This Annual Report
on Form 10-K contains forward-looking statements. These forward-looking statements include predictions and statements regarding
our future:
You can identify these
and other forward-looking statements by the use of words such as “may,” “will,” “expects,”
“anticipates,” “believes,” “estimates,” “intends,” “project,” “potential,”
“forecast” “continues,” “strategies,” or the negative of such terms, or other comparable terminology,
and also include statements concerning plans, objectives, goals, strategies and future events or performance.
Our actual results
could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those
set forth below under the heading “Risk Factors.” We cannot assure you that we will achieve or accomplish our expectations,
beliefs or projections. All forward-looking statements included in this document are based on information available to us on the
date hereof. We assume no obligation to update any forward-looking statements.
Item 1. Business
The discussion of our
business is as of the date of filing this report, unless otherwise indicated.
Overview
QS Energy, Inc. (“QS
Energy” or “Company” or “we” or “us” or “our”) develops and seeks to commercialize
energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil transport,
and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic and international
patents and patents pending, a substantial portion of which have been developed in conjunction with and exclusively licensed from
Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology
(AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. Engineered specifically to reduce pipeline
pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents
to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity by applying
a high intensity electrical field to crude oil while in transit. AOT technology delivers reductions in crude oil viscosity and
pipeline pressure loss as demonstrated in independent third-party tests performed by the U.S. Department of Energy, the PetroChina
Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™, at full-scale test facilities in the U.S. and China,
and under commercial operating conditions on one of North America’s largest high-volume crude oil pipelines. Prior testing
on a commercial crude oil condensate pipeline demonstrated high correlation between laboratory analysis and full-scale AOT operations
under commercial operating conditions with onsite measurements and data collected by the pipeline operator on its supervisory
control and data acquisition (“SCADA”) system. The AOT product has transitioned from laboratory testing and ongoing
research and development to initial demonstration and continued testing in advance of our goal of seeking commercial acceptance
and adoption by the upstream and midstream pipeline marketplace. We continue to devote the bulk of our efforts to the promotion,
design, testing and the commercial manufacturing and test operations of our crude oil pipeline products in the upstream and midstream
energy sector. We anticipate that these efforts will continue during 2020.
Our Company was incorporated
on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save
the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The name change
was affected through a short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Additionally, QS Energy Pool,
Inc., a California corporation, was formed as a wholly owned subsidiary of the Company on July 6, 2015 to serve as a vehicle for
the Company to explore, review and consider acquisition opportunities. To date, QS Energy Pool has not entered into any acquisition
transaction. However, the Company will still consider entering into potential beneficial acquisitions. The Company is considering
dissolving QS Energy Pool to reduce costs associated with operating this subsidiary. The Company’s common stock is quoted
under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s updates,
fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.
Between 2011 and 2012,
the Company transitioned from prototype testing of its AOT technology at the U.S. Department of Energy Rocky Mountain Oilfield
Testing Center, Midwest, Wyoming (“RMOTC”), to the design and production of full-scale commercial prototype units.
The Company worked in a collaborative engineering environment with multiple energy industry companies to refine the AOT Midstream
commercial design to comply with the stringent standards and qualification processes as dictated by independent engineering audit
groups and North American industry regulatory bodies. In May 2013, the Company’s first commercial prototype unit known as
AOT Midstream, was completed.
In 2013, the Company
entered into an Equipment Lease/Option to Purchase Agreement (“TransCanada Lease”) with TransCanada Keystone Pipeline,
L.P. by its agent TC Oil Pipeline Operations, Inc. ("TransCanada") which agreed to lease and test the effectiveness of
the Company’s AOT technology and equipment on one of TransCanada’s operating pipelines. As previously reported in our
10-K report filed with the SEC on March 16, 2015, in June 2014, the equipment was accepted by TransCanada and the lease commenced
and the first full test of the AOT equipment on the Keystone pipeline was performed in July 2014 by Dr. Rongjia Tao of Temple University,
with subsequent testing performed by an independent laboratory, ATS RheoSystems, a division of CANNON™ (“ATS”)
in September 2014. Upon review of the July 2014 test results and preliminary report by Dr. Tao, QS Energy and TransCanada mutually
agreed that this initial test was flawed due to, among other factors, the short-term nature of the test, the inability to isolate
certain independent pipeline operating factors such as fluctuations in upstream pump station pressures, and limitations of the
AOT device to produce a sufficient electric field to optimize viscosity reduction. Subsequent testing by ATS in September 2014
demonstrated viscosity reductions of 8% to 23% depending on flow rates and crude oil types in transit. In its summary report, ATS
concluded that i) data indicated a decrease in viscosity of crude oil flowing through the TransCanada pipeline due to AOT treatment
of the crude oil; and ii) the power supply installed on our equipment would need to be increased to maximize reduction in viscosity
and take full advantage of the AOT technology. While more testing is required to establish the commercial efficacy of our AOT technology,
we were encouraged by the findings of these field tests performed under commercial operating conditions. The TransCanada Lease
was terminated by TransCanada, effective October 15, 2014. Upon termination of the TransCanada Lease, all equipment was uninstalled,
returned, inspected and configured for re-deployment.
On July 15, 2014, the
Company entered into an Equipment Lease/Option to Purchase Agreement (“Kinder Morgan Lease”) with Kinder Morgan Crude
& Condensate, LLC (“Kinder Morgan”) under which Kinder Morgan agreed to lease and test the effectiveness of the
Company’s AOT technology and equipment on one of Kinder Morgan’s operating crude oil condensate pipelines. Equipment
provided under the Lease included a single AOT Midstream pressure vessel with a maximum flow capacity of 5,000 gallons per minute.
The equipment was delivered to Kinder Morgan in December 2014 and installed in March 2015. In April 2015, during pre-start testing,
low electrical impedance was measured in the unit, indicating an electrical short. A replacement unit was installed May 2015. The
second unit also presented with low impedance when flooded with crude condensate from Kinder Morgan’s pipeline. Subsequent
to design modifications, a remanufactured AOT unit was installed and tested at Kinder Morgan’s pipeline facility in August
2015. Initial results were promising, with the unit operating generally as expected. However, voltage dropped as preliminary tests
continued, indicating decreased impedance within the AOT pressure vessel. QS Energy personnel and outside consultants performed
a series of troubleshooting assessments and determined that, despite modifications made to the AOT, conductive materials present
in the crude oil condensate appeared to be the root cause of the decreased impedance. Based on these results, QS Energy and Kinder
Morgan personnel mutually agreed to put a hold on final acceptance of equipment under the lease and suspended in-field testing
to provide time to re-test crude oil condensate in a laboratory setting, and thoroughly review and test selected AOT component
design and fabrication. Subsequent analysis and testing led to changes in electrical insulation, inlet flow improvements and other
component modifications. These design changes were implemented and tested by Industrial Screen and Maintenance (ISM), one of QS
Energy's supply chain partners in Casper, Wyoming. Tests performed by ISM at its Wyoming facility indicated significant improvements
to system impedance and efficiency of electric field generation.
In February 2016, the
modified AOT equipment was installed at Kinder Morgan’s facility. Pre-acceptance testing was performed in April 2016, culminating
in more than 24 hours of continuous operations. In-field viscosity measurements and pipeline data collected during this test indicated
the AOT equipment operated as expected, demonstrating viscosity reductions equivalent to those measured under laboratory conditions.
Supervisory Control And Data Acquisition (“SCADA”) pipeline operating data collected by Kinder Morgan during this test
indicated a pipeline pressure drop reduction consistent with expectations. Results of this test were promising, however due to
the short duration of the test and limited data collection, definitive conclusions regarding the AOT performance and its impact
on pipeline operations could not be reached. Based on final analysis of in-field test results, SCADA operating data and subsequent
analysis of crude oil condensate samples at Temple University, became unlikely Kinder Morgan would use the AOT at the original
test location or other condensate pipeline. Kinder Morgan expressed interest in AOT operations at one of their heavy crude pipeline
locations subject to results of other AOT demonstration projects and provided the Company with additional crude oil samples which
have been tested at Temple University for future test correlation and operational planning purposes. The Kinder Morgan Lease is
currently in suspension and there are no current plans to resume the lease or reinstall an AOT device at a Kinder Morgan facility.
Southern Research Institute
(SRI) was engaged by QS Energy in 2015 to investigate the root cause of the crude oil condensate impedance issue by replicating
conditions experienced in the field utilizing a laboratory-scaled version of the AOT and crude oil condensate samples provided
by Kinder Morgan. In addition, QS Energy retained an industry expert petroleum pipeline engineer to review the AOT design and suggest
design modifications to resolve the crude oil condensate impedance issue. This engineer has studied design details, staff reports
and forensic photographs of each relevant AOT installation and test. Based on these investigations, specific modifications were
proposed to resolve the impedance issue, and improve the overall efficiency of the AOT device, resulting in a new value-engineered
design of certain AOT internal components.
