7.  OIL AND NATURAL GAS PROPERTIES AND EQUIPMENT

Extension of Term of Etame 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 an extension for additional years (“PSC Extension”) to the Consortium to operate in the Etame Marin block.  Our 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 Exclusive Exploitation Authorization area 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.  We have accrued our $1.7 million share of this remaining payment as of September 30, 2018.  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, we 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 our net deferred tax assets.  We have allocated our 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 well bores.  We estimate the cost of these wells will be approximately $61.2 million ($20.5 million, net to VAALCO).  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 is planning to commence drilling these wells in the second half of 2019.  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).

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 Etame 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%.

Depletion and Impairment

We review our 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 an 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 our 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 first quarter of 2019 that would cause us to believe the value of oil and natural gas producing properties should be impaired.  Factors considered included the fact that we incurred no significant capital expenditures in 2019 related to the fields in the Etame Marin block, the future strip prices for the first quarter of 2019 increased from the fourth quarter of 2018, and there were no indicators that adjustments were needed to the year-end reserve report.

There was no triggering event in the first quarter of 2018 that would cause us to believe the value of oil and natural gas producing properties should be impaired.  Factors considered included the fact that we incurred no significant capital expenditures in 2018 related to the fields in the Etame Marin block, the future strip prices for the first quarter of 2018 modestly increased from the fourth quarter of 2017, and there were no indicators that adjustments were needed to the  year-end reserve report.

Undeveloped Leasehold Costs

We have a 31% working interest in an undeveloped portion of a block offshore Equatorial Guinea that we acquired in 2012 (the “Block P interest”). We are currently awaiting the Equatorial Guinea Ministry of Mines and Hydrocarbons (“EG MMH”) to approve our appointment as operator for Block P.  Compania Nacional de Petroleos de Guinea Equatorial (“GEPetrol”) is the state-owned oil company and one of the joint venture owners in Block P.  GEPetrol was required to introduce a new investor or joint venture owner to the EG MMH by March 28, 2019, and it has fulfilled this requirement.  Upon EG MMH approving the new join owner, the Contractor group has one year to drill an exploration well.  We intend 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 the joint venture owners fail to drill an exploration well, we would lose our interest in the license, and the associated costs would become impaired.  As of March 31, 2019, we had $10.0 million recorded for the book value of the undeveloped leasehold costs associated with the Block P license.  We and our joint venture owners are evaluating the timing and budgeting for development and exploration activities under a development and production area in the block, including the approval of a development and production plan.  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.  We allocated $6.7 million of our 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.