SUBMARINE PURCHASE SPARKS DEBATE IN PORTUGAL

C O N F I D E N T I A L SECTION 01 OF 04 LISBON 000561

SIPDIS

E.O. 12958: DECL: 10/23/2019
TAGS: MARR MASS MCAP MOPS PREL PGOV PO
SUBJECT: SUBMARINE PURCHASE SPARKS DEBATE IN PORTUGAL

Classified By: Pol-Econ Officer Mario Fernandez,
reasons 1.4(b) and (d)


1. (C) Summary. The Portuguese prosecutor's office filed
fraud charges September 30 against seven Portuguese and three
Germans involved in the controversial one billion Euro
purchase of two German-built diesel submarines for the
Portuguese Navy, sparking debate about whether Portugal needs
-- or can afford -- the top-of-the-line submarines and
raising expectations that the Portuguese government may
renegotiate the deal. While full details have yet to emerge
and the legal process has just commenced, the prosecutor's
office alleges that the German Submarine Consortium conspired
with Portuguese companies to include as offsets business that
already existed, double-invoiced certain offsets, and in some
cases reported costs far above the invoice price, defrauding
the GOP of approximately 34 million Euros. To date, no GOP
officials have been charged.


2. (C) Although the unfolding scandal is unlikely to derail
the purchase this late in the decade-long process -- one of
the submarines is now undergoing sea trials -- the sobering
price tag, which came due during a recession, has some
government officials second guessing the purchase and finger
pointing across the aisle, with the former Speaker of
Parliament saying that Portugal "does not need the submarines
at all" and "urgently needs to sell" them to acquire more
useful weapons. While the submarines are not inconsistent
with Portuguese national maritime strategy -- Portugal has
had submarines since 1913 -- Post believes an enhanced
maritime patrol capability, such as surface patrol vessels,
would be a more efficient use of Portugal's limited defense
budget. End Summary.

BACKGROUND
--------------


3. (SBU) Since the late 1990s, the Portuguese Ministry of
Defense had been interested in replacing its last operating
Cold War-era submarine -- commissioned in 1968 -- by 2010.
The acquisition was controversial from the beginning and was
hotly debated in Parliament, proponents arguing that
Portugal, with its maritime history, required the submarines
to protect its vast maritime territory while opponents
countered that a country of 10 million could not afford them.
In the end, Parliament approved the purchase and, in 2003,
the Portuguese government -- then led by the center-right
Social Democrats (who are now in opposition) -- put out for
bid a contract for two diesel submarines. While companies
from five European countries submitted bids, the GOP selected
a proposal from a German consortium as best in price,
offsets, and operational capability.


4. (U) In April 2004, the GOP signed a contract with the
German Submarine Consortium, an enterprise composed of the
two German yards with experience in making submarines, for
the construction of two specialized diesel submarines at a
cost of over 800M Euros (approximately 960M USD in 2004),
with an option for a third. The parties agreed, however,
that the German Submarine Consortium would provide trade
offsets, such as the creation of industrial projects in
Portugal, worth 1.21 billion Euros. As is customary, the
offsets were specified in a separate, not publicly available,
contract. (Note: An "offset" is a contract mechanism by
which the buyer requires the seller to reinvest a portion of
the contract price in the buyer's economy. They can take
many forms, including co-production, subcontractor awards,
technology transfer, and local investment.) With the first
of the two submarines conducting sea trials and scheduled to
arrive in Portugal in spring 2010 and the second in spring
2011 -- Portuguese crews have been training in Germany for
some time -- the Portuguese prosecutor's office filed charges
September 30 against seven Portuguese and three Germans
involved in the deal for forging contract documents and
defrauding the GOP out of approximately 34M Euros.

