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BIS Shrapnel’s engineering construction report

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Industry analyst and forecaster, BIS Shrapnel , says the engineering construction sector is showing signs of fatigue following several years of strong growth and warns the current boom in infrastructure and mining construction is set to slow throughout 2007/08 and decline in 2008/09.

Even so, the coming downturn in total engineering construction work is expected to be mild, with activity levels to remain double what were attained during the 1980s and early 1990s, according to BIS Shrapnel’s Engineering Construction in Australia, 2006 to 2021 report.

“The immediate outlook for engineering construction activity is still positive, with infrastructure and mining-based construction activity set to achieve reasonable growth in 2006/07 following a 25% surge during 2005/06,” said BIS Shrapnel senior economist and project manager, Adrian Hart.

“Overall, total engineering construction activity has more than doubled during the past five years to more than $43bn. BIS Shrapnel expects activity to peak during 2007, then slide back around 15% over the three years to 2009/10.”

The new Australian Bureau of Statistics (ABS) figures show total engineering construction activity rose 16% on average through calendar year 2006 to just over $43bn (in constant 2004/05 prices).

However, BIS Shrapnel believes much of this slowdown occurred during the second half of the year as activity dropped back from the red hot pace achieved in 2005/06.

The company forecasts single digit growth in engineering construction activity through 2006/07, with a downturn expected for later on this decade.

The timing of completion of several large projects has contributed to the weak growth outlook, while strong increases in construction costs and supply chain difficulties are also constraining growth.

“While there are no detailed measures of the extent of cost increases in the engineering construction segment, the engineering construction implicit price deflator surged over 11% during 2006,” explained Hart.

“Anecdotal evidence suggests costs are rising by even more than this, particularly in regional ‘hotspots’. In turn, sharply rising construction costs and the difficulty in sourcing key staff and materials will continue to delay many projects. With activity having doubled since the 1990s, it may be that we are fast approaching a limit to how much more work we can do.”

With the federal budget just days away and more state government budgets to follow, BIS Shrapnel warns both the federal and state governments against releasing unrealistic infrastructure plans.

“While more investment in infrastructure capacity is clearly required, both state and federal governments need to work together on this. In particular, governments need to be aware of the volume of work already in the pipeline and the distinct possibility of further blow-outs in project costs and timing delays,” explained Hart.

“In this environment, it is questionable whether governments are getting value for money or whether they will be able to fulfil their infrastructure plans on time and on budget.”

While overall growth in engineering construction activity is slowing, BIS Shrapnel expects infrastructure and mining construction activity will rise further over the next 12 to 18 months, given robust commencements and the record level of work in the pipeline.

During 2006, the value of commencements in this sub-sector rose 18% in real terms to just under $50bn, according to the ABS.

Over the same period, the value of work yet to be done exceeded $25bn, with strong growth occurring in mining and heavy industry, railways, water, sewerage and electricity.

“The resources boom has been the engine of growth for engineering construction activity, fuelling a spike in heavy industry work done and construction of related infrastructure such as railways and ports. In addition, generally robust state and federal government finances have seen a strong, and long overdue, pick-up in public sector spending on roads, bridges, water and electricity,” said Hart.

However, Hart cautions that while the new ABS data is strong it is now around four months old. “Based on a project-by-project analysis and our understanding of key markets, we feel the peak in commencements is probably happening around now, implying a shift to lower levels of construction activity in 12 to 18 months’ time. In the meantime, we can expect the cost pressures and shortages of labour and materials will only get worse.”

BIS Shrapnel is forecasting a slump in mining construction and a deterioration in public spending on infrastructure through 2008/09.

An anticipated cyclical downturn in minerals investment late in the decade and declining public sector revenues, leading to cuts in capital works programs are expected to be key drivers of the weakening engineering construction outlook.

Despite this, BIS Shrapnel expects the coming downturn to be relatively mild considering the strong growth in construction activity since the 2000/01 trough.

