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Vaalco Energy

Oil Patch Research Investment Profile - 3rd Quarter 2008

Update - 10/16/2008

Update - 12/31/2008

Update - 02/18/2009

Fred Seiter
Contributing Writer - Oil Patch Research
Fred.Seiter@gmail.com

Introduction

Vaalco Energy (NYSE: EGY) is a Houston, Texas based, small-cap independent energy firm that operates primarily in the west-African country of Gabon where it produces mainly oil from the shallow off-shore 1186 square mile Etame Marin block (30.4 working interest with five discoveries) of which 3 are on production and the on-shore Mutamba Iroru 270,000 acre block (100% working interest). Vaalco also holds an interest in Block 5 of offshore Angola (40% working interest) and two other Blocks in offshore North Sea (25% working interest). As of December 31, 2007, Vaalco had proven reserves of 6.2 million BOE and probable reserves of 10.4 million BOE and 61 mmcf of natural gas. The company's average production is approximately 4,900 bpd. Vaalco Energy operates with the goal in mind to optimize their cash flow while seeking to grow their concessions in proven oil basins, thus growing their reserves organically by the drill bit.

Pritchard Energy Conference - January 2008

Etame Field Overview

Investment Drivers

Vaalco Energy presents to the oil investor an elegant, yet simple business model. You have heard of the saying, "to go where none have gone before". In the case of Vaalco, its the reverse. This highly profitable, essentially debt free company has compiled an impressive inventory of oil assets in areas that are proven reservoirs. When the major oil companies exploit oil fields, they do just that, skimming the easy oil to extract and often leaving behind smaller, largely untapped reservoirs. That is in part, the compelling nature of Vaalco's business model. They go after areas that have considerable potential and where modern data and drilling technology can be used to unlock reserves. And being very low cost producers, Vaalco can make a very good living with this model...and has.

The potential to grow their proven reserve base is exponential. But Vaalco's management is exceptionally disciplined as to which leads and prospects from their relatively substantial inventory is tapped into first. Their drilling success rate is impressive and its through this level of operational discipline that Vaalco is able to provide one of the best financial statements in the industry as witnessed by their robust operating and profit margins (e.g. 73% and 23.5% respectively at quarter ending 6/30/08) and healthy cash flows. Part of this discipline evolved from several years ago prior to Vaalco becoming a public company. At that time, the Bush family had a hand in the investment and a large part of the company's income was distributed. To minimize risk, much of the exploration element of the business was curtailed. Now the throttle has been opened up, though still there is a strong measure of due diligence and discipline employed to minimize risks.

Vaalco current oil production is coming from the Etame field in which the company has exploited 3 of the 5 discoveries. These discoveries lie about 20 miles off shore along the coast of the friendly African nation of Gabon. The reservoir lies in a sub-salt formation about 250 feet. Vaalco is presently pursuing a development plan for the area called Ebouri. They will drill a development well to exploit the 48 feet of net pay. Plans are to initiate drilling late 2008 and with first oil production expected in early 2009. There is no development plan at present for the discovery called North Tichibala. The entire Etame block has a gross reserve potential in excess of 60 million barrels. As you can see, Vaalco is asset rich as it relates to drilling opportunities in the Etame Block considering the reserves that have yet to be fully exploited.

The other Gabon property is called Mutamba and it consists of 270,000 acres in which the company has identified 10 leads. This exploration area was awarded to Vaalco in November 2005 and Vaalco has a 100% working interest and expects to drill two exploratory wells in December 2008 with a combined reserve potential in excess of 30 million barrels. Aero magnetic and gravity surveys have been performed and the expected pay zones are at about 3500-4000 feet. A pipeline that Vaalco can tie into once production begins, runs through the southwest edge of the permitted property. Again, what drives the attractiveness of this "play" is the abundance of leads to explore. The Gamba oil and Rabi Kouga discoveries serve as "analogues" given their adjacent location, with the Gamba within the permitted acreage boundary (see Vaalco Jan 2008 presentation). These two oil fields have EURs of 290 million and 1.1 billion barrels respectively. Vaalco is utilizing upgraded geophysical 2D software and recently acquired aero magnetic survey of the area.

