# Epsilon Energy Ltd.: Form 10-Q for the period ended Mar 31, 2022

- Company: [Epsilon Energy Ltd.](/companies/epsn.md) (CIK 1726126)
- Form: 10-Q
- Filed: 2022-05-12
- Accepted by EDGAR: May 11, 2022, 18:49 ET
- Period: 2022-03-31
- Accession: 0001558370-22-008381
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1726126/000155837022008381/epsn-20220331x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1726126/000155837022008381/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2022-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2022-01-01 to 2022-03-31 | $13.6m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Operating income | 3 months, 2022-01-01 to 2022-03-31 | $9.0m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2022-01-01 to 2022-03-31 | $15.3k | us-gaap:InterestExpense |
| Income tax | 3 months, 2022-01-01 to 2022-03-31 | $2.2m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2022-01-01 to 2022-03-31 | $5.8m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2022-01-01 to 2022-03-31 | $0.24 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2022-01-01 to 2022-03-31 | $0.25 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2022-01-01 to 2022-03-31 | 23,862,428 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2022-01-01 to 2022-03-31 | $7.7m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Cash and equivalents | at 2022-03-31 | $30.1m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2022-03-31 | $37.0m | us-gaap:AssetsCurrent |
| Total assets | at 2022-03-31 | $106.1m | us-gaap:Assets |
| Current liabilities | at 2022-03-31 | $9.4m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2022-03-31 | $22.1m | us-gaap:Liabilities |
| Shareholders' equity | at 2022-03-31 | $83.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 30,553 characters.

*The following discussion is intended to assist in the understanding of trends and significant changes in or results of operations and the financial condition of Epsilon Energy Ltd. and its subsidiaries for the periods presented. The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto presented in this report, including the unaudited condensed consolidated financial statements as of March 31, 2022 and 2021 and for the three months then ended together with accompanying notes, as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs, and expected performance. Actual results and the timing of events may differ materially from those contained in these forward- looking statements due to a number of factors. See “Part II. Item 1A. Risk Factors” and “Forward-Looking Statements.”*

### Overview

Epsilon Energy Ltd. (the “Company”) is a North American onshore focused independent natural gas and oil company engaged in the acquisition, development, gathering and production of natural gas and oil reserves. Our primary area of operation is Pennsylvania. Additionally, we initiated a small appraisal program on our leases in the NW Anadarko basin of Oklahoma producing oil, natural gas, and natural gas liquids. Our assets are concentrated in areas with known hydrocarbon resources, which are conducive to multi-well, repeatable drilling programs.

Substantially all of the production from our Pennsylvania acreage (4,597 net) is dedicated to the Auburn Gas Gathering System, or the Auburn GGS, located in Susquehanna County, Pennsylvania for a 15 year term expiring in 2026 under an operating agreement whereby the Auburn GGS owners receive a fixed percentage rate of return on the total capital invested in the construction of the system. Epsilon owns a 35% interest in the system which is operated by a subsidiary of Williams Partners, LP. In the three months ended March 31, 2022, Epsilon paid $0.37 million to the Auburn GGS to gather and treat our 2.3 Bcf, of natural gas production in Pennsylvania ($0.38 million to the Auburn GGS to gather and treat our 2.4 Bcf of natural gas in the three months ended March 31, 2021).

Epsilon realized net income of $5.8 million for the three months ended March 31, 2022, as compared to net income of $2.7 million for the three months ended March 31, 2021.

Our common shares trade on the NASDAQ Global Market under the ticker symbol “EPSN.”

### Business Strategy

Our business strategy is to manage the cash flow generated from our producing leasehold and midstream assets in a manner where the risked capital allocation provides attractive rates of return. Our remaining inventory of drillable locations within existing leasehold is sufficient to maintain this cash flow for several years at capital expenditure levels well within the yearly cash flow generated from these assets. In addition, we seek to identify attractive onshore natural gas and oil properties in the United States, to acquire leasehold interests and to develop our leasehold interests with the goal of deploying capital to earn attractive rates of return.

