stated that the

funding issue and alternatives were under discussion but conclusions had 

not yet been reached. 

Air Force May Not Award Some 

Additional Privatization 

Projects Due to Funding Issues 

Page 20 GAO-06-914 Defense Infrastructure
DOD has made a number of changes designed to improve utility 

privatization contract administration and oversight since our May 2005

report. However, it may take some time for the improvements to be fully 

implemented as the changes are applied to new privatization contract 

awards and efforts may be needed to ensure that the changes are applied,

where needed, to previously awarded contracts.

To address privatization contract oversight concerns, DOD issued 

supplemental program guidance in November 2005 that emphasized to the 

services the importance of contract oversight and directed a number of 

actions designed to ensure adequate contract administration and 

oversight. Among other things, the guidance 

DOD Directed Actions to 

Improve Utility 

Privatization Contract 

Oversight but Some 

Concerns Remain 

DOD Has Taken Steps to 

Address Oversight Concerns 

• directed the Defense Energy Support Center to develop specific preaward 

and postaward procurement procedures for the effective management of 

utilities services contracts resulting from a utility conveyance, and 

coordinate with the Defense Acquisition University to develop a training 

program for all contracting officers and DOD components involved in 

utilities privatization efforts; 

• directed contracting agencies to adequately train and prepare personnel 

involved in the administration of the utilities services contracts resulting 

from a utilities conveyance; 

• stated that contracting officers must be able to use guidance for 

postaward contract management and contract provisions to ensure that 

the government’s interests are protected in the long-term utility service 

contracts and associated real estate documents; 

• stated that prior to awarding a services contract resulting from a utility 

conveyance, DOD components are responsible for ensuring, among other 

things, that resources required to properly administer the contract have

been identified; and 

• directed that transfers of contract administration responsibilities from the 

procuring contract office to the contracting administration office should 

include an on-site transfer briefing with government and contractor 

personnel that includes, among other things, a clear assignment of 

responsibilities. 

During our visit to the Defense Energy Support Center in April 2006, 

officials stated that in accordance with the guidance, the center had 

already issued the preaward and postaward procurement procedures that 

would help ensure the effective management of utilities services contracts. 

The officials stated that they had also begun developing a training program 

for all contracting officers and other DOD personnel involved in utilities 

privatization efforts and had developed procedures for transferring 

Page 21 GAO-06-914 Defense Infrastructure
contract responsibilities that should help ensure effective contract 

oversight. During our visits to the services, officials stated that, in addition

to working with the Defense Energy Support Center, further efforts were 

underway to ensure that postaward management is effective. For example, 

Air Force officials stated that they had developed their own postaward 

plan, which defines the responsibilities and standards by which the 

government could ensure that utility services are provided in accordance 

with requirements. Navy officials stated that the Navy plans to prepare a 

quality assurance plan for each utility privatization contract awarded. 

Although the steps taken by DOD, the Defense Energy Support Center, and 

the services are significant improvements, implementation will be the key 

to ensuring effective oversight of all utility privatization contracts, and it 

may take some time to fully implement improvements as new privatization 

contracts are awarded. From the time DOD’s supplemental guidance was 

issued and other improvement measures were put into place through the 

time of our review in June 2006, the services awarded no new utility 

privatization contracts. Thus, to assess contract oversight, we were unable

to visit installations with utility privatization contracts awarded after 

DOD’s changes were implemented. Instead, we assessed contract 

oversight at four installations with five utility privatization projects that 

were awarded prior to our May 2005 report. We found continuing concerns 

about the adequacy of oversight because no additional resources were 

provided to oversee the contracts at all four installations and mandatory 

written plans for overseeing contractor performance were not prepared at 

two installations. 

For example, officials at each of the four installations we visited noted 

that no additional resources were provided at the installation level to

perform contract oversight once their utility systems were privatized. The 

contract officials stated that the extra work associated with the contracts 

was added to their workload of overseeing other contracts. Some officials 

stated that they did not have sufficient personnel to perform the level of 

detailed monitoring of contractor performance that they believed was 

needed. According to Fort Eustis officials, when the electric system was 

privatized, they requested three additional people to oversee the contract 

based on the magnitude of the workload associated with this contract. Yet, 

no additional people were provided and the extra workload was added to 

the workload of the staff responsible for overseeing other contracts. 

Also, our review of the electric distribution system privatization projects 

at Fort Eustis and the Army’s Military Ocean Terminal Sunny Point found

that neither installation had a quality assurance surveillance plan in place 

Some Contract Oversight 

Concerns Identified at the Four 

Installations We Visited 

Page 22 GAO-06-914 Defense Infrastructure
for overseeing contractor performance. Such plans are required by the 

Federal Acquisition Regulation. Officials at both installations stated that 

although a formal surveillance plan had not been prepared, they were 

performing oversight to ensure that the contractors met contract 

requirements. Nevertheless, formal contractor performance monitoring 

plans are an important tool for ensuring adequate contract oversight. 

