Love on the Rocks: CASA’s $600M Venezuelan Plane Sale Hits Heavy Turbulence, Crashes

CN-235MPA Persuader
(click to view full)

In January 2005, the USA used ITAR resale restrictions on military-designated technologies to block a EUR 500 million sale of 12 CASA aircraft to Venezuela – 10 C-295 light transport aircraft and 2 CN-235MPA Maritime Patrol Aircraft. Sources were telling media outlets that the deal was dead, but later reports revealed a possibility that Spain would go ahead and substitute non-US technology. Politics and job-creation (job transfer, really) can create some odd contortions, so the idea wasn’t entirely surprising. Nevertheless, there were significant US market implications for EADS if the deal went forward – and in any really involved drama, there’s always another twist. This was starting to look like a real Latin American soap opera, so DID grabbed some popcorn. And waited.

Lo and behold, more twists have indeed followed. Including a side-story involving Brazil. Are we on, or are we off – and if the answer is “off,” who might step into the breach? Since it’s impossible to resist a rocky relationship like this one on Valentine’s Day, DID decided to update our readers…

• Done Too Soon: The Sale & The Roadblocks
  
• Star-Crossed Lovers: Will They? Won’t They?
  
• There’s Always A Morning After
  
• Song Sung Blue: Further DID Analysis/ Op-Ed
  
• Additional Readings
  

Done Too Soon: The Sale & The Roadblocks

C-295 hits American chill
(click to view full)

Shortly after the deal between EADS-CASA and Venezuela was announced, the USA blocked the transfer of any American technology under the 1976 Arms Export Control Act.

That 1976 law subjects US-made technologies designated as “military” to export control. This means that customers require approval from the US State Department any time one wishes to transfer those technologies to another country, either as a direct sale or as a component in a larger platform. DID has covered stories related to this phenomenon that have affected even close allies such as Britain (F-35 program) and Israel (AWACS sales to South Korea, also F-16 upgrades to Venezuela). Countries who buy American military technology accept these restrictions as part of their contract, so there’s no legal question involved.

That leaves the policy question in Washington’s hands: to interfere, or not to interfere? Unfortunately for Spain, President Zapatero has whatever the reverse of “influence” is in Washington. At the same time, Venezuelan El Caudillo Hugo Chavez’ moves to destabilize his neighbours and petrodollar-fueled military buildup have landed him of America’s threat radar. Venezuela remains America’s 5th largest supplier of oil, but the USA appears quite determined to use all of their diplomatic and legal levers to complicate Chavez’ military plans.

Spain sold similar aircraft to Colombia, at almost the same time, with no hassles. If that sale was intended to protect the Venezuelan deal by providing similar equipment to Venezuela’s US-allied neighbor on favorable terms, it failed.

The US technology transfer veto does not completely block the Venezuelan sale, of course. EADS-CASA is not an American company, and the sale could continue if no US military technologies were present. What would Spain do, therefore? Would it fold its hand? Hold to the deal despite the additional costs? Or seek to go ahead under altered terms that would have Venezuela pay those additional costs?

Star-Crossed Lovers: Will They? Won’t They?

Sra. de la Vega

“Fold ’em” seemed to be the initial answer. While the Spanish government said that manufacturer EADS-CASA would seek alternative suppliers for the U.S. parts, the Financial daily La Gaceta quoted Spanish defense industry sources who said that the aircraft sale to Venezuela would not be viable with substitute components – not “unless a political decision is taken forcing the company to carry through the order.” A report by Foreign Policy Studies magazine noted that production costs would increase by EUR 12-15 million, which would be enough to cancel out the deal’s profitability.

On Jan 13/06, however, Spain’s Vice-President Maria Teresa Fernandez de la Vega, was quoted by Agence France Presse as saying that:

“[CASA] is looking for mechanisms and procedures to meet the agreements. This usually happens in all private economic relations under contracts… If you are facing problems in connection with one clause because you are lacking some technology, then you have to find the way to replace the technology you lack with another, and then fully meet the agreements.”

De la Vega also noted her belief that the American veto applies only to aviation technology, as the Navantia “Economic Area Vessels” to be sold to Venezuela under a EUR 1.2 billion deal were entirely of Spanish design as far as she knew. She said that the Spanish defense industry is “very important,” and that “in recent times, its workers above all have suffered the consequences of some bad relations between other countries. I am sure that we are going to live up to our word as always.”

This was a pretty clear signal of political pressure to continue with the deal. In response, the Venezuelan authorities reserved their options, saying that they’d make a go/no-go decision once they received EADS-CASA’s new proposal.

