Nonresidential construction spending has declined 28 percent since peaking in October 2008. Despite the corresponding meager demand for materials in the United States, input prices have climbed.
Construction materials price inflation increased 0.3 percent in July after declining 0.1 percent in June. This followed 11 consecutive months of price increases totaling nearly 9 percent. The increase in prices largely has been motivated by higher commodity prices worldwide—the result of a soft U.S. dollar and robust economic expansion in key emerging economies. According to the International Monetary Fund, the Chinese and Indian economies expanded at a pace of more than 10 percent last year. Brazil expanded 7.5 percent in 2010, and Russia grew about 4 percent. China is expected to expand 9.6 percent this year, while Indian growth is expected to exceed 8 percent. Brazil will grow another 4 percent this year, and the Russian economy is positioned to grow approximately 5 percent.
In general, domestic commodities such as gypsum, cement and lumber did not contribute to the most recent surge in input prices. Rather, between June 2010 and June 2011, many of the largest increases in input prices were associated with globally traded commodities. For instance, the price of copper ores rose 30 percent during this one-year period, copper base scrap rose 34 percent, diesel fuel rose 50 percent, steel pipe and tube was up 12 percent, and nonferrous pipe and tube increased 27 percent. According to IHS Global Insight, mill prices for structural steel shapes and concrete reinforcing bar rose earlier this year to their second highest level on record.
Cost variations by city are substantial, a likely reflection of project mix, transportation expenses, distribution channels and other regional factors. For instance, according to Engineering News-Record’s July 2011 index, materials prices rose 11.1 percent in Cincinnati during the past year, but declined 1.3 percent in Baltimore. Prices were up 8.6 percent in Pittsburgh and nearly 7 percent in Cleveland despite rising only 2.5 percent in Chicago and 2.6 percent in New York.
Postponed Recovery
A number of implications are associated with rising prices, including a slowdown in the pace of recovery as projects become more expensive and therefore less viable. Contractor margins also are impacted negatively. This is particularly true because purchasers of construction services have been more inclined to place the risk of construction materials price increases on contractors in the context of a weak marketplace, giving owners the buying power to negotiate better deals and demand additional services.
Rising materials prices slowed the pace of a construction industry recovery even prior to the recent soft patch in the overall macroeconomy. Through the first five months of 2011, the construction industry’s growth steadily deteriorated. In May, the seasonally adjusted annual rate of construction spending was down to roughly $750 billion, according to the U.S. Department of Commerce, a 7.1 percent drop from the previous year. Even if the broader U.S. economy re-accelerates during the latter portion of 2011, additional materials price increases would frustrate the construction sector’s much anticipated recovery, particularly given the fact that lending remains cautious and there’s still intense focus placed on cost containment at every level of economic production.
Potential for Relief
Given the performance of nonresidential construction during the past three years and the performance of the residential sector since 2005, it has become simpler to believe pessimistic forecasts rather than optimistic outlooks. That said, the global economy is beginning to slow, which should translate into falling commodity prices. Although China’s manufacturing sector continues to expand, it is doing so at its slowest pace in more than two years. This is largely the result of efforts undertaken by Chinese policymakers to slow growth through reduced access to credit. Similarly, India continues to slow economic growth due to inflationary pressures, and growth in much of Europe is likely to be below trend going forward.
In terms of geo-political events, commodity prices have risen recently in part due to ongoing unrest in northern Africa and the Middle East. While the current wave of unrest could become even more volatile, it also is possible the unrest will begin to subside, which should reduce oil and related prices. If some, or all, of these things occur, materials prices may fall in the year ahead, helping spur a more robust recovery in construction spending.