During the third quarter
2016, the Company developed an onsite testing program to demonstrate AOT viscosity reduction at prospective customer sites. This
program utilized a laboratory-scale AOT device designed and developed by the Company and tested at the Southern Research Institute.
Under this program, Company engineers set up a temporary lab at the customer’s site to test a full range of crude oils. Fees
charged for providing this service were dependent on scope of services, crude oil sample to be tested, and onsite time requirements.
In the fourth quarter 2016, the Company entered a contract to provide these onsite testing services to a North American oil producer
and pipeline operator over a one-week period in early 2017 at a fixed price of $50,000. This test was performed in January 2017;
data analysis and final report was completed in March 2017. Test results demonstrated viscosity reduction under limited laboratory
conditions. The oil producer requested access to observe a full-scale demonstration facility and view operating data when they
become available.
In 2014, the Company
began development of a new suite of products based around the new electrical heat system which reduces oil viscosity through a
process known as joule heat (“Joule Heat”). The Company built and tested its first Joule Heat prototype in June 2015.
The system was operational; however, changes to the prototype configuration would be required to determine commercial effectiveness
of this unit. In December 2015, we suspended Joule Heat development activities to focus Company resources on finalizing commercial
development of the AOT. We may resume Joule Heat development in the future depending on the availability of sufficient capital
and other resources.
In July 2017, the Company
filed for trademark protection for the word “eDiluent” in advance of rolling out a new marketing and revenue strategy
based on the concept of using AOT to reduce pipeline dependence upon diluent to reduce viscosity of crude oils. A primary function
of AOT is to reduce viscosity by means of its solid-state electronics technology, in essence providing an electronic form of diluent,
or “eDiluent”. Subject to successful testing of our AOT technology and sufficient the availability of operating capital,
the Company plans to market and sell a value-added service under the name eDiluent, designed to be upsold by the Company’s
midstream pipeline customers in an effort to provide the Company with long-term recurring revenues.
During the third quarter
2017, the Company built a dedicated laboratory space at its Tomball Texas facility, and now has the capability to perform onsite
testing utilizing our laboratory-scale AOT device, among other equipment. Development of an AOT unit for use in crude oil upstream
and gathering operations was restarted in September 2017 utilizing resources at the Tomball facility, and the Company may resume
Joule Heat development in the future depending on the availability of sufficient capital and other resources. Also, during the
third quarter 2017, the Company built an outdoor facility at its Tomball Texas facility for onsite storage of AOT inventory and
other large equipment. The Tomball facility is owned by the Company’s CEO as described in our Form 10-K filed with the SEC
on April 1, 2019.
Throughout 2018 our
primary strategic goal was focused on installing and operating a demonstration AOT project on a commercial crude oil pipeline.
Much of our time was spent meeting with industry executives and engineers in North and South America and working with local representatives
in the Asian and the Middle Eastern markets. In December 2018, we reached mutual agreement with a major U.S.-based pipeline operator
on a demonstration project under which we would install and operate our AOT equipment on a crude oil pipeline located in the Southern
United States. We believe the selected project site should be ideal for demonstration purposes, delivering heavy crudes which,
based on samples tested at Temple University, and, subject to the discussion below, should experience significant viscosity reduction
when treated with our AOT technology.
While management focused
on finding a partner and finalizing terms of the demonstration project, and in our continuing efforts to commercialize our AOT
technology, our engineering team worked throughout 2018 to prepare one of our inventoried AOT units for deployment. All system
upgrade, inspections and testing protocols were completed in December 2018. The pipeline operator finalized site selection and
began site design and engineering in January 2019, completing site preparation and equipment installation in June 2019. The project
was installed within budget, quality compliant, and without safety incidents. The system passed the pre-start safety review, data
acquisition signal verifications, and mechanical inspections. Under full crude oil flow, the system was confirmed to have no leaks
and no environmental issues were noted. Data collected during the full-flow startup phase confirmed internal differential pressures
to be negligible and consistent with design specifications. However, when the system was energized, and the unit was run-up to
high-voltage operations, the primary power supply began to operate erratically and had to be taken offline. Subsequent inspection
determined the primary power supply had failed.
After removing the
primary power supply, our engineers reconfigured the system to run off a smaller secondary power supply. Although this unit was
not capable of achieving target treatment voltage, we performed limited testing and troubleshooting measures, after which the damaged
power supply was shipped to the manufacturer for expedited repair and reconditioning. Inspections performed during the repair process
indicated internal power supply components had been physically damaged. Though not definitive, it appears that damage may have
occurred during transit prior to initial installation at the demonstration site. While the demonstration project was offline for
power supply repairs, our engineering team worked with oil samples pulled from the operating pipeline for testing at our Tomball
laboratory facility. These tests were designed to confirm our target power requirements as accurately as possible and help us fine-tune
enhancements planned for a new optimized AOT internal grid pack design we had planned to test at the demonstration site as part
of our continuing value engineering effort.
During initial testing
with the small power supply, current draw was greater than prior field deployments. While it was expected that the small power
supply would not achieve treatment voltage, as voltage was increased, actual current draw experienced under test conditions exceeded
the operating limit of the power supply. Subsequent laboratory and in-field testing performed at our Tomball facility showed the
electrical conductivity of the oil to be quite high and in line with field observations. Although these tests indicated the unit
was generally functioning properly, results further indicated the damaged power supply, once repaired, would not be capable of
providing sufficient power to fully treat the crude oil due to the oil’s high electrical conductivity. In anticipation of
this result, the Company initiated in advance of testing parallel tasks of: i) installation of the repaired power supply and perform
limited testing to confirm laboratory and in-field test results; and ii) procurement of a new power supply capable of providing
significantly more power and a modified AOT grid pack assembly reconfigured and generally optimized based on the latest laboratory
and in-field test results.
When the repaired power
supply was installed in late August 2019, the system operated as expected, and limited testing was performed at that time. Results
of this limited testing were consistent with laboratory tests performed to date. As expected, the repaired power supply was not
capable of providing sufficient power to fully treat the crude oil under commercial operating conditions. Based on results of this
limited testing, Company engineers completed designs and began implementation of modifications to the AOT internal grid pack assembly.
The new high capacity
power supply and modified grid pack were installed in December 2019. However, prior to flooding the system with crude oil, early-phase
startup testing indicated an electrical short circuit. Subsequent inspection revealed damage to the internal grid pack which likely
occurred during installation. The grid pack was shipped offsite for repairs with reinstallation scheduled for January 2020.
The AOT demonstration
project continued to experience setbacks during the first quarter of 2020. After repairing and re-installing the modified grid
pack, the system shut down again during commissioning presenting with error conditions similar to the December 2019 failure. At
that time, based on external inspections and on-site testing, our engineers suspected the grid pack had again been damaged during
re-installation and that such suspected damage was the most likely cause of the electrical short circuit. It was determined at
that time the best course of action would be to remove the modified grid pack and re-install the original grid pack which had previously
been installed multiple times without sustaining damage, and perform a detailed inspection of the modified grid pack in an effort
to determine the cause of the electrical short circuit.
Executing this plan,
our team removed the modified grid pack and re-installed the original grid pack assembly in the AOT in January 2020. After removal,
our engineers performed a detailed inspection of the modified grid pack. Inconsistent with expectations, no damage to the modified
grid pack was found during this inspection, leaving the cause of the electrical short circuit undiagnosed.
In January and February
2020, our engineers tested and attempted to operate the AOT under a variety of conditions. In these tests, the system could be
run at high voltage under static “shut-in” conditions; however, the system continued to shut down due to an electrical
short circuit when operated under pressure. In simple terms, this means the system could be flooded with crude oil and powered
up in excess of 10,000 volts when the system was shut-in by closing the intake and outtake valves which isolates the system from
the pipeline’s operating pressure. However, once the valves were opened and the system was subjected to the pipeline’s
operating pressure, the system developed an electrical short circuit and shut down.
As the presence of
high pressure appears to trigger the short circuit, it is the belief of our engineers that it is unlikely the fault is in the grid
pack assembly as this component is fully submerged in crude oil and is generally subjected to equal pressure on all components.