Venezuela also stepped up the pressure on the patrol boat issue. On Jan 31/06, Chavez said that he needed to know “once and for all” whether Spain will sell Venezuela the military patrol boats that it ordered, or whether Venezuela needs to begin negotiations to buy them from other countries. “We’re going to tell the Spaniards to tell us once and for all whether they can sell them to us or not, because then we’ll buy those boats from Russia, or China, or Iran, or India, or in Brazil.” He has also threatened to go to Russia or China for alternatives to the Spanish aircraft – probably Antonov An-32s or Chinese Yun-8 (An-12 copy, offered in many versions including maritime patrol) and Yun-7 (An-26 copy).

Chavez further claimed that Venezuela’s purchase from Spain was an attempt to help Spanish prime minister Zapatero, since Zapatero had told him “that he had problems with some shipyards.”

That last statement was significant. Politicians in every country have been known to do unnatural things in order to provide make-work for their national defense industrial base. If Spain really did have a lag in its order pipeline, the Spanish government could well choose to address the deal’s profitability issue itself, in order to keep the production lines humming.

At that point, it appeared that the deal might go through after all. Yet the picture was incomplete. While the coverage focused on the interested parties, and made it seem like a saga of star-crossed lovers attempting to stay together despite all odds, subsequent events would make observers wonder if a closer analogy might be arranged marriage.

There’s Always A Morning After

CN-235MPA:
Replace it all?!?
(click to view full)

At the same time as the Spanish spat arose, Washington was placing pressure on Brazil’s Embraer to cancel its planned $500 million sale of 36 Super Tucano/ ALX light attack and counter-insurgency turboprops to Venezuela. The Spain Herald reported on Jan 30/06 that Embraer’s export submission had stated a willingness to manufacture the aircraft at a plant in Florida.

It was an odd response, given the USA’s core issue with the sale. Like the Israelis before them, the Brazilians discovered that US motives were political, not protectionist. The Super Tucanos also contain a Pratt & Whitney Canada engine that could be blocked on technology transfer grounds, and in the face of that blockage, Lula da Silva’s administration and Brazil’s Embraer opted to call off the deal. This avoided friction with the USA that might lead to technology transfer issues, or poison Embraer’s welcome in the world’s largest defense market. One down. Meanwhile, Colombia had just ordered 25 Super Tucano aircraft of its own, for $234.5 million.

Back in Spain, a closer reading of the Spanish saga showed a distinct and significant split in tone. The government was firm, but industry sources saw obstacles and remained either silent or non-committal. As Spain’s government pushed and Venezuela pressed, EADS-CASA dug in. Diplomatically, of course, but the message was unmistakable. As El Universal noted on Feb 8/06:

“In a meeting last week with Venezuelan Defense minister, admiral Orlando Maniglia, EADS-CASA representatives asked Spanish and Venezuelan authorities to wait for one month until they found “a final solution” to the sales agreement… However, sources claimed that replacing US components (avionics, radars and even engines, which are manufactured by US firm Honeywell) in C-295 airplanes with equipment manufactured in other countries would… virtually amount to designing a new model.

“Replacements would significantly increase the price of each aircraft and would require design modifications in wings and other components of this model, the C-295. Among other reasons, a change in engine would entail modifications in weight distribution and in the aircraft power,” [Spanish newspaper] ABC explained in a report published Tuesday. Industry sources told the Spanish newspaper that replacing US-made avionics components would cost over $1.7 million per aircraft, for a total of some $20 million, not to mention the cost of full engineering re-designing.

Therefore, moving forward with this negotiation would result in losses for EADS-CASA, and it would even risk losing contracts in the United States. [emphasis DID’s]”

All of these required engineering changes and costs are true, and valid. While the avionics are from Honeywell, the engines are actually by Pratt & Whitney Canada, but still contain US technology. Not to mention the changes that would be required in the CN-235MP surveillance aircraft’s optical system sensors, radar, and high technology cameras.

But it’s the last line of the Venezuelan newspaper’s report that really matters.

Once upon a time, the Spanish government’s view might have been decisive. Lack of profitability can easily be overcome with subsidies, tax breaks, or R&D financing to develop wholly European versions of CASA’s aircraft. In the modern era of a consolidating Euro-defense industry, however, a government that had pushed hard for European defense integration would find that very phenomenon to be its undoing.

CASA was now CASA-EADS, and no longer an independent company in the strict sense of the term. EADS had a potential stake in the US defense market that was, and is, enormous.

