Overview
BioFuel Energy Corp. produces and sells ethanol and its co-products (primarily distillers grain and corn oil), through its two ethanol production facilities located in Wood River, Nebraska and Fairmont, Minnesota, each having an undenatured nameplate production capacity of approximately 110 million gallons per year (“Mmgy”). Our operating strategy is focused on optimizing production and streamlining operations with the goal of producing at or above nameplate capacity at the lowest cost per gallon.
Our operations and cash flows are subject to wide and unpredictable fluctuations due to changes in commodities prices, specifically, the price of our main commodity input, corn, relative to the price of our main commodity product, ethanol, which is known in the industry as the “crush spread.” See “Risk Factors — Risks relating to our business and industry — Narrow commodity margins have resulted in decreased liquidity and continue to present a significant risk to our ability to service our debt.” Since we commenced operations, we have from time to time entered into derivative financial instruments such as futures contracts, swaps and option contracts with the objective of limiting our exposure to changes in commodities prices, and we may continue to enter into these instruments in the future. However, our experience with these financial instruments has at times been unsuccessful. See “Risk Factors — Risks relating to our business and industry — Our results and liquidity may be adversely affected by future hedging transactions and other strategies.” In addition, we are currently able to engage in such hedging activities only on a limited basis due to our lack of financial resources, and we may not have the financial resources to conduct any hedging activities in the future. See “Risk Factors — Risks relating to our business and industry — We are currently limited in our ability to hedge against fluctuations in commodity prices and may be unable to do so in the future, which further exposes us to commodity price risk.”
We are a holding company with no operations of our own, and are the sole managing member of BioFuel Energy, LLC (the “LLC”), which is itself a holding company and indirectly owns all of our operating assets. As the sole managing member of the LLC, BioFuel Energy Corp. operates and controls all of the business and affairs of the LLC and its subsidiaries. The Company’s ethanol plants are owned and operated by the Operating Subsidiaries of the LLC.
Our Facilities
Our facilities are strategically located in the Midwest “Corn Belt,” and each of our facilities is able to meet local, regional, national and international demand for ethanol. Both facilities have unit train access to the Union Pacific Railroad, and are positioned in some of the lowest-priced, highest-supply feedstock markets in the United States. Each of our facilities was constructed by TIC Wyoming, an industrial general contracting firm, under engineering, procurement and construction (EPC) contracts, utilizing an operations and process technology licensed from its joint venture partner Delta-T Corporation, an engineering and design firm. In connection with each of the EPC contracts, Delta-T granted to us perpetual limited licenses to use Delta-T’s proprietary technology and information in connection with the operation, maintenance, optimization, enhancement and expansion of each of our facilities up to the designed limits. Consideration for the licenses was included as part of the payments under the EPC contracts. These facilities have been in operation for over three years, and during that period we have made capital modifications and improvements that have increased our capacity utilization rates and yield (measured by gallons of denatured ethanol per bushel of corn), and have continuously lowered our overall fixed costs per gallon of production.
Our relationship with Cargill
From inception, we have worked closely with Cargill, Inc., one of the world’s leading agribusiness companies, with whom we have an extensive commercial relationship. Cargill participates in almost every aspect of the corn industry in the United States, including operation of grain elevators, management of export facilities, transportation, ethanol production and livestock nutrition. Our two plant locations were selected primarily based on access to corn supplies, the availability of rail transportation and natural gas and Cargill’s competitive position in the area. Pursuant to 10-year ethanol marketing agreements, Cargill purchases 100% of the ethanol produced at our facilities and, under 20-year corn supply agreements, supplies 100% of our corn for these facilities. We also have the opportunity to utilize Cargill’s risk management services.
Corn supply
Our ethanol facilities each require approximately 41 million bushels of corn per year in order to produce their undenatured nameplate capacity of 110 Mmgy of ethanol. Cargill supplies all of the corn to our facilities. Under the corn supply agreements, Cargill has agreed to deliver U.S. No. 2 yellow dent corn meeting certain specifications. We regularly contract in advance for physical corn delivery (basis only). On the day of delivery, we pay the applicable corn futures price then in effect, less the local basis differential paid by Cargill to purchase corn on our behalf, plus an origination fee of $0.045 per bushel.
We have also entered into concurrent 20-year leases of Cargill’s existing grain elevators at each of our Wood River and Fairmont sites. These elevators provide corn storage capacity to service the plants at normal operating levels plus excess capacity to allow us to purchase corn opportunistically, for example, based on seasonality.
