The Contractor's Song: The Times They Are A-Changin' — Managing Commodity Volatility In Water Infrastructure
By Jeremy Holland
Bob Dylan clearly didn’t mean to describe in his song, “The Times They Are A-Changin,” the tremendous upswing in commodity prices that has occurred in the last six months and that could potentially “drench” our projects with added uncertainty and costs, but it is certainly true that one thing we can all count on is that in all times, things change. In our role of building water infrastructure projects, there is no doubt that managing change is one of the biggest requirements. So, let’s walk down the path of pricing change that has gotten a lot of people’s attention recently.
Commodities In Water Infrastructure Projects
Water infrastructure depends on commodity materials such as, concrete, steel, plastic, wood, or copper. They go into the tanks, pipes, wires, and equipment that we use to treat and convey water. As with all things, prices fluctuate and can typically be absorbed as project costs escalate over time. What’s different right now is the dramatic increase that has occurred in the last six months as the supply chain has been disrupted by the pandemic while demand for construction materials has continued in many places unabated. That supply/demand imbalance has put tremendous upward pressure on prices for the materials needed to build our projects.
Commodity Effects On Pricing
While commodity prices are being heavily discussed in the news, and have owners concerned about impacts on overall project costs, let’s break down their impact a little more to understand the net effect. It’s important to remember that commodities are usually the raw materials that go into finished goods that are installed in projects. We don’t buy copper; we buy copper wire. We don’t buy steel; we buy steel pipe. Also, materials only make up a portion of the overall project cost, with labor being a much larger percentage and equipment also comprising part of the overall cost. It is reasonable to think that materials account for 25 to 30 percent of a construction project’s overall costs. So, if we look at price escalation for commodities in the range of 20 percent, it will impact a total project cost by 5 to 6 percent.
Tracking Price Changes
In spite of various influences on project cost impacts, it is still prudent to keep track of these price changes. The first step is to understand material trends that are occurring using existing data-tracking resources. At Mortenson, our estimators and buyers develop an internal quarterly report highlighting construction costs and trends in our various markets. While we can’t predict the future with this information, we can stay informed on potential project impacts and educate our customers of cost risks.
Cost Control In Design
We can control costs in two ways during a project’s design process. Although these methods seem to run counter to each other, both are effective. First, more comprehensive, accurate and detailed designs can help contractors price uncertainty. If we can provide more accurate information on project requirements, better bid pricing will occur. Separately, designs that allow for flexibility in material selection can convince contractors to provide a lower bid. Do we have the flexibility to choose between plastic or metal pipe? Do components need to be stainless steel, or can carbon steel be acceptable? Providing flexibility opens opportunities for contractors to control costs.
Eliminating Scope Gaps In Trades
The next, and closely related, way to control costs is to spend time reducing or eliminating gaps in trade partner scopes. A general contractor that is buying out various packages of work can be methodical and detailed in understanding the interfaces of various trades to clearly identify who owns which responsibilities. If I have a trade partner that is supplying erosion control measures and another that is installing pipeline, is it extremely clear to all parties who maintains erosion control during the project? Careful delineation of scopes and discussions, followed by documentation, aid in minimizing scope gaps.
Allocating Escalation Risk In Pricing
Sometimes you already know that pricing has escalated and you have no choice but to absorb the costs. If there are clear trends that suggest pricing will continue upwards, then allocating that risk in pricing won’t avoid the costs; however, it will correctly account for the costs. If this is the pathway that must be taken, it also affords the opportunity to evaluate other scope options. We recently completed the purchase of timber boardwalks that would be installed in a wetland. Knowing that lumber prices were at historical highs, we were not only able to reduce the length of some boardwalks, but also included the anticipated escalation in timber within the final guaranteed maximum price (GMP) to avoid a potential change order in the future.
You Better Start Swimmin’
Dylan said it best, “You better start swimmin’ or you’ll sink like a stone.” Commodity prices need to be understood and tracked, so we remain cognizant of impacts and avoid unexpected increases. There are ways to mitigate these costs and help our customers build the water infrastructure they need. And while these prices pose a challenge, again, we are certain that this trial will pass and our focus will turn to new risk-management endeavors in the future.
Jeremy Holland is a Market Executive in the Water Infrastructure Market in Mortenson Seattle’s Operating Group. With 23 years of engineering experience, Jeremy has served as project principal, technical advisor, project manager, and design engineer. His industry knowledge spans a wide variety of projects, clients, disciplines, and engineering problems. A licensed Professional Engineer in Oregon, WA, and Puerto Rico, Jeremy received a Bachelor of Science in Chemical Engineering and a Bachelor of Arts in English from the University of Notre Dame, and a master’s degree in Business Administration from Portland State University. He is a board member of the Oregon Association of Clean Water Agencies and is the Co-Chair of the Water Quality Committee.