PAMANTASAN NG LUNGSOD NG MAYNILA

GRADUATE SCHOOL OF ENGINEERING

GEM 831 - MANAGEMENT OF CONSTRUCTION SYSTEMS

REFLECTION PAPER ON PRICE ESCALATION

Submitted by: Ragasa, Jerso Ryan B.

2016-61080

Submitted to: Dr. Rolando D. Rabot

PRICE ESCALATION

In general, construction projects are usually of quite lengthy ranging from several months to several years. All
projects are to be performed according to a pre-confirmed contract amount and contract agreement in
principle. Therefore, there is a strong probability that the cost of labour and material will rise or fall periodically,
to a greater or lesser extent during the life of project. Hence there is a possibility for most of contractor is that
they have to bear damage at that particular period due to sudden change rise of international raw materials or
exchange rates under lump sum or fixed price contract. Therefore, the provisions regarding contract price
escalation should be rearranged systematically to cope with the sudden price changes. Escalation is a term
used in most countries, to indicate extent of these changes from the commencement of a project through any
point during its life.

Definition

 Escalation can be defined as change in price levels driven by underlying economic conditions.
 Escalation is the provision in cost estimate for increase in the cost of equipment, material, labour etc.
Due to continual and periodical price changes over the time.

 Escalation is used to estimate the future cost of project or to bring historical cost to the present.

 Escalation reflects changes in price-drivers such as productivity and technology, as well as changes in
market conditions such as high demand, labour shortages, and profit margins as soon.

 Escalation also includes the effects of, but differs from, inflation which is a general changes in price
caused by debasement of the value of a currency from an estimators perspective, escalation it is a
unique I/0 cost that must be estimated.

Construction Escalation Factors

6LOBAL DEMAND:

The global demand for commodities is greater than any prior time inhistory.

ENERGY COSTS:

The costs of oil, natural gas , coal, and electricity are major components of construction cost. They
are expected to continue to rise substantially as a result of thefollowing.

UTILITY DEREgULATION:

Rates, which have been locked at an artificially low level for anumber of years, are opening up to
market pricing and large increases are expected.

ENVIRONMENTAL REgLATIONS:

Fear of global warming fears are driving retrofits of power plants, use of cleaner fuels, and pollution
controls on new diesel equipment-all of which are expensive.

AgIN6 INFRASTRUCTURE:

Such of the power distribution system in the @/ is beyond its life expectancy.
Escalation Relationships:

Escalation in cost estimating has two main uses:

1. to convert historical costs to current costs (historical escalation index)

2. and to escalate current costs into the future (predictive escalation index) for planning and budgeting.

The historical escalation index is used to bring the historical cost to the present and then a predictive

escalation index is used to move the cost to the future.

APPLICATION OF A PRICE ADJUSTMENT FORMULA for Escalation

In various countries, during the periods of steep price rises sophisticated systems for 'recording' and 'monthly

publishing' of cost indices were developed.

These permit contract prices to be regularly modified using suitable formulae with invoices adjusted by

comparing the updated indices to the indices applicable at the time of bidding.

In overall terms, this system allows the contract prices to be adjusted at a rate probably slightly ahead of the

retail price index and inflation.

Price adjustments to contracts can be any of the following:

a)Fixed (no escalation) for a contract of a stipulated length of time (variations and claims excepted)

b) Variation of price allowed if the contract period exceeds a pre-set time from a pre-set time

c) Variation of price by an agreed formula, if the 'change' in any constituent ,of the formula is greater than a

certain percentage (e.g., 5%) wrt its value at time of tender

d) As per a contract that allows for periodic adjustments of rates changed according to published indices over

the base indices. The period of adjustment may vary from one month to one year after the date of tender and

then every agreed period thereafter.

...A Simple And Compact Method

R = Total value of work done during the month. It would include the amount of secured advance granted, if

any, during the month, less the amount of secured advance recovered, if any, during the month. It will exclude

value of works executed under variations for which price adjustment will be worked out separately based on

the terms mutually agreed.

Adjustment for 'labour' component: .

i) Price adjustment due to an increase or decrease in the cost of labour shall be paid in accordance with the

following formula:

VL = 0.85 x P1/100 x R x (Li –Lo/Lo)

VL =Increase or decrease in the cost of work during the month under consideration due to change in rates for

local labour.

Lo =The consumer price index for industrial workers for the State on the day 28 days preceding the date of

opening of bids, as published by Labour Bureau, Ministry of Labour, Government of….

Li = The average consumer price index for industrial workers for the State for the month under consideration

as published by Labour Bureau, Ministry of Labour, Government of. ....

P1 =Percentage value of labour component of the work.

Adjustment for ‘Cement’ component:

Price adjustment due to an increase or decrease in the cost of cement procured by the Contractor, shall be

paid in accordance with the following formula:

Vc= 0.85 x Pc/100 x Rx (Ci -Co)Co

Vc= Increase or decrease in the cost of work during the month under I consideration due to change in rate. of

cement.
Co = The countrywide wholesale price index for cement on the day 28 days preceding the date of opening of

bids, as published by the Ministry of Industrial Development, Government of. ….

Ci=The countrywide average wholesale price index for cement for the month under consideration, as

published by the Ministry of Industrial Development, Government of.

