VAALCO Energy - Earnings Call - Q3 2018

Transcript

Speaker 0

Good morning. My name is Zitania, and I will be your conference operator today. At this time, I would like to welcome everyone to the VAALCO Energy Third Quarter twenty eighteen Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

I would now like to turn the conference over to Ms. Liz Prochnell, Chief Accounting Officer. Ma'am, you may begin.

Speaker 1

Thanks, operator. And on behalf of the management team, I welcome all of you to today's conference call to review VAALCO's third quarter twenty eighteen operating and financial performance. After I cover the forward looking statements, Carrie Downs, our Chief Executive Officer, will review key highlights of the third quarter along with operational results. Phil Patman, our chief financial officer, will then provide a more in-depth financial review. Carrie will then return for some closing comments before we take your questions.

During our question session, we ask you to limit your questions to one and a follow-up. You can always reenter the queue with additional questions. I would like to point out that we posted an updated investor deck on our website this morning that has additional financial analysis, comparisons and updated 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. SACA disclaims any intention or obligation to update or revise any forward looking statements, whether as there is 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 on our website and in the reports we filed with the Securities and Exchange Commission, including the Form 10 Q that was filed yesterday. Please note that this conference call is being recorded.

Let me turn the call over to Caris.

Speaker 2

Thank you, Liz. Good morning, everyone, and welcome to our third quarter twenty eighteen earnings conference call. While I'm very pleased with our operational success as well as the strong financial results that we delivered in the third quarter, I am most excited about the Gabon government granting VAALCO and our joint owners an extension to our Etame PSC in Gabon. Over the past several years, we have taken the steps necessary to transform VAALCO into a focused and financially strong company. The PSC extension gives us the time horizon we need to execute on projects that will add significant reserves and production at Etame.

With the PSC extension in place, a clean balance sheet, and strong quarterly results, VAALCO is now positioned to create significant shareholder value for many years to come. Now I'll go into a little more detail on the PSC extension that provides a solid foundation to develop the resource potential at Etame. The government of Gabon has granted a ten year extension to the exploitation period for the Etame block to 09/16/2028 with two additional five year options that could extend the license for a total of twenty years through 2038. As part of the extension, the consortium agreed to a signing bonus of $65,000,000. Our portion of the signing bonus was $11,800,000 net in cash upfront, an 8,400,000 reduction to the VAT receivable owed to us by the government of Gabon, and an additional $1,700,000 cash payment to be made at the completion of the next drilling campaign.

As part of the extension, the Gabon government agreed to increase the cost recovery percentage from 70% to 80% for the ten year extension period. The government of Gabon also agreed to expand the acreage in the exploitation areas so that VAALCO can pursue prospective leads we have identified near our existing infrastructure. Under the extension, the joint venture owners agreed to drill two development wells and two appraisal wells or I'm sorry, two appraisal wellbores. We are currently estimating the cost of these wells will be approximately $61,200,000 gross or $20,500,000 net to VAALCO, and we are planning to drill the wells during the 2019. Under the extension agreement, next year, we will also be reevaluating the Etame crude sweetening project that could allow us to develop our our sour crude resources.

In 2019, we will invest up to $2,000,000 gross or $700,000 net to VAALCO to evaluate the cost and economics of developing the sour resources, and we will keep you informed of of the results. As you are all well aware, our prior earnings calls, securing an extension of our PSC was our highest priority in Gabon, and we are very pleased to have executed an agreement that we believe adds value to VAALCO, its shareholders and the government of Gabon. Turning back to operations. Production for the third quarter averaged 4,120 barrels of oil per day net, which was above the high end of our guidance range of 3,800 to 4,100 barrels of oil per day net. At the end of the second quarter, we completed a workover program on the Abuma platform to restore production from wells where electric submersible pumps had failed.

