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13 May 04.The FT reported that Boeing may be forced to close its 767 production line after a report from a Pentagon body found no “compelling material or financial reason” for the US Air Force to pursue its controversial $23.5bn order for refuelling aircraft.

The report, from the Defense Science Board, found corrosion problems on the USAF’s tanker fleet of KC-135s were “manageable”, contradicting claims by the Air Force. It also found no need to initiate a replacement programme before an analysis of alternatives had been completed – a review that could take up to 18 months.

The conclusions are a blow to Boeing, which had been positive the deal would go ahead and had included the contract in its recently raised earnings and revenue guidance for 2004 and 2005. The USAF order for 100 767 aircraft to start replacing its ageing KC-135s was critical to the future of Boeing’s 767 production line. Boeing has just 25 remaining firm orders for the aircraft, representing more than a year of production.

In Seattle on Tuesday, Alan Mulally, chief executive of Boeing’s commercial aircraft division, said: “If the Air Force wants it, we are ready to make it, but if they can’t make a decision soon it will be more costly to start [the 767 production line] up again.

“We are getting to a place over the next few months where we will have to make some decisions.” In a filing with the Securities and Exchange Commission in March, Boeing said it could take a termination charge of $310m in the event of an adverse decision from the USAF and warned margins for its Italian and Japanese tanker contracts would also be affected. Boeing may also now have to revise its forecasts for 2004 and 2005. Opponents to the deal, led by Senator John McCain’s office, have led a high profile campaign attacking it on the grounds of cost and necessity. Last month a Pentagon Inspector General’s report also criticised the deal for the way it was put together and for its high costs.

The DSB report suggested that the USAF had a range of alternatives to buying the Boeing aircraft. Mr McCain’s investigations have already helped lead to the firing of Mike Sears, Boeing’s finance director, and Darleen Druyun, a senior Air Force official who helped negotiate the initial 767 contract and who later joined Boeing. Phil Condit, Boeing’s former chief executive, also resigned last year in an effort to staunch concerns about an ethics crisis at the company. DSB alternatives to the 100 aircraft sale include putting new engines on the KC-135s or modifying used commercial aircraft for use as refueling tankers. Boeing on Thursday said it was still reviewing the impact of the announcement, but raised doubts about the alternatives suggested.

Comment: Sources suggest that Boeing could have thrown in the towel on the present proposal and may delay the introduction of new tankers until it starts 7E7 production and base the new tankers on this model. It may be that the company will gain a significant refurbishment contract on the existing fleet of KC-135 aircraft and that the closure of the 767 line now may be cheaper for the company in the long-term. Other sources suggest that the MoD, EADS and the Treasury are still not ready to sign the UK Air tanker PFI deal due to doubts over forecasts by EADS of charter revenue forecast of £600m.

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