Because contractors own installation utility systems after privatization 

and, therefore, may have an advantage when negotiating contract changes 

and renewals, containing utility privatization contract cost growth may 

become a challenge as contracts go through periodic price adjustments 

and installations negotiate prices for additional needed capital

improvement projects and other changes. In March 2006, DOD stated that 

although it recognizes that privatization may limit the government’s 

options during contract negotiations, the department continues to prefer 

privatization with permanent conveyance and believes that safeguards are

in place to adequately protect the government’s interests. Although it is 

too early in the program’s implementation to know to what extent DOD’s 

efforts will be successful in ensuring equitable contract price adjustments 

and limiting long-term cost growth in the utility privatization program, our 

review found indications that containing cost growth may become a 

concern. 

In our prior report, we noted that, according to DOD consultant reports, 

DOD’s approach to utility privatization differs from typical private sector

practices in that private sector companies may outsource system 

operations and maintenance but normally retain system ownership. As a 

result, the consultant reports note that DOD’s preferred approach of 

permanently conveying utility system ownership to contractors may give 

the contractor an advantage when negotiating service contract changes or 

renewals. This occurs because DOD must deal with the contractor or pay 

significant amounts to construct a new utility distribution system to 

replace the one conveyed to the contractor, attempt to purchase the 

system back from the contractor, or institute legal action to reacquire the 

system through condemnation proceedings. Because of concern that 

contractors may have an advantage when it comes time to negotiate 

contract changes and renewals, we recommended that DOD reassess 

whether permanent conveyance of utility systems should be DOD’s 

preferred approach to obtaining improved utility services. 

DOD stated that it has reassessed its position and continues to believe that 

owning, operating, and maintaining utility systems is not a core mission of 

Containing Utility 

Privatization Contract Cost 

Growth May Be a 

Challenge 

DOD Continues to Prefer 

Permanent Conveyance but 

Has Taken Steps to Control 

Costs 

Page 23 GAO-06-914 Defense Infrastructure
the department and that permanent conveyance of systems under utilities 

privatization enables the military installations to benefit from private 

sector innovations, economies of scale, and financing. Although DOD 

contends that private industry can normally provide more efficient utility 

service than can the government, DOD has not provided any studies or 

other documentation to support its contention. Given that the private 

sector faces higher interest costs than the government and strives to make

a profit whereas the government does not, it is not certain that utility 

services provided by the private sector would be less costly than utility 

services provided by the government through the use of up-front 

appropriations. 

Although DOD continues to prefer privatization with permanent 

conveyance of the utility systems, DOD has recognized that privatization 

may limit the government options during contract renegotiations and has

taken steps to help control contract cost growth. First, DOD stated in its 

March 2006 report to Congress that a contractor also may have limited 

options under privatization because the contractor typically cannot use 

the installation’s utility system to service other customers. DOD reported 

that privatization creates a one-to-one relationship between the 

installation and the contractor. In this relationship, DOD stated that both 

parties must work together to execute fair and equitable contract changes, 

both parties have significant vested interests in successful negotiations, 

and both parties retain substantial negotiation leverage. 

Second, DOD noted that service contracts awarded as part of a 

privatization transaction are contracts subject to the Federal Acquisition 

Regulation and applicable statutes. Because it is recognized that 

privatization will as a practical matter limit future opportunities to 

recompete this service, DOD stated that all contracts will include 

appropriate provisions to protect the government’s interest while allowing 

the contractor reasonable compensation for the services provided. DOD’s 

report further stated that fixed price contracts with prospective price 

adjustment provisions have been determined to be the most appropriate 

contract in most situations and that this type of a contract will mitigate 

cost risk and hopefully result in a satisfactory long-term relationship for 

both the contractor and the government. 

Third, DOD noted that utility services contracts resulting from a utility 

conveyance may include a contract clause that provides an option for the 

government to purchase the system at the end of the contract period. 

According to Defense Energy Support Center officials, the center has 

developed language for future Army and Air Force contracts that would 

Page 24 GAO-06-914 Defense Infrastructure
provide an option for the government to buy back a system at the end of 

the contract period. Center officials stated that this clause may help the 

government in negotiations at the end of the contract term. Navy officials 

stated that the Navy does not plan to include a buy back clause in its 

future utility contracts because a system could be taken back, if necessary, 

through condemnation procedures. 

Fourth, in its November 2005 supplemental guidance, DOD emphasized 

the importance of controlling contract cost growth. Specifically, the 

guidance noted that prior to awarding a services contract resulting from a 

utility conveyance, DOD components are responsible for ensuring that the 

acquisition plan adequately addresses cost growth control, which includes 

specifying the appropriate price adjustment methodology and postaward 

contract administration. 

Although DOD has policies, guidance, and procedures to help control 

contract costs and ensure that price adjustments are equitable, cost 

growth may still become a concern as utility privatization contracts go 

through periodic price adjustments and, in some cases, installations 

negotiate changes for additional capital improvement projects or other 

needs. According to DOD, most utility privatization contracts include 

provisions for periodic price adjustments. The price adjustment process 

allows contract price changes based on changes in market prices, 

generally to cover inflation, and changes to the service requirement from 

system additions or modifications resulting from capital upgrades. Under 

this process, the contractor is required to submit sufficient data to support 

the accuracy and reliability of the basis for service charge adjustments. If 

the contractor’s data is determined to be fair and reasonable, the 

contracting officer negotiates a service charge adjustment. Utility 

privatization contracts normally provide for price adjustments after an 

initial 2-year period and every 3 years thereafter. In addition to cost 

increases from service charge adjustments, contract costs can also 

increase as a result of contract modifications to pay for additional capital

improvement projects not included in the initial contract. 

