Organization

12 Months Ended

Dec. 31, 2022

Organization

Organization

(1) Organization

Company 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 organized in two business segments: ‘refinery operations’ (owned by LE) and ‘tolling and terminating services’ (owned by LRM and NPS). ‘Corporate and other’ includes Blue Dolphin subsidiaries 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 “we,” “us,” “our,” or “ours,” refer to Blue Dolphin, one or more of its consolidated subsidiaries or all of them taken as a whole.

An Affiliate, combined with Jonathan Carroll, controlled approximately 83% of the voting power of our Common Stock as of the filing date of this report.  An Affiliate also operates and manages all Blue Dolphin properties, funds working capital requirements during periods of working capital deficits, guarantees certain of our third-party secured debt, and 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

In accordance with GAAP accounting standards, we evaluated whether there are conditions and events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern within one year after the date that our consolidated financial statements are issued. While results of operations were significantly improved for the twelve months ended December 31, 2022 versus the prior twelve month period, management determined that certain factors continue to present substantial doubt about our ability to continue as a going concern. These factors include significant current debt, which impacts our ability to meet debt covenants, and historical net losses and working capital deficits. Our consolidated financial statements assume we will continue as a going concern and do not include any adjustments that might result from this uncertainty.  Management is working to alleviate these factors by entering into forbearance agreements with lenders, maximizing operation of the Nixon refinery given favorable refining margins, and pursuing opportunities to obtain capital and/or refinance debt.

Our significant current debt is the result of certain third-party and related-party loan agreements being classified within the current portion of long-term debt on our consolidated balance sheets at December 31, 2022 and 2021. Excluding accrued interest, we had current debt of $47.4 million and $63.0 million, respectively, as of December 31, 2022 and 2021. Our significant current debt consists of bank debt to Veritex and GNCU, investor debt to John Kissick, and related party debt to LEH.

Forbearance Agreement.  Pursuant to the November 2022 Veritex Forbearance Agreement, Veritex agreed to forbear from exercising any of its rights and remedies related to existing defaults pertaining to covenant violations under the LE Term Loan Due 2034 and LRM Term Loan Due 2034 for a period beginning on November 18, 2022 through September 30, 2023.  During the forbearance period, Veritex agreed to forbear from testing borrowers’ compliance with financial covenants as specified in the LE Term Loan Due 2034 and LRM Term Loan Due 2034 and forbear from exercising its rights or remedies with respect to non-compliance with the financial covenants. As part of the Veritex Forbearance Agreement, LE and LRM paid Veritex: (i) $4.3 million in past due principal and interest at the non-default rate (excluding late fees), (ii) $1.0 million into a payment reserve account, and (iii) $0.04 million in Veritex attorney fees.  In the event that LE and LRM pay off all amounts due under the LE Term Loan Due 2034 and LRM Term Loan Due 2034 on or before September 30, 2023, Veritex also agreed to waive late fees totaling approximately $0.4 million in the aggregate.  The Veritex Forbearance Agreement shall terminate on the first to occur: September 30, 2023, failing to  make a payment when due, breach, or any new event of default.  As of December 31, 2022 and the filing date of this report, LE and LRM were in compliance with the Veritex Forbearance Agreement.

Other Defaults. We are in default under the NPS Term Loan Due 2031 due to covenant violations.  We are also in default under the Kissick Debt, June LEH Note, and BDPL-LEH Loan agreement related to past due obligations at maturity. Defaults permit the lender to declare the amounts owed under the related loan agreements immediately due and payable, exercise their rights with respect to collateral securing obligors’ obligations, and/or exercise any other rights and remedies available. 

Favorable Refining Margins. The strong demand for our products, particularly jet fuel, and the increase in refining margins were the primary contributors to us reporting $32.9 million in net income for the twelve months ended December 31, 2022. Comparatively, we reported a net loss of $12.8 million for the twelve months ended December 31, 2021. Our operating results for 2022, including operating results by segment, can be found within ‘Results of Operations’ in “Part II, Item 7. Management’s Discussion and Financial Analysis of Financial Condition and Results of Operations” in this report.

