A few clients have reached out to us about the impact of recent oil price increases on the cost of construction this year. While we do not have a definitive answer, here are our thoughts on the issue.
Each year e2Value indicates our suggested inflation amounts for the upcoming policy terms and factors for carriers to use as part of their inflation-guard practices. Then throughout the year we adjust that number based on what has occurred and keep looking ahead 12 to 24 months.
Since March of 2020 we have indicated a compounded rate of inflation at 50%. Costs today are at least 50% higher than in March of 2020. For this year we looked at 6.5% as a guide.
There is a saying “Prices go up like a rocket and down like a feather.” The past few weeks have seen a rocket-style cost increase for gas. It is yet to be seen if any feathering follows.
We did a flash survey of a small group for their thoughts on the overall economy. Our findings are at the end of this article.
We see a range of possibilities concerning forward-looking pricing. Things can happen that cause major disruptions or there can be a few disruptions to the economy and therefore the cost of structures can go from falling off a cliff to rising above our 6.5% benchmark.
We are pretty early in the current cycle of issues raised by the USA and Israeli bombing of Iran. Data by June or July will be more helpful about pricing directions for this year, in theory, but there can also be more disruptions. As of now, we still like our 6.5% glide path.
Why does 6.5% still look okay?
There have been a few things impacting costs over the past six years that were never seen before in the previous 25 years—maybe even further back. The “economy” plays a big role in that. What is the “economy”? For most Americans it is what is in their budget to buy things. Across the income spectrum, individuals typically feel good or bad about the economy based on their individual spending power. As that sentiment moves past any one individual to groups of people it becomes a measure of how the overall economy is doing.
Literally six years to the month, we’ve gone from Covid bust to booms, from oil being worth zero to oil being worth a great deal. We had years of steady or low inflation followed by a rapid acceleration of costs followed by some stabilization of costs.
Now we have a disruption in the oil market. What do we think will happen with home or commercial construction inflation this year and maybe next? Our thoughts now is that it will not be good.
Some facts:
Oil, natural gas, and distillates are up 35% to 40% in price since the US and Israel started bombing Iran.
The Strait of Hormuz is sort of open and sort of closed. As of now, it is closed to oil and gas tankers. Since 1/5 of all the world’s oil shipments go through that strait, it means 20% less oil is getting to the market. The past three weeks represented the steepest drop in the global oil supply ever.
Oil and natural gas facilities in the Mideast region have been damaged. The US has the ability to produce more oil, and it seems we have access to Venezuelan oil. However, there is a difference in cost, desirability, and ability to refine light and heavy crude oil. The US has light crude. Many facilities process heavy crude. That creates a mismatch from the supply of what is out there to what can be refined.
Other commodities potentially affected are that a significant amount of aluminum and the ingredients in aluminum are produced in the Gulf region. The same with helium.
Taiwan, Japan and South Korea, to name a few places, are dependent on natural gas for their manufacturing and basic living needs.
From Moody’s Analytics: Oil Price Impact Rules of Thumb:
Every $10 increase in the price of oil:
- Increases U.S. gasoline prices by 25¢/gal
- Costs consumers $30 billion over the course of a year
- Costs households $250/yr additional
- Reduces GDP growth by 10 bps
- Boosts the inflation rate by 15 bps
If $40 increase is sustained for a year:
- U.S. gasoline prices rise by $1/gal
- Consumers pay $120 billion over the course of a year
- Households pay $1,000 each additional for energy
- 40 bps reduction in GDP growth
- 60 bps increase in the inflation rate
Predictions:
It’s tough to make predictions so it’s probably best to stick with a range of possibilities.
Best Case: The bombing ends soon and Iran won’t harm vessels in the Strait of Hormuz.
Probable/Mid-Case: Bombing doesn’t end soon and few vessels navigate through the straight.
Worst Case: Stuff goes further sideways.
From that range of scenarios things will be more expensive – oil induced and otherwise – for the foreseeable future.
The trick is the degree to which things are more expensive. Higher prices can be absorbed without much market disruption but if they go too high too fast, then it can cause an economic crash. (Remember 2008?)
Before the operation in Iran started, the US was losing jobs, losing better paying jobs, had a medium to lethargic GDP, and inflation was moving up—not down. That causes pain for the incumbent party in elections. With the 2026 mid-term elections on the horizon, there is political pressure to end the action and get the oil markets back on track.
The issue for US leadership is the other side gets to “vote” in things, as well. Iran has attacked and damaged oil and gas infrastructure. It won’t matter if the Strait is open, facilities will have to be rebuilt in order to get oil and gas into tankers.
The stock market was doing great. Folks invested in the stock market, 401k accounts, and retirement funds, and all were going along well. Real estate was holding steady or increasing a bit in value.
At the other end of the spectrum, things were not going along well. Gas was down in cost, but cars, car insurance, food, rent, and the cost of buying a home were all elevated.
Higher costs and a poorer economy is called stagflation.
Higher and lower income differences
90% of the US population has an income of $155,000 or less. 9% are making $156,000 to $450,000. 1% make above $450,000.
That puts 10% in the doing well category and 90% in the not-so-well category. 90% of the population will drive the economic direction of the country.
Wage growth was higher for the lower income earners after Covid and now it is lower. Wage growth was slower for high-income earners after Covid and is now doing better. Spending was higher right after Covid and is now lower. 10% of the population does not move the economic direction of a country as well as 90% moves it.
As of now petroleum and petroleum-based products are more expensive, loans are more expensive, stocks are worth less than before, there are job-market disruptions, driving season is upcoming (making gas even more expensive), and with petroleum more expensive, most groceries will be more expensive.
That tends to point to a slower economy but not slow enough to send home or commercial construction costs lower.
Our Informal Survey
As for our informal survey: 12% of the group think the economy is about the same now as before. However, 88% use words like “shaky,” “declining,” “not improving,” and “bad.” 12% are optimistic about the economy in the next six months and 88% pessimistic. 100% think things cost more this year versus last year.
While not as scientific as a Family Feud survey, “pessimism” and “expensive” are not heart-warming economic terms. Those might be the best prognosticator of things to come. If a majority of people are pessimistic, they tend to spend less and when they know things will cost more, it’s not a recipe for a great economy. The 6.5% for 2026 is still on track. However, with all the turmoil and uncertainty, prices may weaken during 2027 and beyond for a year or two.