Costs of engineering construction: outlook for the water sector IWA/AWA Conference 27 June 2014 Forecast cost escalation indexes Table 1 cost escalation forecast indexes , water sector construction index class and comparison economic projections for Victoria  Escalation Factors Category  2012‐13 Civil ‐ General Construction Plant Materials Labour 2013‐14 ‐2.0% ‐1.0% 0.2% 5.0% 2014‐15 0.0% ‐0.9% 2.3% 5.0% 2015‐16 2.6% 2.2% 3.0% 5.0% 2016‐17 3.5% 3.2% 3.7% 5.0%   Victorian economic projections Consumer Price Index (headline) Victoria real gross state product Unemployment rate Wage price index Source: 2014‐15 Budget Overview 2.20% 1.60% 5.70% 3.30% 2.75% 2.00% 6.25% 2.75% 2.25% 2.50% 6.25% 3.25% 2.50% 2.75% 6.00% 3.50% 2.50% 2.75% 5.75% 3.50% We expect construction engineering related costs to grow at an increasing rate from now. Cost escalation index points to growth at or below headline inflation, GSP forecasts to 2014‐15. Construction engineering, plant and materials move together. Labour cost growth above headline inflation estimates, at a marginal premium to expected State and Australian wage growth, based on anticipated enterprise bargaining premiums. Factors driving the cost indexes Australian engineering construction market trends Engineering total ($ million) 2011‐12 prices Figure 1 real activity by sector, Australia engineering construction ($ million per year, 2013-14 prices) 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Water and sewerage Telecommunications Roads Recreation and other Heavy industry incl. mining Electricity, pipelines Bridges, railways, harbours  Engineering construction expected to peak this year  at $128 billion  Contraction reflects Australian economy transitioning out of an unprecedented infrastructure led investment phase.   RBA expects GDP to pick up to an at or above‐trend pace by 2015‐16, due to lower Australian dollar, the return to at‐trend economic growth of major trading partners and lower interest rates. Source: (Australian Construction Industry Forum, May 2014) Low interest rates and expected housing market construction activity will contribute to boosting household consumption post 2014‐15. Commonwealth infrastructure spend kicking in 2015‐16 and 2016‐17. Impacts of household activity, stronger global economy and budget infrastructure commitments, is not expected to start flow through to non‐mining businesses and investment and GDP growth until 2015‐ 16. Factors driving the recommended indexes Victorian engineering construction marketplace trends Figure 2 real activity by sector Victoria, engineering construction ($ million per year, 2013-14 prices) Engineering total ($ million) 2011‐12 prices 14,000 12,000 Water and sewerage Telecommunications 10,000 8,000 Roads 6,000 Recreation and other 4,000 Heavy industry incl. mining 2,000 Electricity, pipelines 0 Bridges, railways, harbours  Engineering construction activity in Victoria expected  to perform better than resource intensive states.  Investments from public purse will dominate forward activity, with 20‐25 percent of annual forecast construction going to publically funded road and transport Source: (Australian Construction Industry Forum, May 2014) Public infrastructure works expected to ramp up starting 2016‐17. Melbourne Rail Link ($8.5‐11 bn) early works commencing 2016‐17 and major construction 2017‐18. Factors driving the recommended indexes Water sector marketplace trends Figure 3: water and sewerage engineering construction activity ($ billion, Select States and Victoria, 2013-14 prices) 10,000  Recent capital expansions in major urban centres have deferred the need for further large investments for the medium term.  