Vaalco Energy Inc /De/ Q4 FY2020 Earnings Call

Good day. And welcome to the VAALCO Energy Fourth Quarter and Full Year 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note today’s event is being recorded. I would now like to turn the conference over to Al Petrie, Investor Relations Coordinator. Please go ahead, sir.

Thank you, Rocco. Good morning, everyone. And welcome to VAALCO Energy’s fourth quarter and full year 2020 conference call. After I cover the forward-looking statements, Cary Bounds, our Chief Executive Officer will review key highlights along with operational results. Liz Prochnow, our Chief Financial Officer, will then provide a more in-depth financial review. Cary will then return for more closing comments before we take your questions. During our Q&A session, we ask that you limit your questions to one and a follow-up. You can always re-enter the queue with additional questions. I’d like to point out that we posted an investor deck this morning on our website that has additional financial analysis, comparisons, and guidance that should be helpful. With that, let me proceed with our forward-looking statement comments. During the course of this conference call, the company will be making forward-looking statements. Investors are cautioned that forward-looking statements are not guarantees of future performance and those actual results or developments may differ materially from those projected in the forward-looking statements. VAALCO disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise. Accordingly, you should not place undue reliance on forward-looking statements. These and other risks are described in yesterday’s press release, the presentation posted this morning on our website and in the reports we filed with the SEC, including the Form 10-K that was filed yesterday. Please note this conference call is being recorded. Let me turn the call over to Cary.

