UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 868-i

HOUSE OF COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE THE

PUBLIC ACCOUNTS COMMITTEE

MAJOR PROJECTS REPORT 2012 AND MOD EQUIPMENT PLAN

JON THOMPSON, BERNARD GRAY, AIR MARSHAL STEPHEN HILLIER and DAVID WILLIAMS

Evidence heard in Public

Questions 1 - 145

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Oral Evidence

Taken before the Public Accounts Committee

on Monday 4 February 2013

Members present:

Margaret Hodge (Chair)

Guto Bebb

Chris Heaton-Harris

Meg Hillier

Fiona Mactaggart

Austin Mitchell

Nick Smith

Ian Swales

Justin Tomlinson

Amyas Morse, Comptroller and Auditor General, Gabrielle Cohen, Assistant Auditor General, Tim Banfield, Director, National Audit Office, and Sam Webb, Alternate Treasury Officer of Accounts, were in attendance.

REPORTS BY THE COMPTROLLER AND AUDITOR GENERAL

The Major Projects Report 2012 (HC 684-I)

Equipment Plan 2012 to 2022 (HC 886)

Examination of Witnesses

Witnesses: Jon Thompson, Permanent Secretary, Bernard Gray, Chief of Defence Matériel, Air Marshal Stephen Hillier, Deputy Chief of Defence Staff, and David Williams, Director General, Finance, Ministry of Defence, gave evidence.

Chair: Welcome.

Jon Thompson: Thank you.

Q1 Chair: This is your second session-I missed the last one-before us as Permanent Secretary. Welcome to all our other witnesses.

We are going to be considering two Reports together: that on the equipment plan, which was published last week; and then, in that context, the major projects Report. I thought it was probably more sensible to look at the overarching position, so we will look at the equipment plan first and then we will pick up issues around individual projects.

Welcome, also, to Sam Webb. I am afraid in your first venture here you may find yourself asked a couple of questions as the Treasury gives a bit of extra money to the MOD. A bit here and there: quite a lot.

Let’s start by welcoming the progress. Certainly in the two and half years since we have been here, welcome progress has been made in trying to get to grips with the budget, particularly on the purchasing of equipment. Our questions are in the context of recognising that you have made great strides forward, but urging you to go further and faster on this one to ensure that we get proper value for money. It is in that context that I want this afternoon’s hearing to be seen.

Can we start? The equipment plan is based on an assumption that you will get a real-terms increase of 1%, starting from which year?

Jon Thompson: Starting from 2011-12-[Interruption.] Sorry. My apologies. Let’s make sure we get that right. It is at the end of the current spending review that the equipment plan-

Chair: So starting 2014-15?

Jon Thompson: It is 2015-16 for six years.

David Williams: 2014-15 is the baseline year from which the rise stems.

Q2 Chair: The reason I ask that is because there was stuff in the press last week; it sort of brings us to the wider issue of the uncertainty of some of the figures surrounding the assumptions that you make. There was a lot of coverage last week during the Prime Minister’s trip to Libya, where it appeared to be confirmed that you could only make that assumption from 2016.

Jon Thompson: The assumption that we are working on, and the one referred to in paragraph 1 of Amyas’s report, is the latest formal communication between the Department and the Chief Secretary to the Treasury. There is a letter we have from him that confirms the cash sum we are to assume for all 10 years. Clearly that remains beyond the current spending review. It remains an assumption, but it is the best assumption we have. Undoubtedly, that will be renegotiated through the current spending review and then for the next Parliament to consider in due course, but that is our current assumption.

Q3 Chair: I am picking this up from The Times, The Telegraph and things like that; that it was made pretty clear last week by the Prime Minister that the 1% increase over inflation is only starting in 2016. Clearly, that raises questions and issues about affordability. At the moment, the assumptions aren’t what you have based it on. That undermines, to a lesser or greater extent, the affordability of the whole plan, does it not?

Jon Thompson: Absolutely. I completely agree with you that that is a risk here, that funding would be reduced from the £159 billion quoted in the report, in which case we would have to re-evaluate the plan. But if that were to happen, from our perspective, depending on what the reduction was, according to the public finances, we would want to revisit the SDSR to see what the policy outcomes that we are trying to aspire to are.

Q4 Chair: That’s a bit scary to start with, on the basis of what we are doing.

The other thing that I wanted to get clarity from you was, did you always understand that the commitment to your 1% increase over inflation related to just equipment, or was it your understanding that it related to the whole defence budget?

Jon Thompson: As I said, only in relation to the equipment plan.

Q5 Chair: Would that be ring-fenced?

Jon Thompson: In order to be clear about what the assumption was-that is why there was an exchange of letters between Ministers, so we have a letter from the Chief Secretary-

Q6 Chair: You have a letter saying that this starts in 2015-16?

Jon Thompson: That is indeed what the current letter says. Until that is renegotiated, that seems a reasonable assumption, from our perspective.

Q7 Chair: Well-[Interruption.] We hear that.

Can I make a second point on assumptions? A further assumption-this is where I get back to the optimism bias that we have seen in the MOD before-is that the equipment budget, which currently is about 39% of MOD expenditure, will rise to 45% by 2021-22.

Jon Thompson: Yes.

Q8 Chair: What sort of certainty or credibility is there in that assumption? What lies behind it? Because if it proves not to be the case, given what has happened to the economy, it was a fragile set of assumptions-a fragile equipment plan-that you laid before Parliament last week.

Jon Thompson: To be clear, our assumption beyond the current spending review is that the rest of the budget will rise in line with inflation, adjusted down by the public pay assumptions that were made in the March 2012 Budget-so it will be rising by slightly less than the rate of inflation. I agree that that remains a risk, given the state of the public finances. That is to be renegotiated in the spending review, which has been announced, and we will have to curtail our plans if funding is reduced. I agree that that is a risk.

Q9 Chair: Thank you for being honest about it. Let me just ask you this: it sounds like it is highly likely that you will not get your 1% extra until 2016-17 at the earliest, and that makes assumptions about general elections and all those sorts of things. It is also highly likely that defence will have to take its fair share of spending cuts, as the Chancellor has put forward. If that is the case, your assumptions look questionable. When would you revisit the plan that has just been laid down?

Jon Thompson: We will fold the spending review-perhaps Mr Williams can give you an idea of when we think the spending review process may conclude-into our budget considerations for 2013-14. We have a number of areas where we could go in relation to the equipment plan. As the Report rightly says, the programme is committed in SDSR terms, but that does not necessarily translate into a contractual commitment. One of the absolute principles that the four of us have adopted, and which is reflected in the MPR Report, is we do not want to resort to some of the Ministry of Defence’s old techniques, such as taking programmes, slipping them back for cash savings and destroying their value. We have not done that since April 2012. We would have to look at programmes where we have no contractual commitments to see whether we could proceed in the light of the funding situation. Once again, if that meant we could not produce the military capability required for the SDSR, we would look to Ministers to revisit the policy.

Q10 Chair: I hear that, but making assumptions about growth and back-ending a lot of the expenditure into 2021-22 sounds a little like optimism bias. My fear, when you talk about contractual commitment, is that you come back to something we have already considered once or twice: cutting things that do not have contractual commitments, such as the armoured vehicles programme. That is very difficult, if not for the Air Force then for the Army’s capability in theatre. I know you are learning, but there are still tendencies in this that suggest that what has always happened in the MOD is still going on-perhaps to a lesser extent, but it is still there.

Bernard Gray: Can I add something? I am not sure there is a year’s timing difference in what people say about 2016. But even if there were, it would amount to £150 million a year for five years. Therefore, a total of £750 million is at issue, depending on whether there is or is not a timing difference from when the real terms increase arises. That is of the order of 10% of the currently unallocated provision that we have in the second half of the decade. Clearly, if it were to fall as you say and we have £750 million a year less than we currently anticipate, that would be, from our perspective, bad rather than good. None the less, we have sufficient flexibility in our planning for the second half of the decade to be able to accommodate that. We would get less output, but we would not have to cancel things. We would have to say, "Of the £8 billion we are currently planning to spend on capability, we will only have £7.25 billion." That is how it would work.

Q11 Chair: We will come to that, because it depends on the view you take on your contingency.

Bernard Gray: Sure. I am just saying that it isn’t-

Chair: You are better placed than you were. We all recognise that, but there are issues.

Q12 Chris Heaton-Harris: On the increase in the equipment budget from 39% to 45%, I assume that there is a counterbalance there. As well as spending more on equipment, there is also a reduction in head count that counts towards that. I do not know what sort of element that might be.

Jon Thompson: As I explained to the Chair, the non-equipment element of the budget is rising at a much lower rate. Given that the equipment plan is rising by a flat rate of +1% and the non-equipment by less than the rate of inflation, and the percentage of the budget that is taken up by the equipment plan grows over a period of time, yes, we are reducing head count. Our plan is to reduce the number of civilians by more than 28,000 and the number of military personnel by 19%. I cannot quite remember the exact number, but around 30,000 or 32,000. Some of that continues beyond the current spending review period. Because of our commitments in Afghanistan, for example, the appropriate way in which to reduce the Army, as advised by CGS, is to do that in a controlled way over a period of time.

Q13 Chris Heaton-Harris: Does that mean that all the head count reductions that we have heard of so far been factored in? Is that it for now, or would you expect further announcements on head count reductions in the future, based on those figures?

