Power Play
Expensive Energy?
Burn Other Stuff,
One Firm Decides

HUICHAPAN, Mexico -- Towering over ancient cornfields tended by peasant farmers with wooden hoes, the two giant ovens of a Cemex SA cement plant here devour enough energy to power a small town. Trucks and rail cars rumble through the farmland silence, carrying 800 tons of fuel a day to stoke the kilns to 2,700 degrees Fahrenheit, hot enough to alter the composition of stone.

With energy prices up steeply this year, you'd think the ravenous appetite of this plant in Mexico's Hidalgo state and the 53 other Cemex plants like it around the globe would be hurting profits at the world's No. 3 cement maker. Rising power and fuel costs have been making life especially tricky for heavy industries such as cement, where energy accounts for up to 40% of operating costs.

Instead Mexico-based Cemex, the biggest cement producer in the U.S., has cut its energy bills by 17% in the past four years. The company is reaping the benefits of an ambitious decade-long effort to refit its cement plants so they can operate on cheap, little-used fuels such as an oil-industry residue called petroleum coke and industrial waste like oily rags.

Cemex's success in reducing its energy expense offers an unusual lesson in global business, showing what a developing-world company can do when forced to deal with competition from the developed world. In some cases the difficult operating environments of emerging markets -- economic turbulence, high borrowing costs, creaky infrastructure and corruption -- can act as a rigorous corporate boot camp, breeding the kind of innovation that makes for lean competitors on the world stage.

"Necessity is the mother of invention, and in the developing world you are always facing some obstacle," says Indian-born Madhu Ranade, vice president for manufacturing for Ispat Inland Inc., the U.S. unit of closely-held LNM Group.

Lately, energy prices have brought this phenomenon into sharp relief. LNM, under the stewardship of Indian billionaire Lakshmi Mittal, has become the world's second-largest steelmaker by snapping up money-losing plants, cutting costs and turning them around. Its U.S. unit, based in East Chicago, Ind., now boasts one of North America's most efficient blast furnaces after completing $100 million of upgrades. The overhaul, which boosted capacity 10% this year, allows the furnace to use a cheaper fuel mix and recycle more heat to generate electricity.

Brazil's Votorantim Group, which competes with giants such as Alcoa Inc. and Glencore International AG in the nickel, aluminum and zinc markets, has cut its production costs to among the lowest in the metals industry to offset Brazilian handicaps such as expensive borrowing costs. Now, after surviving national electricity shortages and forced power rationing in 2001, Votorantim is investing $630 million to build hydroelectric plants to keep its power costs competitive.

Cemex's biggest weapon in its war on energy costs has been petroleum coke, a blackened leftover from the oil refining process. It had long been used as an occasional energy supply in some cement plants around the world. It burns hotter than coal, the cement industry's main fuel source, and is much cheaper. But burning pet coke creates its own problems and the difficulty of getting enough supply had prevented "pet coke" from becoming a primary fuel source for the cement industry.

After overcoming those hurdles, Cemex is using pet coke at most of its global plants. Pet coke now accounts for half of Cemex's fuel needs. That has given Cemex a big competitive advantage, particularly in recent months as the price of coal soared to about twice that of pet coke.

Energy efficiency is part of the reason Cemex has significantly higher profit margins than its bigger rivals, Zurich-based Holcim Ltd. and Paris-based Lafarge SA, according to Citigroup Smith Barney Inc. analyst Stephen Trent. His analysis looks at earnings before interest, taxes, depreciation and amortization. Lafarge says pet coke, which it has been using since the 1980s, now accounts for 25% of its global fuel mix. Holcim did not respond to requests for comment.

"Cemex was the first cement company to use pet coke as a key strategy for gaining competitive advantage," says Ben Ziesmer, an energy consultant and a contributing editor to the Pace Petroleum Coke Quarterly and other specialized energy publications. "They recognized it early, spread the use of pet coke throughout their organization, and others have started to follow."

In the early 1990s, Cemex faced a crunch. Back then, the cement maker relied on fuel oil to heat its kilns. But Mexican President Carlos Salinas was preparing to dismantle trade and investment barriers that had protected Mexican companies for a century. In preparation for a free-trade agreement with the U.S. and Canada, the Salinas government ended price controls on fuel oil.

Cemex Chief Executive Lorenzo Zambrano was already worrying that lowered trade barriers would make it easier for international rivals to operate in Mexico. Like all companies based in Mexico, Cemex was at a some significant disadvantages compared with its first-world rivals. Mexican manufacturers face power failures twice a month, while paying about 60% more for power than U.S. rivals. And Mexico's periodic currency crashes raised the cost of borrowing.

Energy costs, including electricity and fuel oil, were Cemex's biggest expense. Not only were fuel-oil prices likely to rise, but Cemex executives expected electricity shortages to worsen as the trade agreement expanded Mexico's economy. Mr. Zambrano decided Cemex's energy strategy needed to be completely rethought.

