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V. NEW COMPLICATIONS: THE MANDATORY ALLOCATION PROGRAM AND THE FEDERAL ENERGY ADMINISTRATION REGULATIONS

MANDATORY ALLOCATION PROGRAM

In January 1974, the situation for the DFSC contracting officer was further complicated when the Emergency Petroleum Allocation Act (EPAA) became effective. The EPAA required the DOD to obtain its domestic petroleum needs by allocations placed on refiners by the Federal Energy Administration (FEA) (originally the Federal Energy Office) which administers the Act. Under the allocation system, competitive procurement was also eliminated, and the normal schedule for competitive bid solicitation, evaluation and contract award was not employed. But competitive bidding for oil products procured by DFSC had been eliminated since May of 1973.

BUYERS LACKED KNOWLEDGE OF FEA REGULATIONS

Approximately 70 percent of DFSC's procurements were awarded under FEA Petroleum Allocation and Price Regulations. Yet a DSA report in 1974 said "none of the buying personnel indicated a thorough working knowledge of the Regulations" (p. 38 DSA September 1974 report).

Lt. Gen. Wallace H. Robinson, Jr., Director, Defense Supply Agency, in a memorandum dated April 24, 1974, to Arthur I. Mendolia, the Assistant Secretary of Defense (Installations and Logistics), said that the contracting personnel at DFSC were no longer able to determine that the prices established by the suppliers in sales to the Government were fair and reasonable.

General Robinson explained:

In general, the prices being paid for petroleum products reflect DFSC's historical position as a spot buyer in the petroleum market. For many years the availability of surplus product enabled DFSC to make purchases at very favorable prices. Now the shortages of product have placed the DFSC at a disadvantage in the marketplace.

Of even greater concern to us is the fact that we must rely upon contractor certification as to the correctness of prices under the Mandatory Allocation Program.

General Robinson recommended that the Federal Energy Administration conduct audits "on our more significant contracts particularly those where the price deviates substantially from the average price paid on other contracts for the same product."

But DFSC was still not using its primary tool to determine price reasonableness: requesting the oil companies to supply cost or pricing data. Again no immediate action was taken to protect the government's

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interest in time for the July 1974 purchases that were made to meet the DOD requirements for the last six months of the year. No attempt was made to obtain cost or pricing data, or in the alternative, to require the potential supplier to file DD Form 633-7, a Claim for Exemption from Submission of Certified Cost or Pricing Data.

In the talking paper attached to General Robinson's memorandum, he stated that the "Validity of prices established by the sellers and need for review of Federal Policy relating to current pricing structure are beyond the purview of DSA."

But in this same communication it was pointed out that a wide range of prices was available to the oil companies in responding to the Federal Energy Office levy. As an example, JP-4 fuel prices ranged from a low of 17.7 cents to a high of 47 cents a gallon. The wide range of prices reflected the different positions of each company as to its crude source and its approach to pricing under the pricing guidelines.

FEA AUDIT REQUESTED

Following the audit recommendation of General Robinson, on May 25, 1974, Arthur I. Mendolia, Assistant Secretary of Defense, wrote a letter to John Sawhill, Administrator of the Federal Energy Administration, and requested an FEA andit of DFSC contracts "to determine whether the prices for military fuels are in compliance with FEA regulations."

Mr. Mendolia also voiced concern that extra costs were being passed on to the Government because of the FEA regulations. He said:

I would also appreciate your views on what might be done to moderate the apparent tendency on the part of some oil companies to treat military allocations as an add on increment to regular business, and thus subject to full passthroughs of highest cost incremental crude and feed stock supply. If this practice continues, there will be a continued heavy impact on Defense operating costs.

DISPROPORTIONATE ALLOCATION OF INCREASED COST TO DOD

Col. R. K. Estes, Acting Commander of DFSC in a June 14, 1974. memorandum to DSA, also discussed, in some detail, this problem of FEA regulations which permitted a disproportionate allocation of increased costs to DOD. He recommended that action be taken to remedy the situation.

Col. Estes explained:

These [FEA] regulations do not permit pass through of the total cost increases for "special products" (i.e., gasoline, No. 2 heating oil and No. 2 diesel fuel). FEA regulations, however, permit a pass through of such costs in the legal prices for unprotected products (ie., turbine fuels, petro chemicals, etc.). According to FEA sources, this loading of the prices of unprotected products is limited only in that the prices charged for unprotected products must be applied equally to all purchasers of each such product with reference to the "class of customer" to which each purchaser belongs. A supplier may, under the FEA regulations, consider DOD

as a class of purchaser by itself and/or its products a separate class of products. Therefore, the supplier may pass through increased costs to DOD and to no other class of customer. This FEA method of permitting suppliers to recover cost increases chargeable to "special products" in sales of unprotected products does violence to cost and pricing concepts found in ASPR and cost accounting standards. ***The above clearly demonstrated a conflict between the FEA price regulations and the Armed Services Procurement Regulations. *** Therefore, DOD should be requested to obtain a modification of the FEA regulations or other appropriate action to eliminate the disproportionate allocation of increased costs to DOD.

RESULTS OF FEA AUDIT

On August 2, 1974, John Sawhill, Administrator of FEA, wrote a letter to Assistant Secretary of Defense Arthur I. Mendolia and said the FEA auditors "had observed" that the oil companies were not loading a disproportionate amount of cost pass-throughs onto military contracts. However, Mr. Sawhill's letter indicated that the auditors had not reached a conclusion on the matter but merely made an observation after checking in only "one instance" of pass-throughs on jet fuel.

Mr. Sawhill's letter reads in part:

The observation on the part of the teams is that the companies are not loading a disproportionate amount of cost passthroughs on to military contracts. The two reasons cited are that prices are negotiated by DOD contracting officers, and that the companies want to retain the historical relationships that the prices have had in the marketplace.