Sales logistics
Both of our ethanol plants are located adjacent to a rail mainline operated by the Union Pacific Railroad. A railcar unit train loading facility capable of handling up to 100 cars has been constructed at each of the plants. We typically ship ethanol in 80-car unit trains, which hold approximately 2.4 million gallons of ethanol, roughly equivalent to 8 days of ethanol production at each of these plants. We also have storage capacity to accommodate approximately 9 days of ethanol production and 9 days of dried distillers grain production at each of these plants. Each of our plants also has road access for loading and transportation of ethanol and distillers grain by truck, as needed.
Under our ethanol marketing agreements, Cargill performs a number of logistics functions relating to the ethanol produced at our facilities, utilizing its extensive network of rail and trucking relationships. These functions include arranging for rail and truck freight, bills of lading and scheduling pick-up appointments. Under the ethanol marketing agreements, we are responsible for providing tank railcars to service our facilities. As a result, we have entered into 10-year leases for our tank railcar fleet from Trinity Industries Leasing Company.
Ethanol Marketing
All of our ethanol is sold to Cargill as our third party marketer and distributor, for which Cargill is paid a commission. Cargill has established relationships with many of the leading end-users of ethanol products such as major oil companies and refiners, as well as independent jobbers, storage companies and transportation companies. Our ethanol that is sold in the United States is “pooled” with all of the ethanol produced by Cargill in the United States whereby we receive the average price of the ethanol sold for the producers in the marketing group. Each of the participants in the pool receives the same price for its share of ethanol sold, net of freight and other agreed costs incurred by Cargill with respect to the pooled ethanol. Freight and other charges are divided among pool participants based upon each participant’s ethanol volume in the pool rather than the location of the plant or the delivery point of the customer. We also sell a portion of our ethanol production to Cargill for export, which sales are shipped un-denatured and are excluded from the marketing pool.
Under our arrangements with Cargill, we have the ability to opt out of the marketing pool described above. In order to opt out of the marketing pool, we would need to provide six months’ notice prior to the date on which ethanol will first be delivered under the contract or any anniversary of that date, except that we may be obligated to participate in the pool for up to 18 months to the extent necessary to allow Cargill to fulfill contractual commitments to deliver ethanol from the pool. We also have the ability to sell ethanol directly to end-customers on a long-term basis, using Cargill as an agent, and in the future we may do so if an attractive opportunity arises. In these circumstances, Cargill would continue to provide transportation and logistics services, would act as a contracting agent and would continue to be paid commissions by us. We will evaluate the desirability of selling ethanol directly to end-customers on an ongoing basis.
Other agreements with Cargill
In addition to the agreements described above, our relationship with Cargill with respect to each of our ethanol facilities is governed by a master agreement. Each of these master agreements provides certain terms and conditions that apply to all of our agreements with Cargill with respect to the relevant plant. The master agreements contain a right of first negotiation in favor of Cargill in the event we subsequently acquire or construct additional ethanol facilities. Under this right, Cargill and we have agreed to negotiate in good faith for Cargill to provide all of the commercial arrangements covered by our agreements with respect to any additional facilities. The master agreements also allow for payments due and owing to each party under all of our agreements with Cargill to be netted and offset by the parties, although we have not done so and do not expect to do so in the future.
We have leased, for an initial term of twenty years, Cargill’s grain facilities located adjacent to each plant, for the purpose of receiving, storing and transferring corn to each ethanol facility. Under the lease agreements, we are responsible for the maintenance and repair of the premises. We will be in default under the leases, and Cargill will have the right to terminate the relevant lease, if we fail to pay any rent or other amounts due to Cargill within 30 days following written notice that such amounts are due and payable, default in any non-monetary obligation under the lease and fail to cure such default within a specified time, become subject to certain events of bankruptcy or insolvency or permit the relevant lease to be sold under any attachment or execution.
