Maritime Security Fleet: Factors to Consider Before Deciding to Select Participants Competitively

Published by the Government Accountability Office on 1997-09-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                   United States General Accounting Office

GAO                Report to Congressional Requesters

September 1997
                   MARITIME SECURITY
                   Factors to Consider
                   Before Deciding to
                   Select Participants

             United States
GAO          General Accounting Office
             Washington, D.C. 20548

             National Security and
             International Affairs Division


             September 24, 1997

             The Honorable Trent Lott
             Majority Leader
             United States Senate

             The Honorable John McCain
             Chairman, Committee on Commerce,
               Science, and Transportation
             United States Senate

             In accordance with the Maritime Security Act of 1996 (P.L. 104-239), the
             Department of Transportation’s Maritime Administration (MARAD) recently
             entered into agreements with 10 shipping companies to participate in a
             program that would provide the Department of Defense (DOD) access to
             U.S.-registered commercial ships, their crews, and other related
             transportation assets in a time of national emergency. MARAD selected
             participants from applications submitted in response to its solicitation. As
             you requested, we evaluated whether program costs could be reduced by
             changing the selection process to permit owners to compete, rather than
             apply for, available slots. Specifically, we determined (1) the potential
             impact that a competitive selection process could have on the number of
             qualifying vessels, program costs, and existing agreements and (2) the
             views of Department of Transportation and DOD officials on making such a
             change to the selection process. On June 6, 1997, we briefed your staffs on
             the results of our work. This report summarizes and updates the
             information provided at that briefing.

             The Maritime Security Act established the Maritime Security Fleet (MSF)
Background   program, authorizing MARAD to enter into agreements with maritime
             shipping companies to provide DOD access to commercial vessels
             operating under U.S.-flag registry and related assets, such as port facilities,
             containers, and rail systems in a time of national emergency.1 In addition,
             the program was established to maintain U.S. presence in international
             commercial shipping by slowing the trend of U.S. ships seeking foreign
             registry, provide a readily available supply of U.S. mariners to crew
             government and commercial ships in a time of national emergency, and

              Vessels operating under U.S.-flag registry, unlike those under foreign registry, must be owned by a
             U.S. citizen or an entity whose members are U.S. citizens and are capable of holding title under U.S.
             laws, crewed by trained U.S. merchant mariners, meet U.S. crewing and safety standards, and comply
             with U.S. tax laws.

             Page 1                                                GAO/NSIAD-97-246 Maritime Security Fleet

encourage shipping companies to participate with DOD in contingency

The MSF program replaces the Operating Differential Subsidy (ODS)
program, which reimbursed American shipowners for cost differentials
associated with operating under U.S. versus foreign registry, including
higher crew, insurance, maintenance, and repair costs. The MSF program,
in contrast, provides a reduced fixed rate to compensate U.S.-flag
operators principally for the higher cost of employing U.S. citizens aboard
U.S.-flag ships. MARAD estimates that ODS payments will average $4 million
per participating vessel in fiscal year 1997 compared with the authorized
$2.1 million per vessel under the MSF program.

Under the MSF program, participating companies will receive a yearly
retainer for agreeing to maintain 47 selected ships under U.S. registry,
crewing them with U.S. mariners, and making the ships available to DOD
for sealift services in a time of national emergency. The act authorized the
program to operate for 10 years—from fiscal year 1996 to 2005—and a
total of $1 billion, or $100 million annually, to fund the program. It also
authorized MARAD to enter into agreements to pay participating companies,
subject to the availability of appropriations and other provisions of the act,
$2.3 million per vessel in fiscal year 1996 and $2.1 million per vessel each
year thereafter. Although the agreements are to be effective for 1 year,
they are renewable, subject to the availability of appropriations, for each
subsequent year of the program. The agreements are defined by the act as
contractual obligations of the United States.

