We prepared the following discussion and analysis to help readers better
understand our financial condition, changes in our financial condition, and
results of operations for the three and nine months ended July 31, 2021 and
2020. This section should be read in conjunction with the condensed
consolidated unaudited financial statements and related notes in PART I - Item 1
of this report and the information contained in the Company's annual report on
Form 10-K for the fiscal year ended October 31, 2020.
Disclosure Regarding Forward-Looking Statements
The SEC encourages companies to disclose forward-looking information so
investors can better understand future prospects and make informed investment
decisions. As such, we have historical information, as well as forward-looking
statements regarding our business, financial condition, results of operations,
performance, and prospects in this report. All statements that are not
historical or current facts are forward-looking statements. In some cases, you
can identify forward-looking statements by terms such as "anticipates,"
"believes," "could," "estimates," "expects," "intends," "may," "plans,"
"potential," "predicts," "projects," "should," "will," "would," and similar
expressions.
Forward-looking statements are subject to a number of known and unknown risks,
uncertainties, and other factors, many of which may be beyond our control, and
may cause actual results, performance, or achievements to differ materially from
those projected in, expressed or implied by forward-looking statements. While
it is impossible to identify all such factors, factors that could cause actual
results to differ materially from those estimated by us are described more
particularly in the "Risk Factors" section of our annual report on Form 10-K for
the year ended October 31, 2020, and on Forms 10-Q for the three months ended
January 31, 2021 and April 30, 2021, as supplemented by the risk factors
disclosed in Item 1A of this report on Form 10-Q. These risks and uncertainties
include, but are not limited to, the following:
Fluctuations in the price of ethanol, which is affected by various factors
? including: the overall supply and demand for ethanol and corn; the price of
gasoline, crude oil and corn, government policies, the price and availability
of competing fuels;
? Fluctuations in the price of crude oil and gasoline and the impact of lower oil
and gasoline prices on ethanol prices and demand;
Fluctuations in the availability and price of corn, which is affected by
various factors including: domestic stocks, demand from corn-consuming
? industries, such as the ethanol industry, prices for alternative crops,
increasing input costs, changes in government policies, shifts in global
markets or damaging growing conditions, such as plant disease or adverse
weather, including drought;
Fluctuations in the availability and price of natural gas, which may be
? affected by factors such as weather, drilling economics, overall economic
conditions, and government regulations;
? Negative operating margins which may result from lower ethanol and/or high corn
prices;
? Changes in general economic conditions or the occurrence of certain events
causing an economic impact in the agriculture, oil, or automobile industries;
? Overcapacity and oversupply in the ethanol industry;
Ethanol may trade at a premium to gasoline at times, resulting in a
? disincentive for discretionary blending of ethanol beyond the requirements of
the Renewable Fuel Standard and consequently negatively impacting ethanol
prices and demand;
Changes in federal and/or state laws and environmental regulations including
elimination, waiver, or reduction of the corn-based ethanol use requirement in
? the Renewable Fuel Standard and legislative acts taken by state governments
such as California related to low-carbon fuels, may have an adverse effect on
our business;
? Any impairment of the transportation, storage and blending infrastructure that
prevents ethanol from reaching markets;
? Any effect on prices and demand for our products resulting from actions in
international markets, particularly imposition of tariffs;
? Changes in our business strategy, capital improvements or development plans;
? Effect of our risk mitigation strategies and hedging activities on our
financial performance and cash flows;
? Competition from alternative fuels and alternative fuel additives;
? Changes or advances in plant production capacity or technical difficulties in
operating the plant;
? Our reliance on key management personnel;
A slowdown in global and regional economic activity, demand for our products
? and the potential for labor shortages and shipping disruptions resulting from
COVID-19.
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Our CEO and General Manager retired effective May 26, 2021, and as a result our
? Company may face challenges that arise from a transition in leadership, which
may adversely affect our business; and
The election of President Joe Biden and the transition to a new presidential
? administration may result in new or different regulations and policies that may
adversely affect our business.
We believe our expectations regarding future events are based on reasonable
assumptions; however, these assumptions may not be accurate or account for all
risks and uncertainties. Consequently, forward-looking statements are not
guaranteed. Actual results may vary materially from those expressed or implied
in our forward-looking statements. In addition, we are not obligated and do not
intend to update our forward-looking statements because of new information
unless it is required by applicable securities laws. We caution investors not
to place undue reliance on forward-looking statements, which represent
management's views as of the date of this report. We qualify all of our
forward-looking statements by these cautionary statements.
