Is construction ready for a full-blown energy costs crisis?

When not reporting on coronavirus or “partygate”, the media has been rather preoccupied in recent weeks with the potentially devastating impact that rising global energy prices are having on household finances.

Monthly average gas prices in Britain have been soaring. Figures from Ofgem showed that the wholesale price of gas through forward delivery contracts jumped 80% in the six months to November 22, while the price of gas delivered through day-ahead contracts more than trebled.

The increase in prices in the UK has been fuelled by rises in global energy costs, with everything from lower pipeline supplies of gas, greater imports from China, rebounding economies post-covid, low levels of wind, outages at nuclear power stations and a colder winter being cited as factors. Now the growing threat of conflict in Ukraine is only adding to the gloom.   

But, while much of the focus has been on the potential for energy cost inflation to devastate household finances – particularly if the price cap is raised as expected in April – much less attention has been given to the impact on businesses.

With its heavy use of materials manufactured using energy-intensive processes, the construction industry in particular is set to take a pounding as energy price rises replace a shortage of materials as the key driver of building cost inflation.

>> See also: Forterra warns on further price hikes for bricks

And it would be unwise to assume that the problems will go anyway anytime soon. Just last week the International Energy Agency warned that “in the absence of faster structural change in the sector, rising demand over the next three years could result in additional market volatility”.

Simon Rawlinson, head of strategic research and insight at Arcadis said: “So you think you’ve got rid of one thing – raw material shortages – and then something else comes and hits you in the form of energy price increases. I guess the question is, looking forward ‘is there anything that’s going to make energy costs fall in the medium to long term?”

The prospects for downward movement – in the short term at least – are not good. British Steel last week (20 January) announced a £30 per tonne increase in its price, the seventh increase in the past 12 months. The Construction Leadership Council’s product availability group, which regularly brings together key organisations and figures across the sector to discuss supply and demand issues, is forecasting that prices will increase by between 5 and 10 per cent in 2022 off the back of a 17 per cent increase in 2021.

Who will feel the impact?

So where will the impact of energy prices be felt most? And what can manufacturers, suppliers, contractors and clients do to mitigate it?

“There is likely to be, particularly over this winter period, a significant increase in the cost of some of the heavy-side products. So you are looking at ceramics, bricks, steel, concrete, cement, and aluminium,” Noble Francis, economics director at the Construction Products Association (CPA), said.

The wide-ranging impact of the cost increases means everything from housebuilding – which is obviously heavily reliant on bricks – to commercial development and its use of steel, to infrastructure could potentially be impacted.

Francis says that double-digit rises in energy costs do not necessarily translate immediately into double-digit rises in material prices as manufacturers tend to hedge against volatility by negotiating fixed prices with producers.

However, while this provides manufacturers with some short-term certainty, it effectively just pushes the problem back as suppliers will factor the case for higher prices into further negotiations.

“If you look at heavy-side manufacturing, around one-third of the manufacturing cost can be energy costs,” Francis says. “Manufacturers won’t be able to absorb all of these costs and how much they pass on will to some extent be dependent on what contractors are willing to accept.”

Materials prices have certainly been going up over the past few months, although the extent to which this is due to energy cost inflation is difficult to determine. In the 12 months to November the price of fabricated structural steel, for example, rose 66% (see table) according to figures from the Department for Business, Energy and Industrial Strategy (BEIS).

Price indices of construction materials
Material	% price increase in Nov 2021 v Nov 2020
Cement and concrete
Cement	6.26
Ready-mixed concrete	7.94
Pre-cast concrete products	14.74
of which : Blocks, bricks, tiles and flagstones	6.93
Concrete reinforcing bars (steel)	56.65
Timber and joinery
Imported sawn or planed wood	52.38
Imported plywood	50.10
Particle board	60.43
Builders woodwork	18.77
of which : Doors and windows	6.29
Metal products
Fabricated structural steel	66.07
Doors and windows	12.90
Screws etc	-5.08
Other builders’ ironmongery	3.48
Central heating boilers	0.17
Taps and valves for sanitaryware	6.46
Metal Sanitaryware	5.09

Source: Department of Business, Energy & Industrial Strategy building materials and components statistics selected figures

This increase in materials prices poses a challenge for contractors’ ability to deliver contracts to budget.

