Economics have a tendency to balance things out. For instance, when farmers enjoy a bumper crop, the price per unit of their output falls, and revenues do not rise significantly. When the crop falls short of expectations, prices per unit rise, protecting farmers from poor revenue outcomes.
These laws of economics apply similarly to construction activities. Revenues rise in a strong economy and contractors stay busy, but labor and materials costs also rise, dampening profit growth. In a weak economy, construction activities shrink and revenues fall, but contractors can more easily access labor and materials due to falling prices.
However, data characterizing construction activity in recent months indicate many contractors are suffering the worst of all possible outcomes: declining industry revenues and rising materials costs. While this may seem unfair, it serves as a reminder that the impacts of globalization are far reaching and constantly shifting.
Prices Rise Again
Contractors have become accustomed to dealing with rising materials prices. During the first half of 2004, the price of steel rose between 50 percent and 60 percent after several years of flat or falling prices. In more recent periods, the price of asphalt and diesel fuel displayed volatility. At one point in the middle of the last decade, the price of asphalt surged nearly 40 percent during the span of just a few months, and many remember the jump in oil prices to more than $140/barrel during the summer of 2008.
Though recent price increases have been far less dramatic than those experienced during the mid-2000s, prior materials price spikes occurred when economic activity was still brisk and when financing for construction projects was readily available. Many developers and other construction industry customers simply absorbed the price increases into their development budgets, fully expecting to be paid back by willing owners.
Now, however, construction is mired in a recession. According to a report released in March by the U.S. Census Bureau, private nonresidential construction spending declined 2.1 percent in January from December of last year, and was down 20 percent on a year-over-year basis. Total (public and private) nonresidential construction spending slipped 1.4 percent in January, down 11 percent from the same time last year.
In certain categories, declines are far more concerning. In January 2010, construction related to lodging was down nearly 46 percent on a year-over year basis. Commercial construction decreased 32 percent year over year, construction related to manufacturing fell roughly 29 percent and office construction declined 25 percent.
Given the magnitude of these losses, the laws of economics would suggest construction materials prices should be in decline. But that is not the case.
Based on data from February, prices of construction materials rose 2.8 percent on a year-over-year basis. Leading the increase is softwood lumber, up 7.5 percent from January and 17.7 percent higher than one year ago. Iron and steel prices continue to rise as well—up 3.6 percent from January and 13.5 percent since February 2009. Prices for copper and brass mill shapes increased roughly 12 percent from October 2009.
Cause and Effect
Many theories can explain the recent rise in construction materials prices, but one stands out among the others: China. Fearing that its economy would fail to meet its 8 percent annual growth target during the Great Recession, the Chinese government introduced a nearly $600 billion stimulus package. The results have been phenomenal. The Chinese economy expanded nearly 9 percent last year, and some Western economists believe China could expand by roughly 12 percent this year.
Because construction materials such as copper and asphalt represent (or are related to) globally traded commodities, increased demand from global sources can offset reduced demand from America. The implication is that materials prices can rise even while the U.S. construction sector remains weak. To be fair, this effect reflects activity in other developing countries, including India, Brazil and South Africa.
Other factors—including speculation in commodities, OPEC’s ongoing activities, the dynamics of the U.S. dollar and the impact of America’s stimulus package—also contribute to materials prices. For now, price increases remain relatively benign. The speculative frenzy of 2008 surrounding commodities is now in the past, and price changes today seem to be motivated primarily by core factors such as supply and demand. Given that, it is expected that construction materials prices will not spike or drop significantly this year.
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Wednesday, February 8, 2012