We prepared the following discussion and analysis to help you better understand
our financial condition, changes in our financial condition, and results of
operations for the three and nine months ended July 31, 2020 and 2019. This
discussion should be read in conjunction with the condensed consolidated
unaudited financial statements and related notes in 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, 2019.
Disclosure Regarding Forward-Looking Statements
The Securities and Exchange Commission ("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-
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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, 2019. These risks and uncertainties include, but are
not limited to, the following:
Fluctuations in the price of ethanol as a result of a number of factors,
? including: the price and availability of competing fuels; the overall supply
and demand for ethanol and corn; the price of gasoline, crude oil and corn; and
government policies;
? 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, resulting from factors such
as 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 trading at a premium to gasoline at times, which may act as a
? disincentive for discretionary blending of ethanol beyond RFS requirements and
consequently negatively impacting ethanol prices and demand;
Changes in federal and/or state laws and environmental regulations including
? elimination, waiver or reduction of corn-based ethanol volume obligations under
the RFS 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; and
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.
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 as a result 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.
Available Information
Our website address is www.granitefallsenergy.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 Compliance," as
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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.
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.
Overview
Granite Falls Energy, LLC ("Granite Falls Energy" or "GFE") is a Minnesota
limited liability company that owns and operates a dry mill corn-based, natural
gas fired ethanol plant in Granite Falls, Minnesota. Additionally, through
Project Viking, L.L.C., a wholly owned subsidiary ("Project Viking"), GFE owns
an approximately 50.7% controlling interest of Heron Lake BioEnergy, LLC ("Heron
Lake BioEnergy" or "HLBE"). HLBE is a Minnesota limited liability company that
owns and operates a dry mill corn-based, natural gas fired ethanol plant near
Heron Lake, Minnesota. Additionally, through its wholly owned subsidiary, HLBE
Pipeline Company, LLC ("HLBE Pipeline Company"), HLBE is the sole owner of
Agrinatural Gas, LLC ("Agrinatural"), which operates a natural gas pipeline.
Beginning as of December 11, 2019, HLBE holds a 100% interest in Agrinatural. At
October 31, 2019, HLBE held a 73% interest in Agrinatural.
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 and its wholly owned subsidiary, HLBE Pipeline Company, LLC, and its
wholly owned subsidiary Agrinatural. When we use the terms "Granite Falls
Energy" or "GFE" or similar words, unless the context otherwise requires, we are
referring to Granite Falls Energy, LLC and our operations at our ethanol
production facility located in Granite Falls, Minnesota. When we use the terms
the "Company," "we," "us," "our" or similar, unless the context otherwise
requires, we are referring to Granite Falls Energy, LLC and our consolidated
wholly and majority owned subsidiaries.
Our business consists primarily of the production and sale of ethanol and its
co-products (wet, modified wet and dried distillers' grains, corn oil and corn
syrup) locally, and throughout the continental U.S. Our production operations
are carried out at GFE's ethanol plant located in Granite Falls, Minnesota and
at HLBE's ethanol plant near Heron Lake, Minnesota.
GFE's ethanol plant has an approximate annual production capacity of 60 million
gallons of denatured ethanol, but has obtained EPA pathway approval and permits
from the Minnesota Pollution Control Authority ("MPCA") to increase its
production capacity to approximately 70 million gallons of undenatured ethanol
on a twelve-month rolling sum basis. HLBE's plant has an approximate annual
production capacity of 60 million gallons of denatured ethanol, but has obtained
EPA pathway approval and permits from the MPCA to increase its production
capacity to approximately 72 million gallons of undenatured ethanol on a twelve
month rolling sum basis. We intend to continue working toward increasing
production at plants to take advantage of the additional production allowed
pursuant to their respective permits so long as we believe it is profitable to
do so.
We market and sell the products produced at our plants 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, Inc. to market all of
the ethanol produced at our ethanol plants. GFE also independently markets a
small portion of the ethanol production at its plant as E-85 to local retailers.