CUSTOM BUILT SUBMARINES; INFERIOR TORPEDOES
--------------


5. (C) The Portuguese Navy has been operating submarines
since 1913, when it purchased its first three submarines from
Italy. In 1964, Portugal bought four diesel-electric attack
submarines from France (Daphne Class). Of these, only the
Barracuda, commissioned in 1968, remains operational --
though there are growing concerns about its safety given its
age -- and is used for training exercises and
counter-smuggling operations. The two new German Class 209
submarines -- one named Tridente, the other Arpao ("Harpoon")
-- would give the Portuguese Navy the capacity for defense

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and law enforcement patrol. It should be noted that the GOP
caused increases in the price by specifying upgrades to the
base 209 design, with features from the newer Class 214
submarines.


6. (C) Similarly, the GOP's choice of torpedoes to equip the
submarines was problematic. While the six torpedo tubes in
each sub could be armed with the U.S. Mark 48, the GOP
purchased 24 Italian "Black Shark" torpedoes, considered less
capable, less reliable and, at a cost of approximately 2.8M
USD per unit, 12 percent more expensive than the Mark 48.
The GOP decision was almost certainly driven by EU pressure
to buy European.

PROSECUTOR'S OFFICE FILES CHARGES
--------------


7. (U) As early as 2007, rumors began to surface that the
Portuguese Judiciary Police were investigating a 24M Euro
transfer from the German Submarine Consortium to a Portuguese
company. On September 30, 2009, following a two-year
investigation in Portugal and Germany, the Portuguese
prosecutor's office filed charges against seven Portuguese
managers and three German representatives from Man Ferostaal,
a company belonging to the German Submarine Consortium, for
forgery and fraud. The Portuguese prosecutor's office
alleged that they improperly benefited from the offsets
program. Investigators estimated the GOP was defrauded of
approximately 34 million Euros. The German consortium has
denied the charges.


8. (U) While the prosecutor's office has yet to provide full
details, the gist is that the representatives of the German
Consortium conspired with Portuguese companies to include as
offsets business that already existed, double-invoiced
certain offsets, and in some cases reported costs far above
invoice. In addition, the offsets appear to have increased
the price of the submarines significantly. According to the
prosecutor's office, the GOP paid five to fifteen percent
more than necessary for the submarines to generate offsets
for Portuguese companies. There were a number of red flags
during the process, such as evidence that the German group
was informed they had won the bid three weeks before the
Portuguese Minister of Defense signed the document making the
decision official. The prosecutor's office is expected to
file a second complaint, but no government officials have
been charged and there is no indication any were involved in
the scandal.

"PORTUGAL DOES NOT NEED THE SUBMARINES AT ALL"
-------------- -


9. (U) The unfolding scandal immediately sparked debate over
the wisdom of buying the subs. The currently ruling
Socialists (PS) were quick to point out that the contract was
signed in 2004 by the Social Democratic (PSD) government then
in power, when PSD leader Manuela Ferreira Leite was Minister
of Finance. Former PS Speaker of Parliament Almeida Santos
quipped that he might be a "bit of a donkey," but he failed
to understand why Portugal needed the subs. "Portugal does
not need the submarines at all," he said, adding that
Portugal "urgently needs to sell the submarines" to acquire
weapons more "useful and necessary." Predictably, then PSD
Minister of Defense Paulo Portas, who signed the contract in
2004, denied the allegations, underscoring that they came
from anonymous sources, were tied to the 2009 election
season, and were a case of "history badly told."


10. (SBU) Defending the submarine purchase on October 15
during his annual state of the Navy address, Admiral Fernando
Melo Gomes, Chief of the Portuguese Navy, spoke in
generalities when he declared that Portugal could not
"dispense with submarine weapons" and "cede to others its
sovereignty and responsibility to intervene in maritime zones
within the national interest." Noting that the purchase had
been approved by the political establishment, Gomes
concluded, "To have submarines is expensive, very expensive,
but more expensive would be not to have them, especially for
those generations that follow us."

