Managing inflation risk: why fluctuation clauses are back on the agenda

Construction projects tend to be long-term undertakings, but markets can change quickly.

Recent years have demonstrated just how rapidly cost pressures can emerge from events outside the industry’s control. Supply chain disruption, energy market volatility, geopolitical instability and changing trade conditions have all influenced construction costs at different points.

More recently, the potential impact of conflict in the Middle East on energy markets, commodities, logistics and international supply chains has brought renewed focus to how inflation risk is managed across construction projects.

Against that backdrop, fluctuation clauses are once again becoming a common topic of discussion after receiving relatively little attention since the sharp inflationary pressures experienced across the construction sector and wider economy in 2022 and 2023.

Discussions at a recent joint meeting of the BCIS Scottish Contractors Panel and BCIS Scottish Tender Price Assessment Panel highlighted growing interest in inflation management mechanisms, particularly where significant uncertainty exists around future costs and project programmes.

What are fluctuation clauses?

A fluctuation clause is a contractual mechanism that allows the contract sum to be adjusted to reflect changes in defined costs after a contract has been agreed.

Rather than requiring one party to absorb all future cost movements, fluctuation provisions establish an agreed process for calculating adjustments when specified costs change during the life of a project.

If significant cost movement occurs between contract award and construction, the parties rely on a pre-agreed methodology to determine how that movement should be reflected in the contract value.

For clients, this can reduce the need for contractors to include substantial contingencies for unknown future inflation. For contractors, it can help manage exposure to exceptional cost increases that could otherwise undermine project viability.

Importantly, fluctuation clauses are designed to provide a framework for managing risk, rather than to eliminate it altogether.

Why are they attracting renewed attention?

One of the strongest themes emerging from recent industry discussions is the growing gap between current uncertainty and the assumptions often built into procurement strategies.

Construction firms are already operating with tight margins and limited capacity to absorb additional cost shocks. At the same time, fuel costs, logistics costs, labour pressures and supply chain risks continue to influence market behaviour.

Provisional BCIS data show the Gas Oil (Diesel in Construction) index increased by 38% in the year to April 2026.

Fuel costs affect far more than plant operation. They influence haulage, logistics, materials distribution and wider supply chain overheads. As a result, movements in construction fuel prices can have implications across multiple work packages.

The challenge is that these effects do not always appear immediately in project pricing. Construction projects often move through procurement over many months. Existing contracts may already be fixed. Some businesses may absorb short-term increases before seeking to recover them through future work.

As a result, inflationary pressures can take time to become fully visible in tender prices.

This was reflected in the Scottish panel discussions. Contractors reported significantly stronger cost movement than consultants were currently observing in tender prices, suggesting that some pressures may not yet have fully fed through the market.

The challenge with fixed-price contracts

Fixed-price contracts remain an important procurement tool and will no doubt continue to have a role in the industry. However, periods of heightened uncertainty can expose the limitations of transferring all inflation risk to a single party.

Where contractors are unable to recover significant increases in fuel, labour or materials costs, those pressures can ultimately flow further down the supply chain.

Specialist subcontractors and suppliers are often particularly exposed because they may have less financial capacity to absorb sustained cost increases while continuing to operate under fixed-price commitments.

The result can be increased pressure on margins, reduced appetite to tender and, in some cases, financial distress within the supply chain.

This does not mean every project should necessarily adopt fluctuation provisions. It does, however, reinforce the importance of understanding where risks sit and whether they can realistically be managed by the parties expected to carry them.

A simplified example

Imagine a contractor is awarded a £20 million project in January 2026.

The contract includes a fluctuation provision linked to agreed BCIS Price Adjustment Formulae Indices (PAFI), with a base date established at contract award.

Six months later, a steelwork package valued at £2 million is due to be procured. During that period, the agreed steel-related index increases by 10%.

Without a fluctuation provision, the contractor may be expected to absorb the additional £200,000 cost increase, depending on the contract terms.

