The following story, with accompanying charts, is a companion piece to yesterday's article posted on the web, "Canadian Construction Material Input Costs are Slowly Easing."

CanaData's construction materials cost index, based on weightings of Statistics Canada's Industrial Product Price Index series, is set for a year-over-year decline on the order of about 5.0% at some time during the first half of this year. The residential sub-index will decline a little (to a range of 0.0% to +2.0%) from where it is now and both the non-residential building (-3.0% to -5.0%) and engineering (-5.0% to -10.0%) sub-indexes will fall to significant degrees.

The Factors that make up Construction Material Costs
Many factors make up what happens to construction material costs. Included are the stage of the cycle for the three major sub-categories of construction; the depth of the recession; the historical pattern of price increases for products; the price trend in base commodities, since they are the building blocks for all building materials; and currency shifts.

In residential markets, weakening starts in Canada will play a backseat to what has happened across the border. For example, lumber prices will continue to be set by the U.S. housing industry, which has been operating in distressed circumstances for several years. Lumber prices have fallen about as low as they can go, with sawmills closing and other capacity reductions helping to provide a floor price. Interestingly, the recent decline in the value of the loonie has actually provided some lift to lumber prices in Canada.

In non-residential building markets, some input prices have displayed a history of moving in discrete increments and only occasionally, say once or twice per year. Sand and gravel, cement and ready-mix concrete are prime examples. Their prices have demonstrated a pattern of jogging upward, mainly in a step pattern. However, if the recession causes a pause in this climb, then the year-over-year price change will quickly drop to 0.0%.

In steel markets, the next bout of iron ore and coal contracts will see substantial downward revisions. Therefore, on the input cost side, steel prices are about to get some relief. On the demand side, some steel categories are already showing weakness. Year-over-year rebar prices have dropped below 0.0% and structural shapes are moderating somewhat, although there is some currency effect at play, as discussed more thoroughly in the next section dealing with engineering construction.

Among the three categories, engineering construction prices are influenced the most by a factor that plays a big role in material costs. Fluctuation in the value of Canada's currency, particularly relative to the U.S. dollar, can have a major impact in three ways. This is especially true if the Canadian product or commodity has large sales volumes into the U.S. market or if U.S. imports account for a large part of Canadian domestic sales.

The Currency Effect
The following sets out the implications based on a decline in value of the loonie versus the greenback. When there is an appreciation, then the opposite is the case.

(1) If the price of the product or commodity is set in U.S. dollars, then a drop in the value of the loonie will raise the price in Canadian-dollar terms.

(2) A drop in the value of the loonie will raise the import price of the product or commodity.

(3) Canadian producers of the product or commodity can raise their price because the price of the import competition has gone up.

These factors have come into play with respect to construction machinery and equipment prices over the past half year. Statistics Canada's "mobile earth moving and allied equipment" sub-index has suddenly shot up from 0.0% year over year through spring 2008 to +12.0% in the last four months. This is a currency effect. On the other hand, mixing and paving equipment for concrete and asphalt has been showing little price movement of late. The year for the largest percentage gains in that equipment category was 2004.

Also playing a major role in the engineering construction price index are fossil fuels. Asphalt prices and diesel prices have both come off their peak levels. However, they have not fallen by as much as the decline in the world price of oil. Besides demonstrating a downstream lag effect with respect to their feedstock costs, they are also being supported to some degree − in Canadian dollar terms − by the drop in value of the loonie.

Net Effect
The net effect of all these influences is difficult to gauge. However, at least in the first half of this year, it appears that total construction material costs are likely to fall by about 5%. As contracts are awarded for the government's infrastructure investment push and job-site activity acquires traction, material prices overall will begin to rise again by the end of this year. This will be augmented by recovering world economies heading into 2010 and modest increases that will be established in some underlying base-commodity prices.