Who’s afraid of fluctuating price contracts?

The recent surge in resource costs has led to calls for contract price fluctuation.

The BCIS TPI panel have reported that while there has been much interest in the topic particularly from contractors whose appetite for fixed price is waning, there has been a resistance from clients.

Whilst fixed price tenders are still the norm, feedback from tendering contractors is that they are having extreme difficulty getting their supply chain to commit to fixed price.

The panel reported that while clients have been asking about fluctuating contracts they are concerned about the cost of the administration.

Some evidence of shared inflation risk is being included in contracts however, with some elements, particularly steelwork being subject to adjustment and the contractor’s risk being capped to the forecast movement in an index.

The advantage of fluctuating price contracts is that the contractors can give the best price at the time of tender. There are costs involved in administering the fluctuations the use of price adjustment formulae indices can minimise this.

In the UK, the most commonly used indices are the Price Adjustment Formulae Indices (PAFI) prepared by BCIS. They can be used with both NEC and JCT contracts as well as other standard and bespoke contracts.

There are separate PAFI indices for:

• Building
• Civil Engineering
• Specialist engineering
• Highways Maintenance

A BCIS paper Inflation Adjustment Clauses provides guidance on the application of indexed linked inflation clauses and points out that allowing for the risk of inflation in a contract ensures the best price and that ‘the risk for inflation should be taken by the party best able to manage it. Inflationary risks derived from the local market can probably be managed by a contractor and their supply chain, but the underlying inflation caused by wider pressures from the outside construction and global markets probably cannot.’

The paper is available here.