BLUE DOLPHIN ENERGY CO - Quarter Report: 2021 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2021

or

For the transition period from ___________ to ___________

Commission File No. 0-15905

713-568-4725

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒     No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒     No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes ☐     No ☒

Number of shares of common stock, par value $0.01 per share outstanding as of November 15, 2021: 12,693,514

Glossary of Terms

Throughout this Quarterly Report on Form 10-Q, we have used the following terms:

Affiliate. Refers, either individually or collectively, to certain related parties, including Jonathan Carroll, Chairman and Chief Executive Officer of Blue Dolphin, and his affiliates (including Carroll & Company Financial Holdings, L.P., Ingleside, and Lazarus Capital, LLC) and/or LEH and its affiliates (including Lazarus Midstream Partners, L.P. and LTRI). Together, Jonathan Carroll and LEH owned approximately 82% of the Common Stock as of the filing date of this report.

Amended Pilot Line of Credit. Line of Credit Agreement dated May 3, 2019, between Pilot and NPS and subsequently amended on May 9, 2019, May 10, 2019, and September 3, 2019, the last amendment being Amendment No. 1; original line of credit amount was $13.0 million; effective October 4, 2021, NPS repaid all its obligations under the Amended Pilot Line of Credit.

Amended and Restated Operating Agreement. Affiliate agreement dated April 1, 2020, between Blue Dolphin, LE, LRM, NPS, BDPL, BDPC, BDSC, and LEH governing LEH’s operation and management of those companies’ assets.

ARO. Asset retirement obligations.

ASU. Accounting Standards Update.

AGO. Atmospheric gas oil is the heaviest product boiled by a crude distillation tower operating at atmospheric pressure. This fraction ordinarily sells as distillate fuel oil, either in pure form or blended with cracked stocks. Certain ethylene plants, called heavy oil crackers, can take AGO as feedstock.

bbl. Barrel; a unit of volume equal to 42 U.S. gallons.

BDEC Term Loan Due 2051. Loan Agreement dated May 4, 2021, between Blue Dolphin and the SBA in the original principal amount of $0.5 million.

BDPC. Blue Dolphin Petroleum Company, a wholly-owned subsidiary of Blue Dolphin.

BDPL. Blue Dolphin Pipe Line Company, a wholly-owned subsidiary of Blue Dolphin.

BDSC. Blue Dolphin Services Co., a wholly-owned subsidiary of Blue Dolphin.

Blue Dolphin. Blue Dolphin Energy Company, one or more of its consolidated subsidiaries, or all of them taken as a whole.

bpd. Barrel per day; a measure of the bbls of daily output produced in a refinery or transported through a pipeline.

Board. Board of Directors of Blue Dolphin.

BOEM. U.S. Bureau of Ocean Energy Management.

BSEE. U.S. Bureau of Safety and Environmental Enforcement.

Capacity utilization rate. A percentage measure that indicates the amount of available capacity that is being used in a refinery or transported through a pipeline. To calculate capacity utilization rate, divide total refinery throughput or total refinery production on a bpd basis by the crude distillation tower’s total capacity (currently 15,000 bpd).

CIP. Construction in progress.

COVID-19. An infectious disease first identified in 2019 in Wuhan, the capital of China’s Hubei province; the disease has since spread globally, resulting in the ongoing 2019–2021 coronavirus pandemic.

Common Stock. Blue Dolphin common stock, par value $0.01 per share. Blue Dolphin has 20,000,000 shares of Common Stock authorized, and 12,693,514 shares of Common Stock issued and outstanding.

Complexity. A numerical score that denotes, for a given refinery, the extent, capability, and capital intensity of the refining processes downstream of the crude distillation tower. Refinery complexities range from the relatively simple crude distillation tower (“topping unit”), which has a complexity of 1.0, to the more complex deep conversion (“coking”) refineries, which have a complexity of 12.0.

Condensate. Liquid hydrocarbons produced in conjunction with natural gas. Although condensate is sometimes like crude oil, it is usually lighter.

Cost of goods sold. Crude oil and condensate costs, fuel use, and chemicals.

Crude distillation tower. A tall column-like vessel in which crude oil and condensate are heated and their vaporized components are distilled utilizing distillation trays. This process refines crude oil and other inputs into intermediate and finished petroleum products. (Commonly referred to as a crude distillation unit or an atmospheric distillation unit.)

Crude oil. A mixture of thousands of chemicals and compounds, primarily hydrocarbons. Crude oil quality is measured in density (light to heavy) and sulfur content (sweet to sour). Distillation must break crude oil into various components before these chemicals and compounds can be used as fuels or converted to more valuable products.

Depropanizer unit. A distillation column used to isolate propane from a mixture containing butane and other heavy components.

Distillates. The result of crude distillation and, therefore, any refined oil product. There are mainly four (4) types of distillates: (i) very light oils or light distillates (such as naphtha), (ii) light oils or middle distillates (such as our jet fuel), (iii) medium oils, and (iv) heavy oils (such as our low-sulfur diesel and HOBM, reduced crude, and AGO).

