Infrastructure Investment Plan 2021-22 to 2025-26: progress report 2022 to 2023

Annex B: Supply chain and inflation issues affecting infrastructure delivery.

The following note highlights the continued impact of the issues around supply chains and the availability of construction materials along with inflation which are affecting the delivery of infrastructure projects.

Purpose

The purpose of this note is to highlight the continued impact of the issues around supply chains and the availability of construction materials, which are affecting the delivery of infrastructure projects.

Summary

There remain unprecedented increases in the cost of materials and delivery times for some materials continue to be prolonged. There is a greater risk of late projects and the quality of materials being reduced to maintain budgets or programmes and financial disputes along with a risk that public and private sector employers will reconsider when and how to bring construction contracts to the market.

In the last two quarters, the trading conditions for businesses within the construction sector has marginally improved and this is evidenced through:

• Industry sentiment that material availability and pricing has improved but volatility still exists.
• Market assessments for UK Tender Price Inflation assessments for 2023 have improved with marginal reductions to tender price inflation.
• UK consumer price index inflation has fallen to 8.7%.

However, the underlying challenges within the construction sector remain as set out within this paper. Experian published their spring 2023 forecasts for the construction sector in May 2023 and identified construction output is set to decline by 1.3% in 2023 as weakness in the housing sector, both in terms of new work and repair, maintenance and improvement, dampen the outlook. While headwinds in the form of elevated inflationary pressures, a cost-of-living crisis, rising interest rates and economic uncertainty continue to collectively weigh on construction going forward, the UK backdrop has brightened compared with the previous forecast and it is largely the fate of the residential sector which is hampering prospects. As the UK economic landscape continues to improve and the housing market recovers towards the end of the year there is a return to construction output growth for the UK of 1.0% and 2.6% in 2024 and 2025 respectively.

Background

There has been an upsurge in construction sector activity following a global drive to stimulate economic recovery from COVID-19 and demand for some resources is greater than their supply or the rate at which they can be supplied. The availability of materials is being constrained by reduced productivity due to the COVID effects and mitigations, which has affected global supply chain logistics. In addition, within the United Kingdom, leaving the European Union (EU) has generated supplementary procedures for goods and materials inbound to the UK from the EU.

The war in Ukraine is having an impact on global trade, particularly on commodities. There are reports of nickel prices doubling since the conflict began (Russia was a major supplier before sanctions hit), which affects the price of stainless steel. The prices of copper, steel, and aluminium have also increased. Alongside a shortage of supply from major neon producers in Odessa and Mariupol and existing Covid-related bottlenecks for microchips and semiconductors from Asia, the electro technical sector is now experiencing inflation on products above 20% as well as price rises between 10-20%. Recent increases in the price of oil will likely affect both fuel and plastics.

Another concern is the rate at which increased energy and raw material costs are driving up prices, particularly for steel, cement, glass and other energy-intensive products. The CLC report in April noted that the previous three months had seen price inflation of 10-15%, on top of price increases introduced at the end of last year. The impact of this will be felt most severely by small and medium sized enterprises (SME's).

Generally there has been an improvement in market conditions for business operating in the sector with reduced volatility noted by industry. A CLC Product Availability Statement "While there has been a slight decline in construction activity, the industry overall is performing better than forecasted six months ago. With demand lower than at this time last year, there is also less pressure on prices. As a result, early indications suggest prices for many products appear to be stabilising and in isolated cases even declining from recent highs, though volatility persists."

Materials / Imported Materials

There have been significant cost increases on the common construction materials utilised on construction projects. According to the UK BEIS (Department for Business, Energy and Industrial Strategy) Monthly Statistics of Building Materials and Components commentary of April 2022, the material price index for 'All Work' increased by 24.5% in March 2022 compared to the same month the previous year. Although cost pressures may have been largely absorbed by contractors so far, the cost of construction materials, including timber and cement had risen by over 20% in the year to January 2022, and the price of fabricated steel rose by 55% over the same period. Since then, steelmakers have been facing additional cost pressures caused by commodity and energy price increases, and British Steel increased prices for fabricated steel by £250 per tonne, an estimated 25% increase. The price of concrete is also reported to be rising quickly.

In order for there to be any reduction in price increases the industry is required to reach a point where supply is no longer being outstripped by demand i.e. stock levels of materials require to rise, however, with the situation around COVID, Brexit, reliance on imported materials and logistic issues, it is unclear when this may occur. There are also reports warning that construction inflation of 5% year-on-year may become the norm and reports continue to circulate stating that further material price increases will continue in the short to medium term. As a consequence, clients bringing projects to market will have to review their available budgets and determine if they should proceed now and accept the increased prices which have occurred or delay projects until such times as the industry supply chain is better able to cope and the fluctuation in prices has settled. It is however unclear when this will occur.