Industry and Market Data
Much of the information in this report regarding the ethanol industry, including
government regulation relevant to the industry is from information published by
the Renewable Fuels Association ("RFA"), a national trade association for the
United States ("U.S.") ethanol industry, and information about the market for
our products and competition is derived from publicly available information from
governmental agencies or publications and other published independent sources.
Although we believe our third-party sources are reliable, we have not
independently verified the information.
Available Information
Our website address is www.heronlakebioenergy.com. Our annual report on Form
10-K, periodic reports on Form 10-Q, current reports on Form 8-K, and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, are available, free of charge, on our website
under the link "SEC Filings," as soon as reasonably practicable after we
electronically file such materials with, or furnish such materials to, the
Securities and Exchange Commission. The contents of our website are not
incorporated by reference in this report on Form 10-Q.
Overview
Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and
operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake,
Minnesota. Our business consists of the production and sale of our ethanol
throughout the continental U.S. and sale of its co-products (wet, modified wet
and dried distillers' grains, corn oil, and corn syrup) locally, and throughout
the continental U.S. Additionally, through a wholly owned subsidiary, HLBE
Pipeline Company, LLC ("HLBE Pipeline Company"), we are the sole owner of
Agrinatural Gas, LLC ("Agrinatural"). Agrinatural operates a natural gas
pipeline that provides natural gas to Heron Lake BioEnergy, LLC's ethanol
production facility and other customers. When we use the terms "Heron Lake
BioEnergy," "Heron Lake," or "HLBE" or similar words, unless the context
otherwise requires, we are referring to Heron Lake BioEnergy, LLC and our
operations at our ethanol production facility located near Heron Lake,
Minnesota. When we use the terms the "Company," "we," "us," "our" or similar
words, unless the context otherwise requires, we are referring to Heron Lake
BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, and its
wholly owned subsidiary Agrinatural.
We have a management services agreement with Granite Falls Energy, LLC, a
Minnesota limited liability company that operates an ethanol plant located in
Granite Falls, Minnesota ("GFE"). GFE owns approximately 50.7% of our
outstanding membership units. Pursuant to the management services agreement, GFE
provides its chief executive officer, chief financial officer, and commodity
risk manager to act in those positions as our part-time officers (the
"Management Services Agreement").
Effective May 26, 2021, Jeffrey Oestmann became Chief Executive Officer ("CEO")
of the Company. GFE appointed Oestmann CEO pursuant to a letter of employment
(the "Employment Agreement") dated May 20, 2021. Pursuant to the Management
Services Agreement, GFE's executive officers also serve as executive officers of
the Company. Thus, Oestmann serves as the CEO of both the Company and GFE.
Oestmann replaces Steve Christensen, who had served as CEO of the Company and
GFE since 2012, and who resigned as CEO effective May 26, 2021, pursuant to a
separation agreement between Christensen and GFE (the "Separation Agreement").
The Employment Agreement is available on the Company's Form 8-K filed with the
SEC May 25, 2021, and is hereby incorporated by reference. The
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Management Services Agreement and Separation Agreement are available on the
Company's Form 8-K filed with the SEC February 22, 2021, and are incorporated
herein by reference.
Ethanol Production
Our primary line of business is the Company's operation of its ethanol plant,
including the production and sale of ethanol and its co-products (distillers'
grains, non-edible corn oil and corn syrup). These operations are aggregated
into one financial reporting segment.
Our ethanol plant has a nameplate capacity of 50 million gallons per year. We
have received EPA pathway approval and have obtained permits from the Minnesota
Pollution Control Authority to increase our production capacity to approximately
72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling
sum basis. We are currently operating above our stated nameplate capacity on an
annualized basis and intend to continue to do so into the future, dependent on
industry conditions and plant profitability. In response to repeated
malfunctions with our boiler, we installed a new boiler at our plant in January
2021 at a cost of approximately $5.3 million, which has improved the efficiency
and profitability of ethanol production at the plant.
We market and sell our products primarily using third-party marketers. The
markets in which our products are sold may be local, regional, national, and
international and depend primarily upon the efforts of third party marketers.
We have contracted with Eco-Energy, LLC to market all of our ethanol, Gavilon
Ingredients, LLC to market our distillers' grains, and RPMG, Inc. to market our
corn oil. We also occasionally independently market and sell excess corn syrup
from the distillation process to local livestock feeders.
Our cost of our goods sold consists primarily of costs relating to the corn and
natural gas supplies necessary to produce ethanol and distillers' grains for
sale at our ethanol plant. We generally do not have long-term, fixed price
contracts for the purchase of corn. Typically, we purchase our corn directly
from grain elevators, farmers, and local dealers within approximately 80 miles
of Heron Lake, Minnesota.
