(8) Commitments and Contingencies

9 Months Ended

Sep. 30, 2013

Notes

(8) Commitments and Contingencies

(8) Commitments and Contingencies

Environmental Matters

Like other petroleum refiners, our operations are subject to extensive and periodically changing federal and state environmental regulations governing air emissions, wastewater discharges, and solid and hazardous waste management activities.  Many of these regulations are becoming increasingly stringent, and the cost of compliance can be expected to increase over time.  Our policy is to accrue environmental and clean-up related costs of a non-capital nature when it is probable that a liability has been incurred and the amount can be reasonably estimated.  Such estimates may be subject to revision in the future as regulations and other conditions change.

Periodically, we receive communications from various federal, state, and local governmental authorities asserting violations of environmental laws and/or regulations.  These governmental entities may also propose or assess fines or require corrective actions for these asserted violations.  We intend to respond in a timely manner to all such communications and to take appropriate corrective action.  We do not anticipate that any such matters currently asserted will have a material impact on our financial condition, results of operations, or cash flows.

Hawaii Consent Decree On September 25, 2013, Hawaii Pacific Energy, Tesoro and HIE entered into an Environmental Agreement (the “Environmental Agreement”), which allocated responsibility for known and contingent environmental liabilities relating to the acquisition of HIE, including the Consent Decree as described below.

Tesoro is currently negotiating a consent decree with the United States Environmental Protection Agency (“EPA”) and the United States Department of Justice concerning alleged violations of the federal Clean Air Act related to the ownership and operation of multiple facilities owned by Tesoro and its affiliates (the “Consent Decree”), including the Refinery.  It is anticipated that the Consent Decree will be finalized sometime during the first quarter of 2014 and will require certain capital improvements to the Refinery to reduce emissions of air pollutants.

It is not possible at this time to estimate the cost of compliance with the ultimate decree. However, Tesoro is responsible under the Environmental Agreement for reimbursing HIE for all reasonable third party capital expenditures incurred for the construction, installation and commissioning of such capital projects and for the payment of any fines or penalties imposed on HIE arising from the Consent Decree to the extent related to acts or omission of Tesoro or HIE prior to the closing date of the Purchase Agreement (the “Closing Date”). Tesoro’s obligation to reimburse HIE for such fines and penalties is not subject to a monetary limitation; however, this obligation terminates on the third anniversary of the Closing Date.

Regulation of Greenhouse Gases The EPA began regulating greenhouse gases in January 2011 under the Clean Air Act Amendment of 1990 (the “Clean Air Act”).  Any new construction or material expansions will require that, among other things, a greenhouse gas permit be issued at either or both the state or federal level in accordance with the Clean Air Act regulations, and we will be required to undertake a technology review to determine appropriate controls to be implemented with the project in order to reduce greenhouse gas emissions.  The determination would be on a case by case basis, and the EPA has provided only general guidance on which controls will be required or delegated to the states through State Implementation Plans.

Furthermore, the EPA is currently developing refinery-specific greenhouse gas regulations and performance standards that are expected to impose, on new and modified operations, greenhouse gas emission limits and/or technology requirements.  These control requirements may affect a wide range of refinery operations but have not yet been delineated.  Any such controls, however, could result in material increased compliance costs, additional operating restrictions for our business, and an increase in cost of the products we produce, which could have a material adverse effect on our financial position, results of operations, and liquidity.

In 2007, the State of Hawaii passed Act 34, which required that greenhouse gas emissions be rolled back on a state wide basis to 1990 levels by the year 2020. Although delayed by two years, the Hawaii Department of Health (“DOH”) is on schedule to finalize and issue regulations by the end of 2013 that would require each major facility to reduce CO2 emission by 16% by 2020 relative to calendar year 2010 baseline (the first year in which greenhouse gas was reported to the EPA under 40 CFR Part 98). The Refinery’s capacity to reduce fuel use and greenhouse gas emissions is limited. However, the state’s pending regulation allows, and the Refinery should be able to demonstrate, that additional reductions are not cost-effective or necessary in light of the state’s current greenhouse gas inventory and future year projection. The pending regulation allows for “partnering” with other facilities (principally power plants) which have already dramatically reduced greenhouse emissions or are on schedule to reduce CO2 emissions in order to comply with the state’s Renewable Portfolio Standards.

Fuel Standards: In 2007, the U.S. Congress passed the Energy Independence and Security Act (“EISA”) which, among other things, set a target fuel economy standard of 35 miles per gallon for the combined fleet of cars and light trucks in the United States by model year 2020, and contained a second Renewable Fuel Standard (the “RFS2”). In August 2012, the EPA and National Highway Traffic Safety Administration jointly adopted regulations that establish an average industry fuel economy of 54.5 miles per gallon by model year 2025. The RFS2 requires 16.55 billion gallons of renewable fuel usage in 2013, increasing to 36.0 billion gallons by 2022. In the near term, the RSF2 will be satisfied primarily with fuel ethanol blended into gasoline. The RSF2 may present productions and logistic challenges for both the renewable fuels and petroleum refining and marketing industries in that we may have to enter into arrangements with other parties or purchase credits from the EPA to meet our obligations to use advanced biofuels, including biomass-based diesel and cellulosic biofuel, with potentially uncertain supplies of these new fuels.

