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KC-767 Lease Deal

On September 11, 2001, the United States was the target of severe terrorist attacks that involved the use of U.S. commercial aircraft manufactured by Boeing. The terrorist events on 11 September 2001 were quite important: within a week, Boeing announced that they were going to lay off 30,000 people. The attacks resulted in a significant loss of life and property and caused major disruptions in business activities and in the U.S. economy overall. The industry downturn in the wake of the terrorist attacks on September 11, 2001, was immediate, serious and widespread.

The attacks on September 11, 2001, resulted in the complete shutdown of the aviation system in the US for three days, which had a worldwide impact. Air travel to, from and within the United States was halted for a period of days. In the United States, airline traffic in September declined 30% from the same month the previous year. Airlines cutback their routes and frequencies to deal with the fall off in traffic. The major U.S. airlines reported significant financial losses in the fourth quarter and profits for European and Asian airlines declined. Each airline in the world cut the capacity and employees for cost reduction, in an effort to make a profit under shrunk operations.

In 2001, revenue passenger miles in the U.S. dropped by 5.9%, the largest drop in the industry's history. The U.S. Congress passed emergency legislation providing federal grants to airlines to cover some of the financial impact of the loss of traffic, but that did not cover the full cost to the industry. Both the U.S. and many foreign economies went into a deep recession in late 2001 and throughout 2002, significantly decreasing demand for air travel, particularly by business travelers. Over that same period, both labor costs and fuel prices rose sharply, as did security costs, resulting in severe financial losses for airline industry.

In 2002, air traffic was indicated to return mainly leisure passengers, and low-cost airlines showed a quick recovery. As a result, the world airline's revenues declined drastically. In the United States, American and United Airlines suffered huge losses nevertheless they received government aids. The world economy, which is the major drivers for traffic growth, grew only 1.6% in 2001 because of the terror attack on September 11th, and in 2002, it will keep lower growth rate of under 2% also.

The Air Transport Association (ATA), the airline industry's trade organization, characterized the state of the industry as of early 2003 as being in a severe crisis. Since September 11, almost 100,000 airline employees had been put out of work, 300 aircraft (6% of the whole fleet) have been grounded, $5.6B in capital expenditures had been deferred, two major airlines (United and US Airways) had filed for Chapter 11 bankruptcy, the industry has lost more than $18B, and total corporate airline debt had increased to $100B.

Commercial aviation was impacted by an economic downturn that began in 2001 and continued through 2002. In addition, the industry suffered a tremendous shock from the terrorist attacks of September 11, 2001. Air travel in most areas of the world had not recovered to the volume carried by the airlines in 2000, which is affecting profitability for many airlines. U.S. full service airlines have suffered the greatest losses. Boeing incurred employment reductions resulting from the decrease in aircraft demand, which directly related to the attacks of September 11, 2001.

At the end of 2002, Boeing's timetable for industry recovery had been delayed. Boeing saw 2003 to be the year of recovery for world air travel; late 2003/early 2004 to be the year of airline profitability recovery; 2004 to be the year of airplane order recovery; and 2005 to be the year of delivery recovery. Commercial Airplanes segment operating earnings in 2001 and 2002 were $3,540 million and $2,845 million, respectively.

In the weeks immediately after September 11th, Air Force acquisition chief Darleen Druyan was particularly active in moving the Boeing tanker lease deal forward.

The current tanker fleet averages over 40 years in age, and yet it is the backbone of US ability to project force. The Air Force would need to replace these aircraft eventually, and the FY2002 bill began that process. The FY2002 House Defense Appropriations bill included included $150 million to buy one 767 and modify it as a tanker. The Senate version, focused on leasing to help the Air Force begin acquiring next generation replacements for its tanker fleet. The final version of the fiscal year 2002 Department of Defense appropriations bill, reflecting the Senate approach, would allow the Air Force to eventually lease one hundred 767 aircraft for use as tankers.

On 23 May 2003 Under Secretary of Defense for Acquisition, Technology and Logistics Edward C. "Pete" Aldridge announced the approval of the Air Force KC-767 tanker lease initiative. In the next step, the Secretary of the Air Force will now forward a report to Congressional oversight committees detailing the terms and conditions for review and approval. The agreement provides for leasing 100 KC-767 aircraft from the Boeing Co. for six years starting in 2006, at a cost of $131 million lease price plus an additional $7 million in lease-unique costs per aircraft. The total cost will be less than $16 billion. The initiative also includes a provision to purchase the aircraft for about $4 billion at the end of the lease 2017. The strategy allows the Air Force to begin replacing the KC-135E tanker fleet three years earlier than planned. With an average age of over 43 years, the KC-135E fleet is the oldest combat weapon system in the Air Force inventory.

Boeing proposed that the Air Force lease these aircraft based on the 767 in a commercial type arrangement. The proposal would allow the Air Force to lease 100 tankers, to replace 136 aging Boeing KC-135E aircraft. The E-model economic service life is markedly different from that of other KC-135s because of the difference in age and technology of some of its major components, most notably the engines. The 767 lease initiative would cost of $20 million per plane per year under a 10-year lease arrangement. An unmodified 767 costs between $100 million and $112 million. The cost of a 767 tanker is somewhere between $150 million and $225 million, depending on the number ordered and the nature of the modifications.

This leasing program also will require between $600 million and $1.2 billion in military construction funding to build new hangars, since existing hangars are too small for the new 767 aircraft. The government would also pay another $30 million to $60 million per aircraft on the front end to convert these aircraft from commercial configurations to military; and at the end of the lease, the government will to pay for $30 million more, to convert the aircraft back. All these costs raise the total cost of the Boeing deal to $30 billion over the ten-year lease.

