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The effective closure of the Strait of Hormuz and the ongoing conflict in the Middle East have sent fuel prices sharply upward in recent weeks, with diesel in New Zealand rising at more than double the rate of standard grade petrol. For construction projects, where fuel is a significant cost across the whole supply chain, the impact is being felt quickly and acutely. Owners and contractors across New Zealand are grappling with how these increased costs should be allocated, and what their contractual rights and obligations are in the current environment.
The Government response and the boarder context
Finance Minister Nicola Willis has confirmed the Government is taking advice on updating the Petroleum Demand Restraint Act 1981 to address the evolving energy crisis. That legislation, passed in the wake of the 1970s oil shocks, provides the Government with powers to intervene in fuel usage, including through coupon schemes, rationing and driving restrictions. However, triggering those measures requires the Government to demonstrate that reasonably available supplies of petroleum products are likely to be insufficient to maintain stocks at "normal prudent levels", a threshold that carries ambiguity.
The Government is making regular announcements about the country's fuel stocks, but the situation remains fluid. Should fuel become scarce and the country move beyond level 1 under the National Fuel Plan, restrictions on supply could materially affect the progress of construction projects nationwide.
Cost escalation -does your contract allow it?
Whether a contractor can pass increased fuel costs on to the principal will depend on the terms of the construction contract. Under NZS 3910, cost escalation provisions apply unless the parties have opted out in the Specific Conditions. Parties should review the special conditions carefully to determine whether cost escalation has been excluded or modified. We note that, since COVID-19, most contracts do not allow for cost escalation, which may become a discussion for parties going forward.
Where the contract is based on a cost reimbursable payment structure, the contractor will generally be entitled to claim the actual cost or expense of performing the contract works, including increased fuel costs.
For lump sum/fixed price contracts with cost escalation provisions in place, the mechanism for adjustment will depend on the specific formula or index adopted. For lump sum/fixed price contracts where cost escalation or fluctuation provisions have been excluded, it may be difficult for the contractor to claim additional costs arising from fuel price increases, as the contractor will generally be taken to have accepted the risk of price movements within its tendered price. However, depending on the terms of the contract, the contractor may wish to consider whether the circumstances give rise to a Variation, particularly where the fuel crisis has fundamentally altered the scope or conditions under which the works are being carried out,
In all cases, understanding the contractual position now, before costs escalate further, is essential.
Delays caused by fuel supply disruption
Beyond cost, there is a real risk that fuel supply constraints could cause delays to construction programmes. If restrictions are imposed under the National Fuel Plan, or if fuel simply becomes difficult to source, contractors may find themselves unable to maintain progress on site.
Under NZS 3910, a contractor may be entitled to an extension of time where the cause of delay was not reasonably foreseeable at the time of tendering. Fuel scarcity arising from the war in the Middle East is likely to meet that threshold. Indeed, the more recent versions of NZS 3910 and NZS 3916 expressly refer to the consequences of war as a potential circumstance not reasonably foreseeable at the time of tendering. However, the standard wording does not allow recovery by a contractor for time-related costs, even if an extension of time may be available. Whether a contractor can recover time-related costs may depend on whether the extension of time event also constitutes a Variation under the contract.
Practical steps for contractors and principals
No matter who bears the risk in the contract, there are some practical steps that can be taken straight away.
NZS 3910 requires early warning notices to be given where a matter may materially affect the Contract Price or materially delay completion of the Contract Works. Even if your contract does not require it, contractors and principals should consider meeting promptly to discuss the actual or potential impacts of the fuel crisis on their projects. Early engagement will allow you to consider options to reduce or mitigate the impact, whether through programme adjustments, alternative supply arrangements or revised sequencing of works.
For those negotiating construction contracts at the moment, it is important to consider how potential fuel supply uncertainties should be addressed. This may include ensuring cost escalation provisions are included, agreeing on appropriate risk allocation for supply disruptions, and building flexibility into programmes.
The current situation is a reminder that external events can have a swift and significant impact on construction projects. Fuel is both a direct and indirect cost in the construction sector, and when energy prices increase, those costs move rapidly through the supply chain. However, with a clear understanding of contractual rights and obligations, proactive engagement between contracting parties, and sound professional advice, the risks can be identified, managed and, where possible, mitigated.
If you have questions about how the current fuel situation may affect your construction contracts, or if you would like assistance in reviewing your contractual position, please do not hesitate to contact our team.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