According to the services, utility privatization contracts for 22 systems are 

currently undergoing, or will be subject to, their first periodic price 

adjustment before the end of calendar year 2007.

18 Although it is too early 

Cost Growth in Utility 

Privatization Contracts May 

Become a Concern 

 18Air Force officials stated that four additional utility privatization contracts were 

previously eligible for periodic price adjustment but no adjustment was made because 

neither the contractor nor the government requested an adjustment. 

Page 25 GAO-06-914 Defense Infrastructure
to know the extent of cost changes that might occur in these contracts, 

our review of six contracts—one that completed a periodic price 

adjustment, one that was undergoing periodic price adjustment, and four 

that had not yet undergone a periodic price adjustment—found conditions

that indicate that cost growth in utility privatization contracts may become 

a concern. Changes in contract costs could result in privatization costs 

increasing above the levels estimated in the economic analyses. To 

illustrate: 

• The Fort Rucker natural gas distribution system privatization contract was 

issued on April 24, 2003. The contract provided for a price adjustment 

after the initial 2 years of the contract and then every 3 years thereafter. In

February 2005, the contractor submitted a proposal for a price adjustment 

and requested an increase in the price paid to the contractor for 

operations and maintenance, associated overhead, and renewals and 

replacements. According to a government memorandum that summarized 

the results of the price adjustment process, the requested increases were 

based on the contractor’s actual labor hours and material costs and 

additional overhead costs which resulted from a change in the way the 

contractor calculated overhead costs. The change in overhead calculations 

included costs that were not included in the original proposal submission 

or in the contract. When queried, the contractor responded that the costs 

were not originally submitted but should have been. After review, the 

government team responsible for the price adjustment process determined 

that the requested increases were allowable and reasonable and approved

the price increase. The change increased the government’s annual utility 

service charge costs from about $87,000 to about $124,000, an increase of

about $36,000, or 41 percent. In approving the increase, the government 

team noted that although the estimated cost avoidance from privatization

would be reduced, the contract was still economical compared to the 

estimated costs of government ownership. 

• The Sunny Point electric distribution system privatization contract was 

issued on September 30, 2003. In January 2006, the contractor submitted a 

proposal for a price adjustment and requested an increase in the utility 

service charge based on the contractor’s actual labor hours and material 

costs associated with operating and maintaining the system, including the

installation’s emergency generators. According to installation officials, the 

costs to operate and maintain the system were significantly higher than 

originally anticipated by the contractor because of errors in the system’s 

inventory used to develop the solicitation, such as not including all of the 

installation’s emergency generators. When queried about the requested 

price increase, the contractor responded that the initial contract bid would 

have been higher if the true inventory of the system had been known. 

Although the price adjustment process was not final at the time of our visit 

Page 26 GAO-06-914 Defense Infrastructure
in June 2006, installation officials stated that the government team 

responsible for the process had determined that the requested increases 

were allowable and reasonable and had approved the price increase. As a 

result of the price adjustment, the government’s annual utility service 

costs are expected to increase from about $415,000 to $798,000 in the third 

year of the contract, an increase of about $383,000, or 92 percent. 

• The Fort Eustis electric distribution system privatization contract was 

issued on June 24, 2004. While this contract is not scheduled for a periodic 

price adjustment until December 2006, the contract costs have increased 

by about $431,000, or 26 percent, since the contract was signed. The 

increase is the result of two factors. First, the annual service charge was 

increased by about $73,000 as the result of correcting errors to the 

system’s inventory described in the privatization solicitation. Second, the 

contract’s cost was increased by about $358,000 to pay for capital 

improvement projects that were added to the original contract. Fort Eustis 

officials stated that funding for the capital improvement projects added to

the contract did not have to compete for funding against other needed 

installation improvement projects because project costs were added to the 

privatization contract. The officials stated that it was unclear whether 

these projects would have been approved for funding had the privatization 

contract not been in place. 

The remaining three contracts we reviewed—the water and wastewater 

privatization contracts at Bolling Air Force Base and the electric 

distribution system privatization contract at Dobbins Air Reserve Base—

were not yet eligible for, or not subject to, a periodic price adjustment. At 

the time of our visits in May 2006, actual contract costs in these cases 

approximated the estimates in the projects’ economic analyses. 

Because DOD has not changed the guidance for performing the economic 

analyses or taken any other steps to change the perception that the utility 

privatization program results in reduced costs to the government, the 

program may continue to provide an unrealistic sense of savings for a 

program that generally increases annual government utility costs in order 

to pay contractors for enhanced utility services and capital improvements. 

The concern was caused by the methodology DOD uses to determine 

whether a proposed privatization contract would meet the statutory 

requirement for reduced long-term costs. In our previous report, we noted 

that DOD’s guidance directs the services to compare the estimated longterm costs of the contract with the estimated long-term “should costs” of 

continued government ownership assuming that the service would 

upgrade, operate, and maintain the system in accordance with accepted 

DOD Has Not Made 

Changes to Provide More 

Realistic Savings 

Estimates from Utility 

Privatization 

Page 27 GAO-06-914 Defense Infrastructure
industry standards as called for in the proposed contract. This estimating 

method would be appropriate, if in the event the system is not privatized, 

the service proceeded to upgrade, operate, and maintain the system as 

called for in the estimate. However, this generally is not the case. 

