The Tribune

EDITOR, The Tribune.

Construction projects, private and public alike, have a long history of cost escalation. Public infrastructural projects, particularly transportation projects, which typically have long lead times between planning and construction, are historically underestimated world over.

The Journal of Management Engineering (October 2009 issue), stated that “approximately 50 per cent of the active large transportation projects throughout the United States have overrun their initial budgets.”

Cost escalation is defined as changes in the cost or price of specific goods or services in a given economy over a period.This is similar to the concepts of inflation and deflation except that escalation is specific to an item or class of items.

Cost escalation is usually calculated by examining the changes in price index measured for goods or services. Future escalation can be forecast using econometrics. Unfortunately, because escalation (unlike inflation) may occur in a micro-market, it may be hard to measure with surveys, and indices can be difficult to find.

Studies and research projects have identified various factors, which have attributed to increased project costs. These factors, which also have an influence on privately funded projects, have a much more detrimental affect on publicly funded projects. The public funds available for a pool of projects are limited, and there is a backlog of critical infrastructure needs, hence Governments have to borrow, therefore, if any project exceeds its budget due to cost escalation supplementary funding is required, and government has to “gap” fund the project.

Because of escalation fears, owners are finding fewer bidders for their projects; some projects need to find alternative funding sources to supplement the overrun or risk cancelling/not completing the project if additional monies are not available.

Another strategy to mitigate future price escalation exposure is for the owner to remove price escalation clauses in the construction contract, however, this will often lead to substantially higher tender and contract prices and larger project costs. As such, most publicly funded projects will include a cost escalation clause to attract more bidders, receive competitive bids and subsequently minimise the potential of not completing a project. If done properly, escalation clauses are intended to protect both contracting parties from the inevitable increases in prices.

Why would the owner agree to a cost escalation clause in the first instance? One reason, an escalation clause increases the bidding pool making it more competitive and as such, contractors would be more comfortable to lower their bid amounts. On the other hand, if an escalation clause is omitted, who will be responsible for price increases? If you’re working under a lump sum contract, the owner faces the risk of not completing the project or the issue becomes a litigious battle for the contractor to get compensated for the unexpected price increases.

Therefore, as mentioned, an escalation clause has its advantages in controlling cost during the bid procedure or reducing the risk of project abandonment due to unforeseen circumstances. It is a standard and typical clause used in agreements for major and minor capital works alike.

Perhaps an alternative that should be given due consideration would be to construct roadways using concrete pavement, which has a comparative costing for placement similar to or lower than asphalt given the recent escalation in oil prices.

FRANCIS CLARKE

Nassau,

November, 2012.