Nabucco pipeline takes another twist....

Nabucco pipeline takes another twist....
By Vladimir Socor

The consortium seeking to build the proposed Nabucco gas pipeline from the Caspian Sea to Europe has decided to reconfigure its project for a new role: a European continuation of the Azerbaijani-Turkish, Trans-Anatolia Gas Pipeline (TANAP) project.

As TANAP plans to replace Nabucco on Turkey's territory, Nabucco would link up with TANAP at the Turkish-Bulgarian border, continuing via Romania and Hungary to Vienna, for an expected 10 billion cubic meters (bcm) of Azerbaijani gas annually in the initial stage of both TANAP and Nabucco. With


Azerbaijan offering to finance up to 80% of TANAP's construction costs, the continuation pipeline in the form of an abridged Nabucco into EU territory becomes financially credible and bankable.

Overcoming initial hesitation, Nabucco's Austrian management has confirmed that it has submitted a proposal along these lines to the Shah Deniz gas producers' consortium in Azerbaijan, as well as to the transit country Turkey. The Nabucco shareholders envisage a final investment decision by 2013 for building the abridged Nabucco, dubbed Nabucco West.

The US special envoy for Eurasian energy affairs, Richard Morningstar, similarly envisages a final investment decision by 2013. By that time it should be possible to determine whether additional gas volumes would be available, on top of those 10 billion cubic meters (bcm) per year in the first stage, for delivery to Europe. However, the Trans-Adriatic Pipeline (TAP) project, its main destination being Italy, lays claim to the same 10 bcm per year of Azerbaijani gas from the BP-led Shah Deniz project.

This is again a zero-sum contest pitting the Italy-bound TAP against the Nabucco countries. According to Morningstar's remarks in Brussels (as quoted), "The first priority has to be getting at least a reasonable amount of gas to the Balkans. The Shah Deniz consortium and BP understand that if they were to build TAP, significant gas would have to be left in the Balkans".

If those 10 bcm per year are divided into two export directions, however, questions arise. What volumes might still be deemed reasonable or significant, if they are mere leftovers from those finite 10 bcm? And how to define the Balkans in this context? TAP would sell some meager volumes in the Balkan countries of Greece and Albania (en route to Italy); whereas Nabucco covers other Balkan countries as well as Central European ones along its route (Bulgaria-Romania-Hungary-Austria-southern Germany). If the gas flow is divided into two main directions, which countries would still qualify for supplies and how small would those supplies have to be?

The European Commission had strongly favored Nabucco on strategic grounds against the Italy-bound, non-strategic projects TAP and ITGI (Interconnector Turkey-Greece-Italy pipeline - recently forfeited to rival TAP). By October-November 2011, however, Nabucco had finally lost credibility in the form proposed (31 bcm of gas annually, starting from Turkey's east, its 8 billion euros (US$10.6 billion) cost an underestimate, and being unbankable in Europe).

In that situation, the European Commission fell back on supporting the Southern Corridor as an overall concept (Nabucco, TAP, ITGI), but reaffirming the same policy priority - namely, supply diversification for countries over-dependent on Russian Gazprom. Those are the Nabucco countries, not the TAP transit countries or Italy.

The TANAP agreement of intent, signed by Azerbaijan's and Turkey's governments on December 26, 2011, gave Nabucco a new lease on life as a potential extension of TANAP into EU territory. Under the agreement, Azerbaijan and Turkey would own 80% and 20%, respectively, of TANAP shares (with an option for Azerbaijan to sell a portion of its shares later to a minority partner, rumored to be BP).

Construction costs are estimated at $5 billion to $6 billion, to be covered by Azerbaijan proportionately with its ownership share. The initial capacity is planned at 16 bcm of gas per year (including 6 bcm for Turkey and 10 bcm for European countries), scalable to 30 bcm annually with additional volumes expected from Azerbaijan and Turkmenistan. Construction work is planned for 2013 to 2017, timed to the first commercial gas flow from Shah Deniz Phase Two by 2017-2018.

The Trans-Adriatic Pipeline (TAP) project threatens the reconfigured Nabucco West and the TANAP-Nabucco West connection. Led by Norway's Statoil, TAP proposes to take those same 10 bcm of Shah Deniz Phase Two gas to Italy as its main market, selling some small volumes along the route in Greece and Albania. "TAP" is an outdated designation; the project by now involves building a longer overland pipeline across Greece, adding to the original trans-Adriatic pipeline, and correspondingly raising the project's costs.

In Italy, the TAP pipeline would link up with the country's pipeline network, operated by Snam (a Gazprom ally). TAP promises to use Italy as a gas "hub" for this project, with onward transportation or swapping of gas to Switzerland and other European countries.

TAP leader Statoil claims that the project enjoys the following "advantages": a possibility to increase the capacity from 10 bcm annually to 20 bcm annually; a link up from Albania to Western Balkan countries (possibly from a storage site to be built in Albania); and use of Italy's pipeline network for further trading operations, inside Italy and northward of it.

At 10 bcm, TAP has limited value, non-strategic with respect both to volume and to destination market. At a putative 20 bcm, however, TAP would turn downright anti-strategic, diverting gas supplies away from countries that depend on Gazprom's monopoly. As long as the EU's strategy is supply diversification, TAP becomes anti-strategic. Italy (as well as Switzerland) is highly diversified and amply supplied; whereas Southeastern and Central Europe (Nabucco countries) need both the diversification and the additional volumes. Describing a storage location in Albania as "strategic" seems hardly convincing (and has not been repeated in the latest company statements).

Ultimately, Azerbaijan will have its own say in selecting export destinations from Shah Deniz Phase Two, other Azerbaijani gas projects, and ultimately Turkmen gas. TANAP itself can link up with a continuation pipeline either toward Central Europe or toward Italy, depending on commercial advantages to Azerbaijan. By re-investing its early oil revenues, Azerbaijan can guarantee financing for the TANAP pipeline across Turkey.

From Statoil's or BP's standpoint, exporting Azerbaijani gas to Europe are corporate business propositions. To Azerbaijan, however, this represents more than a lucrative business opportunity to be maximized. It represents a vital national interest and an investment into the country's future, a direct link to Europe, and Azerbaijan's emergence as an international gas exporter - comparable with its role as oil exporter - and for a longer duration. Thus, TANAP gives Azerbaijan a strong hand to play in the upcoming negotiations.

Fed-encouraged inflation serves only banks and borrowers....

Bernanke looks wrong way while Fed-encouraged inflation serves only banks and borrowers....

By Axel Merk

In his new lecture series, Federal Reserve chairman Ben Bernanke is going out of his way to discuss the "problems with the gold standard". To a central banker, the gold standard may be considered "competition", as their power would likely be greatly diminished if the US were on a gold standard.

The Fed, Bernanke argues, is the answer to the problems of the gold standard. We respectfully disagree. We disagree because the Fed ought to look at a different problem.

Bernanke lists price stability and financial stability as key objectives of the Fed. Focusing on the latter one first, the Fed was established to reduce the risk of financial panics. Bernanke points out:

A financial panic is possible in any situation where longer-term, illiquid assets are financed by short-term, liquid liabilities; and in which short-term lenders or depositors may lose confidence in the institution(s) they are financing or become worried that others may lose confidence.

Bernanke goes on to blame the gold standard for the panics. While he is certainly not alone in his view - indeed, his very lecture to students at George Washington University is promoting that view to a new generation of economists - we beg to differ.

Banks - by definition - have a maturity mismatch, making long-term loans, taking short-term deposits. As such, banks are prone to financial panics as described by Bernanke. To mitigate the risk of financial panics, central banks can do what the Fed is doing, namely to be a lender of last resort. Alternatively, central banks can focus on the core issue, the structural "problem of banking".

Following the Fed's approach, there are inherent moral hazard issues - incentives for financial institutions to increase leverage, to become too-big-to-fail. To address a panic that might happen anyway, the Fed would double down (provide more liquidity), potentially exacerbating future banking panics. After yet another crisis, new rules are introduced to regulate banks.

The resulting financial system may not be safer, but it will increase barriers to entry, further bolstering the leadership position of existing, too-big-to-fail banks. With all the government guarantees and too-big-to-fail concerns, banks might then be regulated in an attempt to have them act more like utilities.

Ultimately, that might make the financial system more stable, but will stifle economic growth. Financial institutions, as much as we have mixed feelings about their conduct, are vital to finance economic growth, as they facilitate risk taking and investment.

The problem of all financial panics is not the gold standard - otherwise, the panic of 2008 would not have happened. The problem of financial panics is - again - that "longer-term, illiquid assets are financed by short-term, liquid liabilities".

Missing from Bernanke's definition is a key additional attribute, leverage. A maturity mismatch without leverage might cause a lender to go bust, but - in our interpretation - does not qualify as a panic when a limited number of depositors are affected. The "panic" and the "contagion" may occur when leverage is employed, as it creates a disproportionate number of creditors (including consumers with cash deposits).

