• High Island Block 115 - During 2007, a well in High Island Block 115 that had previously earned us a 2.5% working interest was re-entered and sidetracked successfully. Production from the well commenced in late November 2007. The well resumed production in the first quarter of 2009 after being shut-in, due to damage to third party onshore facilities resulting from Hurricane Ike in September 2008.

• High Island Block 37 - The A-2 well resumed production in the first quarter of 2009 after being shut-in due to damage to third party onshore facilities resulting from Hurricane Ike in September 2008. In early 2008, we elected to participate in an exploratory well in High Island Block 37 at our 2.8% working interest. Drilling of the exploratory B-2 well commenced in mid-April 2008. The B-2 well was determined to be non-commercial and was plugged and abandoned in the third quarter of 2008.

Our pipeline assets remain significantly under-utilized. The Blue Dolphin System is currently operating at approximately 11% of capacity, the GA 350 Pipeline is currently operating at approximately 34% of capacity and the Omega Pipeline is inactive. Production declines, temporary stoppages or cessations of production from wells tied into our pipelines or from our working and overriding royalty interests in wells in Galveston Area and High Island blocks as noted above could have a material adverse effect on our cash flows and liquidity if the resulting revenue declines are not offset by revenues from other sources. Due to our small size, geographically concentrated asset base and limited capital resources, any negative event has the potential to have a material adverse impact on our financial condition. We are continuing our efforts to increase the utilization of our existing assets and acquire additional assets that will diversify the risks to our cash flows and be accretive to earnings. Results of Operations
For the year ended December 31, 2008 ("current period"), we reported a net loss of $1,966,240, compared to a net loss of $1,625,572 for the year ended December 31, 2007 ("previous period"). For the three months ended December 31, 2008 (the "current quarter"), we reported a net loss of $822,650 compared to a net loss of $283,751 for the three months ended December 31, 2007 (the "previous quarter").
2008 Compared to 2007
Revenue from Pipeline Operations. Revenues from pipeline operations decreased by $45,575, or 2%, in the current period to $2,448,831. Revenues in the current period from the Blue Dolphin System totaled approximately $2,042,000 compared to approximately $2,107,000 in the previous period. Daily gas volumes transported through the Blue Dolphin System averaged approximately 23 MMcf of gas per day in the current period compared to approximately 22 MMcf of gas per day in the previous period. Revenues on the GA 350 Pipeline increased by approximately $20,000 to approximately $407,000 in the current period primarily due to throughput from new shippers that commenced production in the previous period. Average daily gas volumes for GA 350 transported increased to approximately 24 MMcf of gas per day in the current period from approximately 23 MMcf of gas per day in the previous period.
Revenue from Oil and Gas Sales. Revenues from oil and gas sales increased by $23,168, or 4.5%, to $540,579 in the current period primarily due to increased commodity prices. One well in High Island Block 37 went off production in January 2008 and production has not been re-established. The other well in High Island Block 37 produced for a portion of the current period. These decreases in production were offset by production in the current period from High Island Block 115, which commenced production in late November of the previous period. Revenues were also affected by an increase in the realized price of natural gas. Our average realized gas price per Mcf in the current period was $11.78 compared to $6.54 in the previous period. The sales mix by product was 97% gas and 3% condensate. Our average realized price per barrel of condensate was $120.25 in the current period compared to $58.45 in the previous period. Revenue breakdown for the current period by field was approximately $246,000 for High Island Block 37 and $294,000 for High Island Block 115.
Pipeline Operating Expenses. Pipeline operating expenses decreased by $65,646 to $1,722,642 in the current period. The decrease was primarily due to decreases in pipeline repair of approximately $176,000, legal fees of approximately $109,000 and compressor repair expenses of approximately $113,000. The decreases were partially offset by increases in storage tank repairs of approximately $214,000, property insurance of approximately $82,000 and bad debt expense of approximately $27,000.
Lease Operating Expenses. Lease operating expenses increased $3,133, or 1% in the current period to $243,450.