Australia wide, water infrastructure investment expected to slow. Focus is now on renewal and expanding existing networks, flood recovery in NSW QLD. Victorian engineering construction forecast to fall from estimated $1.5 billion in real terms in 2013‐14 to around $1.3 billion per annum over the medium term. 9,000 Engineering total ($ million) 2011‐12 prices 8,000 7,000 ACT 6,000 NT TAS 5,000 WA 4,000 SA 3,000 QLD NSW 2,000 VIC 1,000 2006‐07 2007‐08 2008‐09 2009‐10 2010‐11 2011‐12 2012‐13 2013‐14 2014‐15 2015‐16 2016‐17 2017‐18 2018‐19 2019‐20 2020‐21 2021‐22 2022‐23 0 Source: (Australian Construction Industry Forum, May 2014)  Factors driving the recommended indexes Victorian water sector marketplace trends Figure 4: Capital growth expenditure metro and regional water businesses, 2012-13 prices)  Capital growth expenditure ($m 2012‐13) 2,500  2,000  1,500 Regionals 1,000 Metros 500 ‐ 2017‐18 (f) 2016‐17 (f) 2015‐16 (f) 2014‐15 (f) 2013‐14 (f) 2012‐13 2011‐12 2010‐11 2009‐10 2008‐09 Source: (ESC Price Review Decisions, 2013) Capital growth spending by rural water businesses doesn’t exceed $80 million per business for whole Water Plan 3 period. Capital growth spending by regional and metro water business forecast to decline in real terms. Most investments characterised by smaller investments, and renewals. − MW has the main large one‐off expenditures: Western Treatment Plant Stage 2 ($190m); WTP sludge drying augmentation ($56m); St Albans stage 2. − YVW: three sewer projects worth $70m − South East Water: two STP upgrades worth $70m − City West: nil − Western W: STP plant upgrades, dominated by Sunbury ($50 million) Economic trends within sectors Civil and general construction: Competitive tendering likely to continue through to 2016 across Australia and Victoria. Increasing pool of available contractor capacity chasing a reduced supply of available work. Tier 1 competition less competitive Materials input costs: Victoria has seen major pipeline constructions completed over the last five years including Desal and North South Pipeline. Currently no major pipeline projects planned over the next few years. This is placing pressure on pipe manufacturers to sell at lower margins. GRP pipe costs have been flat over the past 24 months. The cost of steel coil to produce MSCL / DICL pipe has been trending down over the previous 2‐3 years, and is expected to remain flat in outlook Plant: Price decreases have been moving broadly in line with the contracting level of engineering construction activity. Signs of margins been reduced as major construction work has contracted. Plant is expected to lag trend broader economic growth. Labour: Labour markets are expected to weaken overall. Engineering construction job losses in the resource states will see shedding of labour over the next two years. Forecast rebound in construction activity likely to absorb some of this labour surplus. Victorian construction wages expected to lead general wage rises as new Enterprise bargaining agreements come into force. Key uncertainties  Timing of significant public expenditure (East‐West link second stage, Metro Rail Capacity Project)  Incidence of natural and other disasters  Victorian public expenditure into medical research and food production  Sales of existing assets will provide an important funding source for public investment  Broader macro conditions How we reached these conclusions  Construction cost indices using ABS, PS and other data sources.  Forward work look for major projects: − IA major projects pipeline; ACIF (May); AiG; IBISWorld, Deloitte Access December 2013 outlook; − ESC water businesses, break down by size and year  Macro conditions based on review of construction outlook and Treasury publications  Industry conditions based on discussion with: − Broad construction industry: AIG, ACIF − Water sector construction: Sydney Water, Water Corp, SEQWater − Pipes: Iplex, Pentair Dr Jeremy Cheesman [email protected] +61 0414 765 739 Peter Jacob [email protected] +61 0408 366 616 Arthur Lambrianidis [email protected] +61 0423 585 701 Check out what else we’re working on www.marsdenjacob.com.au www.projectsupport.com.au Marsden Jacob Associates Financial & Economic Consultants Melbourne office: Level 3, 683 Burke Road Camberwell Victoria 3124 Telephone: +61 3 9882 1600 Project Support Independent Estimators and Project Advisors Melbourne office: Suite 3, Ground Floor 11 Queens Road MELBOURNE VIC 3004 Telephone: +61 3 8672 5626