Report to Congress Treatment & Immobilization of Hanford Radioactive Tank Waste

3.0 Privatization Concept for Hanford Tank Waste Treatment and Immobilization

In 1992, DOE formally established the TWRS program to ensure that highly radioactive tank wastes at Hanford would be stored, treated, and immobilized in a safe, environmentally sound, and cost-effective manner. Beginning in 1994, DOE embarked on a strategy to procure the services of private companies to treat and immobilize these tank wastes.

The contracts signed in September 1996 for TWRS Phase I with BNFL and LMAES reflected a DOE contracting strategy to purchase tank waste processing services at fixed-unit prices from contractor-owned and contractor-operated facilities at the Hanford Site on a demonstration basis. Under this privatization approach, DOE sought to achieve greater accountability and risk-sharing with the contractor(s) than under traditional DOE cost-reimbursement contracts. DOE also expected to achieve improved performance and fewer delays with this approach and to realize savings for American taxpayers over the life cycle of the TWRS Phase I project.

DOE’s contracting approach on TWRS Phase I has evolved with time in order to adjust the realities of the vendor and financial markets, incorporate lessons learned on other projects, and consider feedback from stakeholders. A review of these changes in DOE’s approach and the underlying reasons is important for the reader to understand the context of DOE’s Part B decision. This section tracks the evolution of the approach.

3.1 Selection of Privatization for TWRS

The privatization contracting strategy for TWRS Phase I began as a concept in 1994 for a more efficient way to carry out the Hanford tank waste remediation mission. The idea was to make greater use of the technologies, demonstrated efficiencies, and management discipline of private industry to provide solutions to the Hanford tank waste cleanup challenge. Fundamentally, this approach sought to identify a portion of the total TWRS work scope (i.e., Phase I) that could be defined with sufficient certainty to enable fixed-price contracts to be signed and attract best-in-class contractors to bid competitively for that fixed-price work. This approach represented a new way of doing business for DOE, which had relied for decades on management contractors to conduct broad scopes of work under cost-reimbursement contracts. However, privatization in one form or another had been used successfully in other federal agencies, in state and local governments, and in other countries.

An analysis of TWRS, documented in A Systematic Look at Tank Waste Remediation System Privatization (Holbrook et al. 1996), was carried out in 1994 to 1995 to examine the feasibility of privatizing a portion of the TWRS work scope. That analysis suggested that a number of features would be advantageous in the contracting strategy. Among these features were:

• Phasing of the work—procuring only that portion of work for which a clear statement of work and input and output specifications could be written, and for which there were reasonably mature technologies to carry out the work;
• Competition to help ensure fair prices; and
• Well-defined interfaces with the site contractor.

A scope for Phase I was identified and approved by the Secretary of Energy in September 1995. That scope consisted of the TWRS functions of pretreatment, LAW immobilization, and HLW immobilization for a specified portion of the TWRS waste that was well-characterized and retrievable. DOE planned that two contractors would operate treatment plants in the proof-of-concept "demonstration" Phase I in order to preserve competition and provide additional opportunities for learning, which would be beneficial in Phase II. Phase II was left largely unspecified, but was understood to be the "production" phase, which would benefit by learning in Phase I, and again would have competing plants, which would be sized to complete the TWRS mission within TPA milestones.

The TWRS programmatic functions chosen for privatization in Phase I are shown in Figure 3-1. That figure also illustrates that several TWRS functions are not privatized, and those functions interface directly with the privatized scope. These non-privatized functions—tank farm operations, waste characterization, safety issue mitigation and resolution, waste retrieval, and waste product storage and disposal—were deemed not feasible for privatization, at least during Phase I, for reasons described in the TWRS feasibility report (Holbrook et al. 1996). These functions will be carried out by the Hanford Management and Integration (M&I) Contractor during Phase I. Fluor Daniel Hanford is currently the Hanford M&I Contractor.

