Department of Energy: Alternative Financing and Contracting Strategies for Cleanup Projects
Published: 1998-05-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Pursuant to a congressional request, GAO reviewed whether privatization will achieve the nuclear weapons waste clean-up goals expected by the Department of Energy (DOE), focusing on: (1) what conditions need to be present in order to successfully use fixed-price contracting for the Office of Environmental Management's privatized clean-up projects; (2) what alternative financing approaches could be used for Environmental Management's privatization contracts; and (3) how alternative financing methods for Environmental Management's privatization projects might affect budget scoring.
section_title: What GAO Found
paragraphs: GAO noted that: (1) fixed-price contracting, one key aspect of Environmental Management's privatization program, can successfully be used for environmental clean-up projects when certain conditions in the Federal Acquisition Regulation are met; (2) when these conditions exist, GAO found that the Office of Environmental Management has successfully used fixed-price contracts for a variety of activities ranging from cleaning up contaminated soils to decontaminating workers' uniforms; (3) however, when these conditions do not exist, GAO found instances in which clean-up projects being performed under fixed-price contracts encountered cost increases and schedule delays; (4) in addition, risks and issues that could affect the eventual performance of the contract must be clearly defined; (5) total private financing represents one end of a continuum of construction financing options; (6) private financing transfers performance risk from the government to the private contractor, but costs for this approach are significant because of the increased risk assumed by the contractor; (7) total government financing represents the other end of the continuum of options; (8) with government financing, financing costs are minimized, but performance risk which has also proven to be costly, remains with the government; (9) in between these two extremes, other financing options exist that attempt to strike a balance between performance risk and financing costs; (10) how Environmental Management's privatization projects are scored for budget purposes depends on the way certain key aspects of the scoring rules are interpreted; (11) Environmental Management's privatization projects are currently scored as service contracts; (12) the use of alternative financing methods may change the interpretation of the scoring guidelines for these projects; (13) as a result, under all of the alternative financing options that GAO analyzed, the Office of Environmental Management would need more budget authority earlier in the projects and would also incur outlays sooner than under the Office of Management and Budget's method; (14) a complex matrix of decision factors needs to be considered when deciding who to contract for and finance a cleanup project; and (15) once a contract type and financing method are chosen, DOE and the contractor would need to carefully develop a contract that clearly defines each party's roles and accountability through provisions that allocate the project's risks between parties.

section_title: Letter
paragraphs: As requested, this report addresses the use of fixed-price contracting and alternative financing strategies for the Department of Energy’s (DOE) Environmental Management program’s approach for privatizing cleanup projects. The report also examines how alternative financing methods might affect budget scoring.
As arranged, unless you publicly announce its contents earlier, we plan no further distribution of this report until 15 days after the date of this letter. At that time, we will provide copies of the report to the Secretary of Energy; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others upon request.
subsections: section_title: Background
paragraphs: Since its inception in 1989, the Environmental Management (EM) program has used management contractors to perform cleanup projects and operate its major sites. While EM contracts authorize fees (i.e., profits) to motivate management contractors to high-quality performance, subpar performance in the areas of controlling costs and meeting schedules has repeatedly occurred. For example, a 1996 study commissioned by EM found that while cost and schedule performance had improved since 1993, cost overruns on EM projects still ranged from 30 percent to 50 percent.More broadly, in November 1996, we found that, of 15 major system acquisitions completed by the Department of Energy (DOE) from 1980 through 1996, the projects cost an average of 63 percent more than the original cost estimates and were completed an average of 71 months late.More recently, DOE’s Inspector General found a number of problems with the implementation of performance incentives in management contracts, including DOE having paid incentives for work that was not completed by the required performance date, for work done before performance measures were established, and for work that was not done at all.
EM’s privatization program is one aspect of DOE’s Department-wide effort that began in 1994 to reform the Department’s contracting practices, including an increased emphasis on the use of performance incentives and fixed-price contracts. EM’s privatization approach currently has two key elements. First, privatization uses fixed-price contracts under which the contractor is paid a fixed amount for acceptable goods and services regardless of the costs the contractor incurs. Second, privatization contractors are expected to provide private financing for the construction of facilities, if needed, to produce the final product EM is buying. The privatization program receives a separate appropriation to cover the capital investment portion of these contracts. However, in the event the contract is terminated by the government before completion, the privatization funding will be used to reimburse the contractor for its capital investment. If the contract is continued through completion, the privatization funding will be used to repay the capital investment as acceptable goods or services are provided. Although this is the current approach to privatization, according to DOE officials, EM’s privatization program will continue to evolve over time as DOE learns more through evaluating actual business proposals.
The privatization program was first funded in fiscal year (FY) 1997, when the Congress appropriated $330 million to support five projects, including the Tank Waste Remediation System at Hanford (see table 1 below). In FY 1998, the Congress provided an additional $200 million for one existing project and four new projects, including Spent Nuclear Fuel projects at Savannah River and at Idaho, a transportation project at Carlsbad, and a waste disposal project at Oak Ridge. In addition, the Congress provided $31.7 million in FY 1998 through the Defense Facilities Closure Projects account for two smaller privatization projects at EM’s Fernald Environmental Management Project in Ohio. The FY 1999 budget request includes about $517 million to continue work on ongoing privatization projects at Hanford, Idaho, and Oak Ridge, and one new transportation project administered by the Carlsbad Area Office.
In 1997, we reported problems with DOE’s FY 1997 and FY 1998 privatization budget requests. These included estimated costs for projects that did not always include all relevant costs, such as those that would be incurred by the sites’ management contractors to support privatized projects. In addition, funding for some projects was not needed when requested. For example, although funds were requested for FY 1998, we found that the Power Burst Facility at Idaho would not be ready for deactivation until FY 1999. In addition, in computing cost savings, EM did not always compare projects of comparable scope, as in the case of the Savannah River M-Area Mixed Waste Tank Remediation project. Finally, in its fiscal year 1997 budget request, EM cited the Idaho Pit 9 project as a successful privatization on the basis of its placement of a fixed-price contract. However, we found that, since the contract was let, the project has fallen significantly behind schedule and that EM and its management contractor are involved in a disagreement with the fixed-price subcontractor over a number of performance issues. The future course, including the ultimate cost, of this project is uncertain until these disagreements have been formally resolved.
