Quarterly report pursuant to Section 13 or 15(d)

Commitments and Contingencies

v3.19.2
Commitments and Contingencies
6 Months Ended
Jun. 30, 2019
Commitments and Contingencies [Abstract]  
Commitments and Contingencies 10.  COMMITMENTS AND CONTINGENCIES

Leases

Under the new leasing standard which became effected January 1, 2019, there are two types of leases: finance and operating. Regardless of the type of lease, the initial measurement of the lease results in recording a ROU asset and a lease liability at the present value of the stream of future lease payments.

Practical Expedients – The new standard provides a package of three practical expedients to simplify adoption. At the transition date, the entity may elect not to reassess: (1) whether any expired or existing contracts as of the adoption date are or contain leases under the new definition of a lease, (2) lease classification for expired or existing leases as of the adoption date and (3) initial direct costs for any existing leases as of the adoption date. These three expedients must be elected or not elected as a package. An entity that elects to apply all three of the practical expedients will, in effect, continue to classify leases that commence before the adoption date in accordance with current GAAP, unless the lease classification is reassessed after the adoption date. A lessee that elects to apply all of the practical expedients beginning on the adoption date will follow subsequent measurement guidance in ASC 842. The Company has elected to use these practical expedients, effectively carrying over its previous identification and classification of leases that existed as of January 1, 2019. Additionally, a lessee may elect not to recognize ROU assets and liabilities arising from short-term leases provided there is no purchase option the entity is likely to exercise. The Company has elected this short-term lease exemption. The adoption of ASC 842 resulted in a material increase in the Company’s total assets and liabilities on the Company’s condensed consolidated balance sheet as certain of its operating leases are significant. In addition, adoption resulted in a decrease in working capital as the ROU asset is noncurrent but the lease liability has both long-term and short-term portions. There was no material overall impact on results of operations or cash flows. In the statement of cash flows, operating leases remain an operating activity.

The Company has entered into several agreements for the lease of office, warehouse and storage yard space, the FPSO and a hydraulic workover rig (“HWU”). The duration for these agreements ranges from 21 to 45 months. The FPSO, HWU and office space contracts require the Company to make payments both for the use of the asset itself and for operations and maintenance services. Only the payments for the use of the asset relate to the lease component and are included in the calculation of ROU assets and lease liabilities.

Payments for the operations and maintenance services are considered non-lease components and are not included in calculating the ROU assets and lease liabilities. For leases on ROU assets used in joint operations, generally the operator reflects the full amount of the lease component, including the amount which will be funded by the non-operators. As operator for the Etame Marin block, the ROU asset recorded for the FPSO, HWU and warehouse and storage yard space used in the joint operations includes the gross amount of the lease components.

The FPSO lease includes an option to extend the term through September 2022. The Company considered this option reasonably certain of exercise and has included it in the calculation of ROU assets and lease liabilities.

The FPSO and HWU agreements also contain options to purchase the assets during or at the end of the lease term. The Company does not consider these options reasonably certain of exercise and have excluded the purchase price from the calculation of ROU assets and lease liabilities.

The FPSO and HWU leases include provisions for variable lease payments, under which the Company is required to make additional payments based on the level of production or the number of days the asset is deployed. Because the Company does not know the extent to which the Company will be required to make such payments, they are excluded from the calculation of ROU assets and lease liabilities.

The discount rate used to calculate ROU assets and lease liabilities represents the Company’s incremental borrowing rate. The Company determined this by considering the term and economic environment of each lease, and estimating the resulting interest rate the Company would incur to borrow the lease payments.

For the three and six months ended June 30, 2019, the components of the lease costs and the supplemental information were as follows:

Three Months Ended June 30, 2019

Six Months Ended June 30, 2019

Lease cost:

($ in thousands)

Operating lease cost

$

3,775

$

7,334

Short-term lease cost

101

404

Variable lease cost

1,408

2,738

Total lease cost

$

5,284

$

10,476

Other information:

Cash paid for amounts included in the measurement of lease liabilities:

Operating cash flows from (to) operating leases

$

8,913

Weighted-average remaining lease term

3.18 years 

Weighted-average discount rate

6.25% 

The table below describes the presentation of the total lease cost on the Company’s consolidated statement of operations. As discussed above, the Company’s joint venture owners are required to reimburse the Company for their share of certain expenses, including certain lease costs.

Three Months Ended June 30, 2019

Six Months Ended June 30, 2019

(in thousands)

Production expense

$

1,626

$

3,223

General and administrative expense

49

98

Lease costs billed to the joint venture owners

3,609

7,155

Total lease costs

$

5,284

$

10,476

The following table describes the future maturities of the Company’s operating lease liabilities at June 30, 2019:

Lease Obligation

Year

(in thousands)

2019

$

6,164

2020

11,979

2021

11,224

2022

8,088

2023

37,455

Less: imputed interest

3,331

Total lease liabilities

$

34,124

Under the joint operating agreements, other joint owners are obligated to fund $25.8 million of the $37.5 million in future lease liabilities.

