The year ahead in infrastructure
Colin Fraser, Partner, and Jonathan Hart, Partner, with Graham Robinson, Global Business Consultant, Pinsent Masons
UNCERTAIN and challenging economic conditions seem to have been a dominant theme for the UK infrastructure sector in recent years, and 2023 has been no different. Here, we have picked out five issues that we expect to have a major bearing on how that market operates in 2024.
1. Inflation is here to stay
In the short to medium term, it is difficult to see the inflationary position changing. Material and labour costs are starting to cool down, energy costs too, but general trends continue to be upwards and instability in the supply of skilled labour, exacerbated by change in immigration requirements, will continue to underpin an inflationary environment.
As we noted when we looked back on a turbulent year for the construction industry earlier this month, there continues to be a mismatch between whether, and how, inflation is recognised by procurers and supply chain: first, that these are important contractual issues; and second, in the ability or willingness to address the question of inflation properly in the contract – whether this is in respect of taking a pragmatic and transparent approach to pricing works to be undertaken, or in the way in which inflation risk is drafted for, allocated and then managed in contractual terms.
Just look at the headline from the latest (UK) BCIS construction industry forecast: construction costs are expected to rise by just over 3% in the year to Q4 2024 – and tender prices by just over 2%. A casual reader may wonder what lies behind that differential. Successful businesses will reflect on how to protect themselves in this environment – with strong relationships and realistic and thoughtful procurement strategies.
2. Don’t expect current trends to lead to soft landings
There is expected to be a levelling of some of the more acute lines that appear on various cost and price trends, which will no doubt come as relief for most industry participants who are constantly looking to come to terms with the ‘known unknowns’. But it is perhaps important not to become too complacent. There remain the ‘unknown unknowns’: the depressing reality is that alongside the human suffering being experienced in Eastern Europe and the Middle East, there remains the related potential wider economic fallout in a sector that is already vulnerable.
Unfortunately, many of the observations that we were making at the start of this year are equally valid going into 2024.
It is going to be important to consider how well any contract arrangements are able to address these kind of issues: having seen a flurry of “supervening event” type drafting in respect of Brexit and Covid-19, and a relatively limited number of clauses specific to the war in Ukraine, these kind of provisions have become less prevalent in contracts in more recent months – despite the continued uncertainties in the market.
3. Supply chain solvency will continue to be a critical concern
Linked to the mixed outlook is the ongoing concern around levels of insolvency amongst construction companies. Recent data from the Insolvency Service shows that insolvencies are currently on track to be the highest since the depths of the financial crisis in 2009, as the era of cheap money is now firmly behind us. Even if the Bank of England begins to reduce interest rates in 2024, they would remain at a high level and there is still a compounding effect of the high cost of borrowing when coupled with increased costs for project delivery.
As we noted recently, solvency concerns will stimulate vertical integration of aspects of work and services which may have previously been provided by subcontractors – a trend we identified earlier on in 2023. This is particularly true in areas such as the construction of higher-risk buildings where the building safety regime in England means a much smaller pool of contractors are operating in this market, coupled with the solvency risks posed by legacy liability.
4. We’re going to hear a whole lot more about AI
The rate of change in relation to the application of AI will steepen further still. In just the past 12 months, generative AI, with OpenAI’s ChatGPT at the forefront, has left the world in awe. This rapid ascent has unveiled AI reasoning abilities previously thought to be decades away, dramatically reshaping expectations in an astonishingly short time. AI presents a powerful opportunity to create value in the built environment, and competitive advantage through early adoption and strategic investment.
There are also practical challenges: if the on-site manager is using AI to analyse trends on site and associated critical paths, how reliable is the data going in and the projections that are coming out? Do they reflect the risk allocation for the contract that is being used? Who owns the data being produced? What might this mean if a subsequent dispute between the parties were to arise?
In principle, AI should be making our lives simpler – but this brings with it a whole new range of demands on users. This is an area where contracts and contract management also need to be running to catch up – a lot of current BIM and data-orientated drafting simply doesn’t contend with latest technology, particularly when this is being used in a multi-party context.
The need for many contractors to re-evaluate business models driven by a digital approach to building safety will ripple out across the market in 2024.
There should always be one version of ‘the truth’ on a project – and, perhaps counter-intuitively, AI may make it harder to agree on what this might be. Despite this, it is clear that the longerterm effects of AI will enable a quantum change in productivity – especially if driving an industrialised approach to construction.
5. Blockages in the pipeline will need fixing
It is axiomatic that order books are central to the health of the industry. Demand shapes recruitment and investment decisions and other forward-planning. For many construction companies, the last 12 months have been a rollercoaster ride in terms of ascertaining where future projects might be. For some companies, there is a pivot going on from focusing upon the retail, commercial, and residential developer market, to other types of projects where demand is higher, risk profiles may be better and contracting strategies more collaborative.
The gauntlet thrown down with the outcomes from COP28 is striking. Let’s hope that 2024 sees our governments rise to the challenge – and that industry as a whole does so too, to fulfil its role in the transformation that is so urgently required.
Uncertainty for certain developments in relation to land acquisition, the direction of travel for the market, and costs of borrowing may have exacerbated this effect. However, the picture in relation to the public sector pipeline is anything but straightforward.
Industry should expect a degree of political uncertainty in 2024, which major elections expected in the US, UK, India, and in the European Parliament. Turbulence can also result at the local level, with instability having arisen at some major procurers in recent times as a result of, for example, local authority insolvencies and resultant central government bail-outs.
It was a depressing reality that the 2023 political conference season in the UK was more notable for project cancellations than for setting out a clear way forward for new opportunities.
Clarity in the future for the UK infrastructure pipeline and greater certainty over the future of the planning system, including for ‘nationally significant infrastructure projects’, would be a welcome relief for investors and the industry.
To date, the proposed strategic guidance for rail that was hoped for through the creation of Great British Railways is yet to appear, while it also remains to be seen whether the advent of new procurement legislation delivers the benefits that are hoped for. The gauntlet thrown down with the outcomes from COP28 is striking. Let’s hope that 2024 sees our governments rise to the challenge – and that industry as a whole does so too, to fulfil its role in the transformation that is so urgently required.
Onwards and upwards
Notwithstanding these and other headwinds, there are things to be upbeat about as we enter the new calendar year.
There is overall demand for construction. That is borne of necessity: with a growing population, vital renewable energy investment, and fastmoving technological shifts. Infrastructure sub-sectors aligned to stronger policy commitments and private investment, such as the energy transition and water sectors, are set to show stronger expansion. In the private sector the tax support to businesses investing in assets should boost logistics and manufacturing space demand.
Construction employs 9% of the UK’s workforce and is profoundly important to our social and economic welfare. As political parties publish manifestos for a general election, let us hope that the importance of the industry to the country is reflected and valued. As to how all of this will affect the legal and regulatory landscape, we will discuss it in our Law Review of Construction in the spring.
Colin Fraser, Partner, and Jonathan Hart, Partner, with Graham Robinson, Global Business Consultant, Pinsent Masons
colin.fraser@pinsentmasons.com
jonathan.hart@pinsentmasons.com
This article originally appeared on Out-Law News: Five things UK infrastructure businesses can expect in 2024 (pinsentmasons.com)