9. COMMITMENTS AND CONTINGENCIES

Litigation

Butcher settlement

On October 3, 2016, the Court approved a Stipulation and Order of Dismissal entered into by the parties in a stockholder class action lawsuit against the Company and all of its directors alleging that a previously terminated shareholder rights agreement, no longer in effect, and certain provisions of the former Chief Executive Officer’s and former Chief Financial Officer’s employment agreements securing change-in-control severance benefits were invalid under Delaware law, case number C.A. No. 12277-VCL, filed on April 29, 2016, in the Court. After the Company and its directors moved to dismiss the lawsuit, the Plaintiff Daniel Butcher agreed to dismiss the lawsuit as moot, and the Company agreed to settle Plaintiff’s application for an award of attorneys’ fees, all of which were covered by our directors and officers insurance as a covered claim.

McDonough litigation

On December 7, 2016, a lawsuit was filed against the Company alleging that a former worker on the Company’s oil and gas platforms off the coast of Gabon was terminated because of his age in violation of the Age Discrimination in Employment Act and the Texas Commission on Human Rights Act. The Plaintiff sought damages for lost wages and benefits as well as attorneys’ fees. The case was pending in the U.S. District Court for the Southern District of Texas styled as McDonough v. VAALCO Energy, Inc., No. 4:17-cv-00361. In a February 2017 demand letter, the plaintiff made a demand for $361,000 to settle this claim. On June 22, 2017, the court entered a final order of dismissal, pursuant to the plaintiff’s motion for voluntary dismissal, and entered final judgment in favor of the Company. This matter is now resolved, and had no material effect on our financial condition, results of operations or liquidity.

FPSO charter 

In connection with the charter of the FPSO, we, as operator of the Etame Marin block, guaranteed all of the lease payments under the charter through its contract term, which expires in September 2020. At our election, the charter may be extended for two one-year periods beyond September 2020. We obtained guarantees from each of our partners 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 $0.5 million and $0.7 million as of December 31, 2017 and December 31, 2016, respectively, representing the guarantee’s estimated fair value. The guarantee of the offshore Gabon FPSO lease has $85.2 million in remaining gross minimum obligations as of December 31, 2017.

Estimated future minimum obligations through the end of the FPSO charter are as follows:

The 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 $12.8 million, $11.2 million and $10.9 million for the years ended December 31, 2017,  2016 and 2015, respectively.

Other lease obligations

In addition to the FPSO, we have operating lease obligations, as follows: 

We incurred rent expense of $2.4 million,  $4.5 million and $4.3 million under operating leases for the years ended December 31, 2017,  2016 and 2015.

Rig commitment

In 2014, we entered into a long-term contract for the Constellation II drilling rig that was under a long-term contract for the multi-well development drilling campaign offshore Gabon. The campaign included the drilling of development wells and workovers of existing wells in the Etame Marin block. We began demobilization in January 2016 and released the drilling rig in February 2016, prior to the original July 2016 contract termination date, because we no longer intended to drill any wells in 2016 on our Etame Marin block offshore Gabon. In June 2016, we reached an agreement with the drilling contractor for us to pay $5.1 million net to VAALCO’s interest for unused rig days under the contract. We paid this amount, plus the demobilization charges, in seven equal monthly installments, which began in July 2016 and ended in January 2017. The related expense was reported in the “Other operating expense” line item in our consolidated statement of operations for the year ended December 31, 2016.

Gabon domestic market obligation and other investment obligations

Under the terms of the Etame PSC, effective in April 2016, the consortium is required to provide to the local government refinery a volume of crude at a 15% discount to market price (the “Gabon DMO”). Prior to April 2016, the discount was 25%. The volume required to be furnished is the amount of the Etame Marin block production divided by total Gabon production times the volume of oil refined by the refinery per year. In 2017, we paid $1.2 million for our share of the 2016 obligation.  In 2016, we paid $1.7 million for our share of the 2015 obligation. In 2015, we paid $2.3 million for our share of the 2014 obligation.  We accrue an amount for the Gabon DMO based on management’s best estimate of the volume of crude required, because the refinery does not publish throughput figures. The amount accrued at December 31, 2017, for our share of the 2017 obligation was $1.3 million. The amount accrued at December 31, 2016, for our share of the 2016 obligation was $1.1 million. These costs are cost recoverable under the terms of the Etame PSC. Also, beginning in April 2016, the consortium is required to pay an additional 1% of revenues for provisions for diversified investments (“PID”) and for investments in hydrocarbons (“PIH”). The amount accrued at December 31, 2017, for our share of the 2017 obligation was $1.4 million. The amount accrued at December 31, 2016, for our share of the 2016 obligation was $0.4 million. 75% of PID and PIH costs are cost recoverable under the terms of the Etame PSC.

Abandonment funding

As part of securing the first of two five-year extensions to the Etame field production license 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 2011) providing for annual funding over a period of ten years at 12.14% of the total abandonment estimate for the first seven years, with annual payments for the remaining unfunded estimated costs spread over 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 $61.1 million ($19.0 million net to VAALCO) on an undiscounted basis. Through December 31, 2017,  $34.8 million ($10.8 million net to VAALCO) on an undiscounted basis has been funded. This cash funding is reflected under “Other noncurrent assets” in the “Abandonment funding” line item of our consolidated balance sheet. Future changes to the anticipated abandonment cost estimate could change our asset retirement obligation and the amount of future abandonment funding payments.

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.

As of December 31, 2016, we had accrued $1.0 million net to VAALCO in the “Accrued liabilities and other” line item of our consolidated balance sheet for certain payroll taxes in Gabon which were not paid pertaining to labor provided to us over a number of years by a third-party contractor. While the payroll taxes were for individuals who were not our employees, we could be deemed liable for these expenses as the end user of the services provided. These liabilities were substantially resolved at the accrued amount in January 2017.

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.

In 2017, the government of Gabon conducted a tax audit of our Gabon subsidiary covering the years 2013 through 2016, and in December 2017, we received a report on their findings.  We have evaluated the results of this audit, and have made an accrual of $0.5 million, net to VAALCO, for the estimated additional taxes along with penalties in the “Accrued liabilities and other” line item of our consolidated balance sheet.

At December 31, 2017, we had accrued $1.3 million net to VAALCO in the “Accrued liabilities and other” line item of our consolidated balance sheet for potential fees which may result from a customs audit. 

Employment agreements

Our Chief Executive Officer and Chief Financial Officer have employment agreements which provide for payments of annual salary, incentive compensation and certain other benefits if their employment is terminated without cause.