These early problems with implementing the privatization program have led to concern in the Congress about whether privatization, as defined by EM, is appropriate for large, capital-intensive projects. These concerns led the Congress to deny a substantial portion of EM’s FY 1998 privatization budget request and to require EM to submit detailed reports analyzing privatization contracts for a 30-day congressional review before incurring any additional contractual obligations. Specifically, DOE cannot (1) enter into a new privatization contract, (2) exercise authorization to proceed with a privatization contract, or (3) extend a privatization contract by more than 1 year without providing the Congress an opportunity to review the proposed action.
subsections: section_title: Objectives, Scope, and Methodology
paragraphs: The Chairman and Ranking Minority Member of the House Committee on Appropriations, Subcommittee on Energy and Water Development, asked us to review EM’s privatization program. Specifically, we determined (1) what conditions need to be present in order to successfully use fixed-price contracting for EM privatization cleanup projects, (2) what alternative financing approaches could be used for EM privatization contracts, and (3) how alternative financing methods for EM privatization projects might affect budget scoring.
To determine the elements needed to successfully use fixed-price contracts for cleanup projects, we visited three Department of Energy sites with active privatization programs—Hanford, Idaho, and Oak Ridge. During our site visits, we gathered information on cleanup projects formally proposed for privatization. We also reviewed a judgmentally selected group of cleanup projects that used an alternative to the traditional method of having the management contractor perform the work on a cost-reimbursement basis, such as the use of various forms of fixed-price and cost-reimbursement incentive contracts. In addition, to determine what factors DOE considers in selecting the type of contract for cleanup projects, we interviewed the privatization coordinators, contracting staff, and project management staff at each of the sites. At DOE headquarters, we also interviewed officials from (1) EM’s Office of Program Integration, (2) DOE’s Contract Reform and Privatization Project Office, and (3) DOE’s Office of Procurement and Assistance Management. We researched the Federal Acquisition Regulation for information on the various types of contracts, their major features, and criteria for selecting which type of contract to use. Finally, we interviewed officials from the Army Corps of Engineers’ Environmental Division.
To identify alternative financing approaches for EM’s privatization contracts, we interviewed officials of companies currently participating in privatization projects and representatives of financial consulting firms that help clients secure capital for environmental and construction projects. We also discussed project financing issues with the DOE headquarters and field staff listed above and searched relevant financial literature to gather background on issues such as private firms’ capital structures and estimation of financing costs. Finally, we constructed a model using actual data from the contract for the Idaho Advanced Mixed Waste Treatment Project. We used the model to determine the comparative costs of financing under several scenarios. We received assistance in the modeling effort from our Office of the Chief Economist.
To evaluate how alternative financing and contracting approaches might affect budget scoring of EM’s privatization projects, we analyzed the scoring guidelines in the Office of Management and Budget’s (OMB) Circular A-11. We also discussed budget scoring issues with officials of OMB and the Congressional Budget Office. We received assistance in this effort from our Accounting and Information Management Division.
We provided a draft of this report to DOE for its review and comment. DOE’s comments and our response are included as appendix III and are discussed in the chapters where appropriate. We performed our review from July 1997 through May 1998 in accordance with generally accepted government auditing standards.
section_title: Certain Key Conditions Need to Be Present in Order to Use Fixed-Price Contracting
paragraphs: Fixed-price contracts can be used for cleanup projects, including privatization projects, when certain conditions in the Federal Acquisition Regulation are met. For example, the regulation finds that fixed-price contracts are appropriate when projects are well-defined, uncertainties can be allocated between the parties, and sufficient price information and/or multiple competing bidders are available to help determine a fair and reasonable price for the work. In addition, EM’s projects place special demands on both EM and the contractor which must be considered when selecting the contracting strategy that will be most cost-effective. For example, contracts for EM’s projects must consider the need to indemnify contractors for accidents involving nuclear materials. Over the past few years, EM has had some success with fixed-price cleanup contracts; however, experiences in Idaho and Oak Ridge illustrate that fixed-price contracting is not appropriate for every cleanup project.
subsections: section_title: Factors to Consider When Selecting Fixed-Price Contracts
paragraphs: The Federal Acquisition Regulation finds that fixed-price contracting is the preferred type of contract for government acquisitions when certain conditions are met. In general, a fixed-price contract provides the most incentive for the contractor to perform efficiently and to exercise cost control. The risk of cost overruns from poor performance is generally borne by the contractor, which helps to protect the government’s interest. In addition, most fixed-price contracts are awarded through an open competition process that helps the government determine a fair price for the work. The conditions most conducive to using fixed-price contracts include the following: a clearly defined scope of work; low probability of major changes to work scope or conditions to avoid costly renegotiation of price; existence of proven technologies that can be applied with no more than sufficient price information and/or multiple competing bidders to aid in determining a fair price for the work, that is, a price that minimizes the cost to the government while providing a fair profit to the contractor; easily verifiable performance measures to facilitate monitoring progress toward project completion; and thorough analysis of risks and appropriate allocation or sharing of risks so that the party best able to manage each risk is responsible for addressing it.
section_title: EM Has Used Fixed-Price Contracts Successfully
paragraphs: When the conditions discussed above have been present, EM has used several varieties of fixed-price contracts to help ensure cost-effective cleanup. For example, Idaho and Hanford have used fixed-price contracts for laundry services for items such as contaminated workers’ uniforms. DOE has estimated the savings from the Idaho contract at $3 million to $8 million over the next 10 years, and savings from the Hanford contract are estimated to be about $4.5 million per year. Hanford also contracted for the treatment of 24,000 to 26,000 gallons of tri-butyl phosphate wastes on a fixed-price contract at a total savings of about $1.5 million. At Savannah River, the M-Area Mixed Waste Tank Remediation project was privatized in 1993. While the contractor has experienced some technical problems, the contractor expects to successfully complete waste treatment operations under the terms of the original contract. EM estimates this contract will save a total of $19 million to 28 million. Finally, at Idaho the fixed-price contract for low-level waste treatment has a unit cost of about one-half that of the on-site facility that formerly performed this work.
While EM’s focus in pursuing fixed-price contracts has been on saving money, fixed-price contracts can incorporate incentives that accommodate other goals. For example, Oak Ridge used an incentive to reduce the amount of waste created in its contract for the cleanup of the St. Louis North County site of the Formerly Utilized Sites Remedial Action Program. If the contractor shipped less waste, primarily soil, to the designated disposal site than estimated in the contract, DOE avoided the costs of waste disposal. As an incentive for the contractor to minimize waste shipments, DOE split the value of those savings with the contractor. Similarly, the contracts for the Oak Ridge Broad Spectrum Low-Level Mixed Waste Treatment are planned to include incentives for minimizing the volume of waste to be disposed of or stored after treatment.
