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VII. OIL PROCUREMENT PRACTICES COST THE GOVERN

MENT MILLIONS OF DOLLARS

STAFF REVIEW OF JULY 1974 JET FUEL CONTRACTS An examination was made by the Subcommittee of about one-third of the large contracts placed by DFSC in the summer of 1974 with special emphasis on the procurement of jet fuel. As pointed out earlier, jet fuel makes up more than half of the total dollar volume of the purchases of DFSC. In a number of files reviewed, there was nothing at all to document what negotiations, if any, had taken place between the contractor and the Government and how the contracting officer had determined that the price was reasonable.

In none of the files reviewed was there any submission by the contractor of certified cost or pricing data nor any submission of market data or any data as to what the contractor was charging other customers for the same product.

Some of the files contained memoranda of negotiations by the contracting officer. These memoranda generally showed that the award was based on a certification by the contracting officer that he had broad experience in the procurement of petroleum products and that he believed, based on his personal knowledge and experience, that the price was a fair and reasonable one and should be accepted. In some cases, the contracting officer quoted information as to bid and asked prices or posted prices for automobile gasoline or kerosene from Platt's Oilgram or the Oil Buyers Guide to support his conclusion. This was done even though, as previously pointed out in this study, DSA had ruled that it was inappropriate to use this data.

In reviewing the contract files and related information pertaining to the July 1974 jet fuel contract awards, the Subcommittee staff noted the average price for jet fuel was about 31 cents per gallon and that there was a spread in the contract prices for the jet fuel from 20 cents per gallon to 48 cents per gallon. The files reviewed contained no adequate explanation as to why these differences in prices existed.

Subcommittee staff undertook to examine the reasonableness of prices paid by DFSC for its jet fuel purchases.

THE PRODUCTS INVOLVED

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The staff was informed that the military uses two types of jet fuel: the Air Force uses JP-4 which is the cheapest and most readily available of jet fuels. The Navy uses JP-5 which is substantially the same as Jet-A, the jet fuel used by commercial airlines. It was learned that there are no significant differences in the manufacturing costs of producing any of the jet fuels-military or commercial.

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How DFSC APPROACHED PRICING

The parent agency of DFSC, the Defense Supply Agency, had criticized DFSC in the past for using data in trade publications to justify prices. However, DFSC continued to use this data in 1974. In fact, since the trade publications do not carry data on military jet fuel, DFSC used price data from trade publications for different products to justify its jet fuel prices as follows:

For JP-4 fuel, a blend of gasoline and kerosene, DFSC would obtain posted commercial prices for motor gasoline and kerosene. It also obtained data on prices bid and asked by brokers for quantities of motor gasoline on the “spot" market. It took this data and through a formula established a composite range of prices which it compared with the prices being asked by oil companies for JP-4.

The same practices were used for JP-5 fuel.

But this procedure has some obvious defects. The prices in trade publications do not in many cases represent actual transactions. The quantities of gasoline and kerosene involved in such transactions were not comparable to the quantities of jet fuel being purchased. Prices from individual suppliers could not be compared directly. And, of course, the delivery conditions and end-use of the products on which quotations appeared in trade publications were vastly different from the Government purchases.

STAFF REVIEW OF JET FUEL PURCHASED BY AIRLINES

In its review of the DFSC July 1974 jet fuel contracts, the Subcommittee staff attempted to find similar purchases by other customers which might establish a market price, especially in light of DSA'S specific findings that use of trade publication data was inappropriate. The logical starting point seemed to be prices paid by commercial airlines for their jet fuel which, as noted earlier does not differ substantially from military jet fuel. In addition, the volume of jet aircraft fuel purchased annually by the domestic airlines is close to that purchased by the Defense Department: both have been using between six and seven billion gallons of jet fuel annually. Moreover, the delivery conditions are similar, the end use is identical and the major oil companies who sell jet fuel to the airlines sell jet fuel to the Government.

There is no indication that DFSC attempted to obtain data on airline jet fuel prices from either the airlines, or the oil companies.

Subcommittee staff obtained some pricing information from the airlines and the Civil Aeronautics Board (CAB).