The electrical short is more likely developing in the electrical connection assembly built into the blind flange at the top of
the pressure vessel, which is subjected to high pressure under normal operating conditions. Unfortunately, this electrical connection
assembly could not be inspected without destroying the assembly itself. Instead, our engineers developed a plan to replace the
installed blind flange and electrical connection assembly with components from inventory which would be rebuilt prior to installation.
As part of an ongoing
reliability-engineering effort, our engineers had been working on incremental modifications to improve electrical isolation within
the blind flange and electrical connection assembly. These previously developed plans allowed us to move quickly with vendors and
present an expedited plan to the pipeline operator. In March 2020, our engineers designed modifications to the blind flange, electrical
connections and related housing intended to minimize the effects of high pressure and likelihood of internal electrical short circuits.
Concurrently, a blind flange with high voltage assembly was shipped from inventory to a shop with specialized equipment used to
strip the flange of all electrical insulation materials. Once the stripping process is complete, castings will be made to complete
the internal assembly. Our engineers believe this modification may solve the electrical short issue we have experienced in prior
tests.
While the blind flange
assembly is being remanufactured, we have taken the opportunity to implement a number of relatively minor modifications to other
system configurations which had been planned for future units based on results of our engineering team’s reliability engineering
work over the past two years. These modifications are designed to improve the reliability of internal electrical connections, increase
the structural support of the internal grid pack, and maintain higher quality control over internal component positioning and alignment
during vertical installation.
As of March 30, 2020,
we are in the process of finalizing the timelines and budget for this plan based on vendor backlog for each of the tasks. Based
on current estimates, this process may take approximately four to six weeks. This schedule may vary depending on vendor backlogs
and other factors which may be out of our control.
The Company’s
ability to continue operations at the demonstration site is dependent upon continued support of pipeline management and our ability
to fund continued operations. We can provide no assurances pipeline management will continue to support ongoing work at the demonstration
site, or that our plan to rebuild and test the electrical connection assembly will be successful. Because of our inability to fully
diagnose the cause of our current electrical problems, we can provide no assurances that we will not face other operational issues
after completing a full diagnosis and evaluation of our technology.
Assuming the corrective
actions discussed above are achieved, our plans moving forward are centered on achieving commercial adoption of our AOT device.
Assuming successful operations, we believe the demonstration AOT project should provide data requested by prospective customers
such as real-time changes in viscosity, pipeline pressure drop reduction and increases in pipeline operating flowrates. All collected
data at the AOT demonstration site will be normalized such that it can be used to evaluate the financial and operational benefits
across a wide range of commercial operating scenarios without disclosing confidential details of our demonstration partner’s
operations. We believe that real-world data from our demonstration AOT project may be used to accelerate our desire to achieve
commercial adoption of our AOT technology, positioning us to re-engage with industry executives, targeting sales in 2020.
QS Energy is working
to maintain normal operations during the current COVID-19 pandemic under social distancing and shelter-in-place guidelines as recommended
or required by the CDC, federal, state and county government agencies. Over the past few years, the Company moved much of its operations
to the cloud. Our employees can perform most vital functions remotely. Currently, most day-to-day operations have been minimally
impacted by COVID-19.
It is unclear, however,
what impact COVID-19 may have on our supply chain, or on our ability to operate on-site at the demonstration project. As of the
date of this report, no suppliers related to the demonstration project have announced reduced operating capacity or advised us
of delays related to COVID-19 restrictions, and we have not been made aware of any COVID-19 restrictions at the demonstration site
that would impact our ability to restart our demonstration testing.
COVID-19 has had a
significant negative financial impact across a wide spectrum of industries, both in terms of operations and access to operating
capital. The Company’s ability to continue operations is, in part, dependent on our access to funding. A published by the
National Association of Manufacturers in March 2020 reports that due to COVID-19, 35% of manufacturers surveyed anticipate supply
chain disruptions, 53% anticipate changes to operations, and 78% anticipate a negative financial impact. With these facts in mind,
no assurances can be made that COVID-19 will not affect our supply chain, will not negatively affect to access or operating restrictions
at the demonstration site, or negatively impact our ability to fund continued operations.
Our expenses to date
have been funded through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise of stock
purchase warrants and options. We will need to raise substantial additional capital through 2020, and beyond, to fund work at the
demonstration site, our sales and marketing efforts, continuing research and development, and certain other expenses, until we
are able to achieve a revenue base. We can provide no assurances that additional capital will be available to us, or if it is,
that such additional capital will be offered at acceptable terms.
There are significant
risks associated with our business, our Company and our stock. See “Risk Factors,” below.
Our Business Strategy
QS Energy intends to
continue to seek commercialization and marketing of its current technologies. Our current and primary product portfolio is dedicated
to the crude oil production and transportation marketplace, with a specifically targeted product offering for enhancing the flow-assurance
parameters of new and existing pipeline gathering and transmission systems.
Our primary goal is
to provide the oil industry with a cost-effective method by which to increase the number of barrels of oil able to be transported
per day through the industry’s existing and newly built pipelines. The greatest impact on oil transport volume may be realized
through reductions in pipeline operator reliance on diluent for viscosity reduction utilizing AOT technology; a process the Company
refers to as electronic diluent, or “eDiluent”. The Company filed for trademark protection of the term eDiluent in
2017. We also seek to provide the oil industry with a way to reduce emissions from operating equipment. We believe our goals are
realizable via viscosity reduction using our AOT product line.
We believe QS Energy’s
technologies will enable the petroleum industry to gain key value advantages boosting profit, while satisfying the needs of regulatory
bodies at the same time. Key players in the pipeline industry continue to demonstrate interest in our technologies.
Our manufacturing strategy
is to contract with third-party vendors and suppliers, each with a strong reputation and proven track record in the pipeline industry.
These vendors are broken up by product component subcategory, enabling multiple manufacturing capacity redundancies and safeguards
to be utilized. In addition, this strategy allows the Company to eliminate the prohibitively high capital expenditures such as
costs of building, operating and maintaining its own manufacturing facilities, ratings, personnel and licenses, thereby eliminating
unnecessary capital intensity and risk.
Our identified market
strategy is to continue meeting with oil and gas industry executives in the upstream, gathering, and midstream sectors from both
domestic and foreign companies. Our goal is to introduce our technology to oil and gas companies and to demonstrate potential value
for the purposes of negotiating commercial implementation of our AOT technology to their existing infrastructures.
Our strategy includes:
|
1.
|
Continue optimization and value engineering of our AOT Midstream commercial product line.
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2.
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Install and operate AOT equipment on a commercial midstream pipeline.
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3.
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Directly market AOT technology to midstream pipeline operators based on results and analysis of data from the AOT demonstration project.
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5.
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Present demonstration project results and analysis at various trade conferences.
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6.
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Continue to make inroads and meet with key strategic potential customers in the following geographic regions:
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a.
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United States
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b.
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Canada
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c.
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South and Central America
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d.
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Middle East
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e.
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Asia
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7.
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Continue to make inroads and strategic alliances with additional supply chain and logistics support to rapidly expand our production capacity beyond its current physical limitations, adding capacity, reach and stability with pre-approved supply chain members that meet the criteria of the customers’ procurement divisions.
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8.
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Develop new AOT technologies crude oil technologies with the potential to expand our market reach upstream and gathering pipeline, offshore pipelines, rail and trucking containers, and crude oil container ships.
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9.
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Continue to collaborate on scientific and technical whitepaper reports, product development enhancements, and additional products with our engineering support, consultants and relationships.
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10.
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Seek long-term recurring revenues by directly offering or licensing electronic viscosity reduction (electronic diluent, or “eDiluent”) as a service to reduce reliance on physical diluent.
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Market Analysis Overview
QS Energy’s AOT
crude oil viscosity reduction technology directly targets the heavy crude oil transportation industry, initially targeting the
midstream crude oil pipeline operations which deliver high volumes of heavy crude oil to market. The U.S. Energy Information Administration
(EIA) forecasts U.S. crude oil production will average 13.0 million barrels per day in 2020, up 0.8 million barrels per day from
2019, but then fall to 12.7 million barrels per day in 2021. The forecast decline in 2021 is in response to lower oil prices and
would mark the first annual U.S. crude oil production decline since 2016. Worldwide, EIA forecasts crude oil prices averaging $43.30
per barrel in 2020, increasing to $55.36 per barrel in 2021. In recent months, oil prices have been driven to local lows due to
a number of external factors. In March 2020, combined factors of the coronavirus pandemic and increase OPEC output drove Brent
Crude prices as low as $20 per barrel compared to an average $64 per barrel for Brent Crude in 2019. Despite this quick drop in
crude prices, long-term forecasts remain strong. The EIA forecasts that, by 2025, the average price of a barrel of Brent crude
oil will rise to $82 per barrel, growing to $93 per barrel (quoted in 2018 dollars to remove the effects of inflation). Prices
are expected to continue to increase as cheap sources of oil are exhausted, making it more expensive to extract oil.