If a fixed-price contract does not appear to be cost-effective, other contracting methods may offer similar benefits. One such alternative is the use of incentives in cost-reimbursement contracts to motivate the contractor to achieve better cost control and performance. For example, Oak Ridge and its management contractor agreed to cost-plus-incentive-fee contracts for several cleanup projects. While the contractor’s costs were covered, the only way for the contractor to earn a fee or profit on the work was to meet or improve on cost and schedule targets. Under this contract, if the contractor missed the targets by specified amounts, the fee earned could be a negative amount, that is, a loss. The first of these incentive projects was for the demolition of a powerhouse complex on the K-25 site. The project was completed 6 months ahead of schedule and $5 million under target cost. Under another cost-plus-incentive-fee contract for the demolition of cooling towers on the K-25 site, the contractor completed the project 2 months ahead of schedule and more than $5 million under target cost, partly by finding an innovative way to dispose of contaminated water that had accumulated in the basins under the cooling towers. (See app. I for further discussion of alternative contract types and illustrative examples of EM’s cleanup contracts using them.)
section_title: Additional Factors Beyond the Contract Type Need to Be Considered
paragraphs: When contracting for cleanup, EM must also consider additional factors that occur because of the unique characteristics of cleanup projects and the special conditions pertaining to working in the DOE complex. These factors include several types of risks that must be shared or allocated between EM and the contractor, the unique aspects of each project, and the availability of personnel to properly manage fixed-price procurements and projects.
Risks must be identified and addressed in the contract so that each party’s responsibilities are clearly defined. Some risks, such as the possibility of changes in environmental regulations during a project’s lifetime, third-party liability and insurance, environmental indemnification, construction cost and schedule changes, interest rate fluctuations, material cost escalation, lack of sufficient appropriations to support the original schedule, and termination for convenience of the government, are not unique to EM’s cleanup projects but must still be considered in estimating the contract price. Other risks, such as indemnification for accidents involving nuclear materials, working with EM’s stakeholders, and addressing the concerns of unionized workers at EM sites, generally are not found outside of the DOE complex. There are also risks inherent in cleanup projects, such as determining whether the existing waste characterization data are sufficient to support technology selection or design, and how new or existing treatment technologies will perform on a specific waste stream. EM also faces risks such as pre-existing site conditions and paying contractors for idle facilities if, for example, EM or the management contractor fails to deliver waste for treatment as specified in the contract.
EM’s 1997 Privatization Project Team Staffing Report states that “mplementing privatization will require the modification of the Department’s traditional project management practices.” When compared to starting cleanup projects using management contractors, EM officials acknowledge that using fixed-price contracts requires additional project definition and planning before and during the procurement process. Under management contracts, EM managers could make changes as the project progressed without explicit recognition of the costs of those changes. While fixed-price contracts can help to reduce costs and improve performance when used properly, the cost of any changes to work scope must be negotiated with the contractor, potentially raising the price of the contract. In recognition of that fact, EM’s Privatization Management Planrequires that privatization contracts contain a clause limiting who can direct the contractor to make changes that could affect the scope (and, implicitly, the price) of the contract. Not all EM managers are comfortable using fixed-price contracts because of this limited flexibility to make changes after the contract is awarded.
Using fixed-price contracts requires that employees have a different skill mix than EM has needed in the past to manage cleanup projects through its management contracts. The Project Team Staffing report also highlighted some areas in which EM managers will need new or strengthened skills to effectively implement the program. For example, the report notes that privatization procurements require more effort in the early stages of procurement development and more staffing in contract administration and monitoring. The report also recognizes that EM project teams have not traditionally had all of the skills—such as those associated with corporate budgeting, capital market analysis, financing of employee benefit programs, and hands-on experience developing complex schedules and project management plans—needed to ensure that privatization procurements and contracts are fully executable. Consequently, some project managers and procurement staff may need additional training to use fixed-price contracts to full advantage. One step DOE has taken to address these new demands on its staff is to require that all privatization procurement requests for proposals and contracts be sent to headquarters for review and concurrence by functional experts, staff in the Office of Procurement and Assistance Management, and other key officials before they are issued. In addition, EM management is working with the field offices to develop a new training curriculum to provide project managers and procurement staff with additional skills so that they can better recognize when to use fixed-price contracts.
Our work has repeatedly highlighted continuing problems with DOE’s management of projects and contracts. In November 1996, we reported that lack of sufficient DOE personnel with the appropriate skills to oversee contractors’ operations was one of the key factors underlying the cost overruns and schedule slippages DOE has experienced in major systems acquisitions. In March 1997, we reported that a key cleanup project at EM’s Fernald, Ohio, site has experienced significant delay and cost growth because DOE did not assign a sufficient number of staff with the proper skills to the project. Finally, as we discuss in detail in the next section, Idaho has experienced problems with the Pit 9 cleanup, which DOE chose to privatize, in part, because of the lack of in-house expertise in large remediation projects.
section_title: Using Fixed Price Contracts DOEs Not Guarantee That EM Will Achieve the Cost Reduction and Performance Anticipated
paragraphs: Without careful attention to devising the right type of contract, the unique aspects of cleanup projects, and proper management oversight, EM may not get the cost reduction and performance it anticipates from using fixed-price contracts. As we noted in our recent report on DOE’s estimates of potential savings from privatizing cleanup projects, DOE’s use of fixed-price contracts has not always been an effective method to minimize cost growth on projects. EM contracted with a consulting firm, which issued a report in November 1993 and an update in April 1996, to review EM’s performance on cleanup projects performed under both cost-reimbursement and fixed-price contracts. The report found that EM’s costs for environmental work were substantially higher than private industry’s. In 1993, it found that growth from estimated to actual costs on a sample of 65 projects with fixed-price contracts was almost 75 percent. In the 1996 update, it reported that EM’s projects typically cost 25 percent to 40 percent more than similar projects in the private sector. While it found that EM’s cost performance had improved since the 1993 review, EM was still experiencing cost growth in the range of 30 percent to 50 percent over original estimates. It concluded that this cost growth has occurred primarily because projects were poorly defined, leading to change orders after the contracts were signed.
In 1994, Lockheed Martin Idaho Technologies Company, the management contractor at Idaho, awarded a fixed-price subcontract to Lockheed Martin Advanced Environmental Systems (LMAES) for the cleanup of Pit 9. Pit 9 is about one acre in size and contains various wastes ranging from contaminated rags to plutonium-contaminated sludge. The cleanup was expected to cost about $200 million and to be completed in 1999. DOE chose a fixed-price approach for the Pit 9 project because Department officials believed a fixed price would help limit the project’s total cost and provide an incentive for contractors to use efficient practices in carrying out the project by shifting the risk of nonperformance to the contractors. During the early stages of the procurement process, concerns arose about the appropriateness of a fixed-price approach given the uncertainty about the contents of the pit. Nevertheless, senior DOE officials decided that this approach was warranted, given the high costs and the inefficient performance the Department had experienced with cost-reimbursement contracts, private industry’s expressed interest in performing the cleanup using a fixed-price arrangement, and the potential benefits of the approach.