DOE’s goal was to issue a draft request for proposal (RFP) for comment by late in 1995, issue a final RFP early in 1996, and award contract(s) by the end of fiscal year (FY) 1996. During this time, DOE was refining its concepts for privatization, and in particular TWRS privatization, and establishing principles on which it would base the TWRS Phase I RFP. These principles expanded on the ideas identified in the earlier TWRS feasibility study and became an essential checklist as the TWRS privatization contracting strategy was further developed. These principles indicated that the solution should:

• Fulfill TPA requirements;
• Shift significant responsibility, accountability, and liability to private contractor(s);
• Make the private contractor(s) responsible and accountable for cost and technical performance;
• Provide for contractor-owned, contractor-operated plant;
• Assign responsibility for environmental protection and compliance to the contractor(s);
• Ensure worker and general public safety and health protection;

Figure 3-1. Division of Contractor Responsibilities for Tank Waste Remediation System (25 Kb)

• Ensure government-purchased products and services meet performance specifications;
• Acquire products and services under fixed-price contract(s) after initial development period;
• Establish competitive framework for cost control;
• Reduce life cycle costs compared to traditional contracting approaches;
• Initiate phased learning and continuous improvements starting with demonstration plants; and
• Ensure contractor(s) possess sufficient technology to carry out work, while DOE focuses on high-risk, high-payoff technology development.

These principles are still embodied, in whole or in part, in the TWRS contracting approach. DOE is not treating these principles as a rigid framework, but is using them as a guide in adjusting for lessons learned, and to tailor the contracting approach to arrive at the best contract vehicle for TWRS Phase I.

3.2 Evolution of the TWRS Privatization Approach—Part A Contracts

The TWRS Phase I draft RFP was issued in November 1995 (DOE 1995), and DOE actively solicited comments in writing and at vendor and public meetings on that draft. In addition, DOE made extensive use of private sector financial advisors during this time frame. Some of that input and feedback resulted in significant refinements in DOE’s contracting approach. Among these refinements were the following changes.

• Clarification by DOE of the regulatory environment in which the private contractors would function. This led to the formation of the TWRS Regulatory Unit, a separate DOE-Richland Operations Office (DOE-RL) organization independent of TWRS, to regulate the Phase I contractors for radiological, nuclear, and process safety (see Section 2.3). The Regulatory Unit has sought to adopt applicable NRC concepts and principles and have NRC staff assigned to coordinate with the Regulatory Unit pursuant to an MOU between DOE and NRC.
• Introduction of the concept of waste feed envelopes. This approach provided the contractor increased assurance that the waste feeds they would be required to treat and immobilize would fall within predetermined and agreed-upon compositional and radionuclide limits. This approach also gave DOE enhanced flexibility in how it might choose to deliver waste to the contractors. Prior to the proposals for Phase I, DOE defined three LAW feed envelopes (Envelopes A, B, and C) of supernatant waste that would demonstrate different waste processing capabilities of the contractors’ facilities, and the Department developed one high-level waste feed envelope (Envelope D) to demonstrate vitrification of a slurry feed. These were refined during Part A contract negotiations.
• Increased emphasis on defining clearly the interfaces that the private contractor would have with DOE or with the Hanford M&I Contractor. This led to the development of Interface Control Documents, which defined the roles and responsibilities of all parties at interface points (see Section 5.3).
• Managing without meddling. Feedback from the vendor marketplace indicated that DOE would have to modify its traditional management approach to reap the benefits of a privatization strategy. It became clear that DOE would have to play a less directive role than it normally used in cost-reimbursement-type, DOE-financed projects (e.g., Management and Operating [M&O] contracts) to take advantage of the incentives and efficiencies of private industry. An additional concern would be that performance risks would be shifted in part back to DOE. To achieve the needed balance in this area, DOE borrowed the concept of Integrated Product/Process Teams from the defense and aerospace industry to provide for non-intrusive monitoring of progress by DOE and a mechanism for contractors to obtain needed information from the Department.
• Split of TWRS Phase I into two parts, Part A and Part B. Feedback from potential bidders to the draft RFP emphasized that it would not be possible to establish fixed-unit prices or to secure private financing until at least after a design phase. A 20-month Part A period was developed in response to this feedback. Each contractor would be paid a fixed price of $27 million for submittal of acceptable Part A deliverables. Contractors would be evaluated to determine whether they should be authorized to proceed to Part B based on viability and best-value assessments performed by DOE upon receipt of the contractors’ Part A deliverables. (See Appendix A for additional detail on these assessments.)