• The $20+ billion future aerial tanker deal, for which it was bidding its A330-MRTT.
  
• The $2-3 billion Light Utility Helicopter (LUH) deal, where EADS Eurocopter’s EC-145 is firmly in the race with none other than Sikorsky on their bid team.
  
• Significant market potential for many of EADS other products, like the containerized Trans-Hospitals it had set up in the wake of Hurricane Katrina.
  
• Not to mention the CN-235MP serving with the US Coast Guard, and the C-295 tied up in a bid with Raytheon for the US Army’s 33-120 plane Future Cargo Aircraft contract.

EADS had been silent up until this point, and still keeps a low profile. With that report in ABC, however, it made its position clear. Spanish subsidies and tax breaks might smooth over an unprofitable deal. They cannot make EADS’ potential losses go away if that deal angers US lawmakers any further.

Of course, none of these bids are guaranteed wins; EADS could, in fact, lose them all. One can imagine the conversations, however. “Do tell me again – we are risking what pieces of business, exactly, for a 500 million Euro sale?”

A glooming peace this morning with it brings;
The sun, for sorrow, will not show his head:
Go hence, to have more talk of these sad things;
Some shall be pardon’d, and some punished:
For never was a story of more woe
Than this of Juliet and her Romeo.

Song Sung Blue: Further DID Analysis/ Op-Ed

Spanish Fly-Away

Y-8 MPA
(click for alternate view)

Even Spanish President Zapatero seems to be backing off, albeit in a somewhat incoherent manner. In an interview with Foreign Policy, he stated that that he himself had set the agenda on policy with respect to Venezuela, “and in this case also by the council of ministers, which deliberated on the issue, though I cannot reveal the content.” As Spain Herlad reported on Feb 1/06:

“According to Zapatero, Venezuela is facing “a difficult situation” after the decline of the traditional party system. “Beyond the figure of Hugo Chavez, who has to be respected because he was elected, the question is why the former party system of Adeco and Copei was destroyed,” he said. In Zapatero’s opinion, Venezuela is a country that needs a process of development and consolidation of democratic institutions, and “it is not good news” that the Venezuelan opposition did not participate in the most recent legislative election in December [2005]. “Whether Chavez or whoever wins, Spain wants to have good relations with Venezuela, but also we want Venezuela to have parameters that can be recognized as democratic.”

It was hard to tell whether this represented CYA for the sale itself, or a qualified distancing from Chavez and Venezuela. Either way, the above stands out as a backhanded endorsement in the extreme – even for a politician.

Reality was biting. Hard. As noted above, Zapatero lacks the tools to force this sale through. The above quote shows a corresponding weakening of the will to try.

EADS’ only sane course, meanwhile, is to back out as gracefully as possible. Which seems to be exactly what they’re doing. If worst comes to worst, they can simply tally a cost figure for the modified aircraft that makes Chavez an offer he must refuse. The month’s grace they have asked for seems like a twofold strategy to either get the impatient Chavez to end the relationship himself, or buy them time to get all their ducks in a row for a proper “Dear Hugo” denouement.

In the end, El Caudillo Chavez will be forced to deal with the Chinese or Russians for an alternative. Fortunately for him, the Chinese Y-8s could get Venezuela substantially more airlift for their petro-dollar, as well as a number of tested and useful variants like the Y-8 MPA maritime patrol variant that meet Venezuela’s needs. Sure, it’s old technology, but that’s hardly an unusual or disqualifying characteristic in that part of the world, and the aircraft would be new-build. The smaller Y-7/An-26, meanwhile, could be used in a high-low mix for short field performance. There will be a loss of commonality with the existing CASA fleet, of course, but the only significant deprivation will be the CN-235MPA Persuader surveillance aircraft, whose technologies will not easily be replaced with Russian or Chinese equipment.

Consequences: They’re Coming to America

Missed opportunity?

The USA, too, will find consequences stemming from its choices.

The clear message here is that American avionics and engines stand to create export difficulties to many of the world’s potential trouble-makers. This may be a fine thing. In practical terms, however, it also means that those who are happy to export weapons to such places, due to differences in trading or political philosophies, may take extra care to find alternatives to US equipment during the design stage. Engine choices greatly affect aircraft design, which is why it so difficult to simply swap in non-American alternatives. Time will tell if engines from non-US sources begin to enjoy an especial uptick in future popularity.

As long as the USA remains such a large and lucrative arms market, the simple threat of “you’ll never work in this town again” will remain a source of substantial leverage with foreign arms dealers. It certainly worked with Embraer, despite the firm’s low level of exposure to the US defense market. In the end, however, an effective policy that values both arms trade security and the US defense industrial base will have to provide rewards as well as sticks.

