For all of 2016, copper prices have been between $2.00 and $2.30. The last time copper was below $2.50 was 2009. While this has been great for developers, it leaves mechanical, electrical and plumbing (MEP) contractors exposed to considerable risk. Typically, contractors will bid for a job based on wire prices on the bid date. If wire prices increase between being awarded a contract and the start of the work, the contractor will have to absorb that cost. With copper hovering near a multi-year low, it is inevitable that eventually it will rise again.
There are a few ways contractors can mitigate this risk. First, they can buy all the wire as soon as they are awarded the contract. This ensures that prices will not rise in the interim, but comes with several downsides:
- The contractor ties up considerable working capital in the purchase.
- The contractor ties up storage space housing the wire.
- The contractor risks having the wire stolen.
- The contractor risks having the project further delayed, or even cancelled.
The second option is hedging. Hedging involves buying futures contracts in order to guarantee the ability to purchase at a set price, at a set point in the future. This sounds simple, but MEP contractors are purchasing wire from a distributor, not copper from a commodities exchange. In order to offset a rise in copper prices, a contractor would need to exercise the futures contract, then resell the copper commodity and use the net to offset the higher cost of copper wire. Copper futures must be reported on taxes, and changing values can cause dramatic shifts in a contractor’s balance sheet. For these reasons, businesses with less than $500 million in revenue rarely hedge.
A third option is to pass the cost increase through to the general contractor or project owner. Contractors rarely have sufficient leverage to persuade a GC or owner to accept this risk from the contractor. Only certain large contractors or contractors with unique, essential capabilities can consider this option.
The fourth option is to insure this risk. Insurance is available to protect contractors from increases in copper prices for wire they use in construction. This eliminates any need to buy or store wire early. Also, insurance is simple; it does not cause balance sheet shifts the way futures contracts do, and there is no complex accounting. Finally, commodity insurance is available to contractors of all sizes.
If you would like to learn more about commodity insurance, I’d be happy to discuss how it would best apply to your situation. Contact me, Daniel Curtin, by email at CurtinDJ@ecsinsure.com or by telephone at 301-948-5800, ext. 136.