We have contracted with RPMG, Inc. ("RPMG") to market the distillers' grains
produced at the GFE plant and with Gavilon Ingredients, LLC to market
distillers' grains produced at the HLBE plant. We have contracted with RPMG to
market all of corn oil produced at our ethanol plants. HLBE also occasionally
independently markets and sells excess corn syrup from the distillation process
at the Heron Lake plant to local livestock feeders.
We do not have any long-term, fixed price exclusive supply contracts for the
purchase of corn for either the GFE or HLBE plants. Both GFE and HLBE purchase
the corn necessary for operating directly from grain elevators, farmers,
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and local dealers within approximately 80 miles of their respective plants.
Neither GFE's nor HLBE's members are obligated to deliver corn to our plants.
In July 2020, HLBE experienced major issues with its boiler, which negatively
impacted production. HLBE ordered a temporary boiler, which allowed operations
to continue in August 2020 until repair or replacement of the boiler could be
completed. HLBE determined that the purchase and installation of a new boiler
would be more economical and efficient than attempted repairs to the failing
boiler. The new boiler is expected to be installed in October 2020. On September
2, 2020, HLBE received notice of approval of the new boiler from the Minnesota
Pollution Control Agency. As a result, HLBE abandoned the failing boiler, is
currently operating with the temporary boiler, and plans to operate with the new
boiler upon its completed installation. HLBE will record the cost for the
abandonment during the fourth fiscal quarter once it has determined the asset
value, and what, if any, of the existing equipment can be salvaged. HLBE
anticipates a loss of approximately $1.8 million in the fourth fiscal quarter of
2020 due to the abandonment of the failing boiler. The estimated cost of the new
boiler is approximately $5.2 million.
At the GFE plant, we pay Center Point Energy/Minnegasco a per unit fee to move
the natural gas through the pipeline, and we have guaranteed to move a minimum
of 1,500,000 MMBTUs annually through December 31, 2025, which is the ending date
of the agreement. We also have an agreement with Kinetic Energy Group whereby
Kinetic Energy Group, on our behalf, procures contracts with various natural gas
vendors to supply the natural gas necessary to operate the Granite Falls plant.
HLBE has a facilities agreement with Northern Border Pipeline Company, which
allows HLBE to access an existing interstate natural gas pipeline located
approximately 16 miles north of its plant. HLBE has entered into a firm natural
gas transportation agreement with its wholly owned subsidiary, Agrinatural.
HLBE also has an agreement with Constellation NewEnergy-Gas Division, LLC to
supply the natural gas necessary to operate the Heron Lake plant.
We have a management services agreement with HLBE pursuant to which our chief
executive officer, chief financial officer, and commodity risk manager also hold
those same offices with HLBE. The management services agreement automatically
renews for successive one-year terms unless either HLBE or GFE gives the other
party written notice of termination prior to expiration of the then current
term. The management services agreement may also be terminated by either party
for cause under certain circumstances.
As of December 11, 2019, HLBE owns a 100% interest in Agrinatural, a natural gas
distribution and sales company located in Heron Lake, Minnesota. Agrinatural
owns approximately 190 miles of natural gas pipeline and provides natural gas to
HLBE's ethanol plant and other commercial, agricultural and residential
customers through a connection with the natural gas pipeline facilities of
Northern Border Pipeline Company. Agrinatural's revenues are generated through
natural gas distribution fees and sales.
We have a natural gas local distribution company management agreement with
Agrinatural pursuant to which our chief executive officer and chief financial
officer also hold those same offices with Agrinatural. The agreement
automatically renews for successive one-year terms unless either Agrinatural or
GFE gives the other party written notice of termination prior to expiration of
the then current term. The agreement may also be terminated by either party for
cause under certain circumstances.