However, in March 1997, when the subcontractor estimated that project completion would be 26 months behind schedule, LMAES requested an equitable adjustment and conversion of the contract type to cost reimbursement. LMAES claims that DOE failed to properly describe the contents of the pit and that DOE and its management contractor have interfered with the contractor’s operations, preventing it from meeting its contractual commitments. DOE and the management contractor at Idaho disagree with LMAES’ claims and claim, in their turn, that the contractor failed to properly manage the project. LMAES has requested a total of $257 million for costs through June 1997, $78 million more than the project was expected to cost, but the waste retrieval and processing facilities are not ready and no wastes have been retrieved or processed. As of May 1998, these issues remain unresolved and the project remains stalled.
In Oak Ridge, a multiphase cleanup project was discontinued after the first phase because the treatment system proposed by the contractor was too expensive and treatment was determined not to be necessary. The management contractor, Lockheed Martin Energy Systems, attempted to contract with multiple firms for the first phase of the West End Treatment Facility project to design a treatment process for a fixed payment. However, they discovered that because the project required each contractor to be able to perform several different types of activities—such as removing sludge from storage tanks, transferring the waste to a treatment facility, and treating the waste—only one firm submitted a responsive bid. Ultimately, the management contractor recommended to EM that the second phase procurement for waste treatment be canceled, but because only one contract had been let, and that contractor had invested more than the fixed amount, EM ended up paying a negotiated equitable adjustment that more than doubled the cost of the first phase contract from $400,000 to about $900,000. In retrospect, EM and management contractor officials told us that they should have reconsidered the project when only one responsive bid was received and determined why they did not receive the level of competition they were expecting. The lack of competition in the procurement for the first phase of this project ultimately led to increased costs when the later phases of the project were canceled.
Another project at Idaho for the long-term storage of damaged fuel from the Three Mile Island reactor has been delayed and the fixed-price contract has been modified 12 times. The Idaho project managers stated that a fixed-price contract would probably not have been chosen for this project if they had known that a change from DOE regulation to Nuclear Regulatory Commission regulation would be made and that the condition of temporarily stored fuel was different from what was expected at the time the contract was awarded. In this instance, the delays and contract modifications have added about $4 million (or 33 percent) to the cost of the project, raising the cost from $12 million to $16 million.
section_title: Alternative Financing Approaches Exist for EM’s Privatization Program
paragraphs: EM’s privatization program relies on private financing of construction costs to create a performance incentive for the contractor to construct a successful facility. However, private financing increases the performance risk borne by the contractor, and as a result, private financing costs can be significant. Other financing options exist that would leave some performance risk with the government by increasing the use of government financing. However, the risk associated with these options could result in significant costs to the government that may offset—or more than offset—the benefit of lower financing costs. In weighing the financing and risk costs, consideration should also be given to the impact of the option selected on ownership of facilities, government oversight, and the terms of contractors’ performance.
subsections: section_title: EM’s Privatization Program Relies on Private Financing
paragraphs: EM’s privatization program relies on private financing for the acquisition of needed cleanup facilities and equipment. Under EM’s approach, the contractor will own all facilities required to deliver the desired cleanup services. The contractor is responsible for all construction costs, including the development of technologies, procurement of equipment, and new-facility construction. In addition, the contractor is expected to finance these construction costs until the facilities are completed and operations begin. Financing cost includes the costs of raising money, taxes, and profit. The contractor is expected to provide the financing for these costs through some combination of its own funds (owners’ equity) and borrowed funds (debt). As the contractor begins to deliver cleanup services, the contractor is paid for its operating costs. In addition, each year the contractor is paid a portion of the construction and financing costs it has incurred until these costs are eventually recouped. These payments for the contractor’s construction and financing costs are directly tied to the amount of cleanup services it provides.
section_title: EM Expects Private Financing to Create Performance Incentive for Contractors
paragraphs: EM expects that its private financing approach will ensure that contractors are properly motivated to perform successfully in two ways. First, because a contractor’s recoupment of its investment is dependent on performance, it will have a greater incentive to perform. Second, because the contractor is financing construction through the use of debt, EM believes that the lenders will provide third-party oversight to ensure that their investment is sound. They are likely to hire various consultants to review all aspects of the contractor’s plans to ensure that the project is feasible, which provides assurance that the likelihood of contractor failure is minimized. In addition, if the contractor does fail to complete the project for some reason, this oversight provides further assurance to the lenders that they could take over the project, bring in another contractor to complete it, and recoup their investment.
While fixed-price contracting is believed to provide some greater control over price, EM believes that private financing is key to ensuring that the project is successful. With only a fixed-price contract and no private financing at stake, EM is concerned that it will have little recourse against a contractor that does not deliver as promised. EM’s concern stems from the fact that contractors that have expressed an interest in large cleanup projects have indicated that they will form separate subsidiaries to perform the contract, using a commonly employed approach known as limited liability companies, that are heavily debt-financed and have few assets of their own. Without appropriate warranties from the parent company, the use of these limited liability companies can financially and legally isolate the project from the parent companies and limit the parent companies’ liability for contract performance. However, under such an arrangement, EM is concerned that if the contractor fails to meet the terms of the contract, the contractor could shut down, leaving EM with an inoperable facility and little hope for recourse against a heavily debt-financed company with few assets.
section_title: Cost of Private Financing Can Be Significant
paragraphs: The total capital cost of a facility consists of the construction costs (including design, construction, and equipment procurement costs) and the financing costs. Private financing costs can be high and can significantly increase the total capital costs. For example, under DOE’s contract with British Nuclear Fuels Limited, Inc., to build the Advanced Mixed Waste Treatment Project in Idaho, EM will pay construction costs of $244.6 million in 1998 dollars. Private financing of these costs will add another $137.9 million, more than half of the construction costs. As larger cleanup projects are considered by EM, such as Hanford’s Tank Waste Remediation System project, which is expected to have construction costs of more than $1 billion, concerns have been raised about whether private financing is a realistic alternative.
section_title: Other Construction Financing Options Are Available
paragraphs: Total private financing represents only one end of a continuum of construction financing options. Total government financing, as traditionally used in EM’s cost-reimbursement management contracts, represents the opposite end of the continuum. Under total government financing, contractors are paid as costs are incurred, eliminating the need to arrange private financing to carry these costs. The performance risk faced by the contractor is also low because the payment is based on costs incurred, not for performance of cleanup services. The government, through EM, bears the bulk of the performance risk.