The cost to taxpayers would be more than $2 billion per year, with a total price tag of as much as $30 billion over 10 years. This leasing plan is significantly more expensive to the taxpayer than an outright purchase. CBO and OMB said they would score this lease agreement not as a lease but as a purchase, costing $22 billion. According to a December 2001 Office of Management and Budget (OMB) estimate, the lease plan would cost $26 billion, nearly three times the cost of simply purchasing the planes. The lease plan represents more than 20 percent of the Air Force's annual cost of its top 60 priorities. But critics note that this program is not actually among the Air Force's top 60 priorities, nor do new tankers appear in the 6-year defense procurement plan for the Service.

The Defense Department Inspector General investigated whether former deputy assistant secretary of the Air Force Darleen Druyun gave Boeing pricing data on the rival Airbus bid. Druyun left public service in January 2003 to become a Boeing executive.

Reacting to criticism from leaders of the Senate Armed Services Committee, on 22 September 2003 the Defense Department presented a revised proposal to lease 74 planes and buy the other 26. Deputy Defense Secretary Paul Wolfowitz said buying the 26 tankers early, between 2008 and 2010 before their six-year leases expire, would add $2.4 billion in initial budget costs while lowering total program costs by $1.2 billion to $22.4 billion. Wolfowitz said buying 75 planes upon delivery would cost an extra $4.6 billion up front but would save $3.5 billion in the long run. He also said leasing 25 tankers and buying 75 more under a separate multiyear procurement contract would add $10.5 billion up front, with savings of $2.7 billion longer term.

The fiscal 2004 National Defense Authorization Act, passed by Congress 07 November 2003, forged a compromise on aerial refueling. The Air Force proposed leasing 100 Boeing 767 aircraft as tankers. The compromise called for the service to lease the first 20 aircraft and buy the rest outright. Officials estimate this will save the American taxpayers $4 billion over the life of the aircraft. The compromise allows the Air Force to begin replacing the aging fleet of KC-135 and KC-10 aircraft. The first KC-767s would be delivered in fiscal 2006.

As chairman of Armed Services at the time, Senator Johnn Warner found fault with the proposed lease contract and after consultations with Members -- in particular Senator McCain, who provided valuable oversight of the entire process -- the committee declined to approve the proposal. Additionally, consultations with outside experts had corroborated that procedures and provisions related to the lease contract required further oversight by Congress. Following a full committee hearing on September 4, 2003, Warner directed the Department of Defense, by letter to investigate the Air Force's initial proposal and analyze alternatives that would meet the operational requirement.

Furthermore, in letters to the General Accounting Office, the Congressional Budget Office, and the Office of Management and Budget, among others, Warner directed that these other agencies provide assessments of the proposal. These assessments, as well as further oversight conducted by both the Senate Armed Services and Commerce Committees, led Deputy Secretary of Defense Wolfowitz to order a "pause" in the execution of the proposed lease contract.

On December 2, 2003, Warner sent a letter to the Deputy Secretary to concur with the decision requiring a "pause" in execution, and stated further: "The Department of Defense Inspector General inquiry should pursue the trail of evidence wherever it leads, in accordance with standard IG procedures." By February 2004, Secretary of Defense Rumsfeld put a "halt" to the entire tanker lease process, pending the DOD inspector general report.

Darleen Druyun, who helped negotiate a controversial plan to lease Boeing 767 commercial jets to the Air Force for use as aerial refueling tankers, and Michael Sears, Boeing's former chief financial officer, were both fired after an internal Boeing investigation found they had violated company policies. Sears had communicated directly and indirectly with Druyun about possible employment with Boeing while she still worked for the Air Force and before she recused herself from official involvement with Boeing contracts. The investigation also uncovered that the two had tried to conceal their misconduct.

On April 20, 2004, Darlene Druyun, Principal Deputy Assistant Secretary of the Air Force, Acquisition and Management entered a guilty plea in Federal court for conspiring with Boeing Corporation's1 (Boeing) chief financial officer to help Boeing win a multi-billion dollar airplane tanker leasing contract. United States of America v. Darleen A. Druyan Criminal Case No. 04-150-A, Supplemental Statement of Facts: "The defendant [Darleen Druyan], since July 28,2004, now acknowledges that she did favor the Boeing Company in certain negotiations as a result of her employment negotiations and other favors provided by Boeing to the defendant." On 01 October 2005 former Air Force acquisition manager Darlene Druyun Druyun was convicted of conspiring with Boeing's chief financial officer to help the company win a multi-billion dollar contract. She was sentenced to nine months in prison, $5,000 fine and 150 hours of community service.

On May 25, 2004, the Department of Defense announced that Secretary of Defense Donald H. Rumsfled had deferred a decision on the tanker recapitalization program until additional studies then underway could be completed later that year. The decision was based in part on recommendations made by the Defense Science Board's Aerial Refueling Task Force.

Michael Sears pleaded guilty in November 2004 to a single count of aiding and abetting illegal employment negotiations. The scandal led to the resignation of Boeing's then-CEO Philip Condit.

On February 14, 2005 Michael W. Wynne, acting under secretary of defense for acquisition, technology and logistics announced that he has asked the DoD Inspector General to review eight contracts which were under the decision-making purview of convicted former Air Force acquisition manager Darlene Druyun. The Defense Contract Management Agency reviewed all the contracts that Ms. Druyan was directly involved with since 1993 at the request of Wynne. They examined more than 8,000 pages of information in 407 contracts and identified these eight contracts that appear to have anomalies in them which warrant further review.



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