On August 2, 2017, GFE made a $7.5 million investment in Ringneck Energy & Feed,
LLC ("Ringneck"). Ringneck has constructed an ethanol plant outside of Onida,
South Dakota. The plant commenced operations in June 2019. On June 10, 2019, GFE
made an additional $500,000 investment in Ringneck. On June 29, 2018, GFE made a
$2.0 million investment in Harvestone Group, LLC ("Harvestone"). Harvestone is
a start-up ethanol marketing, logistics, and trading company headquartered in
Franklin, Tennessee. Details regarding our investment in Ringneck and
Harvestone are provided below in the section below titled "Investments."
Plan of Operations for the Next Twelve Months
The Company, and the ethanol industry as a whole, experienced significant
adverse conditions throughout most of 2019 and so far in 2020 as a result of
industry-wide record low ethanol prices due to reduced demand and high industry
inventory levels, exacerbated in 2020 by the COVID-19 pandemic. These factors
resulted and continue to result in prolonged negative operating margins, lower
cash flow from operations and substantial net losses. We expect to have
sufficient cash generated by continuing operations, availability on our credit
facility, and additional debt with the
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Company's current lenders to fund our operations. However, should unfavorable
operating conditions continue or worsen in the ethanol industry that prevent us
from profitably operating our plant, we may need to seek additional funding or
further idle ethanol production altogether.
Over the next twelve months, we will continue our focus on operational
improvements at our plants. These operational improvements include replacing the
boiler at HLBE, exploring methods to improve ethanol yield per bushel and
increasing production output at our plants to take full advantage of our
permitted production capacities, reducing our operating costs, and optimizing
our margin opportunities through prudent risk-management policies. Additionally,
we expect to continue to conduct routine maintenance and repair activities at
our ethanol plants to maintain current plant infrastructure, as well as small
capital projects to improve operating efficiency. We anticipate using cash from
our revolving term loans to finance these plant upgrade projects.
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 well as governmental programs designed to create incentives for
the use of corn-based 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, 2020 and the three
months ended April 30, 2020, and "PART I - Item 1A. Risk Factors" of our annual
report on Form 10-K for the fiscal year ended October 31, 2019.
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. If the corn-ethanol spread
is compressed or negative for sustained period, it is possible that our
operating margins will decline or become negative and our plants may not
generate adequate cash flow for operations. In such cases, we may reduce or
cease production at our plants to minimize our variable costs and optimize cash
flow.
Management currently believes that our margins will remain negative or low
during the remainder of the fiscal year 2020. The negative market effects of the
COVID-19 pandemic will likely continue to negatively impact our profitability.
Due to the market risks and uncertainties related to the pandemic and its
ramifications, HLBE idled its ethanol production from on or about March 30, 2020
through approximately May 31, 2020 and GFE temporarily idled its operations from
on or about April 3, 2020 through approximately May 18, 2020. June and July also
saw lower than normal ethanol production levels at HLBE, due primarily to issues
with HLBE's boilers. Additionally, continued large corn supplies and ethanol
production capacity increases could have a negative impact on the market price
of ethanol which could adversely impact our profitability. This negative impact
could worsen if domestic ethanol inventories remain high or grow, or if U.S.
exports of ethanol decline. Recent US Energy Information Administration ("EIA")
reports indicate that ethanol stocks remain high since the conclusion of fiscal
year 2019. Further, while ethanol production briefly significantly declined
during the second fiscal quarter of 2020, ethanol production has mostly
rebounded during the third fiscal quarter of 2020. In addition, management
believes that increased waivers of small refiner renewable volume obligations
("RVOs") by the U.S. Environmental Protection Agency ("EPA"), as well as
uncertainty regarding the Renewable Fuels Standard ("RFS") reset, will
contribute to the projected negative or low margins.
Increased waivers of small refiner RVOs by the EPA has contributed to
management's expectation regarding margins. The impact of the increases in small
refiner waivers granted by the EPA and the reductions in Chinese imports
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continues to have a negative impact on prices for renewable identification
numbers ("RINs") for corn-based ethanol. As a result, RINs prices remain lower,
removing a blending incentive from the ethanol marketplace.