On September 27, 1974, Mr. Sawhill of FEA wrote again to Mr. Mendolia and said FEA auditors had reviewed four additional contracts. He said that his review showed there was "no evidence to suggest that increased cost of crude petroleum are being passed through to the Department of Defense to any greater extent than to any other class of purchaser."

The FEA responses to a request of this importance with millions of dollars at issue are not satisfactory. First, the FEA judgment is based on the auditors having checked in only a small number of instances of pass-throughs on jet fuel. Second, the safeguard pointed to by FEA to insure there were no excessive pass-throughs-that prices were negotiated by DFSC contracting officers-was a myth. As demonstrated earlier, no backup data was requested which would have determined excessive pass-throughs and "first offers" were accepted by contracting officers who had little experience in the area. Third, FEA's observa

As the 1974 DSA Audit report indicates, the contracting officer accepted the price of the contractor and would certify that his pricing was within the maximum allowable under FEA regulations. The report said: "However, there was no requirement for the Vendor to specifically identify or reconstruct the legal product price. In instances where Procurement personnel endeavored to obtain legal price data, they were unsuccessful. Vendors generally responded by indicating that while they did not furnish a specific ceiling price, the prices submitted fell within the FEA guidelines. As a result, DFSC negotiators ld not establish whether prices were within the FEA legal price as they had not made Inquiry beyond the contractor's negotiating personnel. As a matter of interest, it was noted that prices for identical products among different contractors during approximately the same time frame, ranged from 20 cents to 47 cents per gallon" (p. 39).

tion that the companies wanted "to retain the historical relationships that the prices have had in the marketplace" indicated again FEA's lack of knowledge of how DOD procurement was operating."

The ramifications of the failure of FEA to exercise its responsibilities on this pass-through question would be great: it probably cost the government millions of dollars on the petroleum purchases for the period July 1, 1973 through December 31, 1974 as will be shown in chapter VII.

The Defense Supply Agency in a September 1974 report, commented on the FEA audit and said it was "not sufficiently detailed to fulfill DFSC's needs" (p. 39).

At the time the DSA voiced its criticism of the FEA audit, it recommended that DOD be given authority to conduct its own audits. In its September 1974 report, DSA said: "FEA informally has indicated that such delegation might be possible; however, the question would have to be explored further before an official FEA determination could be made" (p. 39).

The Defense Department did not act on this DSA recommendation until December 6, 1974, when Martin Hoffman, General Counsel of DOD, wrote Robert E. Montgomery, Jr., General Counsel of FEA. Mr. Hoffman asked whether FEA could legally delegate to the Secretary of Defense its statutory audit authority.

The authority of DOD to conduct such audits was never granted. On December 10, 1974, DOD informally notified FEA that such audit authority was no longer desired.

Undoubtedly as a result of the Subcommittee investigation, FEA renewed its interest in the question.

On March 28, 1975, members of the Subcommittee staff interviewed Lon Smith of the Refining Audit and Review Program of FEA. Mr. Smith was asked about the details of the audit that was conducted by FEA pursuant to the DOD letter of May 25, 1974.

Mr. Smith admitted the issue whether the oil companies were loading a disproportionate amount of cost pass-throughs onto the military contracts had not been determined by the earlier audit. Mr. Smith said this matter had not been pursued further until two days earlier, March 26, 1974, when he personally prepared a "special directive" ordering a "special audit" be conducted and given top priority.

The special directive ordered "a comprehensive audit of jet fuel prices" be made of the following major oil companies: Atlantic Richfield, Continental Oil, Gulf, Exxon, Mobil, Texaco, Standard of California and Standard of Indiana.

The audit report was to include, among other things, "a summary of cost allocations and pricing procedures and conclusions on compliance with all phases of the pricing regulations with respect to jet fuel."

VI. NEGOTIATED PRICES FOR JULY-DECEMBER 1974 CONTRACTS AGAIN IGNORE COST AND PRICING DATA AND RELY ON TRADE PUBLICATIONS

MAY 1974 WAIVER REQUEST

Despite continuing criticism that it was not obtaining enough backup data, DFSC requested in May 1974, from DSA, a blanket waiver of the requirement for contractors to submit cost or pricing data to support their prices for all purchases of petroleum products for the last six months of 1974.

On May 16, 1974, Admiral Oller, Commander of the DFSC, sent a memorandum to the DSA seeking a deviation from the requirements of ASPR relative to obtaining cost and pricing data and dispensing with the DD Form 633-7.

WAIVER REQUEST DENIED

Both of these requests were denied by Dale R. Babione, Executive Director of Procurement and Production of the Defense Supply Agency, in a memorandum dated June 4, 1974 to the Commander, Defense Fuel Supply Center.

In his memorandum, Babione reiterated the criticism of using trade publications as the sole basis for supporting an exemption from the requirement to obtain certified cost or pricing data.

He said:

4. Although prices quoted in certain petroleum news media, such as Platt's Oilgram and the Oil Buyers' Guide, may be used as an indicator of these "market prices," we do not consider that prices reflected in such media represent market prices within the context of the ASPR and hence may not be used as a sole basis for an exemption from the requirement to obtain certified cost or pricing data. These reported prices represent an undetermined mix of quotes, offers, and actual sales prices, and do not reflect prices charged largevolume purchasers such as airlines and large retail chains, under long-term contracts. Also other unreported sales are made both above and below the published price ranges. A more reliable market price indicator will have to be found to justify a market price exemption (pp. 1-2).

WAIVER REQUEST RENEWED IN JUNE 1974

On June 14, 1974, Col. R. K. Estes, the Acting Commander of the Defense Fuel Supply Center, wrote another memorandum to the Defense Supply Agency and again requested permission to use various

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