Depletion, Depreciation and Amortization. Depletion, depreciation and amortization expense decreased by $26,732 in the current period to $527,972 primarily due to interruption of production in the fourth quarter from damage to third party shore facilities during Hurricane Ike.
Impairment of Oil and Gas Properties. We recorded a full cost ceiling impairment of $213,563 for the year ended December 31, 2008. A variety of economic and other factors have recently caused significant declines in oil and gas prices. We utilize the full cost method of accounting to account for our oil and natural gas exploration and development activities. Under this method of accounting, we are required on a quarterly basis to determine whether the book value of our oil and natural gas properties (excluding unevaluated properties) is less than or equal to the "ceiling," based upon the expected after tax present value (discounted at 10%) of the future net cash flows from our proved reserves, calculated using prevailing oil and natural gas prices on the last day of the period, or a subsequent higher price under certain circumstances. Any excess of the net book value of our oil and natural gas properties over the ceiling must be recognized as a non-cash impairment expense. Our ceiling was calculated using prices of $44.60 per barrel of oil and $5.26 per MMbtu. Accordingly, at December 31, 2008, our costs exceeded our ceiling limitation, resulting in a write-down of our oil and natural gas properties.
General and Administrative Expenses, and Stock Based Compensation. General and administrative expenses increased $73,495 in the current period to $2,251,771 primarily due to increased compensation related expenses of approximately $136,000, including $116,000 of non-cash stock option expense. These increases were partially offset by decreases in legal fees of approximately $33,000 and other accounting and tax expense of approximately $39,000.
Interest and Other Income. Interest and other income decreased $128,568 in the current period due to a decrease in invested funds and the interest rate earned on those funds.
Three Months Ended December 31, 2008 Compared to Three Months Ended December 31, 2007
Revenue from Pipeline Operations. Revenues from pipeline operations decreased by $41,272, or 6%, in the current quarter to $644,441. Revenues in the current quarter from the Blue Dolphin System decreased to approximately $548,000 compared to approximately $559,000 in the previous quarter. Although daily gas volumes transported on the Blue Dolphin System averaged 25 MMcf of gas per day in the current quarter, up from 22 MMcf of gas per day in the previous quarter, lower condensate prices in the current quarter reduced our separation and storage revenue to offset the increase in gas transportation revenue. Revenues on the GA 350 Pipeline decreased to approximately $97,000 compared to approximately $127,000 in the previous quarter due to a decrease in average daily gas volumes transported of 22 MMcf of gas per day in the current quarter from 29 MMcf of gas per day in the previous quarter.
Revenue from Oil and Gas Sales. Revenues from oil and gas sales decreased by $68,395, or 106%, in the current quarter primarily due to the interruption in production from High Island Block 115 and High Island Block 37 from damage to third party shore facilities caused by Hurricane Ike in September 2008. Pipeline Operating Expenses. Pipeline operating expenses in the current quarter increased by $128,877 to $489,009 due to increases in storage tank repairs and other repairs related to damage from Hurricane Ike.
Lease Operating Expenses. Lease operating expenses increased in the current quarter to $69,473 due to an adjustment of expense in the previous period due to incorrect charges on a producing property.
General and Administrative Expenses and Stock Based Compensation. General and administrative expenses decreased by $23,027 to $554,850 in the current quarter primarily due to a decrease in stock option expense of approximately $39,000 from the previous quarter. This decrease is partially offset by an increase of approximately $11,000 in other accounting expenses associated with Sarbanes-Oxley compliance work.

