8. COMMITMENTS AND CONTINGENCIES

Litigation – On December 7, 2015, Plaintiff Vladimir Gusinsky Living Trust filed a stockholder class action lawsuit in the Court of Chancery of the State of Delaware (the “Court”) against the Company and all of its directors alleging that certain provisions of the Company’s Restated Charter and Second Amended and Restated Bylaws that restricted the removal of its directors to removal for cause only (the “director removal provisions”) were invalid as a matter of Delaware law. Plaintiff George Shapiro also filed a similar stockholder class action lawsuit in the Court on December 7, 2015. Thereafter, the plaintiffs agreed to the consolidation of their cases (the “Consolidated Case”).

After a hearing on the Consolidated Case on December 21, 2015, Vice Chancellor Laster issued an opinion in In re VAALCO Energy, Inc. Stockholder Litigation, Consol. C.A. No. 11775-VCL holding that, in the absence of a classified board or cumulative voting, the director removal provisions conflicted with Section 141(k) of the Delaware General Corporation Law and are therefore invalid. No appeal to the ruling has been made.

However, the plaintiffs still maintain a pending request in the Court to recover their attorneys’ fees and costs associated with the Consolidated Case (the “Fee Request”). The Fee Request is still in its early stages as a schedule for briefing potential fees and costs associated with this ruling in the Court has not yet been set. Since no settlement agreement has been made nor briefs filed with the Court on the matter, we cannot express any further opinion as to the specific range of potential loss related to the Fee Request. That notwithstanding, the Company expects to recover from its insurer of legal liabilities involving the Company’s directors and officers an amount that exceeds the expected liability in connection with the Fee Request. We have accrued $550,000 in expense related to our expected settlement of this litigation. No amounts have been accrued for expected recoveries from our insurer.

FPSO charter – In connection with the charter of the FPSO, we, as operator of the Etame Marin block, guaranteed the full charter payments through contract term, which goes until September 2020. The charter will continue for two years beyond that period unless a year’s prior notice is given to the owner of the FPSO. We obtained several guarantees from our partners for their shares of the charter payment. Our net share of the charter payment is 28.1%. Although, we believe the need for performance under the charter guarantee is remote, we have recorded a liability of $1.0 million and $1.0 million at December 31, 2015 and 2014 representing the guarantee’s fair value.

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

The charter payment, including a $0.93 per barrel ($0.25 per barrel in 2013) 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, was $10.9 million, $11.8 million and $10.4 million for the years ended December 31, 2015, 2014 and 2013.

Other lease obligations – In addition to the FPSO, we have operating lease obligations, including drilling rig commitments, as follows: 

We incurred rent expense of $4.7 million, $4.0 million and $4.1 million under operating leases for 2015, 2014 and 2013.

Rig commitment – Not included in the lease obligations for 2016 above are the remaining costs for the Constellation II drilling rig that has been under a long-term contract for the multi-well development drilling campaign offshore Gabon. The campaign included drilling of several development wells and workovers of existing wells in the Etame Marin block. The rig commenced drilling activities in October 2014 and continues under a contract until July 2016, at a day rate of approximately $172,000 on a gross basis. As of December 31, 2015, the remaining rig commitment was $32.2 million ($9.8 million net to VAALCO). In 2016, we released the Constellation II rig and no longer intend to drill any wells in 2016 on our Etame Marin block offshore Gabon. We are currently in negotiations with the rig operator to settle the remaining amount due. A liability will be recognized in the first quarter of 2016 for costs associated with day rate incurred after the rig is returned through the end of the contract expiration.  These costs will be reported as expense in the first quarter of 2016.

Gabon domestic market obligation – Under the terms of the Etame PSC, the consortium is required to provide to the local government refinery a volume of crude at a 25% discount to market price (the “Gabon DMO”). 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 2015, we paid $2.3 million for our share of the 2014 obligation. In 2014, we paid $3.3 million for our share of the 2013 obligation. In 2013, we paid $3.0 million for its share of the 2012 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, 2015, for our share of the 2015 obligation is $1.8 million. These 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 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 $61.1 million ($17.3 million net to VAALCO) on an undiscounted basis. Through December 31, 2015, $18.3 million ($5.1 million net to VAALCO) on an undiscounted basis has been funded. The obligation for abandonment of the Gabon offshore facilities is included in the Asset retirement obligation shown on our consolidated balance sheet. This cash funding is reflected under other long term assets as Abandonment funding on our consolidated balance sheet.

Open audits – In October 2014, we received a provisional audit report related to the Etame Marin block operations from the Gabon Taxation Department as part of a special industry-wide audit of business practices and financial transactions in the Republic of Gabon In November 2014, we responded to the Gabon Taxation Department requesting joint meetings to advance the resolution of this matter and later provided a formal reply to the provisional audit report in February 2015. A tentative agreement was reached with the Gabon Taxation Department in April 2015, and we are working with the Gabon Taxation Department to finalize the audit. During 2015, we accrued an estimated settlement of $0.3 million based upon preliminary negotiations. The ultimate outcome of the claim and impact cannot be predicted, and an adverse result of the audit could result in a material liability and adversely affect our financial condition.

