Rising material costs hit UK construction

The cost of raw materials in the UK is expected to more than triple in 2022, according to the Building Cost Information Service (BCIS) materials cost index.

The figure had already quintupled during the Covid-19 pandemic, rising from -0.9% in 2020 to 4.8% in 2021 – a 40-year high, according to the Royal Institution of Chartered SurveyorsAnalysis of figures from the Office for National Statistics (ONS). The BCIS material cost index is now expected to reach 17.5% by the end of 2022.

The Covid-19 outbreak has pushed up already growing global demand in the construction industry, while also causing logistical challenges that have led to unprecedented shortages, delays and ultimately increases in material prices across the board. fields.

The UK occupies a particularly precarious place in this scenario as the above trends are complicated by Brexit, which affects all aspects of trade as well as the availability of labour.

the ONS construction statistics show that after a 12% decline in the second quarter of 2020, construction output in the UK – i.e. all work – increased by 9.7% in the second quarter of 2021 compared to the same period in 2020.

Looking at specific materials, the BCIS Materials Cost Index shows that steel and wood saw the largest increases between January and September 2021, while a high degree of volatility can be seen across all cost categories. materials.

“The cost of materials for the construction of a three-bedroom semi-detached house increased by 14%, or around £7,300, between January and September 2021,” said James Fiske, director of BCIS. “It is expected to rise by a further 1%, or £600, by the end of 2022.”

BCIS Senior Consultant Joe Martin added: “Pressure on material pricing and availability is expected to continue at least through the end of 2022. Labor shortages are expected to evolve as the main driver of rising overall construction costs next year and the construction sector would need to compete [with other sectors] for [these workers].”

The output-input dynamic

The increase in construction output – construction and civil engineering work done over a period of time – pushes the demand for construction inputs – the resources, including raw materials, used in the production of the product leading to the production – which also increases the cost of inputs.

Data from the Department for Business, Energy and Industrial Strategy in August 2021 showed that the the average cost of materials in the construction industry was 23.5% higher only in August 2020.

The ONS report also highlights that global price trends in commodities such as iron and copper are pushing up construction input prices, with iron ore prices soaring 97% in July 2021 compared to the previous year.

“Steel and metal joinery are the most weighted inputs of private industry. [projects] and the second largest weighted in bridge construction projects,” the ONS report adds. “Structural metal products for the domestic market had the highest prices of the components that enter the index. August 2021 and September 2021 saw price increases of 13.4% and 15.7%, respectively, compared to similar periods in 2020.”

GlobalData Construction Project Momentum Indexwhich assigns a score between 5 and -5 to each project based on its current progress, found that momentum had slowed slightly in February.

The scores are then weighted by the value of each project to arrive at overall scores for countries, regions and sectors.

“The UK’s overall score was 0.71 in February, down from 0.80 in January 2022 and the lowest score in four months,” the GlobalData report said. “The score for projects in progress fell to 0.85 from 0.87 in January, while for pre-implementation projects the score slipped to 0.26 from 0.39 in January.

“While relatively stable, momentum is still generally limited by ongoing concerns about outbreaks of Covid-19 variants and the risk of related activity restrictions, as well as shortages of key building materials and rising costs. price.”

Cumulative effect of price increases at all levels

Inflation drives up costs in all industries and countries, not just building materials. However, for UK builders, the burden of material cost inflation is significant.

“Rising raw material costs are our clients’ biggest concern right now,” says Neal Morris, head of construction advisory and litigation at law firm Pinsent Masons. “This is especially true for those in fixed price contracts as they generally cannot charge more if the price of materials increases. It should be noted that many of the largest construction contracts are fixed price.

While some projects are developed on cost-reimbursement terms, the impact of rising material prices has been significant as it has exceeded the typical 3-4% profit margin for infrastructure, Morris says.

