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COSTING AND PROJECT EVALUATION
6.4. 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 indexinyear A
Cost in year A D Cost in year B ð 6.1
Cost indexinyear 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:
C D 0.45Eq C 0.1Ci C 0.19Cn C 0.26Di
where C D the composite index
Ci D civil engineering index
Cn D site engineering index
Di D design index
The base year used for the index is revised about every 5 years. The base for the current
index is January 2000 D 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.
The Process Engineering index, over a ten-year period (January to January), is shown
in Figure 6.1a.
Process Engineering also publishes monthly cost indices for several other countries,
including the United States, Japan, Australia and many of the EU countries.
A composite index for the United States process plant industry is published monthly in
the journal Chemical Engineering, the CPE plant cost index. This journal also publishes
the Marshall and Swift index (M and S equipment cost index), base year 1926. The CPE
index over a ten-year period is shown in Figure 6.1b.
All cost indices should be used with caution and judgement. They do not necessarily
relate the true make-up of costs for any particular piece of equipment or plant; nor the
effect of supply and demand on prices. The longer the period over which the correlation is
made the more unreliable the estimate. Between 1970 and 1990 prices rose dramatically.
Since then the annual rise has slowed down and is now averaging around 2 to 3 per cent
per year.
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 the extrapolation of one of the published
indices, tempered by the engineer’s own assessment of what the future may hold.