California Construction Midyear Update

In our January 2008 Construction Forecast, we wrote:

It may not become the "perfect storm," but three "bad weather fronts" are headed toward California's construction industry in 2008 and beyond. Bad enough to go into storm protection mode ...

It is safe to say the storms have gone beyond the brewing phase and have hit hard. How long they will linger is very difficult to predict. In fact, many in the construction industry are saying these are the hardest times they've experienced in decades. In January, here were the three areas looked at, and as of mid-July 2008, their current conditions:

1. The Housing Slump

The sub-prime mortgage fiasco hit California hard. The trickle-down effect of foreclosed mortgages, slowdown of new housing construction, and lost construction jobs continues. However, some sales of existing and new housing are picking up slightly due to bargains gained by extreme loss of home values in some tracts. In Corona and Riverside, $1-million homes have sold for half as much as foreclosures, causing banks to play "let's make a deal."

As Michael Bobeczko of Sukut Construction, one California's largest grading contractors, predicted in January, "The downturn in the residential market is going to affect the construction industry hard in 2008, especially the dirt-moving contractors. I think it is going to stay down for another year or two. A lot of people have a lot of equipment parked right now. It's tough to finance engine re-builds or buy new equipment if your equipment is parked; that's probably the biggest problem facing the industry right now."

It is also tough to figure the future of your equipment because of the following issues:

2. New CARB Regulations and Fuel Prices

The final version of California Air Resources Board (CARB) off-road diesel regulations became law June 15, 2008. By 2010, fleets with over 5,000 horsepower must be compliant or face heavy fines. It appears certain add-on devices for heavy equipment over 300 horsepower are not only non-viable, but also unavailable.

It should not take long for this prediction by Kenneth Simonson, AGC of America's chief economist, to be verifiable: "The (CARB) rules as proposed will create extreme and unnecessary hardships on contractors, driving up costs to the point that many projects are canceled or blocked because the required equipment doesn't exist."

High priced fuel continues to be the biggest factor in bidding jobs.

In January Bobeczco said, "Fuel used to be about 10 percent of our costs. Now, with diesel fuel above $4.00 per gallon, fuel is 68 percent of our costs and a major consideration in bidding jobs. And no one can predict what the price will be three months from now."

"Over $2.50 per gallon" looks like 'the good old days' just six months later, because currently diesel fuel is pushing $5.60 per gallon in some places, and gasoline is in the $4.50 per gallon range.

Kenneth Simonson added, "Elevated petroleum prices mean many construction materials costs will be higher in 2008." And even that is an understatement, as Simonson himself documents price increases of construction materials from 30 percent to 70 percent within the past few months.

3. Big State Budget Deficit

In January, the California's Legislative Analysts office said: "In order to balance the 2008–09 budget, the state will have to adopt nearly $10 billion in solutions," an all-time record deficit. Plus, questions linger for 2008–09 whether some designated transportation funds will enter a lock-down mode or be directed elsewhere. As reported by Transportation California, the current budget allows:

• Full funding of Proposition 42 at $1.48 billion plus $80 million in repayment of past Prop. 42 loans and another $100 million in tribal gaming money earmarked for transportation.
• Appropriation of $4.2 billion to fund Proposition 1B projects in 2007–08.
• But there is diversion of $1.259 billion from transit to the General Fund, including $800 million in so-called "spillover" money and another $400 million from PTA reserves.

As of this writing, the budget has not been finalized. The governor is traveling the state showing the latest polls that Californians are tired of the legislature's irresponsible spending. Yet, they also do not want cutbacks in areas that affect them. It is the classic case of 'you can't have your cake and eat it, too.' Budget squabbles could linger into the fall if agreements aren't made soon.

Kenneth Simonson agreed in January with other analysts that some bright spots existed for California's construction industry in 2008: "Energy, power, medical, and university construction should be in good shape," he said. "In fact, K through 12 school construction is in good shape with Bond passage (Prop. 1D $10.4 billion) funds secured." So far, that prediction is true.

According to the Construction Industry Research Board's (CIRB) latest data, California construction employment averaged 824,600 in April 2008, down 4,100 (0.5 percent) from March and down 81,700 (9 percent) from April 2007.