I am pleased to report that the workover campaign was a success, and the strong performance from these wells enabled us to exceed our production expectations during the quarter. For the fourth quarter, we expect production to be in the range of 3,700 to 4,000 barrels of oil per day net, which is down slightly from the third quarter due to planned maintenance that will require us to shut in production for a short period of time. Our realized Brent pricing rose to over $75 per barrel in the third quarter, which boosted operating income to 17,300,000 barrels. I'm sorry, to $17,300,000. We also generated significant adjusted EBITDAX of $16,000,000 in the quarter, and we have now generated over $39,000,000 in adjusted EBITDAX year to date.

We believe we will be at or above the high end of our second half twenty eighteen adjusted EBITDAX guidance of $27,000,000 to $30,000,000 Later on, Bill will go into more detail on the financial results. Now I will spend the next few minutes reviewing our 2019 drilling program. As part of the PSC Extension, we committed to drilling two development wells and two appraisal wellbores. We are currently planning to drill these wells and a possible third well in the 2019, but the wells are subject to approval by the joint venture owners the government of Gabon. In our most recent presentation posted to the VAALCO website, we have detailed the 2019 drilling campaign, which includes the wells we plan to drill to meet our commitment under the extension agreement, plus a third well that is under consideration for drilling next year.

We believe that the two development wells could add a total of 1,500 to 2,000 net barrels of oil per day to Valvo and potentially one to one and a half million barrels of net proven plus probable reserves. These development drilling locations are easily drilled off of our existing platforms with the jackup rig, and the wells can be placed on production quickly with minimal increase in operating and overhead costs. We currently expect any capital expenditures made during 2019 will be funded by cash on hand and cash flow from operations. The appraisal wellbores we are drilling are to assess the potential in Etame and evaluate a step out area in Southeast Etame. If the appraisal well wellbores prove up resources in these areas, there is the potential to access two to five additional well locations in the future drilling campaign.

As we look to the future beyond Gabon, we are reassessing our technical evaluation of the opportunities on Block P, our offshore Equatorial Guinea license. Block P contains both development and exploration opportunities that could provide reserve and production growth in the next few years. The first step in Equatorial Guinea is to secure operatorship of the license, which we are actively pursuing with government authorities. VAALCO and our Block P joint venture owners are evaluating the timing and budgeting for development and exploration activities on the block, including the approval of a development and production plan. Preparation for development and exploration activities could begin as early as 2019, but no significant expenditures are expected in 2019.

In Angola, we are in discussions I'm sorry. In Angola, we are in discussions to finalize our exit on reasonable terms, and we will provide an update when we have when we have more information to share. We believe that continuing to operate efficiently in Gabon, generating significant cash, and strengthening our balance sheet in 2018 is pivotal to our plans for reserves and production growth in 2019, and we are excited about the opportunities that lie ahead for VAALCO. With that, I will turn the call over to Phil to discuss our financial results.

Speaker 3

Thank you, Carrie, and good morning, everyone. Our financial results for the third quarter were very strong as we restored production in Oboomah as a result of our successful workover operations. VAALCO's income from continuing operations of $78,600,000 or $1.28 per share included a $66,200,000 or $1.08 per diluted share noncash deferred tax benefit recognized in part as a result of benefits associated with the PSC Extension as well as continuing higher oil prices. It also included a $3,300,000 or $05 per diluted share noncash benefit from the deferral of asset retirement obligations associated with the PSC Extension. Excluding these two noncash items related to the PSC Extension totaling $69,500,000 adjusted income from continuing operations was $9,100,000 or $0.15 per diluted share.

This adjusted income amount includes a noncash mark to market charge related to our crude oil swaps of $1,100,000 or $02 per diluted share. Adjusted EBITDAX for the third quarter was $16,000,000 which was up 82% versus the 2018. On a year to date basis, VAALCO has generated $39,300,000 in adjusted EBITDAX. As Carrie detailed, we are forecasting to be at or above the high end of our second half twenty eighteen adjusted EBITDAX guidance of $27,000,000 to $30,000,000 which would be a significant increase of more than 20% over the 2018 actions. We currently estimate that for every $5 increase in realized oil price, our annual adjusted EBITDAX increases $6,000,000 Third quarter oil sales totaled 329,000 net barrels compared with 336,000 net barrels in the same period a year ago and 319,000 net barrels in the 2018.

