Fuel price volatility: Managing uncertainty in the infrastructure construction sector

Recent events affecting shipping through the Strait of Hormuz are a reminder that fuel prices can change rapidly in response to global events. We don’t know how long this disruption will go on, or what impact it will have if it continues. But we do know that prices are elevated and volatile.

We can expect global oil prices to flow through to local prices. The New Zealand Infrastructure Commission’s research shows that increases or decreases to global oil prices pass through to New Zealand almost immediately. Paying those higher global prices is necessary to keep supplies flowing our way.

We’re facing the biggest oil supply shock since the 1970s; however, the difference is that the New Zealand economy – like the world economy – is much less oil-intensive than it was back then. On the eve of the 1979 oil shock, New Zealand used roughly a third of a barrel of oil for every $1000 of GDP produced. Today that figure is closer to one-sixth of a barrel.

Infrastructure construction remains exposed to oil prices, however. Diesel is the fourth largest material input to heavy and civil construction – behind only structural steel, aggregates, and concrete. Construction firms’ direct purchases of diesel account for a bit under 2% of total spending in this sector, and diesel is also baked into transport costs and prices for other materials.

In the short term, there aren’t good substitutes for diesel or bitumen in construction, so infrastructure projects can expect to bear cost increases. We expect impacts to be larger for road maintenance and resealing work than for new construction, because bitumen costs make up a greater share of the cost of road maintenance projects.

So, what can firms and clients do? Monitor prices. Look at forward contracts if volatility is a major risk. Understand project-specific exposure – a road renewal is not the same as a new build. And make sure input price escalation, not just from oil, is clearly addressed in contracts.

This isn’t the 1970s. But for road works especially, oil is a cost worth watching closely.