With each month that passes in the 2022 calendar year, prices continue their upward rise. At the time of writing, the official Consumer Price Index (a measure calculated by the Office for National Statistics and used widely in government and business) is 7%. This means that the average price of a typical basket of consumer products has risen by 7% compared to the same point last year. On 5 May 2022, the Bank of England shocked many when it issued a warning that it predicts inflation could hit a peak of 10% during 2022.
The CPI is widely recognised across the construction industry, but ultimately the basket of goods doesn’t correlate to the input costs of a construction firm:
- Raw materials
- Labour costs
- Professional services
- Equipment hires
This last bullet point is what we’ll focus on in this article because debates about energy costs tend to focus on household energy consumption rather than industrial use. But of course, many industries are energy-intensive:
Fortunately, there is some existing government support for business energy use, such as exemptions from the climate change levy, feed-in tariffs and the contracts for different mechanisms. However, these policies were designed to generally subsidise high-energy users in normal market conditions and have not been revised or updated to deal with the dramatic rise in gas and wholesale electricity costs that have been passed on to businesses and consumers during 2021 and 2022 so far.
Looking at gas specifically, the European wholesale price has seemingly exploded under supply constraints (and fears of supply cut-off) from Russia.
To illustrate: on 31 March 2021, the price of Gas on forwarding delivery contracts was £51.05 per therm. That price rose to £230.68 by 28 March 2022.
How are construction firms responding?
Some industries simply become unviable when the price of input commodities rises, however, property and construction do not follow this behaviour. Buoyed by a hot property market, construction firms are still active and most major programmes are continuing under the current market circumstances.
Firms often have the contractual right to claim a higher fee if they experience short-term price inflation. Where a contract doesn’t include these terms, a firm may protect itself by breaking a longer project into separate phases which are only priced closer to the time. This allows a firm to ask for a higher price if the cost of future phases rises.
It’s more important than ever that a company assesses its business insurance coverage to ensure that it is covered for the legal costs of contractual disputes or the losses from suppliers that decide to breach their contracts, because the original terms have become unprofitable.
Alternatively, a firm can look to low-energy materials, which have become cost-effective as the price of energy has risen. Government and other corporate programmes often include targets for low-carbon construction and other modern construction methods. The eye-watering inflation of commodity inputs is only likely to further accelerate interest in these techniques.
A construction firm feeling margin pressure because of energy price inflation should first look to the existing support structure put in place by the government to subsidise energy-intensive industries, which includes steel.
They should also consider how they contract with customers, particularly for longer programmes that will span several years and create significant uncertainty over future input costs.
Finally, they should examine whether modern construction methods and low-carbon materials could provide a cost-effective alternative to materials that have become more expensive now that their producers are having to pay gas bills that have increased six-fold in a single year.