Sun
Economics is really a simple subject made complicated by
S-curves and diffusion indexes. Take the price elasticity of demand, for example. What this jargon boils down to is the common sense notion that the price of something will greatly influence the decision to buy it.
That basic principle is beginning to take a toll on the provincial economy. Construction is becoming too expensive and buyers are backing away.
Last week, NovaGold and Teck Cominco announced plans to suspend a major mining project in northwest British Columbia because it has become too costly. The companies announced a partnership just six months ago to build the Galore Creek copper-gold mine based on a 2006 feasibility study that estimated its cost at $2 billion. Rapidly escalating construction and materials costs, however, helped push the projected capital cost to $5 billion, and that was too rich even accounting for high commodity prices.
Galore Creek would have created 1,000 construction jobs over a four-year building phase and 500 full-time mining jobs over a mine life expectancy of at least 20 years. Development of the mine was also to be the catalyst for a new $400-million electricity transmission, which has now been put on hold. It would have linked the northwest, where diesel generators supply electricity, to the provincial power grid. Shelving the transmission line will likely discourage other projects and depress further exploration activity in the region.
Reverberations are being felt by communities in the region, first nations bands and stock market investors, the last having have seen NovaGold lose half its share value since the announcement.
Meanwhile, Barrick Gold Corp. says the cost of its Donlin Creek mine in Alaska may climb to about $4 billion, 60 per cent more than an initial estimate last year.
The impacts of escalating construction costs are being felt closer to home too. Inflation in the cost of non-residential construction in Metro Vancouver reportedly reached a record of 13.6 per cent in the third quarter of 2007 over a year earlier, although some dispute the number.
And it’s not just mines and warehouses being hit with construction cost inflation. The cost of building infrastructure — roads, bridges, schools, community centres, skating rinks and swimming pools — has put pressure on public sector budgets, which normally use the Consumer Price Index as their inflation factor.
Nor is residential construction immune from cost inflation. The Eden Group recently cancelled two city condominium projects, saying construction costs would have caused huge losses if they had gone ahead. Several other residential developments have been curtailed, including the Riverbend project in Coquitlam.
The cost of apartment building construction in Metro Vancouver rose 13.8 per cent in the third quarter from the same period last year, far ahead of the national rate of 8.5 per cent.
The good news, or bad news depending on your perspective, is that our model of price elasticity assumes that prices will bring demand and supply back into equilibrium.
In other words, by cancelling projects, scaling back others and putting more on hold, market players will create the conditions that will bring construction costs down.
If developers refuse to build at current prices, suppliers of labour, construction materials and the ancillary goods and services that support the construction sector will have little choice but to lower them.
So this could be the beginning of the end of the construction boom, and prices will begin to drop to a level at which investors and developers feel comfortable that their projects will be profitable.
Of course, one of the problems with economics is it assumes a perfect or contestable market, without the distortions of government interference. In this poker game, politics is the wild card.
© The Vancouver Sun 2007