In 2019, demand for
crude oil averaged 101 million barrels per day. The EIA forecasts demand will remain flat, averaging 102 million barrels per day
by the end of 2021. Long-term, EIA forecasting demand to grow at an average of 0.4% annually. Commitments to stop climate change
introduced more uncertainty into future oil demand. Barclays predicted that oil demand could peak by 2025, falling by as much as
30% by 2050 if countries kept their Paris Climate Accord commitments.
2018 worldwide crude
oil production at 82 million barrels per day. North American production (U.S. and Canada) is estimated at 16 million barrels per
day. At $50 per barrel, this represents annual worldwide and North American sales of $1.5 trillion and $292 billion, respectively.
The EIA estimates 71% worldwide crude oil production is transported by midstream pipelines, with 90% of North American production
transported by midstream pipelines. In 2014, the Congressional Research Service estimated the average cost of midstream pipeline
transportation at $5 per barrel. Assuming a $5 per barrel transportation cost and 2018 crude oil production rates, annual worldwide
and North American midstream crude oil transportation costs are approximately $83 billion and $22 billion, respectively.
The energy sector continues
to operate in a period of both rapid change and expansion. Due to the relatively recent and widespread adoption of advanced oilfield
drilling and completion technologies, known as enhanced oil recovery (EOR) techniques, enormous reserves of “tight”
oil and gas are now recoverable from shale formations throughout North America and the world. This historic surge in upstream crude
oil production has resulted in costly and persistent transportation bottlenecks when moving upstream production to downstream storage,
offloading facilities and refineries. This persistent and severe industrywide problem is stimulating investments in new and existing
pipeline infrastructure and a reliance on less desirable alternate forms of transport, including rail and freight truck.
Since the initial use
of EOR or tertiary recovery techniques in the 1970s, oil and gas producers have progressively relied more heavily on the application
of gas and chemical injection as well as thermal recovery. These extraction techniques, coupled with a much greater number of new
wells in active oilfields, has raised the output of reservoirs by 30 to 60 percent above traditional primary and secondary recovery
practices. Due to the rapid adoption of advanced extraction technologies throughout the U.S. energy industry, a 34-year decline
in domestic oil and gas production was reversed in 2006. Historically high output from massive shale formations such as North Dakota’s
Bakken, Texas’ Eagle Ford and Permian Basin, Colorado’s Green River and Utah’s Uintah Basin continues to the
present day.
Other nations with
significant exploitable shale formations include Russia, China, Argentina, Colombia, Ecuador, Libya, Australia, Venezuela, Mexico
and dozens of others, providing a ready market for crude oil pipeline optimization technologies as production comes online. All
told, the U.S. Energy Information Administration estimates there to be 345 billion barrels of identified and recoverable shale
oil worldwide.
Consequently, oil production
exceeds the capacity of existing pipelines in the U.S., Canada, South and Central America, and many other regions of the world,
often resulting in delivery delays to refineries and increased reliance on more costly rail and tanker truck transport.
Recently, the softening
of oil prices worldwide has incentivized producers and transporters to reduce costs and seek technologies that can provide greater
operational efficiencies. AOT is specifically designed to increase pipeline capacity, while reducing reliance on diluent, pipeline
operating costs and overhead, thereby increasing margins and delivering measurable competitive advantages.
Projected Pipeline Infrastructure Investment
Among the challenges
facing the global crude oil production and transportation sectors, few are as intransigent or detrimental to the industry as the
transportation bottlenecks and well-to-market delivery delays that are endemic here in North America and overseas. While new pipeline
infrastructure projects are underway here in the U.S., Canada and in foreign markets, gaining legislative approval is a lengthy
process and their construction is highly capital-intensive.
Although pipelines
are by far the safest and most economical transportation method, outmoded pipeline infrastructure constructed primarily in the
1950s and 1960s cannot provide the capacity necessary to move production downstream to storage, refinery and offloading facilities.
Consequently, delivery delays to refineries and reliance on less desirable rail and tanker truck transport have increased exponentially
since 2008 when the shale boom began in earnest. Data compiled by the U.S. Energy Information Administration, IHS Global and the
American Petroleum Institute identify billions in lost revenue opportunities for E&P companies and tax collection agencies
in leading oil producing states such as Texas, North Dakota, Alaska, California, Colorado, Wyoming and Utah directly attributable
to production takeaway constraints.
Despite the recently
depressed price level of global oil benchmarks, experts forecast continued growth in crude oil pipeline capital expenditures. In
June 2018, the Interstate National Gas Association of America published a study titled “North America Midstream Infrastructure
through 2035.” Among its key findings, this report estimates $321 billion will be invested in midstream crude oil infrastructure
between 2018 and 2035. This demand is largely due to capacity constraints coupled with the high cost of delivering crude oil by
truck or rail.
We believe QS Energy’s
AOT technology is strategically aligned with the major requirements and challenges facing the petroleum pipeline economy. The AOT
is designed to increase pipeline flowrate while relaxing pipeline viscosity requirements, effectively increasing pipeline capacity
and reducing or eliminating bottlenecks. This has the ancillary benefit of reducing the need to add diluent or heat to reduce viscosity
while reducing reliance on more costly truck and rail transport to meet increasing capacity demands. Our AOT technology may also
mitigate costly operating factors such as vapor pressure, pigging (pipeline cleaning) frequency, power consumption, and onset of
turbulent flow. Of these factors, vapor pressure, which may be mitigated by AOT through reduced reliance on diluent and a reduction
in heat buildup in transit, is of high importance to many pipeline operators as vapor pressure is tightly controlled by the EPA
and is very expensive to mitigate by other means. We are now seeking to commercialize AOT as a cost-efficient solution for both
new and existing pipeline operations.
Target Markets
The oil and gas sector
market can be segmented into three primary categories: Upstream Producers, Midstream Transporters and Downstream Refiners:
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The Upstream segment is involved in the exploration and production (E&P) of oil and gas.
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Midstream companies and partnerships transport oil and gas to markets via pipelines, rail and shipping, and provide storage in the field and at the destination location.
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The Downstream sector refines oil and gas into finished products and, in cooperation with manufacturers and retailers, markets and distributes fuels and other refined petroleum products.
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Upstream Producers
The Upstream segment
has the greatest exposure to commodity prices. When prices fall as has been the case recently, they feel the brunt of this realignment.
They also have the most to gain from additional flow throughput capacity and therefore would see immediate benefit from QS Energy’s
AOT.
This sector is typically
nimble and faces few barriers to entry. With clear financial upside for every additional barrel of crude oil that they are able
to transport, these companies are often open to new and innovative technology capable of providing greater efficiencies, lower
costs and improved cash flow. Upstream producers physically move the most volume of product. They are customers to the Midstream
transporters and enter into long-term contractual shipping obligations (tariff-based transportation contracts) with Midstream transporters
to secure the movement of product from their fields to the refiners and markets downstream.
Producers make the
spot market price for every barrel delivered to refinery, minus the transport costs, tariffs, and marketing discounts associated
with bringing the product to market. A rough rule of thumb for this market is that the further away they are from the refinery,
the higher the transport costs to deliver the product. Discussions with Upstream entities has uncovered strong interest in solutions
that unlock chokepoints from their field equipment to the transmission line loading terminals through viscosity reduction (AOT).
In addition, this group would also benefit from transporters implementing our AOT transmission-line series due to its ability to
increase the overall flow capacity of pipelines transporting product from loading terminals to market.
Midstream Gathering
Transporters
A subset of the Midstream
transporters sector is the gathering line operators. This group often functions as a part of the Upstream producers’ operations,
or within the Midstream transporter’s operations. Midstream gathering lines are the regional transportation infrastructure
that connect Upstream oilfield gathering lines to Midstream long-distance main trunk lines. Typically, these pipelines are of a
relatively short length (20-100 miles) and have diameters between 6” and 12”, and could benefit from our smaller, lower
cost AOT technology.
Midstream entities
transport the bulk of the world’s crude oil output via the 400,000 miles of crude oil pipelines globally. Domestically, they
deliver a large percentage of the U.S. daily production of 9.2 million barrels per day through 160,000 miles of crude pipelines.
Midstream operators represent a strong and ready market for AOT, and field test deployments for both solutions are underway.
