The Ministry of Defence (MoD) has agreed a £2billion contract to secure the future of Royal Ordnance in a deal that could lead to a sale of the historic ammunition factories.

BAE Systems, Europe's largest defence company, owns Royal Ordnance and has been negotiating a new explosives-to-bullets deal with the MoD for two years. The contract will be unveiled by the MoD today and formally announced on Friday.

The 15-year contract will allow BAE to invest in the Second World War-era Royal Ordnance factories and bring them up to international standards after decades of neglect.

Having secured Royal Ordnance's future, BAE has the option to sell the division.

Senior defence industry sources have revealed that Mike Turner, BAE's chief executive, has spoken to rival companies about divesting the division, although it is not for sale at present. Chemring, the rapidly growing manufacturer of flares and aircraft counter-measures, is understood to have expressed interest.

BAE bought Royal Ordnance in 1987 when the Government dropped a privatisation of the ammunition factories. The division, which is part of BAE's Land and Armaments business, has lost money since the acquisition and the company has closed a dozen factories, leaving only three in the UK. It had threatened to close the business if the MoD did not offer a long-term contract that would allow it to upgrade the facilities and make a profit.

The MoD briefly considered sourcing all munitions from foreign countries, but this option was rejected on the grounds of national security.

Royal Ordnance traces its history back to the founding of the Royal Gunpowder Factory at Waltham Abbey in 1560.

Its acquisition by British Aerospace, BAE's predecessor, was the company's first big move away from aircraft manufacture. BAE has since become the world leader in land systems, building equipment such as armoured vehicles and howitzer field guns.

The MoD spends about £280million a year on munitions. The new contract will be worth more than £2billion initially.

Howard Wheeldon, senior strategist at BGC Partners, said: “A guarantee of long-term supply to the MoD will allow BAE to invest in this business and turn it around. It also makes a sale possible.”

Times Recommends

• Calls grow for steep rate cut as services deteriorate
• Stagecoach shares fall 20% on rail warning
• UK broadcasters web TV 'limits competition'