Both crude oil and steel prices surged to new record highs during the second quarter, giving inflation a major boost. However, the full impact on construction’s cost indexes, as well as the economy’s general inflation rate, are still to be felt.
“In the last three months we tracked a 22% increase in the cost of fabricated structural steel for buildings in the Mid-Atlantic region and about 13% in the rest of the country,” says Steven Plotner, a senior engineer with R.S. Means, Kingston, Mass. “But those increases won’t hit our index until the third quarter.” Plotner expects higher steel prices to continue pushing cost indexes after that. “These price hikes are not over yet,” he says
Economists believe it won’t take long for the inflation contractors are facing to start to spill over into the general economy. “We expect the Consumer Price Index to go up 4.8% this year,” says John Mothersole, economist with Global Insight Inc., Washington, D.C. “Just last year, the top line CPI was 2.9%.”
The full impact of higher oil prices is only starting to work its way through the economy, says Mothersole. For example, even if Global Insight’s prediction that crude oil prices will fall from its recent peak of $138 per barrel back to $117 by June of next year holds, prices for plastics would still have a long ways to go to catch up, he says.
“Inflation is going to spread beyond commodities,” adds Global Insight steel analyst John Anton. “You can’t tell me the price of sheet steel will double and not feed into the price of cars and appliances.” As for contractors, the impact has been immediate.
“The structural steel market is very tight,” says Anton. In recent years the domestic steel market has had a two-year inventory cycle, which would have led to some strong increases this year anyway, says Anton. But the real push on prices came from the global market where worldwide production rose by the slowest rate since 2003. Global production did not keep pace with consumption and this dictated domestic prices to a great extent, says Anton.
The global market was so tight that it choked off net imports of structural steel. Most countries did not have any spare product to ship to the U.S. no matter how weak or strong the dollar was, says Anton. He expects structural steel prices to peak at $1,041 per ton by next quarter, a 42% increase over 2007.
Structural steel prices are moving at a higher rate and faster pace than the steel pricing crisis of 2004, says Neil Platt, the Detroit-based purchasing manager for Turner Corp. He says mills have raised prices $280 a ton since last January, with April’s $110 increase being “a killer.”
Higher steel prices are negating some of the cost break related to the housing recession. “Drywall on a commercial job costs more today because the higher price of steel studs has wiped out lower gypsum wallboard prices,” says Platt.
The silver lining is that contractors are better prepared for this recent price surge than they were in 2004. “The industry is more aware of escalation and firms are not getting caught short like they did in 2004,” says Platt.
The same global pressure that the steel market is feeling also has pushed the price of oil to a record $138 a barrel. Many economists believe this is a long-run phenomenon and that the days of $100-per-barrel oil are forever behind us.
“The fact is that the supply situation is tight worldwide, and it is tightest for light sweet crude,” says Chris Skrebowski, editor of Petroleum Review, published by the Energy Institute of London, U.K. The bulk of the world’s refineries are built for light sweet crude and the production of light sweet crude has peaked, he says.
There also is real pressure on the bottom of the barrel. “There is too much heavy crude and not enough refining capacity. The pressure on the middle distillates is what’s driving the price,” Skrebowski says.
Hedge fund billionaire George Soros of New York says the upward trajectory in oil prices is due more to underlying market fundamentals than market manipulation by futures traders. The major factors behind long-term higher prices include the increasing cost of discovering and developing new reserves and the accelerating depletion of existing oil fields, Soros said in recent testimony to the U.S. Senate Committee on Commerce, Science and Transportation.
He addressed the oil bubble question by saying, “Speculation and index commodity buying reinforce the upward pressure on prices…[but] the bubble is super-imposed on an upward trend that has a strong foundation in reality.”
Texas petroleum exploration geophysicist Jeffrey J. Brown of Dallas says, “The problem is that more and more oil exporting countries are showing lower exports, mainly due to declining production from aging fields.” Indonesia is now a net importer and has dropped its OPEC membership, he notes. The U.K. is also a net importer with its North Sea fields in decline.
Brown points out those declines are happening at the same time that consumption worldwide is increasing. “What’s driving prices is a bidding war between importers and commercial users for declining exports on top of the oil-exporting countries consuming more at home as they develop their economies.”
Brown’s analysis is backed by James D. Hamilton, a professor of economics at University of California, San Diego. He notes that new discoveries and attempts to squeeze more oil out of old fields will not be enough to meet future demand. The large hedge funds may contribute to the price of crude, but this is not the main driver, says Hamilton.
“The major factors are the growth of countries like India and China, increasing internal use in the producing countries, and very weak growth on the supply side,” he says. “We would need to discover and bring online new reserves equal to Iran every year just to keep up. Even if there is a drop in the market, oil is not going back to $60 a barrel when there was strong demand at $120.”