There's a better way. To avoid having financial institutions serve as "panic" incubators, regulation should address the core of the issue. Bernanke shouldn't use gold, as a scapegoat for all that was wrong with the US. economy previously, to justify a license to print money.

First, failure must be an option; individuals and businesses must be allowed to make mistakes and suffer the consequences. The role of the regulator, in our opinion, is to avoid an event where someone's mistake wrecks the entire system.

The easiest way to achieve a more stable financial system is to reduce incentives for leverage. A straightforward method is through mark-to-market accounting and a requirement to post collateral for leveraged transactions. The financial industry lobbies against this, arguing that holding a position to maturity renders mark-to-market accounting redundant.

Consider the following example, which highlights the implication: assume a speculator before the financial crisis took a leveraged bet that oil prices - at the time trading at $80 a barrel - would go down to $40 a barrel. In the "ideal world" according to the banks, this speculator would not have been required to post collateral and would have been proven right when oil (briefly) dropped to $40 a barrel after the financial crisis.

In reality, however, as oil prices soared to $140 a barrel before declining, the typical speculator would have been forced to post an ever larger amount of collateral; likely, the speculator's brokerage firm would have closed out the position, as the speculator ran out of money. The speculator lost money because he was unable to meet a margin call; importantly, though, the system remained intact.

The speculator might complain: the price ultimately fell to $40! But such whining is futile because the rules of engagement were known ahead of time. As such, the speculator had an incentive to use less (or no) leverage. The bank's attitude, in contrast, incubates panics. In this example, regulated exchanges exist. But even without regulated exchanges or easily priced securities, similar concepts can be developed.

Another way to make financial firms more panic prone is to require them to issue staggered subordinated debt. Rather than relying heavily on short-term funding (retail deposits or inter-bank funding markets), banks should be required to stagger the maturities of their own funding over years.

If, say, each year 10% of their loan portfolio needs to be refinanced, then - in times of financial turmoil - it might become exorbitantly expensive for a bank to finance that 10% of their loan portfolio. A bank should be able to shrink its loan portfolio by 10% in a year in an orderly fashion, without jeopardizing the survival of the firm or spreading excessive risks throughout the financial system. Note that this is a market-based mechanism to police the financial system.

These concepts reduce leverage in the system. And that's the point, as leverage is the mother of all panics. The concepts presented above will not solve all the challenges of banking, but blaming "the problem of the gold standard" for financial panics is - in our analysis - premature.

Modern central banking is not the answer to mitigate the risk of financial panics because the cost for this perceived safety is enormous. As a result of responding to each potential panic with ever more "liquidity", entire governments are now put at risk when a crisis flares up.

Beyond that, central banks have done a horrible job in containing inflation. The wisdom of central banking is that 2% inflation is considered an environment of stable prices. At 2%, a level often touted as a "price stable environment", the purchasing power of $100 is reduced to $55 over a 30-year period. It's a cruel tax on the public. What's more, in practice, countries with a fiat currency system have generally been unable to keep long-term inflation below 2%.

Bernanke warns of deflation. To the saver, deflation is a gift. Not to the debtor. In a debt-driven world, deflation strangles the economy. Governments don't like deflation as income taxes and capital gains taxes are eroded. In a deflationary world, governments would need to rely more on sales taxes (or value added taxes): gradually reduced revenue in a deflationary environment would be okay as the purchasing power of those tax revenues would increase.

That assumes, of course, that the government carries a low debt burden - deflation would be a good incentive to limit spending. Get the picture why governments don't like deflation?

Black Sea sliver may decide Nabucco fate....

Trans-Caspian pipeline remains distant prospect, Black Sea sliver may decide Nabucco fate....

After Turkmen government representatives met European Union officials to discuss a possible gas pipeline across the Caspian Sea, a leading energy expert said the chances of it happening were slim. Talks on the pipeline took place at a conference in Berlin on March 12-14, intended to promote the EU-backed Southern Gas Corridor project to take natural gas from the Caspian region to Europe.

To become more than a plan, this framework pact would need at least two pipeline projects to come to fruition. First, a major westward route which could be either the Trans-Anatolian Gas Pipeline, on which Azerbaijan and Turkey recently signed a preliminary agreement; or else the long-heralded Nabucco pipeline from eastern Turkey to Europe, which would require an additional stretch to be laid to Azerbaijan.

Secondly, a pipeline would need to be laid under the sea from Turkmenistan to Azerbaijan to feed in gas from the Central Asian state’s massive reserves.

To facilitate this, Azerbaijan and Turkmenistan are likely to sign a bilateral agreement, in a talks process that the European Union has been mediating. This document would commit Turkmenistan to supplying a certain volume of gas to make the whole Southern Gas Corridor viable.

News Briefing Central Asia asked Rovshan Ibrahimov, head of the foreign policy department at the Centre for Strategic Studies in Azerbaijan, about the prospects for an undersea route - the Trans-Caspian Gas Pipeline project, TCGP - given the numerous obstacles it faces.

NBCentralAsia: How feasible is a pipeline across the Caspian?

Rovshan Ibrahimov: If the participants continue making the same arguments they did at the Berlin conference, the project will remain nothing more than a topic for endless debate. The practical realities and requirements for pushing the project forward are being ignored.

NBCA: Would existing treaties among Caspian littoral states allow Turkmenistan and Azerbaijan to sign the kind of bilateral agreement that’s planned?

RI: Legally speaking, there wouldn’t be a problems if Azerbaijan and Turkmenistan, at least, could reach a bilateral agreement on the status of the Caspian Sea. However, no such agreement exists.

Baku and Ashgabat disagree on which of them owns the Kapaz/Serdar hydrocarbon deposit. It’s impossible to agree on such matters when the states in question hold opposing views on how sectoral demarcation of the Caspian should work.

But even if we assume that Baku and Ashgabat do sign an agreement, we must also acknowledge the practical realities of geopolitics. Russia and Iran would obstruct it [TCGP] in every possible way. And it will not be possible to go ahead and ignore their national interests.

NBCA: What are the conditions for mitigating the risks and for making the Trans Caspian south branch a reality?

RA: At the Berlin conference it was agreed that the EU would sponsor the [Azerbaijani-Turkmen] agreement. But the EU will also have to provide security guarantees, and insure against possible interference by Russia and Iran.

Furthermore, the financing for the project has to be clarified. It would be reasonable to expect the EU to provide this, but I doubt it is in a position to do so - it doesn't have the mechanisms. Its foreign and energy policies are implemented through inter-government ties, not at supranational level, and this limits the options for reaching comprehensive agreements.

Germany, the driving force in the EU, has close connections with Russia [an opponent of TCGP] in the gas sector. It's unclear whether the EU will provide the kind of guarantees that Azerbaijan and Turkmenistan will need to make the pipeline happen. Neither country is going to be able to handle the risks on its own....

Black Sea sliver may decide Nabucco fate....
By Vladimir Socor

On March 22 and 25, Romania's Foreign Affairs Minister Cristian Diaconescu announced on television that a "legal dispute" ("litigium") exists between Romania and Bulgaria over the delimitation of their maritime border, continental shelf, and exclusive economic zones in the Black Sea.

The dispute affects, in one way or another, ExxonMobil's oil and gas exploration plans in Bulgarian waters, Gazprom's South Stream project, and the EU-backed Nabucco project.

Diaconescu's initial announcement generated some confusion until Romanian diplomats intervened with clarifications. The minister stated that the dispute over maritime borders concerned an area of merely 17 square kilometers; and he complained also about Bulgaria's treatment of its ethnic Romanian minority, seemingly linking the two issues.

According to subsequent Romanian clarifications, the disputed maritime area measures some 350 square kilometers in a critical location. It forms a triangle, centered on the point at which Romania's, Bulgaria's, and Turkey's respective exclusive economic zones converge.

Bucharest's follow-up statements no longer mentioned the Romanian ethnic minority issue in Bulgaria, but digressed into a further border issue on the Danube, where the river's thalweg (main channel, deepest watercourse) has apparently shifted toward Bulgaria, inspiring Bucharest to seek a corresponding shift of the riverine border in Romania's favor.

In the Black Sea, the disputed area overlaps with ExxonMobil's planned offshore exploration area. The disputed area also intersects South Stream's planned route on the seabed of the Black Sea to the Bulgarian coast. And it would (if Romania wins its claim) narrowly connect Romania's exclusive economic zone directly with Turkey's exclusive economic zone on the seabed of the Black Sea, potentially enabling Romania to link up with Turkey by an offshore pipeline, instead of the overland Nabucco via Bulgaria (see below).

According to Romania's Foreign Affairs Ministry, two recent developments prompted Bucharest to serve public notice that this legal dispute exists. On January 31, Bulgaria announced its offshore oil and gas exploration tender via European Union official publications, staking out a 14,000 square kilometer area that overlaps with Romania's continental shelf claim.

On March 19 (the direct trigger), the CEOs of Gazprom and Bulgargaz, Aleksei Miller and Dimitar Gogov, agreed in Moscow to promptly designate a company for mapping out South Stream's Bulgarian section, starting with the pipeline's landfall point on the Black Sea coast.