This saga provides a classic example; unfortunately, it’s an example of a missed opportunity.

Rather than simply pressuring the Brazilians over the Super Tucano, with little countervailing opportunity upside in the USA, and stirring up resentment thereby, a better option might have been available. The stable turboprop-powered Super Tucano/ ALX counter-insurgency aircraft would be extremely useful in Iraq. Brazil and the USA have no major political issues with each other; to the contrary, they have a long-standing defense relationship.

It might have been a smarter move for the USA to offer to pick up Venezuela’s contract for the 36 aircraft, while accepting Embraer’s offer to have assembly done in Florida. The Super Tucano could then be sent to Iraq as fine close-support aircraft for the Iraqis, not to mention patrol aircraft over pipelines et. al. that pack a formidable attack punch should their pilots spy any threats below. When the day comes that the Iraqi Air Force once again has fast jets, the Tucanos can even fade into the important ALX trainer role. Venezuela is deprived of aircraft that could be turned on its population, the Brazilians feel recompensed, jobs are supported in the USA, and the Iraqis receive a substantial upgrade to their capabilities as the aircraft were delivered over time.

That this was not done may represent a significant missed opportunity all around.

There is less of a missed opportunity in the EADS-CASA deal, as anything that rewarded the Spanish in Iraq was not a serious option for Washington or Baghdad. The Iraqi Air Force operates C-130 Herules aircraft, and has a weak logistics and support tail right now. That makes CASA’s C-235 a far less suitable choice than Alenia’s high-commonality C-27J Spartan/ “Baby Herc”. Besides which, [a] EADS is amply recompensed by retaining access to existing US opportunities; and [b] Any problems Zapatero faces as a result of a US item export veto are his own hard luck as far as Washington is concerned.

UPDATES

Chinese Yun-8
(click to view full)

November 2010: Venezuela announces that it’s negotiating with China to buy 10-12 Y-8 transports instead. Read “With C-295s Blocked, Venezuela Looks to Chinese Y-8 Aircraft.”

May 2007: Iraq has launched a competition for counter-insurgency and surveillance aircraft. The competition includes 4 aircraft – one of which is Embraer’s Super Tucano.

August 2006: Things worked out pretty much as predicted. EADS Eurocopter won the $3 billion LUH competition in July 2005; at the end of July, a Venezuelan government spokesman declared the contract nullified. General Alberto Muller, Staff advisor to President Hugo Chavez, said: “They (Spain) needed to replace the aircraft parts, which were made in the United States, with other components, and it seems that this alters significantly the planes’ value.”

In other words, Zapatero could not force the sale through, and EADS-CASA gracefully bowed out by setting a price Venezuela must refuse. FINIS. DID’s “Love on the Rocks II: The Divorce is Official“.

Additional Readings

Background: Aircraft

• Air Force Technology – C-295M Twin Turboprop Transport Aircraft, Spain

• Naval Technology – Airtech CN-235MP/MPA – Maritime Patrol Aircraft, Spain/ Indonesia

• Air Force Technology – EMB-314 Super Tucano / ALX Trainer / Light Attack Aircraft, Brazil

• Sino Defence – Y-8 Tactical Transport Aircraft (An-12 variant), incl. Maritime Patrol Version

• Sino Defence – Y-7/An-24/An-26 Transport Aircraft

• AirFoyle Heavy Lift – An-32

• GlobalSecurity.org – An-24 COKE/ An-26 CURL / An-30 CLANK / Y-7 / Y-14

Export Control Issues

• US Department of State – Defense Trade Controls – The International Traffic in Arms Regulations (ITAR) [HTTPS connection]. See the official version, and an unofficial consolidated version that integrates recently-introduced amendments. Note that all documents here are in PDF format.

• USA’s International Trafficking in Arms Restrictions – excerpts in HTML. Warning: older version.

• DID (Sept 10/07) – Australia Signs Defense Trade Agreement With USA. The agreement framework is similar to Britain’s.

• AW Aerospace Daily & Defense (Sept 6/07) – Now Is Best Chance To Remake U.S. Export Controls

• US GAO (July 26/07, #GAO-07-1135T) – Export Controls: Vulnerabilities and Inefficiencies Undermine System’s Ability to Protect U.S. Interests.

• British MoD (June 22/07) – UK and US Sign Treaty on Defence Cooperation. In effect, it’s a special set of arrangements re: ITAR for qualifying British firms.

