VAALCO Energy, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing is an annual report, not a standalone fourth-quarter filing; it also presents unaudited quarterly figures. VAALCO is an independent oil company whose producing operations and substantially all revenue are concentrated in the Etame Marin block offshore Gabon. Equatorial Guinea is an undeveloped interest; Angola is reported as discontinued operations.
Financial and operating results
| Metric | 2018 | 2017 |
|---|---|---|
| Revenue | $104.9 million | $77.0 million |
| Operating income | $51.3 million | $20.0 million |
| Net income | $98.2 million | $9.7 million |
| Net cash from operating activities | $37.2 million | $9.0 million |
| Cash and cash equivalents at year-end | $33.4 million | $19.7 million |
| Debt at year-end | None | $9.0 million |
- Revenue rose 36%, principally because the average realized oil price increased to $70.32 per barrel from $52.58. Net Gabon production declined to 1.369 million barrels from 1.518 million; sales volumes rose slightly to 1.442 million barrels, partly reflecting lifting timing.
- Production expense was $40.4 million, compared with $39.7 million. Production expense averaged $28.03 per BOE, versus $27.90.
- 2018 net income included a $56.9 million deferred tax benefit, largely associated with recognizing tax assets after the Etame PSC extension. The company also recorded a $13.7 million current tax provision. Net income therefore substantially exceeded operating earnings and should not be treated as a measure of recurring cash generation.
- Continuing operating cash flow was $38.2 million. Investing cash use was $14.1 million, mainly for the PSC extension signing bonus and equipment; financing cash use was $8.7 million, including repayment of the remaining loan. Unrestricted cash was $33.4 million; restricted cash and abandonment funding are separate balances.
- Year-end current assets were $58.8 million and current liabilities were $41.0 million. Total assets were $166.3 million, total liabilities $56.5 million, and shareholders’ equity $109.8 million.
- Fourth quarter: Revenue was $27.6 million, operating income $15.2 million, and net income $10.4 million. These are unaudited quarterly figures; the filing does not provide a standalone fourth-quarter cash-flow statement.
Material changes and business developments
- The Etame PSC was extended through September 2028, with two additional five-year extension options. The extension raises the cost-recovery percentage from 70% to 80% through September 2028 and expands the area available for exploration and development.
- Proved reserves increased 76% to 5.37 million barrels at year-end, all in Gabon. Additions included 2.235 million barrels associated with the PSC extension and upward revisions from reservoir performance and higher SEC pricing. The 2018 reserve replacement ratio was 270%; the standardized measure of discounted future net cash flows was $80.1 million and is not presented as market value.
- VAALCO prepaid its IFC term loan in May 2018 without a prepayment penalty and ended the year debt-free.
- Gabon’s share of Profit Oil was taken in-kind for the first time in 2018, with a lifting in September. The company cautions this may affect the timing of sales and realized prices.
- Equatorial Guinea lifted the suspension on Block P in September 2018. VAALCO was awaiting approval as technical operator and approval of a new joint owner; required steps include an exploration well within one year after the joint owner is approved.
Outlook, risks, contingencies, and unusual items
- Management planned an Etame drilling campaign in the second half of 2019, including two wells and two appraisal well bores, with a possible third well. The net estimated cost of the required wells was $20.5 million; the consortium must complete its drilling commitment by September 16, 2020. VAALCO expected 2019 capital spending to be funded by cash on hand, operations, and potentially debt or equity, and said available cash and expected operating cash flow were adequate through March 31, 2020 at then-current prices.
- Four Etame wells were shut in for high hydrogen sulfide levels; no proved reserves were booked for them. Reopening could require processing facilities, recompletions, and additional drilling. The consortium planned to reassess facility economics in 2019.
- All proved reserves and substantially all production were tied to one Gabon block. Oil-price volatility, offshore operating hazards, production declines, country and currency risks, joint-owner funding, and dependence on oil liftings and infrastructure are significant exposures. One purchaser, Glencore, accounted for approximately 100% of customer revenue in 2018; Mercuria was contracted for sales from February 2019 through January 2020.
- The November 2018 abandonment study estimated gross undiscounted costs of $61.8 million ($19.2 million net to VAALCO); $37.4 million gross ($11.6 million net) had been funded. In February 2019, regulators required the bank holding the abandonment funds to transfer them for conversion from U.S. dollars to local currency, creating currency and fund-access risks.
- VAALCO had a $15.0 million accrual for potential Angola drilling-obligation payments and said it was negotiating with Sonangol, expecting the ultimate amount to be lower but giving no assurance. Failure to meet Block P conditions could result in loss of the license and impairment of $10.0 million of capitalized costs. The filing also reports $1.3 million accrued for Gabon audit matters, resolved in January 2019 for that amount.
- Oil swaps covered approximately 172,000 barrels through June 2019 at a $74-per-barrel benchmark; their year-end fair value was a $3.5 million asset. The swaps limit some downside exposure but also limit gains if prices rise.
- Restatement and controls: The 10-K restates the September 30, 2018 balance sheet to correct an $18.6 million deferred-tax/property accounting error. The adjustment changed long-term asset classifications but not total assets or working capital; the prior 10-Q was not amended, and the 10-K supersedes its figures. Management identified a material weakness in controls over income-tax effects of significant, unusual transactions; disclosure controls and internal control over financial reporting were deemed ineffective at year-end. The auditor gave an adverse opinion on internal control, but an unqualified opinion on the consolidated financial statements. Management planned remediation during 2019.
Most important facts for investors to verify
- How much of 2018’s reported earnings reflects the noncash deferred tax benefit, and what recurring cash earnings support future investment?
- Whether the 2019 Etame wells and appraisal bores were completed on schedule and within budget, and whether they deliver the planned production and reserve results.
- Whether shut-in H2S-affected wells can be economically returned to production, and the cost and timing of any required facilities.
- The final resolution of the Angola obligation, Gabon audit matters, and the currency treatment and accessibility of abandonment funds.
- Whether the income-tax control weakness was remediated and tested effectively, and whether the September 2018 restated figures are consistently reflected in company reporting.