PORTUGUESE NAVAL MARITIME STRATEGY
--------------


11. (SBU) The Portuguese Navy considers the vast triangular
maritime area in the Atlantic Ocean delineated by Portugal,
the Azores, and Madeira to be their neighborhood to defend
and patrol. Under the Law of the Sea, Portugal actually has
jurisdiction over a smaller area encompassing some 1.7
million square kilometers. According to Portuguese Navy

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maritime strategy, "that sea must be protected, surveyed,
exploited, and defended, in order to safeguard national
interests." Submarines can fulfill many maritime
applications and can, in fact, be justified as contributing
to the Portuguese Navy's dual defense and law enforcement
mission. In addition to their defense function, submarines
serve as discreet surveillance platforms that can be used to
track suspicious vessels with illicit cargo. Proponents are
hard-pressed, however, to articulate specifically why, other
than their stealth, the submarines are more appropriate than
other, cheaper platforms.

SIGNIFICANT OPPORTUNITY COSTS
--------------


12. (C) The problem with the submarines is not that they do
not readily fit into Portuguese strategy; but rather, the
purchase represents a missed opportunity to procure more
urgently needed, and arguably more strategically useful,
assets. As maritime threats to national security have
decreased, the Portuguese Navy has been increasingly focused
on its law enforcement mandate. Thus, a fleet of
ocean-crossing surface vehicles might have been more
appropriate. Similarly, the Portuguese Air Force needs
helicopters to replace its twenty 1960s vintage helicopters,
and to modernize avionics for its six C-130 transport
aircraft. Finally, the submarines contribute little to
NATO's emphasis on deployable forces. As if to underscore,
Embassy Lisbon is currently fielding a Portuguese request to
borrow from the U.S. 25 Humvees for an infantry unit Portugal
intends to deploy to ISAF in January 2010.

SUBMARINE COST WILL IMPACT DEFENSE BUDGET
--------------


13. (C) The submarine purchase will impact the 2010 defense
budget. Though the 2010 budget has yet to be passed,
assuming 2009 figures, the submarine purchase represents more
than 50 percent of the defense budget, which itself
constitutes 3 percent of the entire government budget.
Further, the GOP did not include maintenance, training,
salaries, and operating costs (including the torpedoes) in
the purchase price. Combined costs will surely run into the
tens of millions of Euros annually. At one point in 2008,
press reports suggested that the GOP was entertaining the
possibility of selling the submarines to Venezuela, though
the GOP immediately denied the report. According to press
reports, the Ministers of Defense and Finance were reportedly
collaborating to solve the problem at that time, even as then
Economic Minister Manuel Pinho was publicly criticizing the
purchase as an "unnecessary expenditure."


14. (SBU) European Union rules provide that defense purchases
be applied to the budget the year they become operational,
regardless of whether the purchase will be financed over
several years. The GOP may well be forced to play budgetary
juggling to comply with EU rules. Because the GOP will
receive one of the submarines in 2010 and the other the
following year, the GOP may be able to split the cost over
two years, softening the impact. In any case, the GOP
appears unlikely to cancel the deal. Although the media have
run unsourced reports that the government was considering
nullifying or renegotiating the contract, the Permanent
Commission on Offsets (a GOP Ministry of the Economy agency
responsible for the implementation of Portuguese Offset Law),
recently stated that it remained committed to comply with the
Portuguese government's contractual obligations.

COMMENT
--------------


15. (C) The Portuguese are steeped in their seafaring history
and feel an almost visceral pride in their maritime tradition
and their past glory as a global empire. With their only
submarine scheduled to be decommissioned in 2010, giving up
the purchase of these two submarines would mean relinquishing
all submarine capability. This sense of pride explains why a
country of ten million people, a member of the NATO alliance
facing no discernible maritime threat, would purchase such
expensive submarines in the first place. While the unfolding
scandal may have sparked public debate over the wisdom of the
purchase, and some legal experts speculate that the fraud
charges open the door to annul or renegotiate the purchase,
the debate at this point is mostly academic. The GOP has
given every indication that it will go ahead with the
purchase and the Portuguese Navy continues to prepare to
incorporate the two submarines into their arsenal. Post
continues to maintain that an enhanced maritime patrol
capability, such as multiple ocean-crossing surface patrol

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vehicles, might have been a more efficient use of Portugal's
limited defense acquisition Euros.


For more reporting from Embassy Lisbon and information about Portugal,
please see our Intelink site:

http://www.intelink.sgov.gov/wiki/portal:port ugal
BALLARD