At the start of 2004, some believed the construction industry's “smooth sailing” outlook for the coming years was too good to be true. Their caution was apparently warranted. Higher oil prices will slow overall economic activity in 2005, delaying a recovery in nonresidential and public construction, according to Portland Cement Association Chief Economist Ed Sullivan. In addition, while a continuation of relatively low mortgage rates will prolong the boom in residential construction, inflation will run stronger, consumer spending will be partially compromised, job gains will be smaller, and sentiment in both the consumer and business areas will be more sedated.

“In retrospect, 2004 represented a year of transition for the U.S. construction market,” says Sullivan in his latest economic forecast.”The strengthening economy and an increase in interest rates have set the stage for a recovery in public and nonresidential activity. the wildcard in PCA's forecast is oil prices.”

For 2005, Sullivan believes construction spending will reach an inflation-adjusted level of $745 billion, or 2.9% growth compared to $724 billion in 2004. Given that the construction markets has been performing at near-historical peaks, he adds, these growth rates are impressive. Through 2008, nonresidential and public spending are expected to assume the mantel of growth leadership, as residential activity will step down to become the growth laggard while maintaining historically strong levels.

Sullivan reminds us that the composition of construction activity during the 2005-2008 period will be much different than the composition of construction activity during the 2001-2004 period. Until 2004, the economy had been characterized by weak economic conditions, staggering job losses, and extremely low interest rates. These conditions led to dramatic declines in capacity utilization, an increase in vacancy rates, reduced state revenue collections, mammoth state deficits, and favorable mortgage rates. These mortgage rates resulted in residential construction as the growth leader in construction — led by single-family builds. Economic weakness and the corresponding run-up in industrial and office vacancy rates resulted in enormous declines in nonresidential activity.

In retrospect, 2004 represented a year of transition for the U.S. construction market. It was a year that state deficits, utilization rates, and vacancy rates stabilized and began the healing process, setting the stage for public and nonresidential recoveries in 2005. 2004 also served to set the conditions for rising mortgage rates to materialize this year.

Tight cement supply conditions now prevail in portions of 35 states (see map above). However, not all portions of each state are characterized by tight supplies. Where cement is in short supply, the reasons are typically twofold: cement demand due largely to strong residential building activity, and limited availability of ships to transport imported cement. PCA forecasts portland cement consumption of 112 million metric tons in 2004, a 4.4% gain from 2003. Gains of 2.9% and 2.1% are forecast for 2005 and 2006, respectively.

Of course, when Sullivan assembled his summer forecast, a scenario was presented where an easement in shortage conditions could potentially be achieved in 2004's fourth quarter, assuming mortgage rates rose. In the current forecast, PCA has lowered the projected near-term path of mortgage rates, suggesting that the vibrant single-family housing sector will show more strength that previously expected — at least through the first quarter of 2005. Sullivan now expects to see a slight ease in single-family construction in the second half of 2005.

Supply conditions hold the key to determining growth in the United States cement market for 2004 and beyond. Domestic production has been stretched to its limits and inventory levels have been squeezed tight. Further increases from domestic operations is limited. According to PCA estimates of capacity expansions, operating rate and inventory assumptions, domestic supply is expected to increase by 2.3% in 2004, followed by 1.8% and 1.7% in 2005 and 2006, respectively. These estimates reflect operating rates in excess of 98% and, therefore, may contain modest downside risks.

Overall, PCA expects public cement demand to grow 3.8% in 2005 and 4.1% in 2006. But this relatively optimistic outlook is tempered by supply conditions. Through the 2005-2008 period, powder producers have announced plans to add roughly 11 million tons of capacity. Total U.S. cement supply is expected to grow 4.5% in 2004 and 3.0% in 2005.

Beyond 2005, PCA has incorporated a higher TEA-21 reauthorization funding level. PCA's previous TEA amount assumption reflected an average of the Bush administration, Senate and House proposals, translating into a $280 billion bill beginning in FY2005. But with the administration's apparent willingness to support a higher level of highway funding, PCA raised its estimated level to $299 billion. That figure has been integrated into the new forecast along with a FY2006 starting point.

SLOW AND STEADY

Ed Sullivan, along with a handful of construction industry experts and economists, gathered in mid-October at Reed Construction Data's North American Construction Forecast conference in Washington, D.C. The group's consensus was that 2005 would be the beginning of an economic recovery that would continue and strengthen through 2007, despite increasing interest rates and sluggish job growth. It was forecasted that the next two years would not only provide an increasingly stronger economy, but also a positive upswing for several sectors of the building industry, including industrial, public and other nonresidential construction markets.

David Seiders, chief economist for the National Association of Home Builders, discussed the future of the residential sector. He predicted that housing volume, which he identifies as one of the key driving forces in the economy, will stabilize over the next year as opposed to the remarkable growth seen in the past two years. Seiders indicated a positive outlook for single-family starts — currently at an all-time high — and a sustained growth rate for multifamily housing, especially condominiums (with the exception of the market rate rentals), now experiencing construction growth despite the current high vacancy rate. He also predicted that the current phenomenal national homeownership rate will continue to grow steady, but possibly slower, pace and will most definitely reach 70% by the end of the decade.

CEMENT INTENSITIES

The favorable outlook for construction activity is expected to coincide with an ongoing increase in cement intensities, says Sullivan, adding to overall cement demand strength. Aside from industrywide promotional efforts, several other factors will shape the level of cement intensities in the near term.

