Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk, including the effects of adverse changes in foreign exchange rates and commodity prices as described below.
Foreign Exchange Rate Risk
Our results of operations and financial condition are affected by currency exchange rates. While crude oil sales are denominated in U.S. dollars, portions of our costs in Gabon are denominated in the local currency (the Central African CFA Franc, or XAF), and our VAT receivable as well as certain liabilities in Gabon are also denominated in XAF. A weakening U.S. dollar will have the effect of increasing costs while a strengthening U.S. dollar will have the effect of reducing costs. For our VAT receivable in Gabon, a strengthening U.S. dollar will have the effect of decreasing the value of this receivable resulting in foreign exchange losses, and vice versa. The Gabon local currency is tied to the Euro. The exchange rate between the Euro and the U.S. dollar has historically fluctuated in response to international political conditions, general economic conditions and other factors beyond our control. As of December 31, 2023, we had net monetary assets of $5.8 million (XAF 3,463.4 million) denominated in XAF. A 10% weakening of the CFA relative to the U.S. dollar would have a $0.5 million reduction in the value of these net assets. For the year ended December 31, 2023, we had expenditures of approximately $48.8 million denominated in XAF.
Related to our Canadian operations, our currency exchange risk relates primarily to certain cash and cash equivalents, accounts receivable, lease obligations and accounts payable and accrued liabilities denominated in Canadian dollars. We estimate that a 10% increase in the value of the Canadian dollar against the US dollar would decrease net earnings for the year ended December 31, 2023 by approximately $0.2 million. Conversely, a 10% decrease in the value of the Canadian dollar against the US dollar would increase net earnings for the year ended December 31, 2023 by approximately $0.1 million.
We are also exposed to foreign currency exchange risk on cash balances denominated in Egyptian pounds. Some collections of accounts receivable from the Egyptian Government are received in Egyptian pounds, and while we are generally able to use the Egyptian pounds received on accounts payable denominated in Egyptian pounds, there remains foreign currency exchange risk exposure on Egyptian pound cash balances. Using month-end cash balances converted at month-end foreign exchange rates at December 31, 2022, we estimate that a 10% increase in the value of the Egyptian pound against the US dollar would increase net earnings for the year ended December 31, 2022 by approximately $0.3 million. Conversely, a 10% decrease in the value of the Egyptian pound against the US dollar would decrease net earnings for the year ended December 31, 2022 by approximately $0.2 million.
We do not utilize derivative instruments to manage foreign exchange risk.
We maintain nominal balances of British Pounds Sterling to pay in-country costs incurred in operating our London office. Foreign exchange risk on these funds is not considered material.
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Commodity Price Risk
Our major market risk exposure continues to be the prices received for our crude oil, natural gas and NGLs production. Sales prices are primarily driven by the prevailing market prices applicable to our production. Market prices for crude oil, natural gas and NGLs have been volatile and unpredictable in recent years, and this volatility may continue. Sustained low crude oil, natural gas and NGLs prices or a resumption of the decreases in crude oil, natural gas and NGLs prices could have a material adverse effect on our financial condition, the carrying value of our proved reserves, our undeveloped leasehold interests and our ability to borrow funds and to obtain additional capital on attractive terms. If crude oil sales were to remain constant at the most recent annual sales volumes of 6,832 MBoe, a $5 per Bbl decrease in crude oil price would be expected to cause a $34.2 million decrease per year in revenues and operating income (loss) and a $25.4 million decrease per year in net income (loss).
With respect to our crude oil sales in Gabon, the price received is based on Dated Brent prices plus or minus a differential. If crude oil sales were to remain constant at the most recent annual sales volumes of 3,196 MBbls, a $5 per Bbl decrease in crude oil price would be expected to cause a $16.0 million decrease per year in revenues and operating income (loss) and a $14.3 million decrease per year in net income (loss).
Egypt production is based on Dated Brent prices, less a quality differential and is shared with the Egyptian government through PSCs. When the price of oil increases, it takes fewer barrels to recover costs (cost oil or cost recovery barrels) which are assigned 100% to the Company. The PSCs provide for cost recovery per quarter up to a maximum percentage of total production. Timing differences often exist between VAALCO’s recognition of costs and their recovery as VAALCO accounts for costs on an accrual basis, whereas cost recovery is determined on a cash basis. If the eligible cost recovery is less than the maximum defined cost recovery, the difference is defined as "excess". In Egypt, depending on the PSCs, our share of excess ranges between 5% and 15%. If the eligible cost recovery exceeds the maximum allowed percentage, the unclaimed cost recovery is carried forward to the next quarter. Typically, maximum cost oil ranges from 25% to 40% in Egypt. The balance of the production after maximum cost recovery is shared with the government (profit oil). Depending on the contract, the Egyptian government receives 67% to 84% of the profit oil. Production sharing splits are set in each contract for the life of the contract. Typically, the government’s share of profit oil increases when production exceeds pre-set production levels in the respective contracts. During times of high oil prices, the Company may receive less cost oil and may receive more profit-sharing oil. During times of lower oil prices, the Company receives more cost oil and may receive less profit oil.
With respect to our crude oil and NGLs sales in Canada, the prices received is based on NYMEX WTI (west Texas Intermediate) prices plus or minus a differential. Natural gas sales are based on Canadian index price that whose price is based, in part, on the NYMEX Henry Hub Natural Gas futures contracts. If Canadian BOE sales were to remain constant at the most recent yearly sales volumes of 865 MBbls, a $5 per Bbl decrease in crude oil price would be expected to cause a $4.3 million decrease per year in revenues and operating income (loss) and a $3.3 million decrease per year in net income (loss).
As of December 31, 2023, we had unexpired derivative instruments outstanding covering approximately 450 MBbls of production through June of 2024. To date in 2024, we added costless collars covering 240 MBbls covering a portion of our production from July 2024 - September 2024. During the year ended December 31, 2022, we had derivative instruments outstanding. These instruments were intended to be an economic hedge against declines in crude oil prices; however, they were not designated as hedges for accounting purposes. See “ Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation s – Derivative instruments and hedging activities ” above.
Interest Rate Risk
At both December 31, 2023 and on the filing date of this Annual Report, we had a zero balance on our Facility. Loans under the Facility will bear interest at a rate equal to SOFR plus the Applicable Margin of (i) 6.00% until the third anniversary of the Facility Agreement or (ii) 6.25% from the third anniversary of the Facility Agreement until the Final Maturity Date. On October 3, 2023, the Company signed an Amended and Restated Facility Agreement to replace the LIBOR component in the original Facility Agreement, with a SOFR plus credit adjustment spread rate. The SOFR plus credit adjustment spread rate is intended to approximate the LIBOR component in the original Facility Agreement. The LIBOR component was replaced due to the phase out of LIBOR as a global reference rate. Any increases in these interest rates can have an adverse impact on our results of operations and cash flows. For additional information on the Facility Agreements terms and conditions, see “ Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Liquidity—RBL Facility Agreement and Available Credit ” above.
Item 8. Consolidated Financial Statements and Supplementary Data
The information required here begins on page F-1 as described in “ Item 15. Exhibits and Financial Statement Schedules — Index to Consolidated Financial Information ”.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.