Materials shortages in the construction sector – Implications and mitigation tools for developers
Whilst the Federal and State Governments struggle to contain the spread of the delta variant of the coronavirus, contractors and developers across Australia are grappling with their own issues of supply shortages.
The cause of this shortage is multi-factorial but, as with most things currently, is driven in part by the coronavirus pandemic. In this article, we consider the forces driving the current shortages and look at the steps developers can take to minimise the impact of these shortages on their projects.
Materials shortages and delays
Construction projects in Australia have historically relied on the importation of certain materials (notably steel, timber, electrical products and specialist components e.g. lifts) from overseas. However, whilst global economies have started to rebound from the effects of the coronavirus (including reopening of production plants closed as a temporary measure to halt the spread of the virus), there is now a significant backlog in production and subsequent delays in domestic construction projects.
This delay in production, coupled with delays in clearing customs driven by the necessity of detailed coronavirus checks and a shortage of haulage and logistics, is resulting in increases to both the time and cost required to bring a project to completion.
Domestic issues are also hindering the supply of construction materials. The bushfires at the end of 2019 and into 2020 burnt many hectares of timber earmarked for domestic and overseas construction projects; one government report has estimated that 130,000 hectares of commercial plantations were burnt. While some of the wood may be salvageable or repurposed, a significant proportion is not salvageable for its original purpose or was completely destroyed. Replacing this crop will be many years in the making.
Raw materials prices
Recent reports indicate both timber and iron ore prices have reached record highs driven by the global shortage in supply and outstripping many optimistic investors' wildest predictions. These price rises are reflected in the cost of the final product, particularly steel, and ultimately in the cost of construction projects.
Investment in construction
Both domestically and internationally, governments are looking to build their way out of the economic downturn created by the coronavirus.
Domestically, the Federal Government unveiled the HomeBuilder scheme which was specifically designed to provide jobs and drive economic activity in the residential construction market. When applications for the HomeBuilder scheme closed in mid-April, a little over 121,000 home renovations and new home projects had been registered. Whilst providing an economic stimulus, each of these projects will need to be resourced with materials and labour which are already in short supply.
Australia is not alone in focusing on infrastructure and construction projects as a means to underpin the national economy; the United Kingdom and the United States are both utilising infrastructure projects to drive their economies. The effect of this is that global demand for materials is soaring. Domestic contractors are facing stiff competition in trying to secure materials and are often needing to pay increased costs to preserve their supply chain.
Whilst the cost of such resources has, to date, been largely absorbed within the supply chain, a continued pressure on the availability of materials will lead to increased costs of construction projects overall.
Form of contract
It is worth noting part of the reason such costs have not been passed on, to date, to the principal is that many current construction projects were negotiated and documented in a pre-coronavirus era. Contracts were entered into for a defined lump sum and without extension of time provisions which specifically addressed coronavirus and pandemics, leaving contractors wearing the risk of time and cost consequences of material shortages.
However, the market is responding and we are now seeing a growing number of new construction projects tendered on a cost plus basis. Contractors are seeking to pass on the direct cost of its supply chain on to the principal (subject to its profit and certain fees). This de-risks the project from a contractor’s perspective but, absent of a guaranteed maximum price, means the risk of price escalation reverts to the principal.
The alternative, where a lump sum price is required, is that we anticipate contractors will price a contingency to buffer from cost escalations within its supply chain within the lump sum price. This approach is often accompanied by proposals from contractors that coronavirus related delays (or even delays associated with the delivery of particular items) become grounds for an extension of time. This thereby relieves the contractor of its risk of being exposed to liquidated damages for the late completion of a project.
One final point to bear in mind is that shortages are not confined solely to materials. Labour shortages remain a consideration on construction projects, whether this be particular skills shortages or legislative restrictions as such limiting the number of workers permitted on a construction site, as currently seen in Melbourne. In addition, given the number of construction projects across the sector, we anticipate skills shortages within the market will drive competition to secure labour leading to overall increases in the cost of a construction project.
Impacts on your development and ways to manage the cost increase?
The bottom line for developers is the cost of procuring construction contracts is likely to be higher for the foreseeable future. However, there are some practical steps developers can take to tackle this cost increase, these include:
- Ensuring a principal is ready to go out to tender/quotation - given how quickly costs are escalating, contractors are increasing reluctant to hold their prices for any period of time. Currently we are seeing prices held for a couple of weeks at most. Ensuring you are ready to enter into a contract within this period will prevent any reprice (and increased cost) due to delay
- Rise and fall mechanism - if cost certainty is the bottom line, ensure that rise and fall mechanisms are removed from a lump sum contract. This however is likely to come at the cost of an increased overall contract sum, as outlined above
- Procuring and storing long lead items - some principals may consider procuring and storing long lead items themselves. This will preserve the program as such free issue items can then be issued to the contractor when required or alternatively the supply contract novated at an appropriate time. For this to work, principals need to have appropriate storage facilities and should be mindful of insurance considerations. However, we have seen this work well where particular bespoke items are required by the principal from overseas
- Advancing payment for particular items - similarly, principals could consider advancing sums to the contractor for particular items to secure their supply in return for appropriate off-site materials security. This may prevent contractors delaying in ordering such items
- Alternative materials - where materials are known to be in short supply, principals could consider asking tenderers to tender alternative materials as part of their tender response which may decrease the overall price or the lead time
- Engaging the contractor under alternative cost plus procurement routes - sophisticated principals could consider engaging the contractor under alternative cost plus procurement routes, subject to appropriate parameters. This risk allocation is likely to be favourably received in the current climate and re-risk the premium which would otherwise be applied in a lump sum environment.
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