Gabon Properties

Vaalco also control a 40% working interest (lead operator) of 1.4 billion acres in an offshore Angola block. It is estimated 50-500 million proven barrels may be exploited. Vaalco is planning on two exploratory wells in late 2009. The Block has a history of 12 wells drilled. Seven were dry and five demonstrated oil shows. Vaalco has identified 5 key leads. 3-D geophysical data is available to Vaalco and the Pinda oil field discovery provides an "analogue" (see presentation for details on geophysical data).

Angola

Finally, Vaalco has a 25% non-operating interest in two Blocks of a natural gas field located in the North Sea. The average net gas reserves is estimated to be 61 billion cubic feet in the "base case" structure. Seismically, the field's structure has been well defined and has dual reservoir properties with higher porosity in the lower zones. The risk profile for this particularly field is low, with strong upside potential. The reservoir can be exploited with a jack-up rig in relatively low risk shallow waters and modest development costs. One exploration well is planned for mid 2009.

Management is exceptionally experienced and owns about 6% of the stock. There are aproximately 60 million shares outstanding and the company employs about 75 employees. Aproximately 700,000 shares are traded daily on the NYSE.

Management

Robert L. Gerry III - Chairman and Chief Executive Officer

Mr. Gerry has served as Chairman of the Board and Chief Executive Officer of VAALCO Energy, Inc. since August 1997.

Until August 1997, Mr. Gerry had been Vice-Chairman of Nuevo Energy Company ("Nuevo") since February 1994. Prior to being appointed Vice-Chairman of Nuevo, Mr. Gerry had served as President and Chief Operating Office of Nuevo since its formation in March 1990. Mr. Gerry had been Senior Vice President of Energy Assets International Corporation ("EAIC") since January 1989. For ten years prior to joining EAIC, Mr. Gerry was active as an independent investor concentrating on energy investments.

Mr. Gerry served on the Board of Directors of Nuevo Energy from 1990-2004 and was appointed as a member of Plains Exploration and Production Company Board of Directors in 2004. He currently serves as a Trustee of Texas Children's Hospital.

W. Russell Scheirman - President and Chief Operating Officer

In October of 2008, Mr. Scheirman was appointed Chief Operation Officer following his overseeing of the planning, fabrication, and installation of the Avouma Field and Ebouri Field production platforms offshore Gabon. Mr. Scheirman continues to serve as President of VAALCO Energy, Inc., a position held since 1992. Mr. Scheirman served as Chief Financial Officer from 1991 to 2008. From 1991 to 1992, Mr. Scheirman served as Executive Vice President of the Company.

Prior to joining VAALCO Energy, Inc., Mr. Scheirman was an Associate at McKinsey & Company, Inc. from 1989 to 1991, an investment banker with Copeland, Wickersham and Wiley from 1984 to 1989, and a Petroleum Reservoir Engineer for Exxon Company, U.S.A. from 1978 to 1984.

Mr. Scheirman holds a B.S. (Summa Cum Laude) and M.S. in Mechanical Engineering from Duke University (1977 and 1978, respectively) and an M.B.A. from California Lutheran University (1984).

Risk & Reward Profile

Every investment bears risk and it comes in all forms. This certainly applies to oil exploration companies. What makes Vaalco rather unique and compelling is both their operation and financial track record. Vaalco Energy can be described as a deliberative, low risk, oil producing/exploration company with a basket of potential assets. As previously discussed, Vaalco comes in behind the major oil companies and essentially scoops up that which is left behind and therein lies the magic of the company's business model. The company's cash cow is the producing Etame Marin Block. As is evidenced from the company's cash flows, Vaalco has secured their exploration aims thru the steady and reliable cash flows from the Etame Block. While Etame is far from being fully exploited, it serves as an "enabler" for Vaalco to radiate outward to explore some of its other assets (e.g. Mutamba, Angola, North Sea). And those exploration opportunities are substantially mitigated through the careful due diligence performed prior to acquiring these assets. Hence, Vaalco operates much like a court room lawyer who almost always knows the answer to the question he poses. No drilling effort is without risk of failure, but if one studies the geology carefully and if previous drilling efforts have demonstrated oil shows or adjacent analogue oil fields have proven to be successful...then risk is diminished.