The Operating Subsidiaries entered into Omnibus Agreements with Cargill, which became effective on September 1, 2009. Pursuant to these agreements, Cargill agreed to extend payment terms for our corn purchases and defer a portion of certain fees and grain elevator lease payments payable to Cargill for one year. The deferred fees were to be payable to Cargill by the Operating Subsidiaries over a two-year period, and the payment terms for corn were to revert to the original terms beginning on September 1, 2010. On September 23, 2010, we entered into a Letter Agreement with Cargill that continues the extended payment terms for the duration of our corn supply agreements and reduces certain fees payable under those agreements and our ethanol marketing agreements. These agreements are expected to provide us with varying amounts of additional working capital over their duration. As of December 31, 2011, $2.9 million of such deferrals remained outstanding, and we continue to make periodic payments of deferred ethanol commissions at our discretion.
Other Marketing Arrangements
Distillers grain marketing
Under our distillers grain marketing agreements, all of the dried distillers grain produced at our two facilities is sold to an independent third party marketer and distributor, for which it is paid a commission. Our dried distillers grain is primarily marketed nationally to agricultural customers for use as an animal feed ingredient. Under these marketing agreements, our third party marketer also performs a number of logistics functions, which include arranging for rail and truck freight, bills of lading and scheduling pick-up appointments.
We market our wet distillers grain through another independent third party marketer. Due to its limited shelf life and high freight cost, wet distillers grain is sold primarily to local agricultural customers for use as an animal feed ingredient.
Corn oil marketing
During 2011, we began installing corn oil extraction systems at each of our plants so that we could begin producing corn oil as an additional co-product. These systems were installed using certain patented technology we have licensed from Greenshift Corporation, for which we pay a royalty. The installation in Wood River was completed in December 2011, and the installation in Fairmont was completed in January 2012. The corn oil produced at our plants is used primarily as a feedstock for the production of biodiesel and, potentially, as an animal feed ingredient. The corn oil produced in Wood River is being sold to the same independent third party marketer that purchases our dried distillers grains from that facility. The corn oil produced in Fairmont is being sold to a biodiesel producer under an off-take agreement. Corn oil is shipped from our plants by trucks.
Industry
Ethanol is a clean burning, high-octane fuel that is produced from the fermentation of carbohydrates such as grain-derived starches and sugars. In the United States, ethanol is produced primarily from corn. It is used primarily as a gasoline additive to increase octane rating and to comply with air emissions regulations by reducing emissions of carbon monoxide and nitrogen oxide. In addition, the Renewable Fuel Standard, or RFS, mandates that renewable biofuels comprise a certain minimum amount of the U.S. fuel supply. Fuel blended with up to 10% ethanol, also referred to as E10 fuel, is approved for use by major motor vehicle manufacturers and is often recommended as a result of ethanol’s clean burning characteristics. In December 2010, the U.S. EPA approved ethanol blends of up to 15% in motor fuel, referred to as E15, for use in all cars manufactured in 2007 and later years. In January 2011, the U.S. EPA extended that approval to cars made between 2001 and 2006. Ethanol also comprises up to 85% of E85 fuel, although flexible fuel vehicles, or FFV’s, capable of using E85 fuel currently comprise a relatively small portion of the U.S. motor vehicles on the road.
We believe that the key drivers of ethanol demand include:
Blending benefits
Ethanol has an octane rating of 113, and is added to gasoline to raise the octane level of gasoline. Unblended gasoline typically has a base octane level of approximately 84. Typical gasoline and ethanol blends (up to E10) have octane ratings ranging from 87 to 93. Higher octane gasoline has the benefit of reducing engine knocking. Gasoline with higher octane typically has been sold at a higher price per gallon than lower octane gasoline. At times when ethanol sells at a discount to gasoline, there are further economic incentives to blend ethanol into motor fuel.
Legislative and government policy support
As mandated by The Energy Independence and Security Act of 2007, or the 2007 Act, the RFS required that 12.6 billion gallons of conventional biofuels, which includes corn-based ethanol, be blended into the U.S. fuel supply in 2011, increasing to 15.0 billion gallons per year by 2015. The 2007 Act also mandated an increasing overall use of renewable fuels through 2022. The new targets are expected to be reached by phasing in additional volumes of both conventional biofuels (including corn-based ethanol) and “advanced biofuels,” such as cellulosic ethanol and biomass based diesel.
The RFS requires motor fuels sold in the United States to contain in the aggregate the following minimum volumes of renewable fuels:
In 2011 and 2012, due to the unavailability of advanced biofuels on a commercial scale, the U.S. EPA granted a waiver to the refining industry setting the cellulosic component of the advanced biofuel blending requirements at lower levels than those called for under the RFS.