The final RFP for TWRS Phase I, which included these and numerous other changes in response to comments on a draft version, was issued in February 1996 (DOE 1996b). DOE had intended to select two or more contractor teams for Part A and down-select to zero, one, or two contractors to proceed to Part B. Two bids were received from teams led by BNFL and LMAES in May 1996. Contracts with both contractor teams were signed in September 1996.

Key lessons learned from the bids and negotiations on the Part A contracts are listed below.

• Need for an equitable risk allocation. In the early stages of developing the Phase I contracting approach, DOE recognized that privatization is effective in shifting significant performance risk to the contractor, but some risks would have to remain with DOE. For example, DOE recognized that the private sector would not accept the risk of potential fluctuations in yearly budget appropriations. In addition, DOE recognized the need to absorb the risks associated with its own performance in areas such as waste characterization and preexisting conditions.
• Nuclear waste processing plants are not likely to be temporary plants. Another major lesson that DOE learned in negotiating the Part A contracts is that safety and financing considerations limited the possibility of having contractors build "temporary" plants (those with useful lives consistent with the Phase I schedule, approximately 10 years) to process high-level tank waste. Based on the need for a conservative, seismic-resistant design, and with input from the financial communities, both Part A contractors proposed more robust, capital-intensive facility designs than originally envisioned by DOE, with plants having a useful life of nominally 30 years. This required a change in philosophy from the original "throw-away" demonstration nature of the plants. The capital funding requirements for these plants increased substantially as a result of this change (see Section 5.6).

3.3 Evolution of the Privatization Approach—Part B Proposals and Implications

The Part A contracts authorized the contractors to propose "enhancements" in technical, business and finance approaches to benefit the contractors as well as the government. The Part A deliverables, which included the proposed enhancements for Part B, were received in January 1998, and provided DOE with additional insight on the type of agreement that the government could expect to negotiate with private industry for TWRS Phase I.

Overall, the January 1998 proposals for Part B indicated that the private sector was not yet in a position to guarantee fixed-unit prices for Part B services. Both contractors maintained that better definition and quantification of project risks were required before they could make the corporate commitments necessary to put their financial resources at risk and attract third-party financing. Issues needing clarification by one or both contractors fell into the following four areas:

• The need to delay the establishment of fixed-unit prices and corporate financial commitments until a later point in the design process;
• The need to minimize concurrent design and construction;
• The need for a combination of public and private financing; and
• The opportunity for Phase I expansion.

Both contractors contended that the regulatory framework for radiological, nuclear, and process safety, permitting requirements, and project design needed additional development to reduce project uncertainties. Although the original concept of TWRS privatization assumed that fixed prices and private financing could be secured at the end of the conceptual design phase (Phase I, Part A), this assumption proved incorrect. Neither contractor was willing to commit to firm fixed prices at the end of Part A without adding significant contingency to their prices. Both contractors recommended subdividing the next phase of the project (Part B) into two or more parts, and one contractor indicated that the division of Part B into two parts—(1) a continuation of the design phase lasting 24 months and (2) a construction and operations phase—would substantially reduce the risk premiums and contingencies required to commit to fixed-unit prices. This approach was also viewed as enhancing the contractor’s ability to secure private financing. DOE determined that this two-phase approach to Part B would strengthen the feasibility and economics of the TWRS project.

Both contractors indicated that concurrent design and construction needed to be minimized so that Phase I plants could be financed and built. Accordingly, both contractors proposed less aggressive schedules than originally requested.

The contractors indicated that the feasibility of the project’s financing and the overall economics of the transaction would be improved by establishing an appropriate mixture of private and public financing instead of the original concept of 100% private financing. For example, the government could effect a decrease in the interest rate charged by project lenders or could favorably influence the prospects for project financing by the private sector, by providing a credit enhancement in the form of a backstop or support for the debt portion of the project’s financing.