• Aviation Week’s Ares (June 5/07) – US Technology? No Thanks! “The only way to resolve technology access and U.S. government export restrictions imposed by ITAR is by “not including any U.S.-sourced technology into our products,” [Dassault CEO Charles Edelstenne] the President of the Aerospace and Defense Industries Association of Europe (ASD) said yesterday… In the context of space programs, steps are already being made towards completely excluding U.S. input in order to stay clear of the ITAR restrictions, adds Francois Gayet, the permanent Secretary-General of the ASD…”

• DID (Nov 9/06) – US Export Restrictions Hand Korean E-X Competition to US Firm. It only takes one or two incidents like this to generate a lot of mistrust, and strong counter-reactions. DID lays out the situation, and explains the policy problem.

• DID (Dec 7/05) – ITAR Fallout: Britain to Pull Out of F-35 JSF Program? The threat was real, and Britain had a ‘Plan B’ – but an accord was eventually reached with all F-35 member countries.

• DID (Dec 1/05) – UK Warns USA Over ITAR Arms Restrictions. Describes what ITAR is, how it works, and some of the policy issues it presents.

• DID (Apr 19/05) – EU Stymied, Conflicted on Lifting China Weapons Embargo

• National Defense Magazine (August 2004) – Multinational Aircraft Program Tests Transatlantic Cooperation. They’re speaking of the F-35 JSF, and some of its ITAR-related snags and teething problems. Also addresses additional efforts to add restrictions contained in various US appropriations bills.

News & Views

• DID (May 9/07) – Iraq Issues RFP for COIN Aircraft. Embraer’s Super Tucano is short-listed. Should have taken care of this earlier.

• Venezuela’s Vheadline.com (Feb 10/06) – US veto: Spain’s EADS-CASA says will not be able to sell planes to Venezuela. Note that the sentence “The US has been accused of hypocrisy over this as it sent $190 billion of military aid to the continent last year” is vastly off-base. As a previous DID article has noted, the total figure to all Latin American countries (primarily Colombia these days, which accuses Venezuela of backing its FARC narco-guerrillas) is more like $120-160 million, with total US global military aid sitting at $6 billlion or so in 2003.

• El Universal, Venezuela (Feb 8/06) – EADS-CASA: aircraft sale to Venezuela is “nonviable”

• UPI (Feb 8/06) – Venezuela gives Spain Arms Deal Deadline. Actually picks up a Spain Herald story from Feb 6/06.

• Spain Herald (Feb 2/06) – Administration to comply with contracts, replace US technology

• Spain Herald (Feb 1/06) – Chavez pressures Spain on sale of military patrol boats

• Spain Herald (Jan 30/06) – Airplane sale to Venezuela to be unprofitable without US tech. Also discusses Brazil’s decision to cancel the Super Tucano ALX sale.

• El Universal, Venezuela (Jan 27/06) – EADS-CASA tries to meet plane sales agreement with Venezuela

• Reuters (Jan 25/06) – Veto May Sink Venezuelan Plane Sale: Report

• Flight International (Jan 24/06) – EADS Venezuela deal in jeopardy

• DID (Jan 19/06) – US Tech Transfer Laws Freeze Venezuela Aircraft Deal

• DID (Jan 13/06) – $8B ACS Spy Plane Program Shot Down By Pentagon. This program had once centered on Embraer’s ERJ-145 business jet. Included mostly for timeline understanding re: Brazil – US defense opportunities and potential sources of pressure. The ACS opportunity was already past by the time the US was pressuring Brazil re: its proposed Super Tucano ALX light attack aircraft sale to Venezuela.

• Voice of America (Jan 12/06) – Brazil Says US Wants to Block Airplane Deal with Venezuela

• DID (Dec 12/05) – Colombia Finalizes Deal for Super Tucano COIN Aircraft. The order is for 25 planes, at $234.5 million.

• DID (Dec 5/05) – Planes, From Spain, To Colombia’s Gain

• DID (Dec 1/05) – Venezuela Signs $2B Arms Contract With Spanish Firms (updated)

• DID (Nov 22/05) – F.I. Looks At Latin American Arms Market, Sees Venezuelan Buildup

• National Defense Magazine (November 2005) – Military Services Competing For Future Airlift Missions. notes that the C-295 is involved in a competition to supply the USA with light cargo aircraft. EADS-CASA is partnered with Raytheon there.

• DID (Oct 26/05) – US Roadblocks re: the Venezuela-Israel F-16 Upgrade: Politics or Protectionism? Definitely looks like politics now.