While a deepening recession and the war on terrorism grabbed the headlines in 2001, there was plenty of news on the back pages for contractors concerned with costs. One of the most interesting was the widespread trend of deflation in the building materials market. Structural steel, reinforcing bar, lumber, plywood, gypsum wallboard, plastic pipe and stainless steel sheet were only some of the products experiencing declining price levels this year.

Energy prices also fell sharply during the fourth quarter. Oil prices fell from $30 per bbl at the beginning of the year to just $18.50 as the Organization of Petroleum Exporting Countries failed to win support for production curtailment. "We expect OPEC to reach some sort of agreement next year, but we still don't see prices going much above $20," says Bruce Cavella, an energy economist for DRI-WEFA, Lexington, Mass. Without an agreement, prices could go below $15, he says.

Natural gas also plunged this year, reducing cost pressure on many materials producers. Natural gas prices fell from $8.08 per million Btu last December to just $2.70 this month, says Ron Denhardt, DRI-WEFA's natural gas specialist. "There is a lot of volume and we are in the middle of a recession," he says. "We only expect prices to average around $2.80 next year."

Falling price levels gave the Federal Reserve Board leeway to aggressively fight a developing economic recession by lowering the interest rate on its key federal funds to its lowest level in 40 years. This month, the Fed announced its eleventh rate cut of the year, dropping the federal funds rate to 1.75%.

While adjustable mortgage rates have reacted to the Fed's moves, falling from 6.5% during the first quarter to 5.7% in the third quarter of this year, fixed mortgage rates have barely moved. Fixed-rates actually increased in the second quarter from 7.0 to 7.1% before slipping back to 7.0% in the third quarter. In its October forecast, The National Association of Home Builders predicts mortgage rates next year to average 6.9% for fixed-rates and 5.4% for adjustable rates.

The resistance of fixed mortgage rates to cuts is partly tied to another big economic story of 2001-- the disappearance of both federal and state budget surpluses, which had been driving long-term rates down. "With deficits starting to appear again, it could drive up the price of funds," says Stan Duobinis, NAHB's forecasting director. So far, it has not pushed long-term rates up, but it has helped to stabilize them, he says.

This year also saw a turnaround in labor costs, which had long been an anchor of moderation. Unions won some of their largest wage hikes in a decade with new wage and fringe benefit packages increasing 4.6% this year, according to the Construction Labor Research Council, Washington, D.C. In addition to higher wages, contractors also felt the pinch of higher insurance costs, including workers' compensation costs (ENR 9/24 p. 34).

 Click here to view: BUILDERS' CONSTRUCTION COST INDEXES

Lower materials prices got the better of higher labor costs in ENR's cost indexes this year. A year-end collapse in lumber prices combined with depressed steel prices to sap most of the indexes' strength. ENR's Building Cost Index was most affected, with its annual escalation rate falling from a peak of 2.3% in July to 0.8% in December. Inflation measured by ENR's Construction Cost Index fell from 2.9 to 1.7% during the same period.

Inflation also is retreating in many other parts of the world, according to ENR's annual survey of international construction costs, conducted by Gardiner & Theobald Inc., London. Global construction inflation is predicted to drop to 1.4% next year, according to 24 countries that provided forecast data. This is down from 3.1 and 3.7% reported by this group of countries for 2001 and 2000, respectively.

In the U.S., the decline in inflation will have mostly played out this year. Both ENR and DRI-WEFA are forecasting relative price stability for materials next year. The large number of multiyear labor contracts should guarantee that wage hikes in 2002 remain close to those seen this year. As a result, ENR is forecasting its BCI to increase 2.3% by next December, while the CCI increases 3.0%.

However, the outlook for materials costs next year may depend more on government intervention than market forces. Both steel and lumber producers are pushing hard for huge tariffs on imports.

Lumber producers may have the most success. An across-the-board 12.65% tariff already is in effect for Canadian lumber, which accounts for 34% of the U.S. market. By next May, a final ruling is expected that could push tariffs as high as 32%. "We expect prices to come back next year," says Paul Janke, vice president of wood products for Resource Information Systems Inc., a Bedford, Mass.-based forecasting company.

RISI forecasts prices for western spruce to hit a peak next summer of $285 per thousand bd ft, up from a low of $180 but below last summer's peak of $340. On the other hand, RISI says prices won't fall off as sharply and sees western spruce ending the year at $265, compared to $212 this month. "With tariffs, I don't see prices going back to this year's low," says Janke. "There will be less volatility in 2002."

The steel industry received some encouraging signs in its search for relief from imports on Oct. 22, when the U.S. International Trade Commission determined that steel imports had resulted in significant harm to U.S. steel makers for 12 products, including rebar and plate steel used in construction.

At a Dec. 6 meeting, the ITC issued a series of varying recommendations for import penalties. The highest tariff recommended was 40%. Other recommendations ranged from 20% for carbon and alloy plate, sheet and strip, to 10% for rebar.

DRI-WEFA believes steel prices will remain stuck at their current depressed levels through the first quarter of next year before starting to stir in the second quarter. Once demand starts picking up, prices should respond quickly, says the firm's steel analyst, John Anton. "The supply side has gotten a lot smaller," he says. However, structural steel shapes will have a weaker price recovery than other steel products, says Anton.

"If those [tariffs] go through, nobody will be able to afford to ship into this country," says Alan L Humbard, purchasing manager for Portland-based fabricator Fought & Co. In particular, he worries that when the market picks back up there will not be enough domestic wide-flange capacity. For now, he is feeling the pinch of the downturn. "New projects aren't bidding right now…and come the end of February, I don't know what will happen," he says.

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