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 2020 Short
Term Energy Outlook, EIA estimates that U.S. gasoline consumption in the second
quarter of 2020 averaged approximately 7.2 million barrels per day, compared to
approximately 9.5 million barrels per day in the second quarter of 2019.
Additionally, EIA estimates that U.S. gasoline consumption in the third quarter
of 2020 will average approximately 8.8 million barrels per day, compared to
approximately 9.5 million barrels per day in the third quarter of 2019. For all
of 2020, EIA forecasts that U.S. gasoline consumption will average approximately
8.4 million barrels per day, a decrease of approximately 10% compared with 2019.
U.S. gasoline prices averaged $2.18 per gallon in July 2020, an increase of 10
cents per gallon from June 2020, but 56 cents per gallon lower than June 2019.
The EIA forecasts regular gasoline prices to average $1.99 per gallon in the
fourth quarter of 2020, largely due to decreases in travel due to COVID-19 and
reflective of a drop in crude oil prices. The EIA projects that U.S. gasoline
prices will average $2.23 per gallon in 2021, compared with an average of $2.12
per gallon in 2020.
In addition, crude oil prices fell sharply in March and April 2020, remaining
low in June and July 2020 but rebounding slightly, as a result of market
reaction to the COVID-19 pandemic, which caused global demand to decline, and
international price wars. Such marked decreases in crude oil prices have had a
negative impact on the demand for ethanol, which are likely to be exacerbated by
overall lessened global energy demand as a result of the COVID-19 pandemic.
Continued ethanol production capacity increases could also have a negative
impact on the market price of ethanol, which could be further exacerbated if
domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol
decline. Throughout 2019 and 2020, some U.S. ethanol plants temporarily
suspended production due to negative margins, largely resulting from the
COVID-19 pandemic, and stagnant export projections caused by trade barriers and
decreased global demand in connection with the COVID-19 pandemic.
During our third fiscal quarter of 2020, distillers' grains prices fell, due to
a combination of decreased seasonal demand as well as an increase in supply, as
many ethanol plants resumed production after the shutdowns caused by the
COVID-19 pandemic. In addition to being an animal feed substitute for corn,
distillers' grains are increasingly considered a protein feed substitute for
soybean meal. Management currently believes that the impact of the current
Chinese imposition of antidumping and countervailing duties on distillers'
grains produced in the U.S. has been absorbed into the market. However, recent
trade disputes with China, Mexico and Canada could result in the imposition of
additional tariffs on distillers' grains produced in the United States, which
could lead to an oversupply of distillers' grains domestically and negatively
impact distillers' grains prices. Additionally, domestic feeding margins in
cattle and hogs in particular could have a negative impact on total domestic
distillers' grains demand.
Corn oil prices have been slightly negatively impacted during the three months
ended July 31, 2020, which aligns with the recent historic perspective, which
has seen corn oil prices over the past few years be impacted by oversupply of
soybeans and the resulting lower price of soybean oil which competes with corn
oil for biodiesel production, in addition to increased corn oil production. The
impact of lower soybean oil prices and the market's increase in corn oil
production during the last few years will likely continue to impact corn oil
prices.
In December 2019, legislation was signed extending the $1.00 per-gallon
biodiesel blender tax credit retroactively to January 1, 2018 through December
31, 2022. However, corn oil prices may decrease if biodiesel producers reduce
production and/or demand for corn oil is reduced without extension of the
biodiesel blenders tax credit.
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.
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Impact of COVID-19 on the Company
Operations
The Company, and the ethanol industry as a whole, experienced significant
adverse conditions throughout most of 2019 and so far in 2020 as a result of
industry-wide record low ethanol prices due to reduced demand and high industry
inventory levels. These factors, which have been compounded by the impact of
COVID-19 in 2020, resulted and continue to result in negative operating margins,
significantly lower cash flow from operations and substantial net losses. In
response to these adverse market conditions, HLBE idled its ethanol production
from on or about March 30, 2020 through approximately May 31, 2020 and GFE
temporarily idled its operations from on or about April 3, 2020 through
approximately May 18, 2020. This strategy during our third quarter reduced
ethanol production levels by approximately 13.9% as compared to the first half
of 2020 production levels. Management believes that this reduction is warranted
due to current negative margins in the ethanol industry resulting in part from a
slowdown in global and regional economic activity and decreased ethanol demand
due to the COVID-19 pandemic. Limiting ethanol production also results in a
corresponding decrease in distillers' grains and corn oil production. The
Company continues to monitor COVID-19 developments in order to determine whether
further 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.