Thank you, Al. Good morning, everyone. And welcome to our fourth quarter and year-end 2020 earnings conference call. Before I discuss our results, I would like to reflect on a number of significant accomplishments we have achieved, all of which are building blocks towards long-term growth. In 2018, we negotiated a license extension of up to 20 years in Gabon that provided VAALCO the runway to maximize value by growing reserves and increasing production from our world-class Etame assets. Also in 2018, we paid off all our outstanding debt and began to rebuild our cash position. In 2019, we initiated trading on the London Stock Exchange, which complements our listing on the New York Stock Exchange by providing us the opportunity to diversify our shareholder base, attract additional research coverage, and provide VAALCO with access to additional sources of capital to help fund our growth objectives. Just as critical, in September of 2019, we kicked off our 2019-2020 drilling campaign. That campaign had three successful development wells and two successful appraisal wellbores. Comparing our full year 2020 production of 4,853 net barrels of oil per day with our 2019 average of 3,476 net barrels of oil per day, we increased production by 40% year-over-year as a result of our drilling success. In 2020, we saw oil prices adversely impacted by the global COVID-19 pandemic as well as supply and demand imbalances. We had hedges in place that provided us good protection when oil prices fell, and we were able to continue to generate meaningful free cash flow from our higher production volumes in 2020. Maintaining our strong balance sheet and financial flexibility gave us the ability to capture value through a very accretive acquisition opportunity that arose in 2020. We were able to overcome the challenges in 2020 and close the acquisition of Sasol’s Etame interest in February 2021 with cash on hand. With the additional production that transaction brings us along with the strong recovery in oil pricing, we’re projecting continued meaningful free cash flow generation going forward. This has provided us with the confidence to announce our next drilling campaign, which is expected to start in late 2021. We are planning to drill up to four wells that could add an additional 7,000 to 8,000 gross barrels of oil per day when the drilling program is completed in 2022. With our higher working interest in Etame, this could be an additional 3,500 to 4,100 net barrels of oil per day to VAALCO. This is truly an exciting time for VAALCO, and we believe that we have a very bright future ahead of us as we are well on our way to achieving our long-term goals. Before I get into our operational results, I would like to review some of the key highlights of the Sasol acquisition. In November of 2020, we agreed to purchase Sasol’s 27.8% working interest in Etame for $44 million, with the final cash settlement amount to be reduced by net cash flows generated from the effective date of July 1 through the closing date. As part of the agreement, we made a $4.3 million cash deposit in November and agreed to a contingent payment of $5 million if Brent oil prices averaged greater than $60 per barrel for 90 consecutive days. We closed the acquisition on February 25th of this year; taking into account the $4.3 million deposit and the cash flow that was generated between July 1, 2020 and the date of closing, we paid $29.6 million at closing all with cash on hand. We believe the deal is very accretive to VAALCO as it is improving our margins, increasing production, and the price we paid for net barrel of oil was about $4.91 for 2P CPR reserves. Since we already operate the asset, we expect minimal increase in G&A expense, there is no integration needed, and we will immediately benefit from the acquisition. Turning to operational results, in the fourth quarter of 2020, we produced an average of 4,662 net barrels of oil per day, which was an increase of 27% over the fourth quarter of 2019, driven by our strong well results from the recent drilling campaign. For the full year, production averaged 4,853 net barrels of oil per day, an increase of 40% year-over-year. Looking ahead to 2021, I would like to spend a few minutes discussing the details of our 2021 production outlook, which includes additional volumes as a result of the Sasol acquisition. Our first quarter production will not include any Sasol volumes prior to the transaction closing date of February 25th. This means that first quarter production includes two months of VAALCO volumes and one month with VAALCO and Sasol volumes combined, which puts our first quarter 2021 guidance between 5,100 and 5,400 net barrels of oil per day. The midpoint of first quarter production guidance is a 13% increase over fourth quarter 2020 average production. Production guidance for the remainder of 2021 includes the full production impact of the Sasol acquisition. In the second quarter of 2021, our production is expected to average between 8,000 and 8,600 net barrels of oil per day. During the second half of 2021, we are planning our annual seven-day turnaround and we are not forecasting any material production uplift from the upcoming drilling campaign. Taking into account natural decline as well, we expect the second half of 2021 to average between 7,100 and 7,800 net barrels of oil per day. Taking all of this into consideration, we expect net production to be in the range of 6,800 to 7,400 net barrels of oil per day for the full year 2021. That is a year-over-year increase of 46% at the midpoint of 2021 guidance. The significant increase in 2021 production, coupled with the rising pricing environment should help generate solid EBITDAX and enable VAALCO to grow its cash position and fund our upcoming drilling campaign from cash on hand. In the fourth quarter, we reported adjusted EBITDAX of $3.5 million. Unfortunately, our fourth quarter results were adversely impacted by a delay in oil sales from late December into early January. As a result, our fourth quarter earnings and adjusted EBITDAX were lower, but sales volumes deferred to January were priced at January Brent pricing, which was higher than December. For the full year 2020, we generated $26.6 million in adjusted EBITDAX. Now I would like to discuss the progress of our 3D seismic acquisition and our plans for the next drilling campaign scheduled to start late this year. In 2020, we completed the acquisition of a new 3D seismic survey over the entire Etame block. We expect the seismic data to enhance subsurface imaging by merging our legacy data with the newly acquired seismic allowing for the first continuous 3D seismic over the entire block. The improved 3D seismic imaging will help us reduce risk and optimize future drilling locations. The success of our 2019-2020 drilling campaign has built a solid foundation for future drilling campaigns at Etame. In our prior quarterly calls, I have said that our vision is to repeat similar drilling programs and continue adding reserves and production over the next several years at Etame. With the Sasol acquisition closed, acquisition of a new 3D seismic over the Etame block complete, and improved oil pricing, we believe the time is right to start our next drilling campaign. We are planning to drill up to four wells starting in the fourth quarter of 2021 and finishing in 2022. We are currently expecting to drill two development wells and two appraisal wells. There are opportunities for sidetrack re-entries that will reduce drilling costs and access low-risk reserves and production. We also have appraisal locations that we believe can offer meaningful upside that is not currently reflected in our reserve report. The final well locations will be determined in conjunction with our processing of the new 3D seismic data we acquired. If the four well program is successful, the estimated increase in gross field production is 7,000 to 8,000 barrels of oil per day or 3,500 to 4,100 net barrels of oil per day to VAALCO when the drilling campaign is completed in 2022. The estimated cost of the program is between $115 million and $125 million gross or $73 million to $79 million net to VAALCO. The upcoming drilling campaign has the potential to generate significant free cash flow when the current prevailing oil prices are combined with our low-cost operating structure. Our strategy is to utilize the additional free cash flow to fund in organic transformative growth opportunities in the future. We will provide more details later as we process the seismic and finalize our well locations. Our net capital expenditures in 2020 were $20 million on a cash basis and $10.5 million on an accrual basis. Our 2020 capital expenditures were primarily related to the 2019-2020 drilling program at Etame. For the full year 2021, VAALCO estimates its net capital expenditures, excluding the 2021 drilling campaign and seismic to total $3 million to $6 million. The full-year capital expenditure estimates also exclude any potential costs related to FPSO life extension or FPSO replacement. While there will be upfront costs associated with either replacing or extending the life of the Nautipa FPSO, we believe we will be able to lower long-term costs. Next, I would like to spend a few minutes talking about our year-end reserves. Our year-end reserves were significantly impacted by pricing. Despite adding 1.6 million barrels as a result of positive performance revisions and the discovery at South East Etame, 4P reserves were slightly down year-over-year. The downward revisions were driven by 1.8 million barrels in production and the downward pricing revision of 1.6 million barrels. VAALCO proved SEC reserves at December 31, 2020 were 3.2 million barrels net. The PV-10 value of these proved SEC reserves at year end 2020 decreased to $14.7 million from $70.4 million at December 31, 2019. The 2020 SEC pricing of $42.46 was down 33% from 2019 SEC pricing of $63.60 per barrel, which drove the SEC proved PV-10 value down significantly. Our year-end 2022 2P CPR estimate of proven plus probable reserves remained virtually unchanged year-over-year at 10.4 million barrels to VAALCO’s working interest. The PV-10 of VAALCO’s 2P CPR reserves at year end 2020 was $84.4 million, assuming year-end 2020 escalated Brent pricing. Our year-end 2020 reserves were fully engineered by VAALCO’s third-party independent reserve consultant, Netherland, Sewell & Associates. They are very familiar with their assets and have provided annual independent estimates of VAALCO’s year-end reserves for over 15 years. Regarding the acquisition of Sasol’s interest at Etame, we estimate that approximately 2.7 million barrels of proved SEC net reserves and 7.9 million barrels of 2P CPR net reserves were acquired using year-end 2020 assumptions adjusted for production. Given the recent significant increase in Brent pricing and assuming that it continues through 2021, we believe that we can see a material increase in reserves not only due to the Sasol acquisition but to pricing as well. I would now like to give you a quick update on our activity in Equatorial Guinea. In the first quarter of 2020, VAALCO acquired additional working interest from Atlas Petroleum, thereby increasing our working interest from 31% to 43%. The cost for acquiring the additional Block P working interest is a future payment of $3.1 million that will only be made if there’s commercial production from Block P. In August, an amendment to our production sharing contract reflecting our updated participating interest and naming us as operator was executed by the Equatorial Guinea Ministry of Mines and Hydrocarbons. The Non-Binding Memorandum of Understanding with Levene to cover off or substantially all about those costs to drill an exploratory well on Block P has expired. We’re evaluating alternatives to fund the cost to drill an exploratory well targeting over 160 million gross barrels of resources at our South West Grande prospect. We are also evaluating scenarios to develop over 16 million gross barrels of contingent resources at our Venus discovery on Block P. We remain excited about EG and we are working to profitably exploit the resource potential. In summary, we have materially enhanced value at VAALCO over the past 12 months, with a highly successful drilling campaign, an accretive acquisition, new 3D seismic, and planning for another drilling campaign later this year. We remain committed to operational excellence while generating strong financial results. We have a strong balance sheet, and with our increased production base in a rising price environment, we should generate significant cash flow in 2021. This will provide flexibility for the future as we look to continue to grow profitably and meet our long-term growth goals. With that, I would like to turn the call over to Liz to share our financial results.

