Form: 10KSB

Optional form for annual and transition reports of small business issuers [Section 13 or 15(d), not S-B Item 405]

March 30, 1998

Documents

10KSB: Optional form for annual and transition reports of small business issuers [Section 13 or 15(d), not S-B Item 405]

Published on March 30, 1998


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

-----------------

FORM 10-KSB

(Mark One)

|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1997
OR

|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

COMMISSION FILE NUMBER 0-20928

-----------------------
VAALCO ENERGY, INC.
(Name of small business issuer in its charter)

Delaware 76-0274813
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

4600 Post Oak Place
Suite 309
Houston, Texas 77027
(Address of principal executive offices) (Zip Code)

Issuer's telephone number: (713) 623-0801
Securities registered under Section 12(b) of the Exchange Act:

Title of each class Name of each exchange
on which registered

None

Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.10 par value
(Title of class)

Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes __ No X .

Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB .

The registrant's revenues for the fiscal year ended December 31, 1997
were $6,437,354.

The aggregate market value of the voting and non-voting common equity of
the registrant held by non-affiliates as of March 23, 1998 was $20,955,283 based
upon the closing price as of such date.

As of March 23, 1998, there were outstanding 15,566,527 shares of Common
Stock, $.10 par value per share, of the registrant.

Documents incorporated by reference: Definitive proxy statement of
VAALCO Energy, Inc. relating to the Annual Meeting of Stockholders to be filed
within 120 days after the end of the fiscal year covered by this Form, which is
incorporated into Part III of this 10-KSB.
VAALCO ENERGY, INC.

TABLE OF CONTENTS

PART I




Item 1. Business...............................................................3

Item 2. Properties............................................................14

Item 3. Legal Proceedings.....................................................20

Item 4. Submission of Matters to a Vote of Security Holders...................20

PART II

Item 5. Market for Common Equity and Related
Stockholder Matters...................................................21

Item 6. Management's Discussion and Analysis or Plan
of Operations.........................................................22

Item 7. Financial Statements and Supplementary Data...........................26

Item 8. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................48

PART III

Item 13. Exhibits and Reports on Form 8-K......................................49

PART I

ITEM 1. BUSINESS

BACKGROUND

VAALCO Energy, Inc., a Delaware corporation, is a Houston-based
independent energy company principally engaged in the acquisition, exploration,
development and production of crude oil and natural gas. As used herein, the
terms "Company" and "VAALCO" mean VAALCO Energy, Inc. and its subsidiaries,
unless the context otherwise requires. VAALCO owns producing properties and
conducts exploration activities internationally in the Philippines and
domestically in the Texas Gulf Coast area, and has recently begun international
exploration activities in Gabon in West Africa.

VAALCO was incorporated in Delaware in 1989. VAALCO's Philippine
subsidiaries include Alcorn (Philippines) Inc. and Alcorn (Production)
Philippines Inc. VAALCO's Gabon subsidiaries are VAALCO Gabon (Equata), Inc.,
VAALCO Gabon (Etame), Inc., VAALCO Production (Gabon), Inc. and VAALCO Energy
(Gabon), Inc. VAALCO (USA), Inc. holds interests in certain properties in the
United States.

RECENT DEVELOPMENTS

Hunt Transaction

In February 1998, the Company agreed to acquire from the 1818 Fund all
of the outstanding capital stock of 1818 Corp. in exchange for 10,000 shares of
New Preferred Stock. The assets of 1818 Corp. consist of a 7.5% limited
partnership interest in Hunt, a partnership that explores for high risk, large
reserve accumulations, generally targeting deposits which pre-drilling seismic
and other data indicate to have potential in excess of 100 MMBOE. Hunt has
entered into production sharing contracts and other arrangements which entitle
it to explore for oil and gas, both onshore and offshore, in countries including
Argentina, Canada, Ethiopia, Ghana, Niger and Peru. The general partner of Hunt
is Hunt Overseas Operating Company ("HOOC"), a subsidiary of Hunt Oil Company.
The closing of the Hunt transaction is subject, among other things, to the
Company raising $5.0 million of additional capital through a private placement
of Common Stock and the execution of certain agreements pertaining to the
Paramount joint venture. There can be no assurance that the Company will
successfully raise the new capital, execute the Paramount joint venture
agreements, or that the Hunt transaction will close. If the Hunt transaction
does close, it will be accounted for as a reverse acquisition, and 1818 Corp.
will be the acquiring entity for accounting purposes.

Under the partnership agreement of Hunt, the Company will have an
obligation to contribute an estimated $6.1 million to fund its share of the
exploration costs of Hunt. In addition, if Hunt discovers oil or gas deposits,
the Company will be required to contribute an additional $7.5 million to fund
appraisal costs. The 1818 Fund has agreed that, immediately prior to the
closing, 1818 Corp. will deposit cash in the amount of $13.6 million (or such
lesser amount as is equal to 1818 Corp.'s unfunded capital commitment) with a
commercial bank that will hold such cash as collateral for a letter of credit
issued in favor of Hunt to secure the Company's

3
obligations to make future capital contributions. If Hunt does not call such
capital contributions as provided in the partnership agreement of Hunt, the cash
collateral will be released to the Company.

The 1818 Fund has agreed to acquire for cash an additional $5.0 million
of common stock of VAALCO ("Common Stock") at a price per share equal to the
lesser of $2.50 per share and the price paid by investors net of placement fees.
A minimum of $5.0 million of Common Stock must be privately placed with
investors for the 1818 Fund to acquire the additional $5.0 million of Common
Stock. These amounts will be used to fund the Company's capital expenditure
program, including investments in the Paramount joint venture and possible
future acquisitions, and for general corporate purposes. There can be no
assurances that the private placement will be successfully completed.

If the Hunt transaction is closed, the holders of the New Preferred
Stock will have the right to appoint three directors of the Company, voting
separately as a class. In addition, the holders of the New Preferred Stock will
have the right to vote as a class with the holders of Common Stock on all
matters submitted to a vote of the holders of Common Stock on an "as converted
basis." Following the Offering, the 1818 Fund will own Common Stock and New
Preferred Stock which will in the aggregate represent approximately 60.2% of the
outstanding voting power of the Company on an as converted basis (excluding
options and warrants), and will therefore have the ability to control the vote
on all matters submitted to a vote of the holders of the Common Stock, including
the election of directors.

Paramount Agreement

In October 1997, the Company agreed to form a joint venture with Paramount
Petroleum, Inc. ("Paramount") to conduct exploration activities primarily in the
onshore Gulf Coast area, including Alabama, Mississippi and Louisiana,
("Paramount joint venture"). The agreement will entitle the Company to acquire,
at its option, 25% of any prospect generated by the joint venture, on a
non-promoted basis taking into account the Company's interest in the joint
venture. The joint venture agreement will also provide for sharing of any
revenues attributable to prospects generated by the joint venture and sold to
others. The Company has committed to expend $3.0 million to fund overhead,
leases, seismic and other amounts in connection with the joint venture, $0.7
million of which has been funded as of the date of this filing. The Company has
agreed to post a letter of credit to secure such commitment. The closing of the
Hunt transaction and the private placement are contingent upon the formation of
the Paramount joint venture.

Sale of Gulf of Mexico Properties

During December 1997, the Company sold its interest in the High Island
and West Cameron Blocks in the Gulf of Mexico for $506,000 and the assumption by
the purchaser of $665,500 of abandonment costs. The Company recognized a $0.9
million gain in connection with such sale.


4
GENERAL

The Company's strategy is to increase reserves and production in a
cost-effective manner through a program that balances lower risk acquisitions
and exploratory drilling on VAALCO's domestic acreage with high potential
international prospects. Internationally, financial exposure and political risk
are mitigated through alliances with experienced industry partners who fund the
majority of required capital.

INTERNATIONAL

The Company's international strategy is to pursue selected opportunities
that are characterized by reasonable entry costs, favorable economic terms, high
reserve potential relative to capital expenditures and the availability of
existing technical data that may be further developed using current technology.
The Company believes that it has unique management and technical expertise in
identifying international opportunities and establishing favorable operating
relationships with host governments and local partners familiar with the local
practices and infrastructure.

The Company owns interests in five production platforms and other
infrastructure offshore of the Philippines in Service Contracts No. 14 and No.
6. In Gabon, the Company is an owner in two offshore blocks, the Equata Block
and the Etame Block.

During 1997, an Australian oil company acquired 132,000 line kilometers
of 3-D seismic data over Service Contracts No. 14 and No. 6 in the Philippines
in exchange for a farm out of interests in the Service Contracts. The Company
expects that the seismic data will be processed and interpreted in the first
half of 1998. In Gabon, the Company farmed out an internally generated
exploration prospect to Western Atlas Afrique, Ltd. ("Western Atlas") in
exchange for an agreement by Western Atlas to conduct a 320 square kilometer
seismic survey and to pay 80% of the costs of an initial exploration well (up to
$4.7 million). In exchange, Western Atlas received a 65% working interest in the
production sharing contract. The Company expects to begin drilling this well in
April 1998.

DOMESTIC

The Company's domestic strategy is to build near-term cash flows to fund
its international exploration activities through focused acquisition of domestic
properties that have significant exploration potential, increasing production
from existing fields with the application of the Company's technical and
operating expertise and participating in exploration through farm out and other
arrangements. Recognizing that international operations are subject to greater
social, economic and political volatility, the Company seeks to build a stable
domestic production and reserve base that will permit the Company to continue to
participate in more high-risk international projects with greater reserve
potential. The Company owns an interest in 8,000 acres onshore Texas and has
interest in producing fields in the Gulf of Mexico. The Company sold interests
in five platforms in High Island and West Cameron in the Gulf of Mexico on
December 31, 1997.

5
CUSTOMERS

Substantially all of the Company's crude oil and natural gas is sold at
the well head at posted or indexed prices under short term contracts, as is
customary in the industry. For the years ended December 31, 1997 and 1996, one
purchaser of the Company's crude oil accounted for essentially all of the
Company's total crude oil sales. During 1997 a second purchaser accounted for in
excess of 90 percent of the Company's domestic gas sales. The Company markets
its crude oil share in the Philippines under an agreement with SeaOil
Corporation, a local Philippines refiner ("SeaOil"). While the loss of this
buyer might have a material effect on the Company in the near term, management
believes that the Company would be able to obtain other customers for its crude
oil.

EMPLOYEES

As of December 31, 1997, the Company had 28 full-time employees, 20 of
which were located in the Philippines. The Company is not subject to any
collective bargaining agreements and believes its relations with its employees
are satisfactory.

COMPETITION

The oil and gas industry is highly competitive. Competition is
particularly intense with respect to acquisitions of desirable oil and gas
reserves. There is also competition for the acquisition of oil and gas leases
suitable for exploration and the hiring of experienced personnel. Competition
also exists with other industries in supplying the energy needs of consumers. In
addition, the producing, processing and marketing of oil and gas is affected by
a number of factors beyond the control of the Company, the effects of which
cannot be accurately predicted.

The Company's competition for acquisitions, exploration, development and
production include the major oil and gas companies in addition to numerous
independent oil companies, individual proprietors, drilling and acquisition
programs and others. Many of these competitors possess financial and personnel
resources substantially in excess of those available to the Company, giving
those competitors an enhanced ability to pay for desirable leases and to
evaluate, bid for and purchase properties or prospects. The ability of the
Company to generate reserves in the future will depend on its ability to select
and acquire suitable producing properties and prospects for future drilling and
exploration.

RISK FACTORS

CHANGE OF CONTROL

If the Hunt transaction and the conditions to closing thereto are
consummated, the 1818 Fund will own Common Stock and New Preferred Stock which
will vote as a class with the Common Stock on an as converted basis, and which
will in the aggregate represent approximately 60.2% of the outstanding voting
power of the Company on an as converted basis (excluding options and warrants).
In addition, the terms of the New Preferred Stock to be acquired by the 1818
Fund provide that while the New Preferred Stock is outstanding, the holders of
New Preferred Stock voting together as a class will be entitled to elect three
directors of the Company.

6
Accordingly, the 1818 Fund will be able to control all matters submitted to a
vote of the stockholders of the Company, including the election of directors.

In connection with the Hunt transaction, the Company has agreed to make
certain changes to its bylaws which will require that at least a majority of the
directors constituting the entire board of directors, which majority must
include at least one of the directors elected by the holders of New Preferred
Stock, approve each of the following transactions effected by either the Company
or, as applicable, any subsidiary of the Company: any issuance of or agreement
to issue any equity securities, including securities convertible into or
exchangeable for such equity securities (other than issuances pursuant to an
employee benefit plan); the declaration of any dividend; the incurrence,
assumption of or refinancing of indebtedness; the adoption of any employee stock
option or similar plan; entering into employment or consulting agreements with
annual compensation exceeding $100,000; any merger or consolidation; the sale,
conveyance, exchange or transfer of the voting stock or all or substantially all
of the assets; the sale or other disposition to another person, or purchase,
lease or other acquisition from another person, of any material assets, rights
or properties; certain expenditures in excess of $300,000; the formation of any
entity that is not wholly-owned by the Company; material changes in accounting
methods or policies; any amendment, modification or restatement of the
certificate of incorporation or bylaws; the settlement of any claim or other
action against the Company or subsidiary in an amount in excess of $50,000;
approval or amendment of the annual operating budget; any other action which is
not in the ordinary course of business; and the agreement to take any of the
foregoing actions. Accordingly, none of the foregoing actions can be taken by
the Company without the approval of at least one director designated by the
holders of the New Preferred Stock.