Abandonment funding

As part of securing the first of two five-year extensions to the Etame PSC to which the Company is entitled from the government of Gabon, the Company agreed to a cash funding arrangement for the eventual abandonment of all offshore wells, platforms and facilities on the Etame Marin block. The agreement was finalized in the first quarter of 2014 (effective as of 2011) providing for annual funding over a period of ten years in amounts equal to 12.14% of the total abandonment estimate for the first seven years and 5.0% per year for the last three years of the production license. The amounts paid will be reimbursed through the cost account and are non-refundable. The abandonment estimate used for this purpose is approximately $61.8 million ($19.2 million net to VAALCO) on an undiscounted basis. Through June 30, 2019, $37.4 million ($11.6 million net to VAALCO) on an undiscounted basis has been funded. This cash funding is reflected under “Other noncurrent assets” as “Abandonment funding” on the Company’s condensed consolidated balance sheets. Future changes to the anticipated abandonment cost estimate could change the Company’s asset retirement obligation and the amount of future abandonment funding payments.

On March 5, 2019, in accordance with certain foreign currency regulatory requirements, the Gabonese branch of the international commercial bank holding the abandonment funds in a U.S. dollar denominated account transferred the funds to the Central Bank for “CEMAC” (the Central African Economic and Monetary Community), of which Gabon is one of the six member states. The U.S. dollars were converted to local currency with a credit back to the Gabonese branch. Amendment 5 to the Etame PSC provides that in the event that the Gabonese bank fails for any reasons to reimburse all of the principal and interest due, the Company will no longer be held liable for the resulting shortfall in funding the obligation to remediate the sites.

FPSO charter

In connection with the charter of the FPSO, the Company, as operator of the Etame Marin block, guaranteed all of the charter payments under the charter through its contract term, which expires in September 2022. At the Company’s election, the charter may be extended for two one-year periods beyond September 2020. The Company obtained guarantees from each of the Company’s joint venture owners for their respective shares of the payments. The Company’s net share of the charter payment is 31.1%, or approximately $9.7 million per year. Although the Company believes the need for performance under the charter guarantee is remote, the Company recorded a liability of $0.2 million as of June 30, 2019 and December 31, 2018 representing the guarantee’s estimated fair value. The guarantee of the offshore Gabon FPSO charter has $53.9 million in remaining gross minimum obligations as of December 31, 2018.

Estimated future minimum obligations through the end of the FPSO charter which reflects the right of early termination are as follows as of December 31, 2018 (in thousands):

Balance at December 31, 2018

(in thousands)

Full Charter Payment

VAALCO, Net

Year

2019

$

31,294

$

9,718

2020

22,634

7,029

2021

2022

2023

Total

$

53,928

$

16,747

The FPSO charter payment includes a $0.93 per barrel charter fee for production up to 20,000 barrels of oil per day and a $2.50 per barrel charter fee for those barrels produced in excess of 20,000 barrels of oil per day. VAALCO’s net share of payments was $10.8 million for the year ended December 31, 2018.

Other lease obligations

In addition to the FPSO, the Company has other operating lease obligations as of December 31, 2018 (in thousands):I

(in thousands)

Gross Obligation

VAALCO, Net

Year

2019

$

1,110

$

627

2020

693

450

2021

2022

2023

Total

$

1,803

$

1,077

The Company incurred rent expense of $0.4 million and $0.9 million, respectively, during the three and six months ended June 30, 2018.

Regulatory and Joint Interest Audits

The Company is subject to periodic routine audits by various government agencies in Gabon, including audits of the Company’s petroleum cost account, customs, taxes and other operational matters, as well as audits by other members of the contractor group under the Company’s joint operating agreements.

In 2016, the government of Gabon conducted an audit of the Company’s operations in Gabon, covering the years 2013 through 2014. The Company received the findings from this audit and responded to the audit findings in January 2017. Since providing the Company’s response, there have been changes in the Gabonese officials responsible for the audit. The Company is working with the newly appointed representatives to resolve the audit findings. The Company does not anticipate that the ultimate outcome of this audit will have a material effect on the Company’s financial condition, results of operations or liquidity.

At December 31, 2018, the Company had accrued $1.3 million, net to VAALCO, in “Accrued liabilities and other” on the Company’s condensed consolidated balance sheets for potential fees which may result from customs audits. This matter was fully resolved in January 2019 for $1.3 million, net to VAALCO.

In July 2019, the Company reached an agreement in principle to resolve a legacy issue related to findings from Etame joint venture owners’ audits for the periods from 2007 through 2016 for $4.4 million net to VAALCO. The agreement in principle also provides for procedures to minimize the chances of future audit claims. Accordingly, the Company has accrued $4.4 million which is reflected in the “Accrued liabilities and other” line of the Company’s condensed consolidated balance sheet and is recorded as a second quarter 2019 expense in the condensed consolidated statements of operations in the line item “Other operating income (expense), net”. The agreement in principle is expected to become final upon signing of a binding settlement agreement by all of the joint venture owners.

Drilling Rig

The Company has contracted a drilling rig to be used to drill two wells, including two appraisal wellbores, for the Etame Marin joint operations beginning in the second half of 2019. The agreement includes options to drill four additional wells at the Etame Marin block. The drilling rig contract stipulates a day rate of approximately $75,000. The Company expects the term associated with the drilling rig commitment to be less than one year.