Plan of Operations for the Next Twelve Months
Over the next twelve months we will continue our focus on operational
improvements at our plant. These operational improvements include exploring
methods to improve ethanol yield per bushel and increasing production output at
our plant, continued emphasis on safety and environmental regulation, reducing
our operating costs, and optimizing our margin opportunities through prudent
risk-management policies. In addition, we expect to continue to conduct routine
maintenance and repair activities at the ethanol plant to maintain current plant
infrastructure.
While the improve operating efficiency provided by the new boiler and strong
demand for transportation fuel during the spring and summer peak driving months
resulted in net income during the three months ended July 31, 2021, the Company
believes demand for fuel may decrease in the coming months and as a result the
Company may experience tight or negative operating margins.
Proposed Merger with Granite Falls Energy, LLC
During the three months ended July 31, 2021, the Company moved forward with
plans to engage in a merger with GFE, its majority owner (the "Merger"). A
special meeting, where members of the Company will vote on the merger proposal
is scheduled for 1 p.m. Thursday September 23, 2021, at the Heron Lake Community
Center, 312 10th Street, Heron Lake, Minnesota 56137 (the "Special Meeting"). A
complete description of the Merger and the Special Meeting is available in the
Company's definitive proxy statement filed with the SEC on August 19, 2021, and
is incorporated herein by reference.
Negotiations regarding the Merger began in early 2021. On March 24, 2021, the
Company and GFE, executed a Merger Agreement (the "Merger Agreement"), pursuant
to which GFE will acquire the minority interest of HLBE. The structure of the
proposed transaction is a merger in which Granite Heron Merger Sub, LLC,
("Merger Sub") a wholly owned subsidiary of GFE, will merge with and into the
Company, with the Company surviving the transaction as a wholly owned subsidiary
of GFE. Copies of the Merger Agreement, a Plan of Merger and associated voting
agreements were published with our Form 8-K filed with SEC on March 25, 2021 and
are incorporated herein by reference.
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GFE currently owns approximately 50.7% of the Company's units. The remaining
approximately 49.3% of the Company's units are owned by approximately 1,200
investors (the "Minority Ownership Interest"). Pursuant to the Merger
Agreement, GFE will acquire the Minority Ownership Interest for $14 million in
cash payable at the closing of the Merger. Each issued and outstanding unit of
the Minority Ownership Interest will be canceled and converted into the right to
receive $0.36405 per Unit. (the "Merger Consideration").
The Merger is subject to approval by the Minority Ownership Interest at the
Special Meeting. The Merger is also conditioned on regulatory approval, the
consent the Company's lender, and GFE's ability to obtain financing for the
transaction. If such approvals and consents are obtained, the Merger is expected
to close following the Special Meeting.
Effect of the Merger
Upon the terms and subject to the conditions of the Merger Agreement, if the
Merger is completed, Minority Ownership Interest unitholders will obtain the
right to receive cash compensation for their units and will cease to be owners
of the Company.
The Minority Ownership Interest comprises 38,456,283 units. If the Merger is
completed, each issued and outstanding unit of the Minority Ownership Interest
will be canceled and converted into the right to receive $0.36405 per unit. Upon
the completion of the Merger, Minority Ownership Interest unitholders will no
longer own any units of the Company and will no longer have any rights as a
member of the Company. The units of Company held by GFE immediately prior
closing of Merger shall be cancelled with no consideration issued to GFE. GFE
will emerge from the transaction as the sole owner of the Company. At the time
the Merger becomes effective, 100 percent of the membership interest in the
Merger Sub shall be converted into and become 100 percent of the membership
interests in the Company, as the surviving company in the Merger.
The Company has identified an exchange agent to administer the distribution of
Merger Consideration to Minority Ownership Interest unitholders. If the Merger
is completed, information will be distributed to unitholders regarding the
process for exchanging their unit certificates for Merger Consideration. A
process will be made available for unitholders who cannot locate their unit
certificates to verify their ownership interest and receive Merger
Consideration. Additional information regarding the Exchange Agent is available
in our definitive proxy statement filed with the SEC on August 19, 2021, and is
incorporated herein by reference.
As a result of the Merger, members of the Minority Ownership Interest would not
have the ability to participate in any possible value appreciation experienced
by the Company above the pro rata share of the $14 million sales price.
Comparatively, by ceasing to be owners or members of the Company, members of the
Minority Ownership Interest would not face any potential future risk regarding
their investment in the Company upon completion of the Merger. Also upon
consummation of the Merger, by ceasing to be owners or members of the Company,
members of the Minority Ownership Interest would not face the prospect of
participating in any decrease in value of their respective ownership below the
pro rata share of the $14 million sales price.