VOLATILITY OF OIL AND GAS PRICES AND MARKETS

The Company's revenues, cash flow, profitability and future rate of
growth are substantially dependent upon prevailing prices for oil and gas. The
Company's ability to borrow funds and to obtain additional capital on attractive
terms is also substantially dependent on oil and gas prices. The Company's
production in the Philippines (representing substantially all of the Company's
oil production since 1994) is from mature offshore fields with high production
costs. The Company's margin on sales from these fields (the price received for
oil less the production costs for the oil) is lower than the margin on oil
production from many other areas. As a result, the profitability of the
Company's production in the Philippines is affected more by changes in prices
than production located in other areas. Historically, oil and gas prices and
markets have been volatile and are likely to continue to be volatile in the
future. Prices for oil and gas are subject to wide fluctuations in response to
relatively minor changes in supply of and demand for oil and gas, market
uncertainty and a variety of additional factors that are beyond the control of
the Company. These factors include international political conditions, the
domestic and foreign supply of oil and gas, the level of consumer demand,
weather conditions, domestic and foreign governmental regulations, the price and
availability of alternative fuels and overall economic conditions. In addition,
various factors, including the availability and capacity of gas gathering
systems and pipelines, the effect of federal, state and foreign regulation of
production and transportation, general economic conditions, changes in supply
due to drilling by other producers and changes in demand may adversely affect
the Company's ability to market its oil and gas production. Any significant
decline in the price of oil or gas would adversely affect the Company's
revenues, operating income, cash flows and borrowing capacity and may require a

7
reduction in the carrying value of the Company's oil and gas properties and its
planned level of capital expenditures.

The recent downturn in certain of the economies in Asia has resulted in
a substantial oversupply of fuel oil in the area. The Company's Philippine
production competes as an energy source with fuel oil, so the price received for
the Company's production is being adversely affected by market instability and
the current oversupply of fuel oil in the area. For example, average prices
during January 1998 were $7.50 per Bbl, compared with $9.00 per Bbl in January
1997. Although the Company believes the oversupply of fuel oil will not be
permanent, no assurances can be given as to the length of time that will be
required to return the supplies of fuel oil to normal.

REPLACEMENT OF RESERVES

The Company's future success depends upon its ability to find, develop
or acquire additional oil and gas reserves that are economically recoverable.
Except to the extent that the Company conducts successful exploration or
development activities or acquires properties containing proved reserves, the
estimated net proved reserves of the Company will generally decline as reserves
are produced. There can be no assurance that the Company's planned development
and exploration projects and acquisition activities will result in significant
additional reserves or that the Company will have continuing success drilling
productive wells at economic finding costs. The drilling of oil and gas wells
involves a high degree of risk, especially the risk of dry holes or of wells
that are not sufficiently productive to provide an economic return on the
capital expended to drill the wells. In addition, the Company's drilling
operations may be curtailed, delayed or canceled as a result of numerous
factors, including title problems, weather conditions, political instability,
economic/currency imbalances, compliance with governmental requirements and
shortages or delays in the delivery of equipment and availability of drilling
rigs. Certain of the Company's oil and gas properties are operated by third
parties or may be subject to operating committees controlled by national oil
companies and, as a result, the Company has limited control over the nature and
timing of exploration and development of such properties or the manner in which
operations are conducted on such properties.

SUBSTANTIAL CAPITAL REQUIREMENTS

The Company makes, and will continue to make, substantial capital
expenditures for the acquisition, exploitation, development, exploration and
production of oil and gas reserves. Historically, the Company has financed these
expenditures primarily with cash flow from operations, asset sales, private
sales of equity, bank borrowings and purchase money debt. The Company believes
that it will have sufficient capital to finance planned capital expenditures
through 1998. If revenues decrease as a result of lower oil and gas prices,
operating difficulties or declines in reserves, the Company may have limited
ability to finance planned capital expenditures in the future. There can be no
assurances that additional equity financing or cash generated by operations or
borrowings will be available to meet these requirements.

The partnership agreement of Hunt obligates the Company to contribute,
when requested by Hunt, up to $6.1 million to fund Hunt's exploration program.
In addition, if Hunt discovers oil, the Company may be required to contribute an
additional $7.5 million to fund the appraisal of

8
the discovery. The 1818 Fund has agreed that, immediately prior to the closing
of the Hunt transaction, 1818 Corp. will have $13.6 million in cash (or such
lesser amount as is equal to 1818 Corp.'s unfunded capital commitment), and will
use such cash as collateral for a letter of credit in favor of Hunt to secure
1818 Corp.'s obligation to make capital contributions to Hunt. If Hunt does not
call such capital contributions as provided in the partnership agreement of
Hunt, the cash collateral will be released to the Company.

The Company has committed to invest $3.0 million in the Paramount joint
venture, of which $0.7 million has already been funded as of the date of this
filing. There can be no assurance that the Company will realize a return on this
investment or that the Company's investment in the Paramount joint venture will
be successful.

HISTORY OF LOSSES

The Company incurred net losses (after preferred dividends requirement)
of $12.3 million, $8.2 million, $7.2 million and $0.6 million for each of the
years ended December 31, 1993, 1994, 1995 and 1996, respectively. For the year
ended December 31, 1997, the Company reported net income (after preferred
dividends requirement and including a $4.2 million gain on sale of assets) of
$2.3 million. No assurance can be made that the Company will operate profitably
in the future. The likelihood of the Company's future profitability must be
considered in light of the financial, business and operating risks, expenses,
difficulties, and delays frequently encountered in connection with the oil and
gas acquisition, exploration, development and production business in which the
Company is engaged.

DRILLING RISKS

Drilling activities are subject to many risks, including the risk that
no commercially productive reservoirs will be encountered. There can be no
assurance that new wells drilled by the Company will be productive or that the
Company will recover all or any portion of its investment. Drilling for oil and
natural gas may involve unprofitable efforts, not only from dry wells, but from
wells that are productive but do not produce sufficient net revenues to return a
profit after drilling, operating and other costs. The cost of drilling,
completing and operating wells is often uncertain and cost overruns are common.
The Company's drilling operations may be curtailed, delayed or canceled as a
result of numerous factors, many of which are beyond the Company's control,
including title problems, weather conditions, compliance with governmental
requirements and shortages or delays in the delivery of equipment and services.

OPERATING HAZARDS AND UNINSURED RISKS

The oil and gas business involves a variety of operating risks,
including fire, explosions, blow-outs, pipe failure, casing collapse, abnormally
pressured formations and environmental hazards such as oil spills, gas leaks,
ruptures and discharges of toxic gases, the occurrence of any of which could
result in substantial losses to the Company due to injury and loss of life,
severe damage to and destruction of property, natural resources and equipment,
pollution and other environmental damage, clean-up responsibilities, regulatory
investigation and penalties and suspension of operations. The Company's
production facilities are also subject to hazards inherent in marine operations,
such as capsizing, sinking, grounding, collision and damage from

9
severe weather conditions. The relatively deep offshore drilling conducted by
the Company overseas involves increased drilling risks of high pressures and
mechanical difficulties, including stuck pipe, collapsed casing and separated
cable. The impact that any of these risks may have upon the Company is increased
due to the low number of producing properties owned by the Company. The Company
and operators of properties in which it has an interest maintain insurance
against some, but not all, potential risks; however, there can be no assurance
that such insurance will be adequate to cover any losses or exposure for
liability. The occurrence of a significant unfavorable event not fully covered
by insurance could have a material adverse effect on the Company's financial
condition and results of operations. Furthermore, the Company cannot predict
whether insurance will continue to be available at a reasonable cost or at all.

UNCERTAINTIES IN ESTIMATING RESERVES AND FUTURE NET CASH FLOWS

There are numerous uncertainties inherent in estimating quantities of
proved oil and gas reserves, including many factors beyond the control of the
Company. Reserve engineering is a subjective process of estimating the
underground accumulations of oil and gas that cannot be measured in an exact
manner. The estimates in this document are based on various assumptions required
by the Commission, including unescalated prices and costs and capital
expenditures, and, therefore, are inherently imprecise indications of future net
revenues. Actual future production, revenues, taxes, operating expenses,
development expenditures and quantities of recoverable oil and gas reserves may
vary substantially from those assumed in the estimates. Any significant variance
in these assumptions could materially affect the estimated quantity and value of
reserves set forth in this document. In addition, the Company's reserves may be
subject to downward or upward revision based upon production history, results of
future development, availability of funds to acquire additional reserves,
prevailing oil and gas prices and other factors. Moreover, the calculation of
the estimated present value of the future net revenue using a 10% discount rate
as required by the Commission is not necessarily the most appropriate discount
factor based on interest rates in effect from time to time and risks associated
with the Company's reserves or the oil and gas industry in general.

It is also possible that reserve engineers may make different estimates
of reserves and future net revenues based on the same available data. In
calculating reserves on a BOE basis, gas was converted to oil at the ratio of
six Mcf of gas to one Bbl of oil. While this conversion ratio approximates the
energy equivalent of oil and gas on a Btu basis, it may not represent the
relative prices received by the Company on the sale of its oil and gas
production.

The estimated future net revenues attributable to the Company's net
proved reserves are prepared in accordance with Commission guidelines, and are
not intended to reflect the fair market value of the Company's reserves. In
accordance with the rules of the Commission, the Company's reserve estimates are
prepared using period end prices received for oil and gas. Future reductions in
prices below those prevailing at year end 1997 would result in the estimated
quantities and present values of the Company's reserves being reduced.

A substantial portion of the Company's proved reserves are or will be
subject to service contracts, production sharing contracts and other
arrangements. The quantity of oil and gas the Company will ultimately receive
under these arrangements will differ based on numerous factors, including the
price of oil and gas, production rates, production costs, cost recovery
provisions

10
and local tax and royalty regimes. Changes in many of these factors do not
affect estimates of U.S. reserves in the same way they affect estimates of
proved reserves in foreign jurisdictions, or will have a different affect on
reserves in foreign countries than in the United States. As a result, proved
reserves in foreign jurisdictions may not be comparable to proved reserve
estimates in the United States.

FOREIGN OPERATIONS

The Company's international assets and operations are subject to various
political, economic and other uncertainties, including, among other things, the
risks of war, expropriation, nationalization, renegotiation or nullification of
existing contracts, taxation policies, foreign exchange restrictions, changing
political conditions, international monetary fluctuations, currency controls and
foreign governmental regulations that favor or require the awarding of drilling
contracts to local contractors or require foreign contractors to employ citizens
of, or purchase supplies from, a particular jurisdiction. In addition, if a
dispute arises with foreign operations, the Company may be subject to the
exclusive jurisdiction of foreign courts or may not be successful in subjecting
foreign persons, especially foreign oil ministries and national oil companies,
to the jurisdiction of the United States.

The Company's private ownership of oil and gas reserves under oil and
gas leases in the United States differs distinctly from its ownership of foreign
oil and gas properties. In the foreign countries in which the Company does
business, the state generally retains ownership of the minerals and consequently
retains control of (and in many cases, participates in) the exploration and
production of hydrocarbon reserves. Accordingly, operations outside the United
States may be materially affected by host governments through royalty payments,
export taxes and regulations, surcharges, value added taxes, production bonuses
and other charges.

Certain of the Company's producing properties are located offshore
Palawan Island in the Philippines, and, consequently, a portion of the Company's
assets is subject to regulation by the government of the Philippines. Although
there has been unrest and uncertainty in the Philippines, to date, the country's
Office of Energy Affairs has been largely unaffected by political changes. The
Company has operated in the Philippines since 1985 and believes that it has good
relations with the current Philippine government. However, there can be no
assurance that present or future governmental regulation in the Philippines will
not materially adversely affect the operations or cash flows of the Company.

All of the Company's current Philippine producing properties are located
in fields covered under Service Contract No. 14. To obtain favorable tax
treatment, at least 15 percent of Service Contract No. 14 must be owned by
Philippine nationals. Residents of the Philippines currently own in excess of
15% of Blocks A, B, C and D of Service Contract 14, including 71% of Block C.
The Company's ability to export oil produced in the Philippines is restricted by
the terms of Service Contract No. 14. The Company currently sells its oil
production within the Philippines and therefore may be exposed to foreign
currency risk.

11
INVESTMENT IN HUNT

While there is no assurance that the Hunt transaction will close, upon
consummation of the Hunt transaction, the Company will be a limited partner in
Hunt. All decisions concerning the operations of Hunt will be made by the
general partner without the consent or input of the limited partners.
Accordingly, the Company will not be able to influence decisions with respect to
operations of Hunt, including decisions regarding the purchase of concessions
and other interests, exploration and development operations (including the
location, testing, completing or plugging and abandoning of wells, as well as
the gathering of seismic and other geophysical data), farm out and other
participation agreements, the acquisition or sale of real and personal property,
insurance coverage, bank and other financings and other matters significant to
the operations of Hunt.

The exploration activity of Hunt is ongoing. To date, Hunt's exploration
activities have not resulted in the discovery of any commercial oil or gas
reserves. No assurance can be given that Hunt's activities will result in
commercial production or that the Company will realize a return on its
investment in Hunt. Hunt's operations are subject to risks applicable to the oil
and gas industry in general as well as to risks inherent in foreign operations,
and are subject to many of the risks disclosed herein under "Risk Factors"
including, without limitation, "--Foreign Operations," "--Volatility of Oil and
Gas Prices anD Markets," "--Replacement of Reserves," "--Drilling Risks,"
"--Operating Hazards and UninsurED Risks," "--Uncertainties in Estimating
Reserves and Future Net Cash Flows," "--EnvironmentaL and Other Regulations" and
"--Acquisition Risks."

ENVIRONMENTAL AND OTHER REGULATIONS

The Company's business is regulated by the laws and regulations of the
United States, Philippines and Gabon. In addition, if the Hunt transaction is
successfully closed, VAALCO will own a 7.5% limited partner interest in Hunt,
which does business in and is subject to the laws and regulations of other
foreign countries. These laws and governmental regulations, which cover matters
including drilling operations, taxation and environmental protection, may be
changed from time to time in response to economic or political conditions. See
"--Foreign Operations."

