A strategy for materials price risk mitigation
Construction projects are too commonly over budget and regularly contend with extreme fluctuations with regard to strategic materials pricing. The engineering and construction (E&C) industry continues to struggle with effective cost control techniques and is in need of new tools and/or strategies to successfully address these mounting issues. A research study was undertaken for construction projects, inclusive of any delivery type, scale, or location, to identify existing strategies currently in use by the E&C industry as well as other industries. A historical markup or price escalator for contingencies is not a universal solution for current and future market volatility. Their use was found to be inadequate 40% of the time. An opportunity exists for the E&C industry to adopt established strategies currently in use by other industries to improve project performance. A model for materials price risk mitigation for particular use in the E&C industry was developed and proposed. Using real-world projects the model is exercised to verify the positive, mitigating impact of derivative usage. The findings are that financial tools used by other industries are not only applicable in the construction industry but unique in project specific application. Hedging, in particular, was found to be effective more than 70% of the time. More specifically, hedging diminishes steel pricing escalation by 21% compared to non-hedging. With the steel market still in its infancy, the growth potential is vast. Other financial instruments and commodity markets should also be analyzed for applicable benefit to the construction industry. Best practices for installing organizational structure and processes for executing the model could be determined. Possible limitations are the lack of transparency in certain market structures and implementation costs. Ultimately, a better informed and more financially savvy E&C industry will emerge.