Romania is in a position to delay both of those projects, simply by announcing that a portion of that area forms the object of a legal dispute between Romania and Bulgaria. This could result in protracted negotiation and litigation between the two countries.

Alternatively, it could force re-mapping and other adjustments to a Bulgarian-ExxonMobil offshore exploration project, as well as to South Stream. The existence of a legal dispute would require these projects to stay out of the disputed area, at least pending its adjudication.

As a third possibility, Gazprom and Bulgaria would have to apply for Romanian consent in order to lay the pipeline through the now-disputed area.

According to Romania's State Secretary for Foreign Affairs, Bogdan Aurescu, the Nabucco pipeline might run from Turkey directly to Romania on the seabed, bypassing Bulgaria. This could become a possibility, if Romania wins the seabed portion that would connect its exclusive economic zone with Turkey's.

This "if" seems a big if in the first place; but even in that eventuality, there is no basis for assuming that Caspian gas suppliers or transit pipeline owners would consider such an idea. As an attempt to build Romanian negotiating leverage against Bulgaria, it lacks credibility.

On the other hand, forcing a delay to South Stream (even at the perception level, which matters primarily with South Stream) would help Nabucco to survive as "Nabucco-West" from Bulgaria to Vienna. This could be the Trans-Anatolia project's continuation pipeline into EU territory.

Romania and Bulgaria have been negotiating since 1994 over delimiting their maritime border, continental shelf, and exclusive economic zones. By various counts, either 14 or 17 rounds of Romanian-Bulgarian negotiation have been held since 1994 at the expert level. Based on the Convention on the Law of the Sea (1982), the two countries seek to advance from the territorial waters limit of 12 nautical miles to the 200 nautical miles limit of exclusive economic zones.

Their respective claims overlap in the small but key area that Romania has now officially declared as "disputed". In the wake of this demarche, Bucharest and Sofia both declare that they seek a bilateral solution, as soon as possible.

Sofia has both good reasons (ExxonMobil offshore exploration) and bad reasons (South Stream) for seeking a quick bilateral solution with Bucharest. The Romanian side, however, has no apparent reason to hurry; instead, it is well placed to stall the bilateral negotiations and go to international litigation.

According to the Foreign Affairs Ministry, Romania is prepared to take the dispute to the International Court of Justice (ICJ) in The Hague, to the International Tribunal for the Law of the Sea in Hamburg, or to some arbitration court.

In 2009, Romania won its case against Ukraine at the ICJ after many years of litigation over delimiting the continental shelf and exclusive economic zones in the Black Sea. The court awarded Romania 9,700 square kilometers, out of the 12,200 in dispute with Ukraine. State Secretary Aurescu litigated that case for Romania. That success colors Bucharest's attitude in the dispute it has just declared with Bulgaria.

In Sofia, the Foreign Affairs Ministry called in the Romanian ambassador for explanations, then issued a conciliatory statement. Satisfied that Romania does not pose "territorial claims", Bulgaria is prepared to negotiate for a quick resolution of the dispute "in the spirit of both countries' membership in the European Union". Prime Minister Boiko Borissov and Bulgarian diplomats are responding in conciliatory tones.

If Bucharest persists with its current approach, Sofia will be playing the weaker hand. Sofia's tactics seem designed to let Bucharest look unreasonable in the eyes of Brussels....

Ben Shalom Bernanke is a misguided Spartan guarding the pass for his paymasters....

Ben Shalom Bernanke is a misguided Spartan guarding the pass at Thermopylae for his paymasters in the financial world....

Dan Denning

Poor old Ben Bernanke has a deflation phobia. He sees it everywhere the way the kid in The Sixth Sense saw dead people. And Bernanke is equally terrified of falling stock prices (and their effect on consumer confidence).

Falling stock prices are what some people call deflation, or asset price deflation. Bernanke, the governor of the US Federal Reserve, believes the Fed made the Depression a Great Depression by raising interest rates too soon during the US recovery. He won’t make that mistake again! He will simply not allow stocks to fall.

The Fed chairman’s recent speech to the National Association for Business Economics lit a fire under US stock prices. All the US indexes charged ahead. And even gold got off the mat to close higher. Stocks are addicted to lower interest rates and yesterday they got a nice satisfying hit.

Bernanke is on the record for saying he’ll keep US rates low until 2014. Yesterday he repeated his willingness to keep rates low, saying, “Further significant improvements in the unemployment rate will likely require a more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies.”

It’s a bizarre world. The Fed chairman thinks lower rates are needed to produce more economic growth. Growth will produce jobs. Jobs will lead to spending. Only then can interest rates — the price of Fed money — be raised.

It’s a shame he can’t understand that the US rate policy is unsound. And since the rest of the world more or less keys off from US interest rates, an unsound US monetary policy leads to an unsound global monetary policy. By “unsound” we mean a policy that keeps interest rates too low, leads to asset price inflation, and a giant boom in debt.

This is all well-worn territory to long-time Daily Reckoning readers. If there’s anything comforting about the tenacity of Bernanke’s stupidity it’s that you have time to narrow down your stock holdings in a rising market. It’s much better to exit the market when stocks are floating along on a sea of liquidity than when they are crashing down.

But then that’s the issue now, isn’t it? As scared as Bernanke is of the 1930s, he and his central banking colleagues around the world are even more scared of another Lehman Brothers. This was a point we made at our Sydney conference. The lesson of Lehman is that central bankers will simply not allow another major financial institution to fail. They can’t afford to.

The financial system is still so leveraged and interconnected (mostly through the derivatives market) that regular infusions of credit and the monetization of government debt are required to keep it at a steady level. In some ways, the deflation you’d normally expect at the end of a credit bubble is actually happening right now — it’s just disguised by the huge growth in central bank balance sheets.

In other words, stock markets have become a giant charade. The indexes don’t communicate useful or accurate information. Prices have become more influenced by the supply of credit in the system than the underlying earnings of the businesses on listed exchanges. The whole thing looks suspiciously like a racket designed only to benefit the banks, the brokers, and the bureaucrats who nominally regulate them.

It’s kind of refreshing to say that, although we concede we could be wrong. It’s refreshing because once you acknowledge that the game you’re being asked to play is rigged, you can choose not to play the game. This makes your asset allocation decisions a lot easier. For instance, we bought more gold bullion this morning.

Not everyone agrees with our view that these periodic rallies are great times to liquidate portions of your portfolio. For example, Goldman Sachs released a report last week making the case for stocks. The report had a lot of big words and complicated arguments. But the basic argument was that stocks will do better than bonds, especially if the Fed keeps rates low.

People seem to forget that businesses exist to provide cash flow to their owners by providing services to their customers. Instead of an investment strategy that depends on the Fed’s monetary policy, why not invest in businesses that grow their earnings without using leverage? That seems like a better long-term bet.

In any event, the Fed’s willingness to keep pumping credit into the financial system gives you time, or at least the illusion of time. Time is a valuable commodity. It’s so valuable you can’t even buy it or sell it. You can only maximize it by using it to your best advantage. These rallies should be sold.

This brings us back to the code breakers of Bletchley Park. These men were brilliant. But they would never have become important if it hadn’t been for the hubris and paranoia of Nazi Germany. Allow us to quickly explain.

You may be familiar with the story of Alan Turing. He was one of the heroes of Bletchley Park. He’s credited with breaking the code used on Germany’s Enigma machines. Those machines were found especially in German U-boats, but were used throughout the German war machine.

Turing, by the way, later became famous for being a sort of God- father of information theory. His work led to the development of the first real computers (Turing machines). The video we linked to yesterday was so interesting because it showed that the Colossus machine built by Tommy Flowers, and based on the mathematics of Bill Tutte, was actually the world’s first electronic and digital computer.

But the Enigma machines were not used by Hitler or the German High Command for their most private and secret communications. Those conversations were conducted via encrypted messages sent by a Lorenz machine, or Hitler’s Blackberry, as one historian has called it. The German word for this machine is Geheimschreiber, or secret writer.

The British called the code generated by the Lorenz machines “Tunny”. Bill Tutte cracked Tunny in 1941. It was an amazing achievement, but it wouldn’t have been possible without a mistake. On August 30th, 1941, the German high command sent the same message twice from Athens to Vienna.

It was a 4,000-character message that wasn’t received correctly the first time. When it was sent a second time, the operator in Athens didn’t change the key in which the message was encrypted. The result was two messages sent with the same encryption. This provided cryptographers with what they call “depth”. Depth allows for pattern detection, but obviously requires multiple messages with the same encryption.

There are many fascinating aspects of the story. For example, you’d think that if the Allies could read the messages between Hitler and his commanders as early as 1941, the whole war would have been shortened. And in fact, it probably was. But the Allies had to be careful about how they used the intelligence they gathered from Tunny.