Hart believes higher levels of investment in infrastructure are required to correct years of under-funding and meet steadily rising domestic demand and societal expectations, boost competitiveness and trade, and harness new technologies in sectors ranging from electricity generation, water and sewerage, and telecommunications.

Furthermore, BIS Shrapnel expects the continued industrialisation of key trading partners such as China will drive ongoing investment in mining and downstream minerals processing.

BIS Shrapnel warns there are some downside risks to companies operating in the engineering construction sector.

“Looking ahead sector by sector, project by project, the coming downturn is still expected to be broadly based, with falls in most categories of engineering construction offset to some degree by a few very large projects in mining and heavy industry, pipelines, water, roads and bridges,” said Hart.

“If these projects were to be delayed or dropped, the downturn would be much more severe.

“Our forecasts also imply a fairly orderly adjustment in minerals investment as global demand and supply moves back into balance. But given the experience of recent cycles, there is no guarantee the adjustment process will be mild.”

“Further, any shock to global demand could disturb confidence and set off a much more severe slump in investment and this would have knock-on effects on state economies and their infrastructure plans.”

New South Wales:

BIS Shrapnel expects New South Wales engineering construction activity to decline around 7% over 2006/07 and slump again in the latter years of the decade as the downturn in mining and heavy work (mainly coal-related) and the completion of key public projects such as the $2bn Epping to Chatswood Rail Link leave a hole in activity.

Victoria:

Following double-digit growth between 2002/03 and 2005/06, BIS Shrapnel expects engineering construction activity in Victoria to slide nine per cent across 2006/07, with activity tipped to fall much further through 2008/09 and 2009/10 -- mirroring recent declines in commencements.

This is due to a simultaneous contraction in private and public engineering construction as major private projects move through to completion and weaker economic conditions curtail capital works programs, according to Hart.

Queensland:

BIS Shrapnel expects the boom in engineering construction in Queensland to peak in 2007/08, then decline sharply over the next two years.

Hart believes the late decade downturn could be worse if several key infrastructure projects spanning roads, rail, ports and heavy industry are delayed.

South Australia:

Engineering construction activity in South Australia is expected to jump around 27 percent through 2006/07, with another strong increase timed for the turn of the decade driven by the Olympic Dam expansion and several large road projects. The current upswing is being driven by mining projects such as Prominent Hill.

Western Australia:

Engineering construction in Western Australia is expected to record impressive growth again through 2006/07, though not as strong as the phenomenal 73% growth achieved in 2005/06, while a substantial decline in work is forecast for 2008/09.

While nearly all industry segments are growing, new mine construction remains the key driver of the outlook, according to Hart, with work-done on related infrastructure particularly railways and ports expected to be the big contributors to growth in the near term.

BIS Shrapnel expects robust state government finances will contribute to a further expansion in public works, with electricity, water, railways and roads the likely beneficiaries.

Tasmania:

BIS Shrapnel believes engineering construction peaked in 2005/06 in Tasmania, with activity forecast to weaken over 2006/07 and through 2007/08, despite rising activity in heavy industry and roads.

Electricity will be the great detractor from growth, according to Hart, with the completion of the Woolnorth wind farm, but overall activity could be much lower if the Gunn’s pulp mill does not proceed.

Northern Territory:

Engineering construction is forecast to decline by over one-third during 2006/07 and 2007/08 in the Northern Territory as work winds down on several large oil and gas fields and the $2.5bn Gove alumina refinery.

Hart expects this will be somewhat offset by rising pipeline construction activity. The next upswing in construction is not expected until next decade as several large oil and gas projects come on-stream.

Australian Capital Territory:

Engineering construction activity is forecast to rise 12% in 2006/07 in the Australian Capital Territory, driven mainly by the $116m Gungahlin Drive Extension. However, Hart expects activity will decline thereafter as this project is completed.

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