The pipeline transport
operators’ business model is to charge a tariff to transport each barrel of oil through their pipeline. Due to the high daily
volume of oil being transported and its value as a commodity, even incremental performance efficiencies can drive significant reductions
in overhead reduction and increases in toll revenues. AOT may also provide pipeline operators the opportunity to offer on-demand
electronic diluent as a service at a premium fee to customers highly dependent on diluent to meet viscosity requirements.
The potential benefits
of AOT includes increased flow, reduced pipeline operating pressure and reduced friction losses and friction-induced heat build-up,
providing economic benefits through increased capacity and toll rate income, and regulatory benefits through reductions in BTU
per ton-mile, off-gassing and reduced carbon emissions (CO2).
Other heavy crude oil transporters
Truck, rail and marine
crude oil carriers rely on heat and other costly and potentially hazardous measures to address the difficulties of onloading and
offloading thick, heavy crudes. The Company is investigating AOT equipment designs specifically targeting this market’s viscosity
and vapor pressure requirements and related evaporation mitigation practices mandated by the U.S. Environmental Protection Agency.
Our Products and Technology
AOT Commercial Products
Beginning in the second
quarter of 2012, the Company began the design and engineering efforts required to transition from laboratory and prototype testing
to AOT units designed for full-scale commercial testing. The Company established its supply chain, designs, drawings, engineering,
certifications and specifications to comply with the engineering audit processes as dictated by the energy industry regulation
processes and North American regulatory bodies. We have built, delivered and tested, under limited duration and conditions, AOT
equipment on a high-volume commercial pipeline. We have not proven the commercial viability of this product. Please see “ITEM
1A, Risk Factors”, for a discussion associated with the commercial viability of our products.
The first commercial
deployment of AOT occurred on the Keystone Pipeline in Udall, Kansas in May 2014, utilizing four AOT pressure vessels in a parallel
“4-Pack” configuration for a cumulative capacity of 600,000 barrels per day. This system was operated under normal
pipeline operating conditions as reported in the ATS RheoSystems field test summary report dated February 5, 2015. See section
titled “Laboratory and Scientific Testing” below for more information on test procedures and results. Subsequent to
testing and termination of the TransCanada lease, the AOT 4-Pack was uninstalled and reconfigured for deployment as four individual
AOT units.
Our second AOT commercial
installation was a single AOT deployment initially installed in March 2015 on the Kinder Morgan Crude & Condensate pipeline,
which provides takeaway capacity for the Eagle Ford Shale in South Texas, primarily delivering light crude oil. As discussed in
the Overview section above, equipment was installed limited operations and tests were performed in 2015 and 2016. Based on final
analysis of in-field test results, SCADA operating data and subsequent analysis of crude oil samples at Temple University, it is
unlikely Kinder Morgan would use the AOT at the original test location or other condensate pipeline. Kinder Morgan may consider
AOT operations at one of their heavy crude pipeline locations subject to results of other AOT demonstration projects.
The Company continues
to optimize and value engineer its AOT product line, targeting both midstream and upstream markets. The Company has installed an
AOT demonstration project in cooperation with a major U.S. pipeline operator. As described in the Overview section above, this
project has experienced numerous failures during initial testing which the Company is working to correct. The most recent round
of repairs and system modifications could be operational in the second quarter of 2020.
Joule Heat Product Development
The Company began development
of its Joule Heat product in 2014, based around the new electrical heat system which reduces oil viscosity through a process known
as joule heat, specifically targeting the upstream crude oil transportation market. The Company’s first Joule Heat prototype
was installed for testing purposes under a joint development agreement with Newfield Exploration Company in June 2015 and the system
was operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this
unit. In December 2015, we suspended Joule Heat development activities to focus Company resources on finalizing commercial development
of the AOT. We may resume Joule Heat development in the future depending on the availability of sufficient capital and other resources.
AOT Commercial Supply Chain
The Company has developed
a well-established supply chain for fabrication of the commercial AOT. The supply chain consists of multiple component suppliers
and manufacturing companies engaged under Independent Contractor Agreements according to their respective fields of expertise.
The supply chain entities have been chosen for their ability to work collaboratively with QS Energy and for their existing relationships
with current and potential future customers of QS Energy technologies. The external components such as pressure vessels, inlet
and outlet piping header systems, personnel and equipment shelters have been manufactured under contract with Power Service Inc.
with offices in Wyoming, Utah, Colorado, Montana, North Dakota, and Texas. Internal components such as grid packs, electrical connections
and other machined parts have been manufactured by Industrial Screen and Maintenance, with offices in Wyoming and Colorado. All
equipment is manufactured in the United States of America, using only approved raw materials and vendors for quality control and
import/export compliance purposes and meet the certifications and specifications as dictated by our customers and their independent
oversight and auditing authorities.
Other components such
as power systems, electrical junction boxes, cabling, hardware, switches, circuit breakers, computer equipment, sensors, SCADA/PLC,
software and other power and integration equipment are purchased as complete units from various suppliers with operations based
throughout North America. All component vendors are required to meet or exceed the same specifications as the parts manufacturers
to maintain compliance as dictated by our customers and their independent oversight and auditing authorities.
AOT Intellectual Property
The Company began its
own independent audit process for the updating of its intellectual property portfolio in 2012. The goal of this process was to
streamline unnecessary legacy items left over from prior management, consolidate efforts to countries and regions of interest and
retire items that were no longer valid or had been replaced with new intellectual property developments. In 2013, the Company retained
the law firm of Jones Walker LLP, with operations based in Houston, Texas and began consolidation and streamlining efforts to manage
intellectual properties. Since that time, QS Energy has filed two additional provisional patents related to our technologies’
method and apparatus.
QS Energy is currently
maintaining and licensing from Temple University a portfolio of domestic and international patents, which have either been granted
or have been published and are pending subject to final approval by the respective patent agency. Each of these intellectual properties
are related to QS Energy’s AOT, Joule Heat and Fuel Injector technologies. AOT technologies are being actively developed
and marketed by the Company. Development of QS Energy’s Fuel Injector and Joule Heat technologies have been suspended. The
Company continues to maintain a license agreement with Temple University with respect to the underlying Fuel Injector patents,
and is considering its options to re-start commercialization, sublicense the technology, or terminate the fuel injector license
agreement with Temple. For details of the licensing agreements with Temple University, see Financial Statements attached hereto,
Note 6. Please see ITEM 1A, Risk Factors below for a discussion of risks associated with these intellectual properties.
Current Business Status
The Company is currently
working with a major U.S. pipeline operator to operate for testing purposes an AOT demonstration project on a high-volume crude
oil pipeline. Once operational, the Company plans to analyze and use AOT performance data to re-engage current and new prospective
customers in our primary target North American and South American midstream crude oil markets. See the Overview section above for
details and current status of this demonstration project.
Throughout 2019, our
efforts have been tightly focused on executing our AOT demonstration project strategy. A number of companies in North America,
South America and the Middle East have expressed interest in our technology and a desire to review demonstration project test results
and visit the demonstration site. Assuming successful operations, we believe the demonstration AOT project should provide data
requested by prospective customers such as real-time changes in viscosity, pipeline pressure drop reduction and increases in pipeline
operating flowrates. All collected data at the AOT demonstration site will be normalized such that it can be used to evaluate the
financial and operational benefits across a wide range of commercial operating scenarios without disclosing confidential details
of our demonstration partner’s operations. We believe that real-world data from our demonstration AOT project may be used
to accelerate our desire to achieve commercial adoption of our AOT technology, positioning us to re-engage with industry executives,
targeting sales in 2020.
Laboratory and Scientific Testing
From 2010 through 2013,
the Company worked with the U.S. Department of Energy (“US DOE”) to test its technology at the Department of Energy’s
Rocky Mountain Oilfield Testing Center (“RMOTC”), near Casper, Wyoming. This third-party testing independently verified
the efficacy of the Company’s technology operating in a controlled facility, using commercial-scale prototype of our AOT
equipment. These tests were summarized in the US DOE Rocky Mountain Oilfield Test Center report dated April 4, 2012 (“ROMRC
Report”), which reported AOT measured pressure loss reduction of 40% and viscosity reduction of 40%; and reported observed
reductions in line-loss and gains in pump operation efficiency across the entire length of the 4.4-mile test pipeline. A subsequent
long-duration (24-hour) test at the RMOTC facility tested the effectiveness of AOT in treating oil overnight, as pipeline oil temperatures
and viscosities drop. In its report dated May 3, 2012 to May 4, 2012, US DOE engineers recorded 56% reduction in viscosity of the
AOT-treated oil versus untreated oil, with AOT effectively stabilizing oil viscosity throughout the overnight run despite dropping
temperatures.
