How long will the construction material price surge last?
Jim Haughey
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Seed Newsvine |
Construction materials cost increased at a 19% annual pace in the first five months of this year, even faster than the 17% January-May surge in 2004. A few more months of rapid prices rises are likely before inflation eases back to the current underlying trend of 4-5%, several percentage points above the inflation trend for the overall economy.
Commodity prices for construction materials, like all commodities, are now being pushed higher by both short-term cyclical factors that will be exhausted in a few months and will at least partially reverse as well as by a longer term secular trend that will persist for at least several more years.
We are in a new era of worldwide capacity pressure on commodities due to rapid demand growth in developing countries, more expensive supply sources and much higher energy costs for transportation and processing. This began gradually early in this decade when all of the world’s largest countries rejected their socialist past and permitted domestic entrepreneurs to use foreign capital to embark on a frenzy of industrial development which quickly more than doubled their use of many commodities. Double-digit GDP growth in China is the best known illustration of soaring demand for commodities but the same process in underway in India, Russia, Brazil and to a lesser extent in dozens of developing countries.
As a result, the world has to use more expensive sources of commodities. This includes oil fields that need longer pipelines or are deeper in the ocean. It also includes ore bodies with more waste and less metal.
Commodity suppliers typically operate in breakeven or loss mode, earning all of their profits in every cycle in a short period of strained capacity. They are very aggressive in pricing when customers are scrambling for supplies.
These are the short-term factors behind the ongoing price surge. On the supply side, crude oil production surprisingly failed to rise significantly over the last six months but it projected to jump 1.75 million barrels/day in the second half of the year as two large Gulf of Mexico platforms starts up and new supplies arrive from Brazil and the Canadian tar sands. Similarly, supplies have been strained for iron ore and coking coal for steel production and for some non-ferrous metals. Huge investments in new sources will yield rising supplies in the second half of the year. Note that supplies for steel mills will remain strained , making steel the major price risk for another six to nine months.
On the demand side, the unsustainably high economic growth in the developing world has begun to ebb and will slow further later this year and in 2009. Chinese GDP growth dropped from 12% to 10% early this year and will drop further to 8-9%. GDP growth in the four key developing countries (Brazil, Russia, India and China) will slow to 10% from a 12.5% pace in the last few years. Overall GDP, according to International Monetary Fund estimates was a record high 5.4% in both 2006 and 2007 but will decline to 4.3% this year and inch up only to 4.5% in 2009. This slowdown to still above average economic growth underestimates the impact on commodity demand. Investment, including construction, is slowing faster than overall economic growth. Hence demand for metals and energy is slowing much faster than overall economic growth.
Also in the steel market, where inflation has been the most intense, 2008 began with very low inventories which aggravated the price surge.
Two other trend changes will also contribute to slowing commodity inflation late this year and in 2009. First, the $US has stopped depreciating. The $US is now worth 8% less in buying imported commodities than it was a year ago but the value of the $US has been steady since early March. The currency impact on US inflation will pause, perhaps end, later this year. Second, the commodity price surge has inevitably brought financial speculators into the market which added more demand but no new supply. This is always temporary. Speculators will bail out when they sense that prices are near the peak. This may be happening already in the crude oil market but not yet in metals. Congress appears likely to make commodity trading less profitable and hasten the exit of speculative buyers.
Again, the bottom line is that rapidly soaring prices will not persist past the summer. But the underlying trend is for construction materials inflation to be well above overall inflation at leas through next year.
If you need some good news, remember that the January-August price surge in 2004 was followed by a full year of no change in the construction materials price index when supply caught up to demand.
