12. COMMITMENTS AND CONTINGENCIES

FPSO charter 

In connection with the charter of the FPSO (the “FPSO charter”), we, as operator of the Etame Marin block, guaranteed all of the lease payments under the FPSO charter through its contract term, which expires in September 2022. At our election, the FPSO charter may be terminated as early as September 2020. We obtained guarantees from each of our joint 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 and $0.5 million as of December 31, 2018 and 2017, respectively, representing the guarantee’s estimated fair value. The guarantee of the offshore Gabon FPSO lease 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:

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, $12.8 million and $11.2 million for the years ended December 31, 2018,  2017 and 2016, respectively.

Other lease obligations

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

We incurred rent expense of $1.3 million, $2.4 million and $4.5 million under operating leases for the years ended December 31, 2018,  2017 and 2016.

Drilling and other commitments

In connection with the PSC Extension, the Etame Marin block joint owners are required to drill two wells and two appraisal well bores by September 16, 2020.  The estimated cost for these wells is approximately $61.2 million ($20.5 million, net to VAALCO). In addition to the drilling commitment, the Etame Marin block joint owners are required to pay $5.0 million ($1.7 million, net to VAALCO) in cash to the government of Gabon following the end of the drilling activities for the two wells.  As the payment is not contingent on the success of these wells and at least $5.0 million would be paid if no wells are drilled, we have accrued a liability for our net $1.7 million share as of December 31, 2018.  The joint owners are also obligated to perform two technical studies estimated to cost $1.3 million ($0.4 million, net to VAALCO).  The costs related to these studies will be recognized in future periods when the studies are performed.

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 released the drilling rig in February 2016, prior to the original July 2016 contract termination date, and 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. The expense related to the termination 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 2018, we paid $1.1 million for our share of the 2017 obligation.  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.  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, 2018, for our share of the 2018 obligation was $1.2 million. The amount accrued at December 31, 2017, for our share of the 2017 obligation was $1.3 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, 2018, for our share of the 2018 obligation was $1.9 million. The amount accrued at December 31, 2017, for our share of the 2017 obligation was $1.4 million. 75% of PID and PIH costs are cost recoverable under the terms of the Etame PSC.

Abandonment funding

Under the terms of the Etame PSC, we have a cash funding arrangement for the eventual abandonment of all offshore wells, platforms and facilities on the Etame Marin block. As a result of the PSC Extension, annual funding payments are spread over the periods from 2018 through 2028.  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 December 31, 2018,  $37.4 million ($11.6 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 working with the currently 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, 2018, 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.  This matter was fully resolved in January 2019 for $1.3 million, net to VAALCO. 

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.