Guessing about Prices

One of the biggest challenges in construction (and economics!) is figuring out where prices will be a year—or even a day—from now. While all businesses share this problem to some degree, it is much more acute in construction, because contractors typical provide owners a guaranteed price months or years before they buy materials. Also, contractors have virtually no ability to substitute materials or change quantities once the design is complete. Adding another layer of difficulty, construction depends on delivery of heavy, bulky items for which rising diesel prices can push up delivered price even if the production cost stays flat. From October 2010 to October 2011, the producer price index (PPI) for material inputs to construction—a weighted average of all goods used in every type of construction, plus items such as diesel fuel that are consumed by contractors—rose 6.9 percent. That was better than the 8.9 percent year-over-year increase recorded in July but far more than the 3.5 percent increase in the consumer price index, rate most people think of as “the” inflation rate. Will construction costs continue to moderate or will they accelerate again? The answer varies by material. Items that are globally traded, or ones that use raw materials in limited supply and in demand from other countries, are at the greatest risk of price spikes. These include diesel fuel, steel, copper and aluminum. Items that are produced from domestic raw materials, for which U.S. construction is the major or principal customer, are more likely to stay flat in price as long as domestic demand is weak. Nevertheless, U.S. suppliers can sometimes ratchet down production enough to impose price increases. Case in point: gypsum makers announced in September that they would raise wallboard and other gypsum prices 35 percent as of January 1. In addition, “The three major producers of portland cement in the southeast announced they will increase prices in March or April,” New South Construction Supply e-News (jim.sobeck@newsouthsupply.com) reported on November 22. “As a result, most manufacturers of products which contain portland cement (mortar mix, concrete patching and repair, self leveling underlayments and overlayments, stucco, etc) have indicated they will increase prices in the second quarter of 2012.” Meanwhile, copper futures prices have fallen by roughly 25 percent from their all-time high last February. Steel and diesel prices have also drifted downward since peaking last spring, although diesel has moved up again recently along with crude oil prices. By the end of 2011, it appears the PPI for materials will wind up 5 to 6 percent higher than a year ago—similar to the 5.3 percent increase from December 2009 to December 2010. It is early for a prediction about 2012 prices, but it seems unlikely the threatened gypsum or cement increases will stick in full, unless construction demand suddenly soars. On the other hand, copper could shoot up at any time. A 5 percent year-over-year increase would be in line with the past eight years. But in any one month, the year-over-year change is likely to vary from that average by as much as four percentage points either way.