To lead a search for cheaper energy, Cemex in 1991 recruited Luis Farias, a technology planner then working at a Mexican steel company. A graduate of the University of London with a doctorate in process metallurgy, Dr. Farias jumped at the challenge. With two of his most trusted engineers in tow, he moved into a new office at Cemex's Monterrey headquarters and disappeared under piles of price charts, blueprints and fuel studies.

He faced a daunting task. Dr. Farias, now 50 years old, had to guarantee long-term access to a plentiful fuel source with stable prices. And he had to do so despite problems endemic in Mexico. Mexico's decrepit ports were too shallow for the big tankers that carry coal.

Cemex executives wanted to experiment with burning waste products like used tires and plastic bottles, a fuel source used in some cement plants in Europe. But ensuring a reliable-enough supply of industrial waste to make it Cemex's primary fuel source would be difficult. In Mexico, poor enforcement of environmental rules meant industrial waste was more often abandoned than collected for disposal.

Dr. Farias knew about pet coke from his days in the steel industry, where it's used to help turn iron into steel. Cheap, hard and compact, it could be moved easily by rail. Its biggest problem was that it tended to clog kilns when burned. But Dr. Farias knew a Spanish cement-maker was running totally on petroleum coke, suggesting it had solved the clogging problem.

So after months spent studying different options, he made an audacious proposal to Mr. Zambrano: Convert as many Cemex plants as possible to run mainly on pet coke.

Cemex executives were skeptical. Installing the necessary equipment, such as burners, storage systems and mills to pulverize the coke, would cost $150 million. Dr. Farias couldn't yet prove that pet coke could work on a large scale.

But he got the proof on a tour of European cement-makers in early 1992. He visited the Spanish company, Valenciana de Cementos Portland SA, and saw how engineers had solved the problem. As part of Mr. Zambrano's expansion strategy, Cemex was already secretly eyeing the Spanish plant as a possible acquisition. Dr. Farias's report on Valenciana's breakthrough helped persuade Mr. Zambrano to pay $1.25 billion to buy the company, complete with its petroleum coke knowhow.

To ensure an adequate supply of pet coke, Dr. Farias set up a subsidiary in Houston to negotiate directly with oil refineries.

"I can tell refineries, look, I have 50 plants around the world, and they are all starving for pet coke," he says. "Our scale allows us to sign big, long-term commitments, guaranteeing removal of every bit of pet coke at an entire plant."

The Houston subsidiary arranges for the coke to be shipped to Cemex's plants around the world, an innovation for an industry where individual plants had traditionally ordered their own fuel supplies. The subsidiary has turned into a small money-maker for Cemex by selling the pet coke the company doesn't need.

In 1993, Dr. Farias turned to industrial waste, which Cemex still hoped could be a fuel source. To guarantee enough supply, he started a business that contracted with big manufacturers to collect their waste for burning in Cemex's cement kilns. In effect, Cemex is being paid to collect some of its energy supply.

At the Huichapan plant, in central Mexico, a conveyer system carries bags of oily rags several stories up to an oven tower, where they help feed the kiln's flames. Nearby, a pile of truck tires waits for loading, while a yellow tank sits ready to spit a blend of paint sludge, industrial lubricants and the remains from hundreds of automobile oil-changes into the flames.

In Spain, Cemex's plants burn ground-up bone meal from cattle. Bone meal, which burns nearly as hot as coal, was used to feed cattle until it was fingered as a likely source of mad-cow disease.

Through the 1990s, as Cemex was buying cement plants around the world, Dr. Farias was overseeing conversion of its newly acquired and existing plants to run on pet coke or industrial waste. By 2000, the conversion was mostly complete. Cemex's plants in Mexico, Spain and Latin America now run mostly on pet coke. Industrial waste supplies 5% to 10% of plants' needs in Mexico. In the U.S., where Cemex operates 13 plants, pet coke is eventually expected to supply half Cemex's heating needs. The rest comes from coal.

Cemex opened an office in Switzerland staffed with engineers continually searching for new energy sources. To keep in touch with this office and pet-coke traders in Houston, Dr. Farias has a live video hookup running 24 hours a day on a flat computer screen in the hallway outside his office.

Cemex has also designed software to make it easier for company executives and plant managers to keep tabs on power use. At Cemex's Huichapan plant, manager Mario Tovar uses the software to plan each month's energy consumption, ensuring that electric grinders, conveyers and other equipment run mainly during off-peak electricity hours. There's trouble if he misses his target by more than 10%, he says.

Cemex built its own 230-megawatt power plant powered by pet coke, which came on line earlier this year. Not only does it guarantee electricity during power shortages in Mexico, it makes Cemex money. The plant's output is cheaper than power generated by Mexico's state utility.

On most days after 6 p.m., when electricity prices at the state utility start to spike, Cemex cuts back on its own usage and starts selling every watt it can to the government electricity monopoly. "Sometimes, we're actually more profitable as a power company than we are making cement," Dr. Farias says.

Write to John Lyons at john.lyons@wsj.com

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