Distillation. The first step in the refining process; crude oil and condensate are heated at atmospheric pressure in the base of a distillation tower. As the temperature increases, the various compounds vaporize in succession at their respective boiling points and then rise to prescribed levels within the tower per their densities, from lightest to heaviest. They then condense in distillation trays and are drawn off individually for further refining. Distillation is also used at other points in the refining process to remove impurities.

DOT. U.S. Department of Transportation.

Downtime. Scheduled and unscheduled periods in which the crude distillation tower is not operating. Downtime may occur for various reasons, including bad weather, power failures, and preventive maintenance.

EIA. U.S. Energy Information Administration.

EIDL. Economic Injury Disaster Loan; provides economic relief to businesses that experienced a temporary loss of revenue due to COVID-19.

EPA. U.S. Environmental Protection Agency.

Eagle Ford Shale. A hydrocarbon-producing geological formation that extends across South Texas from the Mexican border into East Texas.

Equipment Loan Due 2025. Installment sales contract dated October 13, 2020, between LE and Texas First to purchase a backhoe. LE previously rented the backhoe under a rent-to-own agreement that matured.

Exchange Act. Securities Exchange Act of 1934, as amended.

FASB. Financial Accounting Standards Board.

FDIC. Federal Deposit Insurance Corporation.

Feedstocks. Crude oil and other hydrocarbons, such as condensate and intermediate products; used as primary input materials in the refining process. Feedstocks are processed into one or more finished products.

Finished petroleum products. Materials or products at their final increments of value through processing; products held in inventory for delivery, sale, or use.

Freeport facility. Assets in Freeport, Texas; comprised of (i) crude oil and natural gas separation and dehydration units, (ii) natural gas processing, treating, and redelivery units, (iii) a vapor recovery unit, (iv) two onshore pipelines, and (v) 162 acres of land.

GAAP. Accounting principles generally accepted in the United States of America.

GEL. GEL Tex Marketing, LLC, a Delaware limited liability company and an affiliate of Genesis Energy, LLC; an arbitrator awarded GEL damages, attorney fees, and related expenses in August 2017; the parties fully resolved the dispute in August 2019.

Gross profit (deficit). Calculated as total revenue less cost of goods sold; reflected as a dollar ($) amount.

HOBM. Heavy oil-based mud blendstock; see also “distillates.”

HUBZone. Historically Underutilized Business Zones program established by the SBA to help small businesses in both urban and rural communities.

IBLA. U.S. Interior Board of Land Appeals.

INC. Incident of Noncompliance issued by BOEM and BSEE.

Ingleside. Ingleside Crude, LLC, an affiliate of Jonathan Carroll.

Intermediate petroleum products. A petroleum product that might require further processing before being offered for sale to a customer. Additional processing may be done by the producer or by another processor. Thus, an intermediate petroleum product might be a final product for one company and input for another company to further process.

IRC Section 382. Title 26, Internal Revenue Code, Subtitle A – Income Taxes, Subchapter C – Corporate Distributions and Adjustments, Part V Carryovers, § 382. Limits NOL carryforwards and certain built-in losses following an ownership change.

IRS. U.S. Internal Revenue Service.

Jet fuel. A high-quality kerosene product primarily used in aviation. Kerosene-type jet fuel (including Jet A and Jet A-1) has a carbon number distribution between 8 and 16 carbon atoms per molecule; wide-cut or naphtha-type jet fuel (including Jet B) has between 5 and 15 carbon atoms per molecule.

Kissick Debt. A loan agreement initially entered between LE and Notre Dame Investors, Inc. in the principal amount of $8.0 million. John Kissick currently holds the debt. In 2017, the parties amended the Kissick Debt to increase the principal amount by $3.7 million; LE used $3.6 million of the additional principal to reduce the arbitration award payable to GEL. The Kissick Debt matured in January 2018 and is currently in default. The Kissick Debt was previously disclosed as the Notre Dame Debt.

LE. Lazarus Energy, LLC, a wholly-owned subsidiary of Blue Dolphin.

LE Term Loan Due 2034. Loan Agreement dated June 22, 2015, between LE and Veritex in the original principal amount of $25.0 million; currently in default.

LE Term Loan Due 2050. Loan Agreement dated August 29, 2020, between LE and the SBA in the original principal amount of $0.15 million.

LEH. Lazarus Energy Holdings, LLC, an affiliate of Jonathan Carroll and controlling shareholder of Blue Dolphin.

LEH Operating Fee. A management fee paid to LEH under the Amended and Restated Operating Agreement; calculated as 5% of all consolidated operating expenses, excluding crude costs, depreciation, amortization, and interest, of Blue Dolphin, LE, LRM, NPS, BDPL, BDPC, and BDSC; previously reflected within refinery operating expenses in our consolidated statements of operations.

Leasehold interest. The interest of a lessee under an oil and gas lease.

Light crude. Liquid petroleum that has a low density and flows freely at room temperature. Has a low viscosity, low specific gravity, and a high American Petroleum Institute gravity due to high proportion of light hydrocarbon fractions.

LRM. Lazarus Refining & Marketing, LLC, a wholly-owned subsidiary of Blue Dolphin.

