Based on our observations of the market in tender returns, survey feedback and our extensive discussions with the supply chain, we have established that a number of inflationary and deflationary pressures are likely to impact tender pricing. Many of the pressures from our previous TPI report continue to impact tender pricing due to the ongoing disruption from the Russia-Ukraine war and the potential for this to escalate further as Russia considers cutting off pipeline gas supply to Europe. Consequently, the number and severity of inflationary pressures continue to far outweigh any current or potential deflationary pressures.
In G&T’s Russia-Ukraine Conflict Report, we explored to what extent the UK is exposed to the impacts of the Ukraine crisis and how it might impact construction costs. In it, we included a scenario-based fan chart outlining how three possible scenarios could potentially impact tender price inflation. In each scenario various supply, demand and macro-economic conditions and qualifying criteria were outlined.
Since publishing the original report the conflict has evolved, increasing in duration and severity and moving beyond the scope and conditions laid out in our ‘Limited Disruption Scenario’. The requisite demand, supply and macro conditions outlined in our ‘Intermediate scenario’ have now been met and so we have updated our fan chart to show what are now the two most relevant scenarios – the ‘Intermediate’ and the ‘Substantial’ disruption scenarios.
The chart below shows G&T’s latest weighted UK average TPI forecast, which now sits roughly in between the upper and lower inflationary ranges of the Intermediate scenario. Also displayed are the upper and lower ranges of the Substantial disruption scenario. Descriptions of each scenario, and the relevant qualifying conditions for each, are provided in our Russia-Ukraine Conflict Report.
With the growing risk that Russia will cut off European pipeline supply of natural gas in the months ahead, many European leaders (including the UK Government) are preparing to ration or scale back energy use. This would constrain manufacturers and producers in energy-intensive industries such as steelmaking and reduce production output. While the UK only relies on Russia for 4% of its gas needs, it would find itself in competition with European buyers for gas if the continent suffered supply shortages. The UK (like most countries) is exposed to global markets – so any supply shocks on mainland Europe would be felt here too. With a reduced global supply of gas, further pressure on energy prices would feed through to commodities and the manufacture of construction materials which manufacturers would seek to pass on through higher pricing strategies.
Russian gas supplies have already been cut to several European countries and significantly lowered to others – a situation which has forced Europe to look further afield for gas supplies, driving up prices across the globe. Any further tightening of Russian gas supply to Europe would likely see manufacturers across Europe increasingly cut production and international trade, severely affecting the supply of European manufactured materials to UK construction sites and impacting project progress. Furthermore, with curtailed manufacturing output and strong inflationary pressures, European economies would face an almost certain recessionary period.
So far this year, material prices have been the biggest contributor to construction input cost inflation. Key indices such as the BEIS ‘All Work’ material price index have risen by 12.6% between January and May 2022 and the same index was 26.5% higher than it was one year ago in May 2021.
While all materials have experienced some degree of inflation in 2022, it has been metals and other energy-intensive products that have been disproportionately affected by high energy costs. A summary of the main pressures and trends affecting key construction materials is provided below:
Owing to rising energy prices and manufacturing input costs, further price rises for most of these energy-intensive products are expected in the second half of the year – some of which have already been notified to customers.
Raw material prices were already being pushed higher by a post-pandemic bounceback and a lack of investment in new energy, but Russia’s invasion of Ukraine has had a compounding affect, triggering sharp rallies in the commodity markets in March. These commodity price rises rippled through to construction products and materials, leading to multiple, unscheduled price increases in recent months from key material suppliers.
It is Russia’s outsized role as a global exporter of energy (such as oil and gas) that has been the real driver of broader material price inflation. Reduced global energy supply has pushed manufacturing costs for nearly all construction materials higher in the wake of the conflict. However, the impacts of rising energy costs since Russia’s invasion of Ukraine have not fully fed through due to most manufacturers working on forward energy contracts (typically lasting six months), which creates a lag between wholesale cost rises and the impact on production costs. These rolling hedging policies will mean higher energy costs for manufacturers in the longer-term, putting upward pressure on materials prices for many months to come, particularly if Russia decides to increasingly curtail or sever gas exports to Europe.
