Escalation: The Forgotten Risk

Every project cost estimate includes some allowance for price escalation in its midst. However, few recognize escalation for the potentially devastating risk that it can be. For example, from 2005 to 2008 the price to get a process plant built increased by 50% at a time of negligible inflation. Economic cycles like these are sporadic but their volatility can span a decade; mega-projects have a good chance of hitting one. Such a decade may be starting now with Covid-19. Despite this experience, few quantify escalation as a risk; i.e., it is not forecast probabilistically. Further, many confuse escalation and inflation. Even if that mistake is avoided, few realize that the price indices they use for escalation estimates (e.g., producer price indices) do not track the price of services that are bid, i.e., the price of engineering, construction, fabrication that dominate major project estimates. The good news is that there are industry practices (from AACE International) that get it right; i.e., that define how to analyze escalation probabilistically using adjusted indices that align with reality. This presentation will address the historical experience, the misperceptions and methodological issues, and describe the best practices. The session is based on Chapter 13 of the presenter’s book: “Project Risk Quantification: A Practitioner’s Guide to Realistic Cost and Schedule Risk Management”.