Upon completion of the Merger, the Company is expected to continue operating its
ethanol production plant in Heron Lake, Minnesota. No significant changes are
expected in the operation of the Company's ethanol plant. Upon consummation of
the Merger, the Company would combine its assets with GFE for potentially more
advantageous leverage terms with lenders.
The Company, which is currently managed by GFE's executive officers pursuant to
the Management Services Agreement, would continue to be managed by GFE's
executive officers if the Merger is completed. Upon consummation of the Merger,
the Company's Board of Governors would cease to exist, and GFE's Board of
Governors would assume managerial and oversight control over the Company in
conjunction with GFE's executive officers. Upon completion of the Merger, and
the subsequent elimination of the Company's Board of Governors, the Company
would lose the insight of Governors engaged in the local production of corn. As
a result, the Company may have less insight about the local corn market.
Comparatively, the elimination of the Company's Board of Governors would result
in more efficient management of the Company provided the centralized nature of
management and oversight duties that GFE's Board of Governors and GFE's
executive officers would impart. By eliminating the Company's Board of Governors
and centralizing management and oversight duties with GFE's Board of Governors
and executive officers, the Company would save approximately $165,000 in annual
Governor compensation pursuant to the information set forth in the Company's
Definitive Proxy
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Statement dated February 26, 2021 under the Caption "Required Information -
Governor Compensation," which is incorporated herein by reference.
Additionally, upon completion of the Merger, the Company intends to file for
de-registration with the SEC by duly filing a Form 15 with the SEC. If the
Company is allowed to de-register, it would no longer be required to file
annual, quarterly, and certain other reports with the SEC. By de-registering
with the SEC and no longer being subject to the various reporting requirements
of the Securities Exchange Act of 1934, management estimates the Company would
save approximately $300,000 in filing fees on an annual basis.
Pursuant to the Merger Agreement, GFE and HLBE would release, acquit, and
discharge each other and all related parties from all claims, including, all
liabilities, obligations, claims, litigation, actions, causes of action, suits,
proceedings, executions, judgments, demands, damages, losses, duties, debts,
dues, accounts, fees, costs, expenses and penalties, and agree not to initiate,
maintain, prosecute or continue to maintain or prosecute any action, suit or
proceeding, or seek to enforce any right or claim against the other or its
related parties.
Upon completion of the Merger, Project Viking, as the holding entity of the
Company, would remain an approximately 50.7% owner of the Company with GFE
holding the remaining approximately 49.3% interest, rather than the members of
the Minority Ownership Interest. Provided that the members of the Minority
Ownership Interest would no longer possess ownership rights in the Company upon
consummation of the merger, this would result in more efficient management of
the Company given that members of the Minority Ownership Interest would cease to
be involved in future member meetings of the Company.
Upon completion of the Merger, Merger Sub would solely serve to effectuate the
Merger and would cease to exist by operation of law once the Merger is complete.
If the Merger is completed, 100% of the membership interest in Merger Sub would
be converted into and become 100% of the membership interest in GFE, as the
surviving company in the Merger.
Effect if the Merger is Not Completed
If the Merger and the transactions contemplated thereby are not completed, the
Company's members will not receive the Merger Consideration or any other payment
for their units of the Company. Instead, the Company will remain a
majority-owned subsidiary of GFE, with GFE controlling approximately 50.7% of
the Company's units and the Minority Ownership Interest controlling the
remaining units.
Further, the Company believes that if the Merger is not completed there is risk
the Company could default on its loans and be forced to cease operations or seek
bankruptcy protection. Prior to the three-month period ended July 31, 2021, the
Company experienced significant net losses due to several factors, including
elevated corn prices, the breakdown of our ethanol plant's boiler, and reduced
demand for ethanol due to the COVID-19 pandemic. Due to these net losses, the
Company violated certain loan covenants related to working capital and net
worth, for which the Company obtained waivers from its lender. The Company was
in violation of such loan covenants as of October 31, 2020, and January 31,
2021. As a result of these loan covenant violations, the Company reported that
as of January 31, 2021, there was substantial doubt about the Company's ability
to continue operating as a going concern.
Due to improved market conditions and operating efficiency, the Company was in
compliance with its debt covenants on April 30, 2021 and as of July 31, 2021.
However, management believes it is possible market conditions to will worsen in
the near future due to various factors including decreased demand for
transportation fuel in the winter months. Accordingly, it possible that the
Company will incur future instances of loan covenant violations for which the
Company's lender will not provide a waiver. Future violations of these loan
covenants would allow the Company's lender to accelerate certain loans and
designate a substantial portion of the Company's debt due and payable. If the
Company's loans became due and payable, there is a substantial risk the Company
would lack the cash on hand, borrowing capacity, and cash flows to repay the
debt, and if this were to occur, the Company could be forced to cease operations
or seek bankruptcy protection. If this were to occur, our members could lose a
substantial portion of their investment in the Company.
