Transportation infrastructure contractors and customers alike are battling the impact of rapidly rising costs. Rhodri Clark talks about coping difficulties and strategies.
High inflation rates cause economic problems even in times that might be considered normal, but this year they are even more damaging than usual due to their suddenness. This time around last year, no one could have predicted that the global resumption of activity following the worst of the COVID pandemic, followed by the war in Europe, would push inflation to the highest level of the past three decades, with official forecasts of RPI and RPIX in the UK peaking at 11% in late 2022.
The situation is all the more painful in the UK as it follows many years of steady low inflation, which may have lulled infrastructure contractors and their customers into a false sense of security. The contracts, in general, were not made with such a large and sudden inflationary surge in mind.
Likewise, infrastructure budgets are based on inflationary assets as usual. This now leaves organizations, from the UK government to local authorities, having to reconsider what they can afford and what they have to reluctantly sacrifice or postpone. The DfT, for example, initiated a review of its main road network policy in January, well before the Russian invasion of Ukraine triggered further increases in oil and other prices.
In January letter to subnational transport entities asking them to reconsider their plans, Philip Andrews, head of road investment, policy and pipeline development at the DfT, said: “It is likely that we will not have enough funds to continue to fund all schemes currently planned at the current scale or timeframe. ‘
David Renard, transportation spokesperson for the Local Government Association, notes: “High rates of inflation will impact municipalities’ ability to provide all local services. Transportation infrastructure is no exception.
“Levels of funding, coupled with building inflation, will make it difficult to plan future maintenance programs and nearly impossible for municipalities to tackle the £ 12 billion backlog of road repairs that now exist.”
Contractors and suppliers are also hindered. “We are seeing very substantial increases in the range of products used in the construction industry,” reports Alasdair Reisner, chief executive officer of the Civil Engineering Contractors Association.
“As far as infrastructure is concerned, the big concerns would be the black roof, steel products (including reinforcement) and concrete products.”
Mark Ollerton, director of commercial deliveries at National Highways, says, “Our major construction and maintenance contracts are not fixed price / lump sum, but are defined cost targets with limited payoff mechanisms that share risk and lump sum. “Delivery opportunity. In such contracts, the pricing mechanism of inflation is maintained by the application of industry-specific cost indices that track market inflation in real time.”
Some Network Rail contracts, however, have fixed delivery prices. This gives Network Rail some protection from high inflation, but other contracts include indexing for inflation. It has not asked for any additional funding for its current program because it attaches great importance to its efficiency program. It recently reduced the unit costs of station platforms, bridges and elevators, for example.
Mark Stevens, chair of the engineering board of ADEPT, says it was common for local authorities to include indexation in contracts because inflation has been so low for so long and no significant budgetary impact from indexation was expected.
ADEPT has given the government the message that inflation is a real problem, but there has been no increase in funding for highway maintenance. Stevens says that for many years he has argued that cutting funding is not the right approach to highway maintenance because local road networks are growing (even where authorities adopt new highways) and inflation takes its toll. A six-year static funding allocation decreases over the period.
“Money doesn’t buy you much at the end of the six-year period because you have more avenues to keep and inflation goes up,” he said. Mr. Reisner says the situation with the projects is currently worrying. ‘Project budgets are very stressed with everything that’s going on.
“For companies that have existing fixed price contracts, it will be very challenging indeed, because the margins that were in the low single digits are simply wiped out by double digit inflation. Some prices are going up from 40% to 50% – we’re on it. seeing proof with some of the steel products. ‘
He fears that some contractors will fail. He says the outage of the past two years has left many companies with no room to tackle the inflationary problem.
‘The challenge with company failure, coupled with the human cost and loss of jobs for people, is the domino effect for suppliers. This could cause wider damage along supply chains, ”she warns.
Mr. Reisner says clients shouldn’t view inflationary pressures as an issue for contractors to address. “It is not in anyone’s interest to have underwater or failing suppliers.”
However, it acknowledges that customers don’t have the money to raise payments to contractors and suppliers. He hopes customers, contractors and the supply chain will avoid contradictory behavior and accusations that one party is exploiting the situation for profit and urges everyone to accept that the situation belongs to no one.
“This puts people in the right mindset to say, ‘We recognize this is happening – what is the best way to manage the process so that we can continue to deliver to our customers and the entire supply chain remains sustainable?’ ‘
Mr. Reiser said the UK government could help find other sources of material that previously came from Ukraine, Russia and Belarus. “The problem is that everyone else in the world is thinking this way too.” He also suggests looking into tariffs and quotas. Aid to the industry on energy costs would also be beneficial, but he adds:
“It’s quite challenging because there is only so much power governments have to support the industry, due to their financial firepower, but also the state aid rules.”
He hopes that customers, contractors and the supply chain will work together to identify ways to deliver the same results at lower costs, including through possible efficiency or productivity gains. “It may be about making pragmatic decisions that we won’t deliver what we anticipated.”
During the pandemic, customers’ flexibility on timing was invaluable. Mr. Reisner believes it would be worth considering now to allow more time on contracts, but it would be less significant than during the pandemic because pricing is currently a bigger problem than material delays or high sick leave rates.
Mr Stevens notes that this year’s £ 1.25bn allocation for maintenance of local motorways in England is not set to increase next year or the following year. “These are local authorities trying to see what they can and cannot do,” says Stevens, who is the Haringey Council’s Deputy Director of Direct Services. He believes most authorities are planning their course until next March.
“One of my counterparts [in another authority] he was saying that due to rising prices, they would not continue with their surface dressing program this year.
“Local authorities will cut their clothes so that preventative maintenance takes some effect, because we need to make sure we can keep the network responsive. The duty is to keep a network as secure as reasonably possible. ‘
Amid the grave darkness, there is a glimmer of hope. The most recent forecasts show that the Office of Budget Responsibility expects RPIX to peak at 11% at the end of this year, but decline by 2023, reaching 5.1% in the second quarter. After a low of 1.8% in early 2024, RPIX is expected to stabilize at around 2.5%.