The CAB issues a monthly report on the cost of jet fuel used by the domestic airlines. This report gives considerable detail as to jet fuel costs by individual airlines, by location, and by quantities used. The Subcommittee staff felt that this report would be useful in determining the market price of jet fuel along with data from either the oil companies or the airlines. The personnel at DFSC were aware of the existence of this data but it was not used by them in their determination of whether a specific price was a fair and reasonable one for the government. Instead they depended upon trade publication data as set out above.

The following is a tabulation of the average cost of jet fuel per gallon used by the airlines in the period shown as taken from the CAB reports and the average cost of jet fuel purchased by the Fuel Center during the same periods :

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A further breakdown of the military jet fuel purchase is as follows:

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This tabulation shows that before the October embargo, the DFSC was buying jet fuel for 2 cents a gallon less than the domestic airlines. After the embargo, it has paid an average of from 4 cents to 8 cents more per gallon. The actual difference between the average prices paid for jet fuel by DFSC and the average prices shown in the CĀB reports may be even greater since the airlines prices usually included transportation and many of the DFSC prices did not include transportation.

If the buyers at the DFSC had been able to purchase jet fuel for the government during the period from July 1, 1973 to December 31, 1974 as effectively as the buyers for the airlines, the government would have saved nearly $600 million.s

DFSC personnel were asked why there was this difference in the prices they paid for jet fuel as compared with the airlines when DFSC had been paying less than the airlines prior to 1973. The first explana

that some of the airlines had long term contracts and the lower prices in these contracts carried through the embargo and even up to the present. DFSC did not have the protection of such contracts. And this, according to DFSC, would distort the airlines prices, and make their average price seem very low.

This argument raises the question why the DFSC did not have the protection of at least some long-term contracts as a hedge against price increases. DFSC said that it had the policy of buying on a shortterm basis only in order to get the best possible price. This policy may The total DFSC purchases for this period were 9.673 billion gallons and the commercial airlines average price over the same period was 6.2 cents per gallon lower.

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have been successful in the past when petroleum supplies were plentiful. But DFSC had a clear warning in 1973 that the petroleum market was changing. DFSC changed from an advertised bid basis of award to separate negotiations with each supplier. DFSC did nothing else to plan or provide for a potential fuel crisis. Any past savings by DFSC's short-term procurement policy must be offset against the losses incurred when the October embargo found the government without adequate contractual coverage for petroleum products.

In addition, DFSC said it is unable to estimate its jet fuel requirements for a period longer than six months. The size and needs of DOD would seem to question this assumption but it is not within the scope of this study to consider this contention in detail.

But in order to test the DFSC theory that long-term contracts accounted for the differences in average prices paid for jet fuel by Defense and the airlines, Subcommittee staff contacted various airlines. Staff found that not all of the airlines had full coverage of their requirements by long-term contract. Many had only a small percentage of their fuel requirements for 1974 covered by contract. They had to purchase the balance in the open market. By comparing what airlines, substantially unprotected by contracts, had to pay on the open market for their jet fuel with that paid by DFSC, the impact of airline longterm contract commitments on average price is, for all practical purposes, eliminated."

The purchasing agents for three of the major domestic trunk airlines confirmed that a major portion of their jet fuel purchases during 1974 had not been covered by long term-contracts. They advised that the average price they paid for all jet fuel during 1974 ranged from about 24 cents to 27 cents per gallon but, more importantly, they advised that the average price they paid for jet fuel purchased without a contract was about 28 cents per gallon. They, of course, had many purchases at many locations and there were many instances where the airlines had to pay prices both considerably higher and lower than this figure.

They further advised that this average price of 28 cents has remained about the same or even a little higher up to the present time. The airlines informed us that they purchased their requirements from the major oil companies.

From the above information it would appear reasonable to expect that the average price negotiated by the DFSC in 1974 with the major oil companies should have been in the 28 cents range to be comparable with the airlines purchases without contracts.

A review was made, therefore, of the quantities and prices charged by the major oil companies which also sell jet fuel to the domestic airlines. This shows the following quantities and prices for JP-4 and JP-5 charged DFSC during the period July to December 1974 by the oil companies who are the major suppliers of the airlines :

9 DESC personnel were asked if any attempt had been made in 1974 to obtain any information about prices from airlines, including prices obtained on purchases without a contract. As stated above, no indication was found of any attempts by DFSC to get any data from airlines for comparison purposes.

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