The Company's domestic operations are subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. The Company's domestic
operations could result in liability for personal injuries, property damage, oil
spills, discharge of hazardous materials, remediation and clean-up costs and
other environmental damages. In addition, the Company could be liable for
environmental damages caused by previous property owners. As a result,
substantial liabilities to third parties or governmental entities may be
incurred, the payment of which could have a material adverse effect on the
Company's financial condition, results of operations and liquidity. The Company
maintains insurance coverage for its operations, including limited coverage for
sudden environmental damages, but does not believe that insurance coverage for
environmental damages that occur over time is available at a reasonable cost.
Moreover, the Company does not believe that insurance coverage for the full
potential liability that could be caused by sudden environmental damages is
available at a reasonable cost. Accordingly, the Company may be subject to
liability or may lose substantial portions of its properties in the event of
certain environmental damages. The Company could incur substantial costs to
comply with environmental laws and regulations.

12
A substantial portion of the Company's producing properties are located
offshore. The costs to abandon offshore wells may be substantial. For financial
accounting purposes the Company accrues a per BOE charge over the life of a
field to cover such abandonment costs. No assurances can be given that such
reserves will be sufficient to cover such costs in the future as they are
incurred.

The Oil Pollution Act of 1990 imposes a variety of regulations on
"responsible parties" related to the prevention of oil spills. The
implementation of new, or the modification of existing, environmental laws or
regulations, including regulations promulgated pursuant to the Oil Pollution Act
of 1990, could have a material adverse impact on the Company.

The recent trend toward stricter standards in environmental legislation
and regulation in the U.S. is likely to continue. For instance, legislation has
been introduced in Congress that would reclassify certain exploration and
production wastes as "hazardous wastes" which would make the reclassified wastes
subject to much more stringent handling, disposal and clean-up requirements. If
such legislation were enacted, it could have a significant impact on the
operating costs of the Company, as well as the oil and gas industry in general.
Initiatives to further regulate the disposal of oil and gas wastes are also
pending in certain states, and these various initiatives could have a similar
impact on the Company.

In addition, while the Company believes that it is currently in
compliance with environmental laws and regulations applicable to the Company's
operations in the Philippines and Gabon, no assurances can be given that the
Company will be able to continue to comply with such environmental laws and
regulations without incurring substantial costs.

ACQUISITION RISKS

The Company intends to continue acquiring oil and gas properties.
Although the Company performs a review of the acquired properties that it
believes is consistent with industry practices, such reviews are inherently
incomplete. It generally is not feasible to review in depth every individual
property involved in each acquisition. Ordinarily, the Company will focus its
due diligence efforts on the higher valued properties and will sample the
remainder. However, even an in-depth review of all properties and records may
not necessarily reveal existing or potential problems nor will it permit a buyer
to become sufficiently familiar with the properties to assess fully their
deficiencies and capabilities. Inspections may not be performed on every well,
and structural or environmental problems, such as ground water contamination,
are not necessarily observable even when an inspection is undertaken. The
Company may be required to assume preclosing liabilities, including
environmental liabilities, and may acquire interests in properties on an "as is"
basis. There can be no assurance that the Company's acquisitions will be
successful.

RELIANCE ON KEY PERSONNEL

The Company is highly dependent upon its executive officers and key
employees, particularly Messrs. Gerry, Walston and Scheirman. Moreover, the
Company's investment in the Paramount joint venture is highly dependent upon
Robert Schneeflock. The unexpected loss of the services of any of these
individuals could have a detrimental effect on the Company.

13
The Company has entered into employment agreements with Messrs. Gerry and
Scheirman which will terminate in August 1998. The Company does not maintain key
man life insurance on any of its employees.

FORWARD-LOOKING INFORMATION AND RISK FACTORS

Items 1, 2, 3 and 7 of this document include forward looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Although the
Company believes the expectations reflected in such forward looking statements
are based upon reasonable assumptions, the Company can give no assurance these
expectations will be achieved. Important factors which could cause actual
results to differ materially from the Company's expectations include general
economic, business and market conditions, the volatility of the price of oil and
gas, competition, development and operating costs and the factors that are
disclosed in conjunction with the forward looking statements included herein.

ITEM 2. PROPERTIES

PHILIPPINES

The Company has an interest in two service contracts in the Philippines.
Service Contract No. 14 covers 158,000 offshore acres and Service Contract No. 6
covers 131,000 offshore acres. In January 1996, the Company suspended production
operations in the West Linapacan "A" Field due to a significant decline in oil
production caused by increasing water intrusion. However, the Company continues
to produce the Nido and Matinloc fields; with a total gross production for 1997
of approximately 835 BOPD.

PRODUCING FIELDS

Nido Field

This field is covered by Service Contract No. 14 and has four producing
wells. These wells have been producing since 1979, and through the year ended
December 31, 1997 had produced an aggregate of approximately 17.0 MMBbls of oil.
The field is produced using the cyclic method under which the field is shut in
for a period of time (generally 60 days) and then opened up to produce
(generally four to five days). Under this cyclical method, the four wells in the
field produced at an equivalent rate of 417 BOPD during 1997. The Company has an
approximate 34.1% working interest and an approximate 26.4% net revenue interest
in the field, subject to proportionate reduction upon SOCDET's successful
completion of its obligations under the farm out discussed below.

Matinloc Field

This field is located within the contract area covered by Service
Contract No. 14 and has three producing wells. The field had produced an
aggregate production of approximately 10.3 MMBbls from 1982 through 1991.
Production was suspended from the field in 1991 until it was

14
reactivated in 1995. At December 31, 1997 the field had produced an aggregate of
10.6 MMBbls. During 1997, the field produced approximately 153 MBbls or 418
BOPD. The Company has an approximate 58.7% working interest and an approximate
43.3% net revenue interest in the field, subject to proportionate reduction upon
SOCDET's successful completion of its obligations under the farm out discussed
below.

During 1997, SOCDET, an Australian oil company, acquired 132,000 line
kilometers of 3-D seismic data over Service Contracts No. 14 and No. 6 in
exchange for a farm out of interests in the Service Contracts. Upon completion
of the seismic shoot, SOCDET will earn a 35% interest in the Service Contracts.
In addition, SOCDET has the option to drill two wells, one on each block, to
earn an additional 25% interest in each Service Contract. The Company expects
the seismic data to be processed and interpreted in the first half of 1998, and
for exploration wells to be drilled in the second half of 1998 or early 1999. No
significant capital expenditures are anticipated by the Company in 1998 for the
Philippines operations.

NON-PRODUCING FIELDS

West Linapacan "A" Field

In December 1990, the Company made an offshore oil discovery in the West
Linapacan area located within the contract area covered by Service Contract No.
14, approximately 40 miles northwest of the northern tip of Palawan Island. The
field is a fractured carbonate reservoir located in approximately 1,150 feet of
water. The Company owns a 29% working interest and an approximate 32% net
revenue interest in the West Linapacan "A" Field.

The field was placed on production in May of 1992. In January 1996, the Company
suspended production operations in the field after total production of 8.8
million barrels due to high water production levels.

Galoc Field

This field is located within the contract area covered by Service
Contract No. 14. Four wells have been drilled in this field, of which one well
in 1,150 feet of water has undergone a long-term testing program. The Galoc
reservoir is made up of a sandstone turbidite fan sequence that was deposited on
top of the Lower Miocene limestone in a deep-water environment.

An extended production test at the Galoc 1 well in 1988 produced
approximately 400,000 Bbls of crude oil at rates up to 5,200 BOPD. As a result
of this test, the Company decided to proceed to the second phase of its testing
program. In early 1989, the Galoc 1 vertical well was reentered as a high-angle
lateral well. This well was drilled through the 9 5/8" casing of the Galoc 1
well to a sub-horizontal length of 2,000 feet in the reservoir. This well proved
the lateral extension of the Galoc oil accumulation but failed to produce, on
the initial test, multiples of the rates achieved in vertical production.
However, combined flow rates of 7,399 BOPD were achieved from the 2,000 foot
horizontal section. Despite the test rates achieved, the Company determined not
to develop this field at that time.

15
Subsequent analysis and research has determined that the Galoc
turbidites have poor vertical permeability as displayed during the various
drillstem tests. Consequently, development plans under consideration are all
based upon production from vertical wells that will maximize the horizontal
permeability. Costs in connection with the Galoc field are recoverable under the
cost recovery procedures of Service Contract No. 14.

GABON

Gabon is a former French colony and was a member of OPEC. Production
from the country is approximately 300 MBbls/day of oil with Shell Gabon and Elf
Gabon SA as the largest producers. The country has a population of approximately
two million, making it relatively under-populated compared to its neighbors. For
this reason, the standard of living is quite high relative to many West African
nations, and the country is politically stable. The French Foreign Legion
maintains a presence in the country due to the large quantities of minerals that
France still imports from Gabon, notably uranium.

VAALCO has an interest in two offshore blocks in Gabon, the Etame Block
and the Equata Block. Interests in these blocks were obtained pursuant to
production sharing contracts providing for a three-year term which commenced in
July 1995. VAALCO initially held a 51% interest in the production sharing
contracts and is designated the operator of the blocks. As a result of the
participation agreement discussed below, VAALCO currently owns a 17.9% interest
in the production sharing contract covering Etame block.

Etame Block

The Etame Block is a 3,073 square kilometer block containing two former
Gulf Oil Company discoveries, the North and South Tchibala discoveries. These
discoveries consist of subsalt reservoirs that lie in approximately 250 feet of
water depth, 20 miles offshore. In April 1997, the Company entered into a
participation agreement with Western Atlas Afrique, Ltd. ("Western Atlas"), a
subsidiary of Western Atlas International, Inc., to conduct a 320 square
kilometer seismic survey at Western Atlas' sole cost and to pay a
disproportionate 80% of the cost, up to $4.7 million, of the estimated $5.8
million (dry hole cost) commitment well. In return for these payments, Western
Atlas earns a 65% interest in the production sharing contract. The Company and
its partners will be responsible for 20% of the cost (35% over $4.7 million) of
the commitment well. VAALCO's share of the dry hole cost of the commitment well
is estimated to be $0.7 million. In June 1997, Western Atlas completed the above
mentioned acquisition of seismic data over the property. This data has been
processed, and the Company expects to begin drilling the commitment well in
April 1998. The consortium of companies owning the Etame Block production
sharing contract have the right to renew the production sharing contract for
three additional years subject to compliance with the terms of the production
sharing contract, including a commitment to drill two additional wells and to
perform a 2-D seismic survey. The consortium has several large structures
identified on the block in addition to the commitment well. It is anticipated
that the consortium will renew the production sharing contract regardless of the
outcome of the currently planned well.

16
Equata Block

The Equata Block is a 50 square kilometer development block over a
discovery made in 1974. The discovery lies in 160 feet of water approximately 10
miles offshore at a subsurface depth of 3,000 feet. A 3-D seismic survey was
shot over the discovery by Sun Oil Company in 1987. VAALCO and its partners are
seeking a third party to drill two appraisal wells to prove the discovery's
upside potential prior to committing to develop the discovery. If the discovery
can be successfully farmed out under the requested terms, VAALCO would retain an
approximate 20-25% interest in the development project. To date, VAALCO and its
partners have not been successful in identifying a farm in candidate. The
consortium of companies owning the Equata Block production sharing contract have
the right to renew the production sharing contract for three additional years
subject to compliance with the terms of the production sharing contract,
including a commitment to drill two additional wells and to perform a 2-D
seismic survey. There are currently no further commitments under the production
sharing contract to the government on the block and given other opportunities,
VAALCO does not anticipate attempting to appraise the block further or renew the
contract without a farm in partner.

DOMESTIC PROPERTIES

Brazos County Prospects

In 1997, the Company acquired working interests in approximately 6,800
acres in Brazos County, Texas, where the Company intends to participate in the
drilling of extended-reach horizontal wells in the underlying Buda and
Georgetown formations. In January 1998, the Company participated for a 25%
working interest in the re-entry of an existing well to the Buda formation on a
200-acre prospect in Brazos County. The well is currently suspended pending
installation of a pumping unit. The Company has sufficient acreage for
approximately 15 additional exploratory drilling prospects in both the Buda and
Georgetown formations and has budgeted to drill four wells during 1998 for a
total gross cost to drill and complete of $1.1 million per well. The Company
expects to sell a portion of its working interests to industry partners so that
it retains a 25-30% interest in the wells to be drilled. The Company expects to
begin drilling the first horizontal exploratory well in the Georgetown formation
in 1998.

Goliad County, Texas

VAALCO has acquired approximately 1,200 acres in two blocks, one located
immediately east of the Goliad townsite in Goliad County, Texas, and the other
located immediately west of the townsite. The acreage consists of approximately
70 leases and is located within an area of the Wilcox trend that has recently
seen a considerable amount of leasing, 3-D seismic and drilling activity.

In January 1998, the Company entered into a farm out agreement with an
industry partner over 1,000 acres of its Goliad acreage whereby it will recover
its lease costs and assign a 75% working interest to its partner. The Company
will retain certain overriding royalties and a 25% working interest in the
acreage.

17
Other Domestic Properties

The Company also owns certain non-operated interests in the Vermilion
and Ship Shoal areas of the Gulf of Mexico, which accounted for less than 5% of
the Company's production during the year ended December 31, 1997. No significant
capital expenditures are anticipated in 1998 for these properties.