According to DOD and service officials, if a system is not privatized, then 

the anticipated system improvements would probably be delayed because

of DOD’s budget allocation decisions, which have limited funds for utility 

improvements. Because of the time value of money, a future expense of a

given amount is equivalent to a smaller amount in today’s dollars. Thus, if 

reduced costs to the government are expected to be a key factor in utility 

privatization decision making, then it would appear more appropriate for 

the services to compare the cost of a proposed privatization contract with 

the cost of continued government ownership on the basis of the actual 

planned expenditures and timing of these expenditures. 

Since May 2005, DOD has not changed the guidance for performing the 

economic analyses nor has DOD taken other steps, such as showing 

current utility system costs in the economic analyses, to change the 

perception that the utility privatization program results in reduced costs to 

the government. DOD’s November 2005 supplemental program guidance 

directed the services to continue to prepare economic analyses based on 

the “should costs,” which is defined as an independent government 

estimate of the costs required to bring the system up to and maintain it at 

current industry standards. Further, DOD’s March 2006 report to Congress 

stated that the “should cost” estimate is the government’s best tool for 

predicting the future requirement for individual systems and is the most 

realistic methodology. Yet, the report also acknowledged that the 

department had done an inadequate job of defining industry standards and

then subsequently programming, budgeting, and executing to that 

requirement. Because DOD has not programmed funds to do the work 

described in the “should cost” estimate if the system is not privatized, 

DOD’s estimates of the reduced costs to the government that would result

from privatization are not based on realistic cost differences.

Information that DOD reported to Congress in March 2006 illustrates our 

concern. DOD’s report stated that the department’s total cost avoidance 

from utility conveyances is expected to exceed $1 billion in today’s dollars 

and, as shown in table 6, the report included information showing that the 

81 contracts awarded under 10 U.S.C. 2688 will result in about $650 million 

in reduced costs to the government in today’s dollars compared to DOD’s 

“should cost” estimate. 

Page 28 GAO-06-914 Defense Infrastructure
Table 6: DOD’s Estimated Cost Avoidance from Utility Privatization 

Dollars in millions 

Component 

Number of 

systems 

privatized

Estimated costs 

under government

ownership

Estimated 

costs under 

privatization

Estimated cost 

avoidance with

privatization

Army 70 $2,377.0 $1,867.5 $509.5 

Navy and Marine 

Corps 

1 308.1 215.4 92.7 

Air Force 10 220.5 173.0 47.5 

Total 81 $2,905.6 $2,255.9 $649.7

Source: DOD. 

Note: Estimates are totals in today’s dollars over the contract terms (50 years for most projects). 

DOD’s reported cost avoidance amounts provide an unrealistic sense of 

savings for several reasons: 

• First, as previously stated, the estimated costs under government 

ownership are not based on the actual expected costs if the system is not 

privatized but rather on a higher “should cost” amount. As a result, 

estimated costs under government ownership are overstated and, 

therefore, DOD’s estimated cost avoidance is overstated, at least in the 

short term. 

• Second, the government’s costs for utility services increase with 

privatization. Army officials estimated that average annual cost increase 

for each privatized Army system was $1.3 million. Also, the services 

estimate that they will need $453 million more than is currently 

programmed for continuing government ownership to pay for the contract 

and other costs associated with the remaining number of utility systems 

that might be privatized through 2010 for the Air Force and the Navy and 

Marine Corps, and through 2011 for the Army. 

• Third, DOD’s reported cost avoidance does not consider the program’s 

one-time implementation costs. Through fiscal year 2005, about $268 

million was spent to implement the program. 

• Fourth, the economic analyses used to estimate the cost avoidance 

between the government-owned and privatization options for several of 

the 81 projects included in DOD’s report to Congress are unreliable. As 

noted in our previous report, our review of seven project analyses 

identified inaccuracies, unsupported cost estimates, and noncompliance 

with guidance for performing the analyses. The cost estimates in the 

analyses generally favored the privatization option by understating longterm privatization costs or overstating long-term government ownership 

costs. When we made adjustments to address the issues in these analyses, 

Page 29 GAO-06-914 Defense Infrastructure
the estimated cost avoidance with privatization was reduced or eliminated. 

Also, as discussed in another section of this report, although DOD has 

taken steps to improve reliability, we found questionable items in 10 

economic analyses supporting projects awarded after our May 2005 report. 

• Fifth, cost growth in privatization contracts might reduce or eliminate the 

amount of the estimated cost avoidance from privatization. We reviewed 

the analysis supporting the Navy’s one privatization project under 10 

U.S.C. 2688, awarded in 1999, and compared actual contract costs to the 

estimated contract costs included in the analysis. The analysis showed 

that if contract costs continue to increase at the same rate experienced 

since the contract was awarded, then the project’s estimated cost 

avoidance would be reduced from about $92.7 million to about $18 million.

This analysis also did not include consideration of privatization contract 

oversight costs. Consideration of these costs would further reduce the 

estimated cost avoidance to about $4 million. As discussed in another 

section of this report, we found contract cost growth concerns in 3 of 6 

additional utility privatization projects we reviewed, which will reduce the 

estimated cost avoidance for those projects. 

