Is the last bastion of the UK Defence Industry at risk?
Urgent decisions are needed about UK shipbuilding
Naval Ships and Submarines are forecast to consume 40% of total UK defence equipment spending over the next decade, so you would think it is a safe assumption that shipbuilding is an excellent market for the likes of BAE Systems, Babcock and Rolls-Royce? Last week’s report by the House of Commons Defence Committee suggests otherwise. MPs highlighted that decisions made over the next year about the Type 26 and Type 31 are critical in establishing whether skills can be maintained, budgets can be met and ships can be delivered on time.
The report concludes that:
“At 19 ships, compared with 35 in 1997, the Royal Navy’s frigate and destroyer fleet is way below the critical mass required for the many tasks which could confront it. If the National Shipbuilding Strategy can deliver the Type 26 and Type 31 GPFF to time, the MoD can start to grow the Fleet and return it to an appropriate size. The 2015 SDSR set out the Government’s ambition for a modern, capable Royal Navy. Now is the time for the MoD to deliver on its promises.”
At Sandhurst it was drilled into me the important difference between a strategy and a plan. The Defence Committee report ‘Restoring the fleet’ seems to suggest the MOD has an overarching strategy, but does not yet have a plan of how to deliver it. It is the plan that is crucial to the defence industry because it will establish when the ships will be built and under what contract terms.
Currently the MOD is dragging its heels over the Type 26 frigate contract and the report highlights that this causes three main issues:
1. There is a risk that the Type 26 will not be in service in time to replace the Type 23 and therefore fleet numbers will fall below our current historic low.
The MOD announced on 4 Nov 2016 that work is due to start on the ships in the summer of 2017, however that date remains dependent upon a successful conclusion to negotiations on both the design of the ship and the contract. The Type 26 frigates are intended to replace the Type 23 frigates, which will start to come out of service in 2023 at twelve-monthly intervals.
“If the new frigates are not delivered to that decommissioning timetable, ship numbers will be reduced further from what is already an historic low (see chart below). The current total of 19 frigates and destroyers—only 17 of which are usable—is already insufficient: to go below that number, even for a transitional period, would be completely unacceptable.”
UK Royal Naval Fleet 1975 – 2016 (Source: UK MOD statistics)
Strict timelines are clearly required, but past experience with the Aircraft Carriers and Type 45 Destroyers does not fill me with confidence that the MOD and industry can deliver to such a strict schedule. At Defence Questions on 7 Nov 2016m the Secretary of State for Defence was asked whether the first Type 26 would be ready to enter service in 2023. His response was uninformative:
“Yes, I can confirm that it is our intention to replace the anti-submarine frigates within the Type 23 force with eight new Type 26 anti-submarine frigates”
2. Contract delays lead to cost inflation which jeopardises the number of ships the MOD will be able to purchase.
The MOD has already admitted that there is a £750m shortfall in the funding for the Type 26 programme in the current year. If work does not start in the summer of 2017 then the overall cost of the programme will increase because BAE is currently paying to maintain capabilities in an underutilised workforce. The Royal Navy budget is already being squeezed (most notably because of the costs to fix the Type 45 engine) and if the unit price increases then consideration will have to be given to purchasing fewer than the planned eight ships. The report warns that the Government must not try and mask the problem by imposing artificial delays to the programme thus stretching the cost over more years (as was done with the aircraft carriers), as this will only increase the problems further down the line for another parliament.
3. There is currently a lack of work for the shipbuilding workforce which risks undermining a national capability.
The 2009 Terms of Business Agreement (TOBA) between BAE Systems and the UK Government was the closest we have ever had to a coherent defence industrial strategy. The National Shipbuilding Strategy is intended to supersede the TOBA and give industry the long-term certainty necessary to generate a secure and skilled workforce. The current delays to Type 26 mean there is insufficient work in Scotland for the existing workforce and has resulted in BAE Systems retaining staff at Rosyth on the carrier programme for “longer than anticipated”. In addition, BAE has reduced its number of apprentices from 100 per year, to 20 per year.
The MOD has announced that the construction of two Offshore Patrol Vessels (OPVs) will start shortly for delivery in 2019 which it hopes will protect jobs before the Type 26 programme gets underway. However, Duncan McPhee from the Unite Union has warned that further delays would be “catastrophic for the industry.” Timelines for the Type 31 General Purpose Frigate must also be made explicit in order to secure jobs through to 2035.
In Conclusion, we are entering a critical period if industry is to benefit from the promised and much anticipated increase in spending on UK Naval ships. Shipbuilding is the last bastion of the UK Defence Industry so it is vital the Government gets this right, otherwise the industrial landscape of the UK could change irrevocably.
Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.