In October 1996, MARAD advertised in the Federal Register for MSF
applicants; a total of 21 responded, offering 97 vessels. MARAD used specific
eligibility and priority ranking criteria outlined in the act, to select
applicants for available slots. To be eligible, a vessel had to be
self-propelled, have a certain physical capacity, be less than a certain age,
and be militarily useful and eligible for U.S.-flag registry.

In the selection process, MARAD followed criteria established in the act,
giving first-priority consideration to vessels (1) owned and operated by
citizens of the United States under section 2 of the Shipping Act of 1916 or
(2) less than 10 years of age and owned and operated by a corporation that
was either eligible for U.S. registry or currently operating, managing, or
chartering vessels for the Secretary of Defense. The act limited the number
of first-priority vessels per owner to the number that owner operated in
U.S. foreign commerce as of May 17, 1995, plus the number that the owner

Page 2                                   GAO/NSIAD-97-246 Maritime Security Fleet

                   chartered to DOD as of that date. Also, if the number of vessels that
                   qualified for first-priority ranking exceeded available funding, the act
                   required that MARAD prorate the award of MSF slots among vessel owners
                   based on the number of first-priority vessels each owned.

                   MARAD   determined that 53 of the 97 vessels offered for the program met
                   eligibility requirements for first-priority status. Because of their military
                   usefulness, 6 additional vessels had the age requirement waived, bringing
                   the total number of first-priority vessels to 59. The $100 million in annual
                   program funding was sufficient to fund 47 vessels, and by January 1997,
                   MARAD had entered into agreements with the 10 owners of these vessels.
                   However, not all of the 47 vessels will be immediately eligible for MSF
                   payments. Some vessels will have to change from foreign to U.S. registry,
                   and others will have to wait until their current participation in the ODS
                   program expires or other government contractual obligations are
                   completed—some possibly as late as November 2000. Because the act did
                   not become law until fiscal year 1997 and not all vessels will be
                   immediately eligible for payment, MARAD estimates the total program costs
                   will be $825.4 million, or about 17 percent less than the $1 billion originally
                   authorized in the act.2

                   Three factors warrant consideration before determining whether to
Results in Brief   incorporate a competitive selection process into the Maritime Security
                   Fleet program: the number of vessels that could qualify, the effect of such
                   a process on program costs, and potential legal risks. First, opening up the
                   selection process to competition would not increase the pool of qualified
                   applicants or the number of eligible vessels without a change in the
                   eligibility and selection criteria. Second, it is uncertain whether
                   competitive selection would result in bids lower than the current
                   $2.1 million annual Maritime Security Fleet payment and thereby lower
                   program costs because (1) annual crew costs alone for a commercial ship
                   operating under U.S. registry exceed those for the foreign registry
                   operation with the next highest crew cost by about $2.4 million;
                   (2) average annual payments under the expiring Operating Differential
                   Subsidy program exceeded the $2.1 million level in every year since 1982;
                   and (3) bids under competitive selection may take inflation and operating
                   cost increases into consideration, whereas the current program fixes the
                   maximum annual per ship payment at $2.1 million through fiscal year 2005.
                   Finally, unilateral changes to the program could lead to legal challenges by

                    Although the act authorized the government to enter into operating agreements beginning in fiscal
                   year 1996, it did not become law until fiscal year 1997.

                   Page 3                                                GAO/NSIAD-97-246 Maritime Security Fleet

                      vessel owners with whom the government has contractual agreements.
                      These challenges could result in substantial costs to the government and
                      the transfer of vessels to foreign registry.

                      On the basis of their analysis of the number of fully qualified vessels
                      eligible to participate in the program and the possibility that competitive
                      selection would lower program costs, neither Transportation nor DOD
                      favor changes to the current selection process. Officials of both agencies
                      believe that a competitive selection process would not result in lower
                      program costs and could actually result in vessel owners withdrawing
                      from the program to operate their vessels under a less costly foreign
                      registry. Such actions could result in a loss of assets needed in a time of
                      national emergency.

