(Photo by Michael Goodman for ENR)

Hurricane Katrina is expected to give inflation in the construction industry a second wind. Prior to the storm, the industry gradually was recovering from last year’s resurgence of inflation. While it is too early to determine the full impact of the storm on construction costs, the uncertainty it has stirred up undoubtedly will lead to higher bids for projects just to cover the new level of risk.

Katrina initially shut down projects in the area and put many others on hold. But that will not dent the tremendous demand for labor and materials being generated by the construction industry, which is on course for another record year.

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"Total construction starts for the U.S. are still expected to rise about 6% in 2005, even with the loss of new construction activity in the Gulf region," says Robert Murray, chief economist for McGraw-Hill Construction, of which ENR is part. "The major uncertainty relates to the price and availability of building materials, which means in the near-term that the construction industry will continue to adjust to a higher cost structure," he adds.

"We were seeing price increases and Katrina will push them even higher," says Karl Almstead, a vice president of Turner Construction Co., New York City. Almstead was using an annual escalation of 7 to 8% in his estimates, but now expects 10 to 12%. "Delivery times will start to stretch out as resources are redirected to the rebuilding effort," he says. "That affects schedules and eventually prices as some people are willing to pay a premium to get delivery on time."

A recent pre-Katrina survey of 167 public owners found that 92% of the owners experienced an average increase in their project costs of 13.2% in 2004, says John Dunkerley, chief estimator for PinnacleOne, Phoenix, which commissioned the survey. "Katrina will only aggravate those conditions," he says. "I had expected industry escalation to slip back to 5% this year. But now I’m expecting Katrina to spike it up over the next 12 to 24 months by 10 to 20% a year."

Two other studies completed since the storm struck also see Katrina as having a major impact on construction costs. Davis Langdon, the Sacramento-based cost consultant, thinks the storm will increase overall costs for residential work 10 to 15% in the impacted region and 5 to 10% nationally over the next two years. Nonresidential building costs are expected to rise 5 to 10% locally and less than 5% nationally, says Peter Morris, principal. Specifically, Morris expects to see annual price increases in the range of 20% for lumber, 30% for panel products and 15 to 20% for gypsum wall board.

Atlanta-based program manager Boyken International Inc. says that estimates it is using over the next six months include 10 to 15% increases in home-related materials and 8 to 10% for commercial building materials.

Labor costs also will increase significantly, especially in the areas being rebuilt, according to Boyken. It expects premiums of about 20% to lure workers and management to the area. The combined higher labor and materials cost will result in a 15% rise in the cost of construction on all projects, the firm says.

Silver Lining

Not all industry experts agree that the cost consequences of Katrina will be so dire, at least not for some products. Before the storm, tight markets and wide-spread regional shortages had pushed cement prices up 14.5% for the year, according to the Bureau of Labor Statistics’ July producer price index. Some fear the stress from Katrina would worsen this situation. But Ed Sullivan, the chief economist of the Portland Cement Association, Skokie, Ill., thinks the affect of Katrina on the national market will be minimal.

Two cement plants in the area were shut down for 14 days as a precaution, temporarily taking 80,000 tonnes off the market. In addition, disruptions to the port of New Orleans and barge traffic on the Mississippi River disrupted another 600,000 tonnes, says Sullivan. PCA estimates that translates into 1% disruption of the supply for the Northern Mississippi River region and 4% for the lower and mid-river area. "This disruption is relatively small and will be dispersed over a large area," says Sullivan.

The rebuilding of New Orleans, which was almost exclusively supplied by imports, is of greater concern, says Sullivan. There are structural limits to the amount of imports that can be brought in and imports already are maxing out at 35 million tonnes a year, he says.

The massive destruction of homes also has raised concerns about lumber and plywood prices, which reacted quickly to the crisis. Prices for 2x4 western spruce had fallen from $460 per thousand bd ft in 2004 to $286 by last August and then jumped back to $321 when the storm hit, according to Resource Information Systems Inc., a Bedford, Mass.-based forecasting firm. Likewise, prices for 7/16-in. Northeast oriented-strand board fell from $405 per thousand sq ft in 2004 to $245 in August before bouncing back to $325 in reaction to Katrina.

Nashville-based Louisiana-Pacific Corp. responded by switching production at one key plant in Silsbee, Texas, from siding to OSB to produce about 7 million sq ft quickly. "We’re just watching the market because we find the need for product is usually felt several weeks to months after the storm in the affected areas. We have a new OSB plant coming on line in British Columbia so we are ready to respond," says Mary L. Cohn, L-P corporate affairs manager.

RISI expects the price spike to be short-lived. "There is an oversupply in the industry for both lumber and panel and that will be the driving force in holding prices down," says Paul Jannke, vice president of wood products for RISI. "Demand and prices have been so high for so long that producers have been investing in their mills. In addition, there are some big expansions coming online," he explains.

RISI predicts that OSB prices by next year will decline 34% from today’s level to $213 per thousand sq ft or about $32 less than what they were before the storm. It also predicts that lumber prices by next August will decline 15% from today’s level to $306 per thousand bd ft.

RISI’s forecast is based on an anticipated slowdown in the national housing market for economic reasons unrelated to Katrina. "The industry has the capacity to build 2.1 million [housing] units a year and, even with Katrina, we will be well below that," says Jannke.

"We have revised our housing forecast because of Katrina but starts will still start falling off in 2006," says Michele Halickman, building products analyst for Global Insight, Washington, D.C. The forecasting firm had expected housing starts to decline 3.2% in the first quarter of 2006 and another 4.9% in the second quarter. Now it is looking for declines of 2.7% and 4.1%, respectively.

Estimators also are closely watching wallboard prices. There are 77 plants in the U.S. and at least two are located in the New Orleans area, says Michael A. Gardner, executive director of the Gypsum Association, Washington, D.C. Through the end of June 2005, shipments were running 5% above last year’s strong numbers, he says.

"Our facility in New Orleans is not running and we have not been able to assess damage yet," says Robert E. Williams, USG spokesman. "We have a new facility in Mexico coming on line to make up the wallboard shortfall," but drywall demand will not peak for at least a year due to Katrina, he says. "Wallboard just isn’t needed in the impacted areas yet, but demand is strong nationwide and our 40 plants have been running over 90% capacity for some time now."

Katrina will only slow the rate of decline for steel prices, says Global Insight. Structural steel prices fell from $561 a ton in the third quarter of 2004 to $537 this year. "Before Katrina, we had prices falling to $503," says John Anton the firm’s steel analyst. By the second quarter of 2006, Anton expects structural steel prices to be back down to $500.