Construction cost inflation set to rise again, warns Oxford Economics Australia

Construction cost escalation, which had previously slowed from the unprecedented inflationary spikes of FY2022 and FY2023, is poised to reaccelerate in the coming years, according to a new report from Oxford Economics Australia.

The independent analyst and industry forecaster warns that despite recent slowdowns, inflationary pressures within the construction sector remain strong, potentially adding hundreds of millions of dollars to the cost of infrastructure projects later this decade.

GALLERY  

Thomas Westrup, senior economist and co-author of the study, attributes the previous surge in construction costs primarily to supply-side factors. These include commodity market volatility, the energy cost crisis, and lingering supply-chain disruptions from the COVID-19 pandemic. “However, cost growth now is increasingly being driven by domestic factors,” Westrup said. “Without substantial improvements in construction industry productivity, we face significant risks of reacceleration in construction cost escalation later this decade.”

Historically, construction cost inflation has outpaced general household inflation measures such as the Consumer Price Index (CPI). Since the mid-1980s, growth in the Engineering Construction Implicit Price Deflator (IPD) has averaged 3.4% per annum, compared to the CPI’s 3.1%. This gap has widened since the 2000s, with the IPD growing at 3.7% per annum against the CPI’s 2.8%.

Adrian Hart, co-author and Director of Construction and Infrastructure at Oxford Economics Australia, explains that this discrepancy arises because construction cost indices and the CPI measure different economic activities. “The CPI focuses on a representative basket of household goods and services, while construction cost indices reflect the prices for construction inputs, including project owner costs and contractor margins,” Hart noted.

The study highlights that construction costs are significantly influenced by prices for raw commodities, such as oil, coal, and steel, as well as construction industry wages. These items have seen greater price increases than the CPI due to supply-demand imbalances in global and national markets.

Recent data indicate that although there have been price drops in key construction inputs like energy and metal commodities, overall construction cost growth has merely slowed rather than reversed. “Instead of international factors driving escalation, domestic price pressures are now the main contributors,” Hart stated. “Strong demand for construction labour and materials is driving higher wages and input prices.”

Oxford Economics Australia forecasts that construction cost escalation could reach 4% per annum by FY2028, significantly impacting major infrastructure projects. “Escalation of this magnitude could add $200 million in costs to a $1 billion megaproject,” Hart warned.

To mitigate these risks, the study emphasizes the need for improved productivity within the construction industry. This includes better risk allocation, front-end planning, education, training, and the adoption of modern construction methods such as modularization and prefabrication.

“Improving industry productivity is crucial not only for minimizing escalation risks but also for fulfilling infrastructure and housing promises amidst limited market capacity,” Hart concluded.






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