Part 2: Economic and financial risks
The first part of this article considered the technological risks involved in the decision, as set out in the 2016 Defence White Paper, to procure twelve new submarines at an acquisition cost of at least $50 billion. The economic and financial risks of this project are discussed here in Part Two of the article.
There is a considerable literature on the economics of defence procurement but the fundamental principles of economics, including corporate financial analysis, can readily be applied to military programs. Any major investment program to acquire a new or updated defence asset should be subject to the same rigorous appraisal that a new investment in, say, a coal mine or a tourism resort would demand in the private sector. Of course, the defence asset is different in that it gives rise to a largely intangible pay-off and doesn’t produce cash flows, but the benefits of the project can still be assessed and set against the costs. Importantly, the risks around both the projected benefits and the costs need to figure prominently in the analysis.
The Defence department should be as well equipped as anybody to assess the technological options and trade-offs around the acquisition of a new military capability. Yet it is far from clear that Defence possesses the economic and financial skills required to undertake sophisticated investment appraisal and cost-benefit analysis. This may well be a major shortcoming of the Defence acquisition process. At the heart of the submarine acquisition process is the determination by Defence that the RAN has a unique requirement for submarines. This view, which is contested in Part Three of this article, means that a military off the shelf solution is not feasible. By itself, the implications of this for the cost of the project, its delivery date and particularly the associated risks are very substantial.
The effects of the decision to design and build a unique submarine are profound. Three issues should be considered, namely the cost of the new capability, the timing of its delivery and the need to address the capability gap that would otherwise exist before the new submarines come on stream.
First of all, the projected cost of the future submarine (FSM) appears to be excessive, perhaps unacceptably so. The acquisition cost, excluding weapons, for each FSM is estimated at around $4.25 billion (approximately US$3.15 billion in March 2016). By comparison, the successful Japanese Soryu class submarine, a contemporary SSK which may well be the basis for the FSM, is far less expensive, with the most recent boat, commissioned in 2015, estimated to cost US$540 million. The cost in FY 2016 of a state-of-the-art Virginia class nuclear attack submarine, nearly twice the size of the FSM and much more capable, is US$2.688 billion. The differential between the cost of the Soryu class SSK and the Virginia class nuclear submarine (SSN) seems entirely justified by the difference in capability. On the other hand, the projected cost of the future submarine cannot in any way be justified on the basis of relative capability. Indeed, on that basis the FSM should cost little more than a Soryu.
The projected cost of the FSM is clearly very high. Yet any rigorous financial modelling evaluation would conclude that the risks of that cost blowing out over a 17-22 year acquisition period (see below) are high, if not very high. We do not yet have an agreed design for the FSM. During the detailed design process, in response to technological progress, which is constant, the specifications could easily change on the upside. Inevitably, the integration of new systems can develop into a financial sinkhole. Unless built to a fixed price contract, there may be substantial unforeseen problems in the manufacturing process for a new and unique submarine. There are significant risks that these costs, which I believe are already unacceptably high, could blow out further, perhaps substantially.
The second issue is delivery timelines. The tone of the White Paper is that because of the strategic situation in Australia’s region, the new FSM capability is required sooner rather than later. Yet because of the requirement for a unique Australian submarine, the timetable for its delivery extends from the early 2030s to 2050. But even this may be optimistic. According to Andrew Davies and Mark Thomson of ASPI, this schedule is based on the Defence estimate that it takes between 17 and 22 years to design and build a new submarine. On this basis, ASPI estimated in 2012 that the best case delivery date for a submarine ordered in that year was 2029 and the worst case 2034 (see Table 3 below). Presumably, on the heroic assumption that the submarine would be ordered in 2016, those estimates have now blown out to 2033 and 2038 respectively (Table 3).
