The construction industry is experiencing ‘hyper-escalation’ – unpredictable, rapid price increases in key commodities combined with supply issues.

Several factors are contributing to the current instability, including COVID, supply chain disruptions, geopolitical instability, shipping and internal transport disruptions, national and international increases in construction activity, skills shortages and raw material price surges.

From reinforcing steel to shipping containers, construction projects are no longer able to be priced with confidence. We have seen examples of price rises over a 12-month period of up to 70 per cent. Suppliers are no longer able to give or hold fixed prices. Yet, clients continue to expect fixed prices to ensure projects are delivered within their budget.

The issue is not just a lump sum/fixed price contractual issue. Even on collaborative contracts, contractors share the risk of escalation, and risk losing profit and overheads for unforeseeable events outside their control.

In the worst-case scenario, contractors cannot sustain these losses and become insolvent. We are seeing the start of a potential wave of construction-sector insolvencies in Australia. We must act now to stem the flow.

The Australian Constructors Association is advocating for a multi-pronged approach to deal with this significant issue. Escalation clauses (‘rise and fall’ provisions) in contracts can treat the symptom, but not the problem. Nonetheless, contractual price adjustments for all forms of contract are an important part of the solution.

We are seeing some good examples of price adjustment provisions in infrastructure contracts. The price adjustment mechanisms recently included in Queensland’s Transport Infrastructure Contract (Construct Only) and the (optional) rise and fall mechanism available in the NSW GC21 contract are good examples.

Many provisions rely on a formula linked to an ABS index. These are not without issue, as the index may not include for the particular item, or geographic anomalies and there lag actual inflation. On the plus side, formulas are efficient and effective adjustment mechanisms.

Another option is an open book approach, or provision of market quotes to verify the increase experienced. This can be a more accurate method to compensate for escalation, provided it is not too resource intensive.

Contract price adjustments can work to protect the client as much as the contractor. For example, a lump sum contract priced on high oil prices can result in benefit to the client should prices fall during the contract period.

Other solutions are aimed at designing to mitigate escalation. Very early contractor involvement, standardised design elements, outcomes-based specifications and value engineering to enable cost and/or scope reductions are all valuable mitigation measures.

Advance payments to enable early ordering and storage of certain materials as well as commitments to faster payments to contractors and the supply chain can also assist.

Hedging is often raised by clients as a potential solution. Unfortunately, this is essentially a form of gambling is not readily available for all commodities and where it is available has a limited timeframe. It is also expensive.

Expecting contractors to build the same design tendered for the same lump sum price, in times of hyper-escalation, is unfair and unsustainable. It is a lose-lose situation: contractors are unlikely to adequately foresee hyper-escalation and be able to realistically price tenders, those with realistic pricing risk being unsuccessful against a tender with less foresight, and clients risk paying a premium should prices fall.

Construction accounts for almost a quarter of all insolvencies and rising. Construction workers are six times more likely to die from suicide than a workplace incident. A worker shortfall of over 100,000 unfilled jobs is predicted for 2023 and women make up around 12 per cent of the total workforce.

If we are serious about addressing the industry’s problems, fair risk allocations, including reasonable compensation for substantial cost increases outside the control of the contractor, must be implemented as part of the solution.

While ‘gainshare/painshare’ arrangements are welcomed, the concept of ‘pain share’ should not be applied to unforeseeable and uncontrollable price increases. Contractors should not lose profit and overheads in these circumstances.

The Australian Constructors Association calls for government and private sector clients alike to review their contracts and include a price adjustment mechanism for price changes outside the control of the contractor. Ideally, this should be done in combination with collaborative contracting arrangements and value engineering where feasible.

Forcing contractors to take on pricing risks outside their control leads to claims, disputes and unfair consequences. This is not good for the industry, its workers, or the community.

As published in Sourceable on 16 June 2022.

Relevant information: A survey undertaken by the Australian Constructors Association in partnership with Arcadis in mid 2022 found the construction industry’s woes are far from over with key materials pricing and availability stress with tendering conditions heating up across Queensland, Victoria, New South Wales and Western Australia. View the survey findings.