Price Indexing in Transportation Construction Contracts

Overview

When market prices of cement, steel, asphalt, fuel or other commodities used in transportation infrastructure construction are increasing, state departments of transportation (DOTs) will typically be faced with demands from their contractors that price indexing or cost escalation clauses be incorporated into construction contracts. Such demands have most recently been spurred by sharply rising petroleum prices and consequently increased costs of fuel and asphalt products. Price indexing and cost escalation clauses shift business risk from the contractor to the DOT. While this shifting of risk may benefit the agency through contractors’ willingness to submit lower bids, the agency faces greater uncertainty in budgeting and managing the final costs of a project. There has been little information available on how agencies’ use of such clauses may affect construction-market competition or commodity prices within a regional market. There has also been little information on how the use of particular price indices (for example, U.S. Department of Labor's Bureau of Labor Statistics Producer Price Index versus state-agency construction cost indices) may influence the aggregate outcome of the agency’s use of indexing, and how general economic conditions may affect these outcomes. Agency decision makers seek guidance for judging if indexing and escalation clauses are warranted, whether the benefits an agency may gain using such clauses outweigh the costs, and how best to implement indexing. The objectives of this research were to (1) describe the current state of DOT practice in using price indexing or cost escalation clauses in construction contracts and (2) provide guidance for DOT staff making decisions about whether and how such clauses should be used. The research was intended to review primarily the experiences of those DOTs that have used price indexing or cost escalation clauses, but considered also other available data that illustrates the effectiveness or ineffectiveness of these practices. The researchers sought to develop explicit guidelines DOTs may use to determine when conditions may warrant the use of price indexing or cost escalation clauses and estimating the likely benefits and risks of using such clauses.