If, for example, the Allies avoided every German ambush, were prepared for every German attack, and shot down every airplane carrying a German officer or general, it would have been obvious to the Germans that their communications weren’t secure and their code had been broken. The Allies had to use the intelligence gathered from Tunny in a way that looked random and improbable, not in a way that looked like they knew exactly what was coming.

Another interesting aspect is the use of pattern detection in code breaking. It would be nice if you could do the same with stock prices. You can’t, of course. But it is some consolation to know that there are patterns in economic and financial history you can study. They aren’t predictive. But they can give you a picture of what has happened in the past. Maybe this improves your probability of correctly preparing for the booms and busts ahead. Or maybe not.

By far the most interesting aspect of the whole affair is how trusting the Germans were in technology. This trust was born of a mistrust of people. The Nazis required machine-generated secrecy because the regime was paranoid. It never occurred to Hitler that his unbreakable machine had been broken. His penchant for secrecy became the proverbial Achilles heel.

We would attribute this failing not just to Hitler or to human psychology but to the entire idea of National Socialism, or top-down central planning. People who believe in their own ability (and moral right) to organize society (and economy) according to their ideals and prejudices are naturally arrogant and possibly psychopathic. That’s why you should never vote for anyone who believes themselves deserving of public office.

The Nazis’ paranoid self-belief cut them off from real thinking people capable of making sound judgments and put them at the mercy of, in this case, machines. It’s no coincidence that the people who support regimes like this are little more than Turing machines that follow orders as if they had no free will. The non-thinking and non- questioning people of the world are generally more compliant of tyranny. In fact, tyranny wouldn’t be possible with them.

By contrast, the British and American code-breaking effort was full of people that would have been excluded from the Nazi hierarchy, or exterminated in the death camps. Jews, gays, loners, and eccentrics all flourished in the Allied war effort, although Turing, who was gay, was later treated shamefully by the British government. These societies were not afraid of using every asset they had in order to defeat their enemies.

Systems that allow human ingenuity to flourish are far more likely to adapt and survive in a hostile environment and produce prosperity (or prolong life, in simpler terms). It’s probably a bit of a stretch to call Bletchley Park (or the Manhattan Project, for that matter) open systems. They were ultra-secret projects, of course. But they did draw on all the talents and strengths produced by American, British, and European society at the time. And those societies were all stronger because of their commitment to political and economic liberty.

We’re referring to the bedrock strengths of liberal democratic societies: the belief in open and honest scientific inquiry, basic political and religious liberty, and the rule of law committed to the protection of private rights and low taxes. Liberal systems must sometimes defend themselves from predatory ideologies and nation states. In this instance, the strengths of liberal society were put in the service of defending the system against the Axis powers.

When not mobilized for war, these strengths, at least for most of the last 300 years, have created innovation and prosperity for individuals in the free market. That should be encouraging. The intuitional DNA of the Western world is strong. If Aristotle is right that all men by nature desire what is good, then we will survive this current experiment in centralized government funded by unsound money and get back to a better, more resilient system.

Today’s system of the world can hardly be described as liberal or democratic or open or resilient. Institutions have been corrupted by unsound money, an intrusive State, and the myriad bad private decisions made by people and corporations under the influence of too much credit. Innovation and adaptation are stifled by a commitment to the debts incurred by corrupt politicians and lazy voters.

Our system, in other words, has become inflexible. This inflexibility makes it brittle and fragile, even as the stewards of the system remain supremely confident in both it and themselves. Hitler’s Blackberry and Bernanke’s printing press are both creations of hubris and vulnerable in the same way. Their overconfidence is their weakness.

But in a way, we’re thankful we’ve got Ben Bernanke on the job. Bernanke is like some misguided Spartan guarding the pass at Thermopylae (for his paymasters in the financial world). He’s giving them time to exit the system at a profit, passing the losses on to tax payers. But his commitment to the dollar-standard and low interest rates gives you time to prepare your portfolio for the world ahead...once the money printers are overrun by their own creation.....

Gazprom seeks Israeli gas for Asia, denying it to European markets....

Gazprom seeks Israeli gas for Asia, denying it to European markets....?
By Robert M Cutler

MONTREAL - Russia's Gazprom announced this week that its Swiss-based subsidiary Gazprom Marketing and Trading, created just last year, has signed a letter of intent with the consortium exploiting the Tamar offshore Israeli natural gas deposit to begin talks for marketing gas from Tamar and another offshore field, most probably Dalit.

Tamar is estimated to contain 265 billion cubic meters (bcm) of natural gas. Gazprom has also expressed an interest in the offshore Leviathan deposit. It is being developed by Israel's Delek Group, and is estimated to hold 700 bcm of gas in addition to 4.2 billion barrels of oil.

Gazprom would purchase the liquefied natural gas (LNG) from a company that the Israeli consortium would create, Russian business newspaper Vzglyad reported. Gazprom's interest is principally to keep Israeli natural gas out of the European markets, where Russia is the principal foreign supplier.

The Tamar consortium has already committed between 113 and 136 bcm to six Israeli entities, including a 15-year deal to supply 42 bcm to the Israel Electric Corporation, according to reports published this week in the Israeli press, This will replace the natural gas that Israel used to receive from Egypt before the latter abrogated the contract and cut off the flow several months ago. Egyptian gas used to represent slightly over one-third of the source for electricity generation in Israel; the remainder comes from coal imported from Russia.

Gazprom's discussions on Tamar are focusing on the quantity of 2-3 million tons of LNG per year as from 2017, Reuters reports. The amount is equivalent to 2.8-4.1 bcm per year (bcm/y) after re-gasification. According to Gazprom's own unconfirmed report, the price would be based on Asian market norms, which are lower than those in Europe.

However, as the letter of intent does not prevent Israel from opening negotiations with other potential partners, this particular aspect of the report may be seen merely as a statement of Gazprom's preferences: much as the statement at the end of last year by the chairman of Gazprom's board of directors (and Russia's first deputy prime minister) Viktor Zubkov, that Gazprom would assist in the geological explorations and form joint ventures with Israeli entities, appears to have been statement of his firm's wishes rather than of agreements reached.

The shipbuilding and marine engineering arm of the South Korean firm Daewoo is constructing an LNG storage unit and terminal according to a November 2011 contract signed with the partners in the Tamar consortium - Noble Energy, Isramco Negev 2 LP, Delek Group, Avner Oil and Gas, and Dor Alon Energy in Israel Ltd - French sources report. The contract is reported to be worth several billion dollars and to extend out for 15-20 years.

Daewoo will construct these facilities so as to receive specially constructed Daewoo tankers that will take the gas to South Korea, where prices are between double and triple the price in Israel, French sources reported at the weekend.

In order to avoid the lengthy and politically sensitive process of permit-granting for an onshore gasification facility, efforts are being made to develop technology allowing the tankers to anchor offshore and take on the gas directly while also liquefying it, a process that involves cooling it to a temperature of approximately -160 degrees Celsius (-260 degrees Fahrenheit).

It appears that all these negotiations and contract-signings are proceeding without reference to the recent Aphrodite strike in Block 12 of Cyprus's exclusive economic zone, where the consortium is led by the same US-based company Noble Energy that leads the Tamar and the Leviathan consortia.

According to the Argus news agency, which specializes in energy matters, quoting chief executive Mehmet Uysal of the Turkish state firm TPAO, his company has signed exploration licenses both onshore and offshore with the administration of the island's northern third, the Turkish Republic of Northern Cyprus, which is recognized only by Ankara.

Of the eight exploration blocks concerned, Uysal says that some of them overlap with areas over which Nicosia asserts formal authority. Probably these are offshore from the port of Famagusta. Uysal said TPAO has no plans to drill there but may try exploration wells, although this decision would be taken by the Turkish government and not by TPAO; but TPAO would begin drilling its first onshore exploration well in the north this month.

Meanwhile, the Turkish newspaper Zaman, considered close to the ruling Justice and Development Party, quotes Turkey's Energy Minister Taner Yildiz as asserting that gas from Cyprus cannot transit Turkey because, rather incongruously, Israel has failed to apologize for the Mavi Marmara incident in 2009.

That concerns the so-called "Gaza Flotilla" incident in which nine passengers on the ship launched from a Turkish port died when, according to the United Nation's "Palmer Report" on the matter (named for former New Zealand prime minister Geoffrey Palmer, who headed the four-person panel), it sought "recklessly" to breach Israel's naval blockade of Gaza. According to the Palmer Commission, that blockade was a "legitimate security measure" to prevent weapons smuggling and was implemented in accordance with the requirements of international law.

Dr Robert M Cutler (http://www.robertcutler.org), educated at the Massachusetts Institute of Technology and The University of Michigan, has researched and taught at universities in the United States, Canada, France, Switzerland, and Russia.

Asia is playing catchup, China leading the way in the latest Arms race....

Asia is playing catchup, China leading the way in the latest Arms race....

By Trefor Moss,

Speculation that Asia is in the throes of an arms race has been about for longer than most defense watchers would care to remember. The speculation is usually idle, with the “arms race” label slapped casually onto news items that are really only about normal defense procurement. Almost all countries invest continually in their armed forces, and improve their capabilities according to their own particular means and requirements. That’s not an arms race.

