Fuel price surge more bad news for construction

The spike in fuel prices over the last month, since the Iran war started, has reignited significant inflationary concerns across the economy, not least across the construction industry. Ahead of our updated Building Forecasts being published in a couple of weeks’ time, we look at the cost implications of the conflict and how they might affect construction activity in coming quarters.

Oil-based fuels, particularly diesel, are a significant input for the construction industry, representing about 5.0% of non-wage input costs for heavy and civil engineering construction and 4.0% of non-wage input costs for construction services. These cost proportions mean these two industries are in the top 10 most affected across the New Zealand economy by higher fuel costs (building construction, at 2.0% of non-wage input costs, is down towards the middle of the pack).

Put simply, the heavy machinery associated with earthworks and civil infrastructure is particularly thirsty when it comes to diesel. This importance is reiterated by the sizable weighting that diesel has an input into NZTA’s infrastructure cost indices across network outcomes and construction other than structures.

There are certain other inputs into construction that are particularly energy intensive. Moving heavy products, such as aggregates or concrete, requires a sizable amount of fuel and, especially in the case of aggregates, transport costs represent a significant component of the final price for the delivered product. Other products, such as steel, require a large amount of energy to produce. Although non-oil energy costs might not go up immediately, we would expect to see a ripple effect on prices as marginal demand substitutes away from oil towards other energy types where possible. For components and products being imported from overseas, international shipping costs have only risen a little so far, but we are keeping an eye out for more significant cost increases or for shipping schedules starting to become disrupted. We have also started to hear reports about larger increases in plastic materials costs.

It is these potential second-round effects of higher oil prices that the Reserve Bank needs to be wary of. Bank Governor Dr Breman gave a speech last week that outlined the Bank’s thinking about the current oil price shock, and we think the speech gave a fair reflection of the dual uncertainties the Bank is grappling with. On one hand, demand conditions across the economy will be softer as households spend more on fuel, and so they have less to spend on other goods and services. Weaker confidence levels will also undermine consumer spending and business investment as people are uncertain about the future. All other things being equal, this softening would lead the Reserve Bank to cut interest rates to cushion the downturn. But on the other hand, increased fuel prices have the potential to lead to higher inflation outcomes beyond the near-term fuel price spike – requiring the Bank to lift interest rates to rein in these medium-term price pressures.

Given weaker demand conditions, one of the key questions becomes what scope do businesses have to pass on higher costs coming through from the transport sector? The orthodox answer seems to be that the scope is limited – and it is unquestionably more constrained than 4-5 years ago, when substantial fiscal and monetary stimulus had created very strong demand conditions across the economy. But for many firms, including in the construction industry, margins have been squeezed and fat in the business has been trimmed over the last three years as activity levels have gone sideways or contracted. We suspect that many businesses now cannot absorb cost increases or find efficiencies elsewhere. If it is a choice between going out of business due to holding prices and being unprofitable, versus losing customers by raising prices (and therefore maybe going out of business), we expect firms will at least try to pass on cost increases, rather than holding prices and therefore simply rolling over and dying.

Higher costs are one thing for the construction industry to grapple with, but the potential for work to be disrupted by fuel supply limitations could arguably be much more problematic. We saw during the COVID-19 pandemic the cascading effects that unexpected delays had on the timelines and final costs of major projects, particularly in the infrastructure sector. In other words, a stoppage in work for a week can create further and additional delays in subsequent parts of the construction process, which then result in more other delays, and so on. The combination of higher input costs from the external shock, as well as the costs associated with having workers and machinery idle, can quickly mount.

A further concern for the infrastructure sector must be the potential for planned work over the next 1-2 years to be scaled back or postponed due to additional fiscal pressure on both central and local government. Fresh on the back of the Infrastructure Commission’s National Infrastructure Plan, which hinted at too much of a focus on new road building and poor value for money across many land transport projects, Transport Minister Chris Bishop talked about risks to the government’s programme at Infrastructure NZ’s conference last week. With respect to the Roads of National Significance and the planned fuel excise duty increases that will help fund their construction, the Transport Minister said, “It’s a day-by-day, week-by-week proposition at the moment, and there are going to be implications for the Government budget, and we’ve just got to work our way through that responsibly.” That sentence hints at the funding limitations the government was already facing around its major roading projects, even before the fuel crisis came along, leading to higher costs and possible changes to our transport behaviour and infrastructure priorities.

In our January Building Forecasts, the outlook for infrastructure over the next couple of years was the most positive of the three construction types. Prospects for growth beyond a 6-12 month horizon must now be less certain, as the government’s fiscal focus pivots to mitigating the effects of the fuel price shock on firms and households, the business case for building more roads looks shakier. There is also a major risk that construction costs for projects jump significantly over coming quarters and limit how many projects the government can realistically push ahead with.

Higher construction costs could also halt the recovery in residential consent numbers and activity that has emerged since mid-2025. The sector had just been stabilising, after the plunge in house prices and surge in construction costs during 2022/23 had dramatically increased the cost of new builds compared to existing homes, undermining the viability of new residential construction projects. Another surge in construction costs now is likely to occur at the same time as weaker housing market conditions. Lower consumer confidence, a weaker labour market, and the likelihood of higher mortgage rates will all weigh on buyer demand. At best, house prices are likely to track sideways this year, and there is increasing potential for house prices to come under moderate downward pressure again.

Non-residential construction continues to suffer a shrinking pipeline of private sector work, and delays to the economic recovery will further push out the timing of any improvement in sentiment and activity.

We are currently preparing a new set of Economic and Building Forecasts, which will be made available to Building Forecast clients on 17 April.