AGC Economist Analyzes Dramatic Rise of Construction Costs

Wed November 16, 2005 - National Edition

Ken Simonson, chief economist of The Associated General Contractors of America (AGC) has issued an analysis of the cost of construction from 2001 to 2005, which examines reasons for the dramatic rise in construction costs in the past two years as compared to the general rate of inflation.

Simonson compared two common inflation measures, the consumer price index for all urban consumers (CPI-U) and the producer price index (PPI) for finished goods, against a variety of PPIs for construction materials and groupings of materials and finds that, “in general, consumer prices have remained very moderate through the entire period, although they have accelerated in the past two years as oil prices have set new records … In contrast, construction costs have risen dramatically in 2004, 2005, or both, after having moved similarly to the overall PPI in the previous three years.”

Hurricanes Katrina and Rita struck especially hard at the supply of construction inputs ranging from diesel fuel to plastics to cement. As of late October, the majority of Gulf of Mexico crude oil and natural gas production was still shut in, virtually assuring that construction materials that use oil or natural gas as a feedstock would be much higher-priced, at least through the winter heating season, than if the storms had not occurred. Katrina also interfered with imports of cement and natural rubber, and the hurricane damaged plants that produce gypsum, lumber and plywood, and liquid hydrogen for galvanizing steel.

“Major construction materials all showed price spikes in 2004 and 2005, after declining or experiencing very modest increases between 2001 and 2003,” said Simonson.

Consequently, many contractors and owners were making little or no provision for price increases in 2004, had not locked in materials prices and had to absorb huge, unexpected cost increases. For example, metal fabricators that had contracted to provide products at fixed prices were squeezed by scrap surcharges and base-price hikes from mills. Some fabricators declared bankruptcy, and many stopped guaranteeing prices beyond a short period.

Simonson added, “Record high diesel prices in 2004 also directly affected contractors for which fuel costs were significant, such as earthmovers, highway contractors, and dump truck operators.

“In addition, the trucking market tightened significantly, partly in response to new hours-of-service rules for truck drivers that lengthened over-the-road hours in some cases, and partly because a robust economy created strong demand for trucking services. Trucking companies passed along higher fuel and wage costs in the form of fuel surcharges and base delivery charges.”

Simonson noted, “In the past 12 months, prices of inputs have diverged sharply, meaning greater variance among both bids and actual costs, depending on the mix of materials and when they were spec-ed or bought, equipment intensity and age, and contractors’ willingness or ability to include cost-sharing mechanisms or contingencies for future price increases.

“There is no longer a unified indicator to predict construction costs, and in fact, construction has significantly diverged from the overall PPI in the last two years,” concluded Simonson.

“Many key categories such as diesel fuel, gypsum products, and copper and brass have seen double-digit price increases in both 2004 and 2005. The global building boom strained supplies of key construction components and may continue to produce large increases in demand for a wide variety of building components in the future.”

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