The UK Construction industry imports circa 60% of the products required. As noted in the previous update, imports of construction materials decreased in Q1 2021 by 6% compared to the previous quarter. Initial pre-Brexit concerns saw manufacturers and suppliers building up stock levels during 2019. However, as the pandemic started to take hold and the UK entered into its first lockdown the flow of materials being imported and manufactured was drastically reduced and, in many cases, had dried up. This resulted in built up stocks being utilised to maintain project delivery of those projects, which were not subject to lockdown conditions. This along with the increase in the demand for materials to support DIY projects has reduced and eliminated stock holding for many construction-related products.

Contractors continue to struggle to procure imported products, especially from China and south east Asia, such as copper and steel. Material supplies have seen a rise in shipping costs as a result of the pandemic and the lack of capacity in Chinese ports. The price of moving a container from the Far East to Europe has dropped as much as 25% from its high at the start of 2022, but many forecasters believe that the elevated costs and volatile delivery schedules caused by the container crisis will nonetheless carry on to mid-2023 and shipping rates are still eight to nine times higher than pre-Covid levels and air cargo rates seven times higher.

ONS (Office for National Statistics) latest results suggest business conditions continue to remain challenging, but estimates show small signs of positive improvement for some measures; examples include a stable proportion of businesses reporting they were able to get materials, goods and services from within the UK, and more businesses reported having fewer concerns for their business

A CLC Product Availability Statement identified that "For the first time since this group began meeting at the height of the pandemic, there is good availability of the vast majority of building materials across the UK, with increasing reports that availability is back to pre-Covid levels." Brick stocks have increased due to a slowdown in the housing market and increased production. There are approximately 8 weeks of bricks in stock and, with new plants in the UK coming on stream over the next 6-12 months, the UK's reliance on more expensive imports to top up stocks will fall rapidly.

Logistic Constraints / Labour and Staff Shortages

36.6% of Construction businesses reported experiencing a shortage of workers in the period 4 April to 17 April 2022. Of those construction businesses experiencing a shortage of workers, 55.5% reported that this has resulted in employees working increased hours and 54.1% reported that they have been unable to meet demands as a result.

The sharp increase in infrastructure works as well as a surge in the house building market has resulted in a skills shortage in some areas. Labour shortages have been exacerbated by a sharp fall in the number of EU construction workers on site. Since January 2021, it has been more difficult for construction workers to come to the UK due to the points-based immigration system, with the associated cost and administration burden. To a certain extent, the lack of labour was also impacted by the furlough scheme. It is currently being reported that labour shortages could possibly last for as long as two years.

Research undertaken has recorded various press reports which highlight that vacancies in construction have risen to the highest level since 2001 and that qualified plumbers, heating engineers, plasterers, joiners and construction workers are all in short supply. A surge in demand for workers is being triggered by the unprecedented levels of infrastructure capital spending in Scotland and across the UK with major projects such as HS2 and Hinkley Point placing significant demands on workforce from across the country.

Product Certification Issues

A particular issue for the construction industry (and others) caused by Brexit has been around product conformity marking. Whilst the UK was in the EU this was undertaken using the European "CE marking" process. The new United Kingdom Conformity Assessment ("UKCA") marking requires re-certification of many construction products for use in the UK. Industry concerns that testing capacity was insufficient to meet demand saw the UK Government delay the requirement for the new markings from January 2022 to January 2023. There remains significant concern both that UK manufactured products will not be re-certified under the new requirements due to insufficient testing capacity and that overseas suppliers may cease to supply to the UK given the need for separate conformity testing after January 2023. The UK Government is saying that there will be no further extension, and this is the final deadline for businesses to get ready. Therefore, businesses are encouraged to be ready for the new UK goods regime as soon as possible, at the latest before 1 January 2023, after which the new UKCA marking will be required to place goods on the market. Officials are in discussion with UKG officials on solutions but due to the reserved nature of the issue there isn't much within the Scottish Government's capacity that can be done.

Steps Taken by the Scottish Government

The Scottish Government are working closely with the construction sector, through the Construction Leadership Forum. As a result of the concerns being raised by industry, the Scottish Government's Minister for Business, Trade, Tourism and Enterprise established a Construction Materials Shortages Working Group, which ran for twelve weeks with the final meeting on 28 September 2021. The working group had representation from industry and the Minister made contact with several suppliers in an attempt to resolve issues with materials availability. The group's focus was on short terms issues and was effective in bring issues to the fore.

To assist alleviate issues arising, a Construction Policy Note 3/2021 was issued by the Scottish Government in July 2021. The intention of this was to set out measures for contracting authorities to manage and mitigate market pressures affecting the availability and affordability of construction sector resources. A subsequent request by industry for a directive alleviating the application of liquidated damages for late delivery where the causation factor was material supply logistical difficulties was discussed. Following which, it was agreed that Scottish Government would publish further communications at Scottish Procurement to promote awareness and enhance the understanding of CPN 3/2021. The Scottish Government acknowledged the ongoing nature of these issues and appropriate mitigations in an open letter to industry in October 2022.

Conclusion

Going forward, labour shortages, materials supply difficulties and material cost increases when combined with available budgets, could result in a reduction of projects coming to market and of those that do, delivery may well take longer than was envisaged.