Our realized oil price for the 2018 averaged $75.40 per barrel, up 48% from $51.1 in the 2017 and up slightly from $74.36 in the 2018. In June 2018, VAALCO executed a crude oil swap at a dated Brent weight average price of $74 per barrel for the period from and including June 2018 through June 2019 for a quantity of approximately 400,000 barrels. As of September '32 thousand eighteen, there were still 285,000 barrels of commodity price swaps remaining for 2018 and 02/2019. These are the only derivative contracts that the company currently has in place for 2018 and beyond. We will continue to evaluate ways to mitigate risk, ensure future cash flows for our drilling programs, and allow for upside to rising commodity prices through our hedging program.

Turning to expenses. Total production expense, excluding workovers, for the twenty eighteen third quarter was down to $7,500,000 or $22.93 per barrel of oil sales compared with $10,200,000 or $30.39 per barrel in the same quarter of 2019 and $8,300,000 or $26.8 per barrel in the 2018. For the 2018, our per barrel costs were below the low end of guidance. These costs were lower as a result of revised estimates of certain contractual obligation costs. We believe these costs will return to normal levels during Q4.

In addition, the decrease in expense year over year was also impacted by a planned maintenance turnaround and asset integrity work that occurred in the 2017. For the 2018, we expect production expense, excluding workovers, to be between $26 and $28 per barrel, and we maintain our expectation for the full year of 2018 to average between $24 and $28 per barrel. G and A for the third quarter of twenty eighteen was $1,100,000 or $3.43 per barrel of oil. This compares to $1,700,000 or $5.06 per barrel in the twenty seventeen third quarter and $1,000,000 or $3.24 per barrel in the 2018. DD and A per barrel decreased from 2017 due to the increase in proved reserves at December 3137.

We continue to estimate our DD and A for the fourth quarter to be three dollars to $4 per barrel. General and administrative expense for the 2018 was $2,800,000 or $8.54 per barrel of oil compared to $2,500,000 or $7.33 per barrel recorded in the same period one year ago and $5,000,000 or $15.7 per barrel in the 2018. These G and A costs include stock based compensation expense totaling $1,000,000 in the 2018, dollars 200,000.0 in the same quarter in 2017, and $2,400,000 in the 2018. Third quarter twenty eighteen stock based compensation included $800,000 related to stock appreciation rights, or SARs, compared with $2,000,000 in the second quarter of this year. SARs are revalued quarterly based on the closing stock price at the end of the quarter, which was $2.73 per share on September 30.

Stock price variability greatly impacts the fair value of the SARs, and there will be an expense or a credit booked every quarter associated with the mark to market value of the SARs. For example, based on yesterday's closing price, there would have been a credit of about $100,000 rather than a charge as was the case of $800,000 for the third quarter. Last quarter, we reduced the high end of our full year 2018 cash G and A guidance to between 9,000,000 and $10,000,000 We also updated our 2018 stock based G and A to be between 5,000,000 and $6,000,000 which includes the SARS charges forecasted through year end. Income tax expense for the 2018 was a benefit of $62,200,000 compared to an expense of $2,700,000 for the same period in 2017 and $3,600,000 in the 2018. The $62,200,000 benefit for the 2018 includes a $66,200,000 deferred tax benefit primarily related to the recognition of deferred tax assets and the reversal of valuation allowances on other deferred tax assets.

As a result of the PSC Extension, the ability to recognize tax benefits has improved significantly, resulting in the recognition of the deferred tax benefit in the 2018. In addition to the $66,200,000 deferred tax benefit, the company had $4,000,000 in current income tax expense, which is primarily for current income taxes payable to the government of the bond and is higher in 2018 than income tax for the comparable 2017 period as a result of higher revenues. Beginning with the 2018, the government of Gabon elected to lift its share of oil, which we report as income taxes separately from the Etame joint interest owners. As a result, Gabon income taxes are being settled when the government of Gabon lifts its share of production. These settlements are expected to occur once or twice per year depending on production levels.