LRM Term Loan Due 2034. Loan Agreement dated December 4, 2015, between LRM and Veritex in the original principal amount of $10.0 million; currently in default.

LTRI. Lazarus Texas Refinery I, an affiliate of LEH.

Naphtha. A refined or partly refined light distillate fraction of crude oil. When blended further or mixed with other materials, it can make high-grade motor gasoline or jet fuel. It is also a generic term applied to the lightest and most volatile petroleum fractions.

Natural gas. A naturally occurring hydrocarbon gas mixture consisting primarily of methane, but commonly including varying amounts of other higher alkanes, and sometimes a small percentage of carbon dioxide, nitrogen, hydrogen sulfide, or helium.

Nixon facility. Assets in Nixon, Texas; comprised of (i) a crude distillation tower, (ii) petroleum storage tanks, (iii) loading and unloading facilities, and (iv) 56 acres of land.

Nixon refinery. The 15,000-bpd crude distillation tower and associated processing units at the Nixon facility.

NPS. Nixon Product Storage, LLC, a wholly-owned subsidiary of Blue Dolphin.

NPS Term Loan Due 2050. Loan Agreement dated August 29, 2020, between NPS and the SBA in the original principal amount of $0.15 million.

NOL. Net operating losses.

Operating days. The number of days that the crude distillation tower was in use during a period. To calculate operating days, subtract downtime in a period from calendar days in the same period.

OPEC. Organization of Petroleum Exporting Countries.

OSHA. U.S. Occupational Safety and Health Administration.

Other conversion costs. Represents the combination of direct labor costs and manufacturing overhead costs. These are the costs that are necessary to convert our raw materials into refined products.

Other operating expenses. Represents costs associated with our natural gas processing, treating, and redelivery facility and our pipeline assets and leasehold interests in oil and gas properties.

PCAOB. Public Company Accounting Oversight Board.

Petroleum. A naturally occurring flammable liquid consisting of a complex mixture of hydrocarbons of various molecular weights and other liquid organic compounds. Petroleum reflects both the naturally occurring, unprocessed crude oils and products made up of refined crude oil.

PHMSA. Pipeline and Hazardous Materials Safety Administration of the U.S. Department of Transportation.

Pilot. Pilot Travel Centers LLC, a Delaware limited liability company.

Preferred Stock. Blue Dolphin preferred stock, par value $0.10 per share. Blue Dolphin has 2,500,000 shares of Preferred Stock authorized, and no shares of Preferred Stock issued and outstanding.

Product slate. Type and quality of products produced.

Propane. A by-product of natural gas processing and petroleum refining. Propane is one of a group of liquified petroleum gases. Others include butane, propylene, butadiene, butylene, isobutylene, and mixtures thereof.

Refined products. Hydrocarbon compounds, such as jet fuel and residual fuel, that a refinery produces.

Refinery. In the oil and gas industry, a refinery is an industrial processing plant where crude oil, condensate, and intermediate feeds are separated and transformed into petroleum products.

Refining gross profit (deficit) per bbl. Calculated as refinery operations revenue less total cost of goods sold divided by the volume, in bbls, of refined products sold during the period; reflected as a dollar ($) amount per bbl.

ROU. Right-of-use.

SBA. U.S. Small Business Administration.

SEC. U.S. Securities and Exchange Commission.

Securities Act. The Securities Act of 1933, as amended.

Segment margin (deficit). For our refinery operations and tolling and terminaling business segments, represents net revenues (excluding intercompany fees and sales) attributable to the respective business segment less associated intercompany fees and sales less associated operation costs and expenses.

Stabilizer unit. A distillation column intended to remove the lighter boiling compounds, such as butane or propane, from a product.

Sulfur. Present at various levels of concentration in many hydrocarbon deposits, such as petroleum, coal, or natural gas. The process of removing sulfur-containing contaminants from natural gas and petroleum also produces sulfur as a by-product. Some of the most commonly used hydrocarbon deposits are categorized by their sulfur content. Lower sulfur fuels usually sell at a premium price; higher sulfur fuels sell at a discount.

Texas First. Texas First Rentals, LLC.

Throughput. Volume processed through a crude distillation tower or refinery or transported through a pipeline.

TMT. Texas margins tax; a form of business tax imposed on an entity’s gross profit rather than its net income.

Topping unit. A type of petroleum refinery that engages in only the first step of the refining process -- crude distillation. A topping unit uses atmospheric distillation to separate crude oil and condensate into constituent petroleum products. A topping unit has a refinery complexity range of 1.0 to 2.0.

Total refinery production. Refers to the volume processed as output through the crude distillation tower. Refinery production includes finished petroleum products, such as jet fuel, and intermediate petroleum products, such as naphtha, HOBM, and AGO.

Turnaround. Scheduled large-scale maintenance activity wherein an entire process unit is taken offline for a week or longer for a more comprehensive revamp and renewal.

USACOE. U.S. Army Corps of Engineers.

USDA. U.S. Department of Agriculture.

Veritex. Veritex Community Bank, successor in interest to Sovereign Bank by merger.

WSJ prime rate. A measure of the U.S. prime rate as defined by the Wall Street Journal.

