Cost Escalation is Back – Are you contracts Ready

Cost Escalation is Back — Are Your Contracts Ready?

The recent escalation of conflict in the Middle East is already having tangible, real-time impacts on Australia’s construction sector.

Fuel prices are rising. Oil markets are volatile.
Transport and logistics costs are increasing rapidly.

As always, these pressures are flowing directly into construction.

Contractors and suppliers are beginning to claim price increases, driven by fuel, freight and energy inputs. Materials are becoming more expensive to produce, more expensive to move, and less predictable to price.

This is not a hypothetical future risk. It is happening now.

Recent movements in global oil markets are already translating into domestic price pressure. Australian fuel prices have risen sharply in recent weeks, with ongoing volatility expected as geopolitical tensions continue to impact shipping routes and energy supply chains.

These conditions are already feeding into contractor pricing and supplier cost adjustments. Key indicators to monitor over the coming months include contractor tender behaviour and the frequency of escalation-related claims.

From Stability to Volatility, Again

For much of 2024 and early 2025, there was a sense that the worst of construction cost escalation had passed.

Markets had stabilised. Supply chains had improved.

Pricing had become more predictable. That assumption is now being tested.

The current environment is not just about rising costs; it is about renewed volatility, and that presents a different, more complex risk profile.

Projects that appeared commercially stable even a month ago may now be exposed to rapid input cost fluctuations, particularly those with:

• high transport inputs
• reliance on imported materials
• energy-intensive manufacturing components

Where the Pressure Will Show First

We are already seeing early indicators across the market, and these will intensify over the coming months.

1. Contractor Pricing Behaviour

Contractors are becoming more cautious in their pricing, including:

shorter validity periods increased contingencies

qualifications around fuel and freight costs increased divergence in pricing between tenderers due to differing assumptions on escalation risk.

In some cases, contractors may decline to hold pricing at all without escalation mechanisms in place to manage their risk.

2.  Supplier Price Increase Notices

Suppliers are moving quickly to protect margins, issuing:

fuel surcharge adjustments revised freight rates

updated material pricing linked to energy inputs

These increases will inevitably flow through to head contractors and ultimately to principals.

3. Increased Claims and Disputes

Where contracts are silent or unclear, cost pressure typically manifests as claims.

Expect to see:

• rise and fall claims (where mechanisms exist or are argued to exist)
• delay and disruption claims linked to supply chain impacts
• creative reliance on latent condition or change in law provisions

A key point of contention will be whether these cost increases fall within the contractor’s assumed risk under a lump sum contract, or whether they give rise to a compensable variation or contractual adjustment.

Not all claims will be well-founded, but all will require time, cost and resources to manage.

4.  Stress on Fixed-Price Contracts

Traditional lump sum contract models are particularly exposed where key input markets are volatile.

Without appropriate price adjustment mechanisms:

• contractors carry disproportionate risk
• margins erode quickly
• project performance deteriorates disputes become more likely

This is especially acute for longer-term infrastructure and civil projects.

Sustained cost pressure may also increase financial stress across the contractor and subcontractor market, with potential implications for project continuity and delivery risk.

The Real Issue: Risk Allocation, Not Just Price

The key issue is not simply that costs are rising, it is who bears the risk of that increase.

The ordinary rule of thumb in risk allocation is that risk should be borne by the party who is best able to manage that risk. Typically the contractor market is ill-equipped to deal with major and uncontrollable fluctuations in input prices.

Many contracts entered into over the past 12–24 months were negotiated in a relatively stable pricing environment.

They may not adequately address: rapid fuel-driven escalation freight volatility

energy cost shocks supply chain disruption

Where risk allocation is unclear or unbalanced, pressure will surface during delivery.

What Should Councils and Principals Be Doing Now?

This is not a “wait and see” moment. There are practical steps that can and should be taken now.

1. Review Existing Contracts

Identify exposure across your current portfolio: Do rise and fall mechanisms exist?

Are they appropriately drafted and triggered? What cost categories are covered (and excluded)?

Are there notification requirements that will become relevant?

Understanding your contractual position early is critical. Whilst principals are under no obligation to do so, some consideration could be given to proactively negotiating cost escalation mechanisms into existing contracts to maintain contractor performance and engagement on projects.

2. Prepare for an Increase in Claims

Contract administration teams should be ready for: higher volumes of notices

• more complex claims
• tighter timeframes for assessment

Clear internal processes and disciplined assessment frameworks will be essential.

3. Reassess Procurement Models

For upcoming procurements, consider whether:

• fixed-price models remain appropriate
• escalation mechanisms should be included risk sharing approaches would deliver better outcomes
• early contractor involvement (ECI) models may better manage uncertainty
• contractor engagement will disappear without well documented risk sharing mechanisms

Procurement strategies that worked in a stable market may not be fit-for-purpose in a volatile one.

4.  Engage Early with the Market 

Understanding where risk sits in the supply chain is critical.

Early engagement can provide insight into:

• materials most exposed to cost increases contractor appetite for risk
• realistic pricing structures
• appropriate allocation of escalation risk

This enables informed, proactive procurement decisions.

5. Focus on Contract Administration Discipline

In volatile environments, outcomes are often determined less by the contract itself and more by how it is administered.

Key focus areas include:

• strict compliance with notice and time provisions, noting that failure to respond within prescribed timeframes may result in loss of entitlement or deemed acceptance of claims
• consistent and transparent decision-making accurate record keeping
• early identification of emerging issues

Strong contract administration can materially reduce dispute risk as well as risk of improper incursion of cost from opportunistic claiming.

Looking Ahead

It is too early to predict the duration or extent of current market disruption.

However, one thing is clear: Volatility has returned. Projects that navigate this period successfully will not necessarily be those with the lowest price, but those with:

• clear and balanced risk allocation procurement models aligned to market conditions
• disciplined contract management
• proactive engagement with contractors and suppliers.

Final Thought

Cost escalation is no longer a theoretical risk.

It is back — and it is already working its way through the construction sector. Projects that navigate this period successfully will not be those with the lowest price, but those supported by clear risk allocation and well-structured procurement.

The question for councils and principals is simple: Are your contracts, and your procurement strategies, ready for it?

How Muscat Tanzer Can Help

Muscat Tanzer works alongside councils and project teams to navigate exactly these conditions; reviewing contracts to identify exposure, strengthening risk allocation and escalation mechanisms, and supporting procurement strategies that remain viable in volatile markets.

We also assist with real-time contract administration, including assessing and responding to claims as they arise. If cost escalation is beginning to impact your projects, we can help you respond early, manage risk, and maintain delivery outcomes.