The costs of delivering infrastructure continue to rise.
Last month’s InfraRead outlined that annual inflation in the year to the December 2021 quarter was 5.9% – the highest increase since June 1990. A lot of that inflation was demand driven on the back of a strong economic recovery. The Reserve Bank of New Zealand responded with a conservative 25-basis point increase to the official cash rate (OCR), bumping it up to one percent, and equalling the rate set between August 2019 and February 2020. It was the third successive OCR increase since October 2021.
A lot can happen in a month. Just as last month’s edition of InfraRead went out, Russia invaded Ukraine. Both countries are substantial exporters of agricultural products and Russia is a major supplier of oil and gas. Fuel prices have skyrocketed, with downstream impacts only adding to a cost of living crisis.
The already high inflation alongside the sharp spike in fuel prices due to the war forced the Government into a rare move of reducing the petrol excise duty by 25 cents per litre for the next three months starting 15 March.
The Government had committed to an equivalent drop in road user charges (RUC) at the time it announced reductions for petrol, though there has been a lag in reductions to RUC. Given RUC is calculated on a per kilometre basis and varies depending on vehicle type and mass, the Government was still working through a number of options on how the reductions would flow through. The Government has since announced that RUC will be reduced by 36 percent across all legislated rates from late April till late July 2022, that is, for RUC purchased from late April. The Government has said this level of discount would offer similar savings to the 25 cents per litre reduction for petrol. The discount is likely to cost around $170 million across three months, depending on uptake.
The Government has also halved public transport fares from 1 April for the next three months. The subsidy has been costed at between $25-$40m and will also be paid for from the Covid-19 Response Fund.
These initiatives will provide some respite to New Zealand households while supplementing the NLTF.
It is important to remember that the Covid-19 Response Fund is made up of money borrowed by the Government, and so this diversion of funds is effectively a case of the Government borrowing to top-up the NLTF. Further relief – likely through borrowings – is not off the cards, meaning the NLTF could take a hit if there is a less than equivalent top-up, which could, in turn, have implications for the delivery of transport infrastructure. There are bound to be winners and losers in terms of projects that will receive NLTF funding. This makes the need for a national infrastructure priority list all the more important.
For the macroeconomic environment, the opening line says it all – the costs of delivering infrastructure continue to rise.
The high cost of labour, materials and services alongside higher cost of borrowing does not bode well for the infrastructure sector, both for building infrastructure and operating it. The Infrastructure Commission expects construction costs to jump by a further 10% in 2022. Several ongoing issues mean construction costs could go even higher, and include:
- fallout from Covid-19, particularly on the workforce
- supply chain disruptions – from shipping costs to congestion at ports
- supply constraints due to manufacturing still being impacted due to sudden lockdowns in key trading partner countries like China
- wage inflation
- interest rate increases that affect project financing
- added fallout and uncertainty due to Russia’s invasion of Ukraine – especially since New Zealand imports most of its fossil fuels.
To put things into context, the early publicly released estimate for the Auckland Light Rail project is $14.6 billion. A 10% cost increase would push that to over $16 billion, and if inflation and other issues become persistent, a price tag around $20 billion should not be unexpected.
In terms of wage inflation, the Australian economy is doing relatively better and there is a risk that a high number of skilled New Zealanders could leave for Australia, creating an even bigger skills gap and further increasing our reliance on migrant labour, only adding to the demand for higher wages and causing further delays to infrastructure projects. The development of a credible infrastructure pipeline – as recommended by the New Zealand Infrastructure Commission – Te Waihanga – to provide the industry with certainty to invest in training and retention may go some way in addressing this issue.
The issue of supply chain disruption is one that deserves further insight. Prior to the Covid-19 pandemic, logistics expenses made up around 5% of the total cost of landing goods for a given company. That is now edging closer to 25-40%.
With global pressures likely to remain for some time yet, any hope that 2023 will look more like ‘normal’ is increasingly looking less likely. A long-term view of the supply chain, focused on resilience, collaboration and partnership is needed.
In a recent HSBC webinar, Mainfreight’s Don Braid highlighted the importance of long-term partnerships and collaboration between the private and public sector in this space. This will necessarily include a coordinated effort to ensure that enabling transportation infrastructure planning and delivery takes a considered approach to building supply chain resilience in the face of what is an undeniably volatile global market.