Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our market risk sensitive instruments and positions have inherent risks including potential loss from adverse changes in commodity prices, RINs prices, and interest rates.
Commodity Price Risk
The Company, as a manufacturer of refined petroleum and renewable products and of nitrogen fertilizer products, all of which are commodities, has exposure to market pricing for products sold in the future. In order to realize value from our processing capacity, a positive spread between the cost of raw materials and the value of finished products must be achieved (i.e., gross margin or crack spread). The physical commodities that comprise our raw materials and finished goods are typically bought and sold at a spot or index price that can be highly variable.
Beginning on January 1, 2024, the Petroleum Segment will utilize a new crude oil purchasing intermediary, Gunvor USA LLC, to purchase the majority of its non-gathered crude oil inventory for the refineries (prior to January 1, 2024, Vitol, Inc. was the intermediary; refer to Note 14 (“Commitments and Contingencies”) for additional information). This arrangement allows the Petroleum Segment to take title to and price its crude oil at locations in close proximity to the refineries, as opposed to the crude oil origination point, reducing its risk associated with volatile commodity prices by shortening the commodity conversion cycle time. The commodity conversion cycle time refers to the time elapsed between raw material acquisition and the sale of finished goods.
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In addition, our refining business seeks to reduce the variability of commodity price exposure by engaging in hedging strategies and transactions that will serve to protect gross margin as forecasted in the annual operating plan. With regard to its hedging activities, our refining business may enter into, or has entered into, financial instruments which serve to (1) lock in or fix a percentage of the anticipated or planned gross margin in future periods when the derivative market offers commodity spreads that generate positive cash flows, (2) hedge the value of inventories in excess of minimum required inventories, and (3) manage existing positions related to a change in anticipated operations and market conditions.
The Nitrogen Fertilizer Segment has commitments to purchase natural gas for use in the East Dubuque Fertilizer Facility at the spot market and through short-term, fixed supply, fixed price, and index price purchase contracts. In the normal course of business, nitrogen-based fertilizer products are produced throughout the year to supply the needs of our customers during the high-delivery-volume spring and fall seasons. The value of fertilizer product inventory is subject to market risk due to fluctuations in the relevant commodity prices. Prices of nitrogen fertilizer products can be volatile. We believe that market prices of nitrogen products are affected by changes in grain prices, demand, natural gas prices, and other factors.
RFS Compliance Price Risk
As a producer of transportation fuels from crude oil, the Petroleum Segment’s obligated-party subsidiaries are required to blend biofuels into the products it produces or purchase RINs in the open market in lieu of blending to meet the mandates established by the EPA, unless the obligations are waived, such as through a small refinery waiver. The Petroleum Segment’s obligated-party subsidiaries are exposed to market risk related to volatility in the price of RINs needed to comply with the RFS that are not otherwise generated through blending of renewable fuels in our refining and marketing operations. To mitigate the impact of this risk on the Petroleum Segment’s results of operations and cash flows, the Petroleum Segment’s obligated-party subsidiaries blend ethanol and biodiesel to the extent possible. Alleviating the Company’s exposure to the market risk of RINs price volatility, the Petroleum Segment’s obligated-party subsidiaries purchase internally generated RINs from our renewable diesel operations to partially satisfy their RFS obligations through the completion of the renewable diesel project at our Wynnewood Refinery in April 2022, which converted the Wynnewood Refinery’s hydrocracker to a RDU capable of producing approximately 100 million gallons of renewable diesel per year and generating up to approximately 170 to 180 million RINs annually depending on operations. We continually monitor the impact of the RFS on our business and evaluate strategies to mitigate the impacts of the RFS program, the administration thereof, and the market volatility for RINs on our business. Refer to Part I, Item 1A, “Risk Factors”, Part II, Item 7, “Management’s Discussion and Analysis” and Part II, Item 8, Note 14 (“Commitments and Contingencies”), of this Report for further discussion about compliance with the RFS and the potential impacts on our business.
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