BAE Systems PLC is in talks with the government of Saudi Arabia over an extension to the controversial 15 billion sterling Al Yamamah contract, The Sunday Times reported citing defence industry sources.

They said that discussions between BAE, the Ministry of Defence and the Saudis are "progressing well," according to the newspaper.

The new agreement -- there have been two previous Al Yamamah deals -- would centre on BAE making substantial improvements to the oil-rich kingdom's fleet of British-built Tornado fighter-bombers. The deal would also extend BAE's service contracts to support Saudi Arabia's armed forces, the article added.

BAE has 5 500 workers in the country, 2 500 of whom are expatriates. Winning a new contract in Saudi Arabia could be crucial to BAE's future. The company's long-held ambition to forge a transatlantic partnership with a big American defence company has been hamstrung by its flagging share price. A new Al Yamamah arrangement would send BAE's shares soaring, the newspaper said.

However, a separate article in The Sunday Telegraph said controversy over reported allegations of a 20 million sterling "slush fund" at BAE is putting the Al Yamamah contract at risk.

The newspaper said it has learned that BAE Systems is in active negotiations with the Saudis over a multi-billion pound upgrade to Tornado aircraft originally supplied under the Al Yamamah arms-for-oil deal.

But the newspaper added that BAE Executives fear that the talks could be undermined by the "slush-fund" allegations reported in the Guardian newspaper last week but denied by the company.

With acknowledgement to AFX News Limited London.