Impact of inflation on Construction

Contracts

Walaa R. SolimanMEng., PMP

SR. QS/Cost Engineer – Hill International

Presentation Contents

1. Inflation in Construction

2. What is the Cost Escalation

3. How Cost Escalation is measured

4. Forecasting Escalation

5. Escalation Formula

6. Example

7. Benefits

Inflation in Construction

Egyptian Construction Industry has a significant increase in inflation during the last 10 years which leads to a major impact ongoing projects, due to the obsession of some Construction materials, recent governmental legislation, fluctuation, fuel price increase.

Introduction

Inflation in Construction

Consumer Price Index

Average consumer prices inflation rate

• During 2018, inflation rate for Egypt was 20.9 %. Though Egypt inflation rate fluctuated substantially in recent years, it tended to increase through 1999 - 2018 period ending at 20.9 % in 2018.

Inflation in Construction

DATE VALUE CHANGE, %

2018 20.9 -11.37 %

2017 23.5 130.78 %

2016 10.2 -7.23 %

2015 11.0 8.88 %

2014 10.1 46.04 %

2013 6.9 -20.07 %

2012 8.7 -22.00 %

2011 11.1 -5.13 %

2010 11.7 -28.02 %

2009 16.2 38.83 %

2008 11.7 6.74 %

2007 11.0

Inflation in Egypt Up-to 2018

https://knoema.com/atlas/Egypt/Inflation-rate

What is Cost Escalation ?

•Cost Escalation refers to the anticipated increase or decrease, over a defined period.

•Building cost increases usually occur as a result of market forces, and reflect increases in the cost of Material, equipment and labor.

Inflation What Should You Carry?

• When construction is actively growing, total construction costs typically increase more rapidly for labor, materialsand equipment. Accordingly the overhead and profit increase as % of the dry cost.

• To properly adjust the cost of construction over time you must use the actual indices for this given period.

What is Cost Escalation ?

How Cost Escalation is Measured?

• Escalation/Inflation is measured by the consumer price index which reflects the annual percentage change in the cost to the basket of goods and services that may be fixed or changed at specified intervals.

• The Escalation formula is generally used by using the averages indices for the year, every 3 months, not end-of-period data.

Forecasting Escalation

Tender phase escalation

Requires the identification of the following fundamental factors:

• Date the estimate was produced.

• Expected Contract award date.

• Estimated escalation rate (as a percentage of the cost estimate per year)

• The time between the tender pricing and Contract award.

Contract phase escalation (Post Contract)

• Where it is likely that costs will increase during the contract phase, an allowance should be included for cost escalation between the expected tender date and the expected date of practical completion

Tender Phase Escalation Contract Phase Escalation

Contract AwardTender Phase Contract Completion

When to Apply Price Adjustment• The risk of price escalation is likely to arise:

(i) for goods contracts with long delivery periods;

(ii) for works contracts with long completion periods;

(iii) for major civil works/MEP contracts;

(iv) for contracts that contain supplies or commodities whose prices fluctuate significantly over a short period;

(v) for time-based consulting services, such as construction supervision services

(vi) due to any unusual/unexpected circumstances in the market in question.

Forecasting Escalation

When Not to Apply Price Adjustmenti. The procurement of certain

types of equipment which may be the case for : Engineering, procurement and Fixed-price contracts.

ii. Contracts for the supply, installation, and construction of facilities wherein the permanent works represents the major part of the estimated cost of the contract.

iii. Simple supply contracts with short delivery periods.

Forecasting Escalation

Escalation Formula

• Provision in a contract for increasing or decreasing the contracted price for labor, material, etc., in step with the market prices or an agreed upon benchmark such as consumer price index (CPI).

Pn= adjustment multiplier to be applied to the estimated contract value in the relevant currency of the work carried out in period n, this period being a month unless otherwise stated in the Contract Data; a = fixed coefficient, stated in the relevant table of adjustment data, representing the non-adjustable portion in contractual payments;b, c, d, etc. = coefficients representing the estimated proportion of each cost element related to the execution of the Works, as stated in the relevant table of adjustment data; such tabulated cost elements may be indicative of resources such as labor, equipment and materials;

Adjustment for changes in Contracts

FIDIC reference for the adjustment formula sub-clause 13.8

• Ln, En, Mn , etc. = current cost indices or reference prices for period ―n, expressed in the relevant currency of payment, each of which is applicable to the relevant tabulated cost element on the date prior to the last day of the period (to which the particular Payment Certificate relates);

• and Lo, Eo, Mo, etc. = base cost indices or reference prices, expressed in the relevant currency of payment, each of which is applicable to the relevant tabulated cost element on the Base Date

Adjustment for changes in Contracts

Example

FORMULA

P= 0.65529 + 0.079 (Ae/A0) + 0.2157 (Be/B0) + 0.05 (Ce/Co)

Fixed Coefficient for the non-adjustable portion

65.53%

Bulk CementCoefficient

7.9%

Reinforced steelCoefficient

21.57%

Diesel Coefficient

5%

0.6553 0.079 0.2157 0.05

And as per the agreed Contract provisions the base date will be Feb 2016, certified amount during the period Jan 2017 was 1,000,000 EGP

Example

Feb-16

BASE COST INDEX FOR BULK CEMENT

A0

BASE COST INDEX FOR STEEL R.F.T.

B0

BASE COST INDEX FOR DIESEL

C0

253.300 189.9 289.6

DESCRIPTION

This indices based on CAPMASS during the

Contract date

Example

Jan -17

BASE COST INDEX FOR BULK CEMENT

Ae

BASE COST INDEX FOR STEEL R.F.T.

Be

BASE COST INDEX FOR DIESEL

Ce

221.1 437.7 542.3

DESCRIPTION

Application of Adjustment Formula Based on CAPMAS

Example

Adjustments for Changes in Cost by using coef. For Feb 2016 to Jan 2017

DESCRIPTION

Feb-16 Jan-17

PEstimated

work to Complete

Net Amount Inflation

KChange in Cost

BASE COST INDEX FOR

BULK CEMENT

A0

BASE COST INDEX FOR STEEL R.F.T.

B0

BASE COST INDEX FOR

DIESEL F0

BASE COST INDEX FOR

BULK CEMENT

Ae

BASE COST INDEX FOR STEEL R.F.T.

Be

BASE COST INDEX FOR

DIESEL F0

Application of

Adjustment Formula Based on CAPMAS

253.300 189.9 289.6 221.1 437.7 542.3 1.3151,000,000 1,315,052 315,052

Example

Then the Contractor is entitled to a change in costs according to the above illustrated table with amount equivalent to 315,052 EGP, and accordingly the contractor’s payment certificate will be 1,315,052 EGP

• Simplify the identification of outdated allowances for cost escalation

• Facilitate improved understanding of how allowances have been calculated

• Improve communication regarding the status of allowances,

• Reduce the risk of having to seek approval for further funding for the project

• Enhance transparency and accountability with respect to budgets for government building projects.

Benefits of applying the Adjustment Formula

wala2a@hotmail.com

- https://knoema.com/atlas/Egypt/Inflation-rate

- The State of Queensland (Australia) (Department of Housing and Public Works)

- FIDIC Red Book 1999