Jon Thompson: I think we have been transparent about what our end position is, but we have not got there yet. It rather depends on how we might continue to reduce the number of personnel, both military and civilian. That is a roundabout way of saying yes, there will be further reductions in order to meet the overall targets that were set in the SDSR. To be transparent, we had a four-year financial settlement. All four of those years require us to continue to press down on a number of personnel, both military and civilian.

Q14 Chris Heaton-Harris: How do you maintain morale in those circumstances? I guess that is partly a question for the Air Marshal. This year has not gone particularly well in the Army in morale terms. When you see further possible threats to military head count in future, how do you keep morale going?

Air Marshal Hillier: From my perspective-clearly, I cannot speak for the Chief of the General Staff-I think morale across the armed forces for those engaged in operations is exceptionally good and is demonstrated by the results that they achieve. Clearly, there are concerns about people’s future, but, if I speak from my own experience, morale is composed of many factors. It is partly head count and partly how hard people are working. It is partly the equipment that they have. If the amount that we spend extra on equipment is going up, that has a positive benefit. We are spending more on infrastructure. We are putting in place a new employment model. There are a whole range of measures that all, in their way, contribute to morale, so I do not think that you can draw a direct correlation between one and the other and say that therefore morale will be adversely affected.

Q15 Chris Heaton-Harris: I guess what I am trying to get to is-I am sure that you and a number of people in the armed forces know what is coming down the line-how are you keeping that balance of fairness, morale and understanding of what the situation is likely to be in future in people’s minds?

Air Marshal Hillier: Perhaps I can offer one thing that I think is very important in the context in which we are talking. If I look back over the years, up until recently, the constant uncertainty about the budget was something that did very much impact on morale-for example, how much money was going to be available and what defence was going to have to do to live within its means. Now we have got ourselves to a position where we have a stable core budget, which is affordable within the current provision that we have, that gives far greater certainty and stability than we have had in the past. That in itself has a potential morale benefit. That is not to say that all the decisions that we have had to make to get there are pleasant. A lot of them have not been, but it is a factor of living within our means, and we are in a much better position as a result of all the effort we have made.

Q16 Ian Swales: It is one thing to have a budget, but it is another to get the estimates right that go into the budget. Certainly, in the past, this Committee has rightly expressed concern about the black hole between what is permitted and the aspirations of the various people in the military, and the money that we actually have. I know that is one of the Secretary of State’s things. At paragraph 20, the Report says that even the Department itself says that the amount for the equipment procurement plan "has been understated by £12.5 billion (15.7 per cent)." Have we still got a culture where people are routinely underestimating in order to get commitment, and then the costs go upwards? That is one of the things that I know really concerns the Committee.

Bernard Gray: Can I tackle that question? I commissioned that work. It was undertaken by our CAAS assurance team. I commissioned it almost two years ago, specifically to address the point that you raise, and I asked them to go away and cost the programme on the basis of the methodology that I had used in our 2009 report. There were a number of other factors that they took into account, but broadly, the issues were what the state of maturity of the project was and then, at whatever point on the curve that particular project was at and given the historic increases in cost that occurred through the life of the project, what discount you would apply, effectively. That was across a range of about 25 live projects. We took that output in terms of that being the outcome if nothing changed-so if nothing else changed inside the Ministry of Defence, that is what would have happened.

The four of us-in Steve’s case, it was his predecessor, Admiral Lambert-sat down and went through, with each of the individual teams and the CAAS team, what was going on in that particular project. So we said, "If we took the past as the guide to the future, we would be expecting X to be the cost of your project. You’re saying it’s Y, where Y is a number somewhat less than X. How are you justifying that?" We went through and then deterministically figured out what we thought the real risk was, which was of the order £5 billion, rather than the £12.5 billion. That difference arises for a number of reasons, including the change in behaviours in the Ministry of Defence of not slipping programmes-we have reduced the total volume of programmes-and a variety of other factors that allowed us to have confidence in that number.

Since that time, I would say that my confidence in that number has gone up rather than down. I tend to be a fairly pessimistic person about life, so when I first looked at that, I thought, "Well, that’s just about liveable." In fact, over the past 18 months since May 2011, when we ran that exercise fully, my confidence in that number has gone up rather than down.

Q17 Ian Swales: I am very pleased to see that the Department is now talking about those sorts of numbers in terms of making contingencies, rather than going cap in hand for budget increases or whatever. That is definitely a step forward. Can you tell us a bit more about what you think the source of that difference is? Is it underestimating in the MOD, or is it commercial pressures, or respecification after initial agreements are made? Where does the difference come from?

Bernard Gray: Which difference are you talking about?

Q18 Ian Swales: The difference between the original estimates and what you now say the cost is going to be. It could be one of a number of areas. Where are the main factors?

Bernard Gray: There are a variety of factors that cause people to be optimistic. One of them applies to everybody, which is you fail to think about some risks. In order to price something, you have to consciously think about it and sometimes people forget-well, not literally, but they do not focus on some things as being risks, for example. There has definitely been an optimism bias in the past: people have wanted to believe that equipment costs less than it really does. There has been over-programming of the Department’s programme, where we have put in more than we can afford to do, and then have to slow everything down, which causes overheads on the final product to be higher than they otherwise would be. There is optimism about the technical solution. There is industry saying it can do things that it cannot. So there are a variety of sources for it. What we have sought to do is to say to the teams that there are no points for being over-optimistic here. We have sat down with them, and part of that conversation was, "Do you not understand that I am trying to give you more money to do this job, not less?" That was an interesting moment for them. Those are the sources of it. We simply sought to challenge them with the historical reality.

Q19 Ian Swales: This is my last question for the moment. To what extent does industrial policy interact with the issues that you have here in costing up the plan and procurement projects? I am particularly thinking of the naval programme, but it could apply to others, too. Is there effectively a fixed cost before we buy anything, because we are running various sites and, if that is the case, is that properly accounted for in the Department?

Bernard Gray: To which I think the answer is, some and some. If you look at the submarine programme, we had definitely made a decision that the UK wishes to have a nuclear submarine building capability, and therefore there is a significant irreducible cost, regardless of however many submarines you make. As we have discussed in this Committee before, we are kind of bumping along the bottom of that-in other words, if you reduced the throughput further, you would not reduce the cost at all. There are other areas where it is a very much shorter cycle time, and it is less so. You are right to say that the naval and, to a certain extent, the combat air sectors are the two most affected by the factors you talk about.

Q20 Chair: I want to develop the issue that Ian has raised. Mr Gray, you say that you have got much better and that your £4.8 billion contingency, rather than the £12 billion suggested by your internal people, is correct, but the Report is absolutely chock-a-block full of areas where I do not have the confidence that you have, and which you can perhaps explain to me.

For example, first, you still do not have the data, because you do not monitor and report actual in-year spend in a form that can be reconciled with forecast cost. You still have not got that. The actual, real way of seeing whether you are staying within budget would be to have that data. What gives you the confidence that you are better in the future, if you have not got the data on which to measure it?

Bernard Gray: Well, we do have data: that is-

Q21 Chair: The Report says that you do not. I have probably got the wrong page, but in paragraph 16 of the equipment plan Report and paragraph 21. Am I right about that-Tim?

Tim Banfield: Yes. Part of what we are suggesting is that, over time, what we are looking for is to be able to see continuous improvement, and that is why-

Q22 Chair: Yes-paragraph 16. You say, "I am totally confident about my £4.8 billion."

Bernard Gray: No, that is not what I said.

Q23 Chair: But you said that you feel more confidence over time.

Bernard Gray: I said that I feel more confident now in that number than I did 18 months ago.

Q24 Chair: Okay, but you have not got the data yet.

Bernard Gray: No, but the experience of the evolution of the programme suggests to me-I have to deal with it every day-that the problem areas that we worry about are the problem areas we have identified, and the rest of the programme, broadly speaking, tracks. Would I like better management information than I have today? Yes, absolutely, but that is a different question. I am interrogating the programme well beyond the standard management information available, and I can say that the areas that I worry about are the areas that we identified 18 months ago.

Q25 Chair: If you are interrogating it and have the data, you should be able to share those data with the NAO, so that they do not, in their Report, say that it is difficult at the moment to know whether or not you will stay within budget, because you do not have spending against budget.

Bernard Gray: We definitely need better management information than we have got. That cannot be drummed up overnight, so what we have to do is to manage the programme in the best way that we can. One of the ways of doing that is to try to take a realistic view about what it is going to cost and to bound the risk, at the same time as trying to infill with better management information. I do not know any other, better way of managing that process.

Q26 Chair: No, but it is one of the risks. The other risk, as I understand it, is that you take a 50% probability on whether projects will be delivered within budget, and you take that across the piece-however big the project and whatever its maturity-and, again, the NAO, in its Report, says that that is not a very sophisticated or appropriate way in which properly to manage risk and see whether or not your contingency is an appropriate amount.

Again, if that is true in the NAO Report-and you guys have signed it off-why does that give you the confidence that you are in a better place than you were before? That is just my second point, and I have further points.

Bernard Gray: Sure. Are we in a better place than we were when we have provided a contingency and we have unallocated money at the end of the decade versus-

Q27 Chair: That is a general point, but can you answer the specific about the 50%? We accept that it’s better to have a contingency and it’s better to have unallocated money. What I am challenging is the greater confidence that you have that your £4.8 billion contingency, which the NAO don’t think is enough, is accurate. I have challenged it first because you haven’t got the data. I am challenging it in a second way because the probability ratio that you take is 50% whatever the project, whatever its maturity, whatever the size.