Angola – In November 2006, we signed a production sharing contract for Block 5 offshore Angola. The four year primary term with an optional three year extension awarded us exploration rights to 1.4 million acres offshore central Angola. Our working interest is 40%. Additionally, we are required to carry the Angolan national oil company, Sonangol P&P, for 10% of the work program. During the first four years of the contract we were required to acquire and process 1,000 square kilometers of 3-D seismic data, drill two exploration wells and expend a minimum of $29.5 million ($14.8 million net to the VAALCO). We fulfilled the seismic obligation by 2008.

The government assigned working interest partner was delinquent paying their share of the costs several times in 2009 and consequently was placed in a default position. By a governmental decree dated December 1, 2010, the delinquent partner was removed from the production sharing contract, and a one year time extension was granted for drilling the two exploration commitment wells. Additional extensions were subsequently granted by the Angolan government until November 30, 2014 to drill the two exploration commitment wells.

In the fourth quarter of 2013 we received a written confirmation from The Ministry of Petroleum of Angola that the available 40% working interest in Block 5, offshore Angola, was assigned to Sonangol E.P., the National Concessionaire. The Ministry of Petroleum also confirmed that Sonangol E.P. would assign the aforementioned participating interest to its exploration and production affiliate, Sonangol P&P. The assignment was made effective on January 1, 2014. Sonangol EP and Sonangol P&P agree that the unpaid amounts from the defaulted partner plus the amounts incurred on the partner’s behalf during the period prior to assignment of the working interest to Sonangol P&P are the responsibility of Sonangol P&P. We invoiced Sonangol P&P for these amounts totaling $7.6 million plus interest in April 2014. Due to the uncertainty of collection, we recorded a full allowance totaling $7.6 million during 2011 through 2013 for the amount owed. Because this amount continued to be owed and due to slow payment history of the monthly cash call invoices since their assignment date of January 1, 2014, we placed Sonangol P&P in default in the first quarter of 2015. Sonangol E.P. acknowledged the legitimacy of the amounts owed and pledged to work to bring the Sonangol P&P account to a current status.

On March 14, 2016, we received $19.0 million from Sonangol P&P as payment for the full amounts owed as of December 31, 2015, which included: (i) $8.1 million of partner receivables reported at December 31, 2015 (representing 2015 activity), (ii) the $7.6 million of unpaid costs assumed by Sonangol P&P when they were assigned the participating interest in January 2014, and (iii) $3.2 million of interest as a result of being in default which we have not previously recognized in our financial results. As of December 31, 2015, we had $8.1 million reflected in Accounts with partners, net of an allowance of $7.6 million. As a result of this payment received subsequent to December 31, 2015, net income (loss) for the first quarter of 2016 will reflect the benefit for the reversal of the $7.6 million allowance and the recognition of the $3.2 million of default interest.

Although Sonangol P&P’s payment in March 2016 resolves the long outstanding amounts owed, there continues to be uncertainty about the future exploration of Block 5. To date, we have not been successful in farming-down our interest in Block 5 and our current liquidity is preventing us from pursuing the project without a partner. Due to the above circumstances regarding our intent and ability to pursue further exploration activities in Angola, we are recording a full impairment totaling $8.2 million of our undeveloped leasehold, the offset being a charge to exploration expense in the fourth quarter of 2015, and writing off the $1.9 million in materials inventory to Other operating income (loss), net.

In October 2014, we entered into the Subsequent Exploration Phase (“SEP”), together with our working interest partner, Sonangol P&P. The SEP extends the exploration period for an additional three year period such that the new expiry date for exploration activities is November 30, 2017. The SEP requires us and our partner to acquire 3D seismic and to drill two additional exploration wells. The seismic related commitment was completed in 2013. The two-well commitment under the primary exploration period carried over to the SEP period. In the first quarter of 2015, we drilled an unsuccessful exploratory well on the Kindele prospect, a post-salt objective, meeting one of the well commitments.

A  $10.0 million dollar assessment ($5.0 million dollars net to VAALCO) applied to each of the three remaining commitment exploration wells for which drilling has not commenced before November 30, 2017. Due to the current outlook for oil prices and the uncertainties about the timing for our partner to pay its share of future costs, there may be delays in drilling the remaining three wells. We have continued to classify $15.0 million commitment for drilling these wells as long term restricted cash on our balance sheet. We believe that it is not probable that we will incur any liability related to not meeting the commitment deadline to drill the three remaining wells as stated in the production sharing agreement with the Angolan government as the government has caused multiple delays in the Company obtaining a partner to participate in the future well commitments. We will seek to extend the term of the exploration license and hence the well  commitment deadline in the coming months.

Employment agreements – Our Chief Executive Officer and certain other officers have employment agreements which provide for payments of annual salary, incentive compensation and certain other benefits if their employment is terminated without cause.  We have also entered into change of control agreements with certain officers providing for additional payments in the event that their employment is terminated without cause just for a specified period after a change of control of the Company.