Davis Langdon looks at the state of the construction economy, including energy price rises, the Olympics, current public spending and the exploding infrastructure sector. Plus, why everybody’s talking about oil …

Construction activity stalled a little at the beginning of the year, according to the latest set of official DTI figures. The hospital building programme in particular seems to have hit a few more obstacles. Education building also stuttered but now seems to be back up and running – in fact there are real fears being expressed about the market’s ability to handle the volume of work likely to be released to the market over the next few years. The first three waves of the Building Schools for the Future programme will benefit 380 schools to the tune of £6.5bn between 2005 and 2008.

Spending on infrastructure has been in decline for the past couple of years and in the first half of 2005 even less money was spent on roads, railways and sewerage. However the water industry’s five-year investment programme is now getting under way and orders for roads and the railways are providing a welcome boost to the civils side of the industry. Civil engineering contractors should be happy through to 2012 as the infrastructure requirements for the London Olympics will provide an additional 25% cash injection into the market for London and the South-east.

Last year the construction industry was hit by the steel crisis, pushing the cost of fabricated steelwork up 60% by the end of the year. But 2005 ushered in greater stability in supply and demand and steel prices have drifted downwards as the year has progressed. However, the year may not be seen out without a swing back upwards. Reinforcement suppliers announced increases of £35 a tonne in September, with suggestions of further rises to come as world scrap prices rise.

In 2005 the steel price crisis has been replaced by the oil price crisis, with oil prices rising 50% this year. Gas and electricity costs are tied to oil prices so energy bills have also risen. Materials suppliers cite oil and energy prices as the reason that prices for construction materials other than steel have steadily increased. The beginning of 2006, a traditional time for many price revisions, may see more price increases than usual.

Shortages of quality tradespeople persist with bricklayers and plumbers most frequently cited as the most difficult to source, from London to Yorkshire and the North-east. But an influx of Eastern European labour has eased the supply problems in many areas, even leading to a softening of site rates in some places. However, there is little evidence of that being passed on to tenders as yet.

Although construction output fell slightly at the beginning of the year, output for the year as a whole is expected to be slightly ahead of 2004. Next year, output is expected to grow more steadily with public non-housing work (including PFI health and education) and infrastructure providing a significant increase in workload. This may be supplemented by an increase in offices activity, particularly in London where a large number of new schemes are gearing up to start.

If output continues to grow then there will continue to be pressure on resources and costs. However there is a shadow on the horizon that appears to grow darker by the day: the UK’s economic growth has shrunk to a mere half the level predicted by Gordon Brown, creating a gap between income and expenditure that may only be closed by higher taxes or a reduction in government spending. It is worth noting that the latest announcement from the Department for Education and Skills on the Building Schools for the Future Programme caveats its figures with the statement “subject to future public spending decisions”. In the private sector too, the stock market has tumbled and investment has declined.

In the short term, construction activity looks set to increase and with higher than usual cost pressures, construction prices are forecast to rise 3.5-4.5% in London over the next year and 4-5% elsewhere, with possible local peaks in excess of this. The following year now looks more difficult to call but if the government is able to stick to its spending plans and an Olympic feelgood factor drags the private sector out of a decline, then construction should be in for another good year, even before the Olympic building activity gets under way. On that basis, construction prices are unlikely to rise less than 4-5% anywhere.

Executive summary

Tender Price Index Analysis of tenders received by Davis Langdon in the third quarter 2005 shows that prices resumed an upward trend, rising 1.5% over the previous three months (see graph). The index shows prices for competitively tendered work in London have risen 5% over the past year. But inflation is never uniform and for such packages as demolitions and curtain walling, where there is plenty of capacity, it has been negligible.

Building Cost Index Davis Langdon’s Building Cost Index shows a leap of over 6% in 3Q05, its largest quarterly rise since 1999. The third quarter always registers a step change as the annual summer wage award for building and civil engineering operatives kicks in. This year, basic rates of pay went up 9.5% at the end of June. The index includes an annual rise of 3.7% in materials prices even though steel prices have been in decline.

Retail Prices Index Over the past year the Retail Prices Index shows a much lower rise than either of the construction measures, increasing 2.8% over the year to the third quarter. The RPI is actually on a declining trend (down from 3.5% at the end of 2004), unlike the Consumer Prices Index, which has risen from 1.1% in 3Q04 to 2.4% now. The RPI includes mortgage interest payments and other housing components, which the CPI excludes.