| VAALCO ENERGY INC /DE/ Item 1A Risk Factors You should carefully consider the following risk factors in addition to the other information included in this report |
| If any of these risks or uncertainties actually occur, our business, financial condition and results of operations could be materially adversely affected |
| Additional risks not presently known to us or which we consider immaterial based on information currently available to us may also materially adversely affect us |
| In this section, the terms “Vaalco”, “we”, “us” and “our” refer to Vaalco and its subsidiaries, unless the context clearly indicates otherwise |
| Almost all of the value of our production and reserves is concentrated in a single field offshore Gabon, and any production problems or inaccuracies in reserve estimates related to this property would adversely impact our business |
| The Etame field, consisting of four producing wells, constituted almost 100prca of our total production for the year ended December 31, 2005 |
| In addition, at December 31, 2005, almost 100prca of our total net proved reserves were attributable to this field |
| If mechanical problems, storms or other events curtailed a substantial portion of this production, or if the actual reserves associated with this producing property are less than our estimated reserves, our results of operations and financial condition could be materially adversely affected |
| Our results of operations and financial condition could be adversely affected by changes in currency exchange rates |
| Our results of operations and financial condition are affected by currency exchange rates |
| While oil sales are denominated in US dollars, portions of our operating costs in Gabon are denominated in the local currency |
| An increase in the exchange rate of the local currency to the dollar will have the effect of increasing operating costs while a decrease in the exchange rate will reduce operating costs |
| The Gabon local currency is tied to the Euro |
| The exchange rate between the Euro and the US dollar has fluctuated widely in response to international political conditions, general economic conditions and other factors beyond our control |
| The Euro appreciated substantially against the US dollar in 2003 and 2004, while in 2005 the US dollar appreciated against the Euro |
| A decrease in oil and gas prices may adversely affect our results of operations and financial condition |
| Our revenues, cash flow, profitability and future rate of growth are substantially dependent upon prevailing prices for oil and gas |
| Our ability to borrow funds and to obtain additional capital on attractive terms is also substantially dependent on oil and gas prices |
| Historically, world-wide oil and gas prices and markets have been volatile and are likely to continue to be volatile in the future |
| In 2005, medium/heavy sweet crude oils, which produce higher amounts of residual fuel oil, experienced weaker demand in the marketplace |
| This has resulted in those crude oils trading at a discount to their traditional benchmark |
| These crude oils are similar to those produced from the Etame Field, and the lower market price may have an adverse impact upon our results of operations |
| Prices for oil and gas are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond our control |
| These factors include international political conditions, the domestic and foreign supply of oil and gas, the level of consumer demand, weather conditions, domestic and foreign governmental regulations, the price and availability of alternative fuels and general economic conditions |
| In addition, various factors, including the effect of federal, state and foreign regulation of production and transportation, general economic conditions, changes in supply due to drilling by other producers and changes in demand may adversely affect our ability to market our oil and gas production |
| Any significant decline in the price of oil or gas would adversely affect our revenues, operating income, cash flows and borrowing capacity and may require a reduction in the carrying value of our oil and gas properties and our planned level of capital expenditures |
| 9 ______________________________________________________________________ [45]Table of Contents [46]Index to Financial Statements Unless we are able to replace reserves which we have produced, our cash flows and production will decrease over time |
| Our future success depends upon our ability to find, develop or acquire additional oil and gas reserves that are economically recoverable |
| Except to the extent that we conduct successful exploration or development activities or acquire properties containing proved reserves, our estimated net proved reserves will generally decline as reserves are produced |
| There can be no assurance that our planned development and exploration projects and acquisition activities will result in significant additional reserves or that we will have continuing success drilling productive wells at economic finding costs |
| The drilling of oil and gas wells involves a high degree of risk, especially the risk of dry holes or of wells that are not sufficiently productive to provide an economic return on the capital expended to drill the wells |
| In addition, our drilling operations may be curtailed, delayed or canceled as a result of numerous factors, including title problems, weather conditions, political instability, economic/currency imbalances, compliance with governmental requirements or delays in the delivery of equipment and availability of drilling rigs |
