Escalation Eases but Costs Remain High

The overall U.S. construction market is starting to defuse three years of explosive materials price escalation. But the damage has been done, with higher costs for many materials taking on the air of permanence. Some state highway departments are exploring ways to deal with the new higher cost structure, while estimators are turning their attention away from materials and toward escalation stemming from other sources. These include lack of competition in the overheated nonresidential and civil works markets and corresponding labor shortages.

“The volatility of the materials market is settling down, which is helping escalation because people are not putting the fear factor into their bids,” says Karl Almstead, vice president of Turner Construction Co., New York City. “Escalation is now being driven by the extreme volume of work, which has given some pricing power to the vendors.”

Labor shortages are replacing materials as a major driver of construction costs. “Higher labor costs are showing up in reduced productivity, overtime and some times paying a bit above scale,” says Almstead. “If you just look at the statistics, they do not really represent the full impact labor shortages are having on costs.”

Although cement producers pushed through another 2.2% price hike in January, that may be their last hurrah, says Michele Halickman, construction materials analysts for the Washington, D.C.-based forecasting firm Global Insight. “We expect cement price escalation to ease during the rest of 2007,” she says. “We don’t expect any significant declines, but prices will begin to unwind.”

Wallboard prices, which stubbornly resisted the downturn in housing, are starting to respond to market therapy. “That market is starting to turn, and we are forecasting a 7.2% decline in wallboard prices this year, followed by another 6.8% decline in 2008,” says Halickman. However, those declines will not match earlier increases.

Copper is a good example of a material that spiked but will not be returning to its old levels anytime soon. Last year, copper prices more than doubled, hitting record levels. “That pushed copper prices well above marginal costs, and that is something that can not be sustained,” says John Mothersole, copper analyst for Global Insight. “We are starting to see a supply-side reaction, but it is slow in coming.” He predicts that copper prices will fall about 33% this year, leaving them well above 2005’s level.

Despite a general easing of inflation, it may still impact materials. Structural steel and reinforcing-bar prices are making a quick rebound from declines late in 2006. “Normally, we would be in a buyer’s market [at this point of the cycle], but construction grades are already going back into a seller’s market, with rebar prices stabilizing and structural prices starting back up,” says John Anton, Global Insight’s steel analyst. “There was much less buying opportunity in this cycle than in any prior steel cycle for the past decade,” he adds.

Wrestling Match

State highway officials are grappling with materials prices, which they say are eroding the value of federal funding increases. At a March 8 session during the winter meeting of the American Association of State Highway and Transportation Officials in Washington, D.C., agencies reported canceling or deferring projects, shrinking scope, honing estimates and using flexible design standards and creative contracting to combat higher costs. The Federal Highway Administration plans a national construction cost forum in May or June.

Missouri DOT is in the vanguard of the cost fight. One of its tenets is “practical design,” says Chief Engineer Kevin Keith. “We’re building a Chevy, not a Cadillac.” That means constructing the right project for the right location, he says. For example, instead of replacing a bridge, MDOT may replace the deck.

Maximizing contract competition also “is a great way to drive down costs,” says Keith. “We are doing alternate bids—concrete pavement vs. asphalt pavement—and letting the marketplace decide which one we’re going to use.” The agency also uses the approach on other items, such as pipe. Keith says the alternate bid method has increased the number of bidders from 3.7 firms per project to 5.2, resulting in a 9% to 10% reduction in paving costs.

MDOT has not yet gone to performance specifications, but it is considering them. For a concrete paving job, “I don’t care what rock they use,” Keith says. Instead, the agency measures pavement smoothness, soundness and strength.

States are taking different approaches to highway contracts “to try to get a better set of prices,” says Pennsylvania Transportation Secretary Allen Biehler. PennDOT has discontinued $2 billion of major projects since 2004, partly for cost reasons. For the surviving projects, it is exploring greater use of design-build delivery, using performance-oriented specifications and revising its approach to design, says Biehler.

For example, PennDOT scaled down a planned upgrade of Route 202, north of Philadelphia, from a four-lane freeway with interchanges to an at-grade configuration that is 80% four lane and 20% two lane. That mitigation effort cut costs from $380 million to $200 million, says Biehler.

Florida also is adopting flexibility in design standards, says Ananth Prasad, Florida DOT’s chief engineer. The aim is to “design what can be built easily, rather than build what can be designed easily,” he says. For instance, FDOT is considering allowing some projects to be built to non-federal-aid highway standards.

Florida also is focusing on bid competition. Between last July and January, 40% of the contracts the agency let had only one or two bidders, says Prasad. To deal with the problem, FDOT is refining its criteria for contract awards. It recently rejected 54 contracts on which cumulative low bids came in 60% above the agency’s estimates. In addition, it is using various bid options to make sure projects fit the state’s pocketbook. For example, FDOT is listing its maximum bid price on all contracts over $25 million. This tells contractors: “That’s all [the money] we got. That’s all you need to bid,” says Prasad.