XBRL. eXtensible Business Reporting Language.

Yield. The percentage of refined products produced from crude oil and other feedstocks.

Important Information Regarding Forward-Looking Statements

This report (including information incorporated by reference) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, including, but not limited to, those under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All statements other than statements of historical fact, including without limitation statements regarding expectations regarding revenue, cash flows, capital expenditures, other financial items, business strategy, goals, expectations concerning market position, future operations, and profitability, are forward-looking statements. Forward-looking statements may be identified by the use of the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar terms and phrases. We believe our assumptions concerning future events are reasonable. However, several risks, uncertainties, and other factors could cause actual results and trends to differ materially from those projected. These include, but are not limited to:

Risks Related to the COVID-19 Pandemic

Business and Industry

Downstream and Midstream Operations

Pipeline and Facilities and Oil and Gas Assets

Common Stock

See also the risk factors described in greater detail under “Item 1A.” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as filed with the SEC and elsewhere in this filing. All forward-looking statements included in this report are based on information available to us on the date of this report. We undertake no obligation to revise or update any forward-looking statements due to new information, future events, or otherwise. References in this report to “Blue Dolphin,” “we,” “us,” “our,” or “ours” refer to Blue Dolphin Energy Company, one or more of Blue Dolphin’s subsidiaries, or all of them taken as a whole (unless the context otherwise requires).

PART I

ITEM 1. FINANCIAL STATEMENTS

Consolidated Balance Sheets (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Operations (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Cash Flows (Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

Notes to Consolidated Financial Statements

(1) Organization

Overview

Blue Dolphin was formed in 1986 as a Delaware corporation. The company is an independent downstream energy company operating in the Gulf Coast region of the United States. Operations primarily consist of a light sweet-crude, 15,000-bpd crude distillation tower, and approximately 1.2 million bbls of petroleum storage tank capacity in Nixon, Texas. Blue Dolphin trades on the OTCQX under the ticker symbol “BDCO.”

Assets are primarily organized in two segments: ‘refinery operations’ (owned by LE) and ‘tolling and terminaling services’ (owned by LRM and NPS). ‘Corporate and other’ includes BDPL (inactive pipeline and facilities assets), BDPC (inactive leasehold interests in oil and gas wells), and BDSC (administrative services). See “Note (4)” to our consolidated financial statements for more information about our business segments.

Unless the context otherwise requires, references in this report to “Blue Dolphin,” “we,” “us,” “our,” or “ours” refer to Blue Dolphin, one or more of Blue Dolphin’s subsidiaries, or all of them taken as a whole.

Affiliates

Affiliates controlled approximately 82% of the voting power of our Common Stock as of the filing date of this report. An Affiliate operates and manages all Blue Dolphin properties and funds working capital requirements during periods of working capital deficits. In addition, an Affiliate is a significant customer of our refined products. Blue Dolphin and certain of its subsidiaries are currently parties to a variety of agreements with Affiliates. See “Note (3)” to our consolidated financial statements for additional disclosures related to Affiliate agreements, arrangements, and risks associated with working capital deficits.

Going Concern

Management determined that certain factors raise substantial doubt about our ability to continue as a going concern. These factors include defaults under secured loan agreements, margin volatility, and historical net losses and working capital deficits, as discussed more fully below. Our consolidated financial statements assume we will continue as a going concern and do not include any adjustments that might result from this uncertainty. Our ability to continue as a going concern depends on sustained positive operating margins and adequate working capital for, amongst other requirements, purchasing crude oil and condensate and making payments on long-term debt. If we are unable to process crude oil and condensate into sellable refined products or make required debt payments, we may consider other options. These options might include selling assets, raising additional debt or equity capital, cutting costs, reducing cash requirements, restructuring debt obligations, or filing bankruptcy.

Defaults Under Secured Loan Agreements. We are currently in default under certain of our secured loan agreements with third parties and related parties.

Third-Party Defaults

Related-Party Defaults

As of the filing date of this report, Blue Dolphin was in default concerning past due payment obligations under the March Carroll Note, March Ingleside Note, and June LEH Note. As of the same date, BDPL was also in default related to past due payment obligations under the BDPL-LEH Loan Agreement. Affiliates controlled approximately 82% of the voting power of our Common Stock as of the filing date of this report, an Affiliate operates and manages all Blue Dolphin properties, an Affiliate is a significant customer of our refined products, and we borrow from Affiliates during periods of working capital deficits.

Substantial Current Debt

As of September 30, 2021, and December 31, 2020, we had current debt of $58.4 million and $57.7 million, respectively, consisting of bank debt, related party debt, and the line of credit payable to Pilot, although the Pilot debt was subsequently repaid. Substantial current debt is primarily the result of secured loan agreements being in default. As a result, these debt obligations were classified within the current portion of long-term debt on our consolidated balance sheets at September 30, 2021, and December 31, 2020.

