The Fool's Todd Wenning recently spoke with Edward Sullivan, Chief Economist at Portland Cement Association -- a trade association that represents cement companies in the U.S. and Canada. Mr. Sullivan has been twice recognized by the Chicago Federal Reserve as the most accurate forecaster of economic growth. In this interview, he elaborates on the current and future state of the cement industry, which followers of cement companies like Cemex (NYSE: CX), CRH (NYSE: CRH), Eagle Materials (NYSE: EXP), and Texas Industries (NYSE: TXI) should find interesting.

Todd Wenning: Dr. Sullivan, cement and concrete industries appear to be in the midst of an aggressive capacity expansion. How easily will this new capacity be digested by the market?

Edward Sullivan: The industry is 85% foreign-owned, and these are typically multinational, large companies. The U.S. players typically have to compete for funds within that group, because there are also tremendous opportunities to invest in China, Latin America, and Eastern Europe. What made the U.S. an attractive market to cement companies was the spike in construction activity that began in 2003. What we're seeing now is that between 2007 and 2012, the industry is going to add about 25 million metric tons -- a 27% increase in domestic capacity -- a huge increase over a short period of time.

The issue is that the timing is horrible. With all the capacity coming online, the likeliness of a U.S. recession now looms large. In 2007, cement consumption declined 8%, and it will decline even further in 2008, and, we think, in 2009 as well. So here you have capacity expansion at the same time as demand decline. Obviously, there are questions about how that is going to play out.

The critical factor is to recognize that roughly 25% of U.S. supply comes from imports. Imports are largely controlled by domestic players, who control 93% of all the terminals. So they can switch on and switch off that import volume number. In 2006, for instance, there was about 36 million metric tons of imported cement; in 2007 there was 22 million tons. So right there alone is a 14 million ton correction in supply. They're likely to cut back even further in 2008 and 2009.

When you look at from a company's perspective, on a regional level, if you're going to build a plant, you build it where demographics are expanding. A typical landlocked cement plant has a distribution range of about 250 miles, so you want to build plants where the demographics are the strongest. In the U.S., that's the south and western mountain states. Those are also the places where there was a housing boom, and now there's a housing bust. What you can see there is, as capacities come online, it will take some time for economies to catch up.

Florida, specifically, is a real problem. Florida was once running a record 11.5-million-ton market. By 2009, we expect it to be down to about 7 million tons. That's a 4.5 million ton correction -- that's huge. And at the same time, you have 4 million tons of new capacity coming online. You can cut imports, but even then, it'll eventually fall on low utilization rates and higher inventory levels. The performance of companies will vary depending on their exposure to those markets that just a few years ago were great markets.

Wenning: You mentioned that imports represent about 25% of U.S. supply. International freights have increased from about $15 per ton in 2003 to more than $90 per ton today on the spot market. Obviously, this is due in part to the strong growth of emerging economies like China. The question then becomes, can these high freight rates be sustained?

Sullivan: I think they can. When you look at import volume declines, it's not just a matter of maintaining utilization rates at plants -- although that's a key thing -- it's also because imports are so expensive and they're expensive because of the freight rates.

Now, what you see happening globally is that world growth is no longer in developed markets like Western Europe, Japan, and the U.S.; it's found in the emerging markets -- Eastern Europe, Latin America, China, and India. If you think about that, those types of emerging countries put a lot into infrastructure -- that's scrap, that's coal, that's energy -- all those things are carried on dry bulk carriers. Dry bulk carriers are also what we use to bring cement from Asia to the U.S., to provide our import supply. Unfortunately, with Chinese growth and other emerging countries so hot year after year, it puts a dramatic demand on these dry bulk carriers.

In late 2003, not only was the construction market starting to heat up and the housing boom was in full gear, that's when you also saw the emerging economies really take off in terms of growth. That put tremendous demand pressure on dry bulk carriers, and freight rates took off, growing about 250%. And that caused shortages -- in 2004 and 2005, we had cement shortages. We could not get ships.

What you've seen happen is the world is in synchronized sustainable growth right now. World economy growth is expected to be anywhere from 2%-3%, so demand will continue to be strong. The complexion of world growth has also changed. We're much more interdependent and that puts increased demand on maritime trade. Maritime freights are expected to grow at least at a 6% clip.

From the dry bulk side, they begin building ships when demand ticks up. They build huge Supramax and Capezises, and the ships are too big for our silos. Our silos, on average, can only hold about 60,000 tons. These ships require a minimum 100,000-ton load. So even though shipbuilding was occurring on the smaller Handymax and Handysize vessels, it wasn't occurring at the same rate.

High freight prices also take a toll on planned ship retirement -- typically, you retire 2% of your fleet each year. With rates so high, you have nearly no retirements. And that's been happening year after year. At some point, you can only play that game so long. Eventually, one of those ships will go out and won't come back. The point is, you've delayed all this retirement, and there's a huge retirement spike out there. That means a reduced number of ships in the context of sustained demand, so when I look at dry bulk carriers, specifically the Handymax and the Handysize, these rates will remain high for at least the next five years.

You can argue that the price of cement in China is $30 to $35. Great, but it doesn't do you any good. With the freight rates for a ton of cement coming from Asia, it will be $95 before it gets here. That doesn't do you any good. That type of situation will continue to play out through at least 2010.

Wenning: One of the concerns we frequently read on the Motley Fool message boards is how climate-change legislation might affect cement companies. What do you think the impact will be on the industry if such laws or regulations come to pass? How should investors monitor these developments?

Sullivan: Two things you should look at. Typically, for every one ton of cement that's produced, there's one ton of CO2. The natural process of converting limestone to clinker counts for about half of it -- that's the calcination process, which is a naturally occurring thing, where limestone is heated at 2,000 degrees and CO2 is released. There's no way to get around it.

If you look at population growth -- we expect the U.S. to add 65 million people between now and 2030, so that means homes, shops, and infrastructure. You can't build any of that without concrete and cement. We're expecting cement consumption to grow from 125 metric tons to over 180 metric tons. That's a significant increase.

There's also the potential that CO2 emissions from cement will increase, whether that be domestically or in Peru. Anyway you look at climate change regulation, it's most likely going to come in the form of some kind of "cap" in trade with some sort of safety valve measure out there. It will raise compliance costs, there's no question about that, but at the same time there's going to be ongoing demand needs.

We think those demand needs are also going to come from "green" demand. Take, for example, a house that has concrete wall systems versus a regular wood frame. Your heating space improves 44% and cooling costs improve 32%, so what that means in terms of CO2 is you save 2 tons per year by having a concrete wall home. Over the course of the life of a home, let's say 50 years, that's a 100 tons of CO2 savings. It only cost an extra 19 tons to produce these types of homes. So you have a net savings of about 80 tons per home. That adds up. This is part of the message the cement industry is trying to get out -- sure, there's going to be CO2 emissions, but you've got to look at climate change in a broad spectrum. What are the long-term savings?

Even green building codes are telling you, "Use concrete." Concrete and cement have long-term "green" benefits. We don't think that message is being played out enough, so we're being more aggressive about that.

Wenning: Thank you, Dr. Sullivan.

Fool contributor Todd Wenning is a former student of Sullivan's at Saint Joseph's University in Philadelphia. Todd does not own shares of any company mentioned. Cemex is a recommendation of both Stock Advisor and Global Gains. The Motley Fool owns shares of Cemex. The Fool's disclosure policy is a brick house.