Bernard Gray: The core programme provision is at the 50th percentile; we also generate numbers for the 90th and 10th percentiles, so we don’t just have a point number. Any investment approvals committee case has a three-point estimate surrounding it and has done for a long time, so there are other data. We have approached this particular problem, as we have data at the 50% level-that’s historically what has been funded-by saying, "What do we need to provide on top of that 50th percentile number in order to generate what we think will be required to finish the project?" One could take a different methodological approach and say, "Do I cost at the 70%?" That might well generate a number that is very similar to the number that we have got today. It’s just a difference of methodological approach.

Q28 Chair: No, it isn’t. I think what the NAO are suggesting is that you differentiate between the stage at which-early on in the project, you are much less certain about the costs than later on and therefore-

Bernard Gray: That is exactly what we’ve done.

Q29 Chair: Well, that is not what’s suggested in the Report.

Bernard Gray: I don’t understand that remark if that’s what the NAO are saying, but as I explained in my initial answer, the basis for our calculation of the contingency that we have provided inside here says that at the earlier stage of the project, because there is greater uncertainty and greater historical cost growth, we have provided more money.

Q30 Chair: The NAO Report does not say that. If that’s the case, you ought to have challenged the Report, which it is open to you to do. Usually what happens at these hearings is that you come with an agreed view on the facts.

Let me raise a third thing. The NAO Report says that you don’t have any regard, in coming to your £4.8 billion, to what they call the risk outside costings-paragraph 26-which, in the eight projects they looked at in their sample, came to £3.3 billion. How do you account for that? They say you don’t account for that in your costings and therefore the way you then assess the necessity of a contingency.

Bernard Gray: The risk outside costing, which is a model that we have used for some time inside DE&S-that’s effectively talking about risks that might accrue for which we have not funded the project-lies inside the £12.5 billion that was estimated by CAAS. What we have said is that we have recognised about £5 billion of that £12 billion in our contingency, so what we are doing-

Q31 Chair: No, you haven’t because you’ve only got a contingency of £4.8 billion. Oh, you mean the whole of that £5 billion includes the risk outside costing-

Bernard Gray: It will not be a precise match, because for some of them we will say, "Yes, we think that’s likely to arise," and for others we will say, "No, we don’t think that’s likely to arise." The point is that we have made a judgment, sitting down with the project teams, of which parts of the £12.5 billion we think are actually likely to arise, as opposed to being theoretically possible, and we have then priced that into our contingency.

Q32 Chair: All I would say to you is that the NAO, in looking at a sample of eight, came to a figure of £3.3 billion just on this risk. You have come to a figure of £4.8 billion across the whole programme, and I find that difficult.

Let me take another category, which is risks outside control, where the NAO, on their eight projects, found that was another 7.4%-£2.4 billion. I don’t understand how you have accounted for that. We’re totting up more figures here than the £4.8 billion contingency. I don’t understand how you account for that. Those are risks that are outside your control but could impact on the cost of projects and therefore ought to be seen within the contingency.

Jon Thompson: Is it possible just to try to declutter this conversation? I don’t think you can add all these numbers together-

Q33 Chair: Why not?

Jon Thompson: And I don’t think that’s what the National Audit Office Report says, either. Tim is shaking his head, so he’s agreeing with me. The primary debate is between the £12.5 billion and the £4.8 billion. The examples you are giving are different ways in which you can see risk that would or would not, depending on how-

Q34 Chair: And different risks, Mr Thompson. There is some totting up of the risks. I don’t accept that there isn’t.

Jon Thompson: I am trying to be clear that what you can’t do is add £12.5 billion to these other risks.

Q35 Chair: I am not adding £12.5 billion to them. Within the £12.5 billion are these risks. You have chosen to discount and go back to £4.8 billion. I think my challenge to you is that in coming to the £4.8 billion you have left yourself very risky. If you go over that, you eat into the £8 billion that the services require for projects you have not yet commissioned.

Jon Thompson: Yes, and as Mr Gray said, we spend a significant amount of time going through these project by project, so you can take a view that says a project has a particular risk. Perhaps I can give a specific example. The initial assessment in the £12.5 billion was that the armoured flying vehicles pipeline had a risk of £600 million. The decision that the four of us made after looking at that project and spending some time with the team was that you could remove that risk by capping the budget because there are three variables, so you can reduce your risk exposure by dealing with projects in different ways. We did not believe that £600 million was appropriate, and we took it out of the calculation. There are different ways in which to deal with risk. Some of it needs to be covered, and some of it can be removed by adopting a different approach to a project. You do not necessarily have to fund every single risk that may occur at some point in the future.

Q36 Chair: Something that you actually know about is that you have bought quite a lot of equipment under the urgent operational requirements. Again, according to the NAO Report, you have made no provision within the equipment budget, which is partly about maintaining the equipment as well as buying new ones, for that. Presumably you have a figure for it. I have no idea what it is-it might be hundreds of millions or billions-but presumably there is a figure, yet it is not in there, so it will have to be met out of contingency. Have you got a figure for it?

Air Marshal Hillier: I do not think it would be helpful to give a precise figure because we are working through it at the moment-

Q37 Chair: So you don’t know.

Air Marshal Hillier: There is a range of figures, depending on how much of the equipment you bring into-

Q38 Chair: Give us the range.

Air Marshal Hillier: It could be of the order of between £1 billion and £2 billion if we were to bring all that equipment into core, but how would we tackle that? First, one path we are looking at is in the unallocated headroom. That gives us choices in that space. One of the other areas we can look at is our spend performance as we see it now. It is recognised in the report that over the last year we have found the headroom, as a result of the way we are doing business, to add equipment into the core programme. We can continue that process into the years leading up to that headroom, and in fact that is what we are starting to plan to do. We are starting to find the headroom in our budget to bring incrementally this equipment into core. It will not all come in immediately out of Afghanistan, but we will retain it and we will bring it in over-

Q39 Chair: I hear what you say. That is what I am concerned about, and I would have thought you would be too. Beyond the £4.8 billion that you have in contingency, you have £8 billion, which is supposed to be meeting unmet need. As I understand your contribution now, around £2 billion could be used just for the maintenance and operation of equipment you have already bought under urgent operational requirements, out of the Treasury’s money. It seems to me you would have been better having a proper contingency and an honest figure for the amount of money available for new equipment, rather than using that new equipment in effect as further contingency.

Air Marshal Hillier: What I would emphasise is that, first, we have a choice of bringing that equipment to core, depending on our needs and affordability, so we would not do it unless we could afford it. Secondly, in relation to all the contingency needs we have been talking about, the initial part bringing those UORs into core would not touch into those contingencies. This is looking at our spend performance as we see it today, particularly within the early years, and making judicious applications of money according to-

Q40 Chair: Can I ask a simple question? You have got this stuff, funded by the Treasury. You have to maintain it, run it, repair it and all that. My understanding from reading the report-simple-minded person-is that there is no money in your equipment budget to do that. Am I right in thinking that you are going to fund that out of the £8 billion that you have got uncommitted? Yes or no.

Air Marshal Hillier: We have not made that decision yet.

Q41 Chair: Where else will you fund it?

Bernard Gray: The Army has not yet decided how many of those vehicles it wishes to continue to run. The option remains open to us to-

Q42 Chair: To leave them in Afghanistan?

Bernard Gray: Once we leave Afghanistan, the question will be: do we want to incorporate those vehicles into the core Army or not? If we do not want to incorporate them into the core Army because the Army feels it is going to fight in a different style in any coming conflict, it is open to us to put those in warehouses and not use them. If we do want to bring them into the core Army and the Army wants to use either all or some proportion of them, that would go into part of the Army’s funding allocation out of that £8 billion.

Q43 Chair: But would that be in the provision that you have for your equipment budget, or would it be out of the £8 billion you have set aside for new equipment?

Bernard Gray: The Army would make a choice about its share of that £8 billion and how it wanted to apply it.

Q44 Chair: Okay. All I am saying to you is that that is not new money for new equipment; it is raiding that pot to run equipment you have already purchased.

Bernard Gray: No, it is not.

Amyas Morse: I recognise that no decision has been made about this point yet, but how likely is it, allowing that a decision may be made, that the decision will be to bring zero back? If we are being realistic about it, there must be a range within which it is most likely the decision will be made.

Air Marshal Hillier: We fully intend to exploit that equipment, because it is relevant and up-to-date and we are familiar with it. We want to use it, so the chances of us getting rid of all that equipment are zero. We have a plan which says, "This is the equipment we think is most suitable to our Future Force 2020 needs," and our plan will be, at a minimum, to bring it back to the UK and put it in storage so that we can access it when we need to. But we do not want to leave it in storage for ever. What we want to do is incrementally bring that into what we call the core programme-in other words, run it, train with it and support it properly-and we will do that according to affordability and our priorities at the time.

In relation to the £8 billion, I absolutely accept that there is an issue there, but a large part of that £8 billion is about ensuring that we can equip the Army properly for its future needs. UORs into core will be a key part of that, so I think it is quite appropriate to see it in that context, but I am not looking at leading all of that figure I mentioned into that headroom. We have other opportunities leading up to that, and as we speak we are planning to start that process to bring it into core.

The other thing I should mention is that UORs into core is about running costs, not capital costs. Running costs extend out over time, which therefore gives us much more choice about the rate at which we bring it into the core programme.

