Forecasting and Managing Construction Cost Escalation

Donal O'Leary
Finding methods to forecast and manage construction cost escalation is critical for owners and contractors.

Costs on construction projects can easily escalate across the lifecycle, affecting the ability of owners to fund project completion and the profitability of contractors. The Gulf Cooperation Council (GCC) countries are especially prone to cost escalation in their projects, due in part to the distinctive features of their built environment culture and business practices.

GCC governments continue to invest in economic diversification, while at the same time spending to maintain or expand hydrocarbon and downstream petrochemical production. Investment in social infrastructure, to service a growing population, is driving the region's construction sector together with event-led projects such as the 2020 Expo in Dubai and 2022 World Cup in Qatar. All GCC countries are actively building with Qatar, Saudi Arabia and the United Arab Emirates (UAE) currently experiencing the highest volumes.

Escalation typically begins with the problem of forecasting final construction costs in the face of changing conditions.

Despite the fall in oil prices, the region still faces the challenge of delivering large, complex and overlapping programmes of work, creating a peak in construction activity over the next five to seven years. Delivering within budget and on schedule will continue to test clients, contractors and consultants in this competitive market known for delays and cost overruns.

Escalation typically begins with the problem of forecasting final construction costs in the face of changing conditions. Optimism bias tends to be high in Middle East projects, and the process for securing government approvals may encourage project sponsors to underestimate costs.

At design stage, Middle Eastern projects frequently encounter high levels of specification uncertainty, and lack of attention to identifying and detailing the best contract format. Post-contract changes are therefore very common, giving rise to a high number of claims.

Although there has been some improvement in recent years, the region's often-adversarial construction climate tends to push costs up and cause delays.

Although there has been some improvement in recent years, the region's often-adversarial construction climate tends to push costs up and cause delays. Identifying common interests among stakeholders is therefore problematic and client decision-making is often delayed, with relatively weak governance structures and a lack of delegation.

Skill shortages are now a serious problem in the region. It's difficult to attract and retain enough suitably qualified people at all levels, with the experience required to deliver complex megaprojects. This leads to further upward pressure on costs. The need to import much of its construction materials, as well as its labour, is a further issue for the region, exacerbated by logistics barriers. In Qatar, for example, the limited capacity of Doha's existing port creates supply chain bottlenecks. The new port development is expected to improve inbound logistics.

Successful management of escalation is assisted by realistic cost modelling with appropriate recognition of risk and ongoing cost monitoring throughout the project.

These constraints increase the risk of cost escalation, highlighting the need for accurate forecasting and control of costs throughout the project lifecycle. Successful management of escalation is assisted by realistic cost modelling with appropriate recognition of risk and ongoing cost monitoring throughout the project. Forecasting of escalation is underpinned by skilled choice of the most appropriate economic model.

To ensure that the economic model's outputs are relevant, the users' business requirements must first be clarified. Secondly, the availability and robustness of data is assessed. At this stage, technical decisions on model design can be made, with a guiding principle of simplicity. Finally, the model must be built, calibrated and tested. Faithful+Gould provides the necessary cost management expertise to forecast and control costs across the lifecycle, together with experience of Middle East construction culture.

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