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,
even when operating at reduced production levels. 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. The pandemic has caused a global economic
slowdown, and it is possible that it could cause a global recession. In the
event of a recession, demand for our products would decline further and our
business would be further adversely effected.
PPP Loans
On April 17, 2020, GFE received a loan in the amount of $703,900 through the
Paycheck Protection Program. Additionally, on April 18, 2020 HLBE received a
loan in the amount of $595,693 through the Paycheck Protection Program.
Management expects that the entirety of both loans will be used for payroll,
utilities and interest; therefore, management anticipates that both loans will
be substantially forgiven. To the extent GFE's loan is not forgiven, the Company
would be required to repay that portion at an interest rate of 1% over a period
of two years, beginning November 2020 with a final installment in April 2022. To
the extent HLBE's loan is not forgiven, the Company would be required to repay
that portion at an interest rate of 1% over a period of two years, beginning May
2021 with a final installment in May 2022.
Outlook
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Although there is uncertainty related to the anticipated impact of the COVID-19
pandemic on our future results, we believe our current cash reserves, cash
generated from our operations, our Paycheck Protection Program loans and the
available cash under our revolving loans leave us well-positioned to manage our
business through this crisis as it continues to unfold. However, the impacts of
the COVID-19 pandemic are broad-reaching, and the financial impacts associated
with the COVID-19 pandemic include, but are not limited to, reduced production
levels, lower net sales and potential incremental costs associated with
mitigating the effects of the pandemic, including storage and logistics costs
and other expenses. As a result, although we were in compliance with our
financial covenants set forth in GFE's Seasonal Revolving Loan and HLBE's 2020
Credit Facility as of July 31, 2020, the impact the COVID-19 pandemic could have
an adverse impact on our operating results which could result in our inability
to comply with certain of these financial covenants and require our lenders to
waive compliance with, or agree to amend, any such covenant to avoid a default.
The COVID-19 pandemic is ongoing, and its dynamic nature, including
uncertainties relating to the ultimate geographic spread of the virus, the
severity of the disease, the duration of the pandemic, and actions that would be
taken by governmental authorities to contain the pandemic or to treat its
impact, makes it difficult to forecast any effects on our 2020 fiscal year
results. However, the challenges posed by the COVID-19 pandemic on the global
economy increased significantly as the third fiscal quarter of 2020 progressed,
and as of the date of this filing, management does not anticipate material
improvement in the macroeconomic environment, and, as a result, our results for
the 2020 fiscal year may be significantly affected.
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 Fuels 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 short-term ethanol prices and
our financial performance in the future.
Under the provisions of the RFS, the EPA must publish an annual rule that
establishes the number of gallons of different types of renewable fuels,
including corn-based ethanol, that must be blended with gasoline in the U.S. by
refineries, blenders, distributors, and importers, which affects the domestic
market for ethanol. In December 2019, the EPA released the final renewable
volume obligations ("RVOs"), which included an overall blending requirement of
20.09 billion gallons for 2020, a slight increase from 2019 mandates.
Conventional corn-based ethanol levels were left at 15.0 billion gallons,
excluding any waivers granted by the EPA to small refiners for "hardship."