Table 3: Delivery timelines for the FSM (based on 2012 order)
|Assumption||First delivery date|
|Defence best-case date||2020|
|Defence worst-case date||2034|
|Off-the-shelf design from overseas||Seven years from contract signature|
|Off-the-shelf design built locally||Nine years from contract signature|
By contrast, six years elapsed between the order being delivered for the very large and complex first of class USS Virginia and its commissioning ceremony. It took four years to commission each of the first six submarines of the Soryu class after the keel was laid. These two production lines are still operating and will be for some time to come.
The risks to the timeline are similar to those identified above in regard to cost. They are material.
The reason why the new capability is required sooner rather than later is not only because of the naval build-up in the Asia Pacific. It also reflects the fact that the Collins class submarines are now obsolescent if not, indeed, obsolete. Admittedly the maintenance situation and crew availability have improved markedly, with five of the six boats available from mid-2016. Yet as former Prime Minister Abbott said recently (supported by the former Defence Minister), the Collins class exhibits a “fragile capability”.
The White Paper acknowledges that an updated submarine capability is required in the period before the FSM begins to come on stream. Its solution to this is to bridge the capability gap by undertaking a significant upgrade of the Collins class. The details and cost of this are not specified in the White Paper documentation beyond $100 – $200 million for new sonar equipment. More importantly, there is no discussion at all about the feasibility of such an upgrade and how a credible capability can be sustained on the Collins platform out to perhaps 2040, when only three or four of the new submarines will have been delivered. This is not only a major omission, but, given public disquiet about the Collins class, it is also quite unacceptable.
In particular, Defence needs to respond to an alternative and arguably far more realistic view that it is not feasible to upgrade Collins to anywhere near the extent required to maintain a credible capability. On this view, within about five years the boats will be obsolete and should no longer be deployed on operations. Attempting to restore their capability would be unsuccessful, would involve throwing good money after bad and would place the crews at significant risk.
James Harrap, a retired naval officer who has commanded two Collins class submarines and served on others, identifies fundamental problems with the Collins platform, including:
“Much of the existing equipment is bespoke (and often obsolete), the need for upgrades is increasing but the cost of acquiring and retrofitting equipment is high. … The Collins class has many components that we are simply stuck with for the life of the platform. For example the diesel generators fit into this category because of their size; unfortunately they are quite possibly the least reliable diesel engines ever built. They have been problematic throughout the life of the class and, despite some design modifications and improvements, are only kept running by ingenuity and sheer determination of the crews at sea and supporting contractors alongside. Because of components and immutable design issues such as these, Collins has a finite service life.” 
Apart from driving the submarine on the surface and while snorting, the diesel engines act as generators for the electric motors, which drive the vessel while submerged. A failure of one or both diesels while on patrol would be quite catastrophic. Yet they cannot in reality be replaced, since because of their size this would mean cutting a large hole in the pressure hull of the submarine.
Writing in 2012, Harrap goes on to note that since the Collins boats were built:
“Numerous advances have occurred in batteries, electric motors, air-independent propulsion, sonars and electro-optics – all of which have revolutionised submarine design even further. These changes have been significant and whilst it may be possible (though very costly) to keep Collins operational for another decade or more, most advances can’t be retrofitted and the boat will most likely be so technically obsolete by 2022 that the credibility of the capability it offers will be seriously eroded. … An inability to keep up with rapid technological change, coupled with high materiel failure rates has aged the boats prematurely, adding cost and complexity to through-life support. The boats must be sustained in the short term, but I do not believe a service life extension for Collins is even possible, much less recommended.”
A major issue here is the absence of air-independent propulsion (AIP) in the Collins class which cannot be retrofitted. Because of the improvement in detection technology, AIP is increasingly regarded as being indispensable for conventional submarines (SSK)s operating in hostile waters because of its substantial impact on reducing the indiscretion rate while on patrol. While new electronic systems could no doubt be added to the submarines, this would likely involve higher power consumption, require more frequent snorting and therefore increase the boats’ indiscretion rate above its already significant level.