Thank you, Cary, and good morning, everyone. We reported a net loss of $3.6 million or $0.06 per diluted share in the fourth quarter of 2020, which included the impact of $3.6 million in exploration expense related to the Etame seismic program during the quarter and $2.2 million of expenses related to stock-based compensation. As Cary mentioned, the liftings scheduled for December 2020 were delayed to January 2021, which reduced sales volume by approximately 155,000 barrels and revenues by approximately $7.8 million, while increasing inventory costs in the fourth quarter of 2020. For comparison purposes, in the fourth quarter 2019, we reported net income of $1 million or $0.02 per diluted share, which included the impact from a non-cash charge of $3.1 million for unrealized mark-to-market losses related to our crude oil swaps, expenses for stock-based compensation of $0.7 million, and a $1.8 million tax benefit related to a decrease in the valuation allowance on deferred tax assets. For the third quarter of 2020, we reported net income of $7.6 million or $0.13 per diluted share, which included an income tax benefit of $2.8 million that reflected the impact of the decrease valuation allowances on deferred tax assets of $5.3 million. Our adjusted net loss in the fourth quarter of 2020 totaled $5.6 million or $0.10 per diluted share as compared to adjusted net income of $5.5 million or $0.09 per diluted share for the fourth quarter of 2019. The decrease in earnings between years is mainly due to the lower revenues as a result of lower oil prices, and lower sales to the delay in the lifting scheduled for 2020, coupled with the $3.6 million of seismic-related exploration expenses in the fourth quarter of 2020. In the third quarter of 2020, VAALCO reported $2.3 million in adjusted net income or $0.04 per diluted share. Adjusted EBITDAX was $3.5 million in the fourth quarter of 2020, compared to $10.4 million in the same period of 2019. In the third quarter of 2020, adjusted EBITDAX was $7 million. As with net loss and adjusted loss, adjusted EBITDAX was impacted by the lower revenue between the fourth quarter of 2019 and the fourth quarter of 2020; this was primarily a result of lower crude oil prices, whereas between the third quarter of 2020 and the fourth quarter of 2020 this was primarily a result of lower sales volumes resulting from the delay in the lifting scheduled for this past December. Production for the fourth quarter of 4,662 net barrels of oil per day increased 27% from 3,664 in the fourth quarter of 2019, due to the new wells that came online during 2020 from our successful 2019-2020 drilling program. Fourth quarter of 2020 production was up 6% from the third quarter of 2020, which was due to the planned full-field maintenance shutdown, as well as OPEC+ curtailment. Sales volumes in the fourth quarter of 2020 were down just 9% from the same period 2019, as the increase in sales from the new wells coming online in 2020 mitigated the impact of the delayed lifting. However, the impact of the delayed lifting was a 30% decrease in revenues between the third quarter and fourth quarter. While the delayed lifting reduced revenue for the fourth quarter of 2020, as Cary mentioned, pricing increased somewhat between December 2020 and January 2021, thereby increasing the amount ultimately realized from the lifting. Our crude oil price realization fell 36% to $4,207 per barrel in the fourth quarter of 2020 versus $6,580 per barrel in the same period in 2019, but was down just 4% compared to $4,363 per barrel in the third quarter of 2020. We didn’t have any derivative contracts in place in the fourth quarter of 2020. However, this past January, we did enter into new crude oil commodity swap agreements for a total of 709,262 barrels at a Dated Brent weighted average price of $53.10 per barrel for the period from and including February 2021 through January 2022. These swaps settled on a monthly basis. As Cary mentioned, we hedge a portion of our production volumes to protect cash flows, which will be used to fund our 2021-2022 drilling program. We took similar actions in 2019 before we began our 2019-2020 program. Those hedges were particularly beneficial for us in 2020 if crude oil prices fell, as we were wrapping up our drilling program. We will continue to assess our needs to mitigate price risk and protect cash flow in the future as we consider any additional derivative contracts. Turning to expenses, production expense excluding workovers for the fourth quarter of 2020 was $6.6 million or $2,266 per net barrel of oil sales, which is lower than the $9.8 million in the fourth quarter of 2019 and the $9.1 million in the third quarter of 2020, primarily due to the lower sales volumes in the fourth quarter of 2020 resulting from the delayed lifting. The per unit production expense, including workovers of $2,266 per barrel in the fourth quarter of 2020, decreased significantly as compared to the $30.70 per barrel in the fourth quarter of 2019, due to the higher overall production rate, and was in line with the per unit production expenses of $22.21 per barrel in the third quarter of 2020. Included in total production expense are COVID-19 related costs incurred to protect the health and safety of the company’s employees, which totaled approximately $0.4 million in the fourth quarter of 2020 and $1.6 million for the full year of 2020. For the full year 2021, we are estimating the guidance range for our production expense, excluding workovers, to be between $69 million and $77 million or $2,450 to $2,925 per barrel of oil sales on a net revenue basis. Production expense for the first quarter of 2021 is projected to be between $16.5 million and $18.5 million or $26 to $31 per barrel of oil sales. Keep in mind that all of the guidance we’re providing today includes the positive impacts from the additional volumes we acquired from Sasol effective on the day we closed February 25, 2021. So for the first quarter of 2021, we will include approximately two months of financial results without Sasol’s interest and one month with. Our production expense guidance excludes any potential future impacts from the COVID-19 pandemic not currently being experienced. DD&A for the fourth quarter of 2020 was $1.3 million or $4.37 per net barrel oil sales compared to $2.1 million or $6.64 per net barrel in the fourth quarter of 2019 and $2.2 million or $5.37 per barrel in the third quarter of 2020. DD&A was lower than both prior periods due to lower sales volumes in the fourth quarter of 2020 resulting from the delayed lifting. As part of the unit DD&A rate in the fourth quarter of 2020 was lower than the rate in the fourth quarter of 2019, due to the impairment charge taken in the first quarter of 2020, and lower than the rate in the third quarter of 2020 due to higher production volumes from fields with a smaller depletion base. General and administrative for the fourth quarter of 2020, excluding stock-based compensation expense, was $2.5 million, compared with $2.2 million in the same period of 2019 and $2.4 million in the third quarter of 2020. G&A expense was higher than in the same period of 2019 due to higher professional fees and legal costs, similar to G&A expense in the third quarter of 2020. The per-unit G&A rate in the fourth quarter of 2020 of $8.73 per barrel of oil sales was higher than both the fourth quarter of 2019 and third quarter of 2020, due to the lower sales volumes as a result of the delayed lifting. For the full year 2020, we are forecasting G&A to be between $10 million and $12 million, essentially unchanged from 2020 despite the large increase in production with Sasol acquisition. While our total G&A expense is materially different than 2021, our G&A per barrel in 2021 will be substantially less than about $4 per barrel at the midpoint of guidance, starting in Q2, compared with $6.57 per barrel in 2020. Stock-based compensation expense was $2.2 million during the three months ended December 31, 2020, primarily due to the increase in the SARs liability as a result of the increase in the company’s stock price during the quarter. For the fourth quarter of 2020, stock-based expense related to SARs was an expense of $1.9 million compared to an expense of $0.6 million in the fourth quarter of 2019. For the third quarter of 2020, a benefit of $0.6 million was recognized for stock-based compensation related to SARs due to the decrease in the stock price during that quarter. Turning now to taxes, income tax was a benefit for both the fourth and third quarters of 2020. For the three months ended December 31, 2020, income tax was a benefit of $0.8 million and included a deferred tax benefit of $2.8 million. For the three months ended September 30, 2020, income tax was a benefit of $2.8 million and included a $5.3 million deferred tax benefit related to decreases in the valuation allowances on U.S. and Gabonese deferred tax assets. Income tax expense for the fourth quarter of 2019 was $4.2 million, which included $1.8 million of deferred tax expense rather than a benefit. Foreign income taxes are attributable to Gabon and are settled by the government by taking their crude oil in-kind. As detailed on slide 28 in the presentation deck posted this morning on our website, we currently estimate that VAALCO’s operational breakeven price for 2020 is now approximately $32.25 per net barrel of oil sales, and our free cash flow breakeven price is approximately $38.75 per net barrel of oil sales. Keep in mind that our realized prices are benchmarked to crude oil prices. These breakeven prices increase over 2020 primarily as a result of low production rates reflecting natural decline. In addition, we have two workovers planned as compared to one in 2020. These estimates exclude the impact of our hedges. In general terms, we estimate that each $5 increase in realized oil price increases our annual adjusted EBITDAX by approximately $14 million. This clearly shows our strong leverage to higher oil prices. At year end 2020, we had an unrestricted cash balance of $47.9 million, which includes $1.4 million of net joint venture under advances. Working capital at December 31, 2020 was $11.4 million, compared with $16.6 million at September 30, 2020, while adjusted working capital at December 31, 2020 totaled $24.3 million, compared with $29.3 million at September 30, 2020. For the full year 2020, net capital expenditures totaled $20 million on a cash basis and $10.5 million on an accrual basis. Our capital expenditures primarily related to the 2019-2020 drilling program at Etame. It has been the case since the second quarter of 2018 that we are carrying net debt. With that, I’ll turn the call back over to Cary.