Our results of operations and liquidity are highly dependent upon the margins that we receive for our refined products. The dollar per bbl commodity price difference between crude oil and condensate (input) and refined products (output) is the most significant driver of refining margins, and they have historically been subject to wide fluctuations. While refining margins and liquidity improved significantly during 2022, the general outlook for the oil and natural gas industry for 2023 remains unclear given uncertainty surrounding the Russian military conflict with Ukraine, COVID-19, recession, and inflation. We can provide no assurances that refining margins and demand will remain at current levels.

Working Capital Improvements. Historically, we experienced net losses during three of the last five years.  We had $45.2 million and $78.5 million in working capital deficits at December 31, 2022 and 2021, respectively.  Excluding the current portion of long-term debt, we had $2.1 million in working capital and $15.5 million in working capital deficits at December 31, 2022 and 2021, respectively. The significant improvement in working capital between the twelve-month periods ended December 31, 2022 and 2021 was primarily due to favorable refining margins and increased gross profit. Continued favorable market conditions will enable us to continue meeting our needs through cash flow from operations. We also continue to explore opportunities to obtain capital and/or refinance debt.  During the twelve months ended December 31, 2022 and 2021, we successfully secured $1.5 million and $10.5 million, respectively, in working capital through CARES Act loans. In October 2021, NPS repaid all obligations owed to Pilot under the Amended Pilot Line of Credit.

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 could include selling assets, raising additional debt or equity capital, cutting costs, reducing cash requirements, restructuring debt obligations, or filing bankruptcy.

Operating Risks

Successful execution of our business strategy depends on several critical factors, including having adequate working capital, favorable refining margins, and maintaining operation of the Nixon refinery.

· Working Capital – As noted above, we have historically had working capital deficits primarily due to having significant current debt. Having sufficient working capital is necessary to meet contractual, operational, regulatory, and safety needs. Our short-term working capital needs are primarily related to: (i) purchasing crude oil and condensate to operate the Nixon refinery, (ii) reimbursing LEH for direct operating expenses and paying the LEH operating fee under the Amended and Restated Operating Agreement, (iii) servicing debt, (iv) maintaining and improving the Nixon facility through capital expenditures, and (v) meeting regulatory compliance requirements. Our long-term working capital needs are primarily related to repayment of long-term debt obligations. To avoid business disruptions and manage cash flow, we optimize receivables and payables by prioritizing payments, optimize inventory levels based on demand, monitor discretionary spending, and carefully manage capital expenditures.

· Refining Margins – Refining margins, which are affected by commodity prices and refined product demand, are volatile, and a reduction in refining margins will adversely affect the amount of cash we will have available for working capital. Crude oil refining is primarily a margin-based business. To improve margins, we must maximize yields of higher value finished petroleum products and minimize costs of feedstocks and operating expenses. When the spread between these commodity prices decreases, our margins are negatively affected. Although an increase or decrease in the commodity price for crude oil and other feedstocks generally results in a similar increase or decrease in commodity prices for finished petroleum products, typically there is a time lag between the two. The effect of crude oil commodity price changes on our finished petroleum product commodity prices therefore depends, in part, on how quickly and how fully the market adjusts to reflect these changes. Unfavorable margins may have a material adverse effect on our earnings, cash flows, and liquidity. To remain competitive in a volatile commodity price environment, we adjust throughput and production based on market conditions and adjust our product slate based on commodities pricing.

· Nixon Refinery Operation – We maintain relationships with suppliers that source and repair key components of the Nixon refinery. We expect our suppliers to maintain an adequate supply of component products and, when components are sent out for repair, to timely deliver components. However, in some cases, increases in demand or supply chain disruptions have led to part and component constraints. We use several suppliers and monitor supplier financial viability to mitigate supply-based risks that could cause a business disruption.

The Russian military conflict with Ukraine, COVID-19, recession, and inflation continue to evolve, and the extent to which these factors may impact working capital, commodity prices, refined product demand, our supply chain, financial condition, liquidity, results of operations, and future prospects will depend on future developments, which cannot be predicted with any degree of confidence.  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 can obtain additional financing on commercially reasonable terms or at all, or margins on our refined products will be favorable.  Further, if third parties exercise their rights and remedies under secured loan agreements that are in default, or if Tartan terminates the Crude Supply Agreement, our business, financial condition, and results of operations will be materially adversely affected.