IRAQ: Military Faces $4 Billion Budget Gap With Halliburton

With military costs rising in Iraq, the top U.S. commander in Baghdad is
facing what he calls an "unaffordable" budget gap of at least $4 billion
between what Halliburton Co. says it will cost to provide food, housing and
other services for U.S. troops for a year and what the government has
budgeted.

The difference dramatizes the cost crunch facing the Pentagon as the bill
for the U.S. involvement in Iraq continues to escalate well beyond initial
White House estimates. Before the war began in March 2003, the
administration said it would cost about $60 billion. The price tag is now
more than three times that figure, and growing. President Bush is expected
to soon send to Congress an $80 billion supplemental spending bill, largely
to cover Iraqi operations, pushing the tab for the current fiscal year,
which began on Oct. 1, to $105 billion.

In December, Halliburton's giant Kellogg Brown & Root unit, which provides
basic services such as food, postal service and telephones to the 150,000
U.S. troops in Iraq, submitted a detailed estimate to the Pentagon for
expected spending in the year starting May 1, based on a list of Army
requirements. The company said its costs for the year could exceed $10
billion.

But the Army has budgeted just $3.6 billion to support the KBR-provided
services during the same period -- nearly $7 billion less than KBR's
estimate.

Since then, the Army has been trimming its requests to close the gap. In an
interview, Gen. George Casey said the difference now stands at closer to $4
billion. Still, he said, "To say that we're not worried would not be true.
Someone has made some assumptions that have driven the costs through the
roof."

Army officials suggest that ultimately their wish list of services for
troops will have to be further slashed, though it's not clear how much basic
services will be reduced for soldiers -- or even how much they can be
without causing significant disruptions. "It is time to focus our attention
on reducing the overall costs without degrading the welfare of our deployed
forces," Gen. Casey wrote in a late December letter to the U.S. Army Audit
Agency, the unit charged with reviewing Army contracts.

Officials say they also may end up pushing inside the Pentagon and on
Capitol Hill for more money to pay for troop support.

Gen. Casey said in an interview last week that he still was trying to
determine whether the spiraling costs reflected in KBR's estimate are due to
a spike in proposed charges by KBR or a substantial increase in requests by
the Army. A team of Army experts is probing that mystery, he said. He said
that the problem could lie within the government, as the Army's needs for
troop support far exceeded the Pentagon's budget ceiling for those services
as overall security costs have mounted.

But several factors are clearly contributing broadly to escalating costs.
Among them is the stubborn insurgency that has boosted the expense of
transportation and security. Another factor is the U.S. move to increase
troop strength in Iraq to 150,000 before and during this week's election,
which put in place substantially more troops currently than had been
expected in earlier planning. In addition, partly because of the insurgency
and elections, the military has been shifting resources and troops away from
large concentrations into smaller bases around the country, adding further
to costs.

Halliburton spokeswoman Wendy Hall played down the significance of the
difference, saying in a statement that it would be inaccurate to compare KBR
cost estimates with what the military actually ends up spending. Since the
inception of the current troop-support project, she said, "KBR has provided
estimates to the Army of nearly $16 billion, while we have only been funded
to perform $9.8 billion worth of work."

The current flap follows a series of dust-ups between the Pentagon and
Halliburton, its main contractor in Iraq, over proper bookkeeping and
pricing for the company's work in Iraq.

KBR has played a unique role among contractors in Iraq thanks to a vast
contract it won in 2000 that made it the main provider of support services
to U.S. troops across the Middle East.

Currently, the company operates more than 80 sites in Iraq, ranging from
military bases to embassy compounds, at which it provides everything from
showers and telephone service to laundry, meals and housing. KBR workers
live alongside the troops and see to nearly all of their daily needs. KBR
was the first private contractor to enter Iraq, and has been in charge
nearly from the start of establishing permanent bases there and equipping
them with basic services such as showers and mess halls.

The Pentagon has spent nearly as much on KBR's wide-ranging logistical
services contract as on all other private contractors doing reconstruction
work in Iraq combined. Last year alone, the Army paid KBR $6.9 billion for
its troop-support services in Iraq, pushing the total bill since the middle
of 2003 to nearly $10 billion.

But Pentagon auditors have had a series of disputes with KBR for well over a
year, largely focused on what the auditors have described as KBR's
sluggishness in fully accounting for past spending in Iraq. The company has
been accused of overcharging for fuel shipments from Kuwait and for millions
of dollars worth of meals at dozens of military bases in Iraq.

KBR has denied overcharging for fuel. The dispute over dining-facility bills
remains open, with the Army still not having decided whether to demand
significant reimbursements from KBR. Pentagon auditors, meanwhile, are
gathering information to compile a series of final bills going back to
mid-2003.

Under KBR's arrangement with the military, the company works on a
"cost-plus" basis, under which it charges only for services provided, adding
on a mark-up for profit. Some military officials have suggested shifting to
a fixed-price contract, paying Halliburton a set fee for services that is
determined in advance, but no decision has been made.

The looming budget gap has caused deep concerns within the Army, and
prompted Gen. Casey in December to order Army auditors to seek out ways to
"aggressively" reduce costs for supporting U.S. troops in Iraq. The Army,
Gen. Casey said in his letter to Army auditors, had to find new efficiencies
that would slash costs and identify "areas vulnerable to fraud, waste and
abuse."

In a letter sent to Army budget and acquisition officials last week, which
was reviewed by The Wall Street Journal, Gen. Casey wrote that costs under
the logistical-support contract were "unaffordable," exceeded "available
funding ceilings to support...the entire United States Central Command area
of responsibility," and had to be trimmed. Central Command is charged with
oversight of all military operations in the Middle East.

He ordered Army officials to come up with a new list of requirements that
"will result in a contract that is affordable, maintains an acceptable
living standard for our service members, and is defendable to Army...and
congressional reviews."

In the letter, Gen. Casey said he plans to shift to what's called an "Alpha
Contracting process," under which Army officials determine reasonable prices
for services in direct discussions with KBR. Gen. Casey said in the letter
that one of the problems is a "current lack of standardization" in the
contracting process across Iraq, which has led to services being provided at
various bases in excess of the actual troop numbers.

During the last quarter of 2004, the Army racked up a troop-support bill of
about $18 million a day. The daily rate starting in May, under the estimate
that KBR put forward late last year, would put that figure at about $28
million a day.

Halliburton's Ms. Hall said that the figures sprang from "estimates of the
cost to satisfy Army requirements as detailed by our customer." She said
that "KBR only performs the work once it is directed and funded by the
Army."

Houston-based Halliburton recently said it plans to put KBR, which has been
losing money, on the block, a move widely seen as an aim to boost
Halliburton's value.

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