Cost escalation inflation

The cost of materials and labour has been subject to inflation since Elizabethan times. All cost-estimating methods use historical data, and are themselves forecasts of future costs. Some method has to be used to update old cost data for use in estimating at the design stage, and to forecast the future construction cost of the plant. 

The method usually used to update historical cost data makes use of published cost indices. These relate present costs to past costs, and are based on data for labour, material and energy costs published in government statistical digests. 

Cost index in year A Cost index in year B 

To get the best estimate, each job should be broken down into its components and separate indices used for labour and materials. It is often more convenient to use the composite indices published for various industries in the trade journals. These produce a weighted average index combining the various components in proportions considered typical for the particular industry. Such an index for the chemical industry in the United Kingdom is published in the journal Process Engineering, Anon. (2004). The composition of this index is  

The base year used for the index is revised about every 5 years. The base for the current index is January 2000 = 100 see Anon. (2002). Care must be taken when updating costs over a period that includes a change in the index base see Example 6.1. 

Im = mechanical engineering index le = electrical engineering index Ic = civil engineering index Is = site engineering index lo = overheads engineering index 

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Life cycle cost analysis is the proper tool for evaluation of alternative systems (11,12). The total cost of a system, including energy cost, maintenance cost, interest, cash flow, equipment replacement and/or salvage value, taxes, inflation, and energy cost escalation, can be estimated over the useflE life of each alternative system. A Hst of life cycle cost items which may be considered for each system is presented in Tables 3 and 4. Reference 14 presents a cash flow analysis which also includes factors such as energy cost escalation. 

In line with the above discussion, a Cost/Savlngs Ratio of 10 was selected as an upper limit, consistent with a fuel cost escalation rate of 5% above Inflation and a breakeven time of under 10 years. 

Indexation is the most commonly used term to describe this inflation correction or cost escalation. The word indexation comes from the method used to define the height of the escalation. The amount of escalation is calculated by the change in price level between two points in time. This is laid down in the price level index which is published periodically by independent organisations like the Central Bureau of Statistics (CBS). 

Since the adjustments for inflation are so large, it is important to fix the date for historical data as closely as possible. For instance, a historical cost estimate from a vendor or contractor for equipment to be delivered in two years would have escalation built in, so the index should be for two years later, when the equipment was expected to be manufactured. However, data based on purchased equipment delivered on a certain date should use the index for the date the equipment was manufactured. 

Frequently you can find cost data that are appropriate for your economic evaluation, but they may be out of date. By taking account of the inflation in cost you can escalate old costs to current values and project current (or old) costs into the future. 

Escalation A provision in actual or estimated cost for an increase in equipment cost, material, labor, expenses, etc., over those specified in an original estimate or contract due to inflation. 

Escalation or inflation of refinery investment costs is influenced by items that tend to increase costs, as well as by items that tend to decrease costs. Items that increase costs include obvious major factors, such as the following ... 

Without reference to a particular HTGR, an input parameter of USD 30/MWt-h was used for the cost of nuclear heat was. Electricity cost was set based on a 2008 price of USD 75/MWe-h. The H2A modelling tool, as published, is based on an assumption that all costs and the selling price have the same rate of inflation. However, for the Shaw assessments, energy costs are projected to rise more rapidly than general inflation, and so a modification to the H2A model was been made to add this analysis capability. For the analysis, real escalation, over and above any inflation, is included at 1%/yr over the plant life for the electric power bought or sold. The assumed reactor outlet temperature for evaluating component costs and process efficiencies was 950°C. 

To estimate the future cost of a plant some prediction has to be made of the future annual rate of inflation. This can be based on an extrapolation of one of the published indices, tempered with the engineer s own assessment of what the future may hold. Prior to 1970 costs were escalating at about 7 per cent per year and this figure was often used to predict future costs. The current rate of inflation, January 1999, is around 3 per cent per year. 

Estimates are prepared based on prevailing prices at the time of the estimate, while actual expenditures will be incurred some time in the future at prices pushed up by inflation. The cost estimate must, therefore, be adjusted by an escalation factor to account for inflation and bring it as close as possible to the actual cost at the time... 

On large, extended projects where the escalation allowance could become a substantial number, it is more appropriate to calculate the escalation for each of the major cost accounts based on the projected inflation rate and the project schedule. By doing so, every cost account will be escalated to the time in which most of the actual expenditure is projected. 

An economic analysis generally involves more imcertain-ties than a thermodynamic analysis. In the above discussion, it has been assumed that each variable in the eco-norrric analysis is known with certainty. However, many values used in the calcirlation are uncertain. A sensitivity artalysis determines by how much a reasonable range of uncertainty assiuned for each uncertain variable affects the frrral decision. Sensitivity studies are recommended to irrvestigate the effect of major assmnptions about values referring to future years (e.g., cost of money, inflation rate, and escalation rate of fuels) on the results of an economic analysis. 

In the estimate of 1982, the prospective total costs had now increased by 300% based on a project delay of 7.5 years. This was attributable 50% to inflation-related price escalation during the time delay and 50% to licensing-related refurbishment and design extensions. 

Construction projects often take several years, which means they are, to some extent, influenced by inflation. Especially projects that include a maintenance period are subject to inflation. For example, a contractor has to estimate the cost of the construction and outfitting of an office building for its client. This estimation should then include the price rise of the carpet installed three years after the client and the contractor have agreed on a price. The contractor has to estimate the nominal price at the time the carpet is bought. Typically, cost estimates are formed in nominal prices at the start of a project, and escalated with an inflation estimation. 

Indexation is a method of escalating cash flows based on independent measurements of price level development over time. Costs or income estimates for a future period are corrected for inflation over that specific period. 

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