The Company believes the Merger will reduce the risk of these potential adverse
consequences because as a wholly owned subsidiary of GFE, the Company is
expected to have adequate working capital and net worth to avoid loan covenant
violations.
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Trends and Uncertainties Impacting Our Operations
The principal factors affecting our results of operations and financial
conditions are the market prices for corn, ethanol, distillers' grains, and
natural gas. As a result, our operating results can fluctuate substantially due
to volatility in these commodity markets. Governmental programs designed to
create incentives for the use of corn-based ethanol also have a significant
impact on market prices for ethanol. Other factors that may affect our future
results of operation include those risks discussed below and in "PART II - Item
1A. Risk Factors" of this report, "PART II - Item 1A. Risk Factors" of our
quarterly report on Form 10-Q for the three months ended January 31, 2021, "PART
II - Item 1A. Risk Factors" of our quarterly report on Form 10-Q for the three
months ended April 30, 2021, and "PART I - Item 1A. Risk Factors" of our annual
report on Form 10-K for the fiscal year ended October 31, 2020, which are
incorporated herein by reference.
Our operations are highly dependent on commodity prices, especially prices for
corn, ethanol, distillers' grains and natural gas. As a result, our operating
results can fluctuate substantially due to volatility in these commodity
markets. The price and availability of corn is subject to significant
fluctuations depending upon a number of factors that affect commodity prices in
general, including crop conditions, yields, domestic and global stocks, weather,
federal policy, and foreign trade. Natural gas prices are influenced by severe
weather in the summer and winter and hurricanes in the spring, summer, and fall.
Other factors include North American exploration and production, and the amount
of natural gas in underground storage during injection and withdrawal seasons.
Ethanol prices are sensitive to world crude oil supply and demand, domestic
gasoline supply and demand, the price of crude oil, gasoline and corn, the price
of substitute fuels and octane enhancers, refining capacity and utilization,
government regulation and incentives and consumer demand for alternative fuels.
Distillers' grains prices are impacted by livestock numbers on feed, prices for
feed alternatives and supply, which is associated with ethanol plant production.
Because the market price of ethanol is not always directly related to corn, at
times ethanol prices may lag price movements in corn prices and corn-ethanol
price spread may be tightly compressed or negative, which can cause our
operating margins to decline or become negative and our ethanol plant may not
generate adequate cash flow for operations. In such cases, we may reduce or
cease production at our ethanol plant to minimize our variable costs and
optimize cash flow.
Management believes that the ethanol outlook for the remainder of fiscal year
2021 will remain steady or worsen compared to the three months ended July 31,
2021, due to various factors including seasonal decreases in the demand for
transportation fuel and the ongoing effects of the COVID-19 pandemic. The spread
of the coronavirus Delta variant could lead to increased COVID-19 infections,
which could reduce demand for travel and thereby reduce for transportation fuel,
including the ethanol we produce. Additionally, continued large corn supplies
and increases in ethanol production capacity could negatively affect our
profitability. This negative impact could worsen if domestic ethanol inventories
increase, or if U.S. exports of ethanol decline.
During the three months ended July 31, 2021, domestic ethanol production
rebounded to pre-pandemic levels, with U.S. ethanol plants producing more than 1
million barrels of fuel ethanol per day for the first time since March 2020,
according to the U.S. Energy Information Administration ("EIA"). The weekly
averages of domestic fuel ethanol production ranged from 979,000 barrels per day
to 1.067 million barrels per day during the three months ended July 31, 2021,
according to the EIA.
In previous quarters, ethanol production had been suppressed due to the effects
of the COVID-19 pandemic, as well as severe whether events. In 2020, some U.S.
ethanol plants, including ours, temporarily suspended production due to negative
margins caused by low demand for fuel due to the effects of the COVID-19
pandemic. Additionally, unusually cold weather affecting much of the United
States in February 2021 disrupted the supply of natural gas and as a result
natural gas spot prices approached record-high levels. Many ethanol production
facilities, including our plant, rely on natural gas to process corn into
ethanol. As a result, in February 2021 many fuel ethanol producers reduced
production rates and estimated fuel ethanol margins fell to negative levels.
U.S. weekly fuel ethanol production fell to an average of 658,000 barrels per
day during the week of February 21, 2021, which was the lowest weekly production
level since May 11, 2020, according to the EIA.