Thanks, Liz. Over the past several years, we have weathered a difficult macro environment. During that time, we worked diligently to build a solid foundation for the future by strengthening VAALCO operationally and financially. This included eliminating debt, growing our production base, and consistently generating positive cash flow. As I looked at 2021 and beyond, I believe that this is a very exciting time for VAALCO. We are profitably growing VAALCO through accretive acquisitions and successful drilling campaigns at Etame. We are in an improving commodity price environment, which should meaningfully assist in our ability to generate significant free cash flow. The closing of the Sasol acquisition underscores our belief in Etame as a strong producing asset with significant upside. We’re also processing and interpreting our newly acquired 3D seismic and we’ll incorporate it with our 20-plus years of knowledge as operators at Etame. The new seismic will help us to optimize and derisk future drilling locations and potentially identify new ones. Now I know that I’ve told this story before, but I think it is worth reminding everyone of the VAALCO track record of success at Etame. When we first began producing Etame in 2002, our third-party reserve auditors estimated there were 30 million barrels of gross recoverable oil. Over the years, we have drilled and expanded Etame such that we have produced over 120 million gross barrels of oil thus far. Looking to the future, we believe that the field still has over 100 million gross barrels of resource potential. We’re planning to drill up to four wells in the upcoming drilling campaign that we expect to initiate in the fourth quarter of this year. We have a strong asset base at Etame that is generating meaningful free cash flow in the current pricing environment. Additionally, we continue to evaluate opportunities that are consistent with our inorganic growth strategy and we believe that we are well-positioned to deliver long-term growth in line with our strategic objectives. Before I close out the call, I would like to discuss our commitment to ESG. At VAALCO, we are committed to developing and producing oil resources in West Africa in a safe and environmentally responsible manner. Last year, we issued our inaugural Sustainability Report, which focused on our community involvement, governance practices, and environmental commitment. In 2020, we created an employee committee charged with the responsibility of monitoring adherence to our ESG standards and formally communicating findings on an ongoing basis to our Board. Also in 2020, our Board's Nominating and Corporate Governance Committee amended its charter to include the oversight of the company’s policies and programs on issues of social responsibility and environmental sustainability. Our Board has empowered our management team to create a working environment that assures our success as a trusted operator, a generous partner to the communities where we operate, and good stewards of the environment. Our 2020 ESG report will be released next month and posted to our website. It will include three years of key ESG Sustainability metrics developed specifically for our industry. We believe that VAALCO has a bright future, and we remain committed to sustainably developing our robust asset base. Thank you. And with that, Operator, we are ready to take questions.