Laboratory testing
of our AOT technology has been conducted by Dr. Rongjia Tao. Testing of the technology as applied to crude oil transmission has
been conducted at Temple University in their Physics Department, in addition to the US DOE, at their Rocky Mountain Oilfield Testing
Center, located on the Naval Petroleum Reserve #3 Teapot Dome Oilfield, north of Casper, Wyoming. In addition, a group led by Dr.
Rongjia Tao, Chairman, Department of Physics of Temple University conducted experiments, using the laboratory-scale Applied Oil
Technology apparatus at the National Institute of Standards and Technology (NIST) Center for Neutron Research (CNR). NIST is an
agency of the U.S. Department of Commerce, founded in 1901 in Gaithersburg, Maryland.
Independent laboratory
testing was also conducted as a collaborative effort by Temple University and PetroChina Pipeline R&D Center (“PetroChina”)
in 2012. In its report dated June 26, 2012 (“PetroChina Report”), PetroChina concluded, “The above series of
tests show that it is very effective to use AOT to reduce the viscosity of crude oil. We can see that AOT has significantly reduced
the viscosity of Daqing crude oil, Changqing crude oil, and Venezuela crude oil, and greatly improved its flow rate.”.
As previously reported
in 2014, QS Energy installed and tested its commercial AOT equipment, leased and operated by TransCanada on TransCanada’s
high-volume Keystone pipeline operation. The first full test of the AOT equipment on the Keystone pipeline was performed in July
2014, with preliminary data analyzed and reported by Dr. Rongjia Tao of Temple University. Upon review of the July 2014 test results
and preliminary report by Dr. Tao, QS Energy and TransCanada mutually agreed that this initial test was flawed due to, among other
factors, the short-term nature of the test, the inability to isolate certain independent pipeline operating factors such as fluctuations
in upstream pump station pressures, and limitations of the AOT device to produce a sufficient electric field to optimize viscosity
reduction. Although Dr. Tao’s preliminary report indicated promising results, QS Energy and TransCanada mutually agreed that
no conclusions could be reliably reached from the July 2014 test or from Dr. Tao’s preliminary report. As a result of this
test, the Company modified its testing protocols and contracted with an independent laboratory, ATS RheoSystems, a division of
CANNON (“ATS”), to perform follow-up tests at the TransCanada facility. This independent laboratory performed viscosity
measurements at the TransCanada facility during subsequent testing in September 2014. As detailed in its field test report dated
October 6, 2014, ATS measured AOT viscosity reductions of 8% to 23% depending on flow rates and crude oil types in transit. Over
the duration of a 24-hour test intended to measure the recovery of the AOT treated oil from its reduced-viscosity treated state
to its original pre-treated viscosity, ATS measured viscosity reductions of 23% three hours after treatment and 11% thirteen hours
after treatment, with the crude oil returning to its untreated state approximately twenty-two hours after treatment. In its summary
report dated February 5, 2015, ATS concluded that i) data indicated a decrease in viscosity of crude oil flowing through the TransCanada
pipeline due to AOT treatment of the crude oil; and ii) the power supply installed on our equipment would need to be increased
to maximize reduction in viscosity and take full advantage of the AOT technology.
Although, as reported
by ATS, the efficacy of the AOT technology operated in the TransCanada field test was constrained due to limitations of the electric
field applied by that unit’s power supply, subsequent analysis by QS Energy personnel of ATS test results compared against
laboratory tests performed at Temple University on oil samples provided by TransCanada revealed a single test run in which the
electric field generated by the AOT was sufficient to fully treat the oil given operating conditions at the time of the test. In
this test run, ATS measured a 23% reduction in viscosity three hours after AOT treatment. Laboratory tests at Temple University
performed on a sample of crude oil provided by TransCanada of the same type treated in that specific field test measured a 27%
reduction in viscosity in the laboratory immediately following treatment. Allowing for the actual three-hour of recovery time of
the field test measurement, the resulting field test viscosity reduction of 23% correlates very well to the 27% viscosity reduction
achieved in the laboratory setting.
Due to the small sample
size of tests performed during the TransCanada field test, results reported by ATS are statistically inconclusive and cannot be
relied upon to provide proof of AOT efficacy. While more testing is required to establish the efficacy of our AOT technology, we
are encouraged by the findings of our independent research laboratory and the results of subsequent comparative analysis of data
collected under laboratory and commercial operating conditions. We look forward to further development and commercialization of
our technology. The TransCanada Lease was terminated by TransCanada, effective October 15, 2014. The Company has modified the design
of the AOT power supply such that future installations of the AOT device are expected to achieve sufficient electric field to optimize
viscosity reduction.
The Company contracted
Southern Research Company (“SRI”) in 2015 to perform independent laboratory tests on its prototype Joule Heat units
AOT Upstream units. SRI performed tests on a prototype Joule Heat unit in September 2015, which showed promising results in which
the Joule Heat prototype was observed to increase crude oil temperatures. In December 2015, we suspended Joule Heat and AOT Upstream
development activities to focus Company resources on finalizing commercial development of the AOT Midstream.
See also our discussion
above in the Overview section regarding our current AOT demonstration project and planned testing activities on a commercial pipeline
in the Southern United States.
Competition
The oil transportation
industry is highly competitive. We are aware of only three currently available competitive technologies in widespread use for reducing
the viscosity of oil throughout the world. Many of our competitors have greater financial, research, marketing and staff resources
than we do. For instance, oil pipeline operators use heat, diluents such as naphtha and/or natural gasoline, and/or chemical viscosity
reduction additives, or chemical drag-reducing agents to improve flow in pipelines. Our research indicates that these methods are
either very energy-intensive, or costly to implement on a day to day basis. Management believes that the Company’s AOT technology
presents advantages over traditional methods, yet the industry’s willingness to experiment with new technology may pose some
challenges in acceptance.
We are not aware of
any other technology using uniform electrical field crude oil viscosity reduction technology which is designed to significantly
improve pipeline operation efficiency. Although we are unaware of any technologies that compete directly with our technologies,
there can be no assurance that any unknown existing or future technology will not be superior to products incorporating our AOT
technology. Major domestic and international manufacturers and distributors of pipeline flow-improvement chemical solutions include
Pemex, Petrotrin, Pluspetrol, Repsol, Glencore, Conoco-Philips, and Baker-Hughes. According to our research, heater skid manufacturers
are generally local to the oilfield and pipeline regions, and are comprised of a large number of relatively small businesses in
a fragmented industry. Major heater skid manufacturers are Parker, KW International, Thermotech Systems, LTD.
Government Regulation and Environmental
Matters
Our research and development
activities are not subject to any governmental regulations that would have a significant impact on our business and we believe
that we are in compliance with all applicable regulations that apply to our business as it is presently conducted. Our products,
as such, are not subject to certification or approval by the EPA or other governmental agencies domestically or internationally.
Depending upon whether we manufacture or license our products in the future and in which countries such products are manufactured
or sold, we may be subject to regulations, including environmental regulations, at such time.
Non-Disclosure Agreements
To protect our intellectual
property, we have entered into agreements with certain employees and consultants, which limit access to, and disclosure or use
of, our technology. There can be no assurance, however, that the steps we have taken to deter misappropriation of our intellectual
property or third-party development of our technology and/or processes will be adequate, that others will not independently develop
similar technologies and/or processes or that secrecy will not be breached. In addition, although management believes that our
technology has been independently developed and does not infringe on the proprietary rights of others, there can be no assurance
that our technology does not and will not so infringe or that third parties will not assert infringement claims against us in the
future. Management believes that the steps they have taken to date will provide some degree of protection; however, no assurance
can be given that this will be the case.
Employees
As of December 31,
2019, the Company had four (4) full-time employees. We also utilized the services of part-time consultants on an as-needed basis
to assist us with various matters, including engineering, logistics, investor relations, public relations, accounting and
sales and marketing. We intend to hire additional personnel to provide services when they are needed on a full-time basis. We recognize
that our efficiency largely depends, in part, on our ability to hire and retain additional qualified personnel as and when needed
and we have adopted procedures to assure our ability to do so.
Item 1A. Risk Factors
We have a history
of losses, and we cannot assure you that we will ever become or remain profitable. As a result, you may lose your entire investment.