Ethanol production is projected to remain steady in 2021 and increase slightly
in 2022. The EIA projects fuel ethanol production will average 970,000 barrels
per day in 2021, up from 910,000 barrels per day in 2020. Further, EIA
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projects fuel ethanol production will average 1.01 million barrels per day in
2021. Continued ethanol production capacity increases could also have a negative
impact on the market price of ethanol, which could negatively affect our
profitability.
Additionally, a decrease in exports could reduce demand for biofuel including
the ethanol we produce. Annual U.S. fuel ethanol exports decreased by 9% in
2020, marking the second consecutive annual drop in U.S. fuel ethanol experts
and the lowest level for such exports since 2015, according to the EIA. Exports
of U.S. fuel ethanol to Brazil, the world's second largest consumer of fuel
ethanol, decreased significantly in 2020. All U.S. fuel ethanol exports to
Brazil now face a 20% Brazilian tariff since a tariff-free fuel ethanol quote
expired in December 2020. The new tariff will likely lower U.S. fuel ethanol
export volumes to Brazil in the near term, according to the EIA. As a result,
demand for biofuel, including our ethanol, could decrease.
Further, management believes that waivers of small refiner renewable volume
obligations ("RVOs") by the U.S. Environmental Protection Agency ("EPA"), as
well as uncertainty regarding enforcement of the RFS , could contribute to
negative or low margins.
Changes in the price for crude oil and unleaded gasoline could have a negative
impact on the demand for gasoline and impact the market price of ethanol, which
could adversely impact our profitability. According to the EIA August 2021
Short Term Energy Outlook, U.S. gasoline consumption is forecast to average 8.6
million barrels per day in 2021, up from 8.0 million barrels per day in 2020.
Further, EIA forecasts U.S. gasoline consumption to average 9.0 million barrels
per day in 2022. U.S. regular gasoline retail prices averaged $3.14 per gallon
in July, the highest monthly average price since October 2014, according to the
EIA, which noted that recent gasoline price increases reflect rising crude oil
prices and rising wholesale gasoline margins, amid relatively low gasoline
inventories. EIA projects that U.S. regular gasoline prices will average $3.12
per gallon in August before falling to $2.82 per gallon in the fourth quarter of
2021.
In addition, EIA forecasts moderate declines in the prices for crude oil,
projecting Brent crude oil prices to decline from an average of $75 a barrel in
July to an average of $72 per barrel in August through November. In 2022, EIA
projects Brent crude prices to decrease to an average of $66 per barrel, due to
supply growth as a result of increased international and domestic production.
Decreases in the price for crude oil generally have a negative impact on the
demand for ethanol.
Given the inherent volatility in ethanol, distillers' grains, non-food grade
corn oil, grain and natural gas prices, we cannot predict the likelihood that
the spread between ethanol, distillers' grains, non-food grade corn oil, and
grain prices in future periods will be consistent compared to historical
periods.
Impact of COVID-19 on the Company
Operations
The Company, and the ethanol industry as a whole, experienced significant
adverse conditions throughout 2020, and into 2021 as the COVID-19 pandemic
greatly reduced travel and thereby reduced demand for fuel, including the
ethanol we produce. Reduced demand and high industry inventory levels resulted
in record low ethanol prices in the spring of 2020. As a result, we experienced
negative operating margins, significantly lower cash flow from operations and
substantial net losses. In response to these adverse market conditions, the
Company idled its ethanol production from on or about March 30, 2020 through
approximately May 31, 2020. Fuel prices generally, and ethanol prices
specifically, have rebounded since the spring of 2020 and remained steady during
the three and nine months ended July 31, 2021. However, the spread of new
coronavirus variants may result in new waves COVID-19 infections, which may lead
to reduced travel and thereby reduce the demand for transportation fuel,
including the ethanol we produce. The Company continues to monitor COVID-19
developments to determine if adjustments to production are warranted.
Employees
The Company has enacted appropriate safety measures to protect the health and
safety of our employees, customers, partners and suppliers, and we may take
further actions as government authorities require or recommend or as we
determine to be in the best interests of our employees, customers, partners and
suppliers.
Management believes that various factors, including unemployment benefits
offered in response to the COVID-19 pandemic, have contributed to labor
shortages. While we currently have sufficient employees to operate our
production
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facility, it is possible that the current shortage of qualified, available
workers could result in higher labor costs and could negatively affect our
ability to efficiently operate our production facility.
Supply and Demand
Although we continue to regularly monitor the financial health of companies in
our supply chain, financial hardship on our suppliers caused by the COVID-19
pandemic could cause a disruption in our ability to obtain raw materials or
components required to produce our products, adversely affecting our operations.
Additionally, restrictions or disruptions of transportation, such as reduced
availability of truck, rail or air transport, port closures and increased border
controls or closures, may result in higher costs and delays, both with respect
to obtaining raw materials and shipping finished products to customers, which
could harm our profitability, make our products less competitive, or cause our
customers to seek alternative suppliers. Additionally, the COVID-19 pandemic has
significantly increased economic and demand uncertainty.
