FEATURE ARTICLE: PRODUCER PRICE INDEX FOR ANZSIC 3109 OTHER HEAVY AND CIVIL ENGINEERING CONSTRUCTION


INTRODUCTION

A Producer Price Index (PPI) for Other Heavy and Civil Engineering Construction (ANZSIC Class 3109) is included in Producer Price Indexes, Australia (ABS cat. no. 6427.0) from the September quarter 2016. The development of this index reflects the ongoing development work by the ABS to enhance the coverage of price measures of goods and services in the Australian economy; and to support the compilation of volume measures in the Australian National Accounts.

This article describes the concept, method and data sources used to compile the Other Heavy and Civil Engineering Construction index.

Engineering construction activities contribute significantly to the Australian economy. A significant part of these activities are classified to ANZSIC 2006 Class 3109 Other Heavy and Civil Engineering Construction. However, developing robust price measures of construction output activities is challenging for National Statistical Offices (NSOs) due to their heterogeneous nature.

Over recent years the ABS has examined various methods and data sources to develop this index. The ABS has determined that the model component pricing approach is the preferred approach to compile this index. In this approach an output price index is calculated by re-pricing an identical model project from its cost components on a quarterly basis. Weights for this index and the items to be priced have been developed in consultation with an engineering consultant; while the prices are obtained from existing ABS price surveys.

The new index for Class 3109 is in concept an output price index, which is designed to measure changes in the prices received by producers. The index supports the main purpose of the ABS PPIs which is to support the compilation of the Australian National Accounts, particularly the production of chain volume measures (CVMs). This index will improve volume measures of outputs of civil engineering construction activities and volume estimate of capital formation.


METHODOLOGY

Output Price Indexes

To construct an output price index for engineering construction using the component pricing approach, engineering construction activities in scope are categorised into construction categories, e.g. electricity, telecommunications, railways, water supply and storage, sewerage and drainage, etc. For each category, projects are selected and model projects are developed. The model project is specified by a set of work-in-place components including a prime contractor margin as a separate component. A model is re-priced with the weights of cost components being held fixed to a reference period.

Ideally, the price of a cost component should be measured at the market transaction price - the basic price which a producer (or contractor) receives from the purchaser (or client) for the work in place. In practice, market transaction prices may not be available. Instead, bid prices may be used. This corresponds to a 'work-in-place' price which is the cost for 'putting things together', including a mark-up for administrative overhead and profit. The price for a cost component, whether a market price or bid price, should exclude costs for financing, right-of-way including land acquisition, and contingencies.


Model Projects

The ABS engaged an engineering construction consultant to assist in selecting types of projects and developing the model projects. There are currently 10 models covering 8 out of a total of 14 construction categories. Table 1 is a summary of the model projects and construction categories these models represent.

Table 1: Construction categories and model projects
	Construction categories	Models
	Railways	Greenfield rail; Brownfield rail
	Harbours	Harbours
	Water storage and supply	Water supply
	Sewerage and drainage	Sewerage
	Electricity	Electricity transmission; Electricity distribution
	Pipelines	Gas pipelines
	Oil, gas and other hydrocarbon	LNG tanks and jetty
	Coal and coal handling	Open cut coal mine

In developing the model projects, the following points were taken into account:

• The model project can be an actual project or a hypothetical project based on observation of actual projects.
• Cost components into which a model is broken down can be reasonably broad (i.e. it is not required that cost be completely itemised).
• Cost components are valued as work in place, except for major items of machinery assembled or installed on site (see below).
• If a cost component usually involves work done by subcontractors, the value should include sub-contractors margin in any cost build-up.
• The range of cost components should include preliminaries, overheads and prime contractors profit margins (because the scope of price measurement for the price index is the final price charged by the prime contractor to the client).
• The assumed contractual arrangements (and hence scope of the work underlying the model and its valuation) are to include design, procurement and construction, but with no ongoing operation or maintenance.
• If projects include major items of machinery or equipment which are assembled or installed on site, then these can be treated as separate cost components for procurement and installation. The model excludes land acquisition and contingencies.