With a fluctuation mechanism in place, the adjustment would be calculated using the agreed methodology and index. In this simplified example, the value of the steelwork package could increase from £2 million to £2.2 million.

The most important point is not the adjustment itself, but that the parties agreed in advance how the adjustment would be calculated. The rules were established before the issue arose.

One size rarely fits all

In practice, projects do not always adopt a single approach to managing inflation risk. Teams are increasingly exploring hybrid solutions that combine different approaches across a project.

For example, packages where costs are considered relatively stable and well understood may be procured on a fixed-price basis. Areas where there is greater uncertainty around future pricing may be subject to fluctuation provisions linked to agreed indices. In some circumstances, open-book arrangements may also be used where transparency around actual costs is considered more appropriate than transferring risk through pricing assumptions.

Returning to the example above, a £20 million project might include:

• £12 million of works let on a fixed-price basis where costs are considered relatively predictable
• £5 million of specialist packages linked to agreed fluctuation provisions and relevant PAFI indices
• £3 million of particularly uncertain elements managed through open-book or target-cost arrangements

The objective is not to eliminate risk. Instead, it is to align the procurement strategy with the nature of the risk being managed.

Different projects, sectors and market conditions may justify different approaches. The key is ensuring that all parties understand how risks will be treated before they arise, rather than attempting to resolve them after costs have already moved.

Why the choice of indices matters

The effectiveness of any fluctuation mechanism depends heavily on the index, or indices, used. Construction inflation is, after all, rarely uniform. Steel may experience very different inflationary pressures from mechanical and electrical services. Labour costs may move differently from fuel costs. Some elements of a project may see significant movement while others remain relatively stable.

Applying a single inflation measure across an entire project may therefore fail to reflect the actual cost pressures affecting different work packages. This is where BCIS Price Adjustment Formulae Indices (PAFI) can play an important role.

PAFI is a suite of indices covering different categories of construction work. Rather than relying on a single measure of inflation, project teams can select indices that more closely reflect the composition of the works being undertaken.

For larger or more complex projects, bespoke approaches may also be appropriate where standard indices do not accurately represent the project’s cost profile.

As discussed by the Scottish panel, selecting the right indices is often one of the most important and most challenging aspects of implementing a fluctuation mechanism successfully.

The challenge of choosing appropriate indices

In practice, different elements of a project can be exposed to very different cost pressures. A steelwork package may be influenced by global commodity markets, while mechanical and electrical services may be more heavily affected by labour availability, manufacturing capacity or specialist supply chains.

There is also the question of timing. Some market movements can occur more quickly than published indices reflect, creating concerns among contractors and subcontractors that adjustments may not always fully align with real-world pricing.

The objective is therefore not simply to select an index, but to choose indices that are appropriate to the work being undertaken and understood by all parties before the contract is agreed.

For larger or more complex projects, this may mean using multiple indices across different work packages, or developing bespoke approaches where standard measures do not adequately reflect the composition of the works.

Ultimately, successful fluctuation mechanisms rely not only on the choice of indices, but also on all parties understanding how those indices will be applied.

Establishing the rules of the game

Perhaps the greatest value of fluctuation clauses is not the adjustment itself, but the framework they provide. Construction projects inevitably involve uncertainty and rather than eliminating uncertainty altogether, the challenge is creating a transparent and agreed process for managing change when circumstances evolve.

As market conditions become more volatile, that principle becomes increasingly important. Whether through fluctuation clauses, inflation allowances or other risk-sharing mechanisms, the objective remains the same: helping project teams understand how adjustments will be made, reducing the potential for dispute and supporting more informed decision making throughout the project life cycle.

The recent discussions in Scotland suggest the industry is once again asking important questions about how inflation risk should be managed. Fluctuation clauses may not be appropriate for every project, but the principles behind them, transparency, agreed methodologies and a clear approach to managing inflation risk, are likely to become increasingly important as organisations navigate a more uncertain market environment.

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