Nobody saw it coming. After more than a decade of relative price stability, contractors have been blind- sided by the largest price hikes for materials since the early 1970s. Steel products caused the most damage but prices for lumber, plywood, gypsum wallboard, copper, stainless steel, pipe and fuel are all joining in to pummel contractors.
In the steel industry, prices have hit crisis proportions, affecting everything from bridge girders to hinges. In the first quarter, construction faced price hikes for steel products ranging from 20 to 60%. Firms with fixed-price contracts were devastated. Many are being pushed toward bankruptcy, with fabricators particularly vulnerable, observers say.
Going forward, virtually everyone is abandoning the fixed-price approach if they can. Owners who have grown accustomed to shifting risk onto contractors are seeing some of that risk coming back home. "We are quoting just 30 days out and telling clients that prices will be adjusted every month. And we are putting it in bold print in the contract," says Jim Mangarella, an estimator with JM Ahle Co. Inc., a mid-sized rebar fabricator in South River, N.J.
With pricing uncertainty making hard-dollar contracts risky, industry associations are petitioning government agencies for relief through escalation clauses on new contracts.
"I think project cancelations are right around the corner," says William Brack, CEO of Barker Steel Co., Milford, Mass. He believes that higher steel prices are working their way up the chain of command and soon will create sticker shock for both public and private owners. Industry sources say that state transportation departments, already working with limited budgets, will have to start prioritizing projects.
Some fear higher steel prices may stunt the rebound in the commercial building market, which is just now emerging from recession. "The office market is most vulnerable, with steel accounting for 5 to 10% of average cost," says Robert Murray, vice president of economic affairs for McGraw-Hill Construction Dodge. But if the economy sees some pickup in employment, office construction could still register a slight upturn in 2004, he says. "The runup in steel prices will dampen the emerging recovery for commercial building, but not derail it," Murray predicts.
There is concern the explosion in steel prices will push general inflation. "This type of uncertainty starts to drive overall pricing because you dont know what you are getting into and you have to hedge your bets," says Karl Almstead, vice president at Turner Corp., New York City.
Almstead believes inflation will pick up this year due to pressure from materials prices. But labor costs remain steady and there is still competitive pressure to keep the selling price of construction low, he adds. "It would be alarmist to say construction inflation is going to take off."
Nevertheless, materials price pressure is widespread. ENRs 20-city average price is tracking annual increases of 41% for plywood, 15% for lumber, 17% for ductile iron pipe and 16% for copper water tubing. Energy prices also remain high. How these levels translate into overall inflation is a major question for the industry. "While commodity prices have exploded, core inflation in the overall economy remains low," says John Mothersole, an economist with Global Insights, Washington, D.C. Anti-inflation forces remain strong, he says.
In particular, market fundamentals point to lower energy prices and Global Insights predicts that oil prices will fall from todays $36 per bbl to under $30. The companys forecast also calls for stainless steel, copper, scrap and steel prices to begin declining soon. "We are optimistic that moderate core-inflation for the overall economy, which the Federal Reserve Board looks at in setting interest rates, can be maintained," Mothersole says.
Steels Tangled Cost Web
The surge in steel prices was triggered when mills tied prices directly to volatile scrap prices that had increased 88% during the previous two years. Huge demand from China is cited as the main culprit in driving scrap prices up. "China increased its steel capacity by 38 million tons in 2003, or about one-third of total U.S. capacity in one year," says Joe Stratman, general manger of Nucor-Yamato Steel Co., Blytheville, Ark. "Thats huge."
While China is driving the bus, there are many other passengers, says Joe Rutkowski, Nucors executive vice president. Besides scrap, virtually all other input costs have risen sharply, with the prices of some alloys tripling, he says. Domestic demand also is up as world supply declines with major suppliers such as Russia and Ukraine restricting exports. "Normally, we would go somewhere else to relieve [cost] pressure but there is nowhere to go," Rutkowski says.
China also disrupted the market by diverting coke exports for its domestic consumption at the same time a major mine fire disrupted U.S. domestic coke supply. The severe shortage in coke forced integrated mills to increase the amount of scrap they use in their melts from 10 to 25%, says John Anton, steel analyst for Global Insights.
But Anton predicts that scrap and steel prices will turn back down after peaking in the second quarter. Scrap prices already are starting to ease as rising freight costs choke off scrap exports to China. And domestic coke production should be back on line this summer as growth in China slows, Anton says. By this time next year, these forces will drive down the average price of structurals and rebar 14% to $365 per ton, Anton predicts. Prices then will hold near this level, well above the $307 average of 2002. "Long-term steel prices will be trending upward with each cyclical trough higher than the last," he says.