Investors should look closely at how the recent flurry of government budgets around the world announcing additional capital expenditure would impact asset prices over the next 12 months and beyond, as this could have unforeseen consequences to asset owners and insurers.
The likely impact would include rising cost of commodities, delays or extensions in delivery time, as well as supply chain constraints that may negatively affect overall performance of companies they invest in and be reflected in the share prices of these companies. Investors should be on the lookout for sectors, industries, and companies that are better positioned to deal with these risks.
“While US President Joe Biden’s announced plans for US$2.3 trillion in infrastructure spending over the next 10 years is still to be ratified, it is one example of how governments around the world are planning their post-pandemic economies around large-scale capital investment,” says Andrew Slevin, chief executive officer of John Foord, which provides insurance valuation.
Apart from the United States, Hong Kong, the United Kingdom and Singapore have also made unprecedented commitments to public capital expenditure. Hong Kong has announced commitments of HK$100 billion (US$12.9 billion) a year, Singapore will issue up to S$90 billion (US$68 billion) in bonds to finance infrastructure in 2021, and the UK government set out a five-year plan in its March budget to spend 640 billion pounds (US$904.3 billion) on infrastructure.
Infrastructure investments of this scale will undoubtedly tie up large amounts of resources in terms of materials, which could make it much more expensive for the private sector to undertake large projects in areas like property, energy, and other heavy infrastructure.
In 2020 to 2021, prices of copper went up by 73%, while steel prices have gone up by100-120%, depending on whether its product comes from China or the US steel. Cement was also up by about 20%.
Logistics costs, meanwhile, have skyrocketed with the price of shipping a container from China to Europe rising by 700% from about US$2,000 at the beginning of 2020 to about US$14,000 at present.
As a consequence, construction costs have gone up in many places. In the UK, for example, construction cost increased by 10% over the last few quarters.
Prices to stabilize
“One example of how capacity constraints have driven up material prices in recent months is steel, which along with many other commodities has experienced rocketing prices. This is due to delays on the supply side coming back online after Covid-induced shutdowns of blast furnaces and production facilities,” Slevin says.
However, prices are likely to stabilize and come back down once capacity that was previously idled returns to the supply chain.
Also, these infrastructure projects will demand expertise from consultants, engineers and contractors, meaning increased competition for labour and specialist skills. Many of these skills are not easily scalable, so rates are likely to increase. With this in mind, there are lessons for asset owners, financiers and insurers in the areas of risk management and property damage insurance.
“If a business is benchmarking reinstatement costs against past commodity prices, some of which have doubled over the past six months, they may have an inaccurate view on current reinstatement costs. If they suffer a loss, not only will they likely face challenges from insurers on the values insured, but they will also find replacing the facilities and restarting business could take much longer than before. This can have a range of knock-on effects for the outlook of the business,” Slevin says.