Amyas Morse: I want to ask one more thing. Just as we look at how you are running things differently now, looking back to the bad old days, there used to be a considerable amount of something called trading. In other words, in trying to balance the programme every year, we would find that people were taking elements out of a lot of the existing continuing projects in order to-

Bernard Gray: De-scoping.

Amyas Morse: Yes, that is a better way of putting it; thank you very much. Is that going on at the same level as it used to, or has it more or less stopped now?

Air Marshal Hillier: If I can speak for requirements setting, since we stabilised the budget in May last year, within the core programme, I do not believe-Bernard will comment-that we have changed any requirements from a requirements setting. We have tried to keep that core programme as stable as possible, which is good for the budget, good for industry and good for the front line.

Amyas Morse: That is its key hygiene test. If you are managing that, that is positive.

Bernard Gray: We have not done that; we have not traded out any capabilities, and we have not re-profiled any spend, as Jon said, since April 2011, as a result of financial measures. It is in a significantly better place.

I just have one more point on UORs into core. To the extent that we bring UOR vehicles into core to generate Army mobility, that will reduce the requirement for purchase of new utility mobility vehicles. Therefore, it is perfectly legitimate for the Army to say, as its share of that £8 billion, "How much of the UORs into core do I want to use for Army mobility, and how many new vehicles do I want to buy?"

Chair: I think we have to agree to differ on that, because, as I understand it, a descriptor of the £8 billion is for new equipment; it is not to manage and maintain equipment that has been purchased and is already being used by the armed services. We have to agree to differ.

Q45 Nick Smith: I have one query and two concerns. The query comes out of an astounding discussion between the Chair and Mr Gray earlier. I have an interest, because General Dynamics is in the constituency next to mine and I have constituents who work there. The Chair was concerned about the 1% increase from 2016 perhaps not being provided and about pressures on the armoured vehicle programme. Is that programme still going to be delivered, Mr Gray?

Bernard Gray: Are you talking about the Scout vehicle programme?

Nick Smith: Yes.

Bernard Gray: Yes, absolutely.

Q46 Nick Smith: Okay. Back to my two questions: the NAO says that you deserve credit for starting to get a grip, which is great, but I have two concerns. The first is on the management of current procurement projects and the updated fuel costs for the Future Strategic Tanker Aircraft, which have gone up by £336 million. Why didn’t you update the fuel costs after the original investment decision five years ago? Do you have a handle on support costs for such projects?

Bernard Gray: I do not understand the methodology that is being used here compared with the methodology that is being used for all of our other aircraft. We control many things, and international fuel prices are not one of them. What is being made here is an assumption about the future price of fuel, which if I knew what it will be next week, I would not be working anymore, never mind in 2044, or some other date in the future. I do not understand, from a methodological point of view, why that is included at all.

Q47 Fiona Mactaggart: Isn’t there a point that there has not been a reassessment to reflect the increases in fuel prices over the past five years, which are all historical and not about prediction?

Bernard Gray: But they are not. In the rest of the aircraft fleet, they are not attributed to the aircraft in that way.

Jon Thompson: As I understand it, they are not part of the PFI any way.

Bernard Gray: So this is not something we are actually paying for.

Q48 Chair: Why didn’t you challenge it? I hate it when people come to the Committee with what are supposed to be agreed facts. One of the cost overruns here is fuel.

Tim Banfield: On FSTA, the way the Department has chosen to put its budget together-and we have looked at and validated the Department’s numbers-is supposed to include fuel costs within the budgeted cost, even though it is not part of the contract.

Bernard Gray: I do not think that makes any sense.

Jon Thompson: We agree with Mr Morse that that does not seem to make any sense-

Chair: I am sorry Mr Thompson, but you are going to have to speak up.

Jon Thompson: We agree with Mr Morse, and he and I discussed this only the week before last. We do not think it makes sense to include future inflation to the year 2035 as part of this. If that is an error on our part, it is an error on our part. There is no factual disagreement.

Q49 Chair: Well, the Report actually says that you have not looked at inflation since ’07, and we know fuel inflation in the past five years, which is the point Fiona Mactaggart is making.

Bernard Gray: This is some proportion of the total fuel bill that we run, all the rest of which is treated in a different way. I do not think it is particularly helpful for any of us to try to predict what on earth is going to happen to the variation in the price of fuel over the next 30 years.

Q50 Chair: I do not think it is particularly helpful to have disagreement on figures at this meeting.

Jon Thompson: We are not disagreeing with the NAO, to be clear.

Q51 Fiona Mactaggart: But you are. You say that you are not disagreeing, but what I have heard is a disagreement. Could someone please explain to me what it is that you are not disagreeing with?

Bernard Gray: There are a set of assumptions that would lead you to say that the fuel price might rise by that amount if you apply a particular methodology. Whether or not that is what actually happens, I do not think any of us in this room is in any position to be able to say. The Ministry of Defence made a decision, for reasons passing my understanding, to include this in its total costing of the programme some many years ago. I do not know why they did that, but guessing the future price of fuel in relation to this aircraft seems to me a pointless exercise.

Q52 Fiona Mactaggart: But you know it is not going to stay at the level that it was in 2007, because-guess what?-in the past five years it hasn’t stayed level with the price in 2007.

Bernard Gray: I have absolutely no idea what it is going to be next week, never mind next year.

Q53 Chair: But that doesn’t mean you shouldn’t be thinking about it in terms of affordability. We think about everything else. You put inflation in; you put absolutely everything else, but fuel doesn’t matter in 10 years’ time. It is completely ridiculous.

Jon Thompson: Sorry. It is that it matters. The reflection on page 6 of the NAO Report is a projection of inflation to 2035, which increases future fuel costs over and above our previous-

Q54 Chair: That is yours. That is your number, not ours, or the NAO’s.

Jon Thompson: Indeed it is. There is no factual disagreement about it being £336 million. We are saying that the way in which we are calculating this is rather unusual. We don’t include fuel costs in the Typhoon project or in A400M.

Q55 Fiona Mactaggart: Mr Thompson, are you telling us that when we see this Report next there is going to be no reference to fuel costs because you have changed your budgeting basis?

Chris Heaton-Harris: Isn’t it more the fact that, when I buy a new car, I don’t predict what fuel I am going to tip in it in five years’ time?

Chair: It doesn’t matter.

Fiona Mactaggart: I accept that it might have been a stupid thing to do, but we didn’t tell you to do it. You have done it. I am asking: are you going to stop doing it in your budgeting basis?

Jon Thompson: Yes.

Bernard Gray: Yes.

Q56 Nick Smith: So, it would be more sensible to have a consistent way of doing this across the Department in future.

Amyas Morse: In fairness, if I may be permitted for a second, in our Report we did distinguish this very clearly from performance on project management and so forth. We are not regarding this as a sign that they can’t run projects. We are regarding it as anomalous.

Q57 Nick Smith: I want to come on to the Queen Elizabeth class aircraft carriers. I understand the forecast costs have increased by £270 million since the agreement of the final target cost in 2011. What is your definition of final target cost?

Bernard Gray: Final target cost was-this is what the Ministry of Defence is aiming at in producing its cost. The difference between those two numbers is essentially what industry thought it would cost, which was about £5.45 billion, and what the Ministry hoped to be able to drive it down to, which, from memory, was about £5.27 billion. The Ministry set out a whole bunch of areas that it wanted industry to work on. Those aspirations for cost savings have not materialised.

Q58 Nick Smith: But £200 million difference is a big difference, isn’t it?

Bernard Gray: Yes.

Q59 Nick Smith: What does it say about industry’s ability to make savings, then, and for you to monitor that?

Bernard Gray: To be fair to industry, I think industry always said that it was its view that the carriers were going to cost around £5.45 billion. We have worked with them to try to cut that down, and it hasn’t happened. You must ask them, but I think they would argue that they have been consistent.

Q60 Ian Swales: Is that because they refused to carry out any of the cost-saving projects? Or did they do the projects and still charge the Ministry the full amount? You must have had some idea of what you asked them to do. Did they just refuse to do it?

Bernard Gray: They were asked to look at areas of efficiency in the production of the ships. People hoped that they might be able to save money by doing this, that and the other. When they looked at that in the course of the past two years, they found that they couldn’t save money on them.

Q61 Nick Smith: It is still £200 million. Did you challenge them along the way?

Bernard Gray: Yes. You also have to look at this in the context of the debate about aircraft carrier variant, where there was a lot of attention being paid. Industry have been pretty consistent that, while they were happy to try to work to identify those savings, they were not prepared to commit to them. In fact, the current contract reflects that fact. I don’t want to go too far into the details in open session, but you can write to me if you want to. There is a structure in the current contract that says that industry does not have much confidence in reducing that number below £5.45 billion.

Q62 Ian Swales: Does that suggest that we have got too many people second-guessing industry who don’t really know what they are doing? They are suggesting things that aren’t practical.

Bernard Gray: Well, I think the way I would describe it is that that was a late-stage application of the optimism bias. It is a fact that people wanted to believe that they could deliver it for less, and therefore persuaded themselves that there were currently uncontracted ways in which they could deliver it.

Q63 Nick Smith: So have you got a new final target cost?

Bernard Gray: We are currently in negotiations with the companies. We have the whole return to a stabilising programme, and I am in the middle of negotiations with them now.

Q64 Guto Bebb: Just on the specific plans, what you are saying in effect is that a hoped-for 3.5% reduction in the cost could not be delivered by industry.