In October 2010, the EPA issued a partial waiver decision under the Clean Air Act to allow for an increase in the amount of ethanol permitted to be blended into gasoline from 10% (“E10”) to 15% (“E15) for 2007 and newer light duty motor vehicles. In January 2011, the EPA issued a second waiver for the use of E15 in vehicles model year 2001-2006. There are numerous issues, including state and federal regulatory issues, which need to be addressed before E15 can be marketed for use in traditional gasoline engines. Since April 2006, the State of Hawaii has required that a minimum of 9.2% ethanol be blended into at least 85% of the gasoline pool, but the regulation also limited the amount of ethanol to no more than 10%. Consequently, unless either the state or federal regulations are revised, qualified Renewable Identification Numbers (“RINS”) will be required to fulfill the federal mandate for renewable fuels.

In May 2013, the EPA published a proposed Tier 3 gasoline standard that would lower the allowable sulfur level in gasoline to 10 ppm, lower the standards for Reid vapor pressure, and also lower the allowable benzene, aromatics and olefins content of gasoline, while possibly increasing octane requirements. The proposed effective date for the new standard,  January 1, 2017, gives refiners nation-wide little time to engineer, permit and implement substantial modifications. Along with credit and trading options, potential capital upgrades for the Refinery are being evaluated. The American Petroleum Institute and American Fuel and Petrochemical Association have already filed extensive comments and intend to challenge the proposed regulation.

There will be compliance costs and uncertainties regarding how we will comply with the various requirements contained in the EISA and other fuel-related regulations. We may experience a decrease in demand for refined petroleum products due to an increase in combined fleet mileage or due to refined petroleum products being replaced by renewable fuels.

Recovery Trusts

On the date we emerged from bankruptcy, or the Emergence Date, two trusts were formed, the Wapiti Recovery Trust (the “Wapiti Trust”) and the Delta Petroleum General Recovery Trust (the “General Trust,” and together with the Wapiti Trust, the “Recovery Trusts”). The Recovery Trusts were formed to pursue certain litigation against third-parties, including preference actions, fraudulent transfer and conveyance actions, rights of setoff and other claims, or causes of action under the U.S.

Bankruptcy Code, and other claims and potential claims that the Debtors hold against third parties. The Recovery Trusts were funded with $1.0 million each pursuant to the Plan.

On September 19, 2012, the Wapiti Trust settled all causes of action against Wapiti Oil & Gas, LLC (“Wapiti Oil & Gas”). Wapiti Oil & Gas made a one-time cash payment in the amount of $1.5 million to the Wapiti Trust, as consideration for the release of claims against it. These proceeds were then distributed to us, along with funds remaining from the initial funding of the Wapiti Trust of approximately $1.0 million. Further distributions are not anticipated from the Wapiti Trust and the Wapiti Trust is anticipated to be liquidated during 2013.

The General Trust is pursuing all bankruptcy causes of action not otherwise vested in the Wapiti Trust, claim objections and resolutions, and all other responsibilities for winding-up the bankruptcy. The General Trust is overseen by a three person General Trust Oversight Board and our former Chief Executive Officer is the trustee. Costs, expenses and obligations incurred by the General Trust are charged against assets in the General Trust. To conduct its operations and fulfill its responsibilities under the Plan and the trust agreements, the recovery trustee may request additional funding from us. Any litigation pending at the time we emerged from Chapter 11 was transferred to the General Trust for resolution and settlement in accordance with the Plan and the order confirming the Plan. We are the beneficiary for each of the Recovery Trusts, subject to the terms of the respective trust agreements and the Plan. Since the Emergence Date, the General Trust has filed various claims and causes of action against third parties before the Bankruptcy Court, which actions are ongoing. Upon liquidation of the various claims and causes of action held by the General Trust, the proceeds, less certain administrative reserves and expenses, will be transferred to us. It is unknown at this time what proceeds, if any, we will realize from the General Trust’s litigation efforts.

From the Emergence Date through September 30, 2013, the Recovery Trusts have released approximately $5.2 million to us, which is available for our general use, due to a negotiated reduction in certain fees and claims associated with the bankruptcy, as well as a favorable variance in actual expenses versus budgeted expenses. The entire $5.2 million was released prior to December 31, 2012.

Shares Reserved for Unsecured Claims

The Plan provides that certain allowed general unsecured claims be paid with shares of our common stock. On the Emergence Date, 106 claims totaling approximately $73.7 million had been filed in the bankruptcy. Pursuant to the Plan, between the Emergence Date and December 31, 2012, the Recovery Trustee settled 25 claims with an aggregate face amount of $6.6 million for $258,905 in cash and 202,753 shares of common stock.  Pursuant to the Plan, during the nine months ended September 30, 2013, the Recovery Trustee settled an additional 47 claims with an aggregate face amount of $17.5 million for approximately $2.7 million in cash and 2,013,773 shares of common stock.

