Minister McGrath introduces measures to address the impact of Construction Material Price Inflation on Public Works Projects

The Minister for Public Expenditure and Reform, Michael McGrath TD, had just announced details of further measures to address the impact that exceptional inflation in construction materials and energy is having on public works contracts.

As economies reopened in the aftermath of Covid-19, significant inflation, coupled with shortages in the supply of particular construction materials was experienced. The Russian invasion of Ukraine has considerably exacerbated these pressures on construction projects. Since early 2022, significant increases in energy prices are driving further price increases and leading to great uncertainty around delivery periods for certain construction materials.

As a consequence of the conditions experienced in 2021, amendments to address further price volatility were announced in November 2021. These apply to new contracts. The amendments did not address energy price volatility or delay caused by supply chain disruption.

Through extensive engagement with industry and public sector stakeholders involved in the delivery of the National Development Plan 2021-2030 NDP, it is clear that the delivery of many critical public capital projects was being put at risk due to the rapid increases in material and energy prices in recent times. For contractors who tendered for projects prior to the onset of these inflationary pressures, this issue is particularly acute.

In the interest of safeguarding public projects that are already under construction and to mitigate the risks of significant losses being sustained by contractors, Minister McGrath is introducing an “Inflation Co-operation Framework” for those parties engaged under a public works contract.

The Framework will facilitate both parties to engage with one another for the purpose of addressing the impacts of this most recent onset of exceptional inflation and supply chain disruption and will operate on an ex gratia basis. The Framework will set down the approaches and the parameters within which parties to a public works contract calculate additional costs attributable to material and fuel price fluctuations using price indices published by the Central Statistics Office.

In recognition that neither party is responsible for the global events that have given rise to inflation, it is proposed that the additional inflation costs will be apportioned between the parties, with, subject to budgetary constraints, the State bearing up to 70% of the additional inflationary related costs. The Framework will apply to payments made from 1 January 2022.

Commenting on the launch of this new financial service, Minister McGrath said: “While the changes introduced in January have brought greater stability to contracting arrangements, through ongoing engagement there has been sustained feedback from Government Departments and their Agencies that successful delivery of priority projects included in the NDP is jeopardised by construction inflation. More recently, Departments have reported specific issues with fuel costs and supply chain disruption, including reduced competition for public works contracts and challenges relating to completing projects underway during 2021. The changes implemented in January have provided a degree of mitigation on materials price increases (for contracts awarded with a revision date of 7th January 2022).

“I recognise the problems that these exceptional material cost increases, fuel costs, and supply chain disruption continue to have on public projects and those charged with their delivery at present. I am conscious of the difficulties being experienced by public bodies in progressing their projects and the ability to deliver the wider NDP whilst at the same time I need to maximise value for money for the taxpayer. It is vital that public works contracts remain a viable proposition for contractors with whom we partner in the delivery of the NDP.

“It is for these reasons, I am introducing further measures in addition to the ones put in place in January. I consider that these actions are necessary and proportionate in the context of the significant risk that global exceptional inflation poses to the delivery of much needed public facilities in the NDP. The measures available under the Framework strike an important balance between the additional costs incurred by the State to support Contractors engaged on public projects and the State’s ability to deliver the NDP, whilst providing value for money for the taxpayer.”

CIF Reaction 

Speaking following the Government announcement, Tom Parlon, Director General of the CIF said, “We welcome the measures announced today by the Minister, which are focused on addressing the inflationary impact of the Ukraine conflict on construction materials and fuel. They represent a positive step. However, it is disappointing that these measures will only be applied to all projects from the 1st January 2022 onwards and will not address the exceptional period of inflation since January 21.

“The current situation has highlighted the necessity for essential reforms of the public works contract and the ability of contractors to accept the transfer of risk beyond their control. The CIF and its members have continually called for more collaborative contracts, which manage risk in a more balanced and sustainable way.

“We will be keenly examining the proposed Inflation Framework Agreement, which we understand will allow engagement between public clients and their contractors, address supply chain disruptions and delays and introduce recovery mechanisms for cost increases in construction materials and fuel on a 70:30 basis. However it is clear further significant steps will be needed if we are to establish a public tendering system in line with international standards,” he concluded.

The key provisions of the Inflation Co-operation Framework are:

• It will operate from the point at which the parties agree to engage until the project is completed.

• Given that further inflationary pressures have been building since the beginning of 2022, it will provide for the back-payment of a proportion of inflation related costs (on materials and energy) to 1 January 2022 on those contracts that are in progress since the beginning of 2022 (i.e. before the revised contracts were issued).

• Going forward, for the duration of the framework, additional inflation costs will be calculated in a similar manner.

• For more recent contracts (i.e. those that commenced under the amended forms of contract), the framework will permit the recovery of costs arising from fluctuations in energy prices.

• And finally, for all contracts currently in progress, where it can be shown that a supply chain disruption has led to a delay in completing the project, contractors will not be held liable to pay liquidated damages for the late delivery of the project.

