Construction Prices:
Rational Science Or Creative Art
Consumer prices have received a great deal of deserved attention over the last few months, but, the price of non-residential construction has been growing at record rates over the last few years in Ontario. From 2002 to 2008 Statcan’s Non-Residential Price Index grew by some 46 per cent, four times the pace of the Consumer price index which rose 11 per cent over the same period.
The disproportionate increase of the price of construction may be partially attributed to the fact that many materials used in construction are quite sensitive to volatile swings in commodity prices, and the large surges we have observed over the last few quarters have had a much greater impact on construction input prices compared to that of general consumer prices. Although prices of some of the primary construction materials such as wood, concrete and steel have been relatively stable compared to some of the spikes witnessed in 2003-2005, prices for diesel fuel, copper and asphalt have all seen record gains recently. This has made the contractor’s job of predicting prices of materials a creative art rather than a rational science, as they frequently estimate costs months or years in advance of actual construction.
Statcan’s Non-Residential Construction Price index, measures changes to the overall selling price of finished construction. The index takes into account the price of materials, labour, equipment, as well as taxes and contractor’s overhead and profit. In addition to this index, there are also a wide variety of basic and complex building price indices in the construction industry to measure the changes in the costs of construction. The ENR Building Material Index, is one of the oldest indices still used in the United States. The index, which has existed since the 1920s, is only made up of three key materials: steel, lumber and cement, and also contains a strongly weighted labour cost component. Despite the limited number of components, it has historically worked as good rough measure of the basic underlying trends of construction prices, and for the first half of this decade, followed Non-Residential Price index fairly closely. However, since 2005, the Building Material index and the NPR index have diverged considerably, and although we can expect the selling price of construction to increase at a faster rate relative to that of the price of materials under conditions of high demand, the divergence in recent years is so large that it is difficult to attribute it to heightened construction activity alone. Which raises the obvious question of: What additional factors, other than the three fundamental material inputs of the ENR Index, could be responsible for such a significant and rapid increase in the price of finished construction?
One factor that might help explain the recent upward pressure on construction prices is a correction in the attitudes and expectations of contractors about future material cost. The fact that contractors often bid on projects slated to begin months, even years, in advance means that in order to protect themselves from risk associated with any unexpected future-material price increases, contractor’s must factor in the potential of those price increases into their bids.
As long-term price expectations tend to be made on current conditions, as well as, those of the immediate past, the recent divergence between construction material and finished construction prices should come as no surprise. The divergence is the logical outcome given the dramatic spike in steel prices witnessed between late 2003 and 2005, on which constrictor’s long-term expectations were made.
Therefore, the shockwave of price increases in 2004 may still resonate in the expectations of contractors today, causing an upward effect on bid price of construction. Moreover, the increasingly diverse mixture of construction materials, combined with recent volatile upswings in the price of a number of key commodities, especially diesel fuel and copper, only exacerbates the unpredictability of future price expectations. Non-residential construction is a diverse industry, with each sector and market segment utilizing a unique mix of material inputs. This heterogeneous make up means that changes in the price and availability of certain materials affects various trades and market segments disproportionately. The recent run up in copper for instance has a great impact on many electrical components, wiring and brass fixtures, but has relatively little effect on the production price of concrete or structural wood products.
Conversely, changes in the price of diesel fuel permeate through most construction material inputs, thus making the full impact of recent surges in oil and diesel prices difficult to predict. Contractors use diesel fuel to power everything from earth movers and dump trucks, to concrete mixers and on-site generators. What’s more, they are also faced with paying rising fuel surcharges on the deliveries of equipment and materials to and from job sites. The cost of diesel works its way into a very large array of materials. Concrete for example, used heavily at almost every construction project, relies on diesel in its production. The entire production process; from quarrying the crushed stone, to mixing ingredients, right through to delivering dense concrete material all add up to a highly fuel intensive undertaking. Between the start of 2002 and the end of March 2008, the price of diesel has increased over 145 per cent and the recent surge has propelled diesel even higher.
With oil breaking $135 per barrel, there is little prospect of the price of diesel falling any time soon. Therefore, as contractors continue to build material price increases into their expectations, it is likely that construction prices will continue to experience inflationary pressure.