If Russian pipeline supplies were cut, key European manufacturing countries such as Germany may have to scale back or ration energy use in the short-term, hitting manufacturing and production in energy-intensive industries such as steelmaking. Another potential result of this scenario could be that energy prices become so high that it makes production uneconomic. Any consequent scaling back of manufacturing output would have significant implications for the construction sector and its ability to source materials to site. Even if Russian gas supplies to Europe are not completely severed, energy prices will remain high until European and domestic energy markets reduce their dependence on Russia through diversification of supply.
Construction purchasing managers continue to report strong demand for construction products and materials. Rapid cost inflation persisted in June with most purchasing managers (71%) reporting a rise in purchasing prices due to higher fuel, energy, and raw material costs. Upward pressure on input prices was also applied through greater logistics costs and supply shortages for some materials. In terms of purchasing activity, there was a sharp fall in June, with input buying increasing to the least marked extent since January 2021. Softer demand for construction products and materials was primarily a result of less new work replacing completed projects due to economic uncertainty and inflationary concerns. There was also less pre-purchasing activity/safety stock building of materials in June which contributed to the sharp drop in purchasing activity.
While there are still global supply chain issues and competition for certain raw materials is heightened, the Construction Leadership Council (CLC) paints an increasingly positive picture on product availability. Some products including bricks, concrete blocks, some roof tiles and semi-conductors (used in building services products and gas boilers) remain on allocation or subject to longer lead times, but manufacturers are mostly keeping up with demand and managing supply with planned delivery times. Any softening of demand as a result of economic uncertainty or inflationary concerns will likely further improve the availability of materials as stocks are allowed to re-build. Even though the availability of materials is improving, supplier delivery times continue to lengthen with longer wait times pinned on staff shortages and a lack of transport availability.
Also likely to alleviate concerns of manufacturers is the UK Government’s recent announcement regarding the transition from CE marking to UK marking. Recognition of CE marking – which indicates a product has been assessed by the manufacturer and deemed to meet EU safety, health, and environmental protection requirements – will end on 31st December 2022. However, the Government has said that manufacturers with existing CE tests from EU notified bodies (under AVCP System 3) can affix the UK mark to their products and continue to supply them to the UK market without the need to be retested, providing the product has been tested by 31st December 2022. This effectively means that manufacturers will still be able to place their products on the UK market next year.
While most main contractors recently surveyed by G&T indicated that staff and project labour resource was available, good quality labour is becoming more difficult to employ and retain. Availability of site workers is particularly constrained and the shallow pool of skilled labour now prefers being more localised rather than travelling great distances.
Strong forward order books are likely to keep labour resource requirements high in the short-term at least, allowing workers to demand higher rates. There is a near record-high number of unfilled construction vacancies in the UK currently, and with retiring site workers and a loss of European migrant labour, these dynamics point to a further tightening in the supply of skilled workers.
There were 46,000 UK construction vacancies in the three months to May 2022, according to the ONS – down from recent peaks but still at historically high levels. The slight (4.2%) drop in vacancies compared to the previous three-month period (Feb-Apr 2022) will do little to ease the tight UK construction labour market. Although June’s UK Construction PMI survey saw a slowing in the rate of job creation due to concerns over future new order growth and business activity, job creation has now been recorded in each month since February 2021. Additional recruitment has been linked to endeavours to boost business capacity in line with rising workloads and the anticipation of new project starts. However, filling these vacancies has been challenging. Construction companies cited severe and ongoing difficulties in finding suitable candidates in June’s survey, despite rising wages and new recruitment initiatives.
