Thursday, July 24, 2008

DOD Should Change its Fuel Pricing

The Defense Energy Support Center (DESC)’s customers, i.e., DoD, are charged standard prices for oil products set in advance by the Office of the Undersecretary of Defense (Comptroller), and, in most cases, are in effect for the entire fiscal year. The aim was to insulate the customer from market fluctuations.

Let us have a look what DESC says about the Standard DOD Customer Fuel Price [emphasis added].

The standard price of fuel is a tool that was created by DoDs fiscal managers to insulate the Military Services from the normal ups and downs of the fuel marketplace. It provides the Military Services and OSD with budget stability despite the commodity market swings, with gains or losses being absorbed by a revolving fund known as the Defense Working Capital Fund (DWCF). In years that the market price of fuel is higher than the standard price, the DWCF loses money. In years that the market price is lower than the standard price, it makes money. This gain or loss can be made up by adjusting future standard prices or by providing our DoD customers with a refund. This decision is typically made by the Office of the Secretary of Defense, Comptroller. However, the DWCF must remain cash solvent. As a result, in rare instances such as fiscal year 05, the standard price is changed during the fiscal year so the fund remains solvent.

The standard price of fuel is not a marketplace price. You cannot compare the standard price of fuel with the price of fuel at the service station down the block. It is not intended that the standard price of fuel be comparable with similar fuels in the commercial marketplace. The prices that you should examine for comparison with the "station down the block" are those which DESC actually paid for those fuels. They are invariably less than the price which is being offered in the commercial marketplace because of the centralized buying power of the federal government.

Well, I made an exercise with JP-8 (see the note in the end of this article for definition), the jet fuel the DoD uses most.

I first compared monthly DOD standard prices for JP-8 with DESC purchase cost and market price (I used New York Harbor Kerosene-Type Jet Fuel Spot Price FOB as market price), all measured in dollars per barrel (as suggested by the DESC). Note that JP-8 price should naturally be a little bit higher than the NY Kerosene price due to additional items added into JP8.

Later, since DoD prices are given for fiscal year, I converted market prices from calendar year to fiscal year by using monthly data. The US Government’s fiscal year is October 1 through September 30. For example, fiscal year 2007 is October 2006 through September 2007.

The chart shows that DESC standard prices were way above the market prices between January 1998 and late 199, in 2001 and 2002, most of the time between mid-2005 and mid-2007. Strangely (or not) DESC standard prices were even below the crude oil prices (in 2000, in the second half of 2004, and lately in May-June 2007).

Frequent changes made to the standard prices since the late 2004 are due to increasing crude costs. However, DESC has not been very successful in determining the new price targets.

So what? Well, it depends how you want to see it.

I show below DoD Jet fuel consumption and Jet fuel prices over the period from 1998 to 2007, all in fiscal years.

Then I calculated what the DoD paid for JP-8 compared to what DOD could have potentially paid if fuel were bought in market prices. Look at 1999 and 2002. It says that DoD services paid nearly double the market price for JP-8. In 2000 and 2004, the prices paid to DESC were slightly lower the market prices.
So what? Well, then let me sum what the DoD services have paid to DESC over the past 10 years (1998-2007):

DoD services’ payment to DESC for JP-8: $43.8 billion
Cost of fuel in market prices: $38.9 billion

Overpayment by the DoD services due to standard prices set by the DESC: $4.9 BILLION.

Conclusion: DoD services paid nearly $5 billion dollars extra to DESC due to improperly set standard prices. It is time for DESC to reevaluate and reconsider its price setting mechanism. Before wining about the fuel costs and blaming on oil producers, the DoD should first look at the problems at home and fix them.

Note on Data Sources:
Jet Fuel Market prices (New York Harbor Kerosene-Type Jet Fuel Spot Price FOB) and crude oil price data are taken from the EIA.
DoD Jet Fuel consumption data are complied from DoD FEMR reports.
DoD standard prices are complied from the information available on DESC website.
All the rest are my calculations.

Definition: Jet Fuel Propellant (JP-8) :
JP-8, or JP8 (for "Jet Propellant") is a kerosene-based jet fuel. It is a replacement for the JP-4 fuel; the U.S. Air Force replaced JP-4 with JP-8 completely by the fall of 1996, in order to use less flammable, less hazardous fuel for better safety and combat survivability. U.S. Navy uses a similar formula to JP-8, JP-5. JP-8 is projected to remain in use at least until 2025. It was first introduced at NATO bases in 1978. Its NATO code is F-34. It is specified by MIL-DTL-83133 and British Defence Standard 91-87. Commercial aviation uses a similar mixture under the name Jet-A. JP-8 in addition contains icing inhibitor, corrosion inhibitors, lubricants, and antistatic agents. JP-5 has even higher flash point than JP-8, but it also has prohibitively higher cost, limiting its use to aircraft carriers. Outside of powering aircraft, JP-8 finds its use as a fuel for heaters, stoves, tanks, and other military vehicles, and serves as a coolant in engines and some other aircraft components.

See also USAF Fact (.doc) sheet on JP-8 and Health, and an early post of mine Single Military Fuel - How Long?
QUESTION: While I was doing this excercise I realised that JP-4 purchases and sales have gone up tremendously over the past few years. What's happening? JP-8 was supposed to replace JP-4 but it seems that JP-4 is coming back!


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