Construction Sector Hit by Rapid Input Prices

Soaring prices in construction materials are hurting the industry.

"After almost two years of decline, steel prices have risen sharply in recent months," Credendo analyst, Matthieu Depreter, wrote in a recent report on the sector. "If we look at the steel price index1, we see that the level of January 2021 is 40% higher than that of January 2020."

Depreter credits restricted population growth and increased Chinese demand as "the main reasons for this movement."

Iron ore prices support the rise in steel prices, "although it makes a dent in the margins of companies that could not pass on the cost increase to their clients."

Global steel production fell 1% in 2020 compared to 2019. "This figure hides many disparities among the different regions in the world," Depreter said.

Depreter expects steel production to rise in 2021, "but not enough to reach the pre-crisis levels (with the exception of China, whose annual production has kept growing for years).

"Global demand … followed an opposite path" due to Chinese demand, Depreter said. "The biggest risk for companies engaged in the steel-making industry is a sudden drop in demand from China, which will possibly happen again, leading to a lower steel price."

Depreter expects overall steel production "to grow faster than consumption, putting downward pressure on the price of steel" and for iron ore prices "to slightly decrease over time."

Several factors could impact prices, however:

• China-U.S. relations
• Delays in vaccination campaigns
• Unexpected spread of Covid-19 variants

A recent Construction Dive article reports one contractor had been paying about $750 per short ton for rebar. As of the time of the Feb. 17 article, the cost had spike, to nearly $900, a 20% increase in just more than a month.

The contractor pointed out, "That could mean an extra $200,000 on a concrete job."

In response to these price hikes, contractors are looking for materials that they can substitute for steel.

"Across commercial construction, steel price increases in recent weeks have caused contractors to rework the material costs on their jobs," Construction Dive reported. Lumber prices have also been volatile. At the start of the pandemic, lumber costs "leaped up before coming back down last summer" and now they have shot up again.

Construction input prices increased 2.5% in January 2021 compared to the previous month, according to an Associated Builders and Contractors (ABC) analysis of U.S. Bureau of Labor Statistics' Producer Price Index data released today. Nonresidential construction input prices rose 2.1% for the month.

Construction input prices rose 4.8% from a year ago. Nonresidential construction input prices experienced a 4.2% increase over that span. Softwood lumber prices are up 73% on a year-over-year basis and iron and steel prices are up 15.6%. Natural gas prices have climbed 30% over the past year, while crude petroleum prices have declined 10.5%.

In an ABC press release, the association's chief economist, Anirban Basu, warns, "The inflation story is real. They say the cure for low prices is low prices. Early in the COVID-19 pandemic, several key commodity prices declined substantially, causing a diminished incentive for suppliers to invest in capacity augmentation. The result is that as demand increases, scarcity builds, and those low prices disappear. Eventually, suppliers respond by investing more aggressively in capacity given the pursuit of higher sales amid higher prices, which eventually results in the pendulum swinging back toward lower prices.

"But this time is a bit different," Basu said. "Because coronavirus vaccine distribution is accelerating, the expectation is that worldwide demand for steel, aluminum, oil and other productive inputs will surge later this year. The result could be substantial upward pressure on construction input prices."

Basu believes some of these dynamics became apparent the second half of last year and will likely become even more obvious as the global economy recovers in earnest. ABC's Construction Confidence Index supports this proposition; more than 55% of contractors expect their sales to increase over the next six months.

He further warns contractors to consider that potential for rapid input price inflation as they enter into new contractual obligations.

"Given the softness in demand in a number of key nonresidential construction segments, the temptation may be to bear the risk of future price increases in exchange for increasing the likelihood of securing new work," Basu said. "That strategy may work out, but estimators, attorneys, executives and others should be aware that the accompanying risks of such approaches are elevated."

For material suppliers, large scale construction projects can be problematic from a pricing standpoint" said Chris Ring, of NACM's Secured Transaction Services. "The material supplier may have bid the project in Nov 2020, and they are awarded the project in March 2021. If the material supplier did not account for price fluctuations in their Nov 2020 bid, they may be held to the lower price when the purchase order is awarded in March 2021. If material suppliers have outstanding bids, they need to review those bids to ensure price increases have been accounted for or renegotiate the bid before it is awarded.