In between these two extremes, other financing options exist that attempt to strike a balance between financing cost and performance risk. On the basis of reviews of literature and discussions with government and private-sector officials involved with privatization financing, we identified several other financing options. These options are by no means inclusive of all of the possible financing options available to EM, but they reflect a range of options that might be considered and the trade-off between financing costs and performance risk borne by the government. These options include government guarantee of private-sector debt, a performance-based partial-payment plan, and progress payments.
subsections: section_title: Government Guarantee of Debt
paragraphs: A contractor’s construction financing will likely include a great deal of private debt financing. The total amount of debt financing is expected to account for about 70 percent or more of the total financing required. Lenders will charge an interest rate on the debt on the basis of their perceived risk of losing the money loaned to the contractor for construction. The higher the perceived risk that the contractor will not be successful and default on the loan repayment, the higher the interest rate charged for the debt financing, assuming private debt financing is available at all. However, if the government were to guarantee the lenders that they would not lose their money through default, then the interest rate charged and the contractor’s financing costs would be lowered. The government could choose to guarantee all or some portion of the total private debt, which could significantly lower the contractor’s financing costs.
Even with a government guarantee of debt, the contractor would still face a performance risk; that is, the contractor would not get paid unless it delivered cleanup services. However, with government involvement in the financing, the government would also bear a performance risk it did not face under total private financing. The government guarantee of debt would put the government in a position in which it would have to reimburse lenders for any defaults on debt financing for the project. If the amount of debt is significant, a 100-percent government guarantee could result in high costs to the government in case of default. Because of the default risk faced by the government, EM would be required to estimate a subsidy cost of providing any debt guarantee. This cost must be considered in addition to the contractor’s financing costs when considering this type of financing option.
section_title: Performance-Based Partial-Payment Plan
paragraphs: Another option that may be available to EM is a partial-payment plan that is tied to the contractor’s performance. Under this option, the government would pay for a portion of the construction costs as they are incurred, while the contractor would be required to finance the balance until it began operations. Then, as in the private financing option, the government would make payments based on the performance of cleanup services—such as the amount of waste processed—that would allow the contractor to recoup its construction costs plus its financing costs. For example, the government could pay 80 percent of construction costs as they are incurred while the contractor would be required to finance 20 percent of the construction costs. With the government providing an increasing portion of construction costs, the amount of private financing required would drop and financing costs could be lowered significantly.
With the performance-based partial-payment plan, the contractor would still face performance risk to the extent that recouping its portion of the construction and financing costs still would be dependent on successful performance. However, as the amount of government financing increases, the amount of performance risk assumed by the government also increases. Many variations of this option may be considered that either increase or decrease the amount of funding the government provides.
section_title: Progress Payments
paragraphs: Progress payments are used throughout the federal government for the procurement of various types of assets, including capital assets. Generally, the government uses progress payments to assist a contractor who will incur significant expenditures prior to the delivery of products that it will not be able to finance itself. The government may provide up to 80 percent of the costs as they are incurred under a contract. The balance is generally paid upon successful completion of the contract.
EM’s privatization projects with large construction costs will cause contractors to incur significant expenditures prior to the completion of facilities and the delivery of cleanup services. Under a progress payment option, the government could pay for a portion of the costs as they are incurred while the contractor would be required to finance the balance of its costs. This option is similar to the performance-based partial-payment plan; however, under the progress payment option, the contractor would recoup its construction costs plus its financing costs as the cleanup facility (the asset) was successfully completed. Payment to the contractor for construction would not be based on performance over an initial operations period. Financing costs would be lower because the contractor would not carry its construction costs over a period of operations.
With the progress payment option, the contractor would still face performance risk for the delivery of a completed facility that works as designed. Many variations of this option could be considered that either increase or decrease the amount of funding the government provides. Once again, as the amount of government financing increases, the amount of government funding at risk to performance increases.
section_title: Advanced Mixed Waste Treatment Project Serves as Model for Analyzing Construction Financing Options
paragraphs: In order to evaluate the impact of other construction financing options on financing costs, we reviewed the financing schedule of EM’s privatization contract with British Nuclear Fuels Limited, Inc., to build the Advanced Mixed Waste Treatment Project in Idaho. The contract, signed in December 1996, is one of the few privatization contracts that has been signed whose construction costs are financed by the private sector. Assuming that construction costs of $244.6 million, in 1998 dollars, would be the same for each financing option, we analyzed the difference in financing costs for the five financing options. (For further detail and discussion of the analysis conducted and the impact on results of using different assumptions, see app. II.)
subsections: section_title: Government Financing Involves a Trade-Off Between Lower Financing Costs and Increased Performance Risk to the Government
paragraphs: Using the Advanced Mixed Waste Treatment Project as a model, total private financing represents the highest financing cost—$137.9 million—for construction financing. As the amount of government involvement in financing increases, the financing costs of the options decrease. With a 100-percent government guarantee of debt, the contractor’s financing costs are $104.1 million. Under a performance-based partial-payment plan that assumes government financing of 80 percent of costs and payment of the balance over the first 5 years of operations, financing costs are $62.7 million. Under a progress payment option with the government financing 80 percent of costs until construction is completed, financing costs are $47.1 million. Finally, with total government financing, no private financing costs are incurred because contractors are paid as costs are incurred.
While government financing of construction costs would appear to be the most attractive option, under this approach the government is assuming a much greater level of performance risk than it would face under a private financing option. This risk includes the risk that the facility the government finances will not be completed successfully or that the facility will experience significant cost growth. The potential costs associated with these risks could offset—or more than offset—any potential benefits of lower-cost government financing. On the basis of DOE’s past experience with major government financed projects, including EM’s projects, these risks are real. For example, we found that between 1980 and 1996, 31 of DOE’s 80 major system acquisitions were terminated prior to completion after the government had expended over $10 billion, in part, as the result of weaknesses in DOE’s contractor management. In addition, for the 15 projects that were completed, final costs exceeded original estimates by an average of 63 percent. However, it is difficult to determine how much of the costs attributable to these risks could have been reduced through the use of more private financing.
We found that termination and/or cost growth of projects is the result of a variety of factors—some of which may be affected by the choice of financing. For example, the risk of cost growth because of a flawed system of incentives for contractors may be reduced by private financing that provides better incentives to perform. However, other factors contributing to risk may not be dependent on the financing choice. For example, changes in work scope could result in terminations or cost growth under any financing approach. As a result, it is difficult to quantify the degree of performance risk borne by the government as government involvement in financing increases. This uncertainty is represented in figure 3.1 by a potential range of additional performance risk assumed by the government with increased levels of government financing.
The options that lie between total private financing and total government financing attempt to strike a balance in the trade-off between the cost of financing and the cost of added performance risk. The cost of added performance risk to the government is difficult to quantify, but it must be considered in weighing any decision to reduce private-sector risk (thereby increasing government risk) by lowering financing costs.