Margin Volatility. Our refining margins generally improve in an environment of higher crude oil and refined product prices, and where the spread between crude oil prices and refined product prices widens. In early 2020, global and national measures taken to address the COVID-19 pandemic, including government-imposed temporary business closures and voluntary shelter-at-home directives, caused oil prices to decline sharply. In addition, actions by members of OPEC and other producer countries in 2020 concerning oil production and pricing significantly impacted supply and demand in global oil and gas markets. With the introduction and approval of COVID-19 vaccines and increased inoculation rates, global economic activity has shown signs of recovery in 2021. Current EIA forecasts show economic growth and mobility increases in the short term. Also, refinery margins are forecasted to improve during the winter months due to projected colder winter temperatures compared to 2020 and low distillates inventory levels. However, forecasts are subject to various factors that are subject to change, including the ongoing impact of COVID-19 and related variants. As a result, we are currently unable to estimate our future financial position and results of operations. Accordingly, we believe these factors could have a material adverse effect on our financial results for the remainder of 2021 and into 2022.

Historical Net Losses and Working Capital Deficits

Net Losses. Net loss for the three months ended September 30, 2021, was $2.9 million, or a loss of $0.23 per share, compared to a net loss of $4.7 million, or a loss of $0.37 per share, during the three months ended September 30, 2020. Net loss for the nine months ended September 30, 2021, was $10.2 million, or a loss of $0.80 per share, compared to a net loss of $12.2 million, or a loss of $0.98 per share, for the nine months ended September 30, 2020. The improvement between both comparative periods resulted from demand recovery, commodity price improvements, and encouraging trends in pandemic containment efforts.

Working Capital Deficits. We had $79.8 million and $72.3 million in working capital deficits at September 30, 2021, and December 31, 2020, respectively. Excluding the current portion of long-term debt, we had $26.2 million and $22.6 million in working capital deficits at September 30, 2021, and December 31, 2020, respectively.

Cash and cash equivalents totaled $2.2 million and $0.5 million at September 30, 2021, and December 31, 2020, respectively. Restricted cash (current portion) totaled $0.05 million at both September 30, 2021, and December 31, 2020. Restricted cash, noncurrent totaled $0 and $0.5 million at September 30, 2021, and December 31, 2020, respectively.

Our financial health has been materially and adversely affected by defaults in our secured loan agreements, margin volatility, and historical net losses and working capital deficits. If Pilot terminates the crude supply agreement or terminal services agreement, our ability to acquire crude oil and condensate could be adversely affected. If producers experience crude supply constraints and increased transportation costs, our crude acquisition costs may rise, or we may not receive sufficient amounts to meet our needs. During the three-month periods ended September 30, 2021, and 2020, our refinery experienced 6 days and 8 days of downtime, respectively, due to crude deficiencies associated with COVID-19 related cash constraints. During the nine-month periods ended September 30, 2021, and 2020, our refinery experienced 11 days and 16 days of downtime, respectively.

Operating Risks

Successful execution of our business strategy depends on several critical factors, including having adequate working capital to meet contractual, operational, regulatory, and safety needs and having favorable margins on refined products. We are currently unable to estimate the impact the COVID-19 pandemic will have on our future financial position and results of operations. Earlier state and federal mandates that regulated business closures due to COVID-19 deemed our business essential, and we remained open. If future restrictive directives become necessary, we expect to continue operating. However, additional governmental mandates will likely result in business and operational disruptions, including demand destruction, liquidity strains, supply chain challenges, travel restrictions, controls on in-person gathering, and workforce availability.

Management continues to take steps to mitigate risk, avoid business disruptions, manage cash flow, and remain competitive in a volatile commodity price environment. Mitigation steps include: adjusting throughput and production based on market conditions, optimizing receivables and payables by prioritizing payments, managing inventory to avoid buildup, monitoring discretionary spending, and delaying capital expenditures. To safeguard personnel, we adopted remote working where possible and social distancing, mask-wearing, and other site-specific precautionary measures where on-site operations are required. We also incentivize personnel to receive the COVID-19 vaccine.

We can provide no guarantees that: our business strategy will be successful, Affiliates will continue to fund our working capital needs when we experience working capital deficits, we will meet regulatory requirements to provide additional financial assurance (supplemental pipeline bonds) and decommission offshore pipelines and platform assets, we will be able to obtain additional financing on commercially reasonable terms or at all, or margins on our refined products will be favorable. Further, if Veritex exercises its rights and remedies under our secured loan agreements, our business, financial condition, and results of operations will be materially adversely affected.

(2) Principles of Consolidation and Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements, including Blue Dolphin and its subsidiaries, were prepared under GAAP for interim consolidated financial information according to the rules and regulations of the SEC under Article 10 of Regulation S-X and the instructions to Form 10-Q. Accordingly, certain information and footnote disclosures usually included in our audited financial statements were condensed or omitted according to the SEC’s rules and regulations. Significant intercompany transactions were eliminated in the consolidation. In management’s opinion, consolidated financial statements include all necessary adjustments for a fair presentation, disclosures are adequate, and the presented information is not misleading.

We derived the consolidated balance sheet as of December 31, 2020, from the audited financial statements at that date. We recommend that investors read the consolidated financial statements and notes in this report together with the consolidated financial statements and notes in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as filed with the SEC. Our financial and operating results for the three and nine months ended September 30, 2021, should not be exclusively relied upon to indicate our performance for the fiscal year ending December 31, 2021, or any other period.