AGGREGATE PRODUCTION

Additional production data (net to the Company) for all of the Company's
operations for the years 1997 and 1996 are as follows:

COMPANY OWNED PRODUCTION


YEAR ENDED DECEMBER 31,
1997 1996
--------- ---------
BOE(1) BBL MCF BOE(1) BBL MCF
------ --- --- ------ --- ---

Average Daily Production
(Oil in BOPD, gas in MCFD) ............... 563 239 1,945 347 347 --

Average Sales Price ($/unit) ............. $ 12.93 $ 10.86 $ 2.41 $ 8.83 $ 8.83 --
Average Production Cost ($/unit) ......... $ 7.68 $ 8.59 $ 1.17 $ 7.81 $ 7.81 --

(1) BOE is barrels of oil equivalent with 6 Mcf of gas equal to 1 Bbl of oil.

18
RESERVE INFORMATION

Reserve reports as of December 31, 1997 and 1996 have been opined on by
Netherland Sewell & Associates, independent petroleum engineers.


As of December 31,
--------------------------------
1997 1996
------------- ------------

CRUDE OIL
---------
Proved Developed Reserves (MBbls) 1,535 215
Proved Undeveloped Reserves (MBbls) -- --
------------- ------------
Total Proved Reserves (MBbls) 1,535 215
============= ============
GAS
---
Proved Developed Reserves (MMcf) -- 1,094
============= ============

Standardized measure of discounted
future net cash flows at 10% (in thousands) $ 2,749 $ 2,838
============= ============

The 1996 data relates to the Philippine properties and the Gulf of
Mexico properties. The 1997 data relates only to the Philippines properties, as
the Gulf of Mexico properties were sold December 31, 1997. The standardized
measure of discounted cash flows does not include the costs of abandoning the
Company's non-producing properties.

There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
Company. Reserve engineering is a subjective process of estimating underground
accumulations of crude oil and natural gas that cannot be measured in an exact
manner, and the accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation and judgment.
The quantities of oil and natural gas that are ultimately recovered, production
and operating costs, the amount and timing of future development expenditures
and future oil and natural gas sales prices may all differ from those assumed in
these estimates. The standardized measure of discounted future net cash flow
should not be construed as the current market value of the estimated oil and
natural gas reserves attributable to the Company's properties. The information
set forth in the foregoing tables includes revisions for certain reserve
estimates attributable to proved properties included in the preceding year's
estimates. Such revisions are the result of additional information from
subsequent completions and production history from the properties involved or
the result of a decrease (or increase) in the projected economic life of such
properties resulting from changes in product prices. Moreover, crude oil amounts
shown are recoverable under the service contracts and the reserves in place
remain the property of the Philippine government.

In accordance with the guidelines of the Commission, the Company's
estimates of future net cash flow from the Company's properties and the present
value thereof are made using oil and

19
natural gas contract prices in effect as of year end and are held constant
throughout the life of the properties except where such guidelines permit
alternate treatment, including the use of fixed and determinable contractual
price escalations. The contract price as of December 31, 1996 was $11.00 per
Bbl. for oil and $3.89 per Mcf for gas. The contract price as of December 31,
1997 was $10.00 per Bbl. of oil for the Philippine reserves. See "Financial
Statements and Supplementary Data" for certain additional information concerning
the proved reserves of the Company.

DRILLING HISTORY

The Company drilled or participated in the drilling of no wells in the
periods ended December 31, 1997 and 1996. The Company had no wells in progress
at December 31, 1997.

ACREAGE AND PRODUCTIVE WELLS

Below is the total acreage under lease and the total number of
productive oil and gas wells of the Company as of December 31, 1997:


UNITED STATES INTERNATIONAL
---------------------------------------------------

GROSS NET(1) GROSS NET(1)
---------------------------------------------------
(In thousands)

Developed acreage.................. 13.3 2.5 16.0 4.6
Undeveloped acreage................ 8.0 7.6 1,069.8 266.2
Productive gas wells............... 2 0.1 -- --
Productive oil wells............... 5 0.3 7 3.1

(1) Net acreage and net productive wells are based upon the Company's working
interest in the properties.

OFFICE SPACE

The Company leases its offices in Houston, Texas (approximately 8,000
square feet) and in Manila, The Republic of the Philippines (approximately 2,000
square feet), which management believes are suitable and adequate for the
Company's operations.

ITEM 3. LEGAL PROCEEDINGS

The Company is currently not a party to any material litigation.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

20
PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

GENERAL

The Company's Common Stock trades on the OTC Bulletin Board. The
following table sets forth the range of high and low sales prices of the Common
Stock for the periods indicated. The prices represent adjusted prices between
dealers, do not include retail markups, markdowns or commissions and do not
necessarily represent actual transactions. As of December 31, 1997 there were
approximately 90 holders of record of the Company's Common Stock.

PERIOD HIGH LOW
- ------ ---- ---

1996:

First Quarter................................ $ 1.31 $ 0.13
Second Quarter............................... 1.00 0.31
Third Quarter................................ 0.44 0.25
Fourth Quarter............................... 0.44 0.16

1997:

First Quarter................................ $ 0.72 $ 0.33
Second Quarter............................... 1.06 0.63
Third Quarter................................ 3.56 1.00
Fourth Quarter............................... 2.78 1.50

1998:

First Quarter (through March 23, 1998)....... $ 3.13 $ 1.81


On March 23, 1998, the last reported sale price of the Common Stock on
the OTC Bulletin Board was $2.50 per share.

DIVIDENDS

The Company has not paid cash dividends and does not anticipate paying
cash dividends on the Common Stock in the foreseeable future. The Company
presently intends to retain its funds for operation and expansion of its
business. If the Hunt transaction closes, the declaration and payment by the
Company of any dividends on its Common Stock in the future and the amount
thereof will depend upon the Company's operating results, financial condition,
cash requirements, future prospects and other factors deemed relevant by the
Company's Board of Directors. The declaration and payment of dividends on the
Common Stock will be subject to approval of a majority of the Board of
Directors, including, if the Hunt transaction closes, at least one director
designated by the holders of the New Preferred Stock.

21
The 10% Cumulative Series A Preferred Stock ("Preferred Stock") accrued
a cumulative dividend of 10% per annum (an aggregate of $225,000 per year),
payable prior to any dividends on the Common Stock. The Company declared
dividends of $225,000 and $56,500 on the Preferred Stock for 1996 and 1997
respectively. These dividends were paid with Common Stock in July 1997. The
Preferred Stock and all accrued but unpaid dividends were retired in July 1997
through the issuance of an aggregate of 2,740,663 shares of Common Stock.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

CAPITAL RESOURCES AND LIQUIDITY

Historically, the Company's primary source of capital resources has been
from cash flows from operations, assets sales, private sales of equity, bank
borrowings and purchase money debt. During 1994 and 1995, the Company's primary
source of cash flow was sales of production from the West Linapacan "A" Field.
In 1996 and 1997, cash flow was derived predominantly from asset sales,
including the sale of marketable securities, and the private placement of Common
Stock. During 1997, the Company sold marketable securities of a subsidiary for
proceeds of $3.4 million and sold the balance of its assets in India for a gain
of $2.5 million. Also during 1997, the Company redeemed all of the issued and
outstanding shares of its Preferred Stock by issuing an aggregate of 2,740,663
shares of Common Stock to the holders of such preferred stock in satisfaction of
the redemption price and payment of accrued and unpaid dividends. The Company
also issued additional shares of Common Stock in satisfaction of certain
consulting agreements. In connection with the redemption of the Preferred Stock
in 1997, the Company also issued 3.5 million shares of Common Stock in a private
placement for net proceeds of $3.2 million. In September 1997, the Company
issued 100,000 shares of Common Stock as payment for certain lease acquisition
costs associated with interests acquired in Goliad County, Texas in 1996. The
Company currently has no outstanding debt.

The Company's primary uses of capital have been to fund acquisitions and
to fund its exploration and development operations. The Company's expenditures
for exploration and development were $0.9 million in 1997 and 1996,
respectively.

The partnership agreement of Hunt obligates the Company to contribute,
when requested by Hunt, up to $6.1 million to fund Hunt's exploration program.
In addition, if Hunt discovers oil, the Company may be required to contribute an
additional $7.5 million to fund the appraisal of the discovery. The 1818 Fund
has agreed that 1818 Oil Corp. will immediately prior to the closing, deposit
cash in the amount of $13.6 million (or such lesser amount as is required to
fund the ongoing commitments to Hunt) with a commercial bank. The cash will be
pledged as cash collateral to secure a letter of credit payable to Hunt for cash
calls associated with the partnership. If Hunt does not call such capital
contributions as provided in the partnership agreement of Hunt, the cash
collateral will be released to the Company.

The Company has committed to invest $3.0 million in the Paramount joint
venture, of which $0.7 million has already been funded as of the date of this
filing. There can be no assurance that the Company will realize a return on this
investment or that the Company's investment in the Paramount joint venture will
be successful.

22
The 1818 Fund has agreed to acquire for cash an additional $5.0 million
of common stock of VAALCO ("Common Stock") at a price per share equal to the
lesser of $2.50 per share and the price paid by investors net of placement fees.
A minimum of $5.0 million of Common Stock must be privately placed with
investors for the 1818 Fund to acquire the additional $5.0 million of Common
Stock. These amounts will be used to fund the Company's capital expenditure
program, including investments in the Paramount joint venture and possible
future acquisitions, and for general corporate purposes. There can be no
assurances that the private placement will be successfully completed.

Substantially all of the Company's crude oil and natural gas is sold at
the well head at posted or index prices under short term contracts, as is
customary in the industry. For the years ended December 31, 1997 and 1996, one
purchaser of the Company's crude oil accounted for essentially all of the
Company's total crude oil sales. During 1997, a second purchaser accounted for
in excess of 90 percent of the Company's domestic gas sales. The Company markets
its crude oil share under an agreement with SeaOil, a local Philippines refiner.
While the loss of this buyer might have a material effect on the Company in the
near term, management believes that the Company would be able to obtain other
customers for its crude oil.

The Company continues to seek financing to fund the development of
existing properties and to acquire additional assets. The Company will rely on
the issuance of equity and debt securities, assets sales and cash flow from
operations to provide the required capital for funding future operations. While
there can be no assurance the Company will be successful in raising new
financing, management believes the prospects the Company has in hand will enable
it to attract sufficient capital to fund required oil and gas activities.

During 1998, if the Hunt transaction closes, the Company anticipates
that it will make capital expenditures on oil and gas properties (other than
through Hunt) of approximately $8.0 million, including a contribution of $2.3
million to the Paramount joint venture (net of $0.7 million already funded) and
for exploration activities in Brazos and Goliad counties, but excluding
potential acquisitions. The Company believes that if the Hunt transaction
closes, the net proceeds of the private placement and the 1818 Fund Investment,
together with funding under the letter of credit facility to Hunt, will be
sufficient to fund the Company's capital budget through 1998.

The Company does not expect that the cost of converting its computer
systems to year 2000 compliance will be material to its financial condition. The
Company believes that it will be able to achieve year 2000 compliance by the end
of 1999, and does not currently anticipate any disruption in its operations as
the result of any failure by the Company to be in compliance. The Company is
currently in the process of determining if its' customers and suppliers are year
2000 compliant.

RESULTS OF OPERATIONS

The Company's results of operations are dependent upon the difference
between prices received for its oil and gas production and the costs to find and
produce such oil and gas. Oil and gas prices have been and are expected in the
future to be volatile and subject to fluctuations based on a number of factors
beyond the control of the Company. Recent events in Asia have created reduced
demands for oil products in the region, which has substantially reduced the
price

23
the Company receives for its Philippines production relative to world oil
prices, which are also substantially below prices in 1997. Although the Company
expects the supply and demand imbalances to correct themselves over time, no
assurances can be made as to the time required for such imbalances to correct
themselves. In addition, the Company's production in the Philippines
(representing substantially all of the Company's oil production since 1994) is
from mature offshore fields with high production costs. The Company's margin on
sales from these fields (the price received for oil less the production costs
for the oil) is lower than the margin on oil production from many other areas.
As a result, the profitability of the Company's production in the Philippines is
affected more by changes in oil prices than production located in other areas.
See "Risk Factors--Volatility of Oil and Gas Prices and Markets."

The Company's results of operations are also affected by currency
exchange rates. As of January 1, 1998, the Company and Seaoil, the purchaser of
the Company's Philippines production, have agreed that 20% of the price of oil
paid by Seaoil to the Company will be paid in Philippine pesos at the prevailing
rate, up to 40 pesos to the dollar. A decrease in the exchange rate of pesos to
the dollar will have the effect of reducing the price received for oil (in U.S.
dollars). This reduction will be partially offset because certain operating
costs paid by the Company and Seaoil are paid in Philippine pesos.

A substantial portion of the Company's oil production is located
offshore of the Philippines. Since 1996, the Company has produced into barges,
which transport the oil to market. Due to weather and other factors, the
Company's production is generally highest during the first and fourth quarters
of the year. From 1994 to 1996, the Company stored its Philippines production in
storage vessels, and sold the production approximately four times a year. The
Company deferred operating expenses in the Philippines until production was
sold, and recognized its revenues and operating expenses when the oil was sold.
As a result, a portion of costs and revenues from production during one year is
not recognized until the next year. The Company sold approximately 108 MBbls of
oil in January 1996, and recognized $1.8 million in revenues and $1.5 million in
operating costs during 1996 that reflected production in 1995.

The Company uses the successful efforts method to account for its
investment in oil and gas properties whereby costs of productive wells,
developmental dry holes and productive leases are capitalized and amortized
using the units-of-productive method based on estimated net proved reserves. The
costs of development wells are capitalized but charged to expense if and when
the well is determined to be unsuccessful. Geological and geophysical costs and
the costs of carrying and retaining undeveloped properties are expensed as
incurred.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

Amounts stated hereunder have been rounded to the nearest $100,000,
however, percentage changes have been calculated using the accompanying
consolidated financial statement amounts.

