Defense Budget

The Office of Management and Budget (OMB) establishes for the Department of Defense (DOD) the price DOD will use for pricing crude oil when constructing its budget for upcoming fiscal years. DOD in turn uses OMB's price in establishing the standard price to be used for a barrel of fuel for budgeting purposes by DOD fuel customers such as the military services. Because of the volatility of world petroleum prices, the standard price for a barrel of fuel included in the President's annual budget request for DOD may be lower or higher than the actual price established by the world market at any point in time after DOD's budget request is submitted to the Congress. During the fiscal year, DOD pays for fuel at the actual market rate, which typically varies from the budgeted rate. As a result, if the actual price of crude oil increases above the price DOD charges its customers, more dollars are needed to pay for fuel than originally budgeted. If the actual price is lower than what DOD charges its customers, DOD has more dollars than needed. Additionally, if DOD responds to increases in the world market crude oil prices by increasing the price it charges its customers above what they initially budgeted, the customers will have additional funding needs to pay their fuel bills. Concerned as to whether DOD's method for setting fuel prices has produced realistic budget estimates, last year the Congress required DOD to consider alternative methods. Specifically, the John Warner National Defense Authorization Act for Fiscal Year 2007 requires the Secretary of Defense to submit a report on the fuel rate and cost projection used in the annual DOD budget presentation. The act required that DOD identify alternative approaches, including approaches used by other federal departments and agencies and the feasibility of using private economic forecasting organizations, for selecting fuel rates that would produce more realistic estimates of the amounts required for DOD to accommodate fuel rate fluctuations. DOD is also required to discuss the advantages and disadvantages of each approach and to identify the department's preferred approach among the alternatives and provide a rationale for preferring that approach. Finally, the act further requires that GAO review DOD's report, including the basis for the Secretary's conclusions for the preferred approach. DOD submitted its report to the Congress on February 27, 2007. In response to the act, we determined (1) the extent to which DOD identified and evaluated alternative crude oil forecasts that could be used in setting its fuel rates--such as forecasts used by other federal departments and agencies and private economic forecasting organizations, and (2) DOD's basis for selecting its preferred fuel rate setting approach.

DOD identified and evaluated approaches for forecasting crude oil prices used by other federal departments and forecasts from private forecasting organizations. DOD received responses from eight agencies. DOD determined that seven of the eight respondents used DOD's forecast, did not have a forecast method, or did not have a forecasting method that would accommodate the size and complexity of DOD's fuel requirement. Thus, DOD concluded that only the Department of Energy's (DOE) forecasting method, which uses the Energy Information Administration (EIA) to provide forecast prices for crude oil, was an option that warranted further evaluation. According to DOD's report, it conducted four analyses using different scenarios to compare its forecast approach, which is based on crude oil forecasts provided by OMB with the methods used by DOE and 38 private forecasting organizations. DOD reported that DOE's EIA analysis produced forecasts that were marginally closer to actual crude oil prices than either DOD's current method or most other private organizations' forecasts, and only in a few cases did the private organizations produce forecasts that were closer to actual costs than DOD's current method. DOD selected its current method as its preferred forecasting approach over the DOE and 38 private forecasting alternatives. According to the DOD report, DOD chose to continue to use its current rate setting method because it believes none of the alternative forecasting methods produced significantly more accurate results. Specifically, DOD did not believe that the margin of difference between forecasts based on its current method and alternative approaches was significant enough to warrant a change. In assessing DOD's comparative analysis, we found limitations on the scope of the analysis due to the lack of available historical forecast data. Specifically, DOD included 18 months of data or less in each of the comparative scenarios it analyzed and the scenarios did not involve forecasts from the same time period DOD used to set its budget request. According to DOD officials, historical forecasting data were not available to conduct a more extensive multiyear comparison or to replicate the time-frame in which the fiscal year 2006 budgeted bulk fuel rate was set. DOD officials agreed that had it been available, these additional data would have produced a more ideal comparison. Consequently, based on the results of the analysis that DOD was able to conduct with the data available and given the volatile crude oil market, we agree that the results did not provide a compelling reason for DOD to adjust its rate setting approach and that DOD's current forecast based on OMB's guidance for crude oil prices is a reasonable approach. In order for DOD to conduct a more robust and extensive analysis, it would need to begin capturing and maintaining the necessary forecast data now to conduct such analyses in the future.