| Our current domestic oil and gas properties are operated by third parties and, as a result, we have limited control over the nature and timing of exploration and development of such properties or the manner in which operations are conducted on such properties |
| Substantial capital, which may not be available to us in the future, is required to replace and grow reserves |
| We make, and will continue to make, substantial capital expenditures for the acquisition, exploitation, development, exploration and production of oil and gas reserves |
| Historically, we have financed these expenditures primarily with cash flow from operations, debt, asset sales, and private sales of equity |
| During 2005, we have participated, and in 2006 we will continue to participate, in the further exploration and development of the Etame Field offshore Gabon |
| We are the operator for the field and thus responsible for contracting on behalf of all the remaining parties participating in the project |
| We rely on the timely payment of cash calls by our partners to pay for the 69dtta65prca share of the budget for which they are responsible |
| However, if lower oil and gas prices, operating difficulties or declines in reserves result in our revenues being less than expected or limit our ability to borrow funds, or our partners fail to pay their share of project costs, we may have a limited ability to expend the capital necessary to undertake or complete future drilling programs |
| We cannot assure you that additional debt or equity financing or cash generated by operations will be available to meet these requirements |
| Our drilling activities require us to risk significant amounts of capital that may not be recovered |
| Drilling activities are subject to many risks, including the risk that no commercially productive reservoirs will be encountered |
| There can be no assurance that new wells drilled by us will be productive or that we will recover all or any portion of our investment |
| The cost of drilling, completing and operating wells is often uncertain and cost overruns are common |
| Our drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond our control, including title problems, weather conditions, compliance with governmental requirements and shortages or delays in the delivery of equipment and services |
| Weather, unexpected subsurface conditions and other unforeseen operating hazards may adversely impact our oil and gas activities |
| The oil and gas business involves a variety of operating risks, including fire, explosions, blow-outs, pipe failure, casing collapse, abnormally pressured formations and environmental hazards such as oil spills, gas leaks, ruptures and discharges of toxic gases, the occurrence of any of which could result in substantial losses to us due to injury and loss of life, severe damage to and destruction of property, natural resources and equipment, pollution and other environmental damage, clean-up responsibilities, regulatory investigation and penalties and suspension of operations |
| Our production facilities are also subject to hazards inherent in marine operations, such as capsizing, sinking, grounding, collision and damage from severe weather conditions |
| The relatively deep 10 ______________________________________________________________________ [47]Table of Contents [48]Index to Financial Statements offshore drilling conducted by us overseas involves increased drilling risks of high pressures and mechanical difficulties, including stuck pipe, collapsed casing and separated cable |
| The impact that any of these risks may have upon us is increased due to the low number of producing properties we own |
| We maintain insurance against some, but not all, potential risks; however, there can be no assurance that such insurance will be adequate to cover any losses or exposure for liability |
| The occurrence of a significant unfavorable event not fully covered by insurance could have a material adverse effect on our financial condition, results of operations and cash flows |
| Furthermore, we cannot predict whether insurance will continue to be available at a reasonable cost or at all |
| Our reserve information represents estimates that may turn out to be incorrect if the assumptions upon which these estimates are based are inaccurate |
| Any material inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present values of our reserves |
| There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, including many factors beyond our control |
| Reserve engineering is a subjective process of estimating the underground accumulations of oil and gas that cannot be measured in an exact manner |
| The estimates incorporated by reference into this document are based on various assumptions required by the SEC, including unescalated prices and costs and capital expenditures, and, therefore, are inherently imprecise indications of future net revenues |
| Actual future production, revenues, taxes, operating expenses, development expenditures and quantities of recoverable oil and gas reserves may vary substantially from those assumed in the estimates |
| Any significant variance in these assumptions could materially affect the estimated quantity and value of reserves incorporated by reference in this document |
| In addition, our reserves may be subject to downward or upward revision based upon production history, results of future development, availability of funds to acquire additional reserves, prevailing oil and gas prices and other factors |