The consideration of added risk costs has been recognized in the government’s policy on the guarantee of debt. If EM were to pursue an option whereby it would guarantee debt, EM would have to estimate and obtain funding for the subsidy cost of providing that debt guarantee. Thus, assuming a 100-percent debt guarantee, costs would include construction costs ($244.6 million), contractor financing costs ($104.1 million), and an estimated subsidy cost. That subsidy cost would largely consist of an estimate of the risk that a contractor might default on its debt obligations. While the estimate of the subsidy cost is difficult, the risk of default could be high for a complex facility that typifies some of EM’s cleanup projects. If the subsidy cost estimate is higher than $33.8 million, then according to our model, this option would be more expensive than total private financing.
The consideration of added risk costs must also be recognized for other financing alternatives to private financing. Using our model, under a performance-based partial-payment plan whereby EM pays 80 percent of construction costs, EM has placed at risk $195.7 million in payments (80 percent of the $244.6 million in construction costs) over the 5 years of construction. This risk must be weighed against the 20 percent of construction costs plus the financing costs that the private contractor has at stake over the construction period and an initial period of operations. If the private contractor does not perform, it will lose its $48.9 million in construction costs (20 percent of the $244.6 million in construction costs) plus as much as $62.7 million in finance costs. In weighing this type of option, EM will have to consider whether the amount of private-sector investment at risk is enough to ensure that the contractor is motivated to deliver a facility that works as designed without significant cost growth.
The consideration of the cost of added risk under a progress payment option is similar to the partial payment aspect of the option discussed above. If the facility does not work, EM may not regain its $195.7 million. However, under a progress payment option, the contractor would be paid for its construction costs and financing costs after the facility is successfully completed, thereby avoiding financing costs over the operations period. Thus, the government is assuming some added risk that the facility may not operate as promised over the first 5 years of operations. Unlike the performance-based option, the contractor will have no investment at stake whose recoupment is dependent upon successful operations. In considering this type of option, EM will have to consider whether the payback (or amortization) of the contractor’s costs over the first 5 years of operations is necessary to ensure that the contractor has delivered an effective plant. An initial testing phase after construction may be sufficient, depending on the size and complexity of the project.
section_title: Other Factors Affect Financing Decisions
paragraphs: The choice of financing options is affected by other factors that affect total costs and financing decisions. As government involvement in financing increases, the government assumes more of an ownership role and has to exercise more oversight, an area in which DOE has not enjoyed success. More importantly, the actual terms of performance in the contract will dictate what performance risk is eventually assumed by the contractor and the government.
subsections: section_title: Increasing Use of Government Financing May Affect Ownership and Oversight
paragraphs: With an increased use of government financing, the issues of government ownership and oversight become important considerations. As the government provides more financing of construction costs, it becomes more likely that EM will be the owner of the facility instead of the contractor. However, along with the benefits of government ownership, EM must consider the negative consequences of ownership, particularly the demands of an increased oversight role.
Financing construction costs could put the government in a position of ownership, especially if it is providing the majority of the funding. This ownership is a positive benefit of government financing that addresses monopoly concerns about private ownership of cleanup facilities. For example, if the private sector owns a facility whose construction costs are paid for after an initial period of operations, it could place the private sector in a monopolistic position for the remainder of the potential operating period. The government may be at a disadvantage in negotiating prices for waste treatment in the future because there will be no other facilities available to compete. However, the government may be able to alleviate monopoly concerns by negotiating long-term operating agreements or having the contract option to take title to the facility.
Given EM’s acknowledged poor history of oversight, government ownership could also be viewed as a negative consequence of government financing. If EM begins to make payments prior to performance, it will need to assure itself that the contractor is making satisfactory progress. However, EM does not have a history of successful contractor oversight. The private sector views increased government oversight as meddlesome, inefficient, costly, and directly counter to the concept of allowing the private sector to decide how to best provide cleanup services.
section_title: Terms of Performance Are an Important Consideration That Affects Risks and Costs
paragraphs: Our discussion of construction financing options has focused on the level of risk that is transferred between the government and the private sector as the level of financing provided by each party changes. However, it is important to point out that the mix of financing provided by the government and the private sector has no bearing on the actual terms of performance that are agreed to in a contract. As noted earlier in our discussion of contracting, risks must be identified and addressed in the contract so that each party’s responsibilities are clearly defined. The government could face more risk and incur more costs from a contract that is totally privately financed if the terms of the contract give the contractor less responsibility for risks compared to another contract that may have government financing.
section_title: Agency Comments and Our Evaluation
paragraphs: DOE agreed with our statement that while government financing appears less costly, the greater performance risk the government assumes when it finances a project, and the potential costs associated with this greater risk, could offset any apparent advantage gained by using lower-cost government financing. However, DOE felt that we should have attempted to compensate for these potential increases in costs in the model we used to estimate the impact of financing alternatives. In earlier meetings with DOE officials, they had suggested performing a sensitivity analysis that would vary the construction costs to reflect various levels of cost growth, specifically 20, 40 and 60 percent.
We considered performing the sensitivity analysis DOE suggested; however, we decided not to do so because we did not have a factual basis for assigning levels of cost growth to all of the various financing alternatives we analyzed. If not properly managed, each of the alternatives we analyzed, including the private finance option, could experience cost growth. However, we could not locate any data that would identify how much cost growth might be associated with one financing option versus another. Applying the same cost growth to all of the options would not change the relative results, only the total costs. To compensate, we emphasized throughout the report that cost growth was a possibility as the government took on more performance risk and cited what evidence we had in terms of independent studies and GAO reports to indicate how large this growth had been under DOE’s existing contracts.
section_title: Use of Alternative Financing Structures Could Change How EM’s Privatization Projects Are Scored in the Federal Budget
paragraphs: Because of budget limitations or “caps” instituted to help balance the federal budget, all budget appropriations and spending for discretionary programs, such as EM’s privatization program, must be measured or “scored” to ensure that the caps are not exceeded. Federal agencies may acquire or use long-term assets constructed to meet the government’s needs, such as the waste treatment facilities EM needs, in several ways. Each of those arrangements may be scored differently. Which arrangement and, hence, which method of scoring is most appropriate may change depending on how the asset is financed, whether the government takes ownership of the asset, and how much risk the government assumes for the cost of construction.
subsections: section_title: Budget Scoring Could Determine What Projects Can Be Pursued
paragraphs: Under the Budget Enforcement Act of 1990, as amended, discretionary spending is constrained by caps or strict dollar limits both on new budget authority and budget outlays. To ensure that caps are not exceeded, the scoring rules contained in the conference report accompanying the Budget Enforcement Act of 1990, as amended, and published in the Office of Management and Budget’s (OMB) Circular A-11 are used to determine when budget authority and budget outlays are scored for discretionary spending proposals—including spending for capital assets. To stay within the caps, budget authority and the resulting outlays are limited for all programs. The way transactions between EM and its privatization contractors are structured affects how they are scored and, because of the budget caps, has consequences not only for EM but also for all the other programs and activities funded by the committees that provide EM’s appropriations.
