10.  COMMITMENTS AND CONTINGENCIES

Leases

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



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



The Company has entered into several agreements for the lease of office, warehouse and storage yard space, the FPSO and a hydraulic workover rig (“HWU”).  The duration for these agreements ranges from 21 to 45 months. The FPSO, HWU and office space contracts requires us to make payments both for the use of the asset itself and for operations and maintenance services. Only the payments for the use of the asset relate to the lease component and are included in the calculation of ROU assets and lease liabilities. Payments for the operations and maintenance services are considered non-lease components and are not included in calculating the ROU assets and lease liabilities.  For leases on ROU assets used in joint operations, generally the operator reflects the full amount of the lease component, including the amount which will be funded by the non-operators.  As operator for the Etame Marin block, the ROU asset recorded for the FPSO, HWU and warehouse and storage yard space used in the joint operations includes the gross amount of the lease components. 



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



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



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



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



For the three months ended March 31, 2019, the components of the lease costs and the supplemental information were as follows:







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







The following table describes the future maturities of our operating lease liabilities at March 31, 2019:





Under the joint operating agreements, other joint owners are obligated to fund $27.7 million of the $40.5 million in future lease liabilities.

Abandonment funding

As part of securing the first of two five-year extensions to the Etame PSC to which we are entitled from the government of Gabon, we agreed to a cash funding arrangement for the eventual abandonment of all offshore wells, platforms and facilities on the Etame Marin block. The agreement was finalized in the first quarter of 2014 (effective as of 2011) providing for annual funding over a period of ten years in amounts equal to 12.14% of the total abandonment estimate for the first seven years and 5.0% per year for the last three years of the production license. The amounts paid will be reimbursed through the cost account and are non-refundable. The abandonment estimate used for this purpose is approximately $61.8 million ($19.2 million net to VAALCO) on an undiscounted basis. Through March 31, 2019,  $36.7 million ($11.4 million net to VAALCO) on an undiscounted basis has been funded. This cash funding is reflected under “Other noncurrent assets” as “Abandonment funding” on our condensed consolidated balance sheets. Future changes to the anticipated abandonment cost estimate could change our asset retirement obligation and the amount of future abandonment funding payments.   

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

FPSO charter 

In connection with the charter of the FPSO, we, as operator of the Etame Marin block, guaranteed all of the charter payments under the charter through its contract term, which expires in September 2022. At our election, the charter may be extended for two one-year periods beyond September 2020. We obtained guarantees from each of our joint venture owners for their respective shares of the payments. Our net share of the charter payment is 31.1%, or approximately $9.7 million per year. Although we believe the need for performance under the charter guarantee is remote, we recorded a liability of $0.3 million as of March 31, 2019 and December 31, 2018 representing the guarantee’s estimated fair value. The guarantee of the offshore Gabon FPSO charter has $53.9 million in remaining gross minimum obligations as of December 31, 2018.

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



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

Other lease obligations

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

We incurred rent expense of $0.4 million during the three months ended March 31, 2018. 

Regulatory and Joint Interest Audits

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

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

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

Drilling Rig

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