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Construction Materials Price Index Released for October

The Bureau of Labor Statistics (BLS) reported that the Producer Price Index (PPI) for construction materials fell 0.6 percent in October after holding steady in September. Despite the recent decline, the measure was up 6.9 percent from a year earlier, and 5.6 percent higher than October 2008.

Cement prices, which rose 1.3 percent in September, returned to their generally downward movement over the last three years, falling 0.7 percent. Cement prices were down 1.0 percent since the end of last year, 1.7 percent since October 2010, and 10.7 percent since October 2008.

Energy prices continue to be a major factor driving construction costs. Diesel fuel prices, which were rising from late summer 2010 into spring of this year, have generally been trending down since April of this year. After rising 7.3 percent in September, they fell 5.5 percent in October. Since their recent peak in April (the highest they have been in about two and a half years), they were down 8.7 percent. Meanwhile, prices were up 27.3 percent from October 2010 but “only” up 10.1 percent from October 2008.

One positive on the energy front continues to be industrial natural gas prices, which have generally been falling for the last three years. With advances in technology and discovery of new reserves, the outlook is for natural gas prices to remain relatively low for the next several years even as demand is likely to ramp up. In October, industrial natural gas prices fell 1.5 percent after a 0.6 percent decline the previous month. They were down 2.7 percent from October 2010, and down 30.7 percent from three years earlier.

Slow economic growth worldwide and the generous surpluses of both production capacity and labor continue to keep construction materials price inflation contained. Recent strength in the U.S. dollar in response to the Euro debt crisis has been another positive holding down commodity prices for U.S. buyers. The pricing environment will remain weak for materials suppliers for the next six to 12 months. Little change in the price index is expected, with a few monthly price declines possible.

Given that commodity prices generally rise faster than overall inflation during the mature phase of an economic recovery, the current low inflation environment will end a few months after world economic growth turns about from the current slow pace to near an average 3 percent plus rate. The earliest that this could happen is spring of 2012, but there is a high likelihood of delay due to both the United States and Europe implementing spending cuts in response to their respective central government deficit/debt problems. Contractors should expect a two or more quarter window with their materials costs rising the same or less than overall inflation.

Note that most price weakness has been in the most economically sensitive materials where prices are set largely in domestic markets – softwood lumber, softwood plywood, gypsum products and concrete products. With the exception of concrete, single-family housing construction is the main driver of demand for these materials. Paradoxically, despite continued soft housing construction activity, prices for softwood lumber, softwood plywood, and gypsum all experienced sharp price increases in October. For the month, they rose 3.6 percent, 5.0 percent, and 3.0 percent, respectively. On a year-over-year basis they were up 5.1 percent, down 0.4 percent, and down 1.0 percent.

Gypsum prices are another matter. Gypsum producers have suffered a number of years of weak demand and therefore a weak pricing environment due to the sharp decline in residential construction. Producers have responded by shuttering their least efficient plants, layoffs, and other cost cutting measures. They have been helped by lower natural gas prices, a key cost of production. Nonetheless, the pressure of lower gypsum prices on producers has been painful and led to several attempts to raise gypsum prices, which so far have ultimately failed.

The latest attempt is a recent announcement by six gypsum producers that they are raising prices 35 percent in January. This appears to already be causing ripple effects among suppliers, pushing gypsum prices higher. However, without more single-family construction it is unlikely that this effort will prove any more successful than past efforts. It will most likely result in some temporary price increases that are eventually rolled back, probably by February or March.

The gypsum case does point out that producers will raise prices at the first opportunity. With housing construction forecast to post only modest gains over the next twelve months, these materials prices are projected to remain soft. A sharper rebound in single-family construction will send these prices higher.

Although residential construction contributes to demand for concrete, commercial construction projects typically are the major driver of demand. With commercial construction projected to show stronger growth than overall economic growth and multifamily housing construction – which uses more concrete than single-family construction -– improving, cement and concrete prices are most likely to be the first to move upward on a sustained basis. The expected slowdown in government highway construction activity will be a counter-force to this improvement, though probably not enough to prevent some increase in prices.

Assuming the economy avoids falling back into recession over the next several months, which we believe to be the most likely outcome, construction materials prices will move roughly in line with general inflation over the next six months. Faster than projected economic growth (in excess of 2.5 percent at an annual rate) will speed up commercial construction activity and push materials price inflation higher than general inflation.