Thank you. Today's first question comes from Stephane Foucaud with Auctus Advisories. Please go ahead.

Hi, everyone. I have two questions. The first is about the 2C contingent resources. I noticed that the economic extension increased from 13 million barrels to 18 million barrels. Given that these are relatively low-risk resources dependent on finalizing the contract, could you explain why this process has been delayed? My second question is straightforward. I noticed there has been an increase in payables, specifically regarding your accounts with joint venture partners, which I believe is $5 million. How will cash capital expenditures change in Q1? Will we need to add these $5 million payments on top of the $2 million to $3 million you’ve projected for CapEx in Q1? Thank you.

It's great to hear from you, Stephane. I’ll address your first question, and then I’ll let Liz take the second one. Regarding the contingent resources and the license extension beyond 2028, the change from 30 million barrels to 18 million barrels occurred because the initial figure was divided into contingent and prospective resources. We do have a management estimate of prospective resources that is not currently included in the table. The contingent resources you've seen for the extension are based on the assessments from Netherland, Sewell. As we analyze the seismic data and develop new interpretations of the subsurface, we will update our internal estimates and collaborate with Netherland, Sewell next year to reassess those volumes. These barrels are anticipated to be produced between 2028 and 2038, and in our assessment, they are considered prospective. We will reevaluate those reserves as we continue our seismic analysis. Now, regarding your second question.

Stephane, regarding your second question, the joint venture payables and receivables are primarily determined by their cash flow timing. We also have a sizable receivable at year-end. The net result of these two is a $1.4 million payable. These amounts tend to balance out over time. If we were flawless in managing our cash flows and if the drilling owners didn’t make early payments, that figure would be zero. However, that’s rarely the case, as it’s difficult to perfectly predict these figures. Ultimately, it trends toward zero over time. So, at year-end, the $1.4 million isn’t a significant impact on future cash flow.