Depletion, Depreciation and Amortization. Depletion, depreciation and amortization decreased in the current quarter by $17,029 to $114,255 due to the interruption in production from High Island Block 115 and High Island Block 37 from damage to third party shore facilities caused by Hurricane Ike in September 2008.
Other Income. Other income decreased due to a decrease in interest income of $47,329 in the current quarter. Interest income decreased because of decreases in both the amount of available funds and the interest rate earned on those funds.
Liquidity and Capital Resources
Sources and Uses of Cash. Our primary source of cash is cash flow from operations. During 2008, we had negative cash flow from operations of approximate $0.6 million, excluding working capital changes, mainly due to low utilization of our pipeline systems and loss of production attributable to Hurricane Ike. We utilized available cash to participate in an exploratory well in High Island Block 37 for a 2.8% working interest for a total of $0.7 million. Unfortunately, the well was determined to be non-commercial and was plugged and abandoned in the third quarter of 2008.
Our Company does not enter into any hedges or any type of derivatives to offset changes in commodity prices. We also do not have any outstanding debt or a credit facility with a bank or institution that may restrict us from issuing debt or common stock of the Company. Our current available cash is $3.9 million at December 31, 2008.

                                                   For Year Ended December 31,
                                                          (in millions)
                                                    2008                2007
     Cash Flow from Operations
     Loss from operations                               ($0.7 )             ($0.7 )
     Change in current assets and liabilities             0.1                 0.5

     Total cash flow from operations                    ($0.6 )             ($0.2 )

     Cash Outflows
     Capital expenditures                               ($0.8 )             ($0.1 )

     Total cash outflows                                ($0.8 )             ($0.1 )

     Total change in cash flows                         ($1.4 )             ($0.3 )

In the past two years, we have used a portion of our cash reserves to fund our working capital requirements that were not funded from operations. Critical Accounting Policies
The selection and application of accounting policies is an important process that has developed as our business activities have evolved and as the accounting rules have changed. Accounting rules generally do not involve a selection among alternatives, but involve an implementation and interpretation of existing rules, and the use of judgment, to the specific set of circumstances existing in our business. We make every effort to properly comply with all applicable rules at or before their adoption, and believe the proper implementation and consistent application of accounting rules is critical. However, not all situations are specifically addressed in the accounting literature. In these cases, we must use our best judgment to adopt a policy for accounting for these situations. We accomplish this by comparatively analyzing similar situations and reviewing the accounting guidance governing them, and may consult with our independent accountants about the appropriate interpretation and application of these policies. Our most critical accounting policies currently relate to the accounting for the impairment of long-lived assets, which

include primarily our pipeline assets, as of December 31, 2008 and the accounting for future asset retirement costs.
Accounting for the Impairment or Disposal of Long-Lived Assets. In accordance with Statement of Financial Accounting Standard ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we initiate a review for impairment of our long-lived assets whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows expected to result from the use and eventual disposition of that asset, excluding future interest costs that would be recognized as an expense when incurred. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected cash flows and, should different conditions prevail or judgments be made, material impairment charges could be necessary. Currently, our pipeline assets are significantly under utilized and such underutilization is an indicator of possible impairment at December 31, 2008. Accordingly, we developed future cash flows as of December 31, 2008 expected to be generated from our pipeline assets based on certain assumptions. The most significant assumption made in connection with the preparation of expected future cash flows is that pipeline throughput volumes will increase over the next few years due to increasing current leasing and drilling activities, and prospective drilling activity surrounding our pipelines. Based on the results of the impairment test, which indicates expected future undiscounted cash flows are in excess of the pipeline assets net carrying value, no impairment has been recorded as of December 31, 2008.
The accounting for future abandonment costs changed on January 1, 2003 with the adoption of SFAS No. 143, Accounting for Asset Retirement Obligations. This standard requires that a liability for the discounted fair value of an asset retirement obligation be recorded in the period in which it is incurred and the corresponding cost capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted towards its future value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, a gain or loss is recognized. Future asset retirement costs include costs to dismantle and relocate or dispose of our offshore platforms, pipeline systems and related onshore facilities, plugging and abandonment of wells and restoration costs of land and seabed. We develop estimates of these costs for each of our assets based upon regulatory requirements, the type of platform structure, depth of water, reservoir characteristics, depth of the reservoir, market demand for equipment, currently available procedures and consultations with construction and engineering consultants. Because these costs typically extend many years into the future, estimating these future costs is difficult and requires management to make judgments that are subject to future revisions based upon numerous factors, including changing technology and the political and regulatory environment. We review our assumptions and estimates of future abandonment costs on a quarterly basis.
Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109. We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 ("FIN 48"), effective January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes ("SFAS 109"). FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB standard also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is a recognition process whereby the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes,

