Road construction strong for three to four years

Leading economic and industry sector research and forecasting firm, BIS Shrapnel reports conclude the current boom in the roads sector has seen work rise 11% in 2003/04 to a record $11 billion.

This follows on from similarly strong growth in 2002/03 which was driven by activity in the private sector, primarily subdivision road construction and toll roads construction.

Road Construction and Maintenance in Australia, 2004 to 2019 estimates that subdivision road construction alone increased $822 million (38%) in 2003/04 to just under $3 billion, while toll road construction rose by $550 million to $720 million, mainly due to work on the Cross City Tunnel and WestLink M7 projects in and around Sydney.

Study leader and economist Adrian Hart asserts that public sector funded construction has so far been the weak link in the roads sector recovery post-2000, having fallen 11% during 2003/04 and 25% in real terms since its last peak in 1999/2000, despite strong revenues.

This will now change however, with a strong pick-up in public sector funded work expected over the next three years. Driving the strong cycle of roads activity ahead, according to BIS Shrapnel, is an ambitious program of government-funded works, from both Federal and state governments, coupling with the largest ever roll-out of private toll road infrastructure in Australian history. State government sponsored projects will be joined by a $3.6 billion boost in Federal funding for major highways, arterials and local roads outlined in the AusLink white paper in mid-2004. Overall, public sector funded road construction is forecast to rise nearly 50% over the three years to 2006/07, to a value of $5.1 billion (in constant 2002/03 prices).

In the next two years alone, BIS Shrapnel expects total road activity to grow by around 15% in real terms, with a 20% rise in construction activity along with a more modest 6% rise in maintenance work.

Over the next six years, work will be undertaken on no less than seven separate major toll road projects. Five of these lie in and around Sydney and include the completion of the $680 million Cross City Tunnel (commenced January 2003), the $1.6 billion Westlink M7 (commenced July 2003), the $1.1 billion Lane Cove Tunnel (commenced April 2004), the $1.8 billion City West Link (M4 East), and the $2 billion F3 to M2 Link. The other two toll road projects include the $1.8 billion Mitcham-Frankston Expressway outside Melbourne and the $1.1 billion first stage of Brisbane's North-South Bypass which BIS Shrapnel now expects to go ahead as a private sector project.

While the coming phase of toll road construction will dwarf the experience of the mid to late 1990s — the period when the M2 Hills Motorway, the Eastern Distributor and Melbourne's Citylink toll roads were built — the key to the forecast cycle in road works over the next five years now lies with the spending plans of Federal and state governments, according to Hart.

“On current timing, the massive wave of toll road projects is likely to provide a high, but relatively steady, base of work over the next six years— around $1 to $1.2 billion per annum — but winding down substantially from around 2010. While higher toll road construction will help drive growth in 2004/05, the major factor driving the coming cycle over the next five years will be how effectively the Federal and state governments manage the `project pipeline' of publicly funded works, which are expected to pick up dramatically from here.”

However, BIS Shrapnel warns that the current boom will prove unsustainable, with a prolonged downturn in road work expected in the three years between 2006/07 and 2008/09 as the economy weakens, housing stagnates and the next tranche of public sector work dries up. BIS Shrapnel is forecasting public sector funded road construction to slump around 23% through 2007/08 and 2008/09. Overall, total road construction and maintenance activity is expected to decline around 13% between the peak in 2005/06 and 2008/09.

The initial trigger for this downturn will be an overdue correction in subdivision construction. BIS Shrapnel estimates that subdivision lot development has run well ahead of underlying demand during 2004. While construction in this sector may hold up over the next year or so, activity is forecast to fall substantially in late 2005 and remain low as inflation spikes and aggressive interest rate rises stifle this sector, and possibly expose a substantial degree of speculative lot development.

From there, high interest rates are forecast to drive a sharp downturn in the domestic economy which is expected to affect the framing of state and territory government budgets.

While both construction and maintenance tasks will be affected by the forecast economic downturn, the weakening position of budgetary finances (by both Federal and state governments) is likely to see a sharper correction in construction activity as this part of the roads budget offers a faster and easier route to cutting expenditure.

Hart says: “The boom/bust outlook is now looking extremely likely and this is expected to be a major challenge for companies operating in this industry over the next five years.”

In the near to medium term, they will have to contend with further increases in labour and construction costs and supply chain difficulties as demand increases. But they will also need a strategy in place to deal with the downturn in work that we are forecasting from 2006/07.”

AusLink funding

Under AusLink , the Federal Government has replaced Australia's 18,000 km National Highways System (NHS) — for which it ostensibly provided 100% funding — with a broader National Network of roads and rail where construction and maintenance costs will be shared between Federal and state governments, explains Hart.

On the construction side, the first AusLink `five-year plan' promises a substantial boost to Federal funding of highways and arterials work, so long as its contributions are matched by the states. However, the Federal Government has capped its commitment to funding road maintenance within this National Network to just $300 million per annum nationally or $1.5 billion over the next five years to 2008/09.

The long-term focus of the Federal Government's AusLink initiative and its emphasis on coordinating land transport planning with the states are positive steps towards coordinating the project pipeline. However, Hart questions the timing of spending under the program.

Hart states:

“Traditionally, Federal governments have used roads spending as part of a broader `counter-cyclical' fiscal policy to boost demand in times of economic weakness. More and more, however, Federal Government spending is becoming decidedly pro-cyclical. Part of this stems from the fashionable — but wrong — belief that fiscal policy no longer matters and we should leave all macroeconomic management to the Reserve Bank. But, it is also the outcome of a big spending election campaign in a highly-charged political cycle.”

Promising a big boost to Federal road funding now — when the economy is strong, when state and territory governments are already raising their expenditure plans, when we have the biggest wave of toll road construction already underway — may be good politics. But it is bad economics. Given the strong phase of work already slated, we believe that AusLink will place upward pressure on construction costs and inflation as economic conditions boom over the next two years. Conversely, as the economy overheats and interests rates rise, the Federal Government will have less in reserve to use as a buffer against the inevitable downturn.”

State outlook

New South Wales has been the standout performer over the past two years, with road construction and maintenance activity rising around 35%, according to BIS Shrapnel. Predominantly, this reflects the concentration of subdivision and tollway road construction in the state. While activity is expected to remain very high in New South Wales over the next two years, the fallback in subdivision work and an aggregate easing in major toll road works in the medium term (despite the commencement of new projects), will see activity move lower, on average, over the next five years.

Queensland is expected to be the strongest performing state over the next five years, as a strong turnaround in public spending on roads couples with continuing strong growth in subdivision work (over the next two years). Later, the anticipated commencement of the state's first private toll road project, the first stage of the North-South Bypass, will further buoy growth in the road construction and maintenance sector.

While Victoria has experienced relatively robust growth in road work over the past three years, a particularly strong boom/bust cycle is expected over the next five years. This cycle will be pushed along by higher public sector roads funding and the construction of the Mitcham-Frankston Expressway. A major risk factor for Victoria is the extent of overbuilding of subdivision lots, given the pace of growth over the past two years. This is likely to see a sharp correction in subdivision road construction through the middle of the decade as interest rates rise and the housing sector cools.

South Australia, Western Australia, Tasmania and the Australian Capital Territory are expected to experience lower total roads activity, on average, across the next five years. Although, particularly strong growth is tipped over the coming year as public sector funded works ramp up and subdivision work is generally sustained at a very high level. However, from 2006/07, roads activity will be in sharp decline in these states as subdivision works collapse and the supply of public sector funded work begins to dry up.