The core Marcellus Shale is one of the most attractive dry gas resources in the United States and has attracted significant development capital. Well productivity has improved dramatically for many years due to improving techniques in drilling and completing wells, resulting in increasing initial production rates and gas recoveries. The resulting supply of natural gas at times stresses the transportation infrastructure of the Northeast US and exacerbates the local price discount to Henry Hub. In many other basins throughout the US, the increase in natural gas production had historically outpaced demand. Over the past couple of years, this over supply condition has become more balanced and demand growth from increased LNG exports and pipeline exports to Mexico have provided attractive markets improving the prices for natural gas.

The operating environment remains challenging in Northeast Pennsylvania. We implemented a number of initiatives to enhance the value of our core assets in the Marcellus including a comprehensive review of well spacing and completion productivity for both the Lower and Upper Marcellus, and we are working with our well operators to increase operating efficiency. In addition, we continue to work closely with our gathering system partners in order to optimize the operating conditions, enhance operational safety, and to preserve and grow the long-term value of our gathering system assets.

The major producers in the Appalachian region are under pressure from capital markets to demonstrate capital discipline and control costs. Several major producers have announced reduced capital programs to balance the supply-demand for the commodity. Accordingly, we expect local production during 2022 to be flat compared to 2021. Our target is to maintain our current production level or grow modestly, but only if natural gas price levels are sufficient and the capital deployed can achieve our internal hurdle rate of return.

In the longer term, we believe natural gas prices will remain constructive due to moderating supply from both dry gas regions and associated gas from oil prone basins, and incremental demand from LNG exports, exports to Mexico and further coal to gas switching for domestic electrical power generation. Specifically, LNG export capacity is expected to grow from the current ~ 13 Bcf/d to 17 Bcf/d by 2024 based only on facilities currently commissioning or under construction.

In the Northwest Anadarko basin of Oklahoma, we continue to appraise recent and historical results of the Meramec formation from both our wells and analog wells within the focus area. At March 31, 2022, our initial well continues to outperform the pre-completion type curve expectations in terms of both production-to-date and projections for ultimate recoveries. We completed the first of two previously drilled wells at the end of the quarter and the second well after the quarter end. Early results are encouraging and the Company is evaluating additional Meramec locations within the focus area for further exploitation on an opportunistically prudent timeline.

### Three months ended March 31, 2022 Highlights

### Operational Highlights

#### Marcellus Shale – Pennsylvania

- During the three months ended March 31, 2022, Epsilon’s realized natural gas price was $4.55 per Mcf, a 77% increase over the three months ended March 31, 2021.
- During the three months ended March 31, 2022, Epsilon’s natural gas production was 2.4 Bcf, as compared to 2.4 Bcf during the same period in 2021.
- Gathered and delivered 18.3 Bcf gross (6.4 Bcf net to Epsilon’s interest) during the year, or 201 MMcf/d through the Auburn Gas Gathering System.
- At quarter end, the Company had 1 gross (0.18 net) well waiting on completion.

#### Anadarko, NW Stack Trend – Oklahoma

- During the three months ended March 31, 2022, Epsilon’s realized price for all Oklahoma production was $7.71 per Mcfe, a 117% increase over the three months ended March 31, 2021.
- Total production for the three months ended March 31, 2022 included natural gas, oil, and other liquids and was 0.17 Bcfe, a 141% increase over the same period in 2021.
- In the first quarter of 2022, the Company completed 1 gross (.44 net) well. At March 31, 2022, the Company had 1 gross (.11 net) well waiting on completion.

### Non-GAAP Financial Measures-Adjusted EBITDA

Epsilon defines Adjusted EBITDA as earnings before (1) net interest expense, (2) taxes, (3) depreciation, depletion, amortization and accretion expense, (4) impairments of natural gas and oil properties, (5) non-cash stock compensation expense, (6) gain or loss on derivative contracts net of cash received or paid on settlement, and (7) other income. Adjusted EBITDA is not a measure of financial performance as determined under U.S. GAAP and should not be considered in isolation from or as a substitute for net income or cash flow measures prepared in accordance with U.S. GAAP or as a measure of profitability or liquidity.