One proposal also suggested that the 30-year facilities could be expanded for a limited additional investment to process a significantly greater portion of the Hanford waste than originally anticipated in Phase I of TWRS. The expansion capabilities and additional processing capabilities of the Phase I facilities offer potential new opportunities for achievement of the total TWRS mission.

3.4 Development of an Optimal Contracting Approach for TWRS Phase I

DOE’s approach for TWRS privatization, both technically and contractually, has evolved considerably to accommodate information gained during and after the first two years of the project. These modifications in approach have been made in coordination with DOE’s Contract Reform and Privatization Project Office, which is using the experience on TWRS to refine its overall approach to privatization of cleanup projects.

In designing and implementing the path forward for TWRS, DOE is establishing a contract structure that provides strong incentives to achieve project schedule, cost, and performance goals while minimizing total project cost to the government. Thus, DOE is seeking to structure an optimal contracting approach for TWRS Phase I that will:

• Allocate risks to the party best able and motivated to manage them;
• Obtain the best mix of private and public financing; and
• Maintain appropriate decision points to adjust project direction in response to new information and to bring competitive pressure to bear on project costs and approaches.

Each of these principles is discussed below. Together, these principles have guided DOE’s negotiation for TWRS privatization services and will continue to guide refinements as that strategy is implemented.

3.4.1 Risk Allocation

Privatization contracts differ significantly from traditional cost-reimbursement contracts in their allocation of risks between the government and the contractor. Under privatization, the contractor assumes a far greater share of risks, particularly those under the contractor’s control such as technology performance and operating efficiency. Under the TWRS contract, DOE has sought to allocate specific risks to the party that is most able to manage the risk.

DOE has evaluated a broad spectrum of risks that are potentially relevant to risk allocation decisions in privatization contracts. These risks are depicted in Figure 3-2. In general, any specific risk will be assigned to a party or it will be shared.

The allocation of risks has a direct bearing on the incentives the contractor faces and ultimately on the total cost of the project. The assignment of all risks to the government (a cost- reimbursement approach) leads to a very high total cost to DOE because of ineffective performance incentives for the contractor. This is in part because the scope and schedule are not defined in adequate detail when the project is planned. In addition, in this type of arrangement, the contractor has little incentive to control costs and schedule. As a result, substantial cost growth has occurred in past projects of this type as documented in GAO (1997) and a draft Pacific Northwest National Laboratory report, DOE Cost Savings from Private Contracting?

However, a complete assignment of risks to the private contractor would lead to very high total cost to DOE because of the risk premium that the contractor would charge for taking on risks that it was not equipped to control. At this extreme, the allocation of risk would lead to an infeasible solution where private financing could not be obtained. A middle ground will lead to savings in total cost to DOE. This concept is illustrated in Figure 3-3.

3.4.2 Benefits of a Mix of Private and Public Financing in the TWRS Case

Based on contractor responses and other market indicators in the past two years, DOE determined that full private financing of Phase I, Part B may be difficult to achieve at affordable levels and began an analysis of options for mixing private financing with government financing. This section examines the tradeoffs associated with the government assuming a greater role in the project’s financing and describes the intent of the financing optimization process planned in the next phase of the TWRS contract. The specific financing approach embodied in the proposed BNFL contract is discussed in Section 5.2.1

The TWRS privatization approach was spurred by the concern that DOE’s traditional cost-reimbursement contracting approach would likely result in cost overruns and schedule slippage. Since the source of financing is a critical ingredient to making privatization effective, DOE is exploring a number of options that the government can take to mitigate the risks of the project and effect savings in the financing costs. In its analysis, DOE has recognized that even though the government’s interest rate is significantly lower than the cost of raising capital in the private sector, the potential for cost growth and schedule delays (as demonstrated by past DOE projects) in the government’s traditional financing of cost-reimbursement contracts outweighs the private sector’s higher cost of capital. On the other hand, the risks associated with 100% private financing may increase the financing costs so much as to make the project unaffordable or infeasible. Between these two financing extremes may be a balance of risks such that the project is both affordable and financially feasible.