| Moreover, the calculation of the estimated present value of the future net revenue using a 10prca discount rate as required by the SEC is not necessarily the most appropriate discount factor based on interest rates in effect from time to time and risks associated with our reserves or the oil and gas industry in general |
| It is also possible that reserve engineers may make different estimates of reserves and future net revenues based on the same available data |
| The estimated future net revenues attributable to our net proved reserves are prepared in accordance with SEC guidelines, and are not intended to reflect the fair market value of our reserves |
| In accordance with the rules of the SEC, our reserve estimates are prepared using period-end prices received for oil and gas |
| Future reductions in prices below those prevailing at year-end 2005 would result in the estimated quantities and present values of our reserves being reduced |
| A substantial portion of our proved reserves are or will be subject to service contracts, production sharing contracts and other arrangements |
| The quantity of oil and gas that we will ultimately receive under these arrangements will differ based on numerous factors, including the price of oil and gas, production rates, production costs, cost recovery provisions and local tax and royalty regimes |
| Changes in many of these factors do not affect estimates of US reserves in the same way they affect estimates of proved reserves in foreign jurisdictions, or will have a different effect on reserves in foreign countries than in the United States |
| As a result, proved reserves in foreign jurisdictions may not be comparable to proved reserve estimates in the United States |
| We have less control over our foreign investments than domestic investments and turmoil in foreign countries may affect our foreign investments |
| Our international assets and operations are subject to various political, economic and other uncertainties, including, among other things, the risks of war, expropriation, nationalization, renegotiation or nullification of existing contracts, taxation policies, foreign exchange restrictions, changing political conditions, international monetary fluctuations, currency controls and foreign governmental regulations that favor or require the awarding of drilling contracts to local contractors or require foreign contractors to employ citizens of, or purchase supplies 11 ______________________________________________________________________ [49]Table of Contents [50]Index to Financial Statements from, a particular jurisdiction |
| In addition, if a dispute arises with foreign operations, we may be subject to the exclusive jurisdiction of foreign courts or may not be successful in subjecting foreign persons, especially foreign oil ministries and national oil companies, to the jurisdiction of the United States |
| Private ownership of oil and gas reserves under oil and gas leases in the United States differs distinctly from our ownership of foreign oil and gas properties |
| In the foreign countries in which we do business, the state generally retains ownership of the minerals and consequently retains control of, and in many cases participates in, the exploration and production of hydrocarbon reserves |
| Accordingly, operations outside the United States may be materially affected by host governments through royalty payments, export taxes and regulations, surcharges, value added taxes, production bonuses and other charges |
| Almost all of our proven reserves are located offshore of the Republic of Gabon |
| As of December 31, 2005, we carried a gross investment of approximately dlra52dtta7 million on our balance sheet associated with the Etame field (dlra35dtta7 million net of accumulated depletion, depreciation and amortization costs) |
| We have operated in Gabon since 1995 and believe we have good relations with the current Gabonese government |
| However, there can be no assurance that present or future administrations or governmental regulations in Gabon will not materially adversely affect our operations or cash flows |
| Competitive industry conditions may negatively affect our ability to conduct operations |
| We operate in the highly competitive areas of oil exploration, development and production |
| We compete for the acquisition of exploration and production rights in oil and gas properties from foreign governments and from other oil and gas companies |
| These properties include exploration prospects as well as properties with proved reserves |
| Factors that affect our ability to compete in the marketplace include: • our access to the capital necessary to drill wells and acquire properties; • our ability to acquire and analyze seismic, geological and other information relating to a property; • our ability to retain the personnel necessary to properly evaluate seismic and other information relating to a property; • the location of, and our ability to access, platforms, pipelines and other facilities used to produce and transport oil and gas production; and • the standards we establish for the minimum projected return on an investment of our capital |
| Our competitors include major integrated oil companies and substantial independent energy companies, many of which possess greater financial, technological, personnel and other resources than we do |
| Our competitors may use superior technology which we may be unable to afford or which would require costly investment by us in order to compete |
| Compliance with environmental and other government regulations could be costly and could negatively impact production |
| The laws and regulations of the United States and Gabon regulate our business |