Significant Accounting Policies

The summary of Blue Dolphin’s significant accounting policies assists investors in understanding our consolidated financial statements. Our consolidated financial statements and accompanying notes are representations of management, who is responsible for their integrity and objectivity. We consistently applied these accounting policies in the preparation of our consolidated financial statements. Our accounting policies conform to GAAP.

Use of Estimates. Preparing our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. Actual results could differ from those estimates. The ongoing COVID-19 pandemic and corresponding governmental responses, volatility in commodity prices, and severe weather resulting from climate change have impacted and likely will continue to impact our business. We assessed certain accounting matters that generally require consideration of forecasted financial information in context with the information reasonably available to us and the unknown future impacts of COVID-19 as of September 30, 2021, and through the filing date of this report. The accounting matters assessed included but were not limited to our allowance for doubtful accounts, inventory and related reserves, and the carrying value of long-lived assets.

Cash and Cash Equivalents. Cash and cash equivalents represent liquid investments with an original maturity of three months or less. We maintain cash balances in depository and overnight investment accounts with financial institutions that, at times, may exceed insured deposit limits. We monitor the financial condition of the financial institutions and, to date, have experienced no losses associated with these accounts.

Restricted Cash. Restricted cash, current portion primarily represents a payment reserve account held by Veritex as security for payments under a secured loan agreement. Restricted cash, noncurrent represents funds held in the Veritex disbursement account for payment of construction-related expenses for completion of new petroleum storage tanks.

Accounts Receivable and Allowance for Doubtful Accounts. We present accounts receivable net of any necessary allowance(s) for doubtful accounts. Receivables are recorded at the invoiced amount and generally do not bear interest. Management establishes or adjusts an allowance for doubtful accounts based on a customer’s current aging status, collection history, and financial condition. At September 30, 2021, and December 31, 2020, we had an allowance for doubtful accounts of $0 and $0.1 million, respectively.

Inventory. Inventory primarily consists of refined products, crude oil, condensate, and chemicals. We value inventory at the lower of cost or net realizable value with cost determined by the average cost method and net realizable value determined based on estimated selling prices less associated delivery costs. We record a write-down of inventory and an associated adjustment to the cost of goods sold if the net realizable value of our refined products inventory declines to an amount that is less than our average cost. See “Note (7)” to our consolidated financial statements for additional disclosures related to inventory.

Property and Equipment.

Refinery and Facilities. We typically make ongoing improvements to the Nixon facility based on operational needs, technological advances, and safety and regulatory requirements. We capitalize additions to refinery and facilities assets, and we expense costs for repairs and maintenance as incurred. We record refinery and facilities at cost less any adjustments for depreciation or impairment. We adjust the asset and the related accumulated depreciation accounts for the refinery and facilities asset’s retirement and disposal, with the resulting gain or loss included in the consolidated statements of operations. For financial reporting purposes, we compute refinery and facilities assets depreciation using the straight-line method with an estimated useful life of 25 years; we depreciate refinery and facilities assets when placed in service. We did not record any impairment of our refinery and facilities assets for the periods presented.

Pipelines and Facilities. We record our pipelines and facilities at cost less any adjustments for depreciation or impairment. We computed depreciation using the straight-line method over estimated useful lives ranging from 10 to 22 years. Per FASB ASC guidance, we performed impairment testing of our pipeline and facilities assets in 2016. Upon completion of testing, we fully impaired our pipeline assets at December 31, 2016. Our pipelines and facilities assets are inactive. Although we planned to decommission the offshore pipelines and platform assets during 2020, decommissioning of these assets was delayed due to cash constraints associated with the ongoing impact of COVID-19. We cannot currently estimate when decommissioning may occur.

Oil and Gas Properties. We account for our oil and gas properties using the full-cost method of accounting. Under this method, all costs associated with the acquisition, exploration, and development of oil and gas properties, including directly related internal costs, are capitalized on a cost center basis. Amortization expenses and estimated future development costs are determined using the unit-of-production method. All leases associated with our oil and gas properties have expired. We fully impaired our oil and gas properties at December 31, 2011.

CIP. CIP expenditures relate to construction and refurbishment activities and equipment for the Nixon facility. We capitalize these expenditures as incurred. We depreciate CIP when placed in service. See “Note (8)” to our consolidated financial statements for additional disclosures related to our refinery and facilities assets, oil and gas properties, pipelines and facilities assets, and CIP.

Leases. We determine whether a contract or agreement is or contains a lease at inception. If the contract is or includes a lease and has a term greater than one year, we recognize a ROU asset and lease liability as of the commencement date based on the present value of the lease payments over the lease term. We determine the present value of the lease payments by using the implicit rate when readily determinable. If the implicit rate is not defined, we use the incremental borrowing rate to discount lease payments to present value. We adjust lease terms to include options to extend or terminate the lease when it is reasonably certain that we will exercise those options.

