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Guessing Game for Materials Costs

BY KEN SIMONSON, CHIEF ECONOMIST
AGC OF AMERICA

BRIAN A JACKSON/SHUTTERSTOCK.COM

After two years of price shocks, contractors have experienced a break in materials cost increases in recent months, but budgeting and estimating are likely to remain challenging throughout 2020.

The most comprehensive and statistically sound measure of construction input costs is called the producer price index (PPI) for inputs to construction, which is posted each month by the Bureau of Labor Statistics. This index is a weighted average of the PPIs for hundreds of goods and services used in every type of construction. The index declined by 0.5 percent from October 2018 to October 2019, a sharp turnaround from the 6.7 percent increase over the previous 12 months.

To figure out whether the good news is likely to continue, it is helpful to look at what components caused the price deceleration. Two product categories stand out: energy costs — mainly diesel fuel and gasoline — plummeted by 15.7 percent between October 2018 and October 2019, and the PPI for steel mill products tumbled 13.1 percent.

The plunge in fuel costs reflects the downturn in global oil prices, due in part to ever-increasing U.S. production of oil from hydraulic fracturing, or “fracking,” as well as slower global demand growth as many economies have slowed or slipped into recession. While oil prices have a history of moving abruptly up or down, it seems unlikely that petroleum product prices will soar in the next year.

The downturn in the steel PPI followed a 19 percent jump the year before. During the period from October 2017 to October 2018, President Trump imposed a 25 percent tariff or a quota on nearly all imported steel. Domestic steel prices soared in response. Once the tariff was removed on steel from Canada and Mexico — two major foreign suppliers — steel prices dropped sharply.

Slower economic growth in the United States and abroad in 2020 may mean that the PPI for steel mill products could slip further in 2020, but it is also possible that tariffs will be re-imposed and perhaps even increased.

Other materials have contributed to the moderation in input prices. For instance, the PPI for gypsum products, such as wallboard, slumped 7.1 percent in the latest 12-month period after climbing 6.2 percent and 8.5 percent in the two previous years. Lumber and plywood prices retreated 5.2 percent between October 2018 and October 2019. Both of these declines coincide with a fall in single-unit housing construction, a market that has begun to expand. If the expansion continues through 2020, as seems likely, the price of these materials will climb as well.

Labor costs also are important to contractors, of course. Unlike the volatility in materials costs, wages and salaries have risen at a fairly steady pace of around 3 percent per year. However, with overall unemployment hovering near a 50-year low and job openings in construction setting records each month, there is a significant risk that labor costs will heat up in 2020, perhaps to a 3.5-4.5 percent range.

Slower economic growth in the United States and abroad in 2020 may mean that the PPI for steel mill products could slip further in 2020, but it is also possible that tariffs will be re-imposed and perhaps even increased.

Thus, the current lull in materials input prices and the stable increases in labor costs may both be near an end. Contractors may find these costs accelerating throughout 2020.