Changes with respect to commodity prices and currency movements mean that it has now become even harder to assess the costs of construction. The following is an attempt to disentangle some of the key issues with respect to understanding construction costing.

From the standpoint of a general contractor trying to determine a bid price there are four major pricing or cost elements: (1) materials; (2) labor; (3) equipment; and (4) mark-up or profit margin. From the viewpoint of an owner contemplating building a structure, there is a fifth element, financing costs.

Current and Expected Market Conditions in the Three Major Segments
With respect to materials and labor, one key determinant of costing (based on supply and demand) is current and expected market conditions in the three major types of construction – residential, non-residential building and engineering. These three market segments are often on different growth paths. Some degree of transference or substitution can take place between them.

Between residential and non-residential building, there can be a fair degree of substitution of labor and some degree, but to a lesser extent, substitution of materials. The lowest rate of substitution is between engineering work and the other two categories. Major sub-components of engineering, such as nuclear and other power projects and oil and gas refineries, use specialized materials and highly trained and skilled trades people.

Domestic versus International Component
With respect to materials, there is a domestic component and an international component, and again this varies considerably depending on type of structure category. Residential construction uses a higher proportion of material produced domestically (e.g., lumber). Non-residential building and engineering construction use more international products. However, steel and cement/concrete producers generally consider “domestic” to mean originating in either the U.S. or Canada.

Almost all building products have at least one internationally traded commodity as a base material. Examples are numerous and obvious — copper in electrical wiring and plumbing fixtures and oil and gas in latex paint, vinyls, plastic pipe, thermal sheeting and asphalt. The world prices of oil and natural gas take on added significance through their impacts on transportation costs, job-site heating costs and applications where heat is an important element in the production process (e.g., bricks).

Imperative to Pay Close Attention to Commodity Prices
Due to increasing demand from emerging nations such as China and India, world commodity prices have been rising dramatically. Furthermore, the overall increases in world trade and world economic growth mean a lower likelihood of significant moderation in commodity prices over the longer term. One only has to consider rising incomes level in China and the consequent increase in demand for cars to understand that the floor on oil prices is being raised.

Therefore, to have a proper understanding of construction material costs, one has to pay close attention to commodity prices. Furthermore, almost all major commodities are priced in U.S. dollars. When the commodity price increases, the degree of that rise is immediately apparent within the United States. However, in countries other than the United States, the impact can be quite varied depending on currency movements.

Hedging for Currency Movements
In Canada, the 60% climb in the value of the Canadian dollar versus the U.S. dollar, since early 2003, has considerably muted the impact of commodity price hikes. Future currency movements may, or may not, be favorable for Canada.

Two factors can moderate the impact of dramatic currency shifts. First, there is a delayed reaction. For example, manufacturers and service providers in Canada are only slowly adjusting their prices down, now that the discrepancies (due to dollar parity) with respect to same or similar products in the U.S. are more obvious. Second, sophisticated companies know how to hedge for uncertainty if they need to make purchases in a foreign currency at some known future date. They buy currency futures contracts.

Machinery and Equipment Costs
The U.S. is a major supplier of construction equipment to world markets. Therefore, demand is determined both domestically and internationally. Equipment prices have been boosted, not only by a period of cyclical strength in U.S. construction markets, but also by investment strength in other countries. There will continue to be buoyancy in U.S. equipment prices as a result of a high level of world construction activity, plus U.S. export sales are being given an extra push from the several-years-long decline in value of the U.S. dollar versus most other major currencies.

The majority of Canadian machinery and equipment purchases are made outside the country. The big jump in value of the Canadian dollar has made such purchases considerably cheaper, despite the price hikes denominated in U.S. dollars. This is another demonstration of the important role being played by currency adjustments.

Labor Charges and Profit Margins
The issues with respect to labor charges and profit margins/mark-ups are mainly domestic and therefore more traditional. Labor costs can vary dependent on the use of union versus non-union workers (often determined regionally) and whether, due to local market demand (e.g., the booming Alberta Tar Sands) “going” rates need to be adjusted upward versus “posted” rates in order to attract and hold workers and/or meet construction schedules. Sometimes, when the supply of skilled workers is in short supply, individuals have to be recruited from other countries.

Margins embedded in bid prices depend on the strength of local market conditions and how seriously other (qualified) bidders are going after the same work.

Financing Costs
The final element in the overall cost of a construction project, for an owner, is the financing cost. This will take into account some combination of the following: interest rates, corporate bond rates, the “opportunity-lost” cost of using one’s own funds; and/or the costs of raising equity on the stock markets.

Some Futuristic Game of Chess in Three Dimensions
It was hard enough before, knowing how to estimate the cost of construction. With the addition of much greater volatility in world commodity prices and some significant currency shifts, this writer now views the task of staying on top of costing issues as being analogous to playing some futuristic version of the game of chess in three dimensions.