North American infrastructure projects challenged by rising costs

North American infrastructure projects face rising operating and capital expenses that are placing upward pressure on project budgets and may increase completion risk, according to Fitch Ratings.

Higher insurance costs and property taxes have contributed to growing expenses, which has reduced financial cushions for some energy projects. Persistent higher expenses have led Fitch to revise its ratings cases for some projects, which has resulted in negative rating actions in several cases. Projects with inadequate inflation indexation in their revenue contracts are particularly vulnerable to ratings pressure, as prolonged periods of high-cost inflation can significantly reduce project margins over time.

Ongoing OEM manufacturing capacity constraints and a growing backlog have resulted in persistent difficulties for projects in securing equipment and spare parts. Supply chains may need to be reconfigured, leading to further procurement delays, cost uncertainty, longer project timelines, maintenance shortfalls and operational inefficiencies, all potentially leading to financial underperformance. Building spare part inventories help mitigate some of these risks.

U.S. tariffs are adding to equipment and component costs. The 50% tariffs on steel, aluminum and copper products have contributed to a significant increase in the effective tariff rate (ETR). Fitch expects the ETR to end the year around 16% as tariff effects feed through the economy. The Commerce Department has also opened Trade Expansion Act Section 232 investigations into critical minerals, polysilicon and wind turbines. Tariffs could be forthcoming for these imports as well, affecting availability and costs of key inputs for energy projects in particular.

Most rated infrastructure projects exposed to completion risk are insulated from escalating construction costs due to fixed-price, date-certain contracts with construction contractors who are responsible for price risk/cost overruns. These contracts may put financial strain on the contractors, eroding their margins and resulting in contract disputes, renegotiations or terminations.

Consequently, contractors may be less inclined to enter into fixed-price contracts for new projects due to concerns about escalating costs. We expect to see more infrastructure projects with progressive design-build contracts, where the entire price is not locked-in at financial close. Under these agreements, contractors only guarantee the price once design has sufficiently progressed and there is greater certainty on costs. Contractors may also negotiate for escalation protection clauses to address input price hikes. Absence of fixed-price construction contracts at financial close would expose new projects to cost overrun risks during construction, requiring higher contingencies to cover any potential cost escalation until the prices are locked-in.

For projects without fixed-price contracts, we examine which project elements are not fixed-priced at financial close. For example, a project with cost risk exposure to structural steel is considered riskier than a project with cost risk exposure to some minor internal fit-out components. We assess whether a project has sufficient contingencies to absorb potential cost escalations, incorporating estimates from an independent engineer. Similarly, we review the contractor’s implementation plan to see if there is adequate float in the construction schedule to absorb potential supply chain delays.