It is difficult to dispute Harrap’s conclusion that the Collins class will be obsolete by 2022 and cannot be upgraded to the degree required to sustain a credible capability. This implies that on the basis of the current timeline for delivery of the FSM, unless the RAN leases boats from overseas Australia will be left with no submarine capability for a period of about 15 years. The lease option may not be possible because of a lack of availability of suitable submarines.
A ten to fifteen year capability gap in submarine capability would have a major negative impact not only on Australia’s force structure and strategic positioning, but also on the Navy’s ability to maintain both a cadre of experienced and highly trained submariners as well as a constantly evolving naval doctrine for submarine warfare.
Unfortunately, Australian governments have form in delaying ordering new Defence assets and then having to undertake costly and risky upgrades in order to bridge the resulting capability gap. The most recent example concerns the delay in ordering the air warfare destroyers. These were originally conceived as a replacement for the RAN’s three Perth class destroyers, which were decommissioned in 1998-2001, twenty years before the AWDs will be available. To fill the air defence gap in the interim, it was decided to upgrade Australia’s six Adelaide class frigates (FFGs), a possibility the parent US Navy considered and rejected for its own ships. The program came in late, way over budget and with many lingering technical problems relating to integrating the new systems. Eventually, only four ships were conditionally accepted and the other two scrapped. The first of the upgraded FFGs (HMAS Sydney) was also decommissioned last year, leaving just three FFGs. Fifteen years after HMAS Brisbane was decommissioned, a capability gap in area air defence for the fleet still exists.
On the basis of this analysis, the risk of a capability gap, where Australia will not be able to deploy any submarines in operational areas over a period of around fifteen years, is extremely high.
Made in Australia?
One major issue that remains unclear is whether the submarines will be built in Australia. While the White Paper includes a commitment to build the new frigates in Adelaide, it temporises to some degree over the FSM: “the Government has already committed to maximising Australian industry involvement in the submarine program, without compromising cost, capability, schedule or risk.”
Based on the AWD project, a local build programme would certainly compromise three of these four elements of the programme, namely cost, schedule and risk. ASC last delivered a submarine over a decade ago. It has no corporate memory of how to build one. By the time the first FSM keel was laid, there would likely be no survivors of the Collins programme either on the shop floor or in management.
In addition, there are negligible economic benefits in local construction. You don’t need to build a defence asset in order to maintain it efficiently, as was shown in the case of the Oberon class submarines and numerous aircraft and helicopters. Unless local industry can build ships to the same cost and timeline as overseas players, it imposes a burden on the Australian community. Indeed, if overseas governments see fit to subsidise the construction of warships for Australia, so much the better for us. The car industry required a much lower level of protection than naval shipbuilding and yet the Abbott government showed it the door. To treat naval shipbuilding differently would suggest that the era of corporate entitlement was still alive and well and that industry policy was characterised by windy rhetoric.
Nevertheless, there clearly is a possibility that a current or future Australian government could determine that the FSM should be built here. This would increase the risk to already unacceptable cost and delivery schedules to a degree that is difficult to contemplate.
Jon Stanford is a Director of Insight Economics. He had a significant career as an economist in the Australian Public Service, ultimately in the Department of Prime Minister and Cabinet. He has worked extensively on economic and policy issues around defence procurement and naval shipbuilding.
 Wikipedia, https://en.wikipedia.org/wiki/Sōryū-class_submarine, retrieved 12 March 2016.
 Wikipedia, https://en.wikipedia.org/wiki/Virginia-class_submarine, retrieved 12 March 2016.
 Andrew Davies and Mark Thomson (2016), “New subs – not so fast”, The Strategist, Australian Strategic Policy Institute, 3 March, http://www.aspistrategist.org.au/new-subs-not-so-fast/
 James Harrap (2012), “Reflections of a Collins submarine captain”, Asia Pacific Defence Reporter, 3 May, http://www.asiapacificdefencereporter.com/articles/226/Reflections-of-a-Collins-Submarine-Captain
 Australian Government (2016), Defence White Paper, Integrated investment program”, Canberra, February, page 83.