Bernard Gray: That is correct.

Q65 Chair: Can I just ask about another general issue with the equipment plan, Mr Thompson? You have looked here at the acquisition of new equipment, which is £73 billion, but you have not looked at the support costs, which are a bigger proportion at £86 billion. When are you intending to look at that to verify whether that is a realistic sum, given that we have just had this debate about the urgent operational requirement equipment, which is not in there?

Jon Thompson: That work is ongoing. We would expect, from speaking to Mr Morse, for there to be more data available for the National Audit Office, so it can verify an equipment support plan. Our track record-

Q66 Chair: I do not understand "ongoing" or "more data". When will we have some certainty about the credibility of the support costs element, which is more than 50% of the equipment plan, rather than vague words?

Jon Thompson: I was simply going to add that our record over the past few years is that the equipment support plan budget is not spent in each year. In general, the budget is not spent, which gives you some reassurance, but we are doing further work, which involves CAAS, which is the same organisation that is currently advising the four of us. We would expect that data to be available to the National Audit Office for this year’s work.

Q67 Chair: For this year. So, by when?

Jon Thompson: Forgive me, but I don’t know the exact date.

Bernard Gray: For MPR13.

Q68 Chair: So for next year’s consideration of major projects, we should have greater security about the underpinning of the support costs. Thank you.

Shall we move in more detail to some of the major projects, because everything is premised on the fact that you will get better control of time and money? That is absolutely key for delivering your equipment plan. What the Major Projects Report shows is that we are-I cannot remember how many months over?

Bernard Gray: Some 139 months.

Q69 Chair: Some 139 months. And on money, we are how much extra?

Bernard Gray: Some £468 million.

Q70 Chair: Do you want to comment on that? You have been there for two years, Mr Gray. I know that Mr Thompson has only just started his present job, but he has been in the Department for two years. That is long enough to start having an impact.

Bernard Gray: Sure. I am happy to take both cost and time. We have already had a debate about the £257 million-worth of fuel in the future strategic tanker, which is, to my mind, not a particularly sensible way of thinking about this problem. It is not our way of thinking about it. I think I will leave it to the policy shop to comment on that export facility with the A400M aircraft. The key significant difference in actual performance relates to the Queen Elizabeth carrier. The one issue which is a genuine concern for us is the delivery of the carrier programme, rather than anything else, and the £217 million that we have just discussed. That is the significant change in real underlying costs for us.

As far as the time is concerned, in the period covered by this Report, we provided the £4.8 billion that we have already discussed at some length against the total programme. I also conducted a separate exercise because I was concerned that people, as well as being too optimistic about costs, were too optimistic about time. They thought that things would be done for less money and more quickly than they turned out to be. So, as well as some actual development problems, such as some of the problems with the development of the Julius cockpit, which are genuine delays, I made people go back and assess what they really thought the time was going to be in order to deliver other projects. A proportion of this, therefore, is down to me forcing people to be more realistic about the time frame in which things are going to be delivered. The percentages involved here, which I have somewhere, are 11.4% in time-

Q71 Chair: I’ve got projects delayed on average by 30%. I got that from page 7-"average project costs have risen by nearly 12 per cent and projects have been delayed by nearly 30 per cent". That is also in "Key facts" right at the beginning of the Report.

Bernard Gray: Sure. Sorry, I am just looking in this period. If I take the £5 billion, which is about a 10% increase in the forward programme cost, there is about an equivalent amount of slippage in time as a proportion of the total programme we have allowed for in this year. I am saying that they are not exactly equal and they were not done this way-

Q72 Chair: Can you explain that to the Committee please, Mr Gray?

Bernard Gray: Sure. What I am saying is not that it was done this way, but there is an approximately equal increase in the percentage time delay as there is in the provisioning of cost. You can see that the slippage in cost against the total extant programme is about 1% of £466 million. So, if you take the £4.8 billion that we have provided, that is about 10%, roughly speaking, of the equipment programme.

Q73 Chair: I don’t understand a word of this in relation to the Report. I’m really sorry, but again, I am simply looking at the beginning. You have obviously taken your percentage against another base.

Bernard Gray: Okay, let me come at it a different way. We have made a provision in cost, which we have talked about extensively. That is the £4.8 billion in that year, yes? We also made a provision in time, and what I am saying is that, as it turns out, the provision in time is of the same order of magnitude as the provision in cost.

Q74 Chair: Well, what the Report says, though, if I just turn to the front-

Bernard Gray: That is the cumulative.

Tim Banfield: I am not sure that I quite understand where Mr Gray is coming from. Our Report looked at the cumulative increases to get to 11% for cost and 30% for time, which is what you were seeing. In the past year, we have not looked at the £468 million.

Q75 Chair: Because you can’t. They have not got the data. Mr Gray, you cannot have that. We just had this discussion a little earlier. You need data showing planned expenditure in the year against actual expenditure in the year, in which case you could look precisely at what you want to look at. But until you have that data, we cannot trust your figures.

Jon Thompson: Sorry, I don’t think that you can quite put those two facts together. The in-year performance in the financial year 2011-12-in other words, what we spent on equipment in that financial year-is not the same as what the equipment plan over a 10-year period might have changed by, which is the number-

Q76 Chair: I understand that. It is absolutely obvious. One of the criticisms of the equipment plan is that, at present, you do not monitor your actual expenditure in-year against your planned expenditure in-year. Mr Gray is trying to tell us that if you look at actual expenditure in-year against planned expenditure in-year, there is a 1% or something-

Bernard Gray: No, I’m absolutely not saying that. Forgive me if I am misleading everybody. I am saying that we made a provision of about 10%-£4.8 billion-against the programme, which we have discussed extensively already. I went through an exercise in this financial year to say, "What is the realistic amount of cost in this programme?" We have debated that quite a lot. I also went through a separate exercise to ask what was the realistic time within which these projects will be delivered. I then caused people to adjust their estimates inside our system to reflect that, which is why you get to the 139 months. I am sorry if I was unclear before.

Q77 Chair: This is quite an irritating hearing, if I may say so, because-we have had this with other permanent secretaries-we have one set of facts here in the Report and then another set of facts, which makes it very difficult. We have got to have a basis on which we can take our evidence.

Bernard Gray: I absolutely agree that we have programmed 139 months of additional time into the programme. That is an agreed number.

Amyas Morse: If I understand it-

Chair: Can you look at us? That might be helpful. I know that you like to have a conversation between yourselves, but it is the Committee that is considering the matter.

Amyas Morse: I am extremely interested in talking to you, Chair, and I apologise for that. If I understand it rightly, what Mr Gray says is that, during this year, he looked at all these projects and decided to adjust their completion dates by pushing them forward. That is why you have a big growth in the planned time to completion in this year. Is that correct?

Bernard Gray: That is correct.

Q78 Ian Swales: But that does not measure the overall delays, does it? We can see some of the delays on the pull-out sheet, such as the A400M, which is 73 months.

Bernard Gray: Most of that has already occurred. What we are looking at here is the increase, from last year, in time. Most of that had already, as it were, been banked in prior years.

Chair: I do not think that that is a very satisfactory way of looking at it. Either you agree to look at it in a different way and then come to us with the Report reflecting that; or we look at it in the way that we have before us, in which case, we take the conclusions that we have and we cannot operate. If you would have liked to have put a different document-you, Mr Thompson, more than Mr Gray, are used to the way that this Committee works-and unless we have the proper stuff in front of us, it is gobbledegook.

Jon Thompson: To be frank, I understood that my predecessor’s predecessor, Sir Bill Jeffrey, had agreed a different way of presenting time slippage in 2009.

Q79 Chair: But then why did you not do this between yourselves? It is no good coming here to Committee and just saying to us, "Actually, we don’t agree with these figures here because they are measuring something else. We want to measure something new and that is not reflected in the Report." It is very irritating.

Tim Banfield: I think that some of the illustrations in the Major Projects Report show exactly what Mr Gray was saying: it is intentional to get more realism. There is a new cockpit being put into Chinook helicopters and six months were added to that programme to reflect some of the lessons people learnt to get more realism into it.

Q80 Chair: Yes: six months added, six months’ further delay.

Tim Banfield: But that puts more certainty into that project to take forward. There are other illustrations of things in the Report that would not have been taken on where I think the judgments were not so clear, like the Falcon communication system, where there were delays that were not anticipated, so there is a mixture of the two.

Bernard Gray: Absolutely. If you take something like Falcon, delays in the development of cryptography inserted all of the delay that we are talking about here for that. So there are definitely some delays of as a result of technical issues, on Falcon in particular-

Chair: Mr Gray, it would be helpful if you talked to us, because you are talking to us, not the NAO, today.

Bernard Gray: I agree with Mr Banfield that there are some technical issues which have led to issues like those with Falcon, and there are some issues which although they did not incur additional cost to us, from that point of view they injected time into the programme. I then said that we needed to go and re-baseline the time required to deliver all the projects, which is part of this time slippage.

Q81 Chair: Okay. Rebasing is delay; I accept that that makes it better from here onwards, but it is delay from when we signed the contract. It may not be from since you joined the Department, but it is delay.

Bernard Gray: It is a more realistic estimate of what it will take to do this.

Q82 Chair: From now. No doubt, your successors will come back to this Committee in years to come and say that you made an unrealistic estimate, actually, and they will again adjust it. That is the experience of this Committee.