In addition to providing an unrealistic sense of savings by providing only 

the “should cost” estimates, the economic analyses do not include other 

information that would provide decision makers with a clearer picture of

the financial effect of privatization decisions. If the analyses included 

information showing the amount that the government currently spends on 

operating, maintaining, and upgrading the utility systems being evaluated 

for privatization, decision makers could better consider the increase in 

costs that will result from privatization as they assess the merits of 

proposed projects. However, DOD’s guidance does not require that the 

services’ economic analyses include current utility system cost 

information. 

The National Defense Authorization Act for Fiscal Year 2006 modified the 

program’s legislative authority by requiring that project economic analyses

incorporate margins of error in the estimates that minimize any 

underestimation of the costs resulting from privatization of the utility 

system or any overestimation of the costs resulting from continued 

government ownership and management of the utility system. This step 

could help improve the reliability of the cost differences between the 

government-owned and privatization options. The modified authority 

stated that incorporating margins of error in the estimates was to be based 

upon guidance approved by the Secretary of Defense. However, as of June 

2006, DOD had only issued general guidance in this area with no details on 

how the services were to comply with the new requirement. Specifically, 

Page 30 GAO-06-914 Defense Infrastructure
on March 20, 2006, DOD issued guidance directing the services to include 

in the economic analysis an explanation as to how margin of error 

considerations were addressed in developing the independent government 

cost estimate and carried forward in the price analysis report and cost 

realism report. Although the guidance referenced Office of Management 

and Budget Circular A-94, dated October 29, 1992; DOD Instruction 7041.3, 

dated November 7, 1995; and Deputy Secretary of Defense memorandum 

and guidance dated October 9, 2002; none of these documents provide 

details on how margins of error should be incorporated into the economic 

analyses. At the time of our review in June 2006, Army and Navy officials 

stated that they were evaluating how to include margins of error into 

future economic analyses. Air Force officials stated that their economic 

analyses already included margins of error calculations but that no formal 

rules existed on how to use the results of the calculations. Without 

detailed DOD guidance, there is little assurance that the services will 

include margins of error considerations in an appropriate and consistent 

manner in future project economic analyses. 

DOD’s changes to implement a modification to the legislative authority for 

the utility privatization program have addressed the fair market value 

concerns discussed in our May 2005 report. Our report noted that in some 

cases implementation of a previous legislative requirement that the 

government receive fair market value for systems conveyed to

privatization contractors had resulted in higher contract costs for utility 

services. To address this concern, we recommended that DOD 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. 

Subsequent to our report, in January 2006, the National Defense 

Authorization Act for Fiscal Year 2006 was enacted.19 The act changed the 

legislative language from stating that fair market value from a conveyance

must be received to stating that fair market value from a conveyance may 

be received.

In March 2006, DOD issued guidance to implement modifications in the 

legislative authority made by the act. With regard to fair market value, 

DOD’s guidance to the services noted that military departments are no 

longer required to obtain fair market value exclusively through cash 

Changes in Legislative 

Authority and DOD’s

Implementation of the 

Change Address Fair 

Market Value Concerns 

 19Pub. L. No. 109-163, § 2823 (2006). 

Page 31 GAO-06-914 Defense Infrastructure
payments or rate credits. The military departments now have the flexibility 

to seek consideration in a manner other than a payment of the fair market 

value when the economic analysis demonstrates it is in the best interest of 

the government. The guidance also stated that the military departments 

may not dispose of the government’s property without receiving an 

appropriate return, but the amount and nature of that return may be 

determined and represented in a number of ways, depending on the 

negotiated deal. 

The change in legislative authority and the additional guidance issued by 

DOD address our concern with receipt of fair market value for system 

conveyances. Our review of 10 economic analyses for projects awarded 

after our May 2005 report showed that the fair market value paid by the 

contractor and the amount recovered were the same. Thus, according to 

these analyses, the receipt of the fair market value for the conveyances in 

these cases did not result in any increased costs to the government. 

DOD has made many changes to improve the management and oversight 

of the utility privatization program since our previous report. If fully 

implemented, the changes should result in more reliable economic 

analyses supporting proposed privatization projects, improved budgetary 

consideration of increased utility costs from privatization, enhanced 

oversight of privatization contracts, and reduced instances where 

contractors recover more than the amounts they paid as the fair market 

value for system conveyances. However, a number of program concerns 

remain because DOD’s changes to address some issues noted in our 

previous report have not been effectively implemented, some changes 

were not sufficient to totally eliminate the concerns, and DOD did not 

make changes to address some concerns. Specifically, implementation of 

DOD’s changes to improve the reliability of the economic analyses, such as 

requiring independent reviews and noting the importance of 

postconveyance reviews to compare actual contract costs with estimates 

from the analyses, could be improved. The reliability of the analyses could

continue to be questionable until DOD requires independent reviewers to 

report to decision makers on the thoroughness of the economic analyses

and any significant anomalies between the ownership options, estimated 

costs, inventories, and assumptions and also issues guidance requiring the 

services to perform the postconveyance reviews as noted in its March 2006 

report to Congress. An additional concern is the services’ estimated 

shortfall in the funds needed to pay contract costs associated with the 

remaining number of utility systems that might be privatized by the end of 

their programs. Unless DOD addresses the potential funding shortfall in 

Conclusions 

Page 32 GAO-06-914 Defense Infrastructure
view of all DOD and service funding and priority needs, questions will 