Pc= Percentage value of cement component of the work.

Adjustment for ‘Steel' component:

Price adjustment due to an increase or decrease in the cost of steel procured by the Contractor shall be paid

in accordance with the following formula:

Vs=0.85 x Ps/100 x R x (Si – So)/ So

Vs= Increase or decrease in the cost of work during the month under consideration due to change in rate of

steel.

So =The country-wide wholesale price index for steel (Bars and rods) on the day 28 days preceding the date

of opening of Bids, as published by the Ministry of Industrial Development, Government of. ..,

Si = The countrywide average wholesale price index for steel (Bars and rods) for the month under

consideration, as published by Ministry of Industrial Development, Government of......

P s = Percentage value of steel component of the work

Note: For application of this clause, the index of Bars and Rods may be. chosen to represent the Steel

group .

Adjustment for 'Bitumen' component:

(Unlike indices for other components, adjustment for bitumen is made directly on a retail price basis since

'indices' may not be available for an item like bitumen.)

Price adjustment due to an increase or decrease in the cost of bitumen procured by the Contractor shall be

paid in accordance with the following formula:

Vb = 0.85 x Pt/100 x R x (Bi -Bo/Bo)

Vb =Increase or decrease in the cost of work during the month under consideration due to change in rate of

bitumen.

Bo =The official retail price of bitumen at the nearest depot centre on the day 28 days prior to date of opening

of bids.

Bi = The official retail price of bitumen at the nearest depot centre for the 15th day of the month under

consideration.

Pb = Percentage value of bitumen component of the work

Adjustment for 'POL' (fuel and lubricant) component:

(… based directly on price of (HSD) , for same reason as for Bitumen). Price adjustment due to increase or

decrease in the cost of POL (fuel and lubricant) shall be in accordance with the following formula:

Vf = 0.85 x Pf/100 x R x (Fi –Fo)/Fo

Vf =Increase or decrease in the cost of work during the month under consideration due to change in rates for

fuel and lubricants.

Fo =The official retail price of HSD at the existing consumer pumps at nearest Depot centre on the day 28

days prior to the date of opening of bids.

Fi = The official retail price of HSD at the existing Consumer pumps at nearest depot centre oil the 15th day of

the month under consideration.

Pf = Percentage value of fuel and lubricants component of the work

Note: For application of this clause, the price of HSD oil may be chosen to represent the fuel and Lubricants

group.

Adjustment for ‘Plant and Machinery /Spares’ Component:

Price adjustment due to an increase or decrease in the cost of plant and machinery /spares procured by the

Contractor shall be paid in accordance with the following formula:

Vp = 0.85 x Pp/100 x R x (Pi –Po)/Po

Vp =Increase or decrease in the cost of work during the month under consideration due to change in rates of

plant and machinery/Spares.

Po =The country wide wholesale price index for heavy machinery and parts on the day 28 days preceding the

date of opening of Bids as published by the Ministry of Industrial Development, Government of….

Pi=The country wide average wholesale price index for heavy machinery and parts for the month under

consideration as published by the Ministry of Industrial Development, Government of…

Pp = Percentage value of plant and machinery/spares component of the work

Note: For application of this clause, the index of Heavy Machinery and Parts may be chosen to represent the

Plant and Machinery/Spares group.

Adjustment for 'Other Materials' Component:

Price adjustment due to an increase or decrease in the cost of local materials other than cement, steel,

bitumen and POL procured by the Contractor, shall be paid in accordance with the following formula:

Vm = 0.85 x Pm/.100 x R x (Mi –Mo)/Mo

Vm =Increase or decrease in the cost of work during the month under. consideration due to changes in rates

of local materials other than cement, steel, bitumen and POL.

Mo =The countrywide wholesale price index (all commodities) on the day 28 days preceding the date of

opening of bids, as published by the Ministry of Industrial Development, Government of ….

Mi =The countrywide average wholesale price index (all commodities) for the month under consideration as

published by the Ministry of Industrial Development, Government of….

Pm= Percentage value of local material component (other than cement, steel, bitumen, and POL) of the work

Percentage Values:

The following percentage values may be assumed for the price adjustment, for example, an entire Highway

contract:

Labour -PL 25%

Cement -Pc 15%

Steel -Ps 25%

POL -Pf 5%

Plant & Machinery Spares -Pp 5%

Other Materials –Pm 10%

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Total 85%

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Factors affecting ambiguities in Escalation formula

 The methodology for allocating % for M, L and POL are not very accurate because these constants

are meagerly derived by the clients .

 For material escalation the WPI index is considered which includes food items and many materials

like fertilizers, tobacco, papers etc which actually do not relate to construction activity.

 For the labour component the formula refers to the CPI for industrial workers . Though in many

projects the clause is related to MWA so lack of uniformity of approach.

 For fuel normally the price of HSD is considered for calculations

 The material supplied by the client are deducted from the running bills before paying escalation. But

since the materials also undergo the construction process, they should be excluded while calculating

escalation on labour and fuel.

 Profit margin is generally excluded while paying escalation which is assumed to be between 10-25%

of every running bill.

 No escalation for P and M though in international projects price variation clause on P an M is also

included.