First, business cycles impact nonresidential cement intensities. During cyclical downturns, investors tend to be less committed to building large nonresidential products, thereby reducing the cement intensity per billion dollars of construction. Investor retraction of the larger projects is tied to lower expected ROIs. During this period, small projects, with lower cement intensities, tend to account for a larger share of the nonresidential construction arena. As the economy recovers, the higher expected ROIs materialize yielding a return to larger-scale projects and a recovery in cement intensities.

A second component Sullivan factors into his forecast is the improving price competitiveness of concrete versus steel building products. Steel mill prices have increased 43.3% during the past year. Tied to scrap shortages largely induced by a dramatic increase in demand from China as the country undergoes a massive construction effort as it prepares for the 2008 Olympic games, these elevated steel prices are not expected to be reversed anytime soon, according to PCA.

As a result of the run-up in steel prices, the relative price of concrete products to steel mill products has been cut roughly 50% of the relative price that existed in 2002. Given enough time lag, this will lead to a substitution of cement for steel in some construction projects. This switch is expected to be linked to smaller-sized projects with a bit more design flexibility and a higher sensitivity to cost changes. This phenomenon will encompass not only nonresidential activity but also public sector intensities as well.

U.S. CONSUMPTION FORECAST (000 Metric Tons)

	2003	2004*	2005**	2006**
Total Cement Consumption	112,264	117,438	120,918	123,408
Portland Cement	107,522	112,295	115,598	118,025
Masonry Cement	4,742	5,143	5,320	5,383
Portland Share of Total (%)	95.8%	95.6%	95.6%	95.6%
Cement and Clinker Imports	23,269	26,263	28,366	29,110
Import Share of Total (%)	21.6%	23.4%	24.5%	24.7%
Percent Change
Total Cement Consumption	3.8%	4.6%	3.0%	2.1%
Portland Cement	3.6%	4.4%	2.9%	2.1%
Masonry Cement	6.9%	8.5%	3.4%	1.2%
Cement and Clinker Imports	3.6%	12.9%	8.0%	2.6%
Source: Portland Cement Association		*trending	**estimated

CEMENT SUPPLY SURVEY

Projected Clinker Capacity Expansion (000 Metric Tons)

	Start	Net Change	End	Growth
2002	-----	-----	91,146
2003	91,146	750	91,896	0.8%
2004	91,896	1,925	93,821	2.1%
2005	93,821	525	94,346	0.6%
2006	94,346	1,500	95,846	1.6%
2007	95,846	4,100	99,946	4.3%
2008	99,946	4,850	104,796	4.9%

HOME PRICES

Concrete prices not to blame for new-home inflation

According to Portland Cement Association estimates, if the current relative prices between concrete and steel is sustained for a full year, nonresidential and public cement intensities will improve adding as much as 1.5 million metric tons to nonresidential cement demand and another 600,000 metric tons to public cement demand. Despite implications that arose from a July 2004 National Association of Homebuilders (NAHB) survey, cement shortages or tight supply conditions — and the resulting price hike of concrete — represent only a small portion of overall material cost increases for single-family homes. The NAHB survey estimated that the cost of materials per new home had gone up $5,000 to $7,000, as compared to 2003. But according to PCA Chief Economist Ed Sullivan, speaking recently at both the 2005 International Builders' Show in Orlando, Fla., and World of Concrete 2005 in Las Vegas, concrete price increases account for only $283, or 5.7%, of the estimated increase range.

During the time period of the NAHB study, concrete prices had increased 4.6%. Other building materials — including lumber, steel, gypsum, copper tubing and plastic plumbing products — all recorded double-digit annual increases compared to year-ago levels. In fact, lumber price escalation accounts for more than half of NAHB's estimated building material cost increase. Sullivan adds that concrete costs represent slightly more than 4.0% of estimated overall home construction costs and less than 2.5% of the $274,000 price of a new home as gauged by the Bureau of Census.

CONSTRUCTION

Record nonresidential construction levels up 9% in 2004

The Associated General Contractors of America (AGC) commented on the value of construction put in place, which soared in December to an eleventh consecutive record $1.03 trillion at a seasonally adjusted annual rate, as reported in February by the Census Bureau. The preliminary full-year total for 2004 was $998 billion, a 9.0% increase for 2003.

“These numbers mark a real turnaround for nonresidential construction and show good acceleration at yearend,” commented Kenneth Simonson, chief economist for AGC. “After falling for three years, private nonresidential construction would up 4% higher than in the previous year, with December's total a solid 6 percent higher than in December 2003. Public construction was 3% higher for the full year and 9% ahead in December.”

Simonson noted that part of the gain was due to steep price increases for many construction materials. “In 2005, I expect prices to rise less dramatically, and for more construction categories to keep expanding in inflation-adjusted terms,” he said. “However, it is essential that Congress approve an adequate level of highway spending on a long-term basis, or this important sector will slip badly by 2006.”

SUPPLY GROWTH ESTIMATES

Year	Domestic Production	Import Volume	Total Supply	Annual Growth(%)
2002	84,075	24,128	108,203	—
2003	88,995	23,269	112,264	3.8%
2004	91,094	26,222	117,316	4.5%
2005*	92,296	28,482	120,778	3.0%
2006*	93,860	29,396	123,256	21.%
2007*	96,623	29,075	125,698	2.0%
2008*	100,528	27,699	128,228	2.0%
Source: Portland Cement Association *estimated