remain over the availability of the additional funds needed to complete the 

program. Also, although DOD’s changes designed to improve utility 

privatization contract administration and oversight are key steps in the 

right direction, it may take some time to fully implement improvements as 

new privatization contracts are awarded and oversight of older contracts 

is assessed. Until DOD ensures that the contracts awarded prior to the 

program changes have adequate resources and contractor performance 

surveillance plans, the adequacy of contract oversight will remain a 

concern. Further, because contractors own installation utility systems 

after privatization, they may have an advantage when negotiating contract 

changes and renewals. Unless DOD places additional emphasis on 

monitoring contract cost growth as utility privatization contracts undergo 

periodic price adjustments and other changes are negotiated, concern will 

continue that containing utility privatization contract cost growth may 

become a challenge.

Because DOD did not change guidance to require that project economic 

analyses show the actual costs of continued government ownership if the 

system is not privatized, or take any other steps to change the perception 

that the utility privatization program results in reduced costs to the 

government, DOD continues to provide an unrealistic sense of savings to a 

program that generally increases government utility costs in order to pay 

contractors for enhanced utility services and capital improvements. Until 

DOD requires that each economic analysis includes information on the 

system’s current costs and the actual expected costs if the system is not 

privatized, decision makers will have incomplete information on the 

financial effect of privatization decisions. In addition, unless the Secretary 

of Defense issues detailed guidance explaining how the services should 

incorporate margins of error in the economic analyses, as required by the 

National Defense Authorization Act for Fiscal Year 2006, there is little 

assurance that the full benefit from this requirement will be achieved. 

We recommend that the Secretary of Defense direct the Deputy Under 

Secretary of Defense (Installations and Environment) to take the following 

seven actions: 

Recommendations for 

Executive Action 

• require independent reviewers to report to decision makers on the 

thoroughness of each economic analysis and any significant anomalies in 

the assumptions used and estimated costs for each ownership option; 

• issue guidance requiring the services to perform the postconveyance

reviews as noted in DOD’s March 2006 report to Congress; 

Page 33 GAO-06-914 Defense Infrastructure
• address the utility privatization program potential funding shortfall in view 

of all DOD and service funding and priority needs; 

• ensure that utility privatization contracts awarded prior to the November 

2005 supplemental guidance have adequate resources and contractor 

performance surveillance plans; 

• place additional emphasis on monitoring contract cost growth as utility 

privatization contracts undergo periodic price adjustments and other 

changes are negotiated; 

• require, in addition to the “should cost” estimate, that each project 

economic analysis include the system’s current annual costs and the actual 

expected annual costs if the system is not privatized; and 

• issue detailed guidance explaining how the services should incorporate 

margins of error in the economic analyses. 

In comments on a draft of this report, the Deputy Under Secretary of 

Defense (Installations and Environment) generally agreed with six of our 

seven recommendations and outlined a plan of action to address each 

recommendation. The Deputy Under Secretary noted that the utility 

privatization systems evaluated in our report were approved prior to 

DOD’s November 2005 program guidance and that the guidance will be 

fully implemented prior to awarding additional contracts. We recognize 

that issues identified in this report pertain to contracts awarded before 

supplemental program guidance was issued in November 2005. 

Nevertheless, we believe the issues identified in this report highlight areas

that merit increased attention as the program continues—and this is 

reflected in the department’s response to each recommendation. 

The Deputy Under Secretary indicated disagreement with our 

recommendation to require, in addition to the “should cost” estimate, that 

each project economic analysis include the system’s current annual costs 

and the actual expected annual costs if the system is not privatized, and 

also stated that full implementation of DOD’s November 2005 guidance 

will provide further reassurance that every conveyance will reduce the 

long-term costs of the department compared to the costs of continued 

ownership. However, as noted in our May 2005 report and again in this 

report, we believe that in the short term it is clear that the utility 

privatization program increases annual costs to the government where 

contractors make system improvements and recoup their costs from the 

department through their service contracts. DOD’s sole use of “should 

costs” as a basis for comparing its long-term costs with those contained in

contractor proposals provides a less clear picture of savings to the 

government since, as our reports have shown, the government’s “should 

Agency Comments 

and Our Evaluation 

Page 34 GAO-06-914 Defense Infrastructure
costs” do not provide a realistic portrayal of the planned government 

expenditures. Accordingly, we believe our recommendation continues to 

have merit. 

DOD’s comments and our detailed response to specific statements in those 

comments are presented in appendix II. 

We are sending copies of this report to other interested congressional 

committees; the Secretaries of Defense, the Army, the Navy, and the Air 

Force; and the Director, Office of Management and Budget. We will also 

make copies available to others upon request. In addition, the report will 

be available at no charge on GAO’s Web site at http://www.gao.gov. 

If you or your staff have any questions about this report, please call me at 

(202) 512-5581 or e-mail at holmanb@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on the 

last page of this report. The GAO staff members who made key 

contributions to this report are listed in appendix III. 

