What Does It Cost?
Perhaps the best news on the building products and materials price front is that there is little or no news. The decline in non-residential construction has thus far not been offset by significant increases in residential construction or exports; so dampened demand remains the driving force keeping prices in check.
The global recession caused producers to reduce capacity rapidly in late 2008 and early 2009 to bring costs in line with the reduced revenue streams. Slower business conditions also offered manufacturers the opportunity to evaluate and shutter operations that were less efficient, less productive or located in strategically poor positions. Thus it was expected that even modest increases in demand for building products and materials would push prices higher because of the lower overall capacity for production.
Recent macroeconomic moves in the emerging markets of China and India, combined with weakness in the European Union countries seem to indicate that overseas markets will not pick up as much slack as was forecasted. China in particular seems to be wrestling with how it wants to stimulate growth without letting its economy overheat. If the Chinese government leans toward restraint, especially if it continues to press its largest banks to tighten lending, capital spending will remain at lower levels. Lower gross domestic product in China and India or lower consumer spending will reduce the market for imports in those countries.
One building product that is bucking the trend is lumber. Futures prices for lumber climbed to a high above $280 per 1,000 board feet on the Chicago Mercantile Exchange in early February, the highest level since August of 2007. That marks a more than 60% climb from a year ago even though the home-building situation hasn't really improved.
Two of lumber’s biggest end use markets, new homes and remodeling, were down 39% and 26% respectively in 2009, so the unexpected rise in price is being seen as a hopeful sign. Lumber mills were one industry that had over built capacity going into the recession, and the current capacity is about 30% less than in 2007. The logistics of lumber distribution also changed from just-in-time delivery to zero inventory, so the uptick in price is being viewed optimistically as an leading indicator of a housing recovery, since lumber yard inventories need to be rebuilt first. Changes in China’s building codes, which expanded the allowed use of wood in construction, may also be accelerating demand ahead of capacity.
More cynical or realistic observers of the lumber market seem skeptical of the price climb as part of a permanent inflation cycle. Acknowledging that a depressed U. S. dollar could be exaggerating the price disparity, lumber industry experts attribute the rise in price to the virtual vacuum in the supply chain and see the trend as short-lived without a prolonged increase in housing construction in the U. S.
Another basic material that is experiencing conflicted market signals is structural steel. Steel prices had plummeted from the mid-2008 highs and fell slightly throughout 2009. The lower demand had plunged capacity to below 40% at the bottom of the market. For the flat rolled portion of the market, the drop in utilization allowed some plant shutdowns, but for the structural shapes manufacturers plants remained available to handle any increase in demand. As 2009 ended the steel producers appeared to be positioning to begin raising prices, announcing small increases in the base price and scrap surcharges. Several manufacturers have made attempts at rolling out increases, but the market has not let them stick.
“At the end of the year the mills announced increases of $40 to $60 per ton for February, but by January 12 those were pulled,” related Robert Thaw of Little Steel, a New Brighton based fabricator. “In February we’ve seen a $50 increase in the scrap surcharge from Steel Dynamics first, then Nucor. There are attempts to get pricing up on the part of the producers, but I don’t think it is a demand driven thing.”
Thaw reminds that the manufacturers were in the position of liquidating higher priced inventory a year ago in order to get liquid, inventory that started through production when energy and scrap costs were 50% to 100% higher than current markets. He believes that any potential volatility could come from the scrap feedstock, which supports manufacturing of steel for multiple markets and would be snapped up quickly if consumer demand returned in the emerging markets.
John Cross, vice president of finance for the American Institute of Steel Construction in Chicago, can’t see a scenario in the near term that would push prices up significantly.
“Demand for structural shapes is down more than 50%. We’ve not seen any mills mothballed. The capacity is out there,” he explains. “Without available credit the demand for the structures that use steel – high rises – is not going to rise any time soon. There may be some minor fluctuations due to volatility in scrap prices but I think we’ll ride a fairly narrow band, maybe a change of $25 to $50 per ton.”
The lack of volatility, especially to the upside, will be an important market condition that supports recovery. One fear about the stimulus programs and the Federal Reserve’s infusion of money into the economy was that the policies were almost certain to trigger inflation once demand returned. Managing the Fed’s withdrawal from the economy will be an ongoing challenge, probably through more than one administration. The potential for high and extended inflation still exists; however, the market conditions as we enter the spring of 2010 are set up to allow manufacturing capacity to be utilized without overheating prices.
Double-digit rates of product price inflation could chill a recovering commercial construction cycle, and the resultant higher interest rates could freeze demand for what little credit is available. Ninety days into 2010 it appears that these scenarios aren’t likely until at least 2011.
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