Using an Index to Help Project Capital Costs Into the Future

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Update: This blog post and the graph were updated on May 15, 2018 to reflect more recent price index estimates and trends.

Sitting at your desk very late in the afternoon, your coffee going cold, staring at a spreadsheet, crunching numbers for a Capital Improvement Plan. You’re ready to call it a day, but decide to do “just one more quick calculation” (you tell yourself). You glance over to the next cell, and you see it. It’s a simple question, but hundreds of thousands of dollars, maybe millions, hinge on it. “At what annual rate are your capital costs inflated into the future?” Do you have a good answer off the top of your head?

Not everyone uses the same method to calculate the construction costs of capital projects that are planned for the future. But in almost all cases, the costs that will be incurred during the year of construction need to be determined, even ten years from now, in order to plan for adequate rate increases and other sources of funding for the projects. Usually you can estimate what the construction costs would be if the utility began construction today – but five or ten years from now? Some may seek out price guarantees. Others have complex models that make an art form of predicting future construction costs. Many will probably estimate the costs in today’s dollars, and then do a simple projection into the future using one or more estimated/expected/predicted/calculated/guessed inflation factor (including our own free do-it-yourself Capital Improvement Planning tool). But what is that factor? How high should that rate be?

The short answer is there isn’t really one correct answer, and there are many ways to try to estimate the cost inflation factor. One of those ways is to look at established cost or price indices to get a good starting point for your estimate. There are many such indices available for your use. I describe two of the most commonly used in this scenario. The most well-known is the Consumer Price Index, which creates the “inflation” rate that we hear and read about in the news. Another option is the Construction Cost Index. But what are those indices, and what have those rates been in recent years?

The commonly-known “inflation” is really the annual rate of change of the Consumer Price Index-All Urban Consumers (CPI-U). The Consumer Price Index is compiled by the Bureau of Labor Statistics and it tracks the change in consumer prices for “a representative basket of goods and services” for urban consumers. The basket of goods and services includes a combination of food, beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services (including water and sewer prices). Essentially, it tracks how much life in general is getting more (or less) expensive for an urban consumer. It has little to do with the cost of building water or sewer infrastructure.

Perhaps a better index that more specifically applies to capital infrastructure projects is the Construction Cost Index (CCI). CCI is calculated by ENR (Engineering News-Record) and tracks the change in price for a specific combination of construction labor, steel, concrete, cement and lumber using data from 20 cities across the United States. The price for this combination of construction labor and materials is probably much closer to the actual costs that your water or wastewater utility may pay for its infrastructure projects, at least compared to the prices of the CPI-U’s basket of consumer goods. CCI isn’t perfect for utilities, but in tracking changes to the costs of building infrastructure, CCI is better suited than CPI-U.

The choice of CPI-U vs. CCI makes a significant difference in future-value cost calculations. This graph reveals the annual change in both indices since 1984. Since 2002, construction costs have generally risen faster than the rate of inflation of consumer goods prices. In fact, between 2013-2017, CCI averaged 2.9%/year increase while CPI-U inflation averaged 1.3%/year. You may hear people warn that “the cost of construction and capital projects rise faster than the rate of inflation.” This is true even after the recession. CCI is still generally higher than CPI-U, and to be more conservative in your capital planning it is wise to use the higher inflation rate in order to better prepare for possible increases to construction costs.

I would caution, though, that both CCI and CPI-U can be volatile from one year to the next. Even though CCI appeared to stabilize around 2.7%/year in the early 2010’s, it has significantly increased after 2015, reaching 3.9% in 2017. CPI-U has recently seen increases by more than one percent a year, but in a couple of years either stabilized at nearly zero percent or actually decreased. Predicting what will happen to these indices is difficult (ENR forecasts CCI for 12 months once a year), but by using this graph, you can come up with a reasonable and justifiable estimate of the range of inflation factors you might choose to use in your own C.I.P. You can also download the CCI and CPI-U data at USDA’s Natural Resources Conservation Service webpage to calculate your own trends. That resource is regularly being updated.

In a future blog post, we will discuss the use of inflation factors (CPI-U, CCI, and even the Municipal Cost Index) in determining annual water and sewer rate adjustments. In the meantime, please feel free to leave a comment below letting us know what capital cost inflation factor you are using, and if it is based on an index or another method to estimate that factor.

Shadi Eskaf is a Senior Project Director at the Environmental Finance Center at UNC.

7 Comments

  1. There is also a Water & Sewer Maintenance CPI that the BLS keeps track of.

  2. Thank you for your comment, Shane, and I will make a note to review that index when I compare indices for rate adjustments, along with MCI, etc.

    After speaking with the people at Bureau of Labor Statistics, I think that this index may be useful in comparing rate increases, but I don’t believe that it is helpful in projecting capital costs for utilities (I think CCI is closer if the capital projects involve construction using concrete and steel). It is better than using CPI, which some utilities and engineering firms may be using, even if it is less-known. Instead of taking the CPI as a whole, you can break it apart and look specifically for the “water and sewerage maintenance” component that went into calculating the overall CPI. The “water and sewerage maintenance” index, however, tracks changes to the seasonally-adjusted water/sewer monthly bill that is charged to households in 87 urban communities, and it is NOT the change of costs of maintenance that utilities face to repair, rehabilitate or replace infrastructure. So when it comes to using an index to project capital cost expenditures at the utility level, the “water and sewerage maintenance” index would provide little help for the same reasons I mention in the blog post.

    If anyone wishes to see the data for BLS’ “water and sewerage maintenance” index, you can find them summarized here: http://www.inflationsummary.com/ConsumerPriceIndex/Housing/FuelsandUtilities/WaterandSewerandTrashCollectionServices/WaterandSewerageMaintenance

    Thank you for pointing out this index, Shane.

  3. Is CCI divided into regions across the United States? I’m looking for CCI rates for the Western US from 2005 to 2016.

    • Hi Jeff –
      Not that I know of. CCI is calculated from construction costs from only 20 cities across the country, and ENR reports each city’s CCI data as well as the national average (which is what we graphed in this blog post). ENR does not publish regional averages, but you could look at the data for the cities in the Western US and compute your own average if you like. San Francisco, LA and Seattle are among the 20 cities. You would have to be a subscriber to ENR to be able to access their data at the city level, though. See http://www.enr.com/economics/
      Thank you.

  4. It is important for water and wastewater utilities to create, maintain and follow a plan to invest in their capital assets; whether to rehabilitate, replace or install new assets. Capital infrastructure costs account for a very large portion of utilities’ total costs. Without proper long-term planning, utilities run the risk of not being able to pay for capital costs when they need to, leading to deterioriting service and, ultimately, public health risks. There have been many studies on the capital needs of drinking water and wastewater infrastructure in the United States, and invariably these needs amount to dozens of billions of dollars. External funding (loans, grants, bonds, etc.) can only cover a portion of these capital needs. Ultimately, the customers of the systems will be covering the rest (if not all) of the capital needs of their systems. Long-term planning is required to schedule major infrastructure improvements and spread the capital costs over many years in order to avoid having to raise rates significantly in any one year to pay for a capital project that was unplanned.

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  5. Tacoma, WA – using CCI published in ENR for our region. We’ve been using 4% in our rate models for constructed capital. Thank you for information.

    • Thank you, Sally. It seems like you were ahead of the curve in your projections! While CCI increases were lower than 4%/year through 2016 (data available by the time you wrote your comment above), it reached 3.9%/year in 2017 according to data released in 2018. Well done in predicting that. May we please borrow your crystal ball (or whatever more scientific method you used) sometime?

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