The commercial shipping industry has attracted a private finance initiative (PFI) project for the first time, carried out for the UK's Ministry of Defence (MoD). The contract is for the supply of six new roll-on roll-off (RoRo) ferries to transport military equipment quickly around the globe. A commercial project company, AWSR Shipping, signed the financial contract with the Ministry on 27 June 2002. Using PFI for a deal to secure two ships full-time and four on stand-by, any difficulty in securing suitable ships at short notice from the commercial sector to serve the MoD can be avoided. This is not only the first PFI in the sea defence sector, it is also one of the largest defence deals that has closed this year.

The combination of blending public with private use has been a prominent feature of the recent raft of PFI projects for the MoD's other two services, on land and air. Last year's army tank transporter deal, a prime example of this, blends MoD and private use ? as will the RAF's imminent aircraft air-to-air refuelling system (future strategic tanker aircraft, or FSTA) deal, due to close this year. The blend is an attractive incentive for sponsors to earn additional commercial revenue on an investment. To tailor the PFI transaction to get the fairest pricing on the deal, some specialist aspects from PFI standardised contracts were used, and commercial-use clauses were then added. The third party risk was then reduced using an asset-backed type charge on the ships.

Joint arrangers and lenders Lloyds TSB and Sovereign Finance provide the £175 senior debt facility equally. It is understood that the loan is priced at 100bp, with no plans to syndicate yet. The four consortium members are all well-established British shipping industry companies. Andrew Weir Shipping, Bibby Line, James Fisher & Sons and Houlder Hadley Shipping have each contributed 25% of AWSR's £12.5 million equity. The contract's whole life value is estimated to be worth a total of £950 million over 24 years. This is said to depend upon the amount of operational and private usage of the ships. Ultimately, the more the ships are used, the more money is made. Originally it is thought the deal would be structured using bridge financing, however this later changed because of leasing, and tax, issues.

Lord Bach, defence procurement minister, has said: "Strategic sealift is the key to moving vehicles and equipment into a theatre of operations quickly and efficiently. This new service is a huge advance on the strategic transport capability we now have. We need six ships to meet our operational needs, but the MoD cannot afford to have ships and crews lying idle waiting for an emergency. Under PFI we get a good solution ? we have the ships when we need them and only pay for what we use."

RoRo ferries will be used on the EU's Rapid Reaction Force, as part of a Strategic Defence Review brought about in 1998, post-Gulf War and the then EC Treaty.

Two of the six new RoRo ferries will be constructed at the Harland and Wolf yard in Belfast, Northern Ireland, and four at the Flensburger yard in Germany. The project is contained and managed by AWSR Shipping. A spokesperson at the company says that yards in Ireland and Germany ? and not the Ministry's own English dockyards - were used to build the ships because they are "not classified as warlike, and so are subject to European commercial construction regulations to get the ships up and running."

Of the six ships, four will operate full-time commercially but on a stand-by, short recall option for MoD use with a contracted notice period. These stand-by ships will be commissioned in a commercial capacity by AWSR Shipping for use as cross-channel freight ferries carrying lorry trailers. They will have a designated area to operate in, so response time is always at the optimum. The remaining two will be used by the MoD full-time as military equipment transporters.

The transaction's combination clause made the deal attractive for bidders at the tender stage because of the potential for a revenue upside. Although revenue from commercial use is only guaranteed if there is a need for it in the market, any lost income from ships being called out of commercial and into MoD use will be compensated for by the MoD .

David Coulter of Norton Rose, which advised the banks for this transaction, said: "In this project, innovative means of reducing costs were adopted based on a blend of commercial and MoD use of the vessels."

Designed to respond quickly in times of crisis, ships must be capable of transporting armoured and unarmoured military vehicles to anywhere in the world. They will be taken into secured areas, which eliminate their use as warships because they will not glide into directly threatening situations. They are insured as commercial vessels, although there is a recognised risk of such ships being damaged, mainly because transporters were targeted in more recent conflicts.

AWSR Shipping, who has responsibility for personnel as well as providing equity, operating, maintaining and using for commercial purposes, has commissioned sponsored Royal Naval Reserves to man the ships.

The RoRo project sets a benchmark for the defence sector. One defence expert says "we can expect the ministry to confirm more deals with this system of PFI financing in the future. It has proved a successful and convenient option several times now. A meeting of heads is on the agenda to discuss which future projects can be financed on a PFI template."

A spokesperson for the MoD says "we need these RoRo ferries to deploy equipment once an area has been secured. We used a PFI structure to get commercial use from them as well, and AWSR will be responsible for this over 22 years." He adds: "This stems from a decision made in 1998 to expand sealift capability. For example, the Gulf War demonstrated the potential difficulty in securing enough vessels from commercial use."

During peacetime, it is expected that the two full-time MoD ships will be enough. However, should war break out, it is highly likely that all six ships would need to be used.

The six ships will not be in full service until 2003. In the interim, three rechartered ships are providing support from a commercial service. Once ready, the recall period will kick in. One ship will operate at five days' notice, three at ten days' notice, one at twenty days' notice and the last at 30 days' notice.

AWSR ShippingStatus: Signed 27 June 2002 Description: PFI shipping transaction between MoD and sponsor company AWSR ShippingSponsors: Andrew Weir Shipping, Bibby Line, James Fisher & Sons and Houlder Hadley ShippingLead arrangers: Lloyds TSB, Sovereign FinanceDebt: £175 million equally fundedTechnical advisers to sponsors: Holder Offshore EngineeringTechnical advisers to banks: Marspec, part of Lloyds TSBLegal adviser to concession awarder: Simmons & SimmonsLegal adviser to sponsors: Berwin Leighton PaisnerLegal adviser to banks: Norton RoseFinancial advisers to sponsors: Ernst & Young Tonnage and tax advice: Watson Farley & Williams