The use of the framework is voluntary, but participation by the parties is strongly encouraged. It represents a pragmatic and proportionate response to the current challenges caused by inflation that are not within either party’s control.

Guidance, workbook templates and forms of agreement will be published by the Office of Government Procurement shortly.

Application of the Inflation Co-operation Framework

• There are two aspects to its application depending on the form of contract that applies –

I. retrospective analysis of cost increases with respect to payments made from 01 January 2022 and delays from the same date up to the point of entering the Inflation Co-operation Framework; and

II. ongoing engagement on mitigating cost increases and delays after entering the Inflation Co-operation Framework up to the completion of the project.

• The inflation analysis will be undertaken using relevant indices published by the Central Statistics Office.

• It is proposed that both parties will share the burden in recognition that neither party is responsible for the events that have already transpired and will continue to evolve. Where costs are identified it is proposed that parties will share these costs with the State bearing 70% of the additional costs.

• Where unavoidable delays are attributable to disruption to supply chains, the Employer will waive liquidated damages for that period identified as arising from disruption to its supply chains.

Any back-payment of additional inflation costs will be paid on a phased basis, with 50% paid up-front, and the remainder apportioned over future payments.

Summary of the application of Inflation Co-operation Framework:

Form of Contract Recovery for Materials Price Inflation Recovery for Energy/Fuel Price Inflation Relief from Liquidated Damages for delay caused by Supply Chain Disruption**
Dated prior to 7 January 2022 Yes Yes Yes
Dated 7 January 2022 No (already provided) Yes Yes

Duration of the measures

Once parties enter into the framework, it will operate until the project is completed or the parties elect to withdraw by giving notice to the other.

Future Amendments

The OGP will amend the conditions of the public works contracts so that some of these measures are incorporated into the contractual framework on a permanent basis. (This is in a similar fashion to how the OGP amended the contracts to provide a Covid mandatory Closure clause, following the introduction of the Agreement for ex gratia costs for mandatory closures).

These amendments will ensure a clear apportionment of the risk associated with inflation to enable contractors to price that risk and ensure that Contracting Authorities retain a reasonable degree of budgetary certainty, without seeing a reduction in those participating in tenders and an over-provision for inflation by those that submit tenders.

Basis of the 70:30 burden sharing

Contractors should continue to carry some degree of the additional costs arising due to inflation in recognition of the original terms upon which they tendered and it encourages more efficient purchasing thereby addressing value for money concerns.

It has been decided that it is appropriate for the State to bear the majority of any additional costs identified on the basis of the limited capacity of contractors to bear these additional costs which are exceptional in terms of the increase and the uncertainty with respect to their duration. As the State is the ultimate owner and beneficiary of the asset that is under construction, it is imperative that quality materials continue to be used to ensure the durability of completed asset.

Previous measures introduced

The interim amendments published on 7 January 2022 only apply to projects whose tenders were submitted on or after 18 January 2022. Amendments were made to the price variation clause to lower the thresholds above which the State would bear the cost of inflation to address the potential for significant spikes in materials. At that point available forecasts, trends in pricing indices and feedback from public bodies indicated that the inflation that had arisen since 2021 was transitory and that supply chain disruptions were settling down.

In addition, the fixed price period was reduced to 24 months and mutual cost recovery is permitted within the fixed price period for material price changes in excess of 15%. The amendments also provided for the indexation of the tender sum to allow for fluctuations in material prices between the point at which the tender was submitted to the award of the contract.

Increases in the cost of construction materials and energy/fuel

Sustained price increases across a range of construction sector inputs, coupled with supply chain volatility, have led to increased market uncertainty and pose a challenge for the successful delivery of the National Development Plan.

Significant movements in timber and steel prices were noted during 2020, they accelerated further in 2021. These movements have broadened out since January 2021 to include a range of materials commonly used on building projects including plastics, insulation and electrical and plumbing fittings. The breadth of price increases is in excess of those typically experienced over the past 10 years.

The ‘All Materials’ category of the Detailed Wholesale Price Indices for Building and Construction Materials saw a 16.9% increase in the 12 months to March 2022. The average increase in the same category over the previous 3 years was 1.4%, the highest in 2021 was 2.3% with the lowest in 2020 being 0.2%. In some of the sub-categories the increase recorded in the March 2022 index over the past 12 months is more severe, ‘other structural steel’ for example shows a 64.1% increase and rough timber 46.3%.

Steel and timber products in particular saw substantial, sustained increases since early in 2021 and, to a lesser extent, materials such as insulation and plastics. These increases arose suddenly with no warning but had levelled off from September 2021 in line with inflationary forecasts from Q2 2021 which predicted that inflation would be temporary.

Energy prices showed marked increases in the latter half of 2021 and since January 2022 have increased further. This has a direct impact on costs in the construction sector, particularly on those projects with a significant complement of heavy machinery. Heightened energy costs also have an indirect impact through the increased cost of manufacturing and transporting materials