The total number of workers employed in the UK construction sector is still significantly below pre-pandemic levels. In Q1 2022, the total number of UK construction workers was 2.18 million – 10% (or 244,000) fewer than there were in the peak just before the pandemic in Q1 2019. The sector desperately needs an injection of new skills in the workforce to replace outgoing workers that retire or migrate. According to the CITB skills body, 25,000 migrant workers left construction in the post-Brexit and pandemic upheavals, and more and more are taking early retirement or moving to other industries. Nearly half of the 244,000 workers that have left the industry over the past two years came from the skilled 45-55 age group – a key age profile. While it is not clear if these workforce changes are permanent, the ageing workforce demographic is a systematic problem – one that has been accelerated by the pandemic and will only deepen in the future without intervention.
There is an urgent need to get attract a new generation of homegrown construction workers or find ways for employers to better engage with the new point-based immigrant system licence scheme that enables them to hire non-UK born workers. Although labour from South America is now becoming more commonplace and helping to fill the void left by European counterparts, some skilled trades are not accessible through the skilled worker visa route (eg dryliners and insulators) and this is preventing some contractors, particularly smaller ones, to take on jobs. Unless greater flexibility is introduced which allows the new points-based immigration system to respond rapidly to changing pressures, workload capacity and output growth in the future will likely be curtailed. Another issue is that with contractors struggling to deliver their current workloads, this is hampering their ability to free up time to invest in the necessary training just as its needed most.
London and the South East, which have historically had higher levels of migrant labour and higher wages, are pulling resource from the rest of the country, exacerbating the skills difficulties nationwide. G&T’s latest Main Contractor survey found that London in particular is seeing volatility around the movement of labour resource caused by high levels of construction activity. This is putting pressure on rates and staff costs. According to G&T’s survey, around 60% of main contractors expect directly employed staff cost movements to ‘increase’ or ‘significantly increase’ over the next 12 months in light of the cost-of-living crisis and current construction employment market dynamics. An even greater proportion (73%) expect subcontract labour cost movements to increase over the period, as strong activity increases competition between contractor to secure labour.
ONS data shows UK construction average weekly earnings (AWE) were 7.6% higher in the three-month period to April 2022 in comparison to the same period one year earlier. This is a greater annual growth rate the UK economy as a while, which saw AWE rise by 6.1% over the same period. The general shortage of quality workmanship across all trades is putting pressure on labour costs and many in our TPI survey suggested that labour could potentially become the bigger issue over the next year and beyond. Slowdowns tend to follow sharp spikes – something which many expect to see in relation to material prices – but underlying pressure on labour from skills shortages is a potentially longer-term issue that will support high pricing beyond any cooling off in material price inflation.
Labour shortages for demolition workers, roofers, and finishing trades (eg drylining) are creating sustained upward pressure on rates. Data from Hudson Contract, which shows self-employed labour rates for several key trades, found that rates for many trades have exceeded the cost-of-living inflationary rises (ie annual CPI inflation of 9.1%):
Hudson contract data shows across all trades and UK regions, labour rates grew by 2.8% compared to the previous month with self-employed subcontractors taking home an average weekly pay of £918 in May.
Earnings rose in all regions in England and Wales in May other than the North-East, with plasterers seeing the biggest month-on-month rise (+12.2%). Wage growth for roofers, demolition workers, scaffolding and lifting workers and plumbers also kept ahead of the UK’s official inflation rate over the same period. However, not all trades with notable labour shortages have seen wage growth keep place with headline inflation. MEP and brick/blockwork for example are all grappling with significant skilled labour shortages but wage growth in these trades failed to keep pace with headline inflation. However, it is important to note that wage growth trends for self-employed workers may differ from directly employed labour, who are reliant on negotiated annual pay deals (often with unions involved). Self-employed workers also have the option to take on more or less work to increase their income which creates differences between direct and self-employed pay.
While very few in the sector are struggling to win work in the current growth market, labour wage inflation could ease if, as some anticipate, demand takes a hit and fewer tenders come through the door. A sustained period of subdued new work growth may take some of the heat out of the labour market and cool rate rises, but even if tendering opportunities do drop off from current levels, the near-record level of job vacancies and widespread skills shortages will maintain pressure on rates and contractors’ prices.