Spring 2022 UK Market Report
Russia-Ukraine war
Commodities price increases
Russia’s invasion of Ukraine has caused a massive humanitarian crisis. Other far-reaching effects of the war include major supply disruptions and significant price escalation for commodities.
The World Bank’s latest Commodities Markets Outlook report shows that commodities pricing surged during the first quarter of 2022. Increases were particularly pronounced for commodities where Russia and Ukraine are large exporters: energy, metals, fertilisers and grains. The latest rises follow an increase in commodity prices as the global economy recovers from the COVID-19 pandemic.
The increases between April 2020 and March 2022 represent the largest for any equivalent 23-month period since 1973 for energy and 2008 for food.
Sanctions on the imports of Russian energy have amplified the rises seen. Brent Crude oil reached a 10-year high in early March. However, strategic releases of oil from inventories by the US and other members of the International Energy Agency eased prices in April.
In March, European natural gas prices peaked due to fears of supply disruption from Russia. An increased demand for coal as a substitute for natural gas in electricity production also led to it reaching an all-time price high.
Non-energy items have also seen price escalation. Wheat prices were almost 30 percent higher in March than in December 2021 and there is concern that as fertiliser prices continue to increase, crop yields will reduce as farmers use fewer fertilisers. Further food price rises are anticipated.
Since the end of the year, the metals and minerals index has risen 13 percent in the quarter to the first quarter of 2022. Aluminium and iron ore prices have seen considerable rises.
The World Bank highlights that commodity markets are facing an array of pressures and that difficult conditions may persist as:
- Increased prices for one commodity typically drive substitution in demand for other commodities
- The price increases of some commodities have pushed up the production costs of others. For example, rising energy costs increase production costs of fuel and fertilisers and in the extraction and refining of metal ores. Higher metal prices then increase the costs of renewable energy technologies
- Broader inflationary pressures — higher wages, increased transportation and storage costs and elevated borrowing costs — generally raise the cost of commodities.
Commodities outlook
Commodities pricing is mainly expected to be sharply higher in 2022 than in 2021 and will remain elevated in the medium term.
The outlook for pricing depends on the duration of the Russia-Ukraine war and the extent of EU sanctions on Russian energy. The EU is committed to reducing its dependence on Russian energy and has vowed to make the EU independent of Russian fossil fuels by 2030.
EU countries have already agreed to phase out Russian coal imports by August. Recent discussions have been focused on banning oil imports, with the phasing out of Russian-supplied crude oil within six months and refined goods by the end of the year.
In 2021, Russia supplied the EU with a quarter of its oil imports and some countries are highly dependent on Russian oil, with timeline concessions required for them to make the transition. Oil prices rose by five percent on the news of the EU plan, with Brent Crude oil reaching $110 per barrel.
Whilst the EU is trying to reduce the consumption of natural gas by 66 percent by the end of 2022, it is considered a less likely target for formal sanctions. Last year, 45 percent of the EU’s natural gas imports came from Russia, with some countries being particularly dependent.
Sanctioning natural gas would severely impact the Russian economy — an analysis published before the war by the Kiel Institute for the World Economy suggests that a total gas embargo by Western allies would reduce Russia’s gross domestic product (GDP) by nearly three percent. As most supplies are delivered along pipelines, it would be difficult for Russia to divert supplies elsewhere. However, such a move would also have substantial economic consequences for the EU.
A reduction in supplies could also come from Russia halting or restricting deliveries. A decree signed by President Vladimir Putin at the end of March required buyers of natural gas from "unfriendly countries" to hold accounts at Gazprombank and settle contracts in rubles.
On 27 April, Gazprom halted natural gas exports to Poland and Bulgaria after those countries refused to pay for supplies in rubles. However, existing contracts state the payment method as euros and leading economies reject any changes to agreements.
The EU has warned member states to prepare for a breakdown in gas supplies as payment in rubles would breach sanctions. Countries are reducing natural gas consumption and stockpiling natural gas ready for winter, paying a premium to do so. At a time when households and businesses are already struggling with high energy bills, the problem comes of how much consumers should pay.
Rising cost of living
The Consumer Prices Index (CPI) reached nine percent in April, following seven percent in March, primarily due to surging energy prices and the increase in the energy price cap. The Bank of England foresees CPI peaking “slightly over 10 percent” in the last quarter of 2022, following an expected further substantial increase in the energy price cap in October.
Interest rates rose to one percent on 5 May, the highest level since 2009. The Bank’s Monetary Policy Committee said there had been a “material deterioration in the outlook for UK growth,” with the economy expected to shrink in the last quarter and contract by 0.25 percent in 2023.
Whilst the Bank is not predicting the two consecutive quarters of negative growth required for a technical recession, many are speculating that 2023 will feel like a recession, nonetheless.
Latest data from the ONS shows that the economy contracted in March as consumers cut back on spending. GDP fell by 0.1 percent after no change in February, leading some to fear that it will be difficult to avoid a recession this year.
Usually, rates rises lead to people spending less, cooling demand for goods and services and slowing inflation. However, economists have warned that interest rate increases may have little impact due to rising global oil and gas prices. The Bank is primarily looking to prevent the embedding of high inflation.
The Bank of England expects inflation to peak this year before falling to 3.5 percent in 2023 and 1.5 percent by 2024. The forecasts consider market expectations that interest rates will rise as high as 2.5 percent in mid-2023 before falling again.
With the cost of living crisis looking set to worsen, there are calls for further government assistance to follow the support provided in the Spring Statement.
Impact on the construction industry
Like the broader economy, the construction industry has been heavily impacted by the Russia-Ukraine war.
Respondents to our survey noted impacts such as increased prices, reduced availability of specified materials and supply chain disruption due to the war.
Overall, the issues mean that projects take longer to start on site. Some 67 percent of respondents to our survey said that they felt the current challenges are impacting growth of the construction industry, with some schemes stalling due to the uncertainty.
Contractors report that tenders are often over clients’ budgets due to the price rises. Many said they consider value engineering options and alternatives as part of their tender to work through the issues.
The reduction in price validity as the supply chain grapples with cost increases adds further pressure, with some clients unable to make decisions in time and then experiencing further cost increases.
There are concerns that the issues, particularly cost escalation, will make schemes unviable. Now more than ever, it is crucial that value management principles are adopted to ensure the achievement of project objectives whilst making the best use of resources.
Project planning is important, along with early engagement of the supply chain. Early orders can be beneficial for securing supplies. Procurement and tendering strategies also need to be carefully considered along with fair risk apportionment.
In our survey, 73 percent of respondents said that they are seeing increased collaboration on their projects to overcome the impacts, continuing a trend seen in response to the COVID-19 pandemic.