section_title: There Are Several Different Options for Scoring the Acquisition or Use of Capital Assets
paragraphs: There are several ways the federal government can acquire capital assets or the use of capital assets, such as an office building or waste treatment facility, that are being constructed for its use. The most direct way is to simply purchase the asset outright, taking full ownership of it. In that case, budget authority for the full cost of the purchase would be scored in the year the budget authority is first made available, and budget outlays would be scored as payments are made to the contractor during construction. Alternatively, agencies may choose not to purchase the asset itself (for example, a waste treatment plant) but merely the services connected with the asset (for example, waste treatment services). For such a service contract, the agency would need budget authority in each year equal to its legal obligations under the contract, including cancellation costs. In a case in which services will not be delivered until the construction of a facility is complete, outlays would not be scored during the construction period; instead, they would be scored as services are delivered.
In addition to outright purchase of an asset or purchase of services, the agency may choose to lease the asset from the private contractor. Under the budget scoring guidelines, the government may enter into three types of leases with private vendors—operating leases, lease-purchases, and capital leases. Operating leases may be used to contract for assets such as general-purpose office space. In an operating lease, the facility or equipment is not built to unique government specifications, there is a private-sector market for the asset, and the present value of the government’s lease payments does not exceed 90 percent of the asset’s fair market value at the beginning of the lease, among other criteria. For an operating lease, the agency would need budget authority and have outlays in each year equal to the payments due to the contractor under the lease.
Transactions that do not meet all of the criteria of an operating lease are considered either lease-purchases or capital leases. In a lease-purchase transaction, ownership of the facility or other assets transfers to the government at or shortly after the end of the lease. If ownership does not transfer, the transaction is a capital lease.
For a lease-purchase arrangement, the government’s risk is assessed against criteria that indicate the government’s acceptance of risk such as whether (1) the government provides financing, (2) the government guarantees third-party financing, (3) there is no private-sector market for the assets, (4) the asset is built to unique specifications, (5) the risks of ownership do not remain with the contractor, and (6) the project is constructed on government land. For a lease-purchase without substantial government risk, the agency would need budget authority in the first year equal to the present value of its obligations under the lease, and outlays would be scored over the lease term. The government’s obligations would include the contractor’s capital investment and termination or cancellation costs. If the government does have substantial risk, budget authority would be scored the same way as noted above, but outlays would be scored during the construction period in the same proportion as the contractor’s costs are incurred. Capital leases are scored in the same way as a lease-purchase without substantial government risk.
Finally, if an agency were to offer a federal government guarantee of some or all of a contractor’s debt financing, the subsidy cost of the guarantee would be scored. The agency would need specific legislative authority to offer a government loan guarantee. If the authority were granted, the agency would have to estimate the subsidy cost of the loan guarantee, which would be based on the risk of default or nonpayment of the loans, among other factors. Estimating the subsidy cost is a very complex process and is subject to review by OMB and the Congressional Budget Office. The agency would need budget authority for the full net present value of the subsidy cost before it could make the guarantee. Outlays of the subsidy cost would occur over the same period and in the same proportion as the lender disbursed the loan to the contractor. That is, if all of the loan money were disbursed in the first year, all of the subsidy cost would be outlayed in the first year as well. If the loan were disbursed over a period of several years, the outlays would be spread over the same period.
section_title: Changing How EM’s Privatization Projects Are Financed Could Affect the Interpretation of the Scoring Guidelines
paragraphs: Currently, OMB scores EM’s privatization projects as service contracts. Under this practice, EM must have enough budget authority each year during the life of the contract to (1) pay off its liability to the contractor if, for example, the project is canceled, and (2) pay for treated waste once facilities begin operations. The contractor is to provide all of the financing for constructing the necessary facilities and equipment to treat EM waste. EM does not intend to acquire title to the facilities that would be constructed by its privatization contractors, even when those facilities are built on federal land and are constructed to provide services strictly for the government. Under OMB’s current scoring, no outlays would be scored until construction of a project is completed and waste processing begins. Outlays would then be scored from the privatization account as the capital cost of the project is amortized or repaid over the first few years of operations. Therefore, while the impact on outlays in the budget is minimized in the early years of the privatization program under this option, it will increase outlays dramatically in later years as these projects come on-line.
subsections: section_title: Loan Guarantee Scenario
paragraphs: Government loan guarantees are usually offered only when the borrower or the project is too risky for private lenders. Because many of the projects proposed for privatization are technically risky—that is, they involve the use of innovative technologies that must be modified to meet EM’s needs—the subsidy cost of a loan guarantee for privatization projects could be substantial. For this option, EM also would need additional budget authority upfront for the subsidy cost. Outlays of the subsidy cost would occur over the construction period as the loan is disbursed by the private lender to the contractor.
If EM were given authority to provide a loan guarantee for the construction of a contractor-owned facility, OMB may decide to continue to score the project’s total capital costs as a service contract. Alternatively, the capital costs might be scored as a capital lease. In that case, budget authority and outlays would occur sooner than under the current service contract scoring method.
section_title: Performance-Based Partial-Payment Scenario
paragraphs: If EM used a performance-based partial-payment plan, scorekeeping guidelines could be interpreted to require EM to have budget authority up front for the net present value of the government’s share of costs. Outlays would occur during the construction period equal to the amount of incurred costs for which EM reimburses the contractor and during the initial period of performance for the remainder of the construction costs. For this option, which might be scored as a capital lease or a lease-purchase (if it is judged that EM has effective ownership), the timing of budget authority and outlays would change, occurring sooner than under the current service contract scoring scenario.
Under this scenario, the greater degree of financial investment and risk that EM would incur could make government ownership of the facility more attractive than only contracting for the services of the completed facility. In that event, EM could choose to structure the contract so that it would acquire ownership of the facility at or near the end of the initial performance period. The initial performance period would provide EM assurance that the facility works and would give the contractor time to recoup all of its investment. However, in that case, the transaction could be deemed a lease-purchase with substantial government risk under the budget scoring guidelines. As a result, the timing of budget authority and outlays would change, occurring sooner than under the current service contract scoring scenario.
section_title: Progress Payment Scenario
paragraphs: If the construction were financed using progress payments, the transaction might be scored as a capital lease or a lease-purchase (if it is judged that EM has effective ownership). In that event, EM would need budget authority equal to the net present value of the government’s share of the costs plus a rate of return earned on the held-back portion. Outlays would occur during construction equal to EM’s share of the portion of costs incurred by the contractor and for the lump-sum payment of the held-back portion of the construction costs once the contractor’s work had been accepted. For this financing option, the timing of budget authority and outlays would change, occurring sooner than under the current service contract scoring scenario.