Barry W. Holman, Director 

Defense Capabilities and Management 

Page 35 GAO-06-914 Defense Infrastructure
List of Congressional Committees

The Honorable John Warner 

Chairman 

The Honorable Carl Levin 

Ranking Minority Member 

Committee on Armed Services 

United States Senate 

The Honorable Ted Stevens 

Chairman 

The Honorable Daniel K. Inouye 

Ranking Minority Member 

Subcommittee on Defense 

Committee on Appropriations 

United States Senate 

The Honorable Duncan L. Hunter 

Chairman 

The Honorable Ike Skelton 

Ranking Minority Member 

Committee on Armed Services 

House of Representatives 

The Honorable C. W. Bill Young 

Chairman 

The Honorable John P. Murtha 

Ranking Minority Member 

Subcommittee on Defense 

Committee on Appropriations 

House of Representatives 

Page 36 GAO-06-914 Defense Infrastructure
Appendix I: Scope and Methodology Appendix I: Scope and Methodology 

To update the status of the Department of Defense’s (DOD) utility 

privatization program, we summarized program implementation status and 

costs and compared the status to DOD’s past and current goals and 

milestones. We discussed with DOD and service officials issues affecting 

implementation of the program, such as the services’ suspension of the 

program between October 2005 and March 2006, and inquired about the 

effects of implementation delays on program completion plans. Using data 

from the services’ quarterly program status reports to DOD, we 

summarized the program implementation status by service and compared 

the status to program status reported in our prior report. We confirmed 

the quarterly reports’ status data on five privatization projects at the four

installations we visited but did not otherwise test the reliability of the data. 

We also reviewed and summarized the services’ estimates of the additional 

number of systems that might be privatized by the completion of their 

programs and the funds needed to pay the costs associated with these 

anticipated projects. 

To assess the effect of DOD’s changes on the program management and 

oversight concerns noted in our May 2005 report, we documented the 

changes made by interviewing DOD and service officials and reviewing 

pertinent policies, guidance, memorandums, and reports, discussed with 

DOD and service officials the intended objective for each of the changes, 

and compared the changes with the concerns identified in our prior report. 

To assess the effect of DOD’s changes on the reliability of the economic 

analyses supporting privatization decisions, we reviewed the economic 

analyses supporting 10 privatization projects that were awarded after our 

May 2005 report and that had been subjected to the services’ new 

independent review processes. The analyses were judgmentally selected to

obtain examples from both the Army and the Air Force. For each analysis, 

we evaluated the basis for the estimates and assumptions used and 

assessed consistency and compliance with DOD guidance. We did not 

otherwise attempt to independently determine estimates of long-term 

costs for the projects. We shared the results of our analyses with service 

officials and incorporated their comments as appropriate. To assess the 

effect of DOD’s changes on consideration of increased costs from utility 

privatization, we summarized the services’ estimates of the additional 

funds that would be needed to pay costs associated with the remaining 

number of utility systems that might be privatized and inquired about 

DOD’s plans for dealing with a potential program funding shortfall. To 

assess the effect of DOD’s changes on the administration and oversight of 

utility privatization projects, we visited four installations with five utility 

privatization projects awarded prior to our May 2005 report: Fort Eustis, 

Virginia; the Army’s Military Ocean Terminal Sunny Point, North Carolina; 

Page 37 GAO-06-914 Defense Infrastructure
Appendix I: Scope and Methodology 

Bolling Air Force Base, Maryland; and Dobbins Air Reserve Base, Georgia. 

These installations were judgmentally selected because they represented a 

cross section of typical utility privatization projects, as corroborated with 

service officials. At each installation, we discussed resources available for

contract oversight and plans for contractor performance monitoring. Also, 

to assess the effect of DOD’s changes on controlling cost growth in utility 

privatization contracts, we reviewed cost changes in the five utility 

privatization contracts at the installations we visited, discussed the 

reasons for the changes with local officials, and compared the actual 

contract costs with estimates from the projects’ economic analyses. We 

also reviewed cost changes in the Fort Rucker natural gas privatization 

contract because, according to the services, it was the only contract 

awarded under the legislative authority specifically provided for utility 

privatization that had completed a periodic price adjustment. To assess 

the effect of DOD’s changes on cost avoidance estimates from

privatization, we reviewed the estimates DOD reported to Congress to 

determine whether the estimates reflected the actual changes expected in

the government’s utility costs. 

We conducted our review from March through July 2006 in accordance 

with generally accepted government auditing standards. 

Page 38 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department Appendix II: Comments from the Department of Defense 

of Defense 

Note: GAO comments 

supplementing those in 

the report text appear at 

the end of this appendix. 

Page 39 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

See comment 1. 

Page 40 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

See comment 2. 

See comment 3. 

See comment 4. 

Page 41 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

See comment 5. 

Page 42 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

Page 43 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

The following is our detailed response to the Department of Defense’s 

(DOD) comments provided on August 21, 2006. 

Our responses to DOD’s comments are numbered below to correspond 

with the department’s various points. 

1. As noted in this report, we identified concerns with the independent 

review performed on each of the 10 economic analyses we reviewed. 