However, the latest Trends in International Arms Transfers report, released this week by the Stockholm International Peace Research Institute (SIPRI), may point to the fact that something more than run-of-the-mill defense procurement may be happening in Asia. The SIPRI data tracks only weapon imports and exports, not domestic defense procurement, which accounts for most of China’s military outlay, for example. But the finding that Southeast Asian arms imports increased 185 percent in the period 2007 to 2011 compared with 2002 to 2006 is an eye-opener, however you look at it.

Even then, if we follow the dictionary definition of an arms race as being “competition between countries to achieve superiority in quantity and quality of military arms,” you have to doubt whether this describes what is occurring in Asia. Take the Philippines and Vietnam, which are both investing in their militaries to help protect their interests from China: there isn’t the slightest expectation that they will achieve superiority over the Chinese military in any department. Indonesia is beginning to ramp up funding for its armed forces, but Jakarta’s modest assembly of a “Minimum Essential Force” suggests it is racing only against the galloping obsolescence of its own rusting kit. Singapore continues to plough money into defense, but it won the quality race against Indonesia and Malaysia many years ago, having never so much as entered the quantity contest.

So, if there’s an arms race in Southeast Asian, it’s one concerned with avoiding the geostrategic wooden spoon. In spite of that 185 percent increase, these countries remain several laps behind the world’s, and even Asia’s, frontrunners. In much the same way, the U.S. is so far ahead of the chasing pack that it can’t be considered part of any meaningful race – especially with U.S. spending on defense slowing down, which is hardly the way you’d expect a racer to behave.

It’s to China and India that anyone concerned about an Asian arms race ought to be paying attention. Both Beijing and New Delhi would of course publicly reject the idea that they are engaged in an arms race, and argue that they are simply modernizing their armed forces. At what point, though, do the scales tip away from normal modernization and towards arms-racing?

There’s a sense that the scales have indeed begun to tip. The evidence is in the slowing of the Chinese and Indian economies. Double-digit defense spending rises are proportionate when the wider economy is growing at a similar rate. However, China’s defense budget is rising by 11.2 percent this year, against anticipated GDP growth of 7.5 percent. India’s defense budget is rising by between 13 and 19 percent, depending on your interpretation of the numbers, against forecasted GDP growth of 7.6 per cent.

Defense spending growth appears organic when it tracks GDP growth, because it sends a statement that defense has a fixed place in a country’s economic framework. But when it starts to outpace GDP growth, it looks like the country in question, and its military, are trying to get somewhere in a hurry – and that defense is ascending the ladder of government priorities.

The Chinese and Indian economies may now be experiencing structural changes that will consign the days of double-digit GDP growth to history. If, despite this structural slowdown, Beijing and New Delhi continue to fund double-digit defense spending rises, then we will know that the race is on....

The tiny island-state of Singapore, home to just over 5m people, has a well-deserved reputation as a quiet, clean-cut hub for banking, lawyering and golf. Yet beyond the fairways it bristles with weapons.

According to a report from the Stockholm International Peace Research Institute (SIPRI), Singapore is now the fifth-largest arms importer in the world, bested only by some obvious behemoths--China, India and Pakistan--plus South Korea. Singapore accounts for 4% of the world's total spending on arms imports. Its defence spending per head beats every country bar America, Israel and Kuwait. This year $9.7 billion, or 24% of the national budget, will go on defence.

These are striking figures, but then Singapore has been one of the bigger spenders in the region since its rancorous split from Malaysia in 1965. The difference now is that almost every country in South-East Asia has embarked on a similar build-up, making it one of the fastest-growing regions for defence spending in the world. Military analysts at IHS Jane's say that South-East Asian countries together increased defence spending by 13.5% last year, to $24.5 billion. The figure is projected to rise to $40 billion by 2016. According to SIPRI, arms deliveries to Malaysia jumped eightfold in 2005-09, compared with the previous five years. Indonesia's spending grew by 84% in that period.

It is part of a wider Asian phenomenon. For the first time, in modern history at least, Asia's military spending is poised to overtake Europe's, according to the International Institute for Strategic Studies, a think-tank in London. China is doubling its defence budget every five years and India has just announced a 17% rise in spending this year, to about $40 billion.

Until recently domestic insurgencies have amply justified some South-East Asian countries' defence spending. Yet for decades there have been no interstate conflicts. An existential angst remains in Singapore over Malaysia to the north and Indonesia, its big neighbor to the south. Still, it is hard to imagine any of the Association of South-East Asian Nations (ASEAN) locking horns, apart perhaps from Cambodia and Thailand, who lob the occasional artillery shell at each other over a disputed temple on the border.

Mostly, though, countries seem to be exploiting economic success to update their hardware while the going is good. Defence spending slowed sharply after the Asian financial crisis in 1997-98, when many planes and ships were already old. Now many countries are enjoying rapid economic growth, of up to 6% a year, and robust budgets. This is not, says Bill Edgar of IHS Jane's, a "strategic" arms race. Rather, he says, it is all about modernization.

Take the regional giant, Indonesia. The Indian Ocean tsunami of 2004 not only devastated communities, it also laid bare the shortcomings of the armed forces, which proved to be ill-equipped and demoralized. As American and Australian troops poured off aircraft carriers and other ships into the ravaged province of Aceh to bring aid and search for victims, Indonesian troops were reduced to spectators. The newly elected president, Susilo Bambang Yudhoyono, took the humiliation personally. A former general, Mr Yudhoyono has since made modernizing Indonesia's armed forces a priority.

Indonesia is spending $8 billion this year on defence--still rather modest for a country of 240m, but up sharply from $2.6 billion in 2006. Much is going on new hardware and spare parts. The country has acquired Russian and American warplanes, including F-16 fighters, vessels for its navy, and spare parts for its C-130 transport planes. In January Indonesia signed a $1.1 billion deal for three German-made diesel-electric submarines, and lawmakers are debating whether to buy 100 Leopard tanks from the Netherlands. Mr Yudhoyono also wants to improve the lot of soldiers, with higher salaries and benefits.

Domestic political calculations are another factor behind the region's defence splurge. Terence Lee at the National University of Singapore argues that in countries where the armed forces have meddled in politics, civilian politicians use larger defence budgets to buy political compliance from the military--Thailand is a case in point. Singapore, on the other hand, has a different motivation. It is the only country in the region building its own high-tech arms industry. Singapore has long sold weapons to other developing countries, but has recently been winning its first large orders from Western armies too. ST Engineering, the only South-East Asian firm in SIPRI's top 100 defence manufacturers, has sold over 100 Bronco (or Warthog) armored troop carriers to the British, for use in Afghanistan.

For all that, strategic concerns do count for something. For example, the sea lanes leading to the Strait of Malacca are the lifeblood of Singapore's prosperity. And over the past decade, some may have worried that America was distracted by war elsewhere. So the growth of a Chinese blue-water navy has implications.

Strategic concerns also loom large for any country with a territorial claim to the disputed South China Sea (see next story), where China's assertive stance has provoked a surge of spending by, for instance, Vietnam. The country recently ordered six Kilo-class submarines from Russia. Vietnam is also buying seven or so new frigates and corvettes over the next decade. In the Philippines the government of President Benigno Aquino almost doubled the defence budget last year, to $2.4 billion.

Even with new submarines and planes, Vietnam and the Philippines are still no match for Asia's new superpower, should it come to war. But it might make China think twice, or even thrice, before trying anything, and buy time before America--presumably--comes to the rescue.

BRICS pump up foreign aid...

BRICS pump up foreign aid...

The so-called BRICS — Brazil, Russia, India, China, and South Africa — are upping their foreign assistance by leaps and bounds at a time when traditional donors’ aid budgets are frozen...

By Elizabeth Dickinson,

Western donors are no longer the only significant providers of international aid as emerging powers are extending their outreach abroad.

For more than a half-century, Western donors have dominated international aid. Rich countries such as the United States, Canada, Britain, and Japan have sent resources, technical expertise, human capital, and ideas to help countries in Africa, Latin America, and Asia develop economically.

But over the last half-decade, the traditional flow of money has begun to shift dramatically, according to a report released today by Global Health Strategies Initiatives, an international nonprofit. The so-called BRICS countries — Brazil, Russia, India, China, and South Africa — are increasing their foreign assistance by leaps and bounds at a time when traditional donors’ aid budgets are frozen or even decreasing.

Traditional donors still vastly outspend their peers in the BRICS. But as the BRICS begin to play a larger role, they stand to reshape not just the budgets but the entire philosophy of international aid. While aid efforts in the past have often been conceived and designed in Western capitals, BRICS countries are refocusing on approaches and innovation conceived in and made for the global South.

“Rather than seeing [beneficiary countries] as grantees, they are more likely to see them as partners,” says Sridhar Venkatapuram, a lecturer at Cambridge University and contributor to the report.