We generated insignificant
revenues from operations in late 2006 and subsequently did not generate any revenues until 2014 and we have incurred recurring
net losses every year since our inception in 1998. For the fiscal years ended December 31, 2019 and 2018, we had net losses
of $5,621,000 and $3,059,000 respectively. To date, we have dedicated most of our financial resources to research and development,
general and administrative expenses and initial sales and marketing activities. We have funded all of our activities through sales
of our debt and equity securities for cash. We anticipate net losses and negative cash flow to continue until such time as our
products are brought to market in sufficient amounts to offset operating losses. Our ability to achieve profitability is dependent
upon our continuing research and development, product development, and sales and marketing efforts, to deliver viable products
and the Company’s ability to successfully bring them to market. Although our management is optimistic that we will succeed
in marketing products incorporating our technologies, there can be no assurance that we will ever generate significant revenues
or that any revenues that may be generated will be sufficient for us to become profitable or thereafter maintain profitability.
If we cannot generate sufficient revenues or become or remain profitable, we may have to cease our operations and liquidate our
business.
Our independent
auditors have expressed doubt about our ability to continue as a going concern, which may hinder our ability to obtain future financing.
In their report dated
March 30, 2020, our independent auditors stated that our consolidated financial statements for the year ended December 31,
2019 were prepared assuming that we would continue as a going concern. Our ability to continue as a going concern is an issue
raised as a result of our recurring net losses and accumulated deficit from operations since inception. During the year ended
December 31, 2019, we incurred a net loss of $5,621,000 and used cash in operations of $2,678,000 and had a stockholders’
deficit of $2,269,000 as of December 31, 2019. Our ability to continue as a going concern is subject to our ability to obtain
significant additional capital to fund our operations and to generate revenue from sales, of which there is no assurance. The
going concern qualification in the auditor’s report could materially limit our ability to raise additional capital. If we
fail to raise sufficient capital, we may have to liquidate our business and you may lose your investment.
Since we have not
yet begun to generate positive cash flow from operations, our ability to continue operations is dependent on our ability to either
begin to generate positive cash flow from operations or our ability to raise capital from outside sources.
We have not generated
cash flow from operations since our inception in February 1998 and have relied on external sources of capital to fund operations.
We had $479,000 in cash at December 31, 2019 and used cash from operations of $2,678,000 for the year ended December 31, 2019.
We currently do not
have credit facilities available with financial institutions or other third parties, and historically have relied upon best efforts
third-party funding. Though we have been successful at raising capital on a best-efforts basis in the past, we can provide no assurance
that we will be successful in any future best-efforts financing endeavors. We will need to continue to rely upon financing from
external sources to fund our operations for the foreseeable future. If we are unable to raise sufficient capital from external
sources to fund our operations, we may need to curtail operations.
We will need substantial
additional capital to meet our operating needs, and we cannot be sure that additional financing will be available.
During fiscal 2019,
our cash burn rate amounted to approximately $223,000 per month and could increase during the remainder of fiscal 2020. In order
to fund our capital needs, we conducted private offerings of our securities in 2018 and 2019. While discussion regarding additional
interim and permanent financings are being actively conducted, management cannot predict with certainty that an equity line of
credit will be available to provide adequate funds, or any funds at all, or whether any additional interim or permanent financings
will be available at all or, if it is available, if it will be available on favorable terms. If we cannot obtain needed capital,
our research and development, and sales and marketing plans, business and financial condition and our ability to reduce losses
and generate profits will be materially and adversely affected.
Our business prospects
are difficult to predict because of our limited operating history, early stage of development and unproven business strategy. Since
our incorporation in 1998, we have been and continue to be involved in development of products using our technology, establishing
manufacturing and marketing of these products to consumers and industry partners. Although we believe our technology and products
in development have significant profit potential, we may not attain profitable operations and our management may not succeed in
realizing our business objectives.
If we are not able
to devote adequate resources to product development and commercialization, we may not be able to develop our products.
Our business strategy
is to develop, manufacture and market products incorporating our AOT technology. We believe that our revenue growth and profitability,
if any, will substantially depend upon our ability to raise additional necessary capital for research and development, complete
development of our products in development and successfully introduce and commercialize our products.
Certain of our products
are still under various stages of development. Because we have limited resources to devote to product development and commercialization,
any delay in the development of one product or reallocation of resources to product development efforts that prove unsuccessful
may delay or jeopardize the development of other product candidates. Although our management believes that it can finance our product
development through private placements and other capital sources, if we do not develop new products and bring them to market, our
ability to generate revenues will be adversely affected.
The commercial viability
of QS Energy’s technologies remains largely unproven and we may not be able to attract customers.
Despite the fact that
we leased AOT equipment in 2014 to a major oil pipeline operator and tested the equipment on their high-volume pipeline under normal
operating conditions, entered into a lease agreement with a second major oil pipeline operator to operate and test AOT equipment
in 2015, and have initiated a project to demonstrate our AOT technology on a commercial pipeline in 2019, the commercial viability
of our devices is not known at this time. If commercial opportunities are not realized from the use of products incorporating the
AOT technology, our ability to generate revenue would be adversely affected. There can be no assurances that we will be successful
in marketing our products, or that customers will ultimately purchase our products. Failure to have commercial success from the
sale of our products will significantly and negatively impact our financial condition. There can be no assurances that we will
be successful in marketing our products, or that customers will ultimately purchase our products. Failure to
have commercial success from the sale of our products will significantly and negatively impact our financial condition.
If our products
and services do not gain market acceptance, it is unlikely that we will become profitable.
At this time, our technology
is commercially unproven, and the use of our technology by others is limited. Specific examples of use to date include:
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Temple University, testing, research and joint development;
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U.S. Department of Energy Rocky Mountain Oilfield Testing Center, testing and research;
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PetroChina Pipeline R&D Center, testing and research;
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TransCanada, short-term testing;
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Kinder Morgan Crude and Condensate, short-term testing;
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On-site short-term testing of a laboratory-scale AOT at a Canadian oil producer’s facility in Alberta Canada.
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A demonstration project currently under development in cooperation with a commercial pipeline operator in the Southern United States
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The commercial success
of our products will depend upon the adoption of our technology by the oil industry. Market acceptance will depend on many factors,
including:
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the willingness and ability of consumers and industry partners to adopt new technologies;
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our ability to convince potential industry partners and consumers that our technology is an attractive alternative to other technologies;
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our ability to manufacture products and provide services in sufficient quantities with acceptable quality and at an acceptable cost; and,
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our ability to place and service sufficient quantities of our products.
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If our products do
not achieve a significant level of market acceptance, demand for our products will not develop as expected and it is unlikely that
we will become profitable.
We outsource and
rely on third parties for the manufacture of our products.
Our business model
calls for the outsourcing of the manufacture of our products in order to reduce our capital and infrastructure costs, capital expenditure
and personnel. Accordingly, we must enter into agreements with other companies that can assist us and provide certain capabilities
that we do not possess, and to increase our manufacturing capacity as necessary. We can provide no assurances that any such outsourcing
will be at commercially acceptable rates or profitable. Moreover, we do not have the required financial and human resources or
capability to manufacture, market and sell our products. Our business model calls for the outsourcing of the manufacture, and sales
and marketing of our products in order to reduce our capital and infrastructure costs as a means of potentially improving our financial
position and the profitability of our business. Accordingly, we must enter into agreements with other companies that can assist
us and provide certain capabilities that we do not possess. We may not be successful in entering into additional such alliances
on favorable terms or at all. Furthermore, any delay in entering into agreements could delay the development and commercialization
of our products and reduce their competitiveness even if they reach the market. Any such delay related to our existing or future
agreements could adversely affect our business.
If any party to
which we have outsourced certain functions fails to perform its obligations under agreements with us, the development and commercialization
of our products could be delayed or curtailed.
To the extent that
we rely on other companies to manufacture, sell or market our products, we will be dependent on the timeliness and effectiveness
of their efforts. If any of these parties do not perform its obligations in a timely and effective manner, the commercialization
of our products could be delayed or curtailed because we may not have sufficient financial resources or capabilities to continue
such development and commercialization on our own.
Any revenues that
we may earn in the future are unpredictable, and our operating results are likely to fluctuate from quarter to quarter.
We believe that our
future operating results will fluctuate due to a variety of factors, including delays in product development, market acceptance
of our new products, changes in the demand for and pricing of our products, competition and pricing pressure from competitive products,
manufacturing delays and expenses related to and the results of proceedings relating to our intellectual property.
A large portion of
our expenses, including expenses for our facilities, equipment and personnel, is relatively fixed and not subject to further significant
reduction. In addition, we expect our operating expenses will increase in the future as we continue our commercialization efforts
and increase our production and marketing activities, among other activities. Although we expect to generate revenues from sales
of our products, revenues may decline or not grow as anticipated and our operating results could be substantially harmed for a
particular fiscal period. Moreover, our operating results in some quarters may not meet the expectations of stock market analysts
and investors. In that case, our stock price most likely would decline.
Nondisclosure agreements
with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.
