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algae strains produced by the Grower Harvester system for the feed trials demonstrated high energy and protein content that
was readily available, similar to other high value feed products used in the feeding of poultry today. BioProcess Algae broke
ground on a five acre algae farm in the first quarter of 2012 at the same location. If we and the other BioProcess Algae
members determine that the venture can achieve the desired economic performance from the five acre farm, a build-out of
400 acres of Grower Harvester reactors will be considered. The cost of such a build-out is estimated at $40 million to $60
million and could take up to a year to complete. Funding for BioProcess Algae for such a project would come from a variety
of sources including current partners, new equity investors, debt financing or a combination thereof. If a decision was made
to replicate such a 400 acre algae farm at all of our ethanol plants, we estimate that the required investment could range from
$300 million to $500 million. BioProcess Algae currently is exploring potential algae markets including animal feeds,
nutraceuticals and biofuels.
Industry Factors Affecting our Results of Operations
Variability of Commodity Prices.
Our operations and our industry are highly dependent on commodity prices, especially
prices for corn, ethanol, distillers grains and natural gas. Because the market prices of these commodities are not always
correlated, at times ethanol production may be unprofitable. As commodity price volatility poses a significant threat to our
margin structure, we have developed a risk management strategy focused on locking in favorable operating margins when
they are available. We continually monitor market prices of corn, natural gas and other input costs relative to the prices for
ethanol and distillers grains at each of our production facilities. We create offsetting positions by using a combination of
derivative instruments, fixed-price purchases and sales contracts, or a combination of strategies within strict limits. Our
primary focus is not to manage general price movements of individual commodities, for example to minimize the cost of corn
consumed, but rather to lock in favorable profit margins whenever possible. By using a variety of risk management tools and
hedging strategies, including our internally-developed real-time margin management system, we believe we are able to
maintain a disciplined approach to risk.
There may be periods of time that, due to the variability of commodity prices and compressed margins identified by our
risk management system, we make a decision to reduce or cease ethanol production operations at certain of our ethanol
plants. In the first quarter of 2012, we have reduced production volumes at two of our ethanol plants by approximately 30%,
or about 5% of our total production, in direct response to unfavorable operating margins. In response to relatively strong
margins in the fourth quarter of 2011, the ethanol industry increased production and ended the year with excess inventories,
which has adversely affected the margin environment in the beginning of 2012.
Reduced Availability of Capital.
Some ethanol producers have faced financial distress over the past few years,
culminating with bankruptcy filings by several companies. This, in combination with continued volatility in the capital
markets has resulted in reduced availability of capital for the ethanol industry generally. In this market environment, we may
experience limited access to incremental financing.
Federal and state governments have enacted numerous policies, incentives and subsidies to encourage the
usage of domestically-produced alternative fuel solutions. Passed in 2007 as part of the Energy Independence and Security
Act, a federal Renewable Fuels Standard, or RFS, has been and we expect will continue to be a driving factor in the growth
of ethanol usage. The RFS Flexibility Act was introduced on October 5, 2011 in the U.S. House of Representatives to reduce
or eliminate the volumes of renewable fuel use required by RFS based upon corn stocks-to-use ratios. The Domestic
Alternative Fuels Act of 2012 was introduced on January 18, 2012 in the U.S. House of Representatives to modify the RFS to
include ethanol and other fuels produced from fossil fuels like coal and natural gas.
To further drive growth in the increased adoption of ethanol, Growth Energy, an ethanol industry trade association, and a
number of ethanol producers requested a waiver from the EPA to increase the allowable amount of ethanol blended into
gasoline from the current 10% level, or E10, to a 15% level, or E15. In October 2010, the EPA granted a partial waiver for
E15 for use in model year 2007 and newer model passenger vehicles, including cars, SUVs, and light pickup truck. In
January 2011, the EPA granted a second partial waiver for E15 for use in model year 2001 to 2006 passenger vehicles. On
February 17, 2012, the EPA announced that evaluation of the health effects tests on E15 are complete and that fuel
manufacturers are now able to register E15 with the EPA to sell. Another major benefit to the industry was the blender’s
credit, which allowed gasoline distributors who blended ethanol with gasoline to receive a federal excise tax credit of $0.45
per gallon of pure ethanol used, or $0.045 per gallon for E10 and $0.3825 per gallon for E85. The blender’s credit expired on
December 31, 2011; however, even without the blender’s credit, ethanol remains at a discount to gasoline.
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the
Reform Act, which, among other things, aims to improve transparency and accountability in derivative markets. While the