U.S. ethanol production capacity exceeded the EPA's 2018 and 2019 RVOs that can
be satisfied by corn-based ethanol. Under the RFS, if mandatory renewable fuel
volumes are reduced by at least 20% for two consecutive years, the EPA is
required to modify, or reset, statutory volumes through 2022. In October 2018,
the Office of Management and Budget announced that the 20% thresholds "have been
met or are expected to be met in the near future." In May 2019, the EPA
delivered the proposed RFS "reset" rule to the White House Office of Management
and Budget for its review. The EPA is expected to propose rules modifying the
applicable statutory volume targets for cellulosic biofuel, advanced biofuel,
and total renewable fuel for the years 2020-2022. The proposed rules are also
expected to include proposed diesel renewable volume obligations for 2021 and
2022. If the statutory RVOs are reduced as a result of reset, it could have an
adverse effect on the market price and demand for ethanol which would negatively
impact our financial performance.
There is growing availability of E85 for use in flexible fuel vehicles; however,
it is limited due to lacking infrastructure. In addition, the industry has been
working to introduce E15 to the retail market since the EPA approved its
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use in vehicles model year 2001 and newer. However, widespread adoption of E15
has been hampered by regulatory and infrastructure hurdles in many states, as
well as consumer acceptance. Additionally, sales of E15 may have been limited
because (i) it is not approved for use in all vehicles, (ii) the EPA requires a
label that management believes may discourage consumers from using E15, and
(iii) retailers may choose not to sell E15 due to concerns regarding liability.
On May 30, 2019, the EPA issued a final rule which allows E15 to be sold
year-round. In June 2019, the American Fuel and Petrochemical Manufacturers
association filed a lawsuit in the U.S. Court of Appeals for the District of
Columbia challenging the final rule. Additionally, in August 2019, the Small
Retailers Coalition filed a lawsuit in the U.S. Court of Appeals for the
District of Columbia seeking review of the final rule. There is no guarantee
that the final rule will be upheld. Legal challenges could create uncertainty
for retailers desiring to implement or expand sales of E15. Additionally,
although the year-round E15 rule is now final, there is no guarantee that
retailers will implement the sale of year-round E15, nor is there a guarantee
that the rule will result in an increase of ethanol sales.
The EPA assigns individual refiners, blenders, and importers the RVOs they are
obligated to use based on their percentage of total fuel sales. Obligated
parties use 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 in certain markets and influences the
purchasing decisions by obligated parties. On April 15, 2020, governors of five
states asked the EPA for a refiner waiver from the RFS, contending that refiners
in their respective states face financial burdens due to the COVID-19 economic
downturn. In June 2020, attorneys general of seven states joined in such
request. The EPA has stated that it is "watching the situation closely, and
reviewing the" request.
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 exemptions, whereby such refiners were alleviated of their
responsibility to supply RINS for their obligated volumes based upon the grounds
of economic hardship. On August 20, 2020, the EPA released data on the number
of waivers filed, which indicated that 28 petitions for waivers for the 2019
compliance year have been received, in addition to three petitions for a waiver
for the 2020 compliance year. For the 2018 compliance year, 44 petitions have
been received. To date, with respect to the 2018 compliance year, the EPA has
approved 31 petitions and denied 6 petitions, 5 petitions have been declared
ineligible or withdrawn, and 2 petitions are pending. The 31 approved petitions
have exempted approximately 1.43 billion RINs, which is approximately 13.42
billion gallons of gasoline and diesel, from meeting the RFS blending targets.
The 37 approved petitions for compliance year 2017 exempted approximately 1.82
billion RINs, which is approximately 17.05 billion gallons of gasoline and
diesel, from meeting the RFS blending targets. It is expected that additional
petitions for waivers for the 2019 and 2020 compliance years will be received by
the EPA. It is also expected that the EPA will approve a significant number of
these waiver petitions, thereby exempting a substantial number of gallons of
gasoline and diesel from meeting the RFS blending targets. These exemptions
decrease demand for our products, which negatively impacts ethanol prices and
our profitability.
A proposed rule released by the EPA in October 2019 proposed changes intended to
project the exempted volume of gasoline and diesel due to small refinery
exemptions, regardless of whether such exemptions were actually granted after
the annual rulemaking. However, the final rule released by the EPA in December
2019 provides that EPA will project exempt volumes based on a three-year average
of the relief recommended by the Department of Energy ("DOE") for years
2016-2018, rather than based on actual exemptions granted. For the 2016
compliance year, the EPA said the DOE's recommended relief was approximately 440
million RINs. The EPA, however, actually granted waivers for approximately 790
million RINs. Similarly, the DOE's 2017 compliance year recommendation was 1.02
billion RINs, as compared to the approximately 1.82 billion RINs granted waivers
by the EPA. For the 2018 compliance year, the DOE recommended the EPA approve
waivers for 840 million RINs, as compared to the approximately 1.43 billion RINs
granted waivers by the EPA. The EPA's final rule also announced its general
policy approach with respect to small refinery waivers on a go-forward basis as
consistent with DOE's recommendations, where appropriate. The final rule fell
short of the relief that was urged by ethanol producers. As a result, management
expects that small refinery exemptions will continue to have a negative effect
on demand for our products, ethanol prices, and our profitability.
Legal challenges are underway to the RFS, including the EPA's recent reductions
in the RFS volume requirements, the 2018 final rule, and the denial of petitions
to change the RFS point of obligation. If the EPA's decision to reduce the
volume requirements under the RFS is allowed to stand, if the volume
requirements are further reduced, or if the RFS
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point of obligation were changed, it could have an adverse effect on the market
price and demand for ethanol which would negatively impact our financial
performance.
Beginning in January 2016, various ethanol and agricultural industry groups
petitioned a federal appeals court to hear a legal challenge to of the EPA's
decision to reduce the total renewable fuel volume requirements for 2014-2016
through use of its "inadequate domestic supply" waiver authority. On July 28,
2017, the U.S. Court of Appeals for the D.C. Circuit ruled in favor of the
petitioners, concluding that the EPA erred in its exercise of "inadequate
domestic supply" waiver authority by considering demand-side constraints. As a
result, the Court vacated the EPA's decision to reduce the total renewable fuel
volume requirements for 2016, and remanded to the EPA to address the 2016 total
renewable fuels volume requirements. In December 2019, the EPA announced that it
is deferring action on this issue until an anticipated date in 2020. While
management believes the decision should benefit the ethanol industry overall by
clarifying the EPA's waiver analysis is limited to consideration of supply-side
factors only, no direct impact on the Company is expected from the decision.
On May 1, 2018, the Advanced Biofuel Association submitted a petition with the
U.S. Court of Appeals for the D.C. Circuit challenging EPA's process for
granting exemptions from compliance under the RFS to small refineries. The
Advanced Biofuel Association petition asks the court to review the EPA's
decision to modify criteria to lower the threshold by which the agency
determines whether to grant small refineries an exemption for the RFS for
reasons of disproportionate economic hardship. In May 2019, the U.S. Court of
Appeals for the D.C. Circuit denied a motion by the Advanced Biofuels
Association seeking a preliminary injunction to prevent the EPA from granting
any additional small refinery exemptions under the RFS until its pending lawsuit
with the agency is resolved. In August 2019, the U.S. Court of Appeals for the
D.C. Circuit denied the petition, upholding the EPA's decisions.
Additionally, on May 29, 2018, the National Corn Growers Association, National
Farmers Union, and the Renewable Fuels Association ("RFA") filed a petition with
the U.S. Court of Appeals for the 10th Circuit challenging the EPA's grant of
waivers to three specific refineries. The petitioners are asking the U.S. Court
of Appeals for the 10th Circuit to reject the waivers granted to three
refineries located in Wynnewood, Oklahoma, Cheyenne, Wyoming, and Woods Cross,
Utah as an abuse of EPA authority. These waived gallons are not redistributed
to obligated parties, and in effect, reduce the aggregate RVOs under the RFS. In
January 2020, the court struck down the exemptions as improperly issued by the
EPA. The court interpreted the RFS statute to require that any exemption granted
to a small refinery after 2010 must take the form of an "extension," which would
require a small refinery exemption in prior years to prolong, enlarge or add to.
