Citing the increasing age of the existing tanker fleet and other concerns, the Air Force has over the past several years been investigating a number of different options for maintaining and improving its tanker capabilities. Over the past year, its attention has been focused on the possibility of leasing 100 Boeing 767 aircraft and converting them to tankers. This option was initially proposed not by the Air Force, but by Congress. Specifically, the conference report on the fiscal year (FY) 2002 Defense Appropriations Act included a provision allowing the Air Force to negotiate a ten-year tanker leasing arrangement.

This Backgrounder provides a brief analysis of the Air Force tanker issue and, particularly, the proposed tanker leasing arrangement. Among other things, it finds that:

The current Air Force tanker fleet needs to be modernized to keep it effective over the long term. However, it is unclear precisely when and how the fleet should be modernized.

A range of options exist for modernizing the tanker fleet, including upgrading existing KC-135E tankers, buying new tankers and leasing new tankers.

Although a final determination cannot be made until the details of the Air Force’s proposed tanker leasing arrangement are finalized and made public, it appears unlikely that this proposal will prove to be the most cost-effective option.

Status and Age of the Existing Tanker Fleet
The Air Force’s fleet of tanker aircraft currently consists of approximately 500 KC-135 aircraft and 54 KC-10A aircraft. Each KC-135 can carry some 200,000 tons of fuel, while each KC-10A can carry about 365,000 tons of fuel.² The KC-135s and, especially, the KC-10As can also be used to transport cargo and personnel. The average KC-10A aircraft is some 16 years old, making it a relatively new aircraft. By contrast, the average KC-135 aircraft is 41 years old, making it one of the Air Force’s oldest aircraft. Prior to the terrorist attacks of September 11, 2001, the Air Force did not plan to begin replacing its fleet of KC-135 tankers until 2009. Under those plans, the Air Force expected to keep at least some KC-135s in service until around 2040.³

Everyone agrees that the Air Force’s tanker fleet needs to be modernized. However, there is little agreement about either the urgency of this requirement or the best way to modernize the fleet. Notwithstanding the high chronological age of KC-135 fleet, in terms of flying hours, the fleet is only approaching middle age. The Air Force has estimated that the airframe life for the KC-135 is about 39,000 hours. Today, the average KC-135 has logged only around 16,000 flight hours.⁴ As a result, in a recent study the Air Force projected that only six KC-135 aircraft would have to be retired before 2040 because they would exceed their airframe life.⁵ On the other hand, the cost of maintaining the KC-135 fleet is projected to increase in coming years. According to the Air Force’s recent KC-135 Economic Service Life Study (ELS), the operations and maintenance (O&M) costs associated with the KC-135 fleet will rise by a total of about $23 million a year over the next 40 years.⁶ Likewise, the amount of time these tankers spend undergoing depot maintenance is projected to gradually increase.

Determining whether concerns about increasing O&M costs and lower mission-capable rates suggest that the Air Force needs to accelerate its tanker modernization plans is far beyond the scope of this Backgrounder. But, should a decision be made to accelerate the modernization of the tanker fleet, a range of options exist for doing so. These options include upgrading existing KC-135E tankers to the KC-135R configuration, buying new tankers and leasing new tankers. The Air Force, making use of the language included in the conference report on last year’s defense appropriations bill, has recently proposed using a leasing arrangement to accelerate the modernization of the tanker fleet.

Current Air Force Proposal
Although the details of the proposed leasing arrangement have not yet been finalized or made public, the Air Force proposal would involve leasing 100 Boeing 767 aircraft and converting them to a tanker configuration. The aircraft would be used to replace 127 KC-135E aircraft—the least capable of the KC-135 aircraft—with deliveries beginning in 2006. Under this plan, the Air Force would begin acquiring replacements for the KC-135 three years earlier than previously projected, and would acquire 100 new tankers six years earlier than previously projected.⁷ Although last year’s conference report stipulated that the lease should be for no more than ten years, the Air Force has stated that it may ask for legislative changes if they would make the leasing arrangement more cost-effective for the government.

Without knowing the details of the proposed leasing arrangement, it is impossible to determine with certainty whether leasing would be the most cost-effective option for modernizing the Air Force’s tanker fleet. However, what information is available concerning the current plan, as well as the cost-effectiveness of leasing versus purchasing more generally, suggests that a leasing arrangement is unlikely to be the best option for the Air Force.

