BY ANDREA SHALAL
WASHINGTON Wed Nov 5, 2014 6:29pm EST
(Reuters) - The U.S. government on Wednesday said it had canceled, at the request of South Korea, a preliminary contract with the U.S. unit of Britain's BAE Systems (BAES.L) to upgrade 134 F-16 fighter jets, ending a major arms deal initially valued at $1.7 billion.
The unusual move, announced by the Pentagon's Defense Security Cooperation Agency, paves the way for South Korea to pursue a similar upgrade deal with Lockheed Martin Corp (LMT.N), the warplanes' original manufacturer.
The decision raises questions about the ability of non-original equipment makers like BAE to compete in the market to upgrade thousands of F-16s in use around the world. BAE was the first non-OEM to win a competition to upgrade F-16s.
South Korea in October said it could cancel the project and seek a different contract after the U.S. Air Force told Seoul the projected cost of 1.75 trillion won ($1.7 billion) could rise by 800 billion won.
U.S. officials said the Air Force's estimate for the cost of the deal rose significantly after the U.S. government determined the sensitivity of the equipment involved meant the contract could not be negotiated by BAE directly with Seoul as a direct commercial sale. It instead needed to be handled as a government-to-government foreign arms sale.
Such sales are generally more expensive and broader in scope to ensure that the requesting country has the needed infrastructure, spares, training and other associated equipment to operate the new or upgraded weapons, said one U.S. official, who was not authorized to speak publicly.
U.S. officials said they told the Seoul government two years ago that there was a substantial risk that the projected cost would rise as a result of the decision to offer "a total package approach."
After a detailed calculation, the Air Force concluded the deal would cost South Korea between $2.1 billion and $2.4 billion, versus initial estimates of the direct commercial sale of $1.7 billion, the officials said.