Bernard Gray: I think the evidence of the corrections that we have made to the Department’s budget in the last two or three years say that there is a different way of approaching this problem.

Chair: There may be, but I have been challenging you this afternoon as to whether, even in the contingencies that you have set aside in the equipment budget, you have got enough there to meet your ambitions. We shall see. That is what you think you have done, and I hope that you are right. We recognise improvement, but we are not yet convinced that you have got the whole way there.

Q83 Guto Bebb: To clarify, the description of this rescaling of the time scales being a positive thing-because it shows the finances would be matching the time scale-obviously ignores the fact that the money has already been spent on the Falcon system, specifically to get something into theatre in Afghanistan. And the system will not actually be utilised in Afghanistan. Although it sounds positive, it actually hides a significant failure, I would argue, to support our troops.

Air Marshal Hillier: Can I just add a little bit from the-

Q84 Guto Bebb: It is a huge concern for the layman that something that is talked about as an accountancy technicality is an issue in terms of supporting troops in-theatre.

Air Marshal Hillier: I agree. We need to look at it through the lens of the military capability output, which is why I have looked carefully at this project.

When we started off down that urgent operational requirement route, that is what we expected. There was a need to service in Afghanistan. As Falcon was developed and as we came across the problems which Mr Gray has highlighted, we were in parallel developing the systems which are currently in Afghanistan. By the time we had got through more of the problems with Falcon, the judgment of the operational commanders on the ground is that the system in place in Afghanistan had been developed to a standard which met their needs. So there was no reduction in the operational capability in Afghanistan and, as a result, we mitigated it by other means.

You might say, "But now we’ve wasted £32 million on Falcon."

Q85 Chair: You have.

Air Marshal Hillier: Which is not the case, because we spent that money on increasing the number of nodes, increasing the amount of connectivity in the way that we operate the system, and that has now been embedded in the core programme, so it has actually enhanced the core capability of Falcon, which is now in service with the Army and the Royal Air Force. It was not nugatory expenditure. It is valuable for the core capability and mitigated the issues in Afghanistan by other means.

Bernard Gray: If I can add, just on Falcon-this is before my time and nothing to do with me-the project teams were highlighting their concerns about the stability and extent of the software development in cryptography, which was the particular issue here, significantly in advance to the companies concerned. The companies were rejecting our analysis of the maturity of their software and they came to us in month 59 of a 60-month project and confessed to having a problem, even though we had been trying to alert them to issues in the previous 12 months. As a result of that, they ended up restructuring their project management team and people lost their jobs.

This is a project where it has definitely gone wrong, but it is not an area where the Ministry of Defence-it is nothing to do with me; I am just commenting on other people before me-was falling down. The Ministry of Defence was pressing and nagging those companies and they were denying they had a problem until right before they were due to drop the final software.

Q86 Nick Smith: It does not sound like the pressing and nagging worked, does it?

Bernard Gray: Well, sure. But part of the problem is that, if people are refusing to accept that there is a problem and are saying that they are going to deliver for you, at the end of the day, apart from marching in and taking control of the factory, there is a limited amount you can do. It has ended up costing them significant amounts of money.

Q87 Guto Bebb: I was going to ask about the financial consequences. Can you give us some figures, or can you write to the Committee?

Bernard Gray: I think we would rather do it privately, if that is all right.

Q88 Chair: This was funded from Treasury-sorry to drag you in on your first appearance here-so who is accountable for this? Are you? This was a UOR.

Jon Thompson: We are. The urgent operational requirement is just a methodological way of approving a project and funding a project. We are still accountable for its funding and delivery.

Q89 Chair: I hear that you have got the contractor-who was the SRO on this? Was there a consistent SRO over the period?

Jon Thompson: I could not answer that question off the top of my head.

Air Marshal Hillier: There would have been two SROs in that period.

Q90 Chair: And why did they not do the proper monitoring to ensure that there was delivery?

Air Marshal Hillier: I think they were doing the proper monitoring, but as Mr Gray said, the problems were not being highlighted to us.

Q91 Chair: But hang on a minute. If you are a proper SRO in charge, monitoring, your job is-Ian is better at this than I am-to discover the real state of progress.

Bernard Gray: That is what I trying to describe. That was going on. The SRO and the project teams were alerting the companies to concerns about the maturity of the software; the company was denying there were problems with their software development; it was only when they had to try and deliver the final product, in August for the September delivery, that they had to admit they had a problem.

Jon Thompson: May I add something further?

Q92 Chair: Please.

Jon Thompson: In the light of the employment of the four of us, we decided to introduce a monthly board report-from April of last year-that covers the 58 largest projects and what their current status is against our project delivery plans and the budget, and so on; so every month the board goes through those, so it knows exactly where we are. We have created a board sub-committee chaired by the Secretary of State, including Mr Gray and Air Marshal Hillier, to go through those problem projects and intervene; so we are trying to deal with the flow of projects overall in higher governance terms.

Chair: Good.

Q93 Nick Smith: Why didn’t you intervene earlier, in this instance?

Bernard Gray: They did try to intervene, but they kept running up against insistence from the company that it was fine.

Q94 Nick Smith: And then walked away again for another month.

Bernard Gray: It is quite difficult, when you have got a contractor who is refusing to accept there is a problem. It has ended up costing that contractor a very large amount of money.

Q95 Ian Swales: It may help the NAO if we look at the main project sheets, because I think some of these differences are explained better, and I want to pick on the aircraft carriers on page 56, which is a subject very dear to the heart to those of us who went up to Scotland to see them being built. I think you can see there that the delay of nine months is only part of a total delay of 24 months-on page 56-and the in-year variation, which Mr Smith was talking about earlier, is only part of an overall difference of £1.8 billion, which I think we have spoken about before.

So it is worth recording that the aircraft carrier £5.4 billion, which you were trying to negotiate downwards, was against an original figure of £3.3 billion; and personally I am so surprised-either that we thought we could do it at all, or the fact that we have allowed the contractors just to say no to the whole thing. Not even part of it was delivered, that your people calculated £217 million as a possibility, and the contractors have not moved one inch. Is that the story?

Bernard Gray: The major portion of that slippage is there is an association with a deliberate policy decision taken in 2009 to delay the aircraft carriers, shortly after the contract was signed for them. That is driving the large majority of that cost. Since the point where the new delivery dates were assigned, there was then a debate between the companies and the Ministry of Defence about exactly how much that revised schedule was going to cost. I think this example neatly makes the point about how much it costs you to delay things. So it is a very big example of the fact that the working capital and capital goods, assumptions of occupying the Rosyth dockyard and the Govan facilities, and so on and so forth, is a really expensive thing to do when we are only going to get the same amount of aircraft carrier out at the end as we would be if we hadn’t delayed it. So the vast majority of that increase is a deliberate policy decision. It shows you how much delay destroys value. Our whole objective is around avoiding further delays in programmes, including that one.

We had this gap, which we have already discussed, between what the Ministry of Defence wanted it to be able to get down to and what the contractors felt was possible, and they have spend the last two years trying to get it down; and they haven’t achieved it.

Q96 Ian Swales: Can I move on to another point, which is I’d like to ask how much the cats and traps fiasco-probably as good a word as any for it-has actually cost: the decision to design a new system. By the way, most of us who went to see the aircraft carrier were not surprised in the least when the decision was changed some months later, because even the people building it were saying it was not really a feasible way of operating for planes of the size that were planned. So how much has that episode cost the taxpayer-the whole decision to put cats and traps in that were a different design to what had ever been seen before on an aircraft carrier that was smaller than such planes had ever landed on before, and then the decision to cancel them? What do you think that has cost?

Jon Thompson: There is, I think, a current NAO review of that, with a view to bringing you a further report on the reversion. I believe that you had a hearing with Mrs Brennan some time ago and you asked her what the number was. It is included on page 57, as I understand it, so at the end of the last financial year, £44 million was committed. That is essentially being written off. We have to work up a final write-off case. That would be included in the 2012-13 financial accounts.

Q97 Ian Swales: I did see that number, because I want to ask a question about that paragraph. So £44 million is the total cost simply for that, is it-for the decision to change the landing system?

Bernard Gray: For the work that was done in the intervening 18 months or so between the defence review and the decision to revert to the STOVL aircraft. We had teams working on how to enact the catapults, people working on changing the design and so forth.

Q98 Ian Swales: I am surprised, because I think the implication of what we have heard is that there’s a bigger number, so I’ll look forward to seeing the NAO Report. I’d like to come on to another point that comes out of that paragraph. It appears that the decision has been taken to move to vertical take-off and landing planes, according to what is written here. It says: "The schedule and cost impact of this decision will need to be assessed and will be part of the project’s re-approval submission toward the end of 2012." Of course, this Report is dated a little earlier than that. What impact is that decision-the aircraft side of the decision-going to have on the budget and is it factored into these reviews?

Jon Thompson: The decision that we were reverting to STOVL was announced to Parliament on 10 May 2012, from memory. We will have to work through the impact of that in relation to the public declaration for MPR 13. By then, you will have had the specific study, so I think you will have all the data that-

Q99 Ian Swales: We don’t have any vertical take-off and landing planes any more, do we?

Jon Thompson: We are buying them.

Q100 Ian Swales: Do we?

Jon Thompson: We’re in the process of buying them.

Bernard Gray: Today we don’t, but it’s a question about which version of the plane we bought. We bought effectively the same plane, which comes in three versions: a normal air force version that takes off from land bases; a carrier version for cats and traps operation; and a STOVL version, like the Harrier. The question was: would we buy the STOVL version, like the Harrier, or the navy version-

Q101 Ian Swales: But it is still the same aircraft?

