The Strategic Sealift Service is the largest Private Finance Initiative defence project involving ships and one of the biggest PFI projects to date, with the full cost of the service at about £950 million. The project provides the UK’s Ministry of Defence the service of six special vessels for military transport, enhancing sealift capability by being able to rapidly move thousands of vehicles to respond to crises around the globe.

Strategic Sealift was groundbreaking in many areas. The ships were built to specification not only for use by the MOD but also for use in the commercial market. When some of the vessels are not required for military purposes, they are able to earn commercial revenue, thereby reducing overall project costs.

The scheme will run until December 2024. Finance for the project was provided by Alliance and Leicester and Lloyds TSB, secured by charges on the vessels, the project cashflow and relevant contracts. The successful bidder was AWSR Shipping Limited (AWSR), a consortium of shipping companies including Bibby Line, Houlder Hadley, James Fisher and Andrew Weir Shipping.

The ships are required to be available for service worldwide for routine military transport, participation in regular four-yearly exercises, support services in relation to operational task and Joint Rapid Reaction Force (JRRF) operations.

All six ships are now in use with four in service under the MOD and two on charter for commercial purposes.  Investment Climate

The Strategic Sealift project was in its final stages during the events of 9/11. The events dramatically changed the strategic environment and the international insurance market. However, the project was completed despite these uncertainties.

The success of project reflects the attractiveness of the PFI concept in the defence sector. AWSR provided the service on budget and on time with the last of the Roll-On Roll-Off cargo vessels being delivered to the MOD in June 2003, 20 months ahead of schedule.

Background

The government published a Strategic Defence Review in 1998 which reflected its commitment to conduct a foreign-policy-led review to assess Britain's security interests and defence needs.

Sealift ships are essential to military forces in the deployment of military cargo and the review recognised a need for six Roll-On Roll-Off vessels to improve this capability.

The MOD said experience has demonstrated the difficulties in obtaining suitable ships to move military equipment in the short timescales demanded by the JRRF and for the Armed Forces’ needs in operations worldwide. With these ships, operational difficulties can be avoided.

Project

According to the British American Security Information Council, an organisation which researches global security issues, including military strategies, Europeans have long sought to develop a vehicle to give expression to a European concept of common defense independent from but closely coordinated with NATO.

Due to its global nature, the Strategic Sealift project is important within the framework for this concept. Historically, there have been imbalances among forces with severe shortages on the logistical side such as EU members lacking sufficient airlift and sealift capabilities, transportable docks, communications equipment and intelligence-gathering satellites.

In order to enhance sealift capability, the UK defence requirement demanded six newly constructed 20,000 tonne Roll-on Roll-off cargo vessels with at least 15,000 metres of capacity.

Required to go anywhere, the ships needed to comply with worldwide standards, such as stringent North American environmental laws. The vessels can move several thousand armoured and unarmoured vehicles. Lord Bach, Minister for Defence Procurement said, ”Strategic sealift is the key to moving vehicles and equipment into a theatre of operations quickly and efficiently.”

The vessels can dock at a wide variety of ports, loading from either the stern or side. They can also carry a 40 tonne crane, have enhanced stability and ice breaking capabilities. All the ships are registered in the UK

Four of the vessels were built at Flensburger Schiffbaugesellschaft (FSG) at Flensburg in Germany and two at Harland & Wolff in Belfast under a license of the FSG design. The vessels were named after UK lighthouses.

The contract is structured so that the full six-ship service is only used by the MOD for specific exercises and military operations as required. The design provides the durability needed for military situations but with the engine capacity required for commercial third party use. The project benefits both the public and private sectors.

Max Gladwyn, managing director of AWSR Shipping, told Infrastructure Journal that the Strategic Sealift Service was unusual in that many MOD projects are not suitable for private market. “Our project is a bit of a one off. We’re using our asset in the commercial market. You won’t see much of that,” he said.

The full cost of Strategic Sealift is about £950 million, depending upon the amount of operational and private usage of the ships.

AWSR

AWSR was awarded the contract in October 2000 following a public advertisement in the Official Journal. The four shortlisted bidders were the Sealion consortium which included BAE Systems, the Stena shipping line and others; Maersk, a UK subsidiary of the Danish-based shipping company Maersk A/S; Novomar, a company linked to the Belgian Cobelfret group; and AWSR.

AWSR Shipping was formed by the British shipping companies Bibby Line, Houlder Hadley, James Fisher and Andrew Weir Shipping. The company was established with the sole purpose of bidding for the £950 million contract. AWSR is equally owned by the four companies.

Financing

The legal advisors to the MOD for the project were London-based Simmons and Simmons. Edwin Godfrey, senior commercial partner, said one unusual feature was that the shipbuilding subcontracts had to be placed long before the main PFI concession contract was signed. 