In this scenario, EM would again be making a substantial financial investment in the facility and incurring a greater degree of risk than it would if the contractor privately financed the construction of the facility. In that case, EM might decide to include an option in the contract allowing it to take title to the completed facility, and the transaction might be considered a lease-purchase under the budget scoring guidelines. In that case, EM would need budget authority equal to the full net present value of the project, regardless of what proportion of the costs were paid to the contractor in progress payments and what proportion are held back for lump-sum payment when the contractor’s work has been accepted.
section_title: Full-Government-Financing Scenario
paragraphs: Finally, if EM fully finances the projects, it would need budget authority to cover the full amount of costs and fee or profit owed to the contractor for the construction of the facility. Outlays would be incurred for the amount of costs incurred by the contractor and any fee or profit earned in each fiscal year. In that case, the government would bear the financial risk and, logically, may want to have ownership of the facility. The contractor would be reimbursed for all allowable costs, including costs for the design and testing of the facility and equipment, during the construction period. For this option, budget authority needs could be larger in the first years of the project than under EM’s current privatization approach, and once again, outlays would occur sooner.
section_title: Ownership and Degree of Government Risk Are Key Factors for Scoring
paragraphs: Under the budget scoring guidelines, how EM’s privatization projects are scored depends on two key factors: who owns the facility and, if the government will have ownership, what degree of risk the government assumes. However, several factors may cause EM to decide to own the facility itself. Some projects may require EM to make a large investment of government funding in the construction of a facility. In addition, privatization contracts are expected to contain clauses, such as termination for convenience and idle facility payments, to protect the contractor from loss if the project is canceled or delayed by the government. For example, a termination for convenience clause provides the government the option of canceling the project if EM cannot get sufficient funding to proceed in any fiscal year. The government may also be liable for payments for idle facilities if the contractor’s facility is ready to operate and EM fails to deliver waste to be treated.
In such circumstances, EM may have to outlay a large proportion of the construction costs whether or not it receives waste treatment services, and it may be in the government’s interest to also take ownership of the facility. In that case, the scoring rules pertaining to outright ownership or lease-purchases would apply. Under other circumstances, such as if total private financing has the hoped-for effect of lowering the total cost and risk, pursuing service contracts may be the best decision. These factors, in addition to scoring implications, will need to be considered in deciding whether ownership of a capital asset is in the best interest of the government.
section_title: Budget Scoring Pressures May Cause Federal Agencies to Make Inefficient Asset Acquisition Decisions
paragraphs: In general, as the financial commitment of the government decreases (that is, moves further away from purchase), the amount of budget authority and outlays that must be scored up front also decreases. We found that this situation may tempt agencies to move away from ownership when caps are very restrictive and to choose arrangements in which budget authority and outlays are not scored all at once or as soon. In some cases, we found that these decisions resulted in agencies spending more than they would have if they had purchased the assets outright. Budget scoring does not affect the total cost of the projects but does change when budget authority is needed and when outlays occur. Under all of the alternative financing scenarios we analyzed, except possibly full-government financing, scorekeeping guidelines could result in EM needing more budget authority earlier in the projects and incurring outlays sooner than under OMB’s current method of scoring privatization projects as service contracts. EM officials have noted that one advantage of privately financing projects is that it allows EM to defer budget outlays to future time periods. While this may be true, EM’s decisions on how to structure privatization contracts need to consider the other factors we have discussed previously—contract type, financing method, risk allocation, and long-term cost—as well as the budget scoring implications of the contracts.
section_title: Agency Comments and Our Evaluation
paragraphs: DOE expressed the view that individual projects have different financing requirements that are not directly addressed by the current budget scoring guidelines of OMB Circular A-11. They also expressed the view that there is considerable flexibility in the scoring rules. We agree that the scoring guidelines do not directly address the unique projects that DOE is considering. We specifically state in all of our discussions of scoring that the scoring rules have to be interpreted for DOE’s projects.
section_title: Conclusions
paragraphs: Unsatisfied with its management contractors, EM has attempted to improve the cost and schedule performance of the cleanup program through the adoption of its privatization approach. In theory, EM’s privatization contractors have a greater incentive to perform under a fixed-price contract than in the traditional cost-reimbursement environment, under which most cleanups have been performed. While we did find examples when the use of fixed-price contracting produced positive results, simply entering into a fixed-price contract is no guarantee of success. If fixed-price contracts are used in situations when they are not appropriate—for example, where waste is inadequately characterized—the cost and schedule performance of the contractor can be worse than under a cost-reimbursement contract.
Private contractor financing, which has the potential to improve cost and schedule performance, comes at a significant increase in financing costs. However, it would be incorrect to look at this difference and simply conclude that traditional cost-reimbursement government financing is cheaper. The apparent difference in cost reflects the different amount of risk the government is bearing. Moreover, if the performance under the cost-reimbursement type of financing is as poor as past history would suggest, the difference, or “savings,” observed in our analysis could easily be consumed by cost overruns.
With respect to scoring, how these projects are scored will depend on how certain key aspects of the scoring rules are interpreted. For example, if ownership is viewed as the critical variable and the government does not own the final facility, any approach we have analyzed could be scored as a capital lease. However, if the government assumes ownership upon completion of an initial performance period, then a lease-purchase would appear more appropriate. Use of a government loan guarantee would require the estimation of the subsidy cost, for which additional budget authority would be needed, and could add significantly to the total budget authority required for privatization projects.
In the end, it is not simply a choice between traditional cost-reimbursement contracting and EM’s new privatization approach. As our analysis shows, a complex matrix of decision factors needs to be considered when deciding how to contract for and finance a cleanup. Among the factors that need to be weighed are the following: (1) What waste needs to be cleaned up and how well is the waste characterized? (2) How much competition is there is among firms with the necessary cleanup expertise? (3) What financing options are available in the private sector? (4) What risks are associated with the cleanup and who is best prepared to bear them? (5) How well equipped is DOE’s staff to design and oversee a cleanup contract? Once a contract type and financing method are chosen, DOE and the contractor would need to carefully develop a contract that clearly defines each party’s roles and accountability through provisions that allocate project risk between the parties, define DOE’s oversight role, and identify appropriate measures against which the contractor’s performance will be judged. Ideally, selection of the appropriate type of contract and method of financing for each project would be made on the basis of what will provide EM with the best chance of successfully completing its cleanup goals at the lowest total cost.