                      According to MARAD data, every commercial owner with vessels that were
Number of Qualified   fully qualified under the existing MSF selection criteria, applied for and
Vessels Would Not     obtained at least one slot in the program. Therefore, the number of vessels
Increase              that could be considered for the program under a competitive selection
                      process would not increase unless the selection criteria were changed.

                      Of the 97 vessels offered for the program, 53 met all of the first-priority
                      selection criteria. An additional six vessels, which DOD determined would
                      be needed to meet contingency requirements to transport containerized
                      ammunition from selected locations on the West Coast, were also granted
                      age waivers to qualify as first-priority vessels. On the basis of a pro rata
                      requirement set out in the act, each of the 10 owners of the 59 first-priority
                      vessels was awarded at least 1 of the 47 slots in the program, leaving 12
                      first-priority vessels unselected. The number of awarded slots was based
                      on the percentage of the 59 first-priority vessels each shipping company
                      owned. Of the 47 vessels selected for the program, 24 were owned by 2
                      shipping companies.

                      Some of the 97 vessels that were offered for the program were determined
                      to be ineligible based on their age or their owner’s citizenship. Other
                      factors, including vessels not being militarily useful or not operating in a
                      domestic-foreign trade route on May 17, 1995, excluded the remainder.
                      Given the same qualifying and selection criteria, these vessels would still
                      not qualify for the MSF program under a competitive bidding process.

                      Page 4                                   GAO/NSIAD-97-246 Maritime Security Fleet

                      Although we cannot be certain of the effect that a bidding process would
Effect of a Bidding   have on the total program cost, a number of factors suggest that owners
Process on Program    may not bid lower than the current $2.1 million per vessel authorization.
Cost Is Uncertain     MARAD data, for example, shows that annual crew costs alone for
                      commercial ships operating under U.S. registry exceed those for the
                      foreign registry operation with the next highest crew cost by about
                      $2.4 million. At the time of our review, shipping companies participating in
                      the MSF program were having mixed results in their efforts to reduce
                      operating costs by negotiating new labor contracts that would consider
                      the reduced subsidy.

                      In addition, payments under the expiring ODS program have historically
                      been higher than $2.1 million. For example, since 1982 the average annual
                      outlay per ship under the ODS program ranged from $2.3 million in fiscal
                      year 1983 to $5 million in fiscal year 1996. In fiscal year 1997, the average
                      annual subsidy per vessel under the ODS program is estimated at $4 million
                      compared with $1.4 million under the MSF program (see fig. 1).

                      Page 5                                   GAO/NSIAD-97-246 Maritime Security Fleet

Figure 1: Expiring ODS and MSF Average Annual Payments

Dollars in millions






    1977   1979       1981   1983   1985   1987   1989      1991   1993      1995   1997   1999   2001     2003   2005

                                                   Average      Average
                                                  ODS outlay   MSP outlays

                                                   Source: MARAD.

                                                   Current legislation does not consider future inflation or increases in
                                                   operating costs; therefore, the $2.1-million cost per ship per year will
                                                   remain constant through fiscal year 2005. Representatives of five shipping
                                                   companies participating in the MSF program told us that if a competitive
                                                   selection process were introduced, they would probably construct their
                                                   bids to account for inflation. Our analysis indicates that bids would have
                                                   to rise to about $2.3 million in fiscal year 2000 and $2.6 million in fiscal
                                                   year 2005 to cover the current inflation projections (see fig. 2).3

                                                   We averaged the annual inflation forecast of two major economic forecasting firms—WEFA and

                                                   Page 6                                                GAO/NSIAD-97-246 Maritime Security Fleet

Figure 2: Impact of Inflation on the MSF Annual Subsidy of $2.1 Million Per Vessel

                    Dollars in millions








       Fiscal year            1997 1998 1999 2000 2001 2002 2003 2004 2005

 Adjusted subsidy            2.100 2.149 2.201 2.257 2.316 2.377 2.444 2.515 2.590