The government of Devon took its first lifting of oil since making its election in in September 2018. Net to VAALCO, this lifting resulted in $9,400,000 of income taxes paid in kind with oil during the third quarter and reduced VAALCO's cash flows from oil sales in the month following the lifting. At September 3038, VAALCO had $1,800,000 of foreign taxes payable. As detailed on Slide 18 in the presentation deck posted this morning on our website, we currently estimate that VAALCO's operational breakeven price in 2018 is approximately $35 per barrel of oil sales, and our free cash flow breakeven price in 2018 is approximately $45 per barrel of oil sales, both figures including workover expense. In the third quarter, our realized price was slightly above $75 and we were able to generate significant free cash flow.

As you can see on the slide, even at the lower $70 realized price, we would realize $29.4 per barrel in operational margin and $21.1 per barrel in free cash flow. In general terms, we estimate that each $5 increase in realized price increases our annual cash flow by $6,000,000 which clearly shows our strong leverage to higher oil prices. The two slides following our breakeven analysis further illustrate our strong financial position. Slide 19 shows the $9,200,000 in working capital from continuing operations that we generated even after paying cash for our share of the PSC Extension signing bonus of $11,800,000 Slide 16 shows our ability to consistently generate positive adjusted income from continuing operations and adjusted EBITDAX as a result of increased commodity pricing, good cost control and strong operational performance. Turning to the balance sheet.

In the second quarter, VAALCO paid off its outstanding IFC debt, and we continue to have no debt outstanding. Cash and cash equivalents totaled $33,700,000 as of September 3038. This balance includes $5,500,000 of cash attributable to non operating partner advances. Despite paying our share of the Etame PSC Extension, Galco's cash payment cash position remains strong, and we currently expect any capital expenditures made during 2019 for drilling or otherwise will be funded by cash on hand and cash flow from operations. As you can see, VAALCO has built a strong financial foundation with no debt and continues to build cash for the 2019 development opportunities and beyond.

Speaker 2

With this, I will now turn the call back over to Kevin. Thanks, Phil. 2018 has seen many significant accomplishments for VAALCO. We have finalized the Etame PSC Extension, paid off all of our outstanding debt, successfully completed three workovers on the Avuma platform, and generated $39,300,000 in adjusted EBITDAX. We are projecting to be at or above the high end of adjusted EBITDAX guidance of 27,000,000 to $30,000,000 for the 2018.

With Brent pricing continuing to be strong, sustained production and our continued focus on cost containment, we expect further meaningful growth in our cash position. As we continue to deliver on our guidance and strengthen our balance sheet, we remain confident in the opportunities on our Etame asset. With the Etame extension, VAALCO is committed to drilling at least two development wells and two appraisal wellbores at an estimated cost of $20,500,000 net to VAALCO. We are planning to drill these wells and a possible third well in the 2019. The third well is subject to approval by the joint venture owners and the government of Gabon.

We are currently forecasting that any capital expenditures made during 2019 will be funded by cash on hand and cash flow from operations. We will continue to execute on our strategy. And with the PSC Extension, we have an expanded runway of opportunities at Etame. We will also continue to review opportunities elsewhere in West Africa and other basins worldwide where we can utilize our offshore development expertise. I am optimistic that we will create substantial value for our shareholders by adding reserves and production in 2019 and beyond.

Thank you. And with that, operator, we are ready to take questions.

Speaker 0

At this time, if you would like to ask a question, please press star then the number one on your telephone keypad. Your first question comes from the line of Bill Dezellem of Titan Capital Management.

Speaker 4

Thank you. A couple of questions here. First of all, if we talk about the the PV 10 calculation, now that the PSC extension is in place, how does that look different? Because it was my understanding that the p v 10 calculation could only take into account the timeline that you had the agreement for. So would you please discuss that?

Speaker 2

Right. So prior to the extension or prior to the PSC extension, we could only include revenue through 2021. And so now that we have extension, we can include revenue at least in 2028. And so what happened, though, is that we have a, obviously, a group of about 12 producing wells, and so those reserves or that production will continue beyond 2021. And then, also, we will drill wells next year and add new reserves in production that will continue well beyond 2021.