PPP Loans
On April 18, 2020, the Company received $595,693 under the Paycheck Protection
Program legislation passed in response to the economic downturn triggered by
COVID-19. This note was forgiven in full in March 2021. The Company received a
second Paycheck Protection Program loan in February 2021 in the amount of
$595,693, which was forgiven in full in August 2021.
Outlook
During the three months ended July 31, 2021, the Company experienced improved
market conditions as the adverse effects of the COVID-19 pandemic subsided. As a
result, the Company experienced improved profitability in the recent three-month
period. However, the pandemic is ongoing and various dynamic factors, including
the spread of new coronavirus variants, make it difficult to forecast the
long-term effects of the pandemic on our industry as a whole and our Company
specifically.
It is possible that even after the pandemic subsides, there will be permanent
changes to social and economic patterns that will reduce demand for ethanol. For
example, increased adoption of "work from home" policies or tele-commuting, and
the use virtual meetings in place of in-person meetings, may permanently reduce
business travel and thereby reduce the demand for transportation fuel, including
the ethanol we produce.
Despite the economic uncertainty resulting from the COVID-19 pandemic, we intend
to continue to focus on strategic initiatives designed to improve on our
operational efficiencies, which is critical in order to drive positive results
in a low-margin environment.
We continue to monitor the rapidly evolving situation and guidance from
international and domestic authorities, including federal, state and local
public health authorities and may take additional actions based on their
recommendations. In these circumstances, there may be developments outside our
control requiring us to adjust our operating plan. As such, given the dynamic
nature of this situation, we cannot reasonably estimate the impacts of the
COVID-19 pandemic on our financial condition, results of operations or cash
flows in the future.
Government Supports and Regulation
The Renewable Fuels Standard
The ethanol industry is dependent on several economic incentives to produce
ethanol, the most significant of which is the federal Renewable Fuel Standard
("RFS"). The RFS has been, and we expect will continue to be, a significant
factor impacting ethanol usage. Any adverse ruling on, or legislation
affecting, the RFS could have an adverse impact on ethanol prices and our
financial performance in the future.
The EPA enforces the RFS by establishing renewable volume obligations ("RVOs"),
which require a certain number gallons of different types of renewable fuels,
including corn-based ethanol, to be blended with gasoline in the U.S. by
refineries, blenders, distributors, and importers. Changes to the RVO levels
have a significant impact on the demand for ethanol. As of August 2021, the EPA
had not yet released RVO requirements for 2021. Industry observers have reported
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that the EPA is expected to propose a decrease in RVO levels in 2021, compared
to the previous year, and a slight increase in 2022 RVO levels. A decrease in
RVO levels is generally correlated with a decrease in demand for renewable
fuels, including the ethanol we produce.
Under the RFS, small refineries may petition for and be granted temporary
exemptions from the RVOs if they can demonstrate that compliance with the RVOs
would cause disproportionate economic hardship. The EPA has recently granted a
number of these small refinery exemptions, whereby such refiners were alleviated
of their responsibility to supply RINS for their obligated volumes based upon
the grounds of economic hardship. Such exemptions decrease the amount of
renewable fuel that must be blended into gasoline supplies and thereby reduce
demand for renewable fuel, including the ethanol we produce.
On June 25, 2021, the U.S. Supreme Court provided a significant setback for the
ethanol industry, issuing a ruling that will make it easier for small refineries
to secure exemptions from the RVOs. The case was brought by a coalition of farm
and ethanol groups, which challenged the hardship exemptions claimed by certain
small refineries. In its decision, the U.S. Supreme Court ruled against the farm
and ethanol coalition, holding that small refineries could apply for an
extension to their hardship exemptions from the RFS' blending requirements, even
if such refineries' exemptions had previously lapsed. The ruling overturned a
2020 decision from the United States Court of Appeals for the Tenth Circuit. The
Supreme Court's decision is expected to lead to more small refinery exemptions
in the near future and thereby decrease demand for renewable fuels, including
the ethanol we produce.
Additional legal actions related to the RFS are underway. These include lawsuits
challenging fuel volume waivers based on "inadequate domestic supply,"
challenging the EPA's lower threshold for granting small refinery exemptions,
seeking broader, forward-looking remedy to account for the collective lost
volumes caused by recent small refinery exemptions, alleging that the EPA and
U.S. Department of Energy have improperly denied access to public records
request by RFA, and challenging the Final 2019 Rule over the EPA's failure to
address small refinery exemptions in the rulemaking. If these legal actions,
which generally seek to require the EPA to enforce the renewable fuel blending
requirements of the RFS, are unsuccessful, there may negative impacts on the
ethanol industry and our financial performance.