Bernard Gray: It is basically the same aircraft.

Q102 Ian Swales: Is there a difference in cost?

Bernard Gray: There’s about a 10% premium on the STOVL version over the other versions, but that was a part of the whole financial calculation that we took into account in the costs of putting in the catapults and changing the design versus the costs-

Q103 Ian Swales: Is that extra cost of those aircraft factored into your budgets yet?

Jon Thompson: Yes, and what we believe to be any other costs. What we believe is our current plan is in our budget, but again, this is subject to review by my friends from the NAO.

Q104 Chair: Can I ask about the complex weapons programme, which seems to be a bit of a problem? What have you learned from that? What would you do differently there?

Air Marshal Hillier: In relation to the complex weapons pipeline, Bernard will be able to talk through the commercial issues, but looking at it from a capability perspective and the budget perspective, if we weren’t to do business in this way, if we were to go out and get all our individual contracts from wherever in industry-the assessment is that it would cost us significantly more to do that.

Q105 Chair: I understand why you conceived of the programme. That’s the answer you’re giving me. But the question I asked you was this-the programme doesn’t seem to be in the best state, so what have you learned from trying to pull it all together as one acquisition, and what would you do differently?

Bernard Gray: I think it works pretty effectively. The one thing that I would like that I don’t have that I have discussed with the operating centre director running this particular area is-it’s your point about management information-a better feel for the state of maturity of each of the individual components within it. We have definitely benefited from the flexibility of being able, against urgent requirements on issues such as Libya and Brimstone for example, to be able to use that flex. We have had a much more co-operative attitude from the company around carrying on with some development work while the defence review and subsequent activities were going on. I would like a better feel for the output related to input maturity of the programme as a whole.

Q106 Chair: You are not thinking of scrapping it?

Bernard Gray: No. You’re not, are you? I’m just checking that nobody else is.

Q107 Chair: Okay. There is something in the Report that suggests that there is consideration about its future. I can’t remember the wording but I read something about that.

Tim Banfield: That was one of the particular components where there were some issues about maturity outcome and considering the future.

Q108 Chair: I misread that. Dotted throughout the major projects Report are areas where you have had to take decisions to curtail investment, which has left with you potential capability gaps and challenges to meet your 2020 promise. That is partly coming out of the A400M. There would be a capability gap there from 2017. That is pretty imminent. I am probably not going to pick up the lot. There is a two-year capability gap in the helicopter programme when the Sea Kings get dropped. Then there is a worrying thing about VC10s, which have got to go out of service because you have closed the maintenance facility. I accept they are very old. You are not sure that TriStars will stay the course. Those are all capability gaps, I think you would accept.

Air Marshal Hillier: Some of them are capability gaps. It might be semantics but some are shortfalls rather than gaps. A gap to me is that you don’t have the capability. Shortfall is being below your ideal requirement. In areas such as air transport we don’t have a gap, we have shortfall against what we would be aiming for. For me, that is an important difference.

Q109 Chair: So, operationally it does not cause you a problem. Is that what you are telling me? Whereas a gap does.

Air Marshal Hillier: A gap is having nothing. The shortfall requires much harder work of prioritising from a commander’s perspective and allocating according to your most urgent needs. Lower down at the tactical level, it quite often requires a lot of extra hard work for people to keep aircraft or ships or tanks going, but we meet the requirement still. An example would be on the air transport side, for which I used to be the operational commander. All of the operations that we were involved in showed, in theory, a shortfall against that requirement, but we still sustained the task in Afghanistan and elsewhere, with a lot of prioritisation and people working hard.

Q110 Fiona Mactaggart: Are you going to be able to sustain that when it comes to withdrawing the troops from Afghanistan?

Air Marshal Hillier: We have that plan at the moment. It can’t be a risk-free plan, both in terms of what it is, which is an enormous task, and also dependency on new aircraft coming into service, sustaining older aircraft in service. There is a huge range of factors in there. It is not risk free, but we have a plan that allows us to achieve that withdrawal.

Q111 Ian Swales: While we are on the subject, can I ask about one thing that strikes me from figure 11, where you have a list of all the various projects? You are talking about spending about a quarter of the entire budget on the tanker and passenger aircraft. It is more than four times as much as on fighter aircraft. Does that feel right to you in terms of the future of our defence capability? Maybe it does.

Air Marshal Hillier: It is not quite comparing like with like. It is not just the cost of the tanker aircraft but the through-life support arrangements-the PFI, I believe, runs for in the order of 30 years-whereas when you talk about the fighter aircraft you are talking about the initial acquisition costs. If you add the initial acquisition costs and the through-life costs, fuel and the people-

Q112 Ian Swales: So this is the rolled-up PFI cost that you have got here.

Bernard Gray: Yes.

Q113 Chair: Going back to capability, currently you do not have capability for air-to-air refuelling, and we had to bring the Americans in to help with the refuelling of the French aircraft in Mali. Am I wrong about that?

Air Marshal Hillier: We do not have a gap in air-to-air refuelling at the moment.

Q114 Chair: But didn’t the Americans come in?

Air Marshal Hillier: That is normal for any operation like this. It is a coalition effort and you would expect to have other nations’ aircraft.

Q115 Chair: So why did they come in?

Air Marshal Hillier: Because if you look across NATO, apart from the US-in fact, for the US as well-there is always a shortage of tanking aircraft when you are in operations. It is always one of the highest demand areas. We saw it in Libya; I am sure we saw it in Mali; we see it in operations everyday. What happens is that we pool and share those capabilities, and prioritise them. So if the Americans roll in to support the French in Mali, that is the way that business is done.

Q116 Chair: I find the definitions of "shortfall" and "capability gap" a little bit incredulous-unless you can explain it to me better.

Air Marshal Hillier: From a UK perspective at the moment, we have the air-to-air refuelling tankers, which are capable of sustaining our quick reaction alert task in the defence of the UK; defending in the Falkland Islands, in the same task; we have them deployed in support of our operations in Afghanistan; and we have aircraft to provide a small training reserve. If additional operations happened at the same time, we would definitely struggle and we would have to prioritise, but it is not the case that we don’t have air-to-air refuelling capability at the moment.

Q117 Chair: In 2017 you won’t, according to the Report.

Air Marshal Hillier: As the FSTA comes into service, its in-service date-

Q118 Chair: In 2017, will you have the capability?

Air Marshal Hillier: We have a capability now. We will have the full FSTA-

Q119 Chair: Nobody is doubting that. What the report says is that you have the capability now, and when the FSTA comes on board, you will have the capability again. In 2017, the report asserts that you haven’t got the capability.

Air Marshal Hillier: In 2017, we will have the full capability. The FSTA starts to, or it is already starting to-

Q120 Chair: It is not refuelling. I don’t know the technical-it’s gone wrong. It’s not working; that is what I understand.

Air Marshal Hillier: It wasn’t working as we would wish. We now have a fixed plan. We are expecting that, within the next couple of months, we will be able to refuel our Typhoon and Tornado aircraft from the Voyager, and then the capability increases to its in-service date in 2014 and then builds up to 2017. As that comes into service, then we’ll take the VC10 and the TriStar out of service.

Bernard Gray: We will have nine aircraft delivered by April 2014.

Q121 Chair: Which work? Which do this refuelling?

Bernard Gray: They work now-

Q122 Chair: I know they work now, but they don’t do all the functions that were anticipated.

Bernard Gray: And we have now fixed that problem, and we will have that in-service date for the nine aircraft available, with the refuelling capability, by the predicted date-the in-service date which was there before-of April 2014.

Q123 Chair: 2014?

Bernard Gray: Which is the date we have programmed.

Tim Banfield: I was just going to say that the air-to-air refuelling gap is in the very near term. The gap that I think you were referring to was around tactical transport, which is as the Hercules aircraft go out and the A400 comes in.

Q124 Chair: So how are you dealing with that?

Air Marshal Hillier: As the report says, tactical air transport-the delay of the A400-is causing problems, as you would expect. It is putting a lot of extra effort on to the C-130 and-as we recognised in the report-we have extended on some of the C-130s for as long as possible. We have also looked at mitigating it by buying other aircraft, and it is part of the reason why we bought additional C-17 aircraft as well. So the A400 delay has caused us a significant problem, but we have mitigated it as much as possible by running on existing times and, where necessary, buying additional capacity.

Q125 Chair: From within budget, or by going to Treasury?

Air Marshal Hillier: The additional C-17s came from the MOD budget.

Q126 Chair: Is the same true for helicopters? My understanding is that with the Sea Kings there is a two-year capability gap there. I don’t know how you’re thinking of filling that. Is that from within your budget, or by going back to Treasury?

Air Marshal Hillier: No, it would be for us to judge, according to our priorities at the time. Again, it’s not a gap; it’s a shortfall. It’s a shortfall, and we just prioritise the most urgent requirements. If all of our operational requirements happen at the same time, we have a difficulty.

Chair: There is a gap.

Amyas Morse: Can I just ask a question? We have had a number of hearings where we have had this point. We had a discussion about Nimrod going out of service and we had an explanation of how more helicopters can fly further and it would be all right. Here we have a three-year gap in tactical air transport and you are saying that it will be all right. How will you know? I am sorry, but I just do not understand how you plan it. I can understand how you come along and want to be positive about it with the Committee, but at what point do you tell people, "This is really getting pretty hairy. We just cannot do this"? Looking at this, it is a long period. You signed off our Report, but it is a long period to say, "Falls critically short of requirement." Quite honestly, how risky will it be?