“Those working in the construction and infrastructure sectors should take action now to mitigate the potential impact of the energy price crisis on contracts,” Helen Waddell and Jonathan Hart, partners at law firm Pinsent Masons, wrote in October.

“If contracts contain express clauses dealing with fluctuations and indexation clauses, they should be examined to determine if they cover situations associated with the current market price increases.”

For Rawlinson a key area to keep an eye on is big public sector projects. “We could get a series of situations where procurement is being delayed because bids come back higher than budgets and then you lose months while there are iterations and rebidding,” he said.

While Rawlinson stresses that he does not think projects such as key housing and infrastructure schemes will be jeopardised entirely, they could be held up.

For a government eager to get on and deliver visible benefits of its “levelling up” agenda as soon as possible, this could cause concern in Whitehall.

And what of the government’s plans to build 300,000 homes a year by the mid-2020s? After all, brick-firing is an energy-intensive process and manufacturer Ibstock last year increased its prices by 10%.

Unlike other materials, stocks of bricks are so low in the UK at present that manufacturers will simply not want to slow down supply to take the sting out of inflation.

“They [manufacturers] are working flat out and, as a result, pretty much all of those energy prices are being passed to their consumers,” says Rawlinson. “Because the last thing anybody wants a brick manufacturer to do at the moment is stop making bricks – there’s an almost perfect inflationary cocktail.”

However, volume housebuilders are arguably better placed than others in the sector to cope, partly because of a booming housing market that delivered a 10 per cent increase in prices in the year to November, according to land registry statistics.

“Fortunately, the value of houses has been going up very strongly indeed,” Rawlinson adds. “So, even though housebuilders have been exposed to inflation, from a materials perspective, that’s only a very small proportion of the overall value sales price of a house.”

Large housebuilders are also much more likely to be able to have in place long-term supply arrangements that will allow them to hedge against materials price increases.

 Builders merchants’ main customer base is SME builders who are rarely able to plan orders many months in advance

However, mortgage lenders are expecting the market to calm down this year, which would reduce the likelihood of price increases cancelling out materials inflation.

It would be a mistake to assume, though, that housebuilders will be comfortable shouldering the extra burden.

“Increases in energy costs are inevitably going to lead to price inflation on materials and products that will not continue to be absorbed by house price inflation and cannot be passed on to the customer,” a spokesperson for the Home Builders Federation warns.

The HBF has calculated that various government departments have created around £3bn of additional regulatory costs a year for housebuilders. It wants the government to consider these as well (not to mention Michael Gove’s controversial proposed £4bn cladding remediation levy) rather than looking at the energy cost issues in isolation.

“We are urging the government to look collectively at these costs, otherwise they will increasingly threaten site viability and the industry’s ability to invest in new sites, and so housing supply,” the spokesperson said.

While there may be limits to how many extra costs can be imposed on large housebuilders, they at least are more likely to have the ability to fix prices as part of long-term arrangements, in effect smoothing out the hit. Other parts of the construction sector will not have this option.

“When you think of most clients, even the big supermarkets or big commercial developers, they are either buying projects individually or have negotiated a set of rates with the contractor. So one or other of those organisations is going to be exposed to that risk,” Rawlinson says.

And what of small and medium-sized enterprises? Without access to scale, in many ways they will be hardest hit of all.

John Newcomb, chief executive of the Builders Merchants Federation (BMF), says: “When manufacturers are forced to raise prices, the majority of merchants will have to pass these on to their customers, although there may be instances where part of the increase on price sensitive products may be absorbed for a time. 