As of September 30, 2013, it is estimated that a total of 34 claims totaling approximately $49.6 million remain to be resolved by the Recovery Trustee. The largest remaining proof of claim was filed by the US Government for approximately $22.4 million relating to ongoing litigation concerning a plugging and abandonment obligation in Pacific Outer Continental Shelf Lease OCS-P 0320, comprising part of the Sword Unit in the Santa Barbara Channel, California. We believe the probability of issuing stock to satisfy the full claim amount is remote, as the obligations upon which such proof of claim is asserted are joint and several among all working interest owners, and the Predecessor Company owned a 2.41934% working interest in the unit. In addition, litigation and/or settlement efforts are ongoing with other claim holders.

The settlement of claims is subject to ongoing litigation and we are unable to predict with certainty how many shares will be required to satisfy all claims. Pursuant to the Plan, allowed claims are settled at a ratio of 544 shares per $1,000 of claim. At September 30, 2013, we have reserved approximately $6.4 million representing the estimated value of claims remaining to be settled which are deemed probable and estimable at period end. A summary of claims is as follows:

	Emergence-Date August 31, 2012				From Emergence-Date through December 31, 2012
	Filed Claims				Settled Claims								Remaining Filed Claims
									Consideration
	Count		Amount		Count		Amount		Cash		Stock		Count		Amount
U.S. Government Claims		3	$	22,364,000		—	$	—	$	—		—		3	$	22,364,000
Former Employee Claims		32		16,379,849		13		3,685,253		229,478		202,231		19		12,694,596
Macquarie Capital (USA) Inc.		1		8,671,865		—		—		—		—		1		8,671,865
Swann and Buzzard Creek Royalty Trust		1		3,200,000		—		—		—		—		1		3,200,000
Other Various Claims*		69		23,113,659		12		2,914,859		29,427		522		57		20,198,800
Total		106	$	73,729,373		25	$	6,600,112	$	258,905		202,753		81	$	67,129,261

	For the Nine Months Ended September 30, 2013
	Settled Claims								Remaining Filed Claims
					Consideration
	Count		Amount		Cash		Stock		Count		Amount
U.S. Government Claims		1	$	—	$	—		—		2	$	22,364,000
Former Employee Claims		19		12,694,596		339,588		1,614,988		—		—
Macquarie Capital (USA) Inc.		—		—		—		—		1		8,671,865
Swann and Buzzard Creek Royalty Trust		1		3,200,000		2,000,000		—		—		—
Other Various Claims*		26		1,620,177		397,754		398,785		31		18,578,623
Total		47	$	17,514,773	$	2,737,342		2,013,773		34	$	49,614,488

*          Includes reserve for contingent/unliquidated claims in the amount of $10 million.

Subsequent to September 30, 2013, the Recovery Trustee settled the Macquarie Capital (USA) Inc. claim for $2.5 million in cash. In addition, two claims with an aggregate face amount of approximately $678,000 were settled for $145,000 in cash and 46,935 shares of common stock.

HIE

Operating Leases

HIE has various cancellable and noncancellable operating leases related to land, vehicles, office and retail facilities and other facilities used in the storage, transportation and sale of crude oil and refined products. In general, these leases have remaining primary terms of up to 32 years and typically contain multiple renewal options.

The majority of the future lease payments relate to retail stations and facilities used in the storage, transportation and sale of crude oil and refined products. HIE has operating leases for most of our retail stations with primary terms of up to 32 years, and generally containing renewal options and escalation clauses. Leases for facilities used in the storage, transportation and sale of crude oil and refined products have various expiration dates extending to 2027.

Minimum annual lease payments extending to 2027, for operating leases to which HIE is legally obligated and having initial or remaining noncancellable lease terms in excess of one year are as follows (in thousands):

2013	$	12,105
2014		11,312
2015		10,384
2016		9,432
2017		8,712
Thereafter		32,172
Total minimum rental payments	$	84,117

Capital Leases

HIE’s capital lease obligations relate primarily to the leases of five retail stations with initial terms of 17 years, with four 5-year renewal options. Minimum annual lease payments including interest, for capital leases are as follows (in thousands):

2013	$	382
2014		382
2015		382
2016		382
2017		382
Thereafter		840
Total minimum lease payments		2,750
Less amount representing interest		968
Total minimum rental payments	$	1,782

Other

On April 22, 2013, Texadian entered into a terminaling and storage agreement whereby the operator will provide Texadian with storage facilities, access to a marine terminal and pipelines, and railcar offloading services. The initial term of the agreement is for a period of four years and Texadian’s minimum purchase commitment during the initial term is approximately $28.0 million.

As of September 30, 2013, Texadian had various agreements to lease railcars, inland river tank barges and towboats and other equipment. These leasing agreements have been classified as operating leases for financial reporting purposes and the related rental fees are charged to expense over the lease term as they become payable. Leases generally range in duration of five years or less and contain lease renewal options at fair value.