Air Marshal Hillier: You ask how we will deal with it. First, as you say, it falls critically short of the requirement. Does that mean that there is a gap? Throughout that period where you are showing red bars, we have a considerable number of C-130s in service doing tactical air transport. Are there as many as we would want? No, because we made assumptions on the arrival of A400. How do we mitigate that? In that period, Afghanistan will continue to be Defence’s main effort. We will ensure that in Afghanistan they get the C-130s that they need. If necessary, that will have an impact on other things that Defence might want to do that are of a lower priority. We will say that those tasks either do not get done or we will look to civil air charter, for example, as a means to pay for it.

Q127 Chair: Or you go to the Treasury and buy something quickly.

Air Marshal Hillier: The other thing that I would point out is that if you look one stage up, it says, "Strategic air transport" and it says in 2016 there will be an excess in our ability to meet the requirements. That arises from the C-17. The C-17 has an excess and the C-130J has a shortfall. Those two can be interchanged. They are aircraft that are flexible; they can be used for one task or the other. The evidence for that is that we bought C-17s partly to mitigate the A400, which is a tactical air transport aircraft, so clearly there is a connection between the two. We would use the C-17 capacity to help buy out the C-130J capacity.

I do not want to make it seem like I’m saying, "Don’t worry, there is not an issue here." As I have said, until two years ago, I was the operational commander looking after this activity. It puts a lot of strain on our air transport force, but I am pretty confident that we have not failed in our tasks in Afghanistan as a result of the approach I have outlined.

Q128 Fiona Mactaggart: That last answer has answered my anxiety about Afghanistan. We know that there will be a big demand for transport aircraft at a particular period. Other countries, such as America, will use their transport aircraft at the same time. From the Report, it did not seem to me that we were necessarily able to meet that, but you have said that you are confident that we will be.

Air Marshal Hillier: We have confidence in the plan that we have developed so far, but I cannot say that it is risk-free. Clearly there are a lot of dependencies there, but that is the nature of the thing that we are dealing with.

Q129 Fiona Mactaggart: Indeed. There will be a lot of soldiers and their families feeling anxious about that.

Air Marshal Hillier: I can absolutely guarantee that the priority is on people. The equipment is something that we can deal with in a different way.

Q130 Fiona Mactaggart: We must make sure that we do not leave it behind.

Air Marshal Hillier: We won’t leave it behind, I promise.

Q131 Chair: Can I just ask you something about VC10s? Clearly you want to take them out of service, but on reading the Report, I did not understand why you closed the maintenance facilities before they were taken out of service.

Air Marshal Hillier: The plan to take out VC10 was based on the arrival of the Voyager-the FSTA. As we have already discussed, the build-up in its capability is happening. It starts off more slowly and eventually gets to where it needs to be in 2014, so we have a problem in that interim period. Back when we had to make the plans on when to close down the depth maintenance facility, we were working on the assumption that Voyager would be in service-

Q132 Chair: It is just a bit of common sense. You don’t close down the maintenance until they are out of service. It seems to me you did it the wrong way round.

Air Marshal Hillier: It is the depth maintenance facility, which is what the aircraft go into. There are many years between those depth maintenance activities. Yes, we could keep everything going right until the final day, but it would be very expensive.

Q133 Chair: I understand it is expensive, but given the delay and your gap in, or lack of, capability-I think that is a semantic debate-it seems a bit bizarre.

Bernard Gray: The maximum time we would keep the VC10s is another six months, which is not the kind of time interval that would cause them to go back into depth maintenance.

Q134 Nick Smith: According to the plan, how long will it take to bring back all the kit from Afghanistan?

Air Marshal Hillier: I don’t have all the detail to hand.

Bernard Gray: We will have all of the equipment out by the end of 2014.

Q135 Nick Smith: What about this problem with the railroad and the fact that you cannot bring a lot of it back over land? What is going to happen there?

Bernard Gray: Clearly, to the extent that we cannot bring the equipment out either by rail or road, we will have to bring it out by air, but we have access to civilian chartering as well as our own facilities, if we have to do that. It will cost more money, obviously, but we can do that.

Q136 Chair: Is there anything else that we need to cover?

Amyas Morse: It may be worth checking on the A400M. It might be an idea to hear whether you are confident that the cost of that plane will not go up again before it comes into service. If the costs do go up, have you any choice but to pay for them?

Bernard Gray: The contractual basis should give us confidence that we are protected from it. Airbus had to meet a significant component of the increase in the original development costs. With the exception of the engine gearbox issue, which has been around over the last few months, the development of the aircraft is substantially complete. They are running through their flight test programme now. From my conversations with them both in the UK and at Toulouse, we are due to receive the ninth aircraft in the fleet. There is going to be a relatively small impact on French aircraft, which are delivered earlier than ours, but they are still confidently predicting that we will get our first aircraft in September 2014.

Q137 Chair: And are you confident about the future of EADS, too, given everything that has been happening in recent times about its viability?

Bernard Gray: It has about €20 billion of cash on its balance sheet.

Q138 Chair: There is one other question that I meant to cover. If you look at these delays, a lot of them come out of software development, so I just wondered how you were tackling that issue.

Bernard Gray: That is right. It is software within computer systems themselves and also within other platforms. You will find me laying heavy emphasis with all the project reviews that I conduct with my teams about the difficulty of capturing that. To come back to the point that we were discussing earlier on Falcon, if you are building a ship, you can go to a shipyard and look at it and say, "Is it there?" If it is not there, the argument that someone is going to deliver it next week is pretty easy to knock over. It is much more difficult to challenge people on the maturity or otherwise of software programmes and also the data migration into those software programmes. We are putting significant emphasis on trying to capture those risks and make people understand that they are significantly different.

Q139 Chair: Is it something about your own capability in house to challenge?

Bernard Gray: There might be some of that, but funnily enough, the largest number of procurement projects I ran in private industry were in software, and you run into exactly the same set of problems. Private industry does the same thing. One of the things you are looking at is the declared number, so as you run towards maturity, you are looking at things like the declared number of bugs versus the rate of fixing them, how many can they sort out in the time before they are due to deliver, for example, and the progress and validation of data migration-when you start putting the data into the software, does it come out looking the way it should and so on?

When you look into all those issues, we could certainly use more capability than we have got, but so could the rest of the world. I have been in at least a dozen arguments over the last decade with contractors-not at the Ministry of Defence, but elsewhere-when I am saying, "You’re definitely not going to deliver this by the due date," and they are arguing with me that they definitely are. In the end, you cannot prove them wrong, except for the fact that it is not ready on the day, and that is the problem.

Q140 Ian Swales: Do you have tight control over re-specification? I have heard about this from MOD suppliers in physical assets, whether ships, helicopters or whatever. I can imagine it might be even more prevalent in the software. Do you have good control for telling all your MOD people: "Hands off. We’ve agreed what we want; now let them get on with it"?

Bernard Gray: We do our best. Sometimes there are genuinely changed circumstances that will cause you to have to try and do something else. Often we are running long-term programmes and something else pops up. To make it real, I struggle with, because if you have a 65,000 tonne object, making a decision to cut a hole in six decks to fit a new piece of equipment seems to me an interesting decision to make, if I can put it that way, and if we were prepared to do that to a large physical object that you can see, what on earth are we prepared to do to software code that you cannot see? It is very abstract. It is a real challenge-for us, as well as for many other organisations-to keep that discipline. I proselytise endlessly in a number of areas, including carrier, for sticking to what we agreed in the first place.

Q141 Ian Swales: Do we have enough expertise on the MOD side in house to agree software specifications up front? Looking at the lessons from systems such as the NHS system, it was a moveable feast for its entire life, really.

Bernard Gray: The answer to that, I think, is no, which is why in a number of programmes we have recruited a systems integration house to work on the MOD side to assist us with that process.

Q142 Chair: A very final question, and thanks for your patience: is progress being made on the privatisation of Defence Equipment and Support, as planned?

Bernard Gray: We are not going to privatise it, whatever we do.

Q143 Chair: So the decision has been taken not to.

Bernard Gray: No, but we are looking at a number of options, which include potentially turning it into a Government-owned contractor-operator, so we would own it although it would be an incorporated entity, as well as looking at how much we can improve the situation within the public sector. So we are running two models to try to determine which one will drive better value for us, and the results of that analysis are being discussed with Ministers. This will come to a conclusion in the course of the next few months and we will decide on a way forward.

Q144 Chair: That is a slight change of direction, isn’t it?

Bernard Gray: We are basically drilling all the wells and trying to figure out which ones make sense.

Q145 Chair: When can we expect to hear? What does a "few months" mean? Is that MOD months?

Jon Thompson: Well, it could be plus 139 months, I suppose. To be clear, as Bernard says, the business case has been presented to our Ministers, but given the scale of the reform, Ministers in other Departments need to approve it-for example the Chief Secretary to the Treasury-because clearly it involves a significant contract and significant funds. I expect it to be two or three months. I would expect the Secretary of State to make a statement to the House when the process is complete.

Chair: Of course. We would all expect that. We are just trying to get an idea of the time frame.

Thank you very much indeed. We wish you well in meeting your ambitions.

Prepared 11th February 2013