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The Cost Outlook for Construction

November 15, 2005
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In 2004 and 2005, construction materials costs have been highly volatile, with much more inflation on the whole than in previous years. This contrasts with overall inflation measures such as the consumer price index (CPI) and the producer price index (PPI) for finished goods, which have shown little volatility or acceleration aside from energy-related costs. (See AGC's Construction Inflation Alert at www.agc.org for documentation of construction and overall price changes in 2001-2005.) Fast-rising materials costs contrast as well with the small rise in wages.

What should contractors and owners expect for 2006? This report discusses the forces influencing several of the major construction inputs as of November 2005. Because projects differ so much in the mix of materials they use and when those items will be purchased, it is not realistic to provide a single estimate for construction inflation. But this report should give interested parties a chance to assess the likely range of price changes they will encounter.

Feedback is welcome. Please write to Ken Simonson at simonsonk@agc.org.

Cost Indexes

Most price changes cited below are changes in PPIs. The CPI and PPI are issued around the middle of each month by the Bureau of Labor Statistics (www.bls.gov). They are longstanding indexes drawn from tens of thousands of actual prices, collected in a statistically rigorous procedure. Current and historical data are available to all users for free on the World Wide Web.

The PPI website includes thousands of separate indexes for specific materials, groups of materials, industries and sub-industries. However, there are limitations. Most PPIs are nationwide and not available on a regional or local basis. (Some scrap prices are local.) The product or industry categories do not necessarily match what is used in construction. Most important, the prices are at the producer's door or loading dock; they do not reflect excise and sales taxes, transport, insurance, further assembly or processing, and installation. Also, these input PPIs do not indicate the finished cost of a construction project, which is affected by labor costs and profit rates. So far, there is only one PPI for finished structures, an index for warehouse buildings that began in December 2004.

Petroleum and Natural Gas Impacts

Although contractors do not use crude oil or natural gas directly, these raw materials influence a large number of prices that contractors do pay. In particular, diesel fuel costs affect contractors three ways. They use diesel fuel to operate offroad equipment such as tower cranes and earthmoving machinery. Diesel fuel runs the highway and power take-off motors for construction vehicles such as concrete mixers and pumpers and dump trucks. Most ubiquitous are the fuel surcharges that truckers impose on the thousands of deliveries to a job site.

As of mid-November, on-highway diesel fuel cost 47 cents per gallon (22%) more than a year before, according to a weekly survey by the Energy Information Administration (www.eia.doe.gov) that is widely used by truckers to adjust fuel surcharges. High-sulfur diesel, which is allowed for offroad use but not trucks, was probably up by a like amount. The price has been pushed up by a tight worldwide supply-demand balance for crude oil.

Assuming no further disruptions to U.S. supply like those caused by Hurricanes Katrina and Rita, the price of diesel in the next several months will be influenced by how much demand there is for heating oil, which is made from the same “fraction” of the barrel of crude oil. If the winter is cold in the Northeast, where most heating oil is used, refiners will put more into that market and less into the diesel fuel market, pushing up diesel fuel prices. After the winter, diesel prices should drop. Therefore, it is likely that diesel prices will be 20-30% higher than a year before for the first quarter of 2006 but perhaps lower than current prices in the fourth quarter.

Natural gas prices are currently about 60% higher than a year ago. That affects the cost of a variety of construction plastics that use natural gas or crude oil as a feedstock or heat source. In particular, polyvinyl chloride (PVC) pipe has risen anywhere from 20% to 100% in the past two months, according to many contractors. (There is no government price index for PVC pipe.) Hurricane Rita knocked out more than 100 oil and gas platforms in the Gulf of Mexico and numerous refineries and gas processing plants. An explosion at the Formosa Plastics complex in Point Comfort, Texas, a little later shut down a major source of resin for PVC for about two weeks.

Now the plants are operating, but many gas platforms will be out of commission indefinitely. That constricts the supply of natural gas, which is used to heat 62% of homes nationwide. Therefore, a prolonged cold spell this winter could lead to supply cutoffs for industrial users and for gas-fired power plants. This uncertainty makes it likely that PVC and other construction hydrocarbon-based products--insulation, roofing materials, membranes--will remain 20-50% more expensive than at the same time in 2005.

Brick and glass use natural gas for heating and drying. Because of their density, transport costs are high. Therefore, both products will be affected by natural gas and diesel costs. They are likely to be 5-10% more expensive than in 2005.

Cement and Concrete

Both products have risen 10-12% from September 2004 to September 2005. In addition, spot shortages have been reported in 32 states. U.S. cement production rose 2% in 2004 but consumption increased 7%, making the U.S. increasingly dependent on imports. Imports as a share of consumption rose from 20% in 2001-2003 to 27% in the first eight months of 2005. While there are adequate supplies worldwide, transport costs are high, both for ocean shipping and for delivery through congested ports and rail lines. In addition, Hurricanes Katrina, Rita, and Wilma successively disrupted deliveries to four of the top five import regions for cement (New Orleans, Houston/Galveston, Tampa, and Miami).

Because cement plants take several years to get construction permits and to complete, there is not likely to be much additional domestic production in 2006. Demand from nonresidential building, highway, water, and sewer construction is likely to keep growing. Housing may dip in 2006, but that sector is far less concrete-intensive. Also, cement production and the quarrying, mixing, and delivery of other concrete components (sand and crushed stone), are energy-intensive, making the cost sensitive to oil prices. It appears likely that cement and concrete prices will rise an additional 10-15% in 2006, with even more widespread shortages than in 2005.

Steel

Strong demand from China for scrap iron and steel in early 2004 contributed to a sudden, steep, and unexpected increase in construction steel prices that spring. Prices gradually leveled off, then retreated slightly in the summer of 2005 before starting up again.

Press reports are very mixed about the outlook for steel prices. China is alternating between being a net exporter and net importer of steel, and India and other Asian economies are contributing to the uncertainty. Worldwide steelmaking capacity is increasing but so is demand. There is currently no reason to expect construction steel prices to be higher in 2006 on balance, but quarterly variations may be large.

Gypsum

Gypsum prices rose more than 10% in each of the past two years. Strong demand from single- and multi-family housing exhausted production capacity. More recently, growing demand from hotel and retail construction has helped keep prices high.

More production is expected to come on line in 2006, while housing may slow. Therefore, gypsum prices are likely to rise less than 5% and may wind up the year lower than in late 2005.

Wood Products

Lumber, plywood, and oriented strand board (OSB) had very strong price spikes in early 2004 but have fallen sharply in the last 12 months. Additional OSB capacity is expected in 2006. With the housing market weakening, prices of these products should be flat to 10% lower than in the same period of 2005.

Labor Costs

Construction employment has grown more than twice as fast as overall employment in the past year, yet wage growth has been very moderate. Wages are likely to increase slightly faster in 2006 as demand for nonresidential labor grows and inflation slowly ratchets up, but wage gains should remain less than 4%. Benefits will continue to grow faster, led by an 8-10% increase in healthcare costs and higher pension contributions.

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