Where possible, a cost component was split into cost inputs (e.g. labour, materials, plant, etc.) plus relevant margin. Such a split is necessary for the calculation of price escalation of a cost component when price for the component is not directly available.

Representative projects are restricted to new construction or upgrade work. Activity related to repair and maintenance is also in scope of Class 3109 (and included in PPI index structures). However, due to their overall small weights, no projects are selected for this type of activity.

In principle, construction projects should be priced by region as the cost structure for a similar type of project varies from region to region. This means that selection of representative projects should be region specific and where possible a representative project should be selected from a region where the type of construction activity is considered as the most significant. In developing the model projects, the location of the project was chosen by the consultant based on recent construction activity.

Although the model projects developed are region specific, indexes for the models are compiled at the national level as prices are sourced from ABS's existing indexes (mostly PPIs) which are available mostly at the national level. Nonetheless, the model structure developed for the chosen region can be used in the future for compiling region specific indexes. The model can be used as the base model which can be adapted to a different region by adjusting for regional differences in the cost structure.

The consultant also provided a basket of items that are representative for key cost components of the models and these basket items will be used in the future for pricing some of the cost components from the market.


Construction Category Weights

The ABS's Quarterly Engineering Construction Survey (ECS) captures values of work done in engineering construction (Engineering Construction Activity, Australia, cat. no. 8762.0). The survey is the main data source for estimating weighting patterns for construction categories.

As the ECS is not an industry based survey, it includes secondary production by units outside 3109. In estimating the category weights, some adjustment was made to exclude work done by units classified outside ANZSIC 2006 Subdivision 31 and 32.

The category weights were calculated as a 2-year moving average and are updated with a 2-year frequency. This was based on the consideration that due to construction related to the mining boom, over the past few years it is unlikely that the ECS data for any one particular year represents normal activity and is representative for future activity. Also, due to the large and variable nature of the projects, there is likely to be considerable change in the relative share of work done in the construction categories over short periods of time as current projects wind up and new projects commence.

For these reasons it is desirable to use as recent data as possible and update frequently. Thus the annual weights were derived using 2-year average and can be updated biennially. In this approach, the weights take into account activity for each year.


COMPILATION OF THE 3109 INDEX

Price Update

The price index for a model project is calculated by quarterly price update using the ABS's existing price indexes.

Specifically, a project model can be price updated from the cost component level or the inputs to cost components, depending on availability of suitable price indexes. Where possible, a work-in-place component is price updated using a relevant output price index. If such an index is not available, the component is price updated from its inputs using relevant input price indexes.

Due to the limited coverage of available input price indexes, it is not feasible in practice to use input price indexes for price updating the input costs. Therefore, a variety of price indexes (e.g. output PPIs, Wage Price Indexes, etc) are used as input indexes. For example, output price indexes for manufacturing were used for a material part of a cost component.

As in most cases PPIs at the regional level are not available, price update is done at the national level. This means an index calculated for a model project represents a national average.

A prime contractor's margin is price updated using movements in the project cost, incorporating movements in percentage mark-up. The latter is imputed from the Quarterly Business Indicator Survey (QBIS) gross operating profit data.


The Class 3109 Index

Category level indexes are compiled at the national level using the model projects and aggregated using the ECS weights to the national 3109 index.


USE OF THE INDEX

The primary purpose of ABS PPIs is to support the compilation of the National Accounts, i.e. they are used for deflation in compiling chain volume measures. The new index is mainly used for compiling chain volume measures of outputs from engineering construction activity and estimate of real capital formation.

In the application of a construction price index, it should be noted that the index by design prices entire projects at a point in time. As construction work, especially engineering construction projects, usually takes months or years to complete, it is usually the case where the value of part of work completed, not the whole project, is measured in the National Accounts.

The Other Heavy and Civil Engineering Construction index is incorporated in the Stage of Production (SOP) framework which provides economy-wide price measures. For the SOP concept and method, see ABS Information Paper: Producer and International Trade Price Indexes; Concepts, Sources and Methods, 2014 (cat. no. 6429.0).


ADDITIONAL INFORMATION

Additional information relating to Producer Price Indexes is available from the ABS website or by emailing the Producer Price Index Director on prices.statistics@abs.gov.au.