Extension of Term of Etame Marin Block PSC

On September 25, 2018, VAALCO together with the other joint owners in the Etame Marin block (the “Consortium”) received an implementing Presidential Decree from the government of Gabon authorizing the PSC Extension. The Company’s subsidiary, VAALCO Gabon S.A., has a 33.575% participating interest (working interest including the working interest attributable to the carried interest owner) in the Etame Marin block.

The PSC Extension extends the term for each of the three exploitation areas in the Etame Marin block for a period of ten years with effect from September 17, 2018, the effective date of the PSC Extension. Prior to the PSC Extension, the exploitation periods for the three exploitation areas in the Etame Marin block would expire beginning in June 2021. The PSC Extension also grants the Consortium the right for two additional extension periods of five years each. The PSC Extension further allows the Consortium to explore the potential for resources within the area of each Exclusive Exploitation Authorization as defined in the PSC Extension.

In consideration for the PSC Extension, the Consortium agreed to a signing bonus of $65.0 million ($21.8 million, net to VAALCO) payable to the government of Gabon (the “signing bonus”). The Consortium paid $35.0 million ($11.8 million, net to VAALCO) in cash on September 26, 2018 and paid $25.0 million ($8.4 million, net to VAALCO) through an agreed upon reduction of the VAT receivable owed by the government of Gabon to the Consortium as of the effective date. An additional $5.0 million ($1.7 million, net to VAALCO) is to be paid in cash by the Consortium following the end of the drilling activities described below. The Company has accrued the $1.7 million share of this remaining payment as of December 31, 2019. This payment was made in February 2020. The amount paid through a reduction in VAT has been recorded at $4.2 million, which represents the book value of the receivable, net of the valuation allowance as of the effective date. In addition, the Company recorded an increase of $18.6 million resulting from the deferred tax impact for the difference between book basis and tax basis. A corresponding $18.6 million deferred tax liability was recorded, which reduced the net deferred tax assets. The Company has allocated the share of the signing bonus between proved and unproved leasehold costs using the acreage attributable to the previous exploitation areas and the additional acreage in the expanded exploitation areas resulting in $22.5 million being attributed to proved leasehold costs and $13.7 million attributed to unproved leasehold costs.

Under the PSC Extension, by September 16, 2020, the Consortium is required to drill two wells and two appraisal wellbores. If the wells are not drilled, then the Consortium must pay the difference between the amounts spent on any wells that were drilled and the estimated costs of the wells as set forth in the Work Program and Budget as approved by the government of Gabon. The Consortium completed drilling one development well and one appraisal wellbore during the second half of 2019 and completed the remaining development well and appraisal wellbore during the first quarter 2020. The Consortium is also required to complete two technical studies by September 16, 2020 at an estimated cost of $1.3 million gross ($0.4 million, net to VAALCO). These studies are currently being performed.

Prior to the PSC Extension, the Consortium was entitled to take up to 70% of production remaining after the 13% royalty (“Cost Recovery Percentage”) to recover its costs so long as there are amounts remaining in the Cost Account. Under the PSC Extension, the Cost Recovery Percentage is increased to 80% for the ten-year period from September 17, 2018 through September 16, 2028. After September 16, 2028, the Cost Recovery Percentage returns to 70%.

Prior to the PSC Extension, the PSC provided for the government of Gabon to take a 7.5% gross working interest carried by the Consortium. The government of Gabon transferred this interest to a third party. Pursuant to the PSC Extension, the government of Gabon will acquire from the Consortium an additional 2.5% gross working interest carried by the Consortium effective June 20, 2026. VAALCO’s share of this interest to be transferred to the government of Gabon is 0.8%.

Proved Properties

The Company reviews the crude oil and natural gas producing properties for impairment quarterly or whenever events or changes in circumstances indicate that the carrying amount of such properties may not be recoverable. When a crude oil and natural gas property’s undiscounted estimated future net cash flows are not sufficient to recover its carrying amount, an impairment charge is recorded to reduce the carrying amount of the asset to its fair value. The fair value of the asset is measured using a discounted cash flow model relying primarily on Level 3 inputs into the undiscounted future net cash flows. The undiscounted estimated future net cash flows used in the impairment evaluations at each quarter end are based upon the most recently prepared independent reserve engineers’ report adjusted to use forecasted prices from the forward strip price curves near each quarter end and adjusted as necessary for drilling and production results.

There was no triggering event in the year ended December 31, 2019 that would cause the Company to believe the value of crude oil and natural gas producing properties should be impaired. During the year ended December 31, 2018, crude oil and natural gas property costs increased significantly as a result of amounts recorded in connection with the PSC Extension and year-end crude oil prices decreased over the prior year; however, reserves increased significantly over the prior year. The Company evaluated these and other factors and determined that no impairment was required for any of the Etame fields. There was no triggering event in the year ended December 31, 2017 that would cause the Company to believe the value of crude oil and natural gas producing properties should be impaired.

Undeveloped Leasehold Costs

The Company has a 31% working interest in an undeveloped portion of Block P offshore Equatorial Guinea that the Company acquired in 2012 for which the Company has $10.0 million capitalized in undeveloped acreage. For a number of years, the Block P interest was in suspension; however, in September 2018, the Ministry of Mines and Hydrocarbons (“EG MMH”) lifted the suspension. The EG MMH approved our appointment as operator for Block P on November 12, 2019 and the Company is currently waiting on a production sharing contract amendment to begin activities in Block P. VAALCO intends to seek a joint venture owner on a promoted basis that will cover all or substantially all of the cost to drill an exploratory well. If VAALCO fails to meet the defined commitments when the new PSC amendment terms are agreed, the capitalized costs associated with Block P would be impaired. As of December 31, 2019, the Company had $10.0 million recorded for the book value of the undeveloped leasehold costs associated with the Block P license. The production sharing contract covering this development and production area provides for a development and production period of 25 years from the date of approval of a development and production plan.

As a result of the PSC Extension, the exploitation area was expanded to include previously undeveloped acreage. The Company allocated $6.7 million of the share of the signing bonus and $7.1 million of the $18.6 million resulting from the deferred tax impact for the difference between book basis and tax basis to unproved leasehold costs using the acreage attributable to the previous exploitation areas and the additional acreage in the expanded exploitation areas. Exploitation of this additional area is permitted throughout the term of the Etame PSC.

Capitalized Equipment Inventory

Capitalized equipment inventory is reviewed regularly for obsolescence. Adjustments for inventory obsolescence are recorded on “Other operating loss, net” line item of the consolidated statement of operations, but were not material for the years ended December 31, 2019, 2018 and 2017.