Figure 3-2. Risks in Environmental Management Projects (58 Kb)

Figure 3-3. Risk Sharing Leads to Optimal Contracting Approach (9 Kb)

In determining the appropriate allocation of public and private financing, it must be recognized that focusing on interest rate comparisons of government debt versus private debt oversimplifies the process of allocating risks and responsibilities between the government and its contractor. Since the source of financing is an integral part of the overall project risk allocation, the allocation process needs to preserve the key benefits associated with private financing, including the inherent performance incentives and the requirements of third-party lending sources. These benefits are discussed below.

• Incentives Associated with Private Financing. Under traditional government cost-reimbursement contracting approaches, the government assumes a significant degree of the risks of project completion and performance. Proponents of private financing point to the built-in incentives associated with having a contractor’s money at risk. In these structures, the team members’ participation, as equity providers, is a critical tool in allocating risk because, if the project were to fail, the team would lose its equity investment. This factor is a strong incentive for the team to bring the project to completion on time and under budget in accordance with performance specifications.
• Requirements of Third-Party Financing Sources: The presence of third-party financing imposes added structure into the project’s planning, construction and operations, thereby ensuring a higher probability of success within budget. Lenders often require very specific terms and conditions in contract documents and introduce additional project oversight. For example, lenders monitor project performance closely, ensuring that, among other things, construction is proceeding on time and within budget specifications.

Participation by the government in a project’s financing has a direct bearing on the nature and impact of the benefits described above. Full public financing using traditional cost reimbursement shifts the risks for project performance to the government and results in relatively weak performance incentives. Accounting for these risks complicates the direct comparison of public and private financing options. The true cost of government financing is not reflected in the government’s interest rate and budget authorization estimates and often will not show up at all in economic analyses of the project. However, just as an insurance company experiences claims on risks it covers, the government will experience the cost of absorbing the contingent liabilities associated with project cost overruns and schedule delays. As noted above, traditional government financing approaches lack many of the built-in incentives and controls of the private financing approach, increasing the likelihood of problems.

Government financial participation can occur in many ways besides direct financing. As a general rule, the method and magnitude of this participation should depend on the unique requirements of the project and should serve to enhance the project’s ability to raise private financing. A range of options exists for government involvement between the extremes of totally private or totally government financing as described in the Pacific Northwest National Laboratory draft report, Privatization Financing Alternatives: Blending Private Capital & Public Resources for a Successful Project.

Some options can build government participation on commercially available financing to improve the project’s attractiveness to private lenders. In some cases, incorporating one or more of these alternatives is necessary simply to make the privatization project feasible.

3.4.3 Decision Points for Project Optimization

The TWRS privatization project is novel and complex and still has uncertainties to resolve. DOE firmly believes that the best approach is to proceed with the project but move forward using discrete steps and explicit decision points. The intent of this approach is to:

• Make iterative refinements in project requirements and directions to accommodate new information (both technical and financial); and
• Maintain competitive pressure on the privatization contractor(s) to ensure peak performance and reasonable prices.

The TWRS EIS and Record of Decision identified the need to proceed with a phased approach. The Record of Decision made specific commitments to conduct formal evaluations of new data and information under DOE NEPA regulations at three key points during the course of Phase I, with an appropriate level of public involvement, and after seeking the advice of independent experts from the financial and scientific community. These evaluations will occur prior to:

• Proceeding to Phase I, Part B;
• Start of hot operations in Phase I, Part B; and
• Proceeding to Phase II.

DOE also concluded that the level of uncertainty with respect to design, financing, and regulation at the end of Part A was such that fixing prices would require an excessive price to compensate for the risk faced by the contractor. Thus, a design phase (referred to as Part B-1 in the contract and introduced in Section 5 of this report) was defined to reduce this uncertainty and to provide DOE with various reviews and decision points prior to proceeding with construction and operations. The design phase will allow time to verify technology performance on Hanford-specific wastes and to optimize debt and equity arrangements and technical requirements. Uncertainties about permits and the regulatory environment also would be greatly reduced.

Proceed to next section