What Does It Cost?

With recent reports on consumer and producer prices showing that inflation is being kept at bay, you wouldn’t expect to see construction material and building product prices rising, but increases in a number of basic items are raising red flags about the cost of construction.

As a general rule, the beginning of a recovery is usually marked by rising prices while supply capacity is added to meet the growing demand. During the past eighteen months, manufacturers and distributors have certainly struggled with the opposite side of the coin, cutting prices throughout the decline as demand shrunk faster than supply could respond. It would be logical then for prices to start inching up now that economic conditions are improving, except that conditions in the construction economy are pretty much as bad as the conditions have been for a year or more. With the long-term impact of inflationary fiscal policies still theoretical rather than reality, most economists feel the price increases are a temporary phenomenon.

AGC’s chief economist, Ken Simonson, listed a variety of reports of price increases from contractors around the country in his April 5-13 weekly DataDIGest. Simonson reported that diesel had topped $3/gallon again, up 38% from a year ago, and the diesel-derived liquid asphalt was similarly up, rising 21% over May 2009 to more than $650. Although smaller increases on building products were reported in April as well, Simonson forecasted a reversal of the trend as 2010 continues at an April 7 cost seminar in Pittsburgh.

“Prices for a number of basic materials may continue to rise even more this spring, but the price increases will be hard to make stick without demand from new construction,” he predicted.

Economic consulting firm IHS Global Insights also weighed in on the prospects for rising prices. IHS sees weak global demand beating back increases during the last two quarters of 2010. In their report, they called out depleted steel scrap inventories for the recent structural steel hikes. They also feel that the copper and aluminum markets have gotten “way ahead of market fundamentals.”

Indeed, the International Monetary Fund’s predictions for manufacturing capacity for 2010 suggest that the supply of precious and industrial metals will be more than adequate to meet even slightly better demand. Copper in particular seems to be building capacity in anticipation of global demand. World copper mine production is forecast to increase by 3% to 16.1 million metric tons as a number of new projects commence operations. Production is also forecast to be higher, since a number of mines that closed in 2008 as a result of low prices are expected to reopen. In 2010, refined production is expected to increase by 2% to 18.4 million metric tons, as an increase in demand for refined copper supports higher production. These dynamics are why Ken Simonson predicts that prices for copper won’t approach the 2008 highs of $4 to 5 per pound. At the same time, futures prices on April 1 were $3.60/pound.

Another of the observations by IHS Global was for an overall decline in wallboard prices of 6.7% in 2010, a prediction that flies in the face of the current environment. IHS Global bases its forecast on the logic of the double dip of depressed residential construction meeting markedly lower non-residential demand; however, the forecaster may be overlooking a less scientific factor that appears to be gaining steam. Both US Gypsum and National Gypsum, the two largest American producers, put drywall price increases of 20% into the market in mid-March. As of late April, these price increases were still in place. The explanation for the price hikes was not demand-related but rather a reaction to two-and-a-half years of losing money.

This pricing strategy, raising prices in order to raise revenues, may not follow the laws of supply and demand, but it may represent a resolve that is not limited to the drywall business. Laura Huch Kerckhoff, president of local precast manufacturer Castcon Stone, refers to the condition as pricing fatigue, a sort of ‘we’re mad as hell and we’re not going to take it anymore’ for suppliers. Almost all vendors have been surrendering margin since the start of the recession, and most manufacturers have been losing money until this most recent quarter, even as they downsized drastically. The fatigue Kerckhoff describes is a capitulation of sorts, a decision to turn down business rather than go any lower.

There is nothing but anecdotal evidence to support this theory, of course, but one factor that is worth noting is that the recession has forced consolidation throughout the supply chain, leaving fewer competitors to work against price increases. Manufacturers understandably blanch at the suggestion of concerted pricing, but in an era where information tends to saturate an industry, don’t rule out the possibility of ‘price fatigue’ gaining momentum.