In the spring of 2021, like many others wanting to take advantage of the time Covid-19 lockdowns afforded, I wanted to build a deck off the back of my house. Between the quote and placing the order two weeks later lumber prices had increased 18%.
On August 9, 2021, the Financial Times published an article stating: “Industry bosses are predicting a worldwide construction ‘supercycle’ that is set to fuel demand for building materials as governments pump billions of dollars into post-pandemic infrastructure projects.“ As basic supply and demand economics (and my deck building experience) tell us, this will drive the price of building materials higher.
Higher building material prices will have the obvious consequence that infrastructure projects will be more expensive than anticipated. Those in the construction industry will benefit. For example, Laing O’Rourke, the UK’s largest privately owned construction group, recently announced a planned public listing in three years riding the wave of a post-pandemic infrastructure boom.
For those already operating within fixed price P3 projects it will mean higher than anticipated operating and maintenance costs (assuming no, or imperfect, hedging). Higher priced infrastructure has the subsequent negative impacts of:
- less economic impact for every dollar of stimulus investment, which hurts everyone, and
- an increased divide between the ‘haves’ and ‘have nots’, with those able to afford the increase proceeding with projects and those without the financial resources increasing the infrastructure and economic recovery gaps.
Infrastructure project authorities need to proceed with infrastructure project procurement, in the face of the challenges posed by price volatility and supply availability, by adapting procurement processes to accommodate. Examples of potential adaptations:
Timing: Structure the timing of the procurement processes to minimize the amount of time between financial bid submission and financial close. Bidders may not be able to hold prices for very long so moving from submission to close in the most expedient manner decreases the risk of price fluctuations.
Introduce reset processes: Typical P3 procurement processes allow for certain financial components to be reset from bid submission as part of the financial close process. Additional pricing components may need to be subject to a reset process in times of high price volatility.
Assess risk allocation: It may make sense for the public sector authority to maintain some of the pricing risks on highly volatile materials.
Allow for innovation: Being outcome oriented and allowing developers to introduce new/innovative/different input materials will enable the market to optimize around supply and demand.
With countries around the world all looking at infrastructure investment as a means to boost economic recovery, and many countries looking to address the infrastructure deficiencies highlighted by Covid-19, it will not be surprising to see a construction boom that results in supply challenges and rapid price increases/volatility.
Infrastructure procurement authorities should continue project development but should recognize the abnormalities in the marketplace and adapt procurement processes and deal structures to reflect the marketplace reality of the time.