based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step is a measurement process whereby a tax position that meets the more-likely-than-not recognition threshold is calculated to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. Earlier application is permitted as long as the enterprise has not yet issued financial statements, including interim financial statements, in the period of adoption. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 should be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year.
The provisions of FIN 48 have been applied to all of our material tax positions taken from January 1, 2007 through the fiscal year ended December 31, 2008. We have determined that all of our material tax positions taken in our income tax returns and the positions we expect to take in our future income tax filings meet the more likely-than-not recognition threshold prescribed by FIN 48. In addition, we have determined that, based on our judgment, none of these tax positions meet the definition of "uncertain tax positions" that are subject to the non-recognition criteria set forth in the new pronouncement.
Fair Value Measurements. On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements("SFAS 157"), which clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. In February 2008, the Financial Accounting Standards Board ("FASB") issued Staff Position 157-2, Effective Date of FASB Statement No. 157 ("FSP 157-2"), that deferred the effective date of SFAS 157 for one year for nonfinancial assets and liabilities recorded at fair value on a non-recurring basis. The effect of adoption of SFAS 157 for financial assets and liabilities recognized at fair value on a recurring basis did not have a material impact on our financial position and results of operations. We are assessing the impact of SFAS 157 for nonfinancial assets and liabilities. Fair Value Option for Financial Assets and Financial Liabilities. On January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 ("SFAS 159"). SFAS 159 permits companies to choose an irrevocable election to measure certain financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. We did not elect the fair value option under SFAS 159 for any of our financial assets or liabilities upon adoption.
Recently Issued Accounting Pronouncements and Accounting Developments Business Combinations. In December 2007, the FASB issued SFAS No. 141R, Business Combinations("SFAS 141R"), which replaces SFAS No. 141, Business Combinations. SFAS 141R establishes principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and liabilities acquired in a business combination, including non-controlling interests, contingent consideration, and certain acquired contingencies. SFAS 141R also requires acquisition-related transaction expenses and restructuring costs be expensed as incurred rather than capitalized as a component of the business combination. SFAS 141R will be applicable prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period

beginning on or after December 15, 2008. SFAS 141R would have an impact on accounting for any businesses acquired after the effective date of this pronouncement.
Non-controlling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. In December 2007, the FASB also issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51 ("SFAS 160"). SFAS 160 establishes accounting and reporting standards for the non-controlling interest in a subsidiary (previously referred to as minority interests). SFAS 160 also requires that a retained non-controlling interest upon the deconsolidation of a subsidiary be initially measured at its fair value. Upon adoption of SFAS 160, we would be required to report any non-controlling interests as a separate component of stockholders' equity. We would also be required to present any net income allocable to non-controlling interests and net income attributable to the stockholders of the Company separately in our consolidated statements of income. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. SFAS 160 would have an impact on the presentation and disclosure of the non-controlling interests of any non wholly-owned businesses acquired in the future.
Hierarchy of Generally Accepted Accounting Principles. In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles ("SFAS 162"). SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with GAAP for nongovernmental entities. The FASB believes that the GAAP hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. This statement became effective on November 15, 2008 following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles." The adoption of SFAS 162 did not have a material effect on the Company's results of operations, financial position or cash flows.
Revisions to the SEC's Oil and Gas Reporting Disclosure Requirements. On December 31, 2008, the SEC issued the Final Rule, which adopts revisions to the SEC's oil and gas reporting disclosure requirements and is effective for annual reports on Forms 10-K for years ending on or after December 31, 2009. Early adoption of the Final Rule is prohibited. The revisions are intended to provide investors with a more meaningful and comprehensive understanding of oil and gas reserves to help investors evaluate their investments in oil and gas companies. The amendments are also designed to modernize the oil and gas disclosure requirements to align them with current practices and changes in technology. . . .