Of course, like traditional donors, the BRICS also bring their own baggage to the table. Aid tends to align with geopolitical interests and focus on areas that are linked to the countries’ domestic economies or priorities. But Western countries have long had a monopoly on using development assistance to curry favor. It’s only natural for the world’s rising powers to get into the game.

Double-digit spending growth

Between 2005 and 2010, Brazil and India grew their foreign aid spending by more than 20 percent. China and South Africa both upped their assistance by about 10 percent. Russia, which had increased its own spending earlier in the decade, now devotes about $500 million annually to development spending overseas.

Over the same period, the foreign aid budget of the United States grew just 1.6 percent. The aid budgets of Britain, France, and Germany all grew slower than 5 percent annually. To codify their increasing efforts, BRICS countries will consider a proposal by India to unify development efforts and create a “BRICS Development Bank” — an analogy to the World Bank, long dominated by Western nations — when they meet for a summit in New Delhi on March 28 and 29.

Among the most promising aspects of the BRICS increased development assistance are their own recent domestic experiences combating similar troubles, the report argues. Public health challenges persist on a large scale in all five countries, but so too do examples of success.

“[Common] experience in a way puts the BRICS and the grantees on the same side in dealing with challenges,” says Dr. Venkatapuram. “The lessons and insights shared by peers can potentially be more relevant and effective.”

India takes lessons abroad

Take India, for example, which succeeded in eradicating polio in February 2012, just three years after reporting the highest caseload of any country in the world. The country’s success was locally driven: The government poured in $1.49 billion over a decade to inoculate the population and build the local health infrastructure necessary to treat the disease. Now it’s looking to take its experience elsewhere. Over the last three years, India has spent $100 million on health projects overseas, largely focused on building up local medical systems and transferring expertise.

Brazil provides a similar example with HIV, an area in which it has invested massively both at home and abroad. In 1996, Brazil’s government promised to provide Anti-Retroviral Treatment to all AIDS patients in need of treatment.

“At the time of Brazil’s commitment, many global policymakers doubted the feasibility of providing universal access to ARV treatment in a developing country with limited resources,” the report recounts. “Brazil’s success upended this conventional wisdom, and the program has become a source of great pride. As a result, other developing countries have sought Brazil’s cooperation and counsel on their own HIV/AIDS and ARV policies.”

The example of HIV assistance from Brazil is indicative of the strategy that nearly all BRICS countries favor: Let demand drive aid. Many of Brazil’s HIV programs overseas in African countries were inaugurated at the request of those local governments, not Brasilia’s suggestion.

For recipient governments, there are also advantages to seeking assistance from BRICS countries, rather than traditional donors. “BRICS have recent and continuing experience with responding using limited resources, low cost resources and strategies, and reaching large populations in non-urban settings,” says Venkatapuram.

The Indian health sector has focused innovation on e-health in recent years, for example, providing diagnosis for conditions by remote teleconferencing. Such technologies are geared precisely to the developmental conditions that a country in, say, West Africa might require. And they are systems that the West simply doesn’t have (or need) access to.

Lack of transparency, monitoring

Development aid from the BRICS is not, of course, immune to the challenges that have plagued assistance from the West for decades. Critics note that the development institutions set up in each of the BRICS countries lack the same level of transparency and monitoring that one might find in, for example, the US Agency for International Development.

The BRICS also clearly have their own interests for getting involved overseas. International influence is one motivation, says Eduardo J. Gomez, a professor at Rutgers University who is writing a book on Brazil’s rise and has studied the country’s health programs overseas. “Brazil has always wanted to be with the ‘in crowd,’ if you will, at the international level, always wanting to get involved and influential.”

There are also more direct advantages for the new donors. Brazil’s and India’s global health programs overseas, for example, often draw on local drug industries at home, providing a market for vaccines and generic treatments. China’s international aid has perhaps come under the most scrutiny for being opportunistic, securing access to minerals and other raw materials in exchange for foreign aid. “By helping to improve health in developing countries, Chinese policymakers feel they can have health impact and help build political and economic alliances,” the report argues.

Still, for the large part, the new donors are being welcomed, says Dr. Gomez. “There's is no hostility or jealousy from the traditional donor nations,” he said on Sunday. “My sense is that the world recession has led traditional donor leaders to welcome contributions from Brazil and other nations.”

Zioconned US Air Force spends more and more on new bombers, with less and less to show for it....

Zioconned US Air Force spends more and more on new bombers, with less and less to show for it....

By David Axe,

In an instant, four tons of steel and explosives slammed into the 522-foot-long warship Schenectady, blowing it apart in a cataclysm of smoke, dust and sound. Overhead, a pair of U.S. Air Force Boeing B-52 bombers orbited, one of them having just released four laser-guided bombs. The huge, eight-engine warplanes had flown directly from Louisiana to attack the decommissioned Navy landing ship as part of an exercise near Hawaii on Nov. 23, 2004.

Schenectady’s dramatic destruction marked a turning point in the Pentagon’s approach to aerial warfare, and led directly to one of the flying branch’s riskiest-ever investments. The sinking of the Schenectady by the Air Force was meant to prove to the flying branch’s reluctant Pentagon masters that bombers could play an important role in a major ocean battle against China and its gigantic navy. In underscoring bombers’ usefulness, the Hawaii demonstration was also part of the Air Force’s efforts to get the Defense Department to sign off on a new bomber program. Two years later, the Air Force got its wish when the Pentagon finally gave the go-ahead for the so-called “Next-Generation Bomber.”

But that program foundered and was cancelled three years later. After a change in leadership in the Defense Department, the Air Force once more pushed for a new bomber initiative — and, again, got it. This year the Pentagon launched a potentially $55-billion effort to build a better bomber, one capable of replacing the venerable B-52 and preserving the long-range, heavy strike prowess the Air Force demonstrated that day off Hawaii eight years ago.

The “Long-Range Strike Bomber” program is a subject of great concern inside the Pentagon, and the topic of my latest investigative feature for the Center for Public Integrity. (The Atlantic also has a version of my story.) Even more than the Air Force’s notoriously expensive stealth fighters, bombers are susceptible to program delays, budget overruns, cutbacks and skyrocketing costs. For half a century, bombers have been a symbol of the Air Force’s overwhelming firepower … and a poster child for Pentagon waste.

If history is any judge, the development and production of up to 100 new Long-Range Strike Bombers has a high probability of ending disastrously. Every time the Air Force has tried to buy a new heavy warplane to replace the 1960s-vintage B-52, it has ended up spending tens of billions of dollars for a dwindling number of aircraft.

In the ’50s and ’60s the Air Force built nearly 800 B-52s for just $70 million apiece in today’s dollars. The first bomber meant to replace the B-52, the ’80s-vintage swing-wing B-1, ended up costing more than $200 million per plane. The third effort, the stealthy B-2 (pictured), shattered cost records with its eye-watering $3-billion-a-pop unit price. Today the Air Force possesses just 60 B-1s and 20 B-2s. The 70 surviving B-52s still form the backbone of the bomber fleet, more than 50 years after they entered service. All three bomber types have been heavily involved in aerial campaigns over Serbia, Afghanistan, Iraq and Libya in the past 15 years.

Even so, the Air Force’s inability to replace the B-52 at reasonable cost led the Pentagon at one time to essentially abandon bomber development. As recently as 1999, the Defense Department had no plans to buy a new bomber before 2037. But the Air Force, nervously observing the rapid growth of the Chinese military, believed it needed a new bomber to stay ahead in the Pacific. The orchestrated destruction of the Schenectady was part of the Air Force-led campaign that helped convince the Pentagon that bombers were critical to winning any future air war against China. Sinking the old Navy ship was meant to prove that the Air Force could defeat a Chinese invasion fleet steaming towards Taiwan, according to retired Lt. Gen. Dave Deptula, who helped organize the 2004 demonstration.

Today Deptula is part of a group of current and retired senior officers who have spoken out on behalf of Air Force bombers. “They allow you to project power globally without projecting vulnerability,” Deptula says of the heavy warplanes. In other words, bombers can deliver massive firepower without the need to deploy a big, vulnerable ground force.

Donald Rumsfeld, the secretary of defense from 2001 to 2006, was convinced by the bomber advocates’ arguments and gave the flying branch permission to develop the so-called “Next-Generation Bomber.” But that new plane design quickly grew to be as complex — and potentially as expensive — as the $3-billion-a-copy B-2. Robert Gates, who took over from the disgraced Rumsfeld, was aghast. “It makes little sense to pursue a future bomber – a prospective B-3, if you will – in a way that repeats [the B-2's] history,” Gates said. In 2009 he cancelled the Next-Generation Bomber. Gates advised the Air Force to try again with a more affordable design.

The air service followed Gates’ advice, but waited until the recalcitrant Pentagon chief and his closest advisers, including Marine general and noted bomber skeptic James Cartwright, retired in mid-2011. The Air Force found Gates’ successor Leon Panetta more amenable to a potentially pricey new bomber program. With the Pentagon on board, the Air Force also lobbied Congress for support, and in the 2012 defense budget legislators ponied up $297 million to start work on the Long Range Strike Bomber’s blueprints. That sum was $100 million more than the Air Force originally requested in its 2012 budget proposal. In essence, Congress is doubling down on the Air Force’s risky bomber bet.