Leasing Versus Purchasing
As with an individual, it sometimes makes more sense for the government to purchase items, at other times it makes more sense for it to lease items. Leasing has a number of advantages. It allows an individual to avoid the high upfront costs that may be associated with buying an item and provides the lessee with greater flexibility, should she or he be uncertain about how long the item will be needed. Thus, for example, leasing, rather than buying, a car may make sense for an individual who is “cash poor” and believes that she or he may need the car for only a relatively short period of time.

But the lower upfront costs and greater flexibility that leasing arrangements can offer come at a price. Generally, if the item represents a long-term requirement, the total costs will be higher under a leasing arrangement than through a purchase. Leasing is also likely to prove less attractive than purchasing in cases where the item must be specially produced to suit the individual’s peculiar requirements. In such cases, the price of the lease would have to be relatively high in order to compensate the lessor for the fact that there may be no private market into which the item can be sold once the lease has expired.

Since the Air Force’s requirement for tanker aircraft is clearly a long-term requirement, and tanker aircraft are highly specialized aircraft for which little or no private sector market exits, these rough rules of thumb suggest that a tanker leasing arrangement for the Air Force is unlikely to prove cost effective. Moreover, recent studies on the subject by the Congressional Budget Office (CBO)⁸ and the Office of Management and Budget (OMB)⁹ have essentially confirmed this conclusion.

CBO has estimated that purchasing 100 Boeing 767 tanker aircraft would cost about $18 billion. This includes about $110 million apiece for each 767 aircraft and $40 million to convert each aircraft to a tanker configuration, plus roughly $2 billion for new hangars and other infrastructure.¹⁰ The operations and support costs associated with these new aircraft would amount to about $5 billion through FY 2020, and another $2 billion would be needed to operate the existing fleet of KC-135E aircraft until it is retired. This would bring the total cost of this option to about $25 billion. According to CBO, the net present value of this option would be some $20 billion.¹¹ By comparison, CBO has estimated that leasing 100 tankers would cost a total of $40-45 billion, or $26-28 billion in net present value terms.¹²

OMB has similarly concluded that leasing would probably not be a cost-effective option over the long term. According to OMB, leasing 100 Boeing 767 aircraft for ten years and converting them to tankers would cost about $26 billion,¹³ while directly purchasing the aircraft would cost the Air Force some $18 billion, roughly $8 billion less.¹⁴

Near-Term Versus Long-Term Costs
More than perhaps anything else, what appears to make the prospect of a leasing arrangement most attractive to the Air Force is the idea that such an arrangement would allow it to “kick start” the modernization of the tanker fleet by avoiding the high upfront costs associated with purchasing new aircraft. A leasing arrangement would, indeed, be less expensive for the Air Force over the next decade or so. This is because, under a lease arrangement, Boeing, rather than the Air Force, would have to pay the upfront costs associated with buying the 100 aircraft. Those costs would amount to $18 billion over roughly the next seven years.¹⁵ By contrast, the CBO figures suggest that under a leasing arrangement only $7-10 billion would be needed over the next seven years.¹⁶

But these savings would be more than offset by the much higher costs associated with leasing after roughly 2010.¹⁷ If the Air Force were to purchase the aircraft they would be fully paid for by around 2010. By comparison, under a leasing arrangement another $23-31 billion would need to be paid between about 2010 and 2020.¹⁸

Viewed in this light, the Air Force’s argument that a leasing arrangement would allow the Service to “kick start” the modernization of its tanker fleet appears to be, at best, misguided. Under this option, the price of accelerating the acquisition of new tanker aircraft in the near term would almost certainly be to raise the cost of modernizing the tanker force over the long term.

Conclusion
It would be difficult to overstate the importance of a highly capable Air Force tanker fleet to the effectiveness of the US military. It is also clear that the existing tanker fleet must be modernized and eventually replaced with new aircraft—although there is considerable disagreement over when the Air Force should begin modernizing this fleet, and how it should be modernized. Once a decision is made to modernize the tanker fleet, a range of options exist for doing so. These options include upgrading existing KC-135E tankers, buying new tankers and leasing new tankers. Identifying precisely when and how the Air Force should begin modernizing its tanker fleet is far beyond the scope of this brief analysis. This analysis does, however, strongly suggest that the Air Force’s proposal to lease 100 new Boeing 767 aircraft and convert them to tankers is unlikely to be the most cost-effective approach to modernizing the tanker force.

