Measures taken in response to the pandemic have resulted in shortages, price spikes and longer lead times for some materials. A huge drop in global demand led to substantial price reductions for raw materials but whether these reductions pass through the supply chain will, in part, depend on the speed of recovery. Resilient demand will support higher material prices whilst subdued demand will likely mean that lower raw material prices will feed through the supply chain to clients.
According to the ONS, material price movements are currently volatile. In Q1 2020 construction material prices began to reverse their slow downward trend seen in 2019. However, April showed a 1% month-on-month decline in material price inflation for the ‘All Work’ construction material price index. The pandemic has caused both supply and demand side shocks. Disruption to the extraction, processing and distribution of materials has resulted in heavy cuts to supply, but this coincided with lower demand which has acted as a counterbalance to price increases.
The recovery in demand has, to an extent, outpaced supply. A backlog of orders accumulated during the lockdown period due to reduced manufacturing/production capacity has resulted in supply shortages for materials such as plasterboard, aggregates and bricks and insulation. However, the increased lead times for these materials are likely to be short-lived as factories and merchants ramp up capacity.
After hitting a near three-year low in February 2020, fabricated structural steel prices increased by 11% in March as a result of supply disruptions and steel mill closures in Europe. Steelmakers have since restarted production but output has been cut significantly in response to a 50% fall in demand since the start of the pandemic in March. However, there is still excess global supply as Chinese mills produced steel at a faster rate through the COVID-19 crisis. IHS Markit now projects that demand weakness and excess capacity will lead to a 4.2% fall in structural steel prices in 2020, followed by an additional 4% drop in 2021 before prices rally by 2.5% in 2022.
Generally, material prices are expected to strengthen in 2021. Halted manufacturing capacity has come back online and commodity prices have rallied since hitting a low in April, but many anticipate that a rebound in prices will be prolonged. IHS Markit, for example, expects that material prices will still be around 10% lower at the end of 2022 than they were in the middle of 2019. However, downside risks remain and material price inflation will be directly impacted by the economic recovery profile and subsequent outbreaks of COVID-19.
With so much uncertainty and volatility in the short-medium term, some clients and contractors will favour localised production (or ‘nearshoring)’, specifying the use of UK-manufactured materials to reduce the risk of supply chain disruption. A free trade agreement (FTA) with the EU has yet to be finalised and many will want to avoid the potential risk of higher import costs and tariffs if the transition period ends without an FTA in place. However, safeguarding their supply chain in this way may still result in higher material costs due to the limited production capacity in the UK for some construction products and materials such as steel and electrical goods and components.
Average weekly earnings (AWE) in the construction industry fell by 11% in the year to April 2020. In April alone, construction AWE dropped by 12.9% on a month-on-month basis, making it the largest monthly fall on record (since January 2000). The drop is unsurprising given that the construction sector has been the second largest user of the Government’s job retention scheme.
According to the ONS, between 18th-31st May 2020 UK construction firms reported that 34.5% of their workforce had been furloughed. However, this figure appears to be improving as activity on site picks up. The latest figures show that between 1st-14th June construction firms reported that 26.2% of their workforce was furloughed.
Alongside the widespread furloughing, the number of vacancies in the industry has more than halved. In the three months to the end of May 2020, the ONS recorded 13,000 job vacancies in the industry compared to 27,000 for the same period last year. Against this backdrop labour costs are likely to remain suppressed for the remainder of the year. With a large pool of unused labour anxious about their future employment prospects, there will be far less upward cost pressure in the short term, which will help keep tender prices in check.
Some upward cost pressure may come from extended site working hours and staggered shift patterns. There could also be an impact on labour costs if those European construction workers that returned home before or during the lockdown are unable or less incentivised to return to the UK under the Government’s 14-day quarantine period. Some of these workers may decide to stay put given this requirement, reducing the pool of skilled construction labour. This could hit London particularly hard as the capital has a large proportion of integral non-UK employees. The UK’s new immigration rules (due to come into effect in 2021) could also impact the pool of construction labour as many won’t be able to meet the entry criteria under the points-based system.
Notwithstanding this, with more than a quarter of the UK construction workforce furloughed, there is a large pool of idle labour to fall back on. Furloughed employees will only be brought back if activity and demand conditions improve. If demand returns to pre-COVID levels the supply of labour could become more of an issue and this will put upward pressure on labour costs. If demand doesn’t improve before the Government’s furlough scheme ends in October and fewer new projects come forward, we could see redundancies on a large scale which will have a dampening effect on tender price changes.
PROFITABILITY AND PROCUREMENT
Tender returns have shown a mixture of pricing levels for OH&P and Preliminaries over the last three months, with our survey showing rates largely unchanged, but some localised reductions in competitive markets for office fit-out and new build commercial.
So far, it seems that preliminaries rises have been kept to a minimum due to market pressure to win work. Over the next 12 months many anticipate preliminaries costs will rise as a result of costs for adapting welfare facilities, satisfying health and safety requirements and elongated programmes from reduced productivity. However, respondents noted this will be balanced against contractors running leaner teams to operate more efficiently and the willingness of pricing to win new work.
68% of respondents indicated that contractors will reduce their OH&P further in order to win work and secure turnover. Keener rates in a more competitive environment are expected in Q3 and Q4 2020 but a few respondents believe that whilst OH&P may reduce as a headline, contractors will still be required to recover similar levels of overhead from lower turnover. To what extent contractors will be forced to start discounting to win projects and secure turnover remains to be seen.
Procurement route will also play a part in creating a more competitive tendering environment. Parties are currently finding it difficult to agree on risk profile and how it should be shared and managed, but contractor’s desire to win work may encourage them to take on unfavourable procurement routes in certain sectors. Whilst design and build two-stage has been the most favoured procurement route in the past three months, in a more competitive tendering environment, contractors may have to become more comfortable tendering on a single stage basis and taking on more of the risk.
REGIONAL BREAKDOWN OF CONSTRUCTION OUTPUT
(Annual Growth Q4 2018 - Q4 2019)