| Our operations could result in liability for personal injuries, property damage, oil spills, discharge of hazardous materials, remediation and clean-up costs and other environmental damages |
| In addition, we could be liable for environmental damages caused by, among others, previous property owners or operators |
| As a result, substantial liabilities to third parties or governmental entities may be incurred, the payment of which could have a material adverse effect on our financial condition, results of operations and liquidity |
| These laws and governmental regulations, which cover matters including drilling operations, taxation and environmental protection, may be changed from time to time in response to economic or political conditions and could have a significant impact on our operating costs, as wells as the oil and gas industry in general |
| In addition, 12 ______________________________________________________________________ [51]Table of Contents [52]Index to Financial Statements the Company is subject to International Finance Corporation environmental guidelines published by the World Bank |
| While we believe that we are currently in compliance with environmental laws and regulations applicable to our operations in Gabon and the US, including those required by the International Finance Corporation, no assurances can be given that we will be able to continue to comply with such environmental laws and regulations without incurring substantial costs |
| If our assumptions underlying accruals for abandonment costs are too low, we could be required to expend greater amounts than expected |
| Almost all of our producing properties are located offshore |
| For financial accounting purposes, we adopted Statement of Financial Accounting Standards 143, – Accounting for Asset Retirement Obligations on January 1, 2003 |
| This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred by capitalizing it as part of the carrying amount of the long-lived assets |
| No assurances can be given that such reserves will be sufficient to cover such costs in the future as they are incurred |
| From time to time we may hedge a portion of our production, which may result in our making cash payments or prevent us from receiving the full benefit of increases in prices for oil and gas |
| We may reduce our exposure to the volatility of oil and gas prices by hedging a portion of our production |
| Hedging also prevents us from receiving the full advantage of increases in oil or gas prices above the maximum fixed amount specified in the hedge agreement |
| In a typical hedge transaction, we have the right to receive from the hedge counterparty the excess of the maximum fixed price specified in the hedge agreement over a floating price based on a market index, multiplied by the quantity hedged |
| If the floating price exceeds the maximum fixed price, we must pay the counterparty this difference multiplied by the quantity hedged even if we had insufficient production to cover the quantities specified in the hedge agreement |
| Accordingly, if we have less production than we have hedged when the floating price exceeds the fixed price, we must make payments against which there are no offsetting sales of production |
| If these payments become too large, the remainder of our business may be adversely affected |
| In addition, our hedging agreements expose us to risk of financial loss if the counterparty to a hedging contract defaults on its contract obligations |
| We rely on our senior management team and the loss of a single member could adversely affect our operations |
| We are highly dependent upon our executive officers and key employees, particularly Messrs |
| Gerry and Scheirman |
| The unexpected loss of the services of any of these individuals could have a detrimental effect on us |
| We do not maintain key man life insurance on any of our employees |
| We rely on a single purchaser of our Gabon production, which could have a material adverse effect on our results of operations |
| We sell all of our crude oil production in Gabon to Trafigura Beheer BV The loss of Trafigura as a purchaser of our Gabon production could force the shut in of our Gabon production until the purchaser is replaced, and could have a material adverse effect on our results of operations |
| There are inherent limitations in all control systems, and misstatements due to error or fraud that could seriously harm our business may occur and not be detected |
| Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls and disclosure controls will prevent all possible error and all fraud |
| A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met |
| In addition, the design of a control system must reflect the fact that there are 13 ______________________________________________________________________ [53]Table of Contents [54]Index to Financial Statements resource constraints and the benefit of controls must be relative to their costs |
| Because of the inherent limitations in all control systems, an evaluation of controls can only provide reasonable assurance that all material control issues and instances of fraud, if any, in our company have been detected |
| These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake |
| Further, controls can be circumvented by the individual acts of some persons or by collusion of two or more persons |
| The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions |
| Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected |
| A failure of our controls and procedures to detect error or fraud could seriously harm our business and results of operations |