For operating leases, we record lease rental payments on a straight-line basis over the lease term; we record lease expenses on the income statement based on the leased asset’s intended use. For finance leases (previously referred to under GAAP as capital leases), we amortize lease payments for the ROU asset on a straight-line basis over the lesser of the leased asset’s useful life or the lease term; we record amortization expenses on the income statement in ‘depreciation and amortization expense;’ we record interest expense on the income statement in ‘interest and other expense.’

Revenue Recognition.

Refinery Operations Revenue. We recognize revenue from refined products sales when we meet our performance obligation to the customer. We meet our performance obligation when the customer receives control of the product. The customer accepts control of the product when the product is lifted. When the product is not lifted immediately (bill and hold arrangements), the customer takes control of the product when added to the customer’s bulk inventory as stored at the Nixon facility. We allocate a transaction price to each separately identifiable refined product load.

We consider a variety of facts and circumstances in assessing the point of a control transfer, including but not limited to: whether the purchaser can direct the use of the refined product, the transfer of significant risks and rewards, our rights to payment, and transfer of legal title. In each case, the term between the sale and when payment is due is not significant. We include incurred transportation, shipping, and handling costs in the cost of goods sold. We do not include excise and other taxes collected from customers and remitted to governmental authorities in revenue.

Tolling and Terminaling Revenue. Tolling and terminaling revenue represents fees under (i) tank storage agreements, whereby a customer agrees to pay a certain fee per tank based on tank size over time for the storage of products and (ii) tolling agreements, whereby a customer agrees to pay a certain fee per gallon or barrel for throughput volumes moving through the naphtha stabilizer unit and a fixed monthly reservation fee for the use of the naphtha stabilizer unit.

We typically satisfy performance obligations for tolling and terminaling operations over time. We determine the transaction price at agreement inception based on the guaranteed minimum amount of revenue over the agreement term. We allocate the transaction price to the single performance obligation that exists under the agreement. We recognize revenue in the amount for which we have a right to invoice. Generally, payment terms do not exceed 30 days.

Revenue from tank storage customers may, from time to time, include fees for ancillary services, such as in-tank and tank-to-tank blending. These services are considered optional to the customer. The fixed cost under the customer’s tank storage agreement does not include ancillary service fees. We consider ancillary services as a separate performance obligation under the tank storage agreement. We satisfy the performance obligation and recognize the associated fee when we complete the requested service.

Deferred Revenue. Deferred revenue represents a liability related to a revenue-producing activity as of the balance sheet date. We record unearned revenue, which usually consists of customer prepayments when we receive the cash payment. Once we satisfy the performance obligation, we recognize revenue in conformity with GAAP.

Income Taxes. We determine deferred income taxes based on: (i) temporary differences between carrying amounts and the actual income tax basis of our assets and liabilities and (ii) operating losses and tax credit carryforwards using currently enacted tax rates and laws in effect for the year in which we expect the differences to reverse. Our provision for income taxes consists of our current tax liability and the change in deferred income tax assets and liabilities.

Management uses significant judgment in evaluating uncertain tax positions and determining the provision for income taxes. As of each reporting date, we consider new evidence, both positive and negative, to assess the realizability of deferred tax assets. We weigh whether there is a more than 50% probability of realizing a portion or all the deferred tax assets. Realization depends on the generation of future taxable income before the expiration of any NOL carryforwards. We record a valuation allowance against deferred income tax assets if there is a more than 50% probability of not realizing some portion of the asset. We recognize an uncertain tax positions benefit in our financial statements if deferred tax assets meet a minimum recognition threshold. First, we determine whether there is a more than 50% probability that our income tax position will be sustained, based upon technical merits, upon examination by the taxing authorities. If we meet the criteria, we record a benefit in the financial statements equal to the largest amount greater than 50% likely to be realized upon settlement with taxing authorities. See “Note (14)” to our consolidated financial statements for more information related to income taxes.

Impairment or Disposal of Long-Lived Assets. We periodically evaluate our long-lived assets for impairment. Additionally, we re-assess our long-lived assets when events or circumstances indicate that the carrying value of these assets may not be recoverable. The carrying value is not recoverable if it exceeds the sum of the undiscounted cash flows expected from the use and eventual disposition of the asset or group of assets. If the carrying value exceeds the sum of the undiscounted cash flows, an impairment loss equal to the amount by which the carrying value exceeds the fair value of the asset or group of assets is recognized. Management uses significant judgment in forecasting future operating results and projected cash flows. If conditions or assumptions change, material impairment charges could be necessary.

Commodity price market volatility associated with the COVID-19 pandemic could affect the value of certain of our long-lived assets. Management evaluated our refinery and facilities assets for impairment as of September 30, 2021. We did not record any impairment of our refinery and facilities assets for the periods presented.

Asset Retirement Obligations. We record a liability for the discounted fair value of an ARO in the period incurred. We also capitalize the corresponding cost by increasing the carrying amount of the related long-lived asset. The liability is accreted towards its future value each period, and we depreciate the capitalized cost over the useful life of the related asset. We recognize a gain or loss if we settle the liability for an amount other than the amount recorded.