Environmental benefits
Ethanol, as an oxygenate, reduces tailpipe emissions when added to gasoline. The additional oxygen in the ethanol results in a more complete combustion of the fuel in the engine cylinder, resulting in reduced carbon monoxide and nitrogen oxide emissions. Prior federal programs that mandated the use of oxygenated gasoline in areas with high levels of air pollution spurred widespread use of ethanol in the United States. Although the federal oxygenate requirement was eliminated in May 2006, oxygenated gasoline continues to be used in order to help meet separate federal and state air emission standards. The refining industry has generally abandoned the use of methyl tertiary butyl ether (MTBE), making ethanol the primary clean air oxygenate currently used.
Geopolitical concerns
The United States is dependent on foreign oil. Political unrest and attacks on oil infrastructure in the major oil-producing nations, particularly in the Middle East, have periodically disrupted the flow of oil. At the same time, developing nations such as China and India have increased their demand for oil. As a result, NYMEX oil prices have ranged dramatically in recent years. As a domestic, renewable source of energy, ethanol can help to reduce the United States’ dependence on foreign oil by increasing the amount of fuel that can be consumed for each barrel of imported crude oil. According to the Renewable Fuels Association, or RFA, the 13.9 billion gallons of ethanol produced in the U.S. in 2011 reduced demand for imported oil by 485 million barrels.
Ethanol as a gasoline substitute
Automakers in the United States now offer a wide variety of Flexible Fuel Vehicles, or FFVs, which are vehicles capable of running on blends up to 85% ethanol. Management believes that motorists may increasingly choose FFVs due to their lower greenhouse gas emissions, flexibility and performance characteristics. Changes in corporate average fuel economy, or CAFE, standards may also benefit the ethanol industry by encouraging use of E85 fuel products. Though E85 is not in widespread use today, auto manufacturers may find it attractive to build more flexible-fuel trucks and sport utility vehicles in order to meet CAFE standards. Future widespread adoption of FFVs could potentially boost ethanol demand and reduce the consumption of gasoline.
Supply of ethanol
The primary feedstock for ethanol production in the United States is corn. Proximity to corn supplies is a crucial factor in the economics of ethanol plants, as transporting corn is much more expensive than transporting the finished ethanol product. As such, the ethanol industry is geographically concentrated in the Midwest based on the proximity to the highest concentration of corn supply. In addition to corn, the ethanol production process requires natural gas or, in some cases, coal in order to power the facility and dry distillers grain.
Despite the geographic concentration, production in the ethanol industry remains fragmented. According to the RFA, as of January 2012 the ethanol industry in the United States was comprised of 209 production facilities with an aggregate industry capacity of approximately 14.9 billion gallons per year (“Bgpy”). According to the RFA, in 2011 domestic ethanol production was approximately 13.9 billion gallons. The top ten producers accounted for approximately 49% of the industry’s total estimated production capacity as of December 2011. Smaller producers and farmer-owned cooperatives, all of which have production capacities less than ours, generate the remaining production. Since a typical ethanol facility can be constructed in approximately 18 months from groundbreaking to operation, the industry is able to forecast capacity additions for up to 18 months in the future. As a result of the existing capacity and potential increases in production due to increasing yields and other improvements, the ethanol industry faces the risk of excess capacity. See “Risk Factors — Risks relating to our business and industry — Excess production capacity in our industry may result in over-supply of ethanol which could adversely affect our business”.
Ethanol is typically either produced by a dry-milling or wet-milling process. Although the two processes feature numerous technical differences, the primary operating trade-off of the wet-milling process is a higher co-product yield in exchange for a lower ethanol yield. Dry-milling ethanol production facilities, including the Company’s, constitute the substantial majority of new ethanol production facilities constructed in the past five years because of the increased efficiencies and lower capital costs of dry-milling technology. Older dry-mill ethanol facilities typically produce between five and 50 Mmgy, with newer dry-mill facilities producing over 100 Mmgy and expected to provide economies of scale in both construction and operating costs per gallon.
Ethanol production process
The dry-mill process of using corn to produce ethanol and co-products that we use at our plants is described below.
Step one: grain receiving, storing and milling
Corn is delivered by truck, at which point it is inspected, weighed and unloaded in a receiving building and then transferred to storage bins. On the grain receiving system, a dust collection system limits particulate emissions. Truck scales weigh delivered corn. The corn is then unloaded to the storage systems consisting of concrete and steel storage bins. From its storage location, corn is conveyed to cleaning machines called scalpers to remove debris from the corn before it is transferred to hammermills or grinders where it is ground into a flour, or “meal.”