                                           The small number of vessel owners, all of whom are already participating
                                           in the MSF program, also limits the potential cost savings of competition, as
                                           does the fact that over one-half of the 59 first-priority vessels are owned by
                                           two companies. By owning a majority of the first-priority vessels, these
                                           two companies could possibly exert enough market power to affect both
                                           the amount of their bids and the number of ships they would make
                                           available. In addition, since DOD has requirements for specific vessel types
                                           and associated transportation systems, the competition may need to be
                                           categorized by vessel type, which would further reduce the number of
                                           potential bidders in each category. For example, medium-sized container
                                           ships, which were needed to meet DOD’s unique containerized ammunition
                                           requirements on the West Coast, were operated by only one MSF program

                                           Page 7                                    GAO/NSIAD-97-246 Maritime Security Fleet

                        Implementation of a competitive selection process into the MSF program
Legal Risks Could Be    presents certain legal risks to the government and could undermine the
Involved in Changing    intent of the program. As noted by MARAD officials, current MSF participants
the Selection Process   may view implementation of a new selection process as a breach of the
                        government’s contractual obligations. Under the MSF program, the
                        government entered into 47 operating agreements with vessel owners.
                        These agreements, defined by the act as contractual obligations of the
                        United States, obligate the government to pay the amount provided for in
                        the agreement to the extent of actual appropriations. Provided there is
                        sufficient funding, the government is obligated to pay $2.1 million a year
                        per ship to the vessel owners. The Supreme Court recently held that the
                        government may be liable for damages if Congress enacts legislation that
                        breaches an existing contract to which the government is a party.4

                        Changes to the selection process that do not interfere with existing
                        agreements would minimize potential liability. According to the act, if
                        funds are not appropriated, the current agreements would automatically
                        terminate. Therefore, one option would be to allow current agreements to
                        terminate and then enact new legislation to require competitive selection.
                        However, vessel owners may have incurred expenses based on the
                        assumption that the program would last through fiscal year 2005 and that
                        the government would make a good faith effort to provide funds. This
                        situation may provide some leverage for participating owners to pursue
                        legal remedies. Also, if funds are not appropriated and the agreements
                        automatically terminate, vessel owners could transfer participating vessels
                        to foreign registry, undermining the intent of the MSF program. Another
                        option for changing the selection procedure would be to retain current MSF
                        agreements and amend the act to allow a bidding process for the selection
                        of any additional or replacement vessels.5 Although this option presents
                        the least risk to the government, current vessel owners could take the
                        position that the language in the current agreements, specifying that
                        contracts are renewable annually, would allow them to terminate their
                        involvement in the program and bid again for their vacated slots at a rate
                        higher than the current $2.1 million.

                         See United States v. Winstar Corp. 116 S. Ct. 2432 (1996).
                         Vessels that originally qualify for the program may have to be replaced because of bankruptcy or
                        changes in ownership from U.S. to foreign, for example.

                        Page 8                                                 GAO/NSIAD-97-246 Maritime Security Fleet

                     Transportation and DOD officials do not support a change in the MSF
Neither              selection process to incorporate bidding. Transportation officials believe
Transportation Nor   that the existing 47-vessel fleet is the best mix of ships and associated
DOD Support          transportation systems at the best price possible. They also believe that
                     the lower level of financial support provided by the MSF program, as
Changing the         opposed to the expiring ODS program, is challenging U.S. vessel owners to
Selection Process    lower their costs. In addition, these officials note that the MSF program has
                     broad consensus and support within government and industry. They
                     believe that a change would offer little possibility of cost savings and
                     introduce the risk of DOD not having access to the ships and associated
                     transportation systems when needed. In particular, the officials are
                     concerned that a bidding process could be more costly, result in the
                     government being held liable for breach of contract, or result in the
                     reflagging of vessels currently under U.S. registry. In June 1997,
                     Transportation formally recommended that the current program not be
                     reopened for competitive bidding.6

