Infrastructure projects must cope with fuel, steel price hikes

Yenwy Wongso ,  Research Analyst   |  Wed, 05/07/2008 9:38 AM

Indonesian performance on completing major infrastructure projects on time, or at all, is poor. There will be more delays as fuel and steel price hikes hit, unless project management improves to cope with these conditions.

Progress on infrastructure construction is limited, especially for public projects. Government plans to raise fuel prices by an average 28.7 percent will increase uncertainties in the sector.

Indonesia may be the largest economy in Southeast Asia, but for infrastructure it has become a never-never land where the only certainty is that it will take forever to finish a project.

If the country continues to under-perform like this, it might soon lose any competitive edge against neighboring countries such as Vietnam and Cambodia.

Recently, the President officially opened the Downtown WaruJuanda International Airport toll road in Surabaya, East Java. Started in 1996 the project was scheduled for completion in early 1999. The 1998 economic crisis was blamed for the delays.

After struggling for nearly 12 years, the investor completed just 12 kilometers, only one third of the initial plan. Meanwhile, costs quadrupled due to land acquisition problems and inflation.

The Surabaya tollway is considered lucky to be completed at all compared to the Bekasi Cawang - Kampung Melayu tollway where construction started in 1997. The financial crisis was also blamed for this one, but it was never completed. Concrete piles for the elevated sections remain as monuments along the side of the West Tarum Drainage canal in Bekasi.

Less than 10 projects put forward in the 2005 Infrastructure Summit 2005 have started construction. Most of the rest are stuck at the prequalification and tender stages. None of the projects proposed during the 2006 summit has been built, or even reached the tender stage.

It is more than 10 years since the economic crisis hit Indonesia. The contribution of construction toward GDP has gradually increased over the past five years, but has not reached precrisis levels yet. Construction as a share of GDP only reached 7.7 percent in 2007, slightly up on 7.2 percent in 2006 but still below the precrisis level of 8 percent.

Development of both public and private infrastructure is required in order to boost the nation's economic growth.

However, infrastructure projects are susceptible to inflation of raw material prices, in particular cement and steel. With crude oil prices nearing US$120/barrel, potential raw material price increases could prove to be stronger than expected.

For instance, hot rolled coils (HRC) in the domestic market recently reached $1,027 per ton, up from $789 per ton in January this year, up 30 percent. Meanwhile, cement producers have increased selling prices for cement products by 5 - 15 percent in April, for example in one case from Rp 37,000 per 50-kilogram sack to Rp 42,000, an increase of 14 percent.

The surge in raw material prices has resulted in submitted cost estimates for construction projects becoming frequently outdated. This means that most projects which have already been tendered are having to review prices again.

To cope with soaring material prices, project owners or construction companies have come up with different strategies.

The most common strategy is to secure future contracts for raw material delivery throughout the entire construction period for new projects. This is commonly done by large construction companies to hedge against inflationary risks in material prices.

Second, construction companies will pass on price increases to project owners via cost escalation clauses in their contracts. This is common for government projects, mostly involving public infrastructure, such as public roads, toll roads, power plants, dams, irrigation, airports and harbors.

Accordingly, the Public Works Ministry takes into account increased construction costs whenever government implements a fuel price hike. The type of compensatory measure varies from cash or a top up payment through to the reduction of project scope (for example for road projects).

Project developers can also split up construction projects using several contractors to speed up implementation as a hedge against inflationary risks in material prices. This is also common in the construction of toll roads.

No matter what strategies are implemented to cope with rising costs of materials, infrastructure development must still go on. Otherwise the country's potential might be held back.

So long these mitigating strategies can be well implemented then the outlook for infrastructure construction might still be considered attractive, despite the increases in fuel and other costs.

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