CASH FLOWS

Net cash used in operating activities for 1997 was $0.9 million, as
compared to net cash used in operating activities of $1.7 million in 1996.

24
Net cash provided by investing activities for 1997 was $3.7 million, as
compared to net cash provided by investing activities of $1.1 million in 1996.
Both amounts reflect cash received from the sale of marketable securities and
the sale of assets in India.

Net cash used in financing activities for 1997 was $0.5 million, as
compared to net cash provided by financing activities of $0.9 million in 1996.
The 1997 amount contains proceeds from the issuance of Common Stock, offset by
debt repayments. The 1996 amount reflects proceeds from a non-recourse loan
received in conjunction with the sale of VAALCO Energy (India), Inc., and from a
loan to purchase certain properties in the Gulf of Mexico. These amounts are
partially offset by the payment of a portion of the Company's debt obligations.

REVENUES

Total oil and gas sales for 1997 were $2.3 million, a decrease of $0.5
million, or 17%, as compared to $2.7 million for 1996. The 1997 revenues include
revenues relating to the Philippines as well as oil and gas revenues relating to
the Company's Gulf of Mexico operations. The 1996 revenues include $1.8 million
from oil produced in 1995 but sold in 1996. The Company continues to produce the
Nido and Matinloc fields at approximately 835 BOPD.

The gain on sale of assets of $4.2 million, recognized in 1997,
was associated with the sale of the Company's interest in several blocks in
India, the sale of an investment in a Philippines company and the sale of the
Gulf of Mexico properties. The 1996 gain on sale of assets of $1.0 million was
from the sale of certain interests in India.

OPERATING COSTS AND EXPENSES

Production expenses for 1997 were $1.4 million, a decrease of $0.3
million, or 18%, as compared to $1.7 million for 1996. The decrease is primarily
due to declining operating costs in 1997 as a result of the suspension of
production at the West Linapacan "A" Field in 1996.

Exploration costs for 1997 were $0.05 million, a decrease of $0.2
million as compared to $0.3 million for the same period in 1996. The decrease is
primarily due to costs incurred in 1996 associated with the Company's Gabon
project.

Depreciation, depletion and amortization of properties for 1997 was $0.5
million, a decrease of $0.1 million, or 20%, as compared to $0.6 million in
1996. The 1996 amount includes an adjustment for depletion costs that were
capitalized in crude oil inventory at December 31, 1995. The 1997 depletion
costs were primarily associated with the Company's Gulf of Mexico production, as
the properties in the Philippines have been fully depleted.

General and administrative expenses for 1997 were $1.8 million, a
decrease of $0.5 million, or 20%, as compared to $2.3 million for 1996. The
decrease is primarily due to reduced overhead costs in the Philippines.

25
OPERATING INCOME

Operating income for 1997 was $2.7 million, an increase of $3.8 million
as compared to a $1.1 million operating loss for 1996. The above mentioned
decreases in operating expenses, depreciation, depletion and amortization of
properties and general and administrative expenses, coupled with the gain on
sales of certain assets by the Company were the primary reason for gain in
operating income.

OTHER INCOME (EXPENSE)

Interest expense and financing charges for 1997 were $0.2 million, a
decrease of $0.1 million, or 39%, as compared to $0.3 million in 1996. This was
primarily due to the repayment of debt in 1997.

Other, net decreased $1.0 million in 1997 as compared to 1996. This was
primarily due to the gain on the sale of certain securities in 1996.

NET INCOME

Net income attributable to common stockholders for 1997 was $2.3
million, an increase of $2.9 million as compared to net loss of $0.6 million in
1996. The 1997 net income was the result of lower operating costs and general
and administrative expenses, coupled with the gain on sales of certain assets by
the Company.

ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

26
INDEPENDENT AUDITORS' REPORT

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF VAALCO ENERGY, INC. AND
SUBSIDIARIES

We have audited the consolidated balance sheets of VAALCO Energy, Inc.
and its subsidiaries ("VAALCO") as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' deficit, and cash
flows for the years then ended. These financial statements are the
responsibility of VAALCO's management. Our responsibility is to express an
opinion on the financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements present fairly, in
all material respects, the financial position of VAALCO at December 31, 1997 and
1996, and the results of its operations and its cash flows for the years then
ended, in conformity with generally accepted accounting principles.

Deloitte & Touche LLP
Houston, Texas
March 26, 1998

27
VAALCO ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS OF DOLLARS, EXCEPT PAR VALUE AMOUNTS)


December 31,
-----------------------
1997 1996
------- --------

ASSETS

CURRENT ASSETS:
Cash and cash equivalents ........................................ 3,379 $ 1,055
Advances-related party ........................................... -- 1,916
Marketable securities-related party .............................. -- 777
Receivables:
Trade .......................................................... 1,527 103
Accounts with partners ......................................... -- 190
Other .......................................................... 655 1,177
Materials and supplies, net of allowance for inventory
obsolescence of $ 4 and $9 at 1997 and 1996, respectively ........ 361 387
Prepaid expenses and other ....................................... 6 9
--------
--------
Total current assets ........................................... 5,928 5,614
------- --------

PROPERTY AND EQUIPMENT-SUCCESSFUL EFFORTS METHOD
Wells, platforms and other production facilities ................. 46,977 46,866
Undeveloped acreage .............................................. 867 808
Equipment and other .............................................. 242 342
------- --------

48,086 48,016

Accumulated depreciation, depletion and amortization ............. (46,330) (46,383)
------- --------

Net property and equipment ..................................... 1,756 1,633
------- --------

OTHER ASSETS:
Other long-term assets ........................................... 129 119
Advances-related party ........................................... 42 --
Other investments ................................................ 300 --
Funds in escrow .................................................. 412 370
------- --------

TOTAL .............................................................. 8,567 $ 7,736
======= ========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:

Accounts payable ................................................. 2,346 $ 1,862
Accounts with partners ........................................... 566 --
Accrued liabilities .............................................. 130 1,280
Deferred income tax .............................................. 86 --
Current portion of debt obligations .............................. -- 3,918
------- --------

Total current liabilities ...................................... 3,128 7,060
------- --------


FUTURE ABANDONMENT COSTS ........................................... 4,277 4,942

OTHER LONG-TERM LIABILITIES ........................................ -- 1,000
------- --------
Total liabilities ................................................ 7,405 13,002
------- --------

COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY (DEFICIT):

Preferred stock, $25 par value, 10% cumulative dividend, 500,000
authorized shares; 0 and 90,000 shares issued and
outstanding in 1997 and 1996, respectively ..................... -- 2,250
Common stock, $.10 par value, 50,000,000 and 15,000,000 authorized
shares;
15,571,922 and 8,870,864 shares issued in 1997 and 1996
respectively,
of which, 5,395 are in the treasury in 1997 and 1996 ........... 1,557 887
Additional paid-in capital ....................................... 16,905 11,401
Accumulated deficit .............................................. (17,287) (19,707)
Net unrealized loss on noncurrent marketable securities .......... -- (84)
Less treasury stock, at cost ..................................... (13) (13)
------- --------
Total stockholders' equity (deficit) ........................... 1,162 (5,266)
------- --------

TOTAL .............................................................. 8,567 $ 7,736
======= ========


SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
28
VAALCO ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)

Year Ended December 31,
-----------------------------
1997 1996
------------ -----------
REVENUES:
Oil and gas sales ........................... $ 2,273 $ 2,732
Gain on sale of assets ...................... 4,164 1,030
------------ -----------
Total revenues ............................ 6,437 3,762
------------ -----------

OPERATING COSTS AND EXPENSES:
Production expenses ......................... 1,426 1,735
Exploration costs ........................... 46 268
Depreciation, depletion and amortization .... 493 614
General and administrative expenses ......... 1,821 2,276
------------ -----------
Total operating costs ..................... 3,786 4,893
------------ -----------

OPERATING INCOME (LOSS) ....................... 2,651 (1,131)

OTHER INCOME (EXPENSE):
Interest income ............................. 85 132
Interest expense and financing charges ...... (175) (285)
Other, net .................................. (99) 925
------------ -----------
Total other income (expense) .............. (189) 772
------------ -----------

INCOME (LOSS) BEFORE TAXES .................... 2,462 (359)
Income expense ................................ (126) --
------------ -----------

NET INCOME (LOSS) ............................. 2,336 (359)
Preferred dividends ........................... (56) (225)
------------ -----------

NET INCOME (LOSS) ATTRIBUTABLE TO

COMMON STOCKHOLDERS ......................... $ 2,280 $ (584)
============ ===========
BASIC INCOME (LOSS) PER COMMON SHARE .......... $ 0.19 $ (0.07)
============ ===========
DILUTED INCOME (LOSS) PER COMMON SHARE ........ $ 0.18 $ (0.07)
============ ===========

BASIC WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING ................... 11,839,423 8,865,469
============ ===========

DILUTED WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING ................... 12,890,947 8,902,218
============ ===========


SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
29
VAALCO ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)



Unrealized
Loss on Total
Preferred Stock Common Stock Additional Noncurrent Stockholders'
--------------- ----------------- Paid-in Accumulated Marketable Treasury Equity
Shares Amount Shares Amount Capital Deficit Securities Stock (Deficit)
------- ------- --------- ------- --------- ----------- ---------- -------- ------------

Balance at January 1, 1996 90,000 2,250 8,865,469 887 11,401 (19,123) (278) (13) (4,876)
Preferred Dividends ................... -- -- -- -- -- (225) -- -- (225)
Net Loss .............................. -- -- -- -- -- (359) -- -- (359)
Unrealized loss on
noncurrent
Marketable securities ............... -- -- -- -- -- -- 194 -- 194
------ --------- ---------- ------- -------- ------- ---- ------ ------
Balance at December 31, 1996 90,000 2,250 8,865,469 887 11,401 (19,707) (84) (13) (5,266)

Preferred Dividends ................... -- -- -- -- -- (56) -- -- (56)
Net Income ............................ -- -- -- -- -- 2,336 -- -- 2,336
Unrealized loss on
noncurrent
Marketable securities ............... -- -- -- -- -- -- 84 -- 84
Retirement of
Preferred Stock ......................... (90,000) (2,250) 2,740,663 1,976 -- -- -- --
Issuance of Common
Stock ................................... -- -- 3,960,395 396 3,528 -- -- -- 3,924
Disposition of
Subsidiary .............................. -- -- -- -- -- 140 -- -- 140
------ --------- ---------- ------- -------- ------- ---- ------ ------
Balance at December 31, 1997 -- -- 15,566,52 $16,905 (17,287) -- (13) 1,162
====== ========= ========== ======= ======== ======= ==== ====== ======


SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

30
VAALCO ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN THOUSANDS OF DOLLARS)

Year Ended December 31,
-----------------------
1997 1996
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ...................................... $ 2,336 $ (359)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation, depletion and amortization ........... 493 614
Provision for losses on accounts receivable ........ (318) --
Provision for deferred income taxes ................ 86
Exploration costs .................................. 46 268
Gain on sale of assets ............................. (4,164) (1,030)
Change in assets and liabilities that provided
(used) cash:
Funds in escrow .................................... (42) (370)
Accounts with partners ............................. 251 (1,442)
Trade receivables .................................. (1,424) (103)
Other receivables .................................. 522 (227)
Crude oil inventory ................................ -- 980
Materials and supplies ............................. (76) 194
Prepaid expenses and other ......................... 3 201
Accounts payable ................................... 1,631 (365)
Accrued liabilities ................................ (331) (69)
Other .............................................. 84 --
------- -------
Net cash used in operating activities ............ (903) (1,708)
------- -------

CASH FLOWS FROM INVESTING ACTIVITIES:
Exploration costs ...................................... (46) (268)
Additions to property and equipment .................... (995) (588)
Proceeds from sale of assets ........................... 5,178 1,825
Other (net) ............................................ (440) 169
------- -------
Net cash provided by investing activities ........ 3,697 1,138
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings ............................... -- 1,618
Repayments of debt obligations ......................... (4,919) (700)
Advances from related parties (net) .................... 1,231 6
Proceeds from the issuance of common stock ............. 3,218 --
------- -------
Net cash (used in) provided by financing
activities ............................................. (470) 924
------- -------

NET CHANGE IN CASH AND CASH EQUIVALENTS ................ 2,324 354

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ....... 1,055 701
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............. $ 3,379 $ 1,055
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Net cash paid for interest ......................... $ 290 $ 184
======= =======
Depletion costs capitalized in crude oil
inventory .............................................. $-- $ 531
======= =======
Non-Cash items:
Redemption of 90,000 shares of $25 par value
preferred stock
by issuance of 2.25 million common shares .............. $(2,250) $ --
======= =======
Issuance of 490,663 common shares for unpaid
dividends .............................................. $ (491) $ --
======= =======
Issuance of 355,000 common shares for accrued
liabilities ............................................ $ (355) $ --
======= =======
Issuance of 100,000 common shares for lease
acquisition costs ...................................... $ (100) $ --
======= =======

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

31
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (in
thousands of dollars, unless otherwise indicated)

1. COMPANY DEVELOPMENTS

VAALCO Energy, Inc. ("VAALCO" or the "Company") explores for, develops
and produces crude oil and natural gas through certain subsidiaries.
Historically, the Company's primary source of capital resources has been
from its production operations in the Philippines, assets sales and the
issuance of debt.

VAALCO owns producing properties and conducts exploration activities
internationally in the Philippines and domestically in the Texas Gulf
Coast area and the Gulf of Mexico, and has recently begun international
exploration activities in Gabon in West Africa. In October, 1997 the
Company entered into an agreement with Paramount Petroleum, Inc.
("Paramount"), a corporation owned by Robert Schneeflock, to jointly
engage in the exploration of oil and gas properties in the United
States, primarily in the onshore Gulf Coast area, including Alabama,
Mississippi and Louisiana. On December 31, 1997, the Company sold
substantially all of its reserves in the Gulf of Mexico. In February
1998, in principal and subject to closing, VAALCO agreed to acquire a
7.5% interest in Hunt Overseas Exploration Company, L.L.P., which has
exploration prospects in a number of international areas.

