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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
- https://knoema.com/atlas/Egypt/Inflation-rate
- The State of Queensland (Australia) (Department of Housing and Public Works)
- FIDIC Red Book 1999