Build Local, Price Global

By Michael A. Moore

Structural steel’s 2004 quantum leap in price signaled the end of one era of construction pricing and the beginning of another.

Basic construction materials became global hot commodities as the huge populations of India and China with their voracious appetites for automobiles, new high-rises, dams, bridges and airports entered the modern consumer world.

Four years later, construction materials continue to rise faster than the Consumer Price Index.

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"From December 2003 to January 2008 the Producer Price Index for inputs to construction industries rose a cumulative 30.2%, compared to 14.5% for the CPI,” says Ken Simonson, chief economist for the Associated General Contractors of America in Washington, D.C.

In the March AGC Construction Inflation Alert, Simonson says, “This comparison is relevant because many public agencies use the CPI to project future costs. Such an index worked well in the past, when there was little difference between the change in construction costs and consumer prices.”

Life after subprime crisis

The factors that drive construction materials prices are new and far more complex than the CPI. They include a mix of global economic, demographic, political, geological and other forces.

And when these factors are added into the calculus of estimating and controlling project costs, they create a real problem for owners, contractors and public agencies.

It has become obvious over the last four years that construction materials prices are controlled by a supply-and-demand equation that is global instead of local or national. The doubling of oil prices in less than a year has sharply underscored that commodity’s impact on all aspects of project costs.

The dollar-oil link has an amplified impact on construction costs. As the dollar has declined in value against other currencies, particularly the yen and euro, the price of oil has risen in dollar terms. Oil producers raise dollar prices to keep constant-value income streams.

Additional factors that affect materials prices are availability of ships for ocean transport, free trade agreements worldwide, national price caps and industry nationalizations, to name a few.

“The key word in steel prices is ‘volatile,’” says John Cross, vice president of the American Institute of Steel Construction in in Chicago. “The perspective has to be global, not domestic. We cannot just look at it from the point of view of a U.S. recession. We have not seen a significant decrease in demand on structural steel.

“The fabricators are still substantially busy. The mills are on record volume levels even though we’ve seen nonresidential construction come down a little bit. The industrial side is maintaining a high level of demand.”

“The U.S. price of structural steel is $20 to $40/ton less than the global market. If our prices come up more, then there will be increased imports. If ours go down, then you’ll see American steel moving overseas.”

Cross says that the value of the dollar plays an important role in steel prices. “In a global market, when you see the dollar weakening, that’s going to force up the domestic price because they’re competing against material traded in another currency,” he adds. “Since late 2003, we’ve gone down 50% against the euro.”

U.S. cement prices have held steady because the struggling economy has reduced demand for housing. Ongoing demand in commercial and industrial projects has provided a market cushion that has kept prices basically stable.

That situation is expected to change in the next two years.

U.S. Portland cement consumption is expected to drop 10% in 2008, followed by an additional 3.6% in 2009. Total 2008 cement consumption is predicted to be 102.7 million metric tons, says Edward Sullivan, chief economist of the Portland Cement Association in Skokie, Ill., in a recent PCA Economic Research Report.

Sullivan foresees U.S. housing will take at least 18 months to recover. According to the PCA report, in the second half of 2009 the economy will gain strength as residential inventories are burned off and credit terms ease. This will lead to a 5.2% growth in cement consumption in 2010 followed by an even stronger gain in 2011.

At the same time, the cement industry is building new plants, such as Holcim’s giant facility that is under way on the banks of the Mississippi River in Sainte Genevieve County, Mo. When completed, the plant will have an annual capacity of approximately 4 million metric tons.

Another factor that has a potential impact on Florida and the Gulf states is the recently announced intention of Venezuela to nationalize cement plants owned by LaFarge, Holcim and Cemex. Venezuelan President Hugo Chavez has stated that he will curb cement exports in order to use the material to help Venezuela’s housing problems.

Florida imports a significant amount of cement, and loss of Venezuela’s supply could create a spike in prices, at least until anticipated imports from Mexico become available in 2009.

Aggregates are another potential problem in the near to long term. The AGC’s Simonson says “there is a problem with availability of aggregates” in some areas, such as south Florida, where delays in environmental permissions and local regulations have restricted access to new sources of sand and gravel.

California also faces a severe shortage of aggregates long term as quarries close and stringent environmental regulations make new ones difficult to open.

The weak dollar is having an impact on lumber and wood products prices as well.

Dimensioned lumber is starting to recover in price, according to Joe Heitz, an associate editor at Random Lengths, a publisher of information about the lumber industry. The Random Lengths Framing Lumber Composite Price mid-May was $277 per thousand board feet, above the bottom of $238 in March. Heitz attributes the recovery to increased exports to Asia due to the weak dollar, mill closings and production cutbacks.

Asphalt prices are directly tied to the price of oil, which accounts for a near doubling of prices in the last three years, but regional factors can affect the price as well.

For example, the Utah Department of Transportation reports in its March/April newsletter that Rocky Mountain asphalt supplies will be tight in the future.

How to deal with volatile construction costs depends on whom you ask.

State highway departments, caught between rising costs and lower revenues, are delaying new projects and struggling to maintain existing roadways.

Large contractors are employing preconstruction teams of subcontractors and suppliers for critical items and services as a form of risk management and are making advance buys of price-volatile materials such as copper wire and pipe.

Smaller contractors are also bringing innovative forms of risk management to the problems of price volatility. One example is Agate Inc. of Scottsdale, Ariz., a general contractor with a pre-engineered building division and steel fabrication facility.

“Steel is out of control,” says Jim Uhl, Agate’s president and CEO. “Prices cannot be predicted and will not be held.”

Uhl says his strategy for dealing with unpredictable steel prices is to separate the steel package from the rest of the job, get mill prices and place the order within an hour of getting a signed contract with the client.

“We just bid a large government project where we had everything ready,” Uhl adds. “When we knew we were the winning bidder, we got mill orders and convinced the client to fast track the order. Three days later a 15% price increase hit. If we had waited we would have lost over $600,000 in three months.”