Step two: conversion and liquefaction, fermentation and evaporation systems
The meal is conveyed into slurry tanks for processing. The meal is mixed with water and enzymes and heated to break the ground grain into a fine slurry. The slurry is routed through pressure vessels and steam flashed in a flash vessel. This liquefied meal, now called “mash”, reaches a temperature of approximately 200° F, which reduces bacterial build-up. The sterilized mash is then pumped to a liquefaction tank where additional enzymes are added. This cooked mash continues through liquefaction tanks and is pumped into one of the fermenters, where propagated yeast is added, to begin a batch fermentation process.
The fermentation process converts the cooked mash into carbon dioxide and fermented mash, called “beer”, which contains ethanol as well as all the solids from the original corn feedstock. The mash is kept in a fermentation tank for approximately two days. Circulation through heat exchangers keeps the mash at the proper temperature.
Step three: distillation and molecular sieve
After batch fermentation is complete, beer is pumped to an intermediate tank called the beer well and then to the columnar distillation tank to vaporize and separate the alcohol from the mash. The distillation results in a 96%, or 190-proof, alcohol. This alcohol is then transported through a system of tanks and molecular sieves where it is dehydrated to produce 200-proof anhydrous ethanol. The 200-proof ethanol is then denatured (rendered unfit for human consumption) by mixing up to approximately 2.4% unleaded gasoline to prepare it for sale in the U.S.
Step four: liquid-solid separation system
The residual corn mash from the distillation stripper, called “stillage”, is pumped into one of several decanter type centrifuges for dewatering. The water, or thin stillage, is then pumped from the centrifuges back to mashing or to an evaporator where it is dried into a thick syrup. The solids that exit the centrifuges, known as “wet cake”, are conveyed to the wet cake storage pad or the gas-fired dryer for removal of residual water. Syrup is added to the wet cake. The result is wet distillers grain with solubles. The wet distillers grain can then be placed into a dryer, where moisture is removed. The end result of the process is dried distillers grain.
Step five: product storage
Storage tanks hold the ethanol product prior to being transferred to loading facilities for truck and rail car transportation. Our plants each have approximately 3.1 million gallons of ethanol tank storage capacity, which will accommodate nine days of ethanol production per plant.
Co-products of ethanol production
Dried distillers grain with solubles. A co-product of dry-mill ethanol production, dried distillers grain is a high-protein and high-energy animal feed that is sold primarily as an ingredient in beef and dairy cattle rations. Dried distillers grain consists of the concentrated nutrients (protein, fat, fiber, vitamins and minerals) remaining after the starch in corn is converted to ethanol. Over 85% of the dried distillers grain is fed to cattle. It is also used in poultry, swine and other livestock feed.
Wet distillers grain with solubles. Wet distillers grain is similar to dried distillers grain except that the final drying stage of dried distillers grain is bypassed and the product is sold as a wet feed containing 25% to 35% dry matter, as compared to dried distillers grain, which contains about 90% dry matter. Wet distillers grain is an excellent livestock feed with better nutritional characteristics than dried distillers grain because it has not been exposed to the heat of drying. The sale of wet distillers grain is usually more profitable because the plant saves the cost of natural gas for drying. The product is sold locally because of its limited shelf life and the higher cost of transporting the product to distant markets.
Corn oil. Corn oil is extracted on the “back end” of the dry-mill ethanol production process from the condensed distillers solubles stream portion of the process. The oil is extracted using a separator, or centrifuge, and then further clarified in settling tanks. It is then sold either as a feedstock to produce biodiesel or as an animal feed ingredient. We began producing corn oil in January 2012.
Competition
Domestic Competition
The markets where our ethanol is sold are highly competitive. According to the RFA, industry capacity in the United States was approximately 14.9 billion gallons per year as of January 2012. The ethanol industry in the United States consisted of approximately 209 production facilities as of January 2012 with relatively few new facilities under construction or expansion, and is primarily corn-based.
Over the past few years, the U.S. ethanol industry has witnessed significant acquisition activity by gasoline and oil refiners that has resulted in a number of relatively large companies competing in the production of ethanol. As a result, we compete with both a small number of large, integrated companies that produce ethanol, as well as with a larger number of smaller, dedicated ethanol producers.