Okay. Thank you.

Our next question today comes from Michael Sensilo with Enquira. Please go ahead.

Hi. Good morning. Thanks for taking my question. I have a couple of questions. One on costs and I’d like to focus on page 28 of your deck. Those cylinders and compare, I am not sure, if you have this available with page eight of your December deck, where the orange piece of the puzzle was $21.13 back in December and now it’s gone to $26. So just curious, I know you went over a bunch of numbers down on the cost side, and I couldn’t really kind of say for them, but I would love to know what the reason is for the $5 increase from your December numbers to the deck you put out today, which includes this one, I believe includes the Sasol acquisition?

Yes. That’s correct. So really what’s driving most of that increase is the lower production volumes. So about 90% of our OpEx is fixed, and so when the production volumes go down, the per barrel amount is going to go up and vice versa. And so we saw a really nice decline in 2020 due to the drilling program. Well, we had natural decline from the field, and so this year, because we aren’t doing another program and we won’t be bringing on new production until very late in the year, maybe in the following year, you don’t see the benefit. That per barrel amount is going to go up. Now, on an absolute basis, our production expense is expected to be comparable between the two years, and I think the midpoint of our guidance points you to that. What we tried to do, the other, I mean, part of this is challenging because you’ve got the mixture of a portion of the year being with and without Sasol. So what we did in the press releases, we gave the growth numbers between the two years and we discussed those. You’ll see that the midpoint of the guidance was to what the gross number was last year.

The decline rate is 15%, which means going from $21 to $26 is a significantly larger increase on a per barrel basis. Is there something else happening, such as cost inflation?

About $4 of the increase is the production rate, and there is a little bit of increase overall in production expense, but not a significant amount. The other thing that you need to take into consideration is the prices that we’re using here. So there is a bit of a change; at slightly higher oil prices, you can end up with slightly higher production expenses as well because there is 10% of it that is variable.

The other expenses have also increased, with taxes rising to $55 since December, along with general and administrative costs and workover expenses. Everything has gone up. Is there a reason for this?

If you’re discussing the tax on a per barrel basis, it will depend on our revenues. Generally speaking, the cash tax we pay is approximately 10% of our revenue. This is mainly because we can deduct 80% as cost recovery, leaving us with 20%, and about 50% of that is paid as tax. So, with an oil price of $65, you can expect a higher tax per barrel as the oil price increases. Additionally, our G&A costs have actually decreased on a per barrel basis compared to last year.

But the December deck showed $3.44 after the, like, you have pre and post, before Acquisition, after acquisition, and so $3.44 after the acquisition, and in today it’s $4, so that was a pretty significant percent increase in that slice of the pie?

Yeah. And that’s going to be more a function of the lower volumes in 2021.

Okay. Let me ask my next question, if I can. Where do you think the stack looks after your 2021-’22 drilling program, and where does your breakeven free cash flow go from and to?

We haven't provided guidance on that yet. However, I can share that during our last drilling program, we achieved an uplift of about 69 to minus 100 barrels a day gross. As Cary noted in his comments and is included in the press release, we anticipate an uplift of between 7,000 and 8,000 barrels a day gross from the next program once it is completed. This can give you an idea of what to expect for 2022 in terms of additional barrels. Clearly, this will have a notable impact compared to what we experienced in the 2019-2020 drilling program. While we haven't released guidance for 2022, this should provide some direction to help you understand the expected per barrel costs.

Okay. My final question is about calculating free cash flow throughout the year and comparing it to the VAALCO portion of the CapEx program and the drilling program for 2021-2022 that starts later this year. Do you have enough cash, considering cash on hand and cash being generated? Will you be okay, or do you plan on seeking a bank loan?

No. Based on current oil pricing, we expect to fund the next drilling campaign from cash on hand.

Okay. And the hedging will protect some of that as well, you’re saying?

Yes. And that is exactly why we put the hedging in place, correct.

Are you layering in more hedges as we speak kind of thing or are we going to…

Not as we speak. I’m sorry; I interrupted you. We’re not layering any new hedges. Not right now layering on any new hedges? Not right now. But we are always considering new hedges.

Okay. All right. Great. Thanks. I’ll leave the floor.

Thank you.

Thank you.

Our next question comes from Bill Dezellem with Tieton Capital. Please go ahead.

Hi. Thank you. A couple of questions. First of all, can you discuss the December lifting and why it was delayed to January? And then secondarily, because oil prices did go up in January versus December, how much was the benefit to you?

Sure. Hi, Bill. Thanks for the question. The delay in the lifting from December to January was due to a couple of reasons. First, it was related to the COVID-19 protocols we have in place. There was a concern just before the lifting began regarding a potentially infected person on the FPSO. Fortunately, it turned out to be a false positive. However, given our commitment to employee safety and health, we decided to pause the lifting until we were sure our employees were safe. That was the primary reason for the delay. Additionally, there were some operational issues, specifically a winch that was not functioning properly on a support vessel, which caused a delay of a few days. Overall, the main reason for moving from December to January was the COVID-19 protocols and our dedication to ensuring employee safety.