2. ORGANIZATION

VAALCO, a Delaware corporation (formerly Gladstone Resources, Ltd.
("Gladstone"), a British Columbia corporation), was formed in March 1984
in British Columbia, Canada and domesticated in Delaware in February
1989. In March 1989, Gladstone issued 37.5 million shares of common
stock to each of Charles W. Alcorn, Jr. and Virgil A. Walston, Jr., both
of whom are officers and directors of VAALCO, representing approximately
97% of outstanding shares after issuance. Such shares were issued in
exchange for approximately 51% of outstanding common stock of Alcorn
International, Inc. ("Alcorn"), a Texas corporation. Concurrently,
Gladstone's name was changed to VAALCO Energy, Inc. At the date of the
exchange, Gladstone had been fully liquidated and had no assets or
liabilities. In December 1992, Alcorn was merged with and into VAALCO.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries, as well as the subsidiaries' share in the assets,
liabilities, income and expenses of joint operations. All significant
transactions within the consolidated group have been eliminated in
consolidation.

CASH AND CASH EQUIVALENTS - For purposes of the consolidated statement
of cash flows, the Company and its subsidiaries consider all highly
liquid debt instruments

32
purchased with an original maturity of three months or less to be cash
equivalents. For the years ended December 31, 1997 and 1996, no payments
were made for income taxes, and cash paid for interest was $290 and
$184, respectively.

FUNDS IN ESCROW - Amounts represent restricted funds for abandonment
costs relating to the Gulf of Mexico properties.

INVENTORY VALUATION - Materials and supplies are valued at the lower of
cost, determined by the weighted-average method, or market.

INCOME TAXES - The Company records taxes on income in accordance with
Statement of Financial Accounting Standards "SFAS" No. 109, "Accounting
for Income Taxes". Under SFAS No. 109, deferred income taxes reflect the
net tax effects of (a) temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes, and (b) operating loss and tax
credit carryforwards.

PROPERTY AND EQUIPMENT - The subsidiaries follow the successful efforts
method of accounting for exploration and development costs. Under this
method, exploration costs, other than the cost of exploratory wells, are
charged to expense as incurred. Exploratory well costs are initially
capitalized until a determination as to whether proved reserves have
been discovered. If an exploratory well is deemed to not have found
proved reserves, the associated costs are expensed at that time. All
development costs, including development dry hole costs, are
capitalized. Provisions for impairment of undeveloped oil and gas leases
are based on periodic evaluations and other factors. The Company
recognizes gains for the sale of developed properties based upon an
allocation of property costs between the interest sold and the interest
retained based on the fair value of those interests.

In 1996, the Company adopted statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of." SFAS No. 121 requires that
long-lived assets and certain identifiable intangibles to be held and
used be reported at the lower of carrying amounts or fair values. Assets
to be disposed of and assets not expected to provide any future service
potential to the Company are recorded at the lower of carrying amount or
fair value less cost to sell. The adoption of SFAS No. 121 did not have
a material effect on the Company's financial position or results of
operations.

Depletion of wells, platforms and other production facilities are
provided on a field basis under the unit-of-production method based upon
estimates of proved developed reserves. Provision for estimated
abandonment costs, including platform dismantlement and site
restoration, is included in depreciation, depletion and amortization
expense on a unit-of-production basis. Provision for depreciation

33
of other property is made primarily on a straight line basis over the
estimated useful life of the property. The annual rates of depreciation
are as follows:

Office and miscellaneous equipment................... 3 - 5 years

Leasehold improvements...............................8 - 12 years

In connection with the annual estimate of the Company's oil and gas
reserves for the fiscal years ended December 31, 1997 and 1996, the
Company's independent petroleum engineers estimated proved oil reserves
at December 31, 1997 and 1996 to be 1.5 million and 0.2 million barrels,
of which 1.5 million and 0.2 million are classified as proved developed,
net to the Company, respectively. Proved gas reserves were estimated to
be 1,094 MMcf at December 1996. The Company had no gas reserves at
December 31, 1997. The proved developed reserves for 1996 relate to the
Company's Philippine operations and to the interests in the Gulf of
Mexico. The 1997 proved developed reserves relate to the Company's
Philippine operations.

MARKETABLE SECURITIES - All of the Company's marketable securities are
classified as "available for sale" and accordingly, are reflected in the
Consolidated Balance Sheets at fair market value, with the aggregate
unrealized loss included in shareholders' equity. Cost for determining
gains and losses on sales of marketable securities is determined on the
FIFO method. Marketable securities consisted of the following:


December 31, 1996
---------------------------------------------------------------
Fair Gross
Market Unrealized Holding
----------------------
Shares Cost Value Gains Losses
------------- --------- --------- --------- ----------

Common stocks:
APMC 2,377,460,000 $ 861 $ 777 $ -- $ 84


In February 1997, the Company sold all of its APMC stock. The Company
owned no marketable securities as of December 31, 1997.

FOREIGN EXCHANGE TRANSACTIONS - For financial reporting purposes, the
subsidiaries use the United States dollar as their functional currency.
Monetary assets and liabilities denominated in foreign currency are
translated to U.S. dollars at the rate of exchange in effect at the
balance sheet date, and items of income and expense are translated at
average monthly rates. Nonmonetary assets and liabilities are translated
at the exchange rate in effect at the time such assets were acquired and
such liabilities were incurred. Gains and losses on foreign currency
transactions are included in income currently and were insignificant
during each of the periods.

34
ACCOUNTS WITH PARTNERS - Accounts with partners represent cash calls due
or excess cash calls paid by the partners for exploration, development
and production expenditures made by the following subsidiaries of the
Company: APPI-14, APPI-6, VAALCO Energy (India), Inc., VAALCO Gabon
(Equata), Inc. and VAALCO Gabon (Etame), Inc.

REVENUE RECOGNITION - The Company recognizes revenues from crude oil and
natural gas sales upon delivery to the buyer.

NET INCOME (LOSS) PER SHARE - Net loss per common share amounts are
based on the weighted average number of common shares outstanding during
each period.

FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's financial
instruments consist primarily of cash, trade accounts and note
receivables, trade payables and debt instruments. The book values of
cash, trade receivables, and trade payables are representative of their
respective fair values due to the short term maturity of these
instruments. The book value of the Company's debt and note receivable
instruments are considered to approximate the fair value, as the
interest rates are adjusted based on rates currently in effect. The fair
value of related party receivables and payables have not been estimated.

CONCENTRATIONS OF CREDIT RISK - The Company's interests were located
overseas in certain offshore areas of the Philippines and Gabon. In
December 1996, the Company acquired its first domestic producing
properties consisting of interests in eight platforms in the federal
waters of the offshore Gulf of Mexico. Interests in five of these
platforms were sold December 31, 1997.

Substantially all of the Company's crude oil and natural gas is sold at
the well head at posted or index prices under short term contracts, as
is customary in the industry. For the years ended December 31, 1997 and
1996, one purchaser of the Company's crude oil accounted for essentially
all of the Company's total crude oil sales. During 1997, a second
purchaser accounted for in excess of 90 percent of the Company's
domestic gas sales. The Company markets its crude oil share under an
agreement with SeaOil, a local Philippines refiner. While the loss of
this buyer might have a material effect on the Company in the near term,
management believes that the Company would be able to obtain other
customers for its crude oil.

USE OF ESTIMATES IN FINANCIAL STATEMENT PREPARATION - The preparation of
financial statements in conformity with generally accepted accounting
principles requires estimates and assumptions that affect the reported
amounts of assets and liabilities as well as certain disclosures. The
Company's financial statements include amounts that are based on
management's best estimates and judgments. Actual results could differ
from those estimates.

35
RECLASSIFICATIONS - Certain amounts from 1996 have been reclassified to
conform to the 1997 presentation.

4. ACCRUED LIABILITIES

December 31,
------------------------------
1997 1996
----------- ------------
Interest $ -- $ 115
Other 130 1,165
----------- ------------
$ 130 $ 1,280
=========== ============

5. DEBT OBLIGATIONS AND FINANCING ARRANGEMENTS

December 31,

-----------------------------
1997 1996
----------- ----------

Note payable - Bank $ --- $3,300

Note payable - Other --- 618

Less current portion 3 --- (3,918)
----------- ----------

Long-term portion $ --- $ ---
=========== ==========

The Company entered into a credit agreement on June 23, 1993 to borrow $6
million, at an interest rate of LIBOR plus 2%, from a European
institutional lender. At December 31, 1996, $3.3 million was outstanding.
The loan was paid in full during 1997.

In December 1996, the Company issued $0.6 in debt associated with the
acquisition of certain properties in the Gulf of Mexico. The loan was
paid in full during 1997.

6. STOCKHOLDERS' EQUITY (DEFICIT)

The Company had the right to redeem any or all of its outstanding shares
of Preferred Stock at any time for $25 per share plus accrued unpaid
dividends. In July 1997, the Company redeemed all of the issued and
outstanding shares of its 10% Cumulative Series A Preferred Stock by
issuing an aggregate of 2,740,663 shares of Common Stock to the holders
of such preferred stock in satisfaction of the redemption price and
payment of accrued and unpaid dividends.

An officer and director of the Company was granted options to purchase
75,000 shares of Common Stock of the Company, and was also granted
75,000 stock appreciation rights ("SARs"), all at an exercise price of
$10.25 per share. One-third of such options and SAR's vest at the end of
each of the three years of the contract term, and are exercisable for
five years from the date of vesting. As of December 31, 1997, the
options and SAR's were completely vested, and none of the options and
SAR's had been exercised. In 1996 additional options were granted to
this officer and director for 1,000,000 shares of the Common Stock of

36
the Company at exercise prices of $0.375 per share for 400,000 shares,
$0.50 for 300,000 shares and $1.00 for 300,000 shares. The options vest
over a term of three years and may be exercised for five years from the
vesting date. As of December 31, 1997, the officer and director had
vested interests in 270,000 shares at $0.375 per share, 150,000 shares
at $0.50 per share and 100,000 shares at $1.00 per share. None of the
options had been exercised as of December 31, 1997.

Another officer of the Company has been granted warrants to purchase
shares of the Company's Common Stock. The warrants are for a term of
five years and will consist of the right to purchase 250,000 shares of
Common Stock at an exercise price of $0.50 per share; 250,000 shares of
Common Stock at an exercise price of $2.50 per share; 250,000 shares of
Common Stock at an exercise price of $5.00 per share; and 250,000 shares
of Common Stock at an exercise price of $7.50 per share. The warrants
were completely vested at December 31, 1997. None of the warrants had
been exercised as of December 31, 1997.

Another officer of the Company has been granted options to purchase
1,000,000 shares at $0.625 per share, vesting 500,000 shares at August
1, 1997 and 500,000 shares at August 1, 1998. None of the options had
been exercised as of December 31, 1997.

An investment banking firm was granted 345,325 warrants to purchase the
Company's Common Stock on July 31, 1997 in connection with the private
placement of 3.5 million shares of Common Stock. The warrants have a
term of five years from the date of issuance and consist of the right to
purchase shares at $1.00 per share. None of the warrants had been
exercised as of December 31, 1997.

Information with respect to the Company's stock options are as follows:


Vested Weighted
Options/ Shares Average
Warrants Under Exercise
Exercisable Option Price
------------- ----------- -----------

Balance, December 31, 1995 450,000 475,000 $4.73
Granted 1,225,000 2,000,000 2.24
Exercised -- -- --
Forfeited -- -- --
------------ -----------
Balance, December 31, 1996 1,675,000 2,475,000 2.73
Granted 1,165,325 1,345,325 0.72
Exercised -- -- --
Forfeited 400,000 400,000 3.75
============ ===========
Balance, December 31, 1997 2,440,325 3,420,325 1.82
============ ===========



37
The following table summarizes information about stock options
outstanding as of December 31, 1997:


Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------------------------
Weighted-
Average Weighted- Weighted-
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices At 12/31/97 Life Price At 12/31/97 Price
----------------- ------------ -------------- ------------- ------------- -------------

$ 0.375 to 1.00 2,595,325 4.66 years $ 0.65 1,615,325 $ 0.66
1.01 to 2.50 250,000 3.75 years 2.50 250,000 2.50
2.51 to 5.00 250,000 3.75 years 5.00 250,000 5.00
5.01 to 10.25 325,000 3.38 years 8.13 325,000 8.13
================= ============ ============== ============= ============= =============
$ 0.375 to 10.25 3,420,325 4.40 years $ 1.82 2,440,325 $ 2.29
================= ============ ============== ============= ============= =============


Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123) encourages, but does not
require companies to record compensation cost for stock-based employee
compensation plans at fair value as determined by generally recognized
option pricing models such as the Black-Scholes model or the binomial
model. Because of the inexact and subjective nature of deriving
non-freely traded employee stock option values using these methods, the
Company has adopted the disclosure-only provisions of SFAS No. 123 and
continues to account for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Had compensation cost for
the Company's stock option plans been determined based on the fair value
at the grant date for awards consistent with the provisions of SFAS No.
123, the Company's net income and diluted income per share would have
been reduced to the pro forma amounts indicated below.