“Builders merchants’ main customer base is SME builders who are rarely able to plan orders many months in advance.”

Indeed, the Federation of Master Builders, which represents small to mid-sized builders, says that 97% of its members are reporting rises in material costs.

Brian Berry, chief executive of the FMB, says builders are in the “unenviable position of having to raise prices for a customer base that is tightening its belt due to the sharp rise in living costs.”

So, what – if anything – can be done to ease the situation?

While the bigger players may have scope to hedge, Berry says SME builders should look to agree flexibility with customers.

“We’ve been encouraging our members to have open and honest dialogue with customers about the current problems in the market, so they get a better picture of what to expect,” he says.

“We also strongly recommend that flexible contracts are drawn up to allow for fluctuating materials costs, so that builders don’t find themselves out of pocket and customers go into the process well informed.”

Some producers, including British Steel, have also been able to slow down production while energy prices are high.

However, there is only so much that those in the construction sector can do to mitigate the impact, and instead all eyes are on the government and the question of whether it will step in.

It also has a big impact for government, given it has lots of ambitions, whether it be 300,000 homes a year, net zero, or levelling up, which involves a lot of local infrastructure

The Energy Intensive Users’ Group (EIUG) – which represents manufacturers of energy-intensive materials including steel, chemicals, fertilisers, paper, glass, cement, lime, ceramics, and industrial gases – has consistently called on the government to take stronger action on the issue.

“Sustained high energy prices, coupled with UK carbon prices at a premium to those in the EU, are driving greater disparity between the UK and its competitors,” Richard Leese, chair of the EIUG, said last month.

The EIUG wants more support for the UK’s energy intensive industries (EIIs) and has described the government’s current relief package as “limited”.

Currently the government exempts EIIs from costs in some circumstances. However, the EIUG argues that the requirement to demonstrate that electricity costs are more than 20 per cent of gross value added over three years means it is not responsive enough to deal with the current energy crisis quickly enough.

It also argues that the current compensation scheme only helps a small number of businesses and is based on outdated carbon prices.

What role for government?

The EIUG was also disappointed this week when the government’s emissions trading scheme authority decided against intervention on high carbon prices despite the breaching of the threshold that allows it to do so.

The BEIS said the government has provided more than £2bn in support to EIIs to make electricity costs competitive since 2013.

A spokesperson added: “Ministers continue to engage with the construction industry and other sectors to understand and to help mitigate the impacts of high global gas prices.”

The spokesperson also rather bullishly added that there were ”no indications that product or material costs will lead to delays in the delivery of major projects”.

However, Francis of the CPA says the impact could potentially be damaging.

>> See also: Procurement in an inflationary market

>> See also: Fears more firms will go bust after latest figures show 25% rise in number going under

He said: “The government needs to understand that the sharp rise in energy costs not only has a big impact for homeowners and households on their energy bills. It also has a big impact for them as a government, given it has lots of ambitions, whether it be 300,000 homes a year, net zero, or levelling up, which involves a lot of local infrastructure”.

A side note to all of this is what happens as we transition towards net zero. Rawlinson suggests there is the potential for a temporary sharp rise in inflation if manufacturing is switched rapidly to more sustainable processes before demand for high energy-intensive products falls. Ultimately, however, the market should adjust.

Rawlinson says: “We will recycle and reuse things more carefully. People might invest a little bit more in insulating the homes and so on.

”Ultimately, there will be a feedback loop to some of this stuff around energy costs, but it’s probably one that that will take a long time to reset simply because the factors driving it up are much more powerful than remedies that we have around reducing utilisation.”

As manufacturers, suppliers, contractors and clients nervously keep an eye on energy price indices, they will be checking their contracts and arrangements and looking at ways of mitigating the impact. They will also be hoping the government might provide help if prices do start to slow down crucial work.

But, if none of this works and delays become noticeable, expect the media’s interest in the energy cost crisis to move away from a focus on households alone.