The court approved a 15-day extension of the deadline to file a petition for
rehearing, which sets the deadline at March 24, 2020. Three small refiners filed
an appeal, but because the Department of Justice did not file an appeal, the
agency is set to implement the decision nationwide.
Related to the recent lawsuits, the Renewable Fuels Association, American
Coalition for Ethanol, Growth Energy, National Biodiesel Board, National Corn
Growers Association, Biotechnology Industry Organization, and National Farmers
Union petitioned the EPA on June 4, 2018 to change its regulations to account
for lost volumes of renewable fuel resulting from the retroactive small refinery
exemptions. This petition to EPA seeks a broader, forward-looking remedy to
account for the collective lost volumes caused by the recent increase in
retroactive small refinery RVO exemptions. In June 2018, the court issued a stay
pending further administrative proceedings. On July 30, 2019, the groups
petitioned the court to lift such stay. It is unclear what regulatory changes,
if any, will emerge from the petition to the EPA. The EPA has not reallocated
volume exemptions in prior years, and continued to approve 31 new requests in
2019. On October 29, 2019, the U.S. House of Representatives Committee on Energy
and Commerce met to examine the effects of the small refinery exemptions on
biofuels and agriculture since 2016. Companies were seeking the EPA to make
available more information on refinery exemptions.
Further, on July 31, 2018, Producers of Renewables United for Integrity Truth
and Transparency filed a petition for review in the U.S. Court of Appeals for
the D.C. Circuit, petitioning for review of final agency action by the EPA in
its decision to allow the generation of RINs by obligated parties under the RFS
that do not represent biofuel production in the year the RIN was generated. In
May 2019, the court issued an order dismissing a portion of the lawsuit
challenging the EPA's timing, due to untimely filing. The order also transferred
the RINs issues to the U.S. Court of Appeals for the 10th Circuit.
Also, on August 30, 2018, the RFA and Growth Energy filed a lawsuit in federal
district court, alleging that the EPA and U.S. Department of Energy have
improperly denied agency records requested by RFA, Growth Energy, and others
under the Freedom of Information Act. The requested documents relate to
exemptions from Renewable Fuel Standard
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compliance obligations granted by EPA. Additionally, on February 4, 2019, Growth
Energy filed a lawsuit in the U.S. Court of Appeals for the D.C. Circuit against
the EPA, challenging the EPA's "failure" to address small refinery exemptions in
its 2019 RVO rulemaking. An administrative stay has been granted to research the
contents of the lawsuit.
Biofuels groups have filed a lawsuit in the U.S. Federal District Court for the
D.C. Circuit, challenging the Final 2019 Rule over the EPA's failure to address
small refinery exemptions in the rulemaking. This is the first RFS rulemaking
since the expanded use of the exemptions came to light, however the EPA has
refused to cap the number of waivers it grants or how it accounts for the
retroactive waivers in its percentage standard calculations. The EPA has a
statutory mandate to ensure the volume requirements are met, which are achieved
by setting the percentage standards for obligated parties. The EPA's current
approach runs counter to this statutory mandate and undermines Congressional
intent. Biofuels groups argue the EPA must therefore adjust its percentage
standard calculations to make up for past retroactive waivers and adjust the
standards to account for any waivers it reasonably expects to grant in the
future.
Although the maintenance of the 15.0 billion gallon threshold for volume
requirements that may be met with corn-based ethanol in the 2020 final rule, in
addition to the year-round E15 rule, signals support from the EPA and the Trump
administration for domestic ethanol production, the Trump administration could
still elect to materially modify, repeal, or otherwise invalidate the RFS. Any
such reform could adversely affect the demand and price for ethanol and the
Company's profitability.
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 USDA did not include any CCC funds for ethanol plants as of this filing.
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 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.
Results of Operations for the Three Months Ended July 31, 2020 and 2019
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, 2020
and 2019 (amounts in thousands).
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