So, you know, it's there there is a whole lot of reserves in production that we can include in our p b 10 calculation that is 2021 through at least 2028, if not 2038.

Speaker 4

Great. Thank you. And then relative to that agreement, the cost account goes up to 80%. When when does that begin, and will that reduce your taxes as a percentage of revenue at at that point when that begins, or what's that process, please?

Speaker 2

What what I will say is the the cost percentage increased from 70 to 80% immediately, so that's already in place. And, Phil, do you wanna address the second part of the question?

Speaker 3

Yeah. What that does, Bill, is that creates, you know, obviously, a higher deduction for us on cash taxes payable in Gabon in the near term. And that, you know, the cost account itself doesn't change by the movement from 70 to 80. We simply get a bigger deduction at the current time. And that runs until 2028 consistent with the ten year existing term of the PSC extension before the option periods.

Speaker 4

And so we will begin to see that then did did we see that in this quarter, or will we see it in the fourth quarter in terms of the impact on taxes?

Speaker 3

It began consistent with the execution of the and the the PSC amendment. So there there was a partial amount in q three, and it will continue on in q four.

Speaker 4

That's helpful. And I know that you'd wanna limit the questions to one with a follow-up. But may I ask more, or would you prefer I jump in in the queue?

Speaker 2

Go it's fine, Bill. Go ahead and ask more. We're happy to take your questions.

Speaker 4

Great. Thank you. So let's talk about acquisition opportunities and how you are are kind of what that pipeline or the opportunity set looks like today relative to earlier this year.

Speaker 2

Well, Bill, let me let me take that one. And as I've said in the past, we are continuously looking for acquisition opportunities. That is an activity that is going on constantly. We have a team dedicated to that work. The type of acquisition that we're looking for is something that where where is a is an opportunity where we can leverage our existing technical capabilities and operational capabilities.

And so we are we feel like we're very good at operating in relatively shallow water offshore, so we're looking at those types of opportunities. I can't talk about any specific opportunity, but I will say that, I guess, the pipeline seems to be a little bit or there seems to be a little bit more in the pipeline right now. But, again, you know, we're under confidentiality agreements, and we can't talk about any of those details.

Speaker 4

Thank you. Let me jump to the sour your sour gas comments or on the in in your opening remarks, would you provide some more detail surrounding kind of what what you're evaluating and and how you're thinking about those? And and would it be a correct assessment that you're now able to think more seriously about those with with the higher commodity prices?

Speaker 2

Sure. The the higher commodity prices have allowed us to think more seriously about our entire portfolio, which includes sour crude sweetening as well as EG, for example. But, you know, when we look at our portfolio, the the opportunities that deliver the most near term value are development wells at Etame. And so right now, we're focused on development drilling. In the second quarter of next year is when we plan to start, Hopefully, first production by midyear, if not early in the third quarter.

And so that that's that's our priority right now. Now, again, you that was you know, what you said is true. The the higher commodity prices have have made crude sweetening look interesting. For now, it it is taking we are going to take a closer look next year at the design and construction of crude sweetening facilities. We we did a detailed analysis back in 2015, and so we're gonna start with that analysis and and polish that up, if you will.

Look at what the current costs are through the developments, if there's any breakthroughs in technology. So execution on a crude sweetening project will not happen in 2019. That's that's that's more of a midterm opportunity. Right now, our focus is on the development wells at Etame.

Speaker 4

Great. Thank you. And then I'm gonna have to play the slow pony here because you make reference to two evaluation wellbores, which sounds different than than wells themselves. Can you talk about what it is that you're doing there, please?

Speaker 2

I I'm happy to, Bill. And in our presentation that we posted to our website this morning on page eight, in in eight, nine, and 10, you will find details on what those appraisal wellbores are intended to accomplish. But what we are drilling, there there's two different types of appraisal wellbores. There's an appraisal wellbores to test deeper sands, and those are the. And so we will we will drill one of those.