Refinery and Facilities. We believe we have no legal or contractual obligation to dismantle or remove the refinery and facilities assets. Further, we believe that these assets have indeterminate lives because we cannot reasonably estimate the dates or ranges of dates upon which we would retire these assets. Management will record an asset retirement obligation for these assets when a definitive obligation arises and retirement dates are evident.

Pipeline and Facilities; Oil and Gas Properties. Management uses significant judgment to estimate future asset retirement costs for our pipelines, related facilities, and oil and gas properties. These costs relate to dismantling and disposing certain physical assets, plugging and abandoning wells, and restoring land and seabeds. Factors considered include regulatory requirements, structural integrity, water depth, reservoir depth, equipment availability, and mobilization efforts. We review our assumptions and estimates of future abandonment costs on an annual basis. See “Note (12)” to our consolidated financial statements for additional information related to AROs.

Computation of Earnings Per Share. We present basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. We calculate diluted EPS by dividing net income available to common stockholders by the diluted weighted average number of common shares outstanding. Diluted EPS includes the potential dilution that could occur if securities or other contracts to issue shares of common stock were converted to common stock that then shared in the entity’s earnings. The number of shares related to restricted stock included in diluted EPS is based on the “Treasury Stock Method.” We do not currently have issued options, warrants, or similar instruments. Convertible shares, if granted, are not included in the computation of earnings per share if anti-dilutive. See “Note (15)” to our consolidated financial statements for additional information related to EPS.

New Pronouncements Adopted. The FASB issues ASUs to communicate changes to the FASB ASC, including modifications to non-authoritative SEC content. During the three and nine months ended September 30, 2021, we did not adopt any ASUs.

New Pronouncements Issued, Not Yet Effective.

Other new pronouncements issued but not yet effective are not expected to have a material impact on our financial position, results of operations, or liquidity.

(3) Related-Party Transactions

Affiliate Operational Agreements Summary

Blue Dolphin and certain of its subsidiaries are parties to several operational agreements with Affiliates. Management believes that these related-party agreements are arm’s-length transactions.

Working Capital

We have historically depended on Affiliates for funding when revenue from operations and availability under bank facilities are insufficient to meet our liquidity and working capital needs. We reflect such borrowings in our consolidated balance sheets in accounts payable, related party, or long-term debt, related party.

Related-Party Long-Term Debt

⁽¹⁾ The original principal amount of the BDPL-LEH Loan Agreement was $4.0 million.

⁽²⁾As a condition for our secured loan agreements, Veritex required Jonathan Carroll to guarantee repayment of borrowed funds and accrued interest personally. Mr. Carroll receives guaranty fees under the guaranty fee agreements. Fees are payable 50% in cash and 50% in Common Stock. We accrue payment of the Common Stock portion quarterly. For the foreseeable future, management does not intend to pay Mr. Carroll the cash portion due to Blue Dolphin’s working capital deficits. The cash portion will continue to accrue and increase the outstanding principal balance owed to Mr. Carroll under the March Carroll Note.

Guarantees, Security, and Defaults

Covenants

The BDPL-LEH Loan Agreement contains representations and warranties, affirmative and negative covenants, and events of default that we consider usual and customary for a credit facility of this type. There are no covenants associated with the March Carroll Note, March Ingleside Note, or June LEH Note.

Related-Party Financial Impact

Consolidated Balance Sheets.

Accounts payable, related party. Accounts payable, related party to LTRI related to the purchase of refinery equipment totaled $0.2 million at both September 30, 2021, and December 31, 2020.

Long-term debt, related party, current portion (in default) and accrued interest payable, related party.

Consolidated Statements of Operations.

Total revenue from operations.

Interest expense.

Other. BDSC received sublease income from LEH totaling $0.01 million for both the three months ended September 30, 2021, and 2020. Sublease income totaled $0.03 million for both the nine-month periods ended September 30, 2021, and 2020.

The LEH operating fee totaled approximately $0.1 million and $0.2 million for the three-month periods ended September 30, 2021, and 2020, respectively. The LEH operating fee totaled approximately $0.4 million and $0.5 million for the nine months ended September 30, 2021, and 2020, respectively. Decreases in both periods was the result of lower operating costs.

(4) Revenue and Segment Information

We have two reportable business segments: (i) refinery operations, focused on refining and marketing petroleum products at the Nixon facility, and (ii) tolling and terminaling, focused on tolling and storing petroleum products for third parties at the Nixon facility. Corporate and other includes BDSC, BDPL, and BDPC.

Revenue from Contracts with Customers

Disaggregation of Revenue. We present revenue in the table below under ‘Segment Information’ separated by business segment because management believes this presentation is beneficial to users of our financial information.

Receivables from Contracts with Customers. We present accounts receivable from contracts with customers as accounts receivable, net on our consolidated balance sheets.

Contract Liabilities. Our contract liabilities consist of unearned revenue from customers in the form of prepayments. We include unearned revenue in accrued expenses and other current liabilities on our consolidated balance sheets. See “Note (9)” to our consolidated financial statements for more information related to unearned revenue.

Remaining Performance Obligations. Most of our customer contracts are settled immediately and therefore have no remaining performance obligations.

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Segment Information. Business segment information for the periods indicated (and as of the dates indicated) was as follows: