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Emerging from the turmoil and shocks of the COVID-19 pandemic, the outlook for the Australian construction industry is very positive with huge growth potential. Having said that, there are also numerous challenges to that growth.
This article first appeared in Chambers & Partners Construction Law 2022 Global Practice Guide.
In terms of positives, the economy appears to be on a good path to recovery, there are unprecedented levels of building activity, governments are committed to massive infrastructure spending and there is an increased demand for resources projects.
On the negative side of the ledger, there are a range of challenges to be faced. While governments promise massive infrastructure investment, the reality is that there is simply too much work for the construction industry to handle currently. There are significant capacity shortfalls in terms of both labour and materials. Economic disruption during COVID-19 and increasing inflation have put contractors under pressure, particularly where they have entered into fixed price contracts. Contractor insolvencies are at record levels. Contractual risk allocation and procurement methods have not adapted properly to the market conditions and there is continuing undue pressure on contractors and subcontractors.
Of course, all of this presents opportunities for the construction industry – for industry participants to grow their businesses; opportunities for foreign companies entering the market; opportunities for immigration and gender diversity; and to reassess outmoded contracting arrangements and risk allocations to achieve more equitable outcomes for the construction industry. If these opportunities are properly grasped, there is cause for real optimism.
In summary, some of the key trends we are seeing include:
Positive Economic Outlook
The outlook for the Australian economy is remarkably positive. The Reserve Bank of Australia expects GDP in 2022 to grow by about 4.25%. In the wake of the COVID-19 pandemic there has been a strong bounce-back in key economic indicators. In 2021 the Australian economy grew by 4.2% with GDP at 3.5% higher than prior to the pandemic. The significant anticipated growth in GDP this year is supported by the reopening of Australian borders, a significant pipeline of infrastructure work, increased commodity prices and accumulation of household wealth over the past two years.
Having said that, we live in uncertain times given the continuing challenges of COVID-19, war in Ukraine and global inflationary pressures. Global commodity prices – notably the prices of oil, coal, base metals and agricultural commodities – have risen dramatically. While many countries are negatively impacted by the growth in commodity prices, Australia's position, as an exporter of these commodities, differs. The Reserve Bank of Australia predicts that increased commodity prices will mean that national income will increase, with higher profits flowing to resources companies and increased tax revenues available to government. This, in turn, should lead to increased expenditure on resources projects and on government infrastructure.
The construction industry in Australia generates more than AUD360 billion in revenue annually, representing 9% of Australia's economy.
As with many other countries, Australian governments – federal and state – see infrastructure spending as a means of stimulating economic growth and recovery post-COVID-19. Infrastructure Australia reports that investments in public infrastructure over the next 10 years will be around AUD300 billion, with annual expenditure reaching AUD52 billion by 2023. This level of investment is unprecedented. Most investment will be in the transport sector, chiefly road and rail. There will be an increased focus on mega-projects – defined as projects over AUD1 billion in capital cost.
More broadly, building activity has seen significant post-pandemic growth. In Australia's largest cities, Sydney and Melbourne, there are a record number of cranes in the sky. The RLB Crane Index recorded 813 cranes in Sydney and Melbourne in the first three months of 2022 – a 13% increase in the number of cranes and the greatest number of cranes recorded since inception of the index in 2012.
Alongside the significant infrastructure and building projects, we are likely to see a substantial increase in construction projects in the mining sector. The post-pandemic reopening of global economies and the disruption of markets by the war in Ukraine has seen a marked growth in demand for Australian minerals and energy.
Indeed, indications are that there will be a mining boom similar to the boom of 2010. In particular there is currently record-breaking exploration expenditure and capital-raising. Independent research agency Austex reports that in the last three months of 2021, exploration spending hit a record AUD974 million – almost double the exploration expenditure for the same period a year earlier.
Similarly, capital raising for the final quarter of 2021 hit a record AUD3.17 billion – a 70% increase on the previous year.
There has also been an increase in construction projects in the renewables space. Arguments continue about whether the Australian government should be doing more to encourage investment in renewables. Even so, according to the Clean Energy Council, as at 2021, 32.5% of electricity supply is provided by renewable energy. This is twice the figure in 2017. In 2021, clean energy capacity grew by 6.3 gigawatts.
Across Australia there are currently 9,331 MW of large-scale renewables energy projects either under construction or financially committed. About half are in New South Wales, valued at more than AUD9 billion and generating nearly 21,000 jobs. Victoria and Queensland each have about AUD3.55 billion in renewables projects either under construction or in the pipeline.
While governments point to economic growth and the anticipated construction pipeline as painting a positive picture, the less-publicised reality is that the Australian construction industry does not currently have sufficient capacity to deliver the planned projects. Capacity constraints relate to both the available workforce and also materials.
Australia needs more workers, not only in the construction industry but more generally. The unemployment rate stands at a low 4%. There are extreme levels of labour shortages in the construction, tourism, hospitality and agriculture sectors.
The lack of workers is primarily due to decreased migration caused by COVID-19-related border closures. Border closures and lockdowns resulted in a net outflow of 100,000 migrants in the 2021 financial year. This was the first loss of migrants since just after the Second World War, and the lowest growth in population in over 100 years. Travel restrictions were lifted in early 2022 and we have already seen a substantial increase in the number of temporary migrants. Even so, Australia's population sits at around 600,000 below pre-pandemic projections.
The infrastructure sector currently employs about 180,000 people. Infrastructure Australia predicts that by mid-2023 there will be a shortfall of approximately 105,000 jobs in the infrastructure sector. There is a skills shortage in the construction industry with a need for scientists, engineers, architects and project managers. To address the capacity deficit, there are calls for increased immigration and incentives to attract appropriately skilled personnel. There is also a drive to achieve greater gender equality in the construction sector, a drive that should bring more workers to the industry. Currently, the construction sector has the lowest female participation of any industry in the country, at just 12.7%.
As with labour, there are significant capacity constraints caused by materials shortages. The demand for construction materials overall is forecast to grow by 30% per year. Demand for construction plant, including cranes, scaffolding, temporary site facilities and tunnel boring machines, is expected to increase by 140% over three years.
The lack of capacity to deliver projects, if not adequately addressed, will only increase the likelihood of claims and disputes and increase the risk of projects failing to be completed on time and on budget.
The Australian construction industry has generally been resilient throughout the COVID-19 pandemic and project shutdowns have been generally avoided; however, there have still been, and there will continue to be, a number of significant longer-term adverse impacts on the industry. There have been supply chain disruptions, manufacturing shortages and a loss of productivity caused by illness and by work health and safety requirements.
Australian industry is heavily reliant upon sea freight and on an ability to transport freight over large distances. The pandemic has placed undue pressure on normal supply chains. It is anticipated that disruptions will continue beyond 2023. We have seen massive increases in fuel prices contributed to by the war in Ukraine and such increases have had, and will continue to have, a flow-on effect for construction industry costs.
Given the challenges of COVID-19 and disruptions to the industry, it is not surprising that contractors have been under financial pressure. While there is currently an abundance of construction work, in the main construction contracts have remained fixed-price contracts with limited rights to claim extensions of time for delays and disruptions in the current market. This has meant that contractors, locked into their existing contracts, have had to absorb the shocks of price increases and delays and disruption.
There is regular news of contractor insolvencies and the resulting hundreds of unfinished projects around the country. Where contractors are placed into liquidation, subcontractors and suppliers are often left without payment, further increasing the burden on industry players. While security of payments legislation throughout the states offers some protection to cash flows, there are calls to introduce more regulatory safeguards for contractors and subcontractors. Queensland has introduced new rules whereby project bank accounts must be in place where deposits for works are held in trust accounts to make payments in the event that builders are unable to complete their projects. We may see more legislation in this area.
In Australia, a range of contract delivery models are used; however, by far the predominant contracting arrangement involves traditional lump sum, fixed-price contracts. Since the late 1980s contractors have taken on increasing levels of risk, particularly on large projects where employers and financiers have required contractors to accept “hard” price and time obligations.
It has become apparent that hard dollar contracts have failed to address properly and fairly the consequences of the COVID-19 pandemic. While we have seen contractors seeking to build price and time risks into their bids, often, when the unavoidable COVID-19-related impacts on price and time have hit, employers have ultimately had to compromise their contractual positions to accommodate those impacts.
We have seen some movement away from inflexible fixed price and time contracts. Some of the trends we have seen in contract risk allocation include:
We anticipate that, apart from the above trends, we are likely to see generally a more contractor-friendly allocation of risk in construction contracts. This should flow as a natural result of market conditions where there will be an abundance of work and the bargaining position of contractors should improve. Indeed, such a shift will be required for the health of the construction industry and for the benefit of construction projects generally.
As a general rule, throughout the ongoing COVID-19 pandemic, state and federal governments have been relatively non-interventionist in relation to construction projects. There were some health and safety requirements imposed on building sites (eg social distancing and mask-wearing) but there were very limited construction industry shutdowns. Indeed, governments saw the continued health of the construction industry as crucial to maintaining a healthy economy overall. The government tended to exclude the construction industry from business restrictions and sought to obviate the effects of COVID-19 on the industry. In New South Wales, for example, the state government relaxed working hours restrictions to enable projects to pick up lost time by working longer hours.
Unrelated to COVID-19, it should be noted that we have seen significant government intervention in the residential sector. Following on from well-known issues with unsafe cladding and some high-profile cases of defective residential buildings, regulation has chiefly been directed towards improving building quality and project supervision and certification.
All of the above discussion means that Australian construction lawyers are likely to be very busy. With more construction projects, lawyers will be heavily involved in the preparation and negotiation of project documentation, in providing advice during project delivery, and in the handling and resolution of the inevitable claims and disputes.
As with all project participants, lawyers will be called upon to be flexible and innovative. Flexibility and innovation will be particularly important as parties seek to adopt new contracting arrangements. Likewise, parties will be looking for guidance and adaptability in resolving claims and disputes.
COVID-19 lockdowns facilitated the adoption of promising and positive innovations in the conduct of court and arbitral hearings. Because of the inability to conduct in-person hearings during lockdowns, technology was used effectively to enable online appearances and hearings, and to support increased electronic document management. Particularly on larger disputes, and particularly where international (or other geographically remote) witnesses, experts, lawyers or tribunal members were involved, those innovations increased efficiencies and reduced costs. Hopefully those innovations will continue to be embraced, as appropriate, by courts and tribunals.
The Australian construction industry is faced with unprecedented opportunities. The promise of a massive pipeline of work needs to be grasped, while addressing the many challenges. There will need to be a real focus on opening borders, encouraging immigration and building the available workforce. Supply chain disruptions need to be addressed or accommodated in construction projects. Contracting arrangements should be reviewed to match market conditions and for the benefit of the industry. Finally, construction industry participants and advisers will need to be adaptable. In terms of uncertainties and market disruption, we may not be out of the woods yet.