1997
-------------
Net income

As reported $ 2,280
Pro forma 2,263

Earnings per share
Basic as reported 0.19
Diluted as reported 0.18

Pro forma basic 0.19
Pro forma diluted 0.18

38
The provision of SFAS No. 123 had no material effect for 1996.

The pro forma fair value of options at date of grant was estimated using
the Black-Scholes model and the weighted average assumptions are as
follows:
1997 1996
--------- ---------
Expected life (years) 5 5
Interest rate 6.50% 6.50%

Volatility 159% 68%

Dividend yield 0% 0%
======================================== ========= =========
Weighted average fair value at
grant date $ 0.58 $ 0.12
======================================== ========= =========

During 1997, the Company implemented Statement of Financial Accounting
Standards No. 128 - "Earnings per Share," ("SFAS No. 128"), which
establishes the requirements for presenting earnings per share ("EPS").
SFAS No. 128 requires the presentations of "basic" and "diluted" EPS on
the face of the income statement. The following reconciliation is
presented as a reconciliation of the numerators and denominators of
basic and diluted earnings per share computations.


For the Year Ended December 31, 1997
-------------------------------------------------
Per-Share Income Shares
Amount (Numerator) (Denominator)
-------------- ------------ ---------------

BASIC EPS
Income attributable to common
shareholders 0.19 2,280 11,839

EFFECT OF DILUTED SECURITIES
Common Stock options (0.01) -- 1,052
-------------- ------------ ---------------

DILUTED EPS
Income attributable to common
shareholders 0.18 2,280 12,891
============== ============ ===============


For the Year Ended December 31, 1996
-------------------------------------------------
Per-Share Income Shares
Amount (Numerator) (Denominator)
-------------- ------------ ---------------
BASIC EPS
Income attributable to common
shareholders (0.07) (584) 8,865

EFFECT OF DILUTED SECURITIES
Common Stock options -- -- 37
-------------- ------------ ---------------

DILUTED EPS
Income attributable to common
shareholders (0.07) (584) 8,902
============== ============ ===============


39
Options excluded from the above calculation, as they are anti-dilutive,
are 800 and 1,600 for 1997 and 1996, respectively.

7. INCOME TAXES

The Company and its domestic subsidiaries file a consolidated United
States income tax return. Certain subsidiaries' operations are also
subject to Philippine income taxes. The Company incurred certain
deferred tax liabilities in the Philippines associated with foreign
exchange gains by its subsidiaries.

Provision (benefit) for income taxes consists of the following:

Year Ended December 31,
1997 1996
------------ -----------
U.S. federal:
Current 40 --

Deferred (40) --
Philippine:

Current -- --
Deferred 126 --
============ ===========
Total 126 --
============ ===========

The primary differences between the financial statement and tax bases of assets
and liabilities at December 31, 1997 and 1996 are as follows:

Year ended December 31,
------------------------
1997 1996
------------ ---------

Deferred Tax Liabilities:

Unrealized foreign exchange gain ............... $ 126 $ --
Deferred Tax Assets:
Reserves not currently deductible .............. 1,047 1,184
Foreign tax credits ............................ -- 7,087
Operating loss carryforwards ................... 3,773 7,465
Alternative minimum tax credit
carryover ........................................ 40 --
Other assets (liabilities), net ................ 108 355
-------- --------
4,968 16,091
Valuation allowance .............................. (4,928) (16,091)
-------- --------
40 --
-------- --------
Net deferred tax liability ....................... $ 86 $ --
======== ========


40
Pretax income (loss) is comprised of the following:

Year Ended December 31,
-------------------------
1997 1996
------- -----

United States .......................... $ 3,287 $(212)
Foreign (Philippine) ................... (825) (147)
======= =====

$ 2,462 $(359)
======= =====

A reconciliation between the provision (benefit) for income taxes
recognized in the Company's Statements of Operations computed by
applying the statutory federal income tax rate and income taxes to
pre-tax losses follows:

Year ended December 31,
---------------------------
1997 1996
-------- -----
Consolidated U.S. at 35% ................ $ 862 $ (74)
Philippine at 42% ....................... -- (62)
Deferred tax asset utilization .......... 10,427 (51)
Change in valuation allowance ........... (11,163) 187
-------- -----
Total ........................................ $ 126 $--
======== =====

The Internal Revenue Service, ("IRS") examined the Company and its U.S.
subsidiaries, for the years up to and including 1993, resulting in
certain adjustments proposed by the IRS. The Company settled the
examination with the IRS Appeals Office in January 1998, resulting in a
tax liability of $130 plus accrued interest of $43, and a carryback
refund claim of $173 rising principally from the filing of amended
returns utilizing creditable Philippines taxes as deductions.

At December 31, 1997, the Company and its subsidiaries had no foreign
tax credit ("FTC") carryforwards for United States tax purposes.

At December 31, 1997, the Company and its subsidiaries had net operating
loss ("NOL") carryforwards of approximately $10.8 million for United
States income tax purposes. A full valuation allowance has been provided
against this NOL

8. RELATED-PARTY TRANSACTIONS

A subsidiary of VAALCO loaned funds to certain officers of the Company,
and advanced funds to parties related to an officer of a wholly owned
subsidiary of the Company, for the purpose of acquiring 3.5% and 10.4%,
respectively, of the outstanding common stock of Alcorn Petroleum and
Minerals Corporation ("APMC"). Certain officers, directors and
stockholders of the Company were also

41
officers, directors and stockholders of APMC. In February 1997 the
shares were sold and the loans repaid. The loans and the advances are as
follows:

December 31,
--------------------------------
1997 1996
------------------ -----------
Advances-related party $ -- $ 1,916




At any given time, APMC may have had a positive or negative balance with
the Company in connection with the assigned working interest in Service
Contract No. 14, including advances for certain expenses. These balances
are settled in the normal course of business. Total amounts due to APMC,
as of December 31, 1996, amounted to $4.

A subsidiary of the Company has a note receivable from an officer,
director and stockholder of the Company which bears interest at 9% per
annum and is due in monthly installments through December 1, 2002. The
balance of the note was $42 and $48 at December 31, 1997 and 1996,
respectively.

General and administrative expenses for consulting services to
companies, owned by certain officers or stockholders, were $50 and $360
for the years ended December 31, 1997 and 1996, respectively.

9. COMMITMENTS AND CONTINGENCIES

In July 1995, the Company acquired two blocks offshore Gabon, the Equata
block and the Etame block. Both blocks contain previous discoveries that
the Company is currently evaluating to determine their commercial
viability. The Company and its partners have an obligation to the
Government of Gabon to obtain approximately 1,500 line kilometers of
seismic data and to drill one well on the Etame block during the
three-year term of the license. In April 1997, the Company entered into
a participation agreement with Western Atlas Afrique, Ltd. ("Western
Atlas") a subsidiary of Western Atlas International, Inc., to conduct a
320 square kilometer seismic survey at Western Atlas' sole cost and to
pay a disproportionate 80% of the cost, up to $4.7 million, of the
estimated $5.8 million (dry hole cost) commitment well. In return for
these payments, Western Atlas earns a 65% interest in the production
sharing contract. The Company and its partners will be responsible for
20% of the cost (35% over $4.7 million) of the commitment well. VAALCO's
share of the dry hole cost of the commitment well is estimated to be
$0.7 million.

In June 1997, Western Atlas completed the above mentioned acquisition of
seismic data over the property. This data has been processed, and the
Company expects

42
to begin drilling the commitment well in March 1998. The consortium of
companies owning the Etame Block production sharing contract have the
right to renew the production sharing contract for three additional
years subject to compliance with the terms of the production sharing
contract, including a commitment to drill two additional wells and to
perform a 2-D seismic survey. The consortium has several large
structures identified on the block in addition to the commitment well.
It is anticipated that the consortium will renew the production sharing
contract regardless of the outcome of the currently planned well.

In October, 1997 the Company entered into an agreement with Paramount
Petroleum, Inc. ("Paramount"), a corporation owned by Robert
Schneeflock, to jointly engage in the exploration of oil and gas
properties in the United States, primarily in the onshore Gulf Coast
area, including Alabama, Mississippi and Louisiana. On December 31,
1997, the Company sold substantially all of its reserves in the Gulf of
Mexico.

10. SUBSEQUENT EVENT

In February 1998, the Company agreed in principal, and subject to
closing, to acquire from The 1818 Fund II, L.P. (the "1818 Fund") all of
the outstanding capital stock of 1818 Oil Corp. ("1818 Corp.") in
exchange for 10,000 shares of Convertible Preferred Stock, Series A
("New Preferred Stock") of VAALCO. The assets of 1818 Corp. consist of a
7.5% limited partnership interest ("Hunt Partnership Interest") in Hunt
Exploration Company, L.L.P. ("Hunt"), a partnership that explores for
high risk, large reserve accumulations, generally targeting deposits
which pre-drilling seismic and other data indicate to have potential in
excess of 100 MMBOE. Hunt has entered into production sharing contracts
and other arrangements which entitle it to explore for oil, both onshore
and offshore, in various countries including Argentina, Canada,
Ethiopia, Ghana, Niger and Peru. The general partner of Hunt is Hunt
Overseas Operating Company, a subsidiary of Hunt Oil Company, which has
extensive experience in international exploration and development
operations. The closing of the transaction is subject among other
things, to the Company raising $10 million of additional capital through
a private placement of Common Stock. There can be no assurance that the
Company will successfully raise the new capital or that the Hunt
transaction will close. If the Hunt transaction does close, it will be
accounted for as a reverse acquisition, and 1818 Corp. will be the
acquiring entity for accounting purposes.

43
VAALCO ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
(in thousands of dollars, unless otherwise indicated)

The following information is being provided as supplemental information
in accordance with certain provisions of SFAS No. 69, "Disclosures about Oil and
Gas Producing Activities". The Company's reserves are located offshore of the
Republic of the Philippines and the Gulf of Mexico. The following tables set
forth costs incurred, capitalized costs, and results of operations relating to
oil and natural gas producing activities for each of the periods.

COSTS INCURRED IN OIL AND GAS PROPERTY
ACQUISITION, EXPLORATION AND DEVELOPMENT
ACTIVITIES

Year Ended December 31,
--------------------------
1997 1996
---- ------
Costs incurred during the year:

Exploration ....................................... $ 46 $ 268
Acquisition ....................................... 720 746
---- ------

Total ........................................... $766 $1,014
==== ======

Exploration and development costs above for 1997 and 1996 include $0 and
$13, respectively, related to the Company's former India operations. Also
included in the above table for 1997 and 1996 are exploration costs of $46 and
$255, respectively, related to the Company's prospects located offshore Gabon
for which no reserves are currently attributable. The acquisition costs in 1996
relate to the Company's interest in the Gulf of Mexico. The acquisitions costs
in 1997 relate to the Company's leases located in Brazos County, Texas.

CAPITALIZED COSTS RELATING TO OIL AND GAS PRODUCING ACTIVITIES:

Year ended December 31,
--------------------------
1997 1996
-------- --------

Capitalized costs ............................ $ 47,844 $ 47,674
Accumulated depreciation,
depletion, and amortization ................. (46,117) (46,122)
======== ========

Net capitalized costs ........................ $ 1,727 $ 1,552
======== ========

Of the above capitalized costs for 1996, $746 are attributable to the
Company's acquired properties in the Gulf of Mexico, while $330 and $297 are
attributable to the Company's Goliad County, Texas properties for 1997 and 1996,
respectively. Other domestic costs include $860 attributable to the Company's
Brazos County acreage. Costs attributable to the Company's Gabon properties are
$537 and $510 for 1997 and 1996, respectively.

44
RESULTS OF OPERATIONS FOR OIL AND GAS PRODUCING ACTIVITIES:

Year Ended December 31,
---------------------------
1997 1996
------- -------
Oil and gas sales .............................. $ 2,273 $ 2,732
Production expenses ............................ (1,426) (1,735)
Exploration expenses ........................... (46) (268)
Depreciation, depletion and
amortization ................................... (484) --
------- -------
317 729
Income tax expense ............................. (111) --
------- -------
Net income from oil and gas
producing activities (excluding
interest expense and general and

administrative expenses) ...................... $ 206 $ 729
======= =======

Proved Reserves

The following tables set forth the net proved reserves of VAALCO Energy,
Inc. (which excludes the interests of the Philippine government and the other
consortium members) as of December 31, 1997 and 1996, and the changes therein
during the periods then ended.

Oil (MBbls) Gas (Mmcf)
---------------- ----------
PROVED RESERVES:
BALANCE AT DECEMBER 31, 1995 ................... 4,848 --

Production .................................... (60) --
Discoveries, extensions and other
additions ...................................... -- 1,094

Sales of reserves in place .................... (4,647) --

Revisions ..................................... 74 --
------ ------

BALANCE AT DECEMBER 31, 1996 ................... 215 1,094

Production .................................... (86) (710)
Discoveries, extensions and other
additions ...................................... -- --

Sales of reserves in place .................... -- (384)

Revisions ..................................... 1,406 --
------

BALANCE AT DECEMBER 31, 1997 ................... 1,535 --
====== ======

In April 1996, the Company sold substantially all of its proved
undeveloped reserves. In December 1997, the Company sold all of its gas
reserves. Production volumes are based on oil and gas sales.

PROVED DEVELOPED RESERVES ........................ Oil (MBbls) Gas (MMcf)
----- -----

-----
Balance at December 31, 1995 ................... 201 1,094
Balance at December 31, 1996 ................... 215
Balance at December 31, 1997 ................... 1,535 --

All of the Company's Proved Developed Reserves are located offshore the
Republic of the Philippines.


45
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH
FLOWS RELATING TO PROVED OIL RESERVES

The information that follows has been developed pursuant to procedures
prescribed by SFAS No. 69 and utilizes reserve and production data estimated by
independent petroleum consultants. The information may be useful for certain
comparison purposes, but should not be solely relied upon in evaluating VAALCO
Energy, Inc. or its performance.

The future cash flows are based on sales prices and costs in existence
at the dates of the projections, excluding the interests of the Philippine
government and the other consortium members. Future production costs do not
include overhead charges allowed under joint operating agreements or
headquarters general and administrative overhead expenses. Future development
costs include amounts accrued attributable to future abandonment when the wells
become uneconomic to produce. The standardized measure of discounted cash flows
for 1996 do not include the costs of abandoning the Company's non-producing
properties.