And the…

…benefit was $5 a barrel.

That's correct. If we had calculated the average price in December, it would have been about $50, which aligns with the $7.8 million and 155,000 barrels we mentioned. In January, the prices rose to around $55. Therefore, this translates to an estimated benefit of $700,000 to $800,000 for us.

Excellent. Congratulations, I guess, on not having the positive COVID and an extra $3.25 million in your pocket.

All right. Thank you, Bill.

Yeah.

And...

I apologize, Mr. Dezellem, please rejoin the queue. In the meantime, our next question today is from Charlie Sharp with Canaccord. Please go ahead.

Yes. Good morning. Thank you very much for a comprehensive update this morning. Really appreciate that. A couple of questions, if I may. One is I think exploring a little bit more an earlier question regarding the development program that you have coming up, the drilling program at the end of this year and into next year, perhaps asking the same question as the earlier question, but in a slightly different way. What oil price do you think you need, given the outlook for production and the cost structure you have at the moment to be able to finance fully that program? That’s one question. And then secondly, with the FPSO contract expiring late next year, should we be concerned about potential uplift in cost structure associated with a replacement or an extension of that? Thank you.

On the drilling campaign, with the current oil prices, we should be able to easily fund it with our available cash and the cash flows we will generate leading up to the program. Although we haven't provided a specific breakeven oil price, I'm satisfied with the current oil prices in terms of funding. As for the FPSO...

And on the FPSO, it's good to hear from you, Charlie. You are correct that our FPSO contract will expire next year in September. We are considering a couple of alternatives, either replacing the FPSO or extending the life of the existing Nautipa FPSO. Both options will require some upfront costs. If we choose to replace the FPSO, there will be installation costs involved. If we decide to keep more personnel on station, that will incur life extension costs. We are currently working through these cost estimates and have not made a decision yet. Once we determine which direction to take, we will disclose any upfront costs. While there will be some initial costs, we anticipate that long-term expenses will be lower regardless of the option we choose.

That’s great. Thank you.

Thank you.

And our next question today comes from Bill Dezellem with Tieton Capital. Please go ahead again, sir.

Thank you. Referring back to the drilling program, I want to confirm that we are interpreting your forecasted production for 2021 correctly. At the midpoint of your forecast and the midpoint of your projected production from the drilling program, is it accurate to say that this indicates an approximate 60% increase in production?

Yes, that's mechanically accurate. However, the production rate of 7,000 to 8,000 is expected at the end of the program. When examining 2022 on a full-year basis, it's important to note that you won't see that production level throughout the entire year; it will likely come late in the program. We didn't attempt to estimate production for 2022 since we anticipate starting the program in December 2021. However, various factors related to rig contracts and other decisions could impact the timeline. Consequently, providing an accurate full-year production estimate for 2022 is quite challenging at this time.

Understood. But mechanically that if the drilling program, if we were to just look at it in isolation relative to the 2021 production, it is that roughly 60% increase in the ‘22 production relative to ‘21 will simply be a function of the timing of when that program comes into play and natural decline rates?

Yes.

Exactly.

That’s very helpful. And just as a reminder for us, and I apologize for not knowing this off the top of my head, what was that equivalent mechanical calculation with your last drilling program? This seems larger to me and just really a big production benefit?

Yes. On slide 10 in the presentation, you can see that for 2019, we had a gross output of 12,800 barrels per day. The Atlas was 6,900, and we ended up with 1,800, which represents a decline. So, 1,800 is slightly under 15%. Overall, our average for the year was just below 18,000 barrels per day.

Great. Thank you. I had not seen that slide. So just again, I did the math quickly. This is the prior program with slightly less, meaning that this new program is slightly more in terms of that mechanical calculation.

Yeah.

Excellent. And so then the follow-on here, do you need to expand the capacity of the FPSO, whether it would be the one on site or a new one to accommodate this significant increase in production that is forthcoming?

We are currently exploring the design of a replacement vessel to maximize production capacity. There are also other options available. The production capacity of the FPSO is definitely being considered, along with the storage capacity. We want to ensure we have ample storage if production rates are high. So, all of these factors are being evaluated as part of the ongoing analysis.

Congratulations and thank you.

Okay. Thank you, Bill.

And our next question today comes from Garrett Finn with Susquehanna Capital. Please go ahead.

Hi, guys. Congratulations on the quarter, and again, on the deal, which looks like it was just an outstanding acquisition for you guys.

Thank you, Garrett.

One question I had is the 10-K states the cost recovery account; is it $51 million? Should we expect that to increase in conjunction with the closing of the Sasol deal?

All right. We would acquire Sasol's share of that. Now, this is subject to certain adjustments and things. So we don’t have the precise number. But there should be an increase, yes.

And should it be like in the ballpark of 80% or…

There’s a lot of factors that go into candidly. I mean, just limitations on depending on what you pay for it and the value at the time. I will keep it in mind that that’s an interest achievable so that when we make our disclosures in the first quarter we consider adding. It should go up, but I can’t comment on whether it’s going to be an 80% increase or not.