As a result, interim arrangements were made between the MOD and AWSR at the end of 2000, allowing for the contracts to be placed with the yards, subject to the possibility that they could be taken over by the MOD in the event that parties failed to reach agreement on the PFI concession contract. Barclays Bank provided interim finance to allow this structure to be implemented.

The commercial and financial closing of the transaction took place on 27 June 2002 and involved a total of 84 separate agreements.

During the competition stage, the MOD left each bidder to propose its own financing solution compared to a separate financing competition.

Up to £175 million of limited recourse was provided to AWSR by traditional debt financing supplied by a consortium of Lloyd TSB Bank and Alliance and Leicester. Each lender provided 50 per cent of the debt and treasury products required to fund the acquisition of the Roll-on Roll-off ships.

There is also a direct agreement between the MOD and the banks which gives the banks the right to step in to the project in the event of default by the contractor. There is a structure of four shareholders. AWSR is the Special Purpose Vehicle. AWSR has subcontracted various segments such as the supervision of construction to Houlder Offshore Engineering, the supply of crew to Bibby Line and ship management to Andrew Weir.

Alliance & Leicester Group and Lloyds TSB were represented by Norton Rose. Legal advisors were Simmons & Simmons and London-based Berwin Leighton Paisner (to AWSR).

Financial advisors to AWSR were Ernest & Young. Other financial advisors were KPMG and Barclays Capital.

Legal issues

The legal framework of the project falls under classic PFI principles and also applies new features not used before in maritime and shipping principles.

The project involved the first use of 180 “Sponsored Reservists,” individual officers recruited for the service are employed by the PFI contractor (or its crewing sub-contractor) under normal navy merchant terms and conditions. However, they also enter into a parallel contract with the MOD in which they agree to become Sponsored Reservists under the Reserve Forces Act 1996. As a result, they could be called out as members of the Royal Naval Reserve.

Godfrey said the call out of seamen as reservists will be exceptional, but the ability to do so provides a degree of security that the service will be carried out as required, while economising on the use of limited armed forces personnel. He added the maritime trade unions helped to set up the structure, providing good prospects of long-term employment for their members.

Regarding the usage of the ships, some would be permanently in government service and paid for under a guaranteed “take or pay” regime while others would be free to take commercial charters.

Risks

With any long-term PFI project there are numerous potential risks. Some risks addressed in the commercial contract included issues of timely delivery, change and change of law, demand projections and crewing.

Another contract issue was third party revenue due to the implications of a commercial service. The company takes a risk on being able to let two of the vessels into the commercial market as they could be requisitioned by the MOD. The fact that the vessels can be called up at short notice restricts the areas of the world in which they will be able to operate in commercial use. AWR has taken significant commercial trading risks under the project’s terms. It took all risks for construction and all operational risks such as providing the crew and maintenance. 

Gladwyn noted this level of commercial risk is rare within the PFI market. “Profitability is dependent on the ability to employ two ships in the commercial market,” he said.

AWSR and the MOD worked closely together in order to devise innovative contract provisions to deal with both marine and non-marine indemnity arrangements. On termination, the MOD has no obligation to acquire the project’s assess leaving the lenders to take on the full market asset risk.

Insurance issues

Because the nature of this project involved assets that can be required to go anywhere, including potential war zones, insurance and security issues are significant.

For example, the government is an insurer of last resort because the vessels may enter situations which are not capable of being covered by normal marine insurance which otherwise would apply.

The project occurred during the government’s introduction of the new tonnage tax which gives shipping companies the option of electing to be taxed at a flat rate based on the tonnage of their vessel, rather than on their profits.

The MOD told Infrastructure Journal that the nature of military operations required some specific provisions. There is structured pay and performance regime which provides for deductions for underperformance and wider provisions dealing with default debt and interest. Commercial insurance is also used where appropriate.

Conclusion

The Strategic Sealift Service project was considered a success due to its overall value for money as well as incorporating unique concepts for PFI defence in areas of shipping and maritime.

The use of PFI in the defence sector has gained momentum and participants in the market say it is likely to continue. David Coulter, partner at law firm Norton Rose which advised the lenders, said  as one of the largest PFI transactions to have closed this year, it is particularly significant that this deal was in the defence sector.

“The Ministry of Defence is increasingly recognising the cost savings achievable through long-term collaboration with the private sector. In this project innovative means of reducing costs were adopted based on a blend of commercial and MOD use of the vessels. Significant cost benefits are a major factor in the increased role of PFI in defence that we are seeing across Europe," he said.

Godfrey agreed, saying the defence sector one of the better areas of PFI, noting that the MOD has considerable procurement experience.

The MOD is currently working on other projects involving assets which are required to go anywhere and may be close to the front line. Two examples are the Future Strategic Tanker Aircraft project (FSTA) and the Heavy Equipment Transporter project (HET).IJ