Philippines Gulf of Mexico Total
------------------- ------------------ -------------------
December 31, December 31, December 31,
------------------- ------------------ -------------------
1997 1996 1997 1996 1997 1996
-------- ------- ------- ------- -------- -------

Future cash inflows ..... $ 15,353 $ 2,363 $ -- $ 4,251 $ 15,353 $ 6,614

Future production costs . (10,180) (1,023) -- (1,122) (10,180) (2,145)

Future development costs (2,414) (1,000) -- (673) (2,414) (1,673)

Future income tax expense -- -- -- -- -- --
-------- ------- ------- ------- -------- -------

Future net cash flows ... 2,759 340 -- 2,456 2,759 2,796
Discount to present value
at 10% annual rate ..... (10) 126 -- (84) (10) 42
-------- ------- ------- ------- -------- -------
Standardized measure of
discounted future net
cash flows .............. $ 2,749 $ 466 $ -- $ 2,372 $ 2,749 $ 2,838
======== ======= ======= ======= ======== =======

Future development costs at December 31, 1997 and 1996 includes $2.4 and $1.7
million, respectively, for future abandonment costs which has been accrued by
the Company. Due to the availability of net operating loss carryforwards, there
are no future income tax expenses attributable to the Company's reserves.

46
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS:

The following table sets forth the changes in standardized measure of
discounted future net cash flows as follows:


Philippines Gulf of Mexico Total
-------------------- ------------------ -------------------
December 31, December 31, December 31,
-------------------- ------------------ -------------------
1997 1996 1997 1996 1997 1996
------- ------- ------- ------ ------- -------
BALANCE AT BEGINNING OF

PERIOD ...................... $ 466 $(1,305) $ 2,372 $ -- $ 2,838 $(1,305)
Sales of oil and gas, net of
production costs ............ (164) (997) (683) -- (847) (997)
Net changes in prices and
production costs ............ (872) 929 -- -- (872) 929
Revisions of previous
quantity estimates .......... 2,860 454 -- -- 2,860 454
Purchase (Sale) of reserves
in place, net of taxes ...... -- -- (1,689) 2,372 (1,689) 2,372
Changes in estimated future
development costs ........... 178 1,045 -- -- 178 1,045
Development costs incurred
during the period ........... -- -- -- -- -- --

Accretion of discount ...... 47 (140) -- -- 47 (140)

Net change in income taxes . 77 -- -- -- 77 --
Change in production rates
(timing) and other .......... 175 480 -- -- 157 480
------- ------- ------- ------ ------- -------

BALANCE AT END OF PERIOD ... $ 2,749 $ 466 $ -- $2,372 $ 2,749 $ 2,838
======= ======= ======= ====== ======= =======

There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
Company. Reserve engineering is a subjective process of estimating underground
accumulations of crude oil and natural gas that cannot be measured in an exact
manner, and the accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation and judgment.
The quantities of oil and natural gas that are ultimately recovered, production
and operating costs, the amount and timing of future development expenditures
and future oil and natural gas sales prices may all differ from those assumed in
these estimates. The standardized measure of discounted future net cash flow
should not be construed as the current market value of the estimated oil and
natural gas reserves attributable to the Company's properties. The information
set forth in the foregoing tables includes revisions for certain reserve
estimates attributable to proved properties included in the preceding year's
estimates. Such revisions are the result of additional information from
subsequent completions and production history from the properties involved or
the result of a decrease (or increase) in the projected economic life of such
properties resulting from changes in product prices. Moreover, crude oil amounts
shown are recoverable under the service contracts and the reserves in place
remain the property of the Philippine government.

In accordance with the guidelines of the U.S. Securities and Exchange
Commission, the Company's estimates of future net cash flow from the Company's
properties and the present value thereof are made using oil and natural gas
contract prices in effect as of year end and are held constant throughout the
life of the properties except where such guidelines permit alternate treatment,
including the use of fixed and determinable contractual price escalations. The
contract price as of December 31, 1996

47
was $11.00 per Bbl for oil and $3.89 per Mcf for gas. The contract price as of
December 31, 1997 was $10.00 per Bbl of crude oil for the Philippine reserves .

Under the laws of the Republic of the Philippines, the Philippine
government is the owner of all oil and gas mineral rights. However, pursuant to
The Oil Exploration and Development Act of 1972, the Philippine government,
acting through its Office of Energy Affairs (formerly, the Petroleum Board), may
enter into service contracts under which contractors will be granted exclusive
rights to perform exploration, drilling, production and other "petroleum
operations" in a contract area. Further, such Act vested the Ministry of Energy
with regulatory powers over business activities relating to the exploration,
exploitation, development and extraction of energy resources.

Pursuant to the service contracts, the Philippine government receives an
allocation of the production from the contract area instead of a royalty. Under
the service contracts, the Philippine government does not take actual delivery
of its allocated production. Instead, the Company has been authorized to sell
the Philippine government's share of production and remit the proceeds to the
Philippine government. Under this production sharing scheme, the consortium is
permitted a Filipino Participation Incentive Allowance ("FPIA") and a deduction
to recover certain costs expended on the development of the contract area of up
to 60% of gross revenues from the contract area. The FPIA, a deduction
equivalent to 7 1/2% of project gross revenue, is allowed when Filipino
ownership participation in the consortium equals or exceeds 15%, which is the
case for Service Contract No. 14. The consortium also receives a production
allowance of approximately 50% of the balance of the oil after deducting FPIA
and cost recovery oil. The remaining oil is shared 40% by the consortium and 60%
by the Philippine government. Under this scheme, the consortium currently
receives approximately 90.3% of the oil produced and the Philippine government
receives approximately 9.7%. Because the cost recovery account contains over
$200 million, the Company anticipates receiving the maximum 60% of cost oil
during the life of the Nido and Matinloc reserves.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

48
PART III

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

2.1 Stock Acquisition Agreement and Plan of Reorganization dated
February 17, 1998 by and among the Company and the 1818 Fund,
II, L.P. (incorporated herein by reference to the Company's
report on Form 8-K filed March 4, 1998 (file no. 000-20928))

3.1f Certificate of Incorporation of the Company, as amended. 3.2 a
Bylaws of the Company, as amended. 4.1 f Certificate of
Designation of 10% Cumulative Preferred Stock, Series A
(contained in Exhibit 3.1 hereto).

10.1a Service Contract No. 6, dated September 1, 1973, among the
Petroleum Board of the Republic of the Philippines and Mosbacher
Philippines Corporation, ET AL, as amended.

10.2a Operating Agreement, dated January 1, 1975, among Mosbacher
Philippines Corporation, Husky (Philippines) Oil, Inc. and Amoco
Philippines Petroleum Company.

10.3a Service Contract No. 14, dated December 17, 1975, among the
Petroleum Board of the Republic of the Philippines and
Philippines--Cities Service, Inc., ET AL, as amended.

10.4a Operating Agreement, dated July 17, 1975, among
Philippines-Cities Service, Inc., Husky (Philippines) Oil, Inc.,
Oriental Petroleum and Minerals Corporation,
Philippines-Overseas Drilling & Oil Development Corporation,
Basic Petroleum and Minerals, Inc., Landoil Resources
Corporation, Westrans Petroleum, Inc. and Philippine National
Oil Company, as amended.

10.5a Production Sharing Agreement for Petroleum Exploration,
Development and Production in Belize, dated September 1, 1992,
between the Government of Belize and Exeter Oil and Gas, Ltd.

10.6a West Linapacan Trustee and Paying Agent Agreement, dated June
17, 1992, between Bankers Trust Company and Alcorn (Production)
Philippines Inc.

10.7a Memorandum of Understanding, dated April 2, 1979, among the
Bureau of Energy Development of the Republic of the Philippines
and Philippines--Cities Service, Inc., ET AL.

10.8a+ Employment Agreement between the Company and Charles W. Alcorn,
Jr. dated March 1, 1992.

10.9a+ Employment Agreement between the Company and Virgil A. Walston,
Jr. dated March 1, 1992.

10.10a+ Employment Agreement between the Company and W. Russell
Scheirman dated March 15, 1993.

10.11a+ Consulting Agreement between the Company and Alcorn Production
Company dated February 15, 1988, as amended.

10.12a+ Consulting Agreement between the Company and V.A. Walston &
Associates, Inc. dated February 15, 1988, as amended.


49
10.13a Indemnity Agreement entered into among the Company and certain
of its officers and directors listed therein.

10.14b Production Sharing Contract, dated December 30, 1994, between
The Government of India and Oil & Natural Gas Corporation LTD.
and VAALCO Energy, Inc., Hindustan Oil Exploration Company
Limited and TATA Petrodyne Private Limited.

10.15b Letter Agreement, dated October 3, 1994, between VAALCO Energy,
Inc. and Allegro Investments, Inc.

10.16b Stock Purchase Warrant to Purchase Shares of Common Stock of
VAALCO Energy, Inc., dated October 3, 1994, between VAALCO
Energy, Inc. and Allegro Investments, Inc.

10.17b Stock Purchase Warrant to Purchase Shares of Common Stock of
VAALCO Energy, Inc., dated October 3, 1994, between VAALCO
Energy, Inc. and Allegro Investments, Inc.

10.18b Stock Purchase Warrant to Purchase Shares of Common Stock of
VAALCO Energy, Inc., dated October 3, 1994, between VAALCO
Energy, Inc. and Allegro Investments, Inc.

10.19c Exploration and Production Sharing contract between the Republic
of Gabon and VAALCO Gabon (Equata), Inc. dated July 7, 1995.

10.20c Exploration and Production Sharing contract between the Republic
of Gabon and VAALCO Gabon (Etame), Inc. dated July 7, 1995.

10.21c Deed of Assignment and Assumption between VAALCO Gabon (Etame),
Inc., VAALCO Energy (Gabon), Inc. and Petrofields Exploration &
Development Co., Inc. dated September 28, 1995.

10.22c Deed of Assignment and Assumption between VAALCO Gabon (Equata),
Inc., VAALCO Production (Gabon), Inc. and Petrofields
Exploration & Development Co., Inc. dated September 8, 1995.

10.23d Letter Agreement dated February 13, 1996 between VAALCO Energy,
Inc. and Hardy Oil & Gas (UK) Limited.

10.24e Letter of Intent for Etame Block, Offshore Gabon dated January
22, 1997 between the Company and Western Atlas International,
Inc.

10.25e Farm In Agreement for Service Contract No. 14 Offshore Palawan
Island, Philippines dated September 24, 1996 between the Company
and SOCDET Production PTY, Ltd.

10.26e Letter Agreement between the Company and Northstar Interests
LLC. dated December 5, 1996.

10.27f Registration Rights Agreement, dated July 28, 1997, by and among
the Company, Jefferies & Company, Inc. and the investors listed
therein.

10.28 Warrant Agreement to Purchase Shares of Common Stock of VAALCO
Energy, Inc., dated July 31, 1997, between VAALCO Energy, Inc.
and Jefferies & Company, Inc.

10.29 Employment Agreement between the Company and W. R. Scheirman
dated March 15, 1996, as amended.

10.30 Employment Agreement between the Company and Robert L. Gerry,
III dated August 1, 1997.

21.1a List of subsidiaries.
- ------------

50
(a) Filed as an exhibit to the Company's Form 10 (File No. 0-20928) filed on
December 3, 1992, as amended by Amendment No. 1 on Form 8 on January 7,
1993, and by Amendment No. 2 on Form 8 on January 25, 1993, and hereby
incorporated by reference herein.

(b) Filed as an exhibit to the Company's Form 10-KSB for the year ended
December 31, 1994.

(c) Filed as an exhibit to the Company's Form 10-QSB for the quarterly
period ended September 30, 1995.

(d) Filed as an exhibit to the Company's Form 10-QSB for the quarterly
period ended March 31, 1996

(e) Filed as an exhibit to the Company's Form 10-KSB for the year ended
December 31, 1996.

(f) Filed as an exhibit to the Company's Form 10-QSB for the quarterly
period ended June 30, 1997.

+Management contract or compensatory plan or arrangement required to be
filed pursuant to Item 13 of Form 10-KSB.

(b) Reports on Form 8-K.
None.

51
SIGNATURES

IN ACCORDANCE WITH SECTION 13 OR 15(D) OF THE EXCHANGE ACT, THE
REGISTRANT CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED,
THEREUNTO DULY AUTHORIZED.

VAALCO ENERGY, INC.
(Registrant)

By /s/W. RUSSELL SCHEIRMAN
-------------------------------------------------
W. RUSSELL SCHEIRMAN, PRESIDENT,
CHIEF FINANCIAL OFFICER AND DIRECTOR

Dated March 25, 1998

IN ACCORDANCE WITH THE EXCHANGE ACT, THIS REPORT HAS BEEN SIGNED BELOW
ON THE 29TH DAY OF MARCH, BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT
AND IN THE CAPACITIES INDICATED.

SIGNATURE TITLE
By: /s/ROBERT L, GERRY, III Chairman of the Board, Chief
---------------------------------- Executive Officer and Director
Robert L. Gerry, III. (Principal Executive Officer)

By: /s/VIRGIL A. WALSTON, JR. Vice Chairman of the Board,
---------------------------------- Chief Operating Officer and
Virgil A. Walston, Jr. Director

By: /s/W. RUSSELL SCHEIRMAN President, Chief Financial
---------------------------------- Officer and Director
W. Russell Scheirman (Principal Financial Officer
and Principal Accounting
Officer)

By: Director
----------------------------------
Charles W. Alcorn, Jr.

By: Director
---------------------------------
Arne R. Nielsen

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