Price Variation Clauses: Who Carries the Risk When Steel and Cement Move

On a fixed-price contract with a long duration, the contractor is carrying a commodity position, whether or not they priced one. Steel, cement, bitumen, fuel and wages all move, and if the contract has no mechanism to pass that on, the movement comes out of the margin.

What a price variation clause does

A price variation or escalation clause adjusts payment for movements in input prices during the contract period. Where one exists, part of the commodity risk sits with the buyer rather than entirely with you.

Clauses typically work by reference to published indices for the relevant inputs, applied through a formula that weights labour, materials and fuel by their share of the contract value, comparing the index at the time of work against the index at a base date.

Reading the clause properly

Five things to establish:

Whether there is one at all. Many contracts, particularly shorter ones, are explicitly fixed price with no adjustment. That is a decision the buyer has made about who carries the risk, and the answer is you.

Which inputs are covered. A clause covering steel and cement but not bitumen leaves bitumen risk with you on a road contract.

Which index applies, and the base date from which movement is measured.

The weightings, which determine how much of a given movement actually flows through. Weightings that do not reflect the real cost structure of the work will under-compensate.

Any threshold or cap. Some clauses apply only beyond a stated percentage movement, or cap the total adjustment.

When there is no clause

On a fixed-price contract, price the risk explicitly rather than hoping:

• Establish the duration over which prices are exposed, including the bid validity period before work even starts
• Identify the inputs that matter, usually two or three that dominate the cost
• Take a view on plausible movement over that period, from recent history rather than optimism
• Put a number in the build-up for it

Where the exposure is large relative to the margin, that is information: it may mean the contract is not worth bidding for at a price that wins. See how to price a government tender.

Partial transfers

Two ways to move some risk off your books:

Supplier quotes with matching validity. A supplier who holds a price for the contract period transfers that portion of the risk, though they will price the option.

Early procurement. Buying material early converts price risk into storage, financing and wastage cost. Sometimes worthwhile, and it consumes working capital you may need for EMD and guarantees.

Neither is free. Both are usually cheaper than an unhedged position on a long fixed-price contract.

Claiming under a clause that exists

Where a clause applies, the adjustment does not happen automatically. It requires the index values, the calculation, and a claim submitted with the running bill in the form the contract requires.

Contractors regularly under-claim, either because the calculation is tedious or because nobody tracked the base index. Set up the calculation once at the start of the contract and apply it each bill. See running account bills.

The interaction with duration

Everything above gets worse the longer the contract runs, and contracts run long more often than they finish early.

Which means the duration risk and the price risk compound: an extension of time on a fixed-price contract extends your commodity exposure at no additional payment. Where a contract has a realistic chance of running over, that belongs in the risk line too.

See retention money and TDS and deductions for the other costs that accrue with duration.