Mindful of its poor track record in developing bombers and still stinging from Gates’ public rebuke, the Air Force has vowed the Long-Range Strike Bomber will be different than previous models. “We are … cautious,” Air Force Secretary Michael Donley said. “Cautious not to repeat the painful experience of previous Air Force bomber programs.” The Pentagon has promised to cancel the new bomber again if projected development and purchase costs exceed $55 billion. To keep costs down, the Air Force says it’s using only existing hardware in the new warplane. Nothing will be invented from scratch, like it was for the cutting-edge B-1 and B-2.

But there are good reasons to be very, very skeptical of the Air Force’s assurances. For in addition to possessing traditional attributes such as long range and heavy payload, the flying branch wants the Long-Range Strike Bomber to include an optional robotic mode. With the flip of a switch, the new plane should be able to transform from a normal manned aircraft to one that can be flown remotely by crews on the ground.

That’s meant to give the bomber the best attributes of a killer drone (long endurance, no risk to aircrews) and a manned warplane (greater flexibility and the ability to respond to a fast-acting enemy). But “optional manning,” as it’s known, has never been attempted on such a large scale before. It represents a big unknown in a program the Air Force insists will rely only on well-understood technologies.

“The new bomber will be both less expensive and more capable than its predecessor,” Deptula says. If he’s right, the Air Force could begin re-equipping with Long-Range Strike Bombers in around 10 years, sustaining for decades the promise of massive, long-range firepower that those ancient B-52s demonstrated near Hawaii that day eight years ago. If he’s wrong, then the historical trend will continue. The Air Force will spend more and more on new bombers, with less and less to show for it....

As drones rise, a manned fighter falls....F-35 on probation...
By Phil Radford

SYDNEY - The world's biggest international defense project, the United States-designed F-35 strike-fighter aircraft, was put on probation by international partners at a formal meeting held this month in Sydney, Australia.

Responding to the latest in a series of cost increases and delivery delays, representatives from the Australia, Canada, Denmark, Italy, Netherlands, Norway, Turkey and the United Kingdom have all threatened to pull out of the project unless the Pentagon and lead private contractor Lockheed Martin can deliver the fighter plane more quickly and cheaply.

The trouble started on February 13 when the US Department of Defense's Comptroller released detailed projections of future Pentagon spending which revealed cuts in planned US purchases of the F-35 fighter as well as related cost increases in the fiscal period spanning 2013- 17.

The 2012 price of the US Air Force version of the F-35 aircraft is almost US$197 million, three times the plane's original projected cost. By postponing the ramp up to mass production, the Pentagon in effect confirmed that the F-35 will not be available in the near-term at a cost allies are willing to pay.

Within days, the Canadian government called an unprecedented meeting of F-35 partners at its embassy in Washington to organize a collective response. The aircraft is the most expensive procurement project on the defense budget books of most project participants. Together the eight countries had committed to purchase over 700 of the fighter planes.

Delivery delays, meanwhile, mean the countries' air forces will face yawning gaps in combat capability. Canada needs new aircraft by 2016, while Australia wanted its first 14 of the fighter planes by 2014. The United Kingdom desperately needs a naval version of the F-35 for its two 60,000 ton aircraft carriers due to enter service in 2016 and 2018.

Before the Sydney meeting, Canadian Associate Defence Minister Julian Fantino underscored the allies' bottom line. "We have not as yet discounted the possibility of backing out of the program," he said, adding in case the point of the meeting was missed, "none of the partners have".

The plane's wider export prospects are also under threat. The F-35's first Asian customer, Japan, warned on February 29 that cost increases or delays might force Tokyo to cancel its contract for 42 aircraft. The multi-billion dollar deal was signed just three months previously.

More broadly, the US's ability to turn its pre-eminence in military technology into lucrative, long-term exports and diplomatic leverage is also at stake. Faced with cost increases, continued delays and technology risks, US strategic allies have started to investigate cheaper, more reliable alternatives, and there is little the cash-strapped US government can do to stop them.

Arm in arm
Back in 2001- 2, the allure of the F-35 "fifth-generation" fighter proved irresistible to many US allies. It would possess high resolution sensors and secure high-capacity data links so pilots could fight armed with an exceptional awareness of the situation around them, while "data fusion" features would make that information easy to comprehend. The plane's stealthy look would produce a tiny radar signature that increased survivability in combat situations.

Many air force chiefs, almost all of them ex-fast-jet pilots, pronounced the F-35 the best fighter of the future. Prospective customers were promised the F-35 would also be economical, with lower maintenance costs than existing aircraft.

For the US, inviting allies to collaborate on F-35 development looked like a neat way to cement its position at the apex of the global defense industry. The collaborative arrangement would help the US to defray development costs, increase export orders and ultimately make allied air forces more useful in US-led operations. It would also subtly make those air forces dependent on the US for support and upgrades because the US would retain the source code required to upgrade the software the plane needed to fly.

What hooked allies most apparently was the commercial opportunity. The Canadian government, for example, which joined the F-35 project in 2002, estimated that by 2010 its C$168 million development contribution had led to C$350 million of contracts from Lockheed Martin. This 2:1 return on investment boosted national capabilities in advanced composites and helped fund research laboratories and universities. (The US and Canadian dollars are currently at parity; all amounts here are in US dollars unless otherwise stated.)

With the US committing to purchasing 2,443 aircraft, plus 700 from the allies and perhaps another 2,000 in exports to non-partner countries, allies eyed a commercial bonanza that would simultaneously propel local technology firms into world-class players once full-scale production began.

Postponed profits
Flash forward 10 years, and the plane is still six years away from full-scale production. In its latest report, released last week, the US Government Accountability Office (GAO) identified deficiencies in the plane's fifth-generation capabilities, including the helmet-mounted display which cannot "fuse" data.

More worrying is the backlog in software coding. The F-35 needs an estimated 24 million lines of code to become operational, including 9.5 million on-board the aircraft. This is six times as much software as on the F/A-18 Hornet, and three times more than the F-22. The GAO reports that "testing of the most complex software and advanced capabilities [is] still in the future," while only "four percent of the aircraft mission system for full combat capability has been verified".

Partly as a result, the flight tests are approximately five years behind schedule. A fully integrated F-35 won't now begin testing until 2015 at the earliest, coinciding with when allies had expected deliveries to have already commenced. Moreover, a Department of Defense (DOD) presentation that accompanied the release of budget figures shows that F-35 funding for testing will now continue up to 2018, which implies full-rate aircraft production will only ramp up at the end of the decade.

But what has the allies more trapped is the cost. Last month, the US DOD's fiscal year 2013 figures showed it will purchase 19 fighters for its air force this year at a unit cost of $197 million, nearly three times higher than the 2001 projected cost of $69 million per plane. This makes the F-35 hopelessly expensive compared to the only practical alternatives available on the international market: $67 million for an F/A-18 Super Hornet; $87-90 million for a Dassault Rafale; and approximately $110-120 million for a Eurofighter Typhoon. [1]

Currently, the Pentagon projects a decline in F-35 unit costs as production ramps up and economies of scale kick in: $171 million for each fighter next year, $140 million the year after, and $121 million in 2016, when it plans to buy 70 aircraft.

But over the last three years, a cash-strapped Department of Defense has repeatedly cut the number of planes it plans to purchase over the forthcoming five-year period in order to reduce costs; by 246 planes in 2010 and a further 179 in January this year. It will now purchase a quarter of the planes originally planned up to 2017. Each cut has precipitated a price increase by Lockheed Martin, which in turn has encouraged the Pentagon to reduce immediate orders.

The date at which the plane becomes economical, meanwhile, recedes into the future. The F-35 was easily the biggest casualty in the US defense budget announced last month, suffering $15.1 billion of cuts out of total defense program reductions of $97 billion.

Besides funding constraints, the budget plan specifically cited "changing departmental priorities" as a reason for the cuts, which indicates waning support for F-35 in the Pentagon, while interest and investment in unmanned drones and cyber warfare builds. The Pentagon has few reasons to rush into full-scale F-35 production while costs remain high and other fighter production lines remain open - and the allies know know this.

Even if the Pentagon sticks to its promises, the price may not drop by much. In its March 20 report, the GAO repeated an earlier ominous warning, that "... the program has not yet demonstrated ... manufacturing processes capable of efficient production". That means the GAO does not believe that Lockheed Martin's projected economies of scale are based in fact. Statistical analysis of the five-year costs submitted to the GAO in 2011 reveal a very modest correlation between increases in aircraft orders and reductions in unit costs. Three-year figures presented by the Pentagon this February reveal no correlation at all. [2]

The most thorough independent analysis comes from Canada, where the federal government's disinclination to reveal data on F-35 costs helped precipitate a general election last May. There, the independent Parliamentary Budget Officer has estimated the likely cost at C$148-C$163 million before the latest Pentagon cuts. This compares to the C$75 million price tag that the Canadian government is now publically committed.