“Materials prices aren’t the only ones to soar in recent months either,” he adds. “Labour and energy costs have also increased, and well beyond the 3-4% margin. As a result, construction projects have experienced significant compression, eroding margins unless they are on properly reimbursable contracts.

The specter of insolvency

Insolvency is the unwanted specter looming over the UK construction industry‘s horizon. A recent example is that of British regional independent contractor Midaswhich went into administration in January, leaving behind £20million in debt to unsecured creditors, who have little chance of getting their money back.

“Midas is a very good example of how passing on additional costs to supply chain customers no longer works, as the vast majority of contracts are now short-term contracts,” says Morris.

Builders have come up with major contingency plans to counter the undesirable effects of rising material costs, but that hasn’t stopped investors’ returns from being hurt.

The private sector bears the brunt of it the most, as rising levels of inflation have led to hikes in interest rates, which in turn is a huge hurdle for infrastructure projects.

“Many projects that were due to come online this year have been put on hold due to rising levels of inflation, and many commercial contracts are being reviewed as contractors raise prices,” says Morris. “We are seeing the beginning of a downturn.”

War, Inflation and Rising Rates

To complicate matters further, Russia’s invasion of Ukraine created a domino effect by amplifying global inflation fears and forcing central banks to act more quickly on quantitative tightening by raising interest rates. , which are a significant burden on construction projects.

“Putting the impact of the war in Ukraine above [of everything else] could be quite damaging, especially if the Bank of England’s monetary policy committee decides to raise UK interest rates faster and harder than expected,” says Graham Robinson, global head of infrastructure and construction at Oxford. Economics and Global Business Consultant at Pinsent Masons. “If they go too strong, you’ll get stagflation, a drop in output accompanied by a prolonged period of inflation.”

The dispute is also likely to have a more direct impact on material costs, as Russia and Ukraine are key suppliers of metals, raw materials, chemicals and machinery.

Russia controls about 10% of the world’s copper reserves and is a major producer of nickel and platinum. Ukraine is one of the main European producers of uranium, titanium, manganese, iron and mercury ores and has the third largest reserves of shale gas in Europe. Russia also supplies 30% of its oil and 40% of its natural gas to Europe.

“Global condemnation and imposition of sanctions against Russia and Belarus in response to Russia’s military invasion of Ukraine is likely to have huge implications and impact on global trade, especially raw materials. , for the coming years. The effect of the war on the supply of building materials in the UK remains to be determined,” said John Newcomb and Peter Caplehorn, chief executives of the Builders Merchants Federation and the Construction Products Association respectively, and co-chairs of the Building Leadership. The Council’s Product Availability Working Group, in a declaration.

“The region comprising Russia, Ukraine and Belarus accounted for just 1.25% of building products imported into the UK in 2021,” they added. “However, it is likely that there are higher levels of direct and indirect exposure to certain components of the product, either through raw materials such as aluminium, copper, bitumen, pig iron and iron ore used in the manufacture of steel, or by higher prices in more exposed European markets. In addition, sanctions against individuals with links to the regime in Russia and Russian-owned companies could affect the UK supply chain.

Cost inflation, the war in Ukraine and rising interest rates are also affecting another crucial factor contributing to the health of the construction industry, in the UK and elsewhere: that of investor sentiment.

“The war in Ukraine has had a very negative impact on investor sentiment for the construction sector,” says Morris. “The rise in energy and materials prices that is being felt as a result of the conflict is highly unsustainable for the sector.”

While Russian forces appear to have withdrawn from parts of Ukraine, there does not seem to be any real end in sight to the conflict, and it is not easy to predict its impact on the price of building materials. .

Rising inflation and the resulting move towards more quantitative tightening are trends that are likely to continue through at least the end of 2022. Many of these macroeconomic trends will continue to pose headwinds to the construction sector for the foreseeable future, both in the UK and globally.

“Entrepreneurs and their supply chains need to discuss their response,” Robinson of Oxford Economics concludes. “The higher prices must be passed on because the sector cannot absorb any more increases.”

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