                     DOD officials believe that the current program provides the capability
                     needed to ensure sealift support and access to critical transportation
                     assets in a time of national emergency. They do not believe that significant
                     cost savings can be achieved by introducing a competitive selection
                     process. According to DOD, over 50 percent of the contingency sealift
                     capacity needed in wartime would be provided by MSF recipients, and any
                     disruption to the current program could affect DOD’s ability to effectively
                     plan for these contingencies. DOD officials noted that MSF agreements
                     provide long-term stability for contingency planning and were concerned
                     that changes could reduce participation by major U.S.-flag carriers, who
                     provide the bulk of the transportation infrastructure, and leave only
                     carriers with significantly reduced capabilities. In a July 1997 letter to the
                     Chairman, Senate Committee on Commerce, Science, and Transportation,
                     the Secretary of Defense recommended continuation of the current MSF
                     selection process.

                     The Department of Transportation and DOD reviewed a draft of this report
Agency Comments      and concurred with our findings. Transportation provided technical
                     comments verbally, which we incorporated where appropriate. DOD
                     advised us that it had no comments or suggested changes to the language
                     of the report.

                      Report to the Chairman, Senate Committee on Commerce, Science, and Transportation on the Issue
                     of Introducing Competitive Bidding to the Maritime Security Program (P.L. 104-239), Department of
                     Transportation, Maritime Administration, June 1, 1997.

                     Page 9                                              GAO/NSIAD-97-246 Maritime Security Fleet

              To address the potential impact of a bidding process on the number of
Scope and     vessels qualifying for the MSF program, we met with representatives from
Methodology   MARAD and the Transportation Command. We analyzed MARAD data
              regarding the pool of qualified bidders, the application process, and
              selection results. We also reviewed MARAD-generated data on the inventory
              of commercial ships to identify the universe of ships participating in
              foreign trade. We analyzed this inventory to determine whether ships that
              met the MSF selection criteria were not submitted for consideration.

              To address the potential impact of a bidding process on MSF program
              costs, we interviewed officials from MARAD; representatives of five shipping
              companies that own 33 of the 47 MSF vessels; and the American Maritime
              Congress, which represents the interests of the U.S. shipping industry and
              lobbies on its behalf to impact proposed legislation and other purposes.
              We used MARAD cost data to compare the projected cost of the MSF program
              with the ODS program and noted the cost differences of operating U.S.- and
              foreign-registered vessels. We also computed the potential impact of
              expected inflation on the $2.1-million MSF payments. We did not test the
              validity or reliability of MARAD cost data.

              To address the legal issues related to introducing a competitive selection
              process into the MSF program, we reviewed the Maritime Security Act and
              relevant case law, and discussed possible legal implications with MARAD
              officials. We also discussed potential legal implications with
              representatives of shipping companies that have signed MSF agreements.

              To determine Transportation’s and DOD’s views on the desirability of
              instituting a bidding process for MSF slots, we interviewed agency officials
              and reviewed related agency reports.

              We conducted our review between April and September 1997 in
              accordance with generally accepted government auditing standards.

              As requested, we plan no further distribution of this report until 15 days
              after its issue date. At that time, we will send copies to the Chairmen of
              the House and Senate Committees on Armed Services and the Senate
              Committee on Appropriations, the Director of the Office of Management
              and the Budget, and the Secretaries of Defense and Transportation. Copies
              will also be made available to other interested parties on request.

              Page 10                                 GAO/NSIAD-97-246 Maritime Security Fleet

Please contact me at (202) 512-5140 if you or your staff have any questions
concerning this report. Major contributors to this report are listed in
appendix I.

Mark E. Gebicke
Director, Military Operations
  and Capabilities Issues

Page 11                                 GAO/NSIAD-97-246 Maritime Security Fleet
Appendix I

Major Contributors to This Report

                        Elliott C. Smith
National Security and   Bennett Quade
International Affairs   Charles W. Perdue
Division, Washington,   Karen Blum

                        Hugh E. Brady, Jr.
Norfolk Field Office    Harry E. Taylor, Jr.

                        Mark C. Speight
Office of the General
Counsel, Washington,

(703198)                Page 12                GAO/NSIAD-97-246 Maritime Security Fleet
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