Since the allies cannot influence the basic dynamics of the F-35 program, their only reaction to date has been to delay orders and hope for the best. The UK, panicking over which version will prove less costly and embarrassing for its carriers, has reduced its 138-plane order to an unspecified number.

In March 2011, Turkey put its 100-plane order on hold indefinitely, apparently in response to a US refusal to share source codes. After learning of the cost increases, the Netherlands postponed making a definite order until 2014, while on February 9 Italy's newfound fiscal sobriety saw projected orders drop from 131 to 90.
The eject-seat option is for allies to write off their development costs and open their fighter procurements to an open competition, pitting the F-35 against the Typhoon, Rafale and Super Hornet. This is what the Canadian opposition parties have pledged to do, even though it means facing down two powerful constituents: top air force officers who can marshal persuasive facts behind professional opinions; and domestic companies, such as Australia's Quickstep, who have invested in large plant expansions in anticipation of multi-billion dollar contracts related to the F-35.

Revolution in time
If the allies can keep older aircraft in the skies a few more years and avoid making hard commitments, progress may yet resolve their dilemma. Unmanned aerial vehicles (UAVs) and the unmanned aerial systems (UAS) of which they form a part are already displacing manned jets from reconnaissance and some strike roles.

According to The Economist (October 2011), unmanned American UAS now fly more hours than manned strike aircraft, and more US pilots are being trained to fly them than their manned equivalents.

Uncomfortably for F-35 proponents, UAS already combine all the elements of fifth-generation fighters but in a more economical form. BAE System's Taranis and Northrop Grumman's X-47 are highly stealthy, and the former is experimenting with drones that have no moveable surfaces at all, further reducing radar signatures.

UAS data fusion, meanwhile, happens on the ground among teams of pilots and operators who can specialize in specific flying, monitoring and combat functions. Without pilots, or the equipment they need to fight, breathe, eject, navigate, or fight, UAVs are smaller, lighter and cheaper. And despite the professional affinity for manned flight, combat pilots may soon concede the skies.

UAVs will be fought centrally from ground-based or ship-situated operations centers, where ground and air-space information is filtered, honed and acted upon by specialized teams to create tactical advantages that airborne pilots cannot individually match or master. Pilots will soon ponder how many coordinated, missile-armed UAVs to have in the sky around them.

What will likely grab politicians' interest is the radically shorter development cycle for UAS, such that new ideas fly in months not decades. Modular approaches to UAV construction together with miniaturized sensor suites will allow aerospace companies to quickly mix and match new UAV platforms with novel weapons and sensors.

New capabilities will be genuinely new. Procurement staff will not find themselves hostage to long, risky development programs; they can simply tell companies to experiment wildly with new combinations, fight competitive procurement battles in real, aerial dogfights, and only then spend money on the winners.

Historically, militaries do not abandon orthodox technology until a decisive engagement proves a new point. But without fail the determining factor is always cost. During World War II, expensive battleships were overwhelmed by swarms of cheap aircraft carrying cheap bombs or torpedos. In exactly the same way, the F-35 will be overwhelmed by cheap drones carrying cheap missiles, before or after it becomes operational.

If the allies can hold their nerve, the F-35's troubles and the Pentagon's delays may yet save them from making the most expensive mistake of their own defense forces' lives.

Notes
1. Export prices of combat aircraft are exceptionally hard to judge because they are subject to numerous variables (e.g., grades of sensors, support levels) and commercial sensitivity. These estimates are taken from i) DoD FY 2013 Navy estimates; ii) Public figures released following Dassault's 'preferred bidder' win in the Indian Air Force competition in January 2012; iii) the 2009 price paid by the German Air Force for its 'Tranche III' Typhoons. All figures calculated from producers' currency using exchange rates on March 26, 2012.
2. For example, according to GAO figures, a 26% increase in F-35 A orders in 2013 leads to a 15% decrease in unit costs, while a 67% increase in orders the following year leads to a broadly similar 18% decrease in unit costs. For 2015 and 2016, the decrease in unit costs is calculated to be the same despite 2016 accounting for a much larger jump in numbers than 2015. According to DoD FY 2013 estimates, unit costs of the F-35C fall between 2011 and 2013 despite the number ordered dropping from seven to four, while the unit costs of F-35 B rise despite numbers ordered rising from three to six. (includes previous year's advance procurements.)

Rick Montgomery | The Kansas City Star

Say you own a 20-year-old car and intend to drive it beyond the year 2050. It will need some fixing.

A challenge similar to that continually faces Whiteman Air Force Base, home to the B-2 stealth bomber. Many aircraft parts made in the 1980s, when the first of 21 B-2s rolled out of a Northrop Grumman Corp. hangar, are as obsolete today as the floppy disk.

Yet the plan is to keep those bat-winged bombers flying, and eluding the latest in radar technology, until 2058.

The Pentagon is moving forward with a $2 billion, 10-year effort to modernize the fleet’s defensive capabilities. Digital equipment will replace analog, antennas will be upgraded, communication systems and pilot displays will be enhanced — all needed to address “emerging and proliferating 21st century ground and airborne threats,” according to an Air Force report last year to Congress.

Col. Rob Spalding of Whiteman’s 509th Bomb Wing called the coming enhancements “the biggest and most complex update of the B-2 in its history.”

Washington’s commitment to the B-2 is a no-brainer, experts say, given the plane’s lethal legacy. It has been involved in every combat action since NATO’s 1999 bombing of Serbia in the Kosovo War.

“The B-2 is a door opener,” said John Pike of GlobalSecurity.org, a think tank on weapons systems. “It has the unique ability to fly unescorted into hostile airspace and blow up a lot of stuff — without us first having to take out the other guy’s air defenses.”

Maintaining the fleet — now down to 20, following the wreck of a B-2 flying out of a Guam air base into heavy rain in 2008 — is job one at Missouri’s Whiteman. Scheduled overhauls happen every seven years, and replacement parts are increasingly difficult to find, Spalding said.

In some instances, technicians at the base have devised their own remedies to keep the bomber current with changing technologies.

Case in point: Avionics Plug and Play, or AP2.

It is an email and communications system that is separate from the aircraft’s operational backbone. This is a huge cost-saver, Spalding said, because any fiddling with the bomber’s core functions requires years of research and testing.

AP2 allows commanders on the ground to shoot coordinates and revised flight plans to the B-2’s two-person crew. Rather than relying on a laptop that once swiveled on a stand between the pilot seats, the new system puts computer screens at the shoulder of each flyer. And it can be easily upgraded as more sophisticated technologies emerge, said Spalding, operations group commander for the 509th.

“We designed it ourselves,” he said. “Necessity is the mother of invention. We saw the need and went out and did it.”

Last month, Northrup Grumman awarded a contract to BAE Systems to replace 30-year-od analogue electronics with digital support systems on all B-2s. The size of the contract was not disclosed, and a Northrop Grumman spokeswoman said sensitive specifics about the planned upgrades would not be divulged.

A BAE executive said in a press release the new electronics will help give the fleet “exceptional situational awareness to reach its targets through highly developed, increasingly sophisticated enemy defenses.”

It’s not such a reach to imagine keeping the B-2s up to date and operational for decades to come, said expert Pike: “We did it with the B-52.”

Many of those bigger bombers were in active service before their crews were born.

“We’re talking about a low-mileage aircraft,” he said, with the typical B-2 accumulating fewer than 5,000 flying hours since birth.

“The notion of the thing getting worn out due to airframe stress, you don’t really need to worry about.”

Then again, Lockheed’s F-117 — a stealth fighter on flight lines since the early 1980s — was phased out of active service by the Air Force beginning in 2007. The fighter’s capabilities were questioned when one was spotted and shot down during the Kosovo conflict, its radar signature compromised with bomb bay doors opened.

The F-117 airframe required substantial maintenance and eventually was superseded by streamlined shapes designed by computers.

Spalding said no B-2s were currently in forward locations such as Diego Garcia, the Indian Ocean atoll from which bombers launched attacks on enemy targets in Afghanistan and Iraq.

The Air Force has $560 million in its present five-year spending plan for modernizing the B-2’s defense-management system, according to InsideDefense.com.

The bomber currently is the only aircraft capable of carrying a super-bunker buster in development — the 30,000-pound Massive Ordnance Penetrator, or MOP. The Pentagon considers the MOP crucial to defense capabilities against hardened, deeply buried targets.

Few in Washington appear inclined to neglect “The Plane That Would Bomb Iran,” as The Atlantic Monthly once called the B-2. Believed to have significantly enhanced their air defenses and radar systems in recent years, Iranian officials last month crowed of successfully identifying and repelling mock fighter jets during four days of war games.

Read more here: http://www.mcclatchydc.com/2012/03/27/143206/b-2-bombers-at-whiteman-afb-get.html#storylink=cpy