Rising Costs and Falling Budgets Demolish U.S. Construction Plans

Construction-grade steel prices are currently stronger than consumer-related steel products, and prices for almost all steel products took off in January and February. Tight supply in the United States is a driving force behind the strong construction-grade steel prices. Compared with December 2007, steel prices were up about 20% in January. Price hikes have also been the result of surcharges placed on scrap by producers. We expect these prices to remain elevated through the second quarter, as demand remains strong in China and other developing countries. Some relief should arrive in the third quarter. Declining U.S. demand due to the slowing economy has been met with thinning inventories and low net imports. We anticipate that prices will stabilize later this year as inventories are replenished.

The producer price index (PPI) for cement prices ended 2007 down 0.8%, after posting gains since 2004. During November and December of last year, the PPI for cement was unchanged, but January showed an increase of 1.9%. According to Engineering News Record's average for 20 U.S. average, cement prices were up 4.5% year-over-year in February, averaging $101.22 per ton. This may come as a surprise, given that U.S. demand for cement has been declining since last June. The Portland Cement Association reported consumption declines of 4.7% in November and 8.7% year to date. Cement is a global commodity, though, and demand for it elsewhere in the world is placing upward pressure on U.S. prices. Indeed, as China builds up its infrastructure for the Olympic Games, demand there has increased—presently, the Chinese consume about half of the world's cement output. Therefore, we do not foresee the decline in U.S. construction activity resulting in significant price declines in the near term.

State and local governments are finding their once robust budgets inadequate, as both prices rise and funds dwindle. The decline in home values means that cities are bringing in less revenue from property taxes, which are used to fund projects such as roads, bridges, and other government buildings. Also, as the economy slows and consumers keep a tighter watch on their wallets, revenue from sales taxes is declining. According to the Center on Budget and Policy Priorities, half of all states will be encountering budget problems this year. An overwhelming 21 states are going to be unable to support current services, creating a combined budget gap of between $36.1 billion and $38.4 billion. Since the lag between planning a project and actually breaking ground can take a significant amount of time, the combination of smaller budgets and higher material prices has caused some cities to scale back or drop plans altogether. Seasonally adjusted, state and local construction spending declined 0.5% in January, while federal construction spending increased 4.2%.

In New York City for example, where public construction activity has been strong since 2001, plans have begun to be scaled back. The Metropolitan Transportation Authority (MTA) has cut back on the elaborate extension of its number 7 subway line. There were also plans to construct a new subway station near Wall Street, but the project had to be scrapped because it could not fit within the MTA's $900-million budget. Plans to rebuild Penn Station are also up in the air, as the $14-billion price tag is beginning to look too large.

And New York is not the only place feeling the pinch from raising costs. Outside of Boston, the cost of building a new high school in Newton, Massachusetts has jumped from the original price of $141 million to $186 million. We expect to see more and more U.S. cities cut back on their construction plans during this period of economic uncertainty and high material prices.