We did not attempt in this report to prove that the questionable items 

we identified with each analysis would have changed the proposed 

outcomes but noted that improvements are needed in the 

thoroughness of the independent reviews that will be performed on 

future projects. Until DOD requires independent reviewers to report to 

decision makers on the thoroughness of the economic analyses and 

any significant anomalies, we continue to believe the reliability of the 

analyses could be questioned. As outlined in our May 2005 report and 

this report, to ensure a valid comparison of costs we continue to 

believe that the government’s “should cost” estimate should be closely 

based on performing the same work that the contractor would 

perform. 

GAO’s Response to 

the Department of 

Defense’s Comments 

2. Our report does not suggest that postconveyance reviews should be 

conducted prematurely as indicated by DOD in its comments. The fact 

is that the utility privatization contracts under 10 U.S.C. 2688 authority 

began to be awarded in 1999, about 7 years ago, and postconveyance 

reviews do not appear to have been performed on many ongoing utility 

privatization contracts since that time. Although DOD noted in its 

March 2006 report the importance of postconveyance reviews as an 

additional measure to help ensure reliable economic analyses, it has 

not issued guidance to require the services to perform such reviews. 

3. Our report clearly shows that Air Force officials, not GAO, stated that 

without additional resources, funding for utility privatization contracts 

must come from other base operating support funds, which would 

result in diverting critical resources from remaining facilities and 

infrastructure. 

Furthermore, DOD’s comment that utility sustainment funds have been 

used for other base support operations in the past only reinforces the 

need to address the utility privatization program potential funding 

shortfall. We have completed a number of reviews in which we have

identified examples where the shifting of operation and maintenance

funds from one account to other accounts to fund must-pay bills and 

Page 44 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

other priorities contributes to management problems and funding 

shortfalls. For example, in February 2003, we reported that the 

services withheld facilities sustainment funding to pay must-pay bills, 

such as civilian pay, emergent needs, and other nonsustainment 

programs, throughout the year and transferred other funds back into 

facilities sustainment at fiscal year’s end.1

 Still, the amounts of funds 

spent on facilities sustainment were not sufficient to reverse the trend 

in deterioration. In June 2005, we reported that hundreds of millions of 

dollars originally designated for facilities sustainment and base 

operations support had been redesignated by the services to pay for 

the Global War on Terrorism.2

 While installations received additional 

funds at the end of the fiscal year to help offset shortfalls endured 

during the year, the timing made it difficult for the installations to 

maintain facilities and provide base support services efficiently and 

effectively. Similarly, unless the potential funding shortfall in the utility 

privatization program is addressed, funding will likely have to be 

redesignated to fund the utility privatization program rather than be 

used for its intended purpose. 

4. Our report raises concerns about the adequacy of the services’ 

oversight of several privatization contracts that were awarded prior to 

DOD’s November 2005 supplemental guidance. Given that the Office of 

the Deputy Under Secretary of Defense (Installations and 

Environment) has overall policy and management oversight 

responsibilities for the utility privatization program, we continue to 

believe that this office is the appropriate level for providing direction 

and assurance that utility privatization contracts awarded prior to the 

supplemental guidance have adequate resources and contractor 

performance surveillance plans, as we recommend. 

5. Our report highlights the importance of monitoring cost growth 

because contractors have ownership of the utility systems after 

privatization and, therefore, may have an advantage when negotiating 

contract changes and renewals. In addition, controlling the potential 

growth in the cost of ongoing utilities privatization contracts is 

important to the services in their planning for the adequate funding of 

the program. We did not review the effect of contract cost growth on 

 1

GAO, Defense Infrastructure: Changes in Funding Priorities and Strategic Planning 

Needed to Improve the Condition of Military Facilities, GAO-03-274 (Washington, D.C.: 

Feb. 19, 2003). 

2

GAO, Defense Infrastructure: Issues Need to Be Addressed in Managing and Funding 

Base Operations and Facilities Support, GAO-05-556 (Washington, D.C.: June 15, 2005).

Page 45 GAO-06-914 Defense Infrastructure
Appendix II: Comments from the Department 

of Defense 

the government estimate because the government estimate is not a 

relevant factor in controlling costs once a system has been privatized. 

Although a comparison of actual costs of a privatization project with 

the estimates included in the project’s economic analysis is a useful 

tool to help improve the reliability of analyses of future privatization 

projects, it is unlikely that such comparisons would assist in 

controlling cost growth. 

Furthermore, DOD’s comment refers to a “savings delta.” As noted in 

our May 2005 report and again in this report, in the short term it is 

clear that the utility privatization program increases annual costs to 

the department where contractors make system improvements and 

recoup their costs through the service contracts.

Page 46 GAO-06-914 Defense Infrastructure
Appendix III: GAO

A

 Contact and Staff 

cknowledgments 

Page 47 GAO-06-914

Appendix III: GAO Contact and Staff 

Acknowledgments 

Barry W. Holman, (202) 512-5581 or (holmanb@gao.gov) 

In addition to the person named above, Susan C. Ditto, Harry A. Knobler, 

Katherine Lenane, Mark A. Little, Gary W. Phillips, Sharon L. Reid, and 

John C. Wren also made major contributions to this report. 

Defense Infrastructure

GAO Contact 

Acknowledgments 

(350812) 
GAO’s Mission The Government Accountability Office, the audit, evaluation and 

investigative arm of Congress, exists to support Congress in meeting its 

constitutional responsibilities and to help improve the performance and 

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