In the period leading up to the March 2018 imposition of tariffs on steel (25%) and aluminum (10%), with exemptions for Canada and Mexico,1 many predicted thIn the period leading up to the March 2018 imposition of tariffs on steel (25%) and aluminum (10%), with exemptions for Canada and Mexico,1 many predicted that materials such as rebar, steel pipe, tubing, and mill products would go up in price.
Indeed, the Associated General Contractors of America (AGC), which publishes pricing index data monthly, showed that the “producer price index jumped by 20% for aluminum mill shapes, 17.4% for copper and brass mill shapes, and 12.3% for steel mill products”2 after the tariff imposition. However, the pricing index for new construction (what contractors are charging) only rose by less than 4.3%, implying that contractors absorbed the increase in costs and shrank potential profit margins.3
As the full impacts of tariffs and rising material costs on the construction industry are being realized, contractors, suppliers, and clients are preparing for recovery. This alters how clients decide to build new projects, and how contractors price these projects while remaining responsive to price-sensitive clients. Fixed price contracts will increase the risk to contractors while reimbursable contracts will increase the risk to clients.
Let’s consider, for example, the steel used in a construction building. The construction industry accounts for 43% of all steel shipments prior to the imposition of tariffs;4 however, steel accounts for only a portion of a project’s costs. If further tariffs are imposed and domestic suppliers cannot fill in the gap, then construction schedules will also increase in length forcing contractors to shift the risk and uncertainty to clients through price increases and contract clauses.
As a direct result of these tariffs, it is estimated that approximately 30,000 jobs would be directly impacted or lost because of higher steel prices on construction projects.5
Steel is used in the construction of several different building components including reinforcing steel in structural concrete, structural steel framing, and miscellaneous metal framing and supports. Although the tariff will affect all of these components, the single biggest impact will be on structural steel in steel framed buildings.
The cost of structural steel is based on four main components – raw material, fabrication, delivery, and erection on site. While the cost of these can and will vary over time and by geographic location, raw steel has historically been about 30% of the total cost per ton for structural steel.6
With prices for raw steel ranging between $600-700 per ton, a 25% tariff would result in an increase of $150-175 per ton.7 Consider a 100,000-square-foot building with a structural steel frame of 20 pounds per square foot:
- Overall cost of building: $400 per square foot x 100,000-square-foot building = $40 million
- Quantity of structural steel in building: $20 per pound per square foot x 100,000-square-foot building = two million pounds = 1,000 tons
- Cost of raw steel: $700 per ton
- Cost of structural steel: $2,800 per ton (structural steel costs are typically 3-4 times more than the raw cost, inclusive of material)
- Overall cost of structural steel in building: 1,000 tons x $2,800 per ton = $2.8 million
- Application of a 25% tariff to raw steel only = 25% x $700 per ton x 1,000 tons = $175,000
The impact of a $175,000 hit to a steel contractor supplying $2.8 million to a building is significant and could affect that contractor’s bottom line. Therefore, measures to recover and/or mitigate those costs are vital.
Look for Relief in Contracts
There are several challenges to recover material escalations in contracts. Typical risks are encountered in lump-sum work where the contractor bears the risk that costs will increase over the life of the contract. This risk is mitigated in costs reimbursable and, in some cases, guaranteed maximum price contracts.
However, in all cases, the contractor should carefully examine the contract language for relief from price escalation. Typical clauses that should be reviewed include: force majeure; delay impacts; escalation clauses; change in law, tax, or regulation; change in conditions; notice requirements; and tariff clauses.
Force majeure is a common contract clause that essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties (war, riot, strike, or an event described as “an act of God,” such as a hurricane, flood, earthquake, volcanic eruption, etc.) prevents one or both parties from fulfilling their obligations under the contract. In practice, most force majeure clauses do not excuse a party’s nonperformance entirely, but only suspends it for the duration of the force majeure.
When negotiating force majeure provisions, clients generally seek a narrow and specific definition frequently resulting in the inclusion of a defined and exhaustive list of occurrences that constitute a force majeure event.
By contrast, contractors usually prefer a broader definition such as “any event beyond the reasonable control of the parties including, but not limited to” specified events. If the definition must include an exhaustive list (i.e., every single possible event of force majeure listed), then it should be as comprehensive as is reasonably possible. Substantial price escalation could constitute a force majeure event, which would excuse both parties from having to perform. This price escalation is usually due to an unforeseen act of government via a tariff, rather than a market-driven escalation, and has greater potential to constitute a force majeure event if it makes it unreasonable or unable to perform the work.