In order to protect
our proprietary technology and processes, we rely in part on nondisclosure agreements with our employees, licensing partners, customers,
consultants, agents and other organizations to which we disclose our proprietary information. These agreements may not effectively
prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of
confidential information. In addition, others may independently discover trade secrets and proprietary information, and in such
cases, we could not assert any trade secret rights against such parties. Costly and time-consuming litigation could be necessary
to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely
affect our competitive business position. Since we rely on trade secrets and nondisclosure agreements, in addition to patents,
to protect some of our intellectual property, there is a risk that third parties may obtain and improperly utilize our proprietary
information to our competitive disadvantage. We may not be able to detect unauthorized use or take appropriate and timely steps
to enforce our intellectual property rights.
The manufacture,
use or sale of our current and proposed products may infringe on the patent rights of others, and we may be forced to litigate
if an intellectual property dispute arises.
We have taken measures
to protect ourselves from infringing on the patent rights of others; however, if we infringe or are alleged to have infringed another
party’s patent rights, we may be required to seek a license, defend an infringement action or challenge the validity of the
patents in court. Patent litigation is costly and time consuming. We may not have sufficient resources to bring these actions to
a successful conclusion. In addition, if we do not obtain a license, do not successfully defend an infringement action or are unable
to have infringed patents declared invalid, we may incur substantial monetary damages ,encounter significant delays in marketing
our current and proposed product candidates, be unable to conduct or participate in the manufacture, use or sale of product, candidates
or methods of treatment requiring licenses, lose patent protection for our inventions and products; or find our patents are unenforceable,
invalid, or have a reduced scope of protection.
Parties making such
claims may be able to obtain injunctive relief that could effectively block our ability to further develop or commercialize our
current and proposed product candidates in the United States and abroad and could result in the award of substantial damages. Defense
of any lawsuit or failure to obtain any such license could substantially harm the company. Litigation, regardless of outcome, could
result in substantial cost to and a diversion of efforts by the Company to operate its business.
We may face costly
intellectual property / license agreements disputes.
Our ability to compete
effectively will depend in part on our ability to develop and maintain proprietary aspects of our technologies and either to operate
without infringing the proprietary rights of others or to obtain rights to technology owned by third parties. Our pending patent
applications, specifically patent rights of the AOT technology and Joule Heating process may not result in the issuance of any
patents or any issued patents that will offer protection against competitors with similar technology. Patents we have licensed
for our technologies, and which we may receive, may be challenged, invalidated or circumvented in the future or the rights created
by those patents may not provide a competitive advantage. We also rely on trade secrets, technical know-how and continuing invention
to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information
and techniques or otherwise gain access to our trade secrets. See Note 6 of our financial statements attached hereto for a discussion
and status of our license agreements with Temple University.
Changes in governmental
regulations and policies may affect export of our technologies.
The Company recognizes
domestic and foreign governmental actions, including but not limited to trade restrictions and tariffs, may adversely affect our
ability to export our technologies, or may adversely affect the economics of cross-border transactions.
We may not be able
to attract or retain qualified senior personnel.
We believe we are currently
able to manage our current business with our existing management team. However, as we expand the scope of our operations, we will
need to obtain the full-time services of additional senior management and other personnel. Competition for highly skilled personnel
is intense, and there can be no assurance that we will be able to attract or retain qualified senior personnel. Our failure to
do so could have an adverse effect on our ability to implement our business plan. As we add full-time senior personnel, our overhead
expenses for salaries and related items will increase compensation packages, these increases could be substantial.
If we lose our key
personnel or are unable to attract and retain additional personnel, we may be unable to achieve profitability.
Our future success
is substantially dependent on the efforts of our senior management. The loss of the services of members of our senior management
may significantly delay or prevent the achievement of product development and other business objectives. Because of the scientific
nature of our business, we depend substantially on our ability to attract and retain qualified marketing, scientific and technical
personnel, including consultants. There is intense competition among specialized automotive companies for qualified personnel in
the areas of our activities. If we lose the services of, or do not successfully recruit key marketing, scientific and technical
personnel, the growth of our business could be substantially impaired. We do not maintain key man insurance for any of these individuals.
Currently, there
is only very limited trading in our stock, so you may be unable to sell your shares at or near the quoted bid prices if you need
to sell your shares.
The shares of our common
stock are thinly traded on the OTC Bulletin Board, meaning that the number of persons interested in purchasing our common shares
at or near bid prices at any given time may be relatively small or non-existent. This situation is attributable to a number of
factors, including the fact that we are a small company engaged in a high-risk business which is relatively unknown to stock analysts,
stock brokers, institutional investors and others in the investment community that can generate or influence daily trading volume
and valuation. Should we even come to the attention of such persons, they tend to be risk-averse and would be reluctant to follow
an unproven, early stage company such as ours or purchase or recommend the purchase of our shares until such time as we became
more seasoned and viable. As a consequence, there may be periods of several days or more when trading activity in our shares is
minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally
support continuous trading without negatively impacting share price. We cannot provide any assurance that a broader or more active
public trading market for shares of our common stock will develop or be sustained. Due to these conditions, we cannot give any
assurance that shareholders will be able to sell their shares at or near bid prices or at all.
The market price
of our stock is volatile.
The market price for
our common stock has been volatile during the last year, ranging from a closing price of $0.08 on January 2, 2019 to a closing
price of $0.38 on February 27, 2019, and a closing price of $0.04 on March 20, 2020. Additionally, the price of our stock has been
both higher and lower than those amounts on an intra-day basis in the last year. Because our stock is thinly traded, its price
can change dramatically over short periods, even in a single day. The market price of our common stock could fluctuate widely in
response to many factors, including, developments with respect to patents or proprietary rights, announcements of technological
innovations by us or our competitors, announcements of new products or new contracts by us or our competitors, actual or anticipated
variations in our operating results due to the level of development expenses and other factors, changes in financial estimates
by securities analysts and whether any future earnings of ours meet or exceed such estimates, conditions and trends in our industry,
new accounting standards, general economic, political and market conditions and other factors.
Substantial sales
of common stock could cause our stock price to fall.
In the past year, there
have been times when average daily trading volume of our common stock has been extremely low, and there have been many days in
which no shares were traded at all. At other times, the average daily trading volume of our common stock has been high. Nevertheless,
the possibility that substantial amounts of common stock may be sold in the public market may adversely affect prevailing market
prices for our common stock and could impair a shareholder’s ability to sell our stock or our ability to raise capital through
the sale of our equity securities.
Potential issuance
of additional shares of our common stock could dilute existing stockholders.
We are authorized to
issue up to 500,000,000 shares of common stock and up to 100,000,000 of preferred stock. To the extent of such authorization, our
Board of Directors has the ability, without seeking stockholder approval, to issue additional shares of common stock or preferred
stock in the future for such consideration as the Board of Directors may consider sufficient. The issuance of additional common
stock or preferred stock in the future may reduce the proportionate ownership and voting power of shareholders.
We may not be successful in identifying,
making, financing and integrating acquisitions.
A component of our
business strategy is to make selective acquisitions that will strengthen our core services or presence in selected markets. The
success of this strategy will depend, among other things, on our ability to identify suitable acquisition candidates, to obtain
acceptable financing, to timely and successfully integrate acquired businesses or assets and to retain the key personnel and the
customer base of acquired businesses. Any future acquisitions could present a number of risks, including but not limited to:
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incorrect assumptions regarding the future results of acquired operations or assets or expected cost reductions or other synergies expected to be realized as a result of acquiring operations or assets;
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failure to integrate successfully the operations or management of any acquired operations or assets in a timely manner;
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failure to retain or attract key employees; and
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diversion of management’s attention from existing operations or other priorities.
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If we are unable to
identify, make and successfully integrate acquired businesses, it could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
Our common stock
is subject to penny stock regulation, which may make it more difficult for us to raise capital.
Our common stock is
considered penny stock under SEC regulations. It is subject to rules that impose additional sales practice requirements on broker-dealers
who sell our securities. For example, broker-dealers must make a suitability determination for the purchaser, receive the purchaser’s
written consent to the transaction prior to sale, and make special disclosures regarding sales commissions, current stock
price quotations, recent price information and information on the limited market in penny stock. Because of these additional obligations,
some broker-dealers may not affect transactions in penny stocks, which may adversely affect the liquidity of our common stock and
shareholders’ ability to sell our common stock in the secondary market. This lack of liquidity may make it difficult for
us to raise capital in the future.
Current COVID-19
(coronavirus) pandemic.
See Overview section
above regarding risks associated with the current COVID-19 (coronavirus) pandemic.