Refineries and other entities subject to the RFS use renewable identification
numbers ("RINs") to show compliance with RVOs. RINs are attached to renewable
fuels by producers and detached when the renewable fuel is blended with
transportation fuel or traded in the open market. The market price of detached
RINs affects the price of ethanol and influences the purchasing decisions by
obligated parties.
During the three month period ended July 31, 2021, the prices of RIN credits -
the compliance mechanisms for the RFS - sharply increased, rising to the highest
levels ever in the 13-year history of the RFS program. As of May 28, 2021, corn
fuel ethanol D6 RIN prices had increased by 129% since the beginning of the
year, according to the EIA. Increases in RIN prices can encourage increased
biofuel consumption. The increase in RIN prices was due, in part, to elevated
prices of agricultural feedstocks, such as corn, which are used as an input in
biofuels, including the ethanol we produce. In August 2021, RIN prices decreased
dramatically following the publication of reports indicating the EPA would lower
the 2021 RVO blending mandates below the 2021 levels. Further decreases in the
prices of RINs may result in reduced demand for renewable fuels, including the
ethanol we produce.
COVID-19 Legislation
In response to the COVID-19 pandemic, Congress passed the Coronavirus Aid,
Relief and Economic Security Act (the "CARES Act") in March 2020 in an attempt
to offset some of the economic damage arising from the COVID-19 pandemic. The
CARES Act created and funded multiple programs that have impacted or could
impact our industry. The USDA was given additional resources for the Commodity
Credit Corporation (CCC), which it is using to provide direct payments to
farmers, including corn farmers from whom we purchase most of our feedstock for
ethanol production. Similar to the trade aid payments made by the USDA over the
past two years, this cash injection for farmers could cause them to delay
marketing decisions and increase the price we have to pay to purchase the corn.
The CARES Act also provided for the Small Business Administration to assist
companies that constitute small business and keep them from laying off workers.
The Paycheck Protection Program (the "PPP") was created and quickly paid out all
of the funds appropriated, including some to farmers and to ethanol plants.
Although we received our first PPP Loan under the CARES Act, as discussed above,
the receipt of PPP funds by farmers could, like the CCC funds, incentivize them
to delay marketing corn which could increase the price of corn.
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On December 27, 2020, the federal government enacted Consolidated Appropriations
Act, 2021, a second COVID-19 relief package. Among other things, the legislation
authorized additional PPP loans. In February 2021, the Company received a second
Paycheck Protection Program loan in the amount of $595,693, which was forgiven
in full in August 2021.
On March 11, 2021, the federal government enacted the American Rescue Plan Act
of 2021, which provided $1.9 trillion in economic stimulus through various
programs intended to accelerate the nation's recovery from the COVID-19
pandemic. The American Rescue Plan primarily provided additional funding for
programs created in previous COVID-19 legislation, such as increased
unemployment benefits, direct payments to households, expanded paid sick leave,
increased food stamp benefits, rental assistance, and small business grants.
Management believes the legislation could contribute to inflation, including
increases in the costs of labor and the raw materials we require to produce
ethanol, and thus could negatively affect our operating margins.
Infrastructure Legislation
On August 10, 2021, the U.S. Senate passed a $1 trillion infrastructure bill,
which includes funding for various transportation and utility projects. The
infrastructure legislation includes various aspects that could affect the
ethanol industry as a whole and our Company specifically. The legislation, if
enacted, would provide funding for roads, bridges, and other transportation
infrastructure, which could increase demand for travel, and thereby increase
demand for transportation fuel, including the ethanol we produce. However, the
infrastructure bill also includes funding for electric vehicle charging
stations, which could increase the adoption of electric vehicles and thereby
reduce demand for transportation fuel, including the ethanol we produce.
Moreover, the infrastructure bill has been criticized by ethanol industry
leaders for failing to provide supports for the ethanol industry. For example,
the bill does not provide incentives for retailers to sell E15 and E85 gasoline;
nor does it provide incentives for automakers to produce flexible fuel vehicles.
Additionally, Management believes the legislation could contribute to inflation,
including increases in the costs of labor and the raw materials we require to
produce ethanol, and thus could negatively affect our operating margins.
Results of Operations for the Three Months Ended July 31, 2021 and 2020
The following table shows summary information from the results of our operations
and the approximate percentage of revenues, costs of goods sold, operating
expenses and other items to total revenues in our unaudited condensed
consolidated statements of operations for the three months ended July 31, 2021
and 2020 (amounts in thousands).
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