Understood. Okay. And for the FPSO in the 10-K it states that it could process approximately 25,000 to 30,000 barrels of fluids per day. Is the right way to think about it that the capacity for this vessel is 25,000 to 30,000 gross barrels of production per day?

Right. The way to think about it is, it’s the capacity is 25,000 barrels of oil per day, plus we could send through another 5,000 barrels of water per day. So it’s 25,000 barrels of oil per day or 30,000 barrels of a combination of oil and water. But keep in mind that we have processing capacity on all four of our platforms. We removed the majority of the water on our platforms. So the way to think about it is, there’s 25,000 barrels of oil per day production capacity on the FPSO.

Understood. Okay. And gross, the Etame has been running, I mean, in your slide, you have it kind of peeking out in the early part of 2020 at around 20,000 and then going up to maybe 22,000 and later in 2022. So it still seems like there is excess capacity on the vessel, which provides a lot of leverage for you guys to the extent that you can increase production and fill it or potentially if you feel like that’s not realistic, get a smaller vessel when the lease expires. Is that kind of how you’re thinking about it?

Well, the way we’re thinking about it is, you are right; we’ve managed over the past 20 years to drill and produce the field at 15,000 to 20,000 - between 15,000 and 25,000 barrels a day, trying to utilize the full capacity. Now going forward, like you mentioned, in September of next year, we will either replace or extend the Nautipa, and our ambition is to increase capacity next September. That’s our ambition, but it has to come at the right price, and so we have to look at, what is the cost of increasing the capacity versus the possibilities that we have to fill that capacity. So all of that is under consideration, but I would say we would lean towards increasing the capacity as of next.

Okay. And is this, I mean, it sounds like you said that you thought the total cost will decrease? Is there any reason to think the leases significantly above or below market or is it sort of reset to market rates with this recent extensions?

The overall market is not as active as it was 20 years ago when we installed the FPSO. I believe it was in 2012 when we amended the contract. We are considering some upfront costs, but in the current market, we see an opportunity to reduce costs in the long run.

Understood. And…

Looking at your slide regarding the deal, you paid $44 million in total, which includes a $4 million deposit. The agreed price required a cash payment of $30 million. In my assessment, this resulted in generating $10 million in cash over an eight-month period at a Brent price of $45.

Right.

And Brent, obviously, is a lot higher now. So that just seems like an incredible deal.

I think it's important to note that during that timeframe, we implemented the seismic program, and the $10 million was essentially a negotiation to acquire a quarter of that seismic work. If you exclude the seismic, and focus more clearly on ongoing operating costs, the number would have been higher.

Wow! Okay. All right. Well, I mean, that’s just a great deal and it’s a wonderful deal for shareholders. So we commend you guys. Thank you.

Thank you. We appreciate the feedback.

And our next question comes from Stephane Foucaud with Auctus Advisories. Please go ahead.

Yes. Hi again, guys. Two further questions for me. Can you say anything more on the plan for Block P? So the Memorandum of Understanding for this amount has expired, but that still remains a very interesting asset. Oil prices much higher, which probably means that even smaller resources are probably more commercial than they looked just six months ago. So how are you seeing the sequence of events for the Block and what are your thoughts? And secondly, another simple one, I was again looking at the aging program; is the $53 barrel fixed price or is that a floor? If you can please remind me? Thank you.

Thank you for your questions, Stephane. Regarding Block P, you are correct that the Memorandum of Understanding with Levene has expired. This agreement allowed Levene to cover the costs of an exploration well. We are still in discussions with Levene, but in light of the expired MoU, we have expanded conversations with other companies. We are pursuing multiple outcomes, including finding a partner to help fund an exploration well. This option remains a priority for us. Additionally, with the increase in oil prices, we are also evaluating the possibility of developing the Venus discovery on Block P independently. We are currently assessing both options and have not committed to either yet, as both are viable. My earlier comments indicated that the Venus discovery contains 16 million barrels of gross resources, and we are exploring cost-effective development alternatives in case we cannot secure a partner for funding. That summarizes the current status for Block P and our activities in Equatorial Guinea. If you could please repeat your second question, Stephane?

That was regarding the aging program. It’s a detailed question. Could you remind me if the $50-ish per barrel is a fixed price or if it’s just a floor that allows for potential benefits from higher current oil prices for the volume not being utilized?

It's a swap with a fixed price of $53.10.

Okay. Yeah. Thank you. Back on Block P. So Cary, is your feeling that Levene is still a serious counterparty? And if it is not, do you get any sort of expression of interest from alternate parties, or is there a risk of might stop again from scratch on the exploration somehow?

On the exploration side, I cannot comment on the interest from other parties as we are still in negotiations. At this point, I can't provide details on the level of interest. Regarding Levene, I am unable to speak for their internal management or strategy. However, it is clear that they have decided not to extend the Memorandum of Understanding we have with them, indicating a change in their level of interest. Despite not extending the MoU, we are still in discussions with Levene.