If it is determined that the tanker fleet needs to be modernized more rapidly than called for under previous Air Force plans, consideration should be given to upgrading the existing force of 127 KC-135E tankers to the KC-135R configuration. Such an effort would cost an estimated $3.2 billion.¹⁹ Among other things, this option could yield substantial savings in operations and maintenance costs.²⁰ This option could also be accomplished more quickly than the proposed leasing option.²¹ Alternatively, if it is determined that a new tanker is required, the Air Force should strongly consider directly purchasing, rather than leasing the aircraft, since over the long run this option is likely to prove substantially more cost-effective.

For more information, contact Steven M. Kosiak at (202) 331-7990.

The Center for Strategic and Budgetary Assessments (CSBA) is an independent policy research institute established to promote innovative thinking about defense planning and investment strategies for the 21st century. The center is directed by Dr. Andrew F. Krepinevich. For more information on CSBA, see our web site at: http://www.csbaonline.org.

1. Among other things, the proliferation of chemical and biological weapons, and ballistic and cruise missiles, may make forward airfields and other bases increasingly vulnerable to attack. For a discussion of the emerging anti-access challenge, see Steven Kosiak, Andrew Krepinevich and Michael Vickers, A Strategy for a Long Peace (Washington, DC: CSBA, January 2001), pp. 5-6.

2. Christopher Bolkcom, “Air Force Aerial Refueling: Background and Issues,” Congressional Research Service (CRS), pp. 2-3.

3. Ibid.

4. Ibid.

5. Mitchell Daniels, Director of OMB, Letter to Senator John McCain concerning Air Force Tanker Analysis Related to KC-135E Replacement and Tanker Requirements, May 3, 2002, p. 1.

6. Daniels, Letter to Senator McCain, p. 1.

7. Neil P. Curtin, Director, Defense Capabilities and Management, General Accounting Office (GAO), “Air Force Aircraft: Preliminary Information on Air Force Tanker Leasing,” May 15, 2002, p. 12.

8. Dan L. Crippen, Director of CBO, Letter to Senator John McCain, May 7, 2002.

9. Ibid.

10. New hangars, as well as taxiways and runway aprons will be needed because the 767 is a larger aircraft than the KC-135. Other infrastructure items include simulators and other support equipment.

11. Net present value takes into account the time value of money. Specifically, it adjusts for the fact that a dollar spent in the future is less costly than a dollar spent today (e.g., because a dollar spent in the future can collect interest until it is spent).

12. CBO analyzed two possible leasing arrangements. The lower cost option would involve leasing the aircraft and modifying the aircraft to a tanker configuration under current law. Under this option it is assumed that the Air Force would lease the aircraft for ten years and purchase the aircraft for their residual value when the lease expired. (CBO also included a variant of this option in which the Air Force would return the aircraft to Boeing when the lease expired. This variant is not discussed in this analysis because it seems unrealistic given the long-term nature of the Air Force’s requirement for tanker aircraft.) The second, higher cost option, assumes that current law would be amended to permit leasing the aircraft in a tanker configuration. As in the first option, this would be followed, after ten years, by purchasing the aircraft for their residual value.

13. In addition to the cost of the leases themselves, these figures include the cost of converting the aircraft to tankers, and the cost of operating and supporting the 100 new tankers through 2020, as well as the cost of operating and supporting the existing KC-135E fleet until it is retired.

14. Daniels, Letter to Senator McCain, pp. 2-3.

15. This estimate assumes (consistent with CBO’s analysis) that the 100 aircraft and associated infrastructure would be funded over the FY 2003-09 period (and delivered over the FY 2005-11 period).

16. This is a CSBA estimate based on CBO data. It includes the cost of not only the leases themselves, but conversion and infrastructure costs. It does not include the annual operations and maintenance cost for the aircraft, which would be similar whether the aircraft were leased or purchased.

17. One reason why total costs would almost certainly be higher under a leasing arrangement than if the aircraft were purchased directly by the Air Force is that in the former case Boeing (rather than the government) would have to finance the purchase of the aircraft, and those finance charges would inevitably be higher than the cost of Treasury borrowing. Crippen, Letter to Senator McCain, p. 1.

18. In addition to the cost of the leases themselves, these figures include the residual value of the aircraft (which would have to be paid upon expiration of the lease if the Air Force were to retain the aircraft beyond ten years). They do not include operations and support costs.

19. Daniels, Letter to Senator McCain, p. 2.

20. According to an Air Force study, annual O&M costs are about $1 million a year less per aircraft for the KC-135R model than the KC-135E model. Curtin, “Air Force Aircraft,” p. 38.

21. Ibid.