And what happens is we we we drill our our pilot hole is what we call it, and then we drill a little bit deeper, and we we look at the. We we take logs, and and we'll evaluate whether oil is there or not, and that will inform us on future development drilling plans. Then we come back up to the pilot hole, and we drill the horizontal section of our development well in the Gombo, which is shallower than the Dentale. So, again, we will we'll drill a pilot hole, and then we'll drill a little bit deeper, look at the Dentale, determine if there are sufficient reserves to develop the Dentale, but come back and use that pilot hole to to drill a horizontal well, a producer, into the Dentale. Then the second appraisal well actually is the the same the same sort of steps and procedures.

We drill a pilot hole, and then we actually drill laterally into a new Gamba fault block. We look and we decide if there are Gamba reserves there. And if there are, we're gonna go ahead and drill a Gamba horizontal well. That would be a dev development well at that point. Drill drill a horizontal Gamba well in this new Gamba fault block, and that could set up two two or three more Gamba development wells in the new fault block.

And I failed to mention if the Dentale works, that may be three to five Dentale development wells that we could drill in a later drilling campaign.

Speaker 4

That is very helpful. And then lastly, I would like to jump to Equatorial Guinea, please. You you mentioned in the press release that you're having conversations with the government. What is it that you are trying to accomplish by the end of this year? And what's what what is the government's enthusiasm to get you active again?

What's what's their level of enthusiasm?

Speaker 2

The the I will say the the government's level of enthusiasm is very high. They would like to capitalize on the the higher oil prices that we're all enjoying right now. So they would like to see activity in their country. We're very close to the Equatorial Guinea authorities. And the first step, whether it's the end of this year or first quarter of next year, is for VAALCO to take over operatorship.

And then next, we would we are looking at drilling an exploration well sometime out in the future. We haven't determined exactly when that would happen, but the exploration potential is very robust on our block. I think you'll see in our in our again, in our presentation, we're carrying about 60 to 65,000,000 barrels of resources that we believe we could explore for in Equatorial Guinea. But, again, the first step is to have operatorship assigned to VAALCO either before the end of this year or or early next year. Right now, the the state oil company, G Patrol, is is the designated operator of Block p.

Speaker 4

Thank you. And then relative to the assets that that are in place, are are there assets that you can tie into and and therefore production would begin reasonably quickly, or would you need to put a platform in for production? Kind of walk us through that if you would, please.

Speaker 2

Sure. Sure. Happy to do that, Bill. What we have in Equatorial Guinea is actually a discovery. It's called the Venus discovery.

It's about 20,000,000 barrels gross of recoverable resources. So that that's there. And then what we want to do again is go and drill an exploration well, and, hopefully, we will discover at least another sixty sixty to 65,000,000 barrels. And what we will do is we have to put new facilities in place. There is there is no existing infrastructure on the block p or at block p as of today.

So thinking ahead, it would probably be an FPSO with subsea well tiebacks, both to Venus and then the discovery that we're that we hope to make out in the future here.

Speaker 4

And, Carrie, long before you were CEO, it was our understanding that offshore Equatorial Guinea could have an equal level of value as as you currently have in Gabon in terms of of production and and reserve opportunity, literally enough to double the company. Is that still valid today?

Speaker 2

I I think that's still valid, but we need to talk about risk, of course. And so, yes, we there are multiple exploration block prospects on the Equatorial Guinea block, but they they carry with them exploration type risk. And so, you know, there there is the potential there to have, you know, ultimate recoveries that are equivalent to what we have in Gabon. But right now, there's a there's you know, again, there's a a low probability of that because it requires expiration.

Speaker 4

That's very helpful. Thank you for taking all the questions.

Speaker 2

You're welcome. Good to talk to you, Bill.

Speaker 4

You too.

Speaker 0

Again, if you would like to ask a question at this time, please press star then the number one on your telephone keypad. Again, that's star one to ask a question. There are no further questions at this time.

Speaker 3

All right. Well, I would like to

Speaker 2

thank everybody for participating in our conference call, and we look forward to talking to you again next quarter. Goodbye.

Speaker 0

This concludes today's conference. You may