As one combs thru Vaalco's financials, one is immediately struck with two thoughts. First, the company has an exceptionally healthy balance sheet and operates comfortably through its cash flow. Secondly, debt is practically non-existent and cash Flows are robust.

VAALCO ENERGY, INC. AND SUBSIDIARIES

CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS

(Unaudited)

(in thousands of dollars)

	Six Months Ended June 30,
	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	14,828		$	8,272
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Depreciation, depletion and amortization		10,173			8,730
Amortization of debt issuance costs		93			431
Dry hole costs		6,399			—
Stock based compensation		494			1,138
Minority interest in earnings of subsidiaries		3,017			1,785
Change in operating assets and liabilities:
Trade receivables		4,566			(2,882	)
Accounts with partners		5,798			14,671
Other receivables		(182	)		(1,257	)
Crude oil inventory		(649	)		(842	)
Materials and supplies		(86	)		—
Deferred tax asset		22			1,385
Prepayments and other		(1,091	)		243
Accounts payable and accrued liabilities		12,071			(10,625	)
Income taxes payable		(200	)		—
Net cash provided by operating activities		55,253			21,049

Valuation Metrics

Vaalco Energy is in a favored position to grow its production and reserves for many years to come. Given the company's deliberative, but persistent pace, the likelihood of long term growth is excellent. There are several ways to value a company (e.g. reserve replacement ratio, p/e ratio, book value, enterprise value, etc) and all of these can be applied to Vaalco Energy. But I think it serves the investor better in this case, not to wrestle with these somewhat subjective valuation metrics. At this writing, the closing share price is $6.27 (July 28, 2008). The company is clearly trading above book value. It would be difficult to argue that this represents a "value play". Rather, I believe a more effective way of gauging value of the company is to consider more closely the geology of its assets....the quality of the numerous prospects and leads that could allow Vaalco to exponentially grow larger than its current proven reserve base. Its the ongoing success of its development and exploration programs that will likely serve as the best barometer to judge its future worth.

Closing Comments

You put it all together and you find an exceptionally well funded, small cap energy producer that is deliberate in its strategy of exploiting its oil assets and supports its operations through a healthy dose of cash flow and an experienced executive management and technical team. There is no flash...no boasting...and no haste, but rather a professional and laser like focus on executing the business plan. There appears to be a loyal following for this small energy producer within the oil patch. It has carved out a niche for itself as an exceptionally low cost oil producer, taking every opportunity to lower its drilling risk profile. In my view, this is a long term hold for the investor. Over the next few years, much will be learned about some of these prospects that Vaalco is exploring. To the extent that oil prices rise, Vaalco will benefit and vice versa. But as a long term hold, this small company stands strong on its balance sheet and potentially packs a meaningful punch as the results of its targeted exploration drilling efforts are determined.

Oil Patch Research is an independent investment website specializing in the energy sector. Contact Fred.Seiter@gmail.com regarding any questions you may have about this investment profile. Oil Patch Research is not a registered investment advisor or dealer/broker. Information, opinions, and recommendations contained at Oil Patch Research website is solely for advisory and information purposes. The information used and statements of facts made in investment profiles have been obtained from sources considered reliable, but we neither guarantee nor represent the completeness or accuracy. Such information and opinions expressed are subject to change without notice. An Oil Patch Research investment profile, editorial, or research update is not intended as an offering or a solicitation of an offer to buy or sell the securities mentioned or discussed. Oil Patch Research and its contributing writers will not be liable for any loss or damage caused by a reader's reliance on information obtained in any of our newsletters, investment profiles, editorials, research updates, email correspondence, or on our web site. Our readers are solely responsible for their own investment decisions. Owners and contributing writers may hold positions in the securities that are discussed in investment profiles, newsletters and our website. Oil Patch Research does not accept any cash or equity compensation from any company from which an investment profile, editorial, newsletter or research update is developed. Profiles, editorials, newsletters, research updates and the website are developed on behalf of the public and are not a service to any company.