Additionally, Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. Epsilon has included Adjusted EBITDA as a supplemental disclosure because its management believes that EBITDA provides useful information regarding its ability to service debt and to fund capital expenditures. It further provides investors a helpful measure for comparing operating performance on a normalized or recurring basis with the performance of other companies, without giving effect to certain non-cash expenses and other items. This provides management, investors and analysts with comparative information for evaluating the Company in relation to other natural gas and oil companies providing corresponding non-U.S. GAAP financial measures or that have different financing and capital structures or tax rates. These non-U.S. GAAP financial measures should be considered in addition to, but not as a substitute for, measures for financial performance prepared in accordance with U.S. GAAP.

The table below sets forth a reconciliation of net income to Adjusted EBITDA for the three months ended March 31, 2022 and 2021, which is the most directly comparable measure of financial performance calculated under U.S. GAAP and should be reviewed carefully.

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | --- | --- | --- |
| **Net income** | ​ | $5,805,888 | ​ | $2,735,567 |
| Add Back: | ​ | ​ ​ | ​ | ​ ​ |
| Net interest expense | ​ | ​ 98 | ​ | ​ 19,260 |
| Income tax expense | ​ | ​ 2,181,898 | ​ | ​ 1,144,573 |
| Depreciation, depletion, amortization, and accretion | **​** | **​** 1,389,219 | ​ | ​ 1,682,860 |
| Stock based compensation expense | ​ | ​ 142,302 | ​ | ​ 202,499 |
| Loss on derivative contracts net of cash received or paid on settlement | ​ | ​ (239,824) | ​ | ​ (401,141) |
| Foreign currency translation loss | ​ | ​ 5,402 | ​ | ​ 332 |
| **Adjusted EBITDA** | ​ | $9,284,983 | ​ | $5,383,950 |

### Results of Operations

### Net Operating Revenues

For the three months ended March 31, 2022 revenues increased $5.2 million, or 61%, to $13.6 million from $8.4 million during the same period of 2021.

Revenue and volume statistics for the three months ended March 31, 2022 and 2021 were as follows:

| ​ ​ ​ ​ Revenues | ​ ​ ​ ​ | ​ ​ Three months ended March 31, 2022 ​ ​ | ​ ​ | ​ ​ 2021 ​ ​ |
| --- | --- | ---: | --- | ---: |
| **Natural gas revenue** | **​** | **$10,703,084** | **​** | **$6,332,099** |
| Volume (MMcf) | ​ | 2,351 | ​ | 2,466 |
| Avg. Price ($/Mcf) | ​ | $4.55 | ​ | $2.57 |
| PA Exit Rate (MMcfpd) | ​ | 23.1 | ​ | 32.8 |
| **Oil and other liquids revenue** | **​** | **$776,241** | **​** | **$107,056** |
| Volume (MBO) | ​ | 14.9 | ​ | 3.7 |
| Avg. Price ($/Bbl) | ​ | $52.22 | ​ | $28.58 |
| **Gathering system revenue** | **​** | **$2,120,773** | **​** | **$2,002,157** |
| **Total Revenues** | **​** | **$13,600,098** | **​** | **$8,441,312** |

We earn gathering system revenue as a 35% owner of the Auburn Gas Gathering system. This revenue consists of fees paid by Anchor Shippers (parties listed in Anchor Shipper Gas Gathering Agreement for Northern Pennsylvania, including Epsilon Midstream, LLC) and third-party customers of the system to transport gas from the wellhead to the compression facility, and then to the delivery meter at the Tennessee Gas Pipeline. For the three months ended March 31, 2022, approximately 76% of the Auburn GGS revenues earned were gathering fees, while 24% were compression fees. Gathering revenues from third-party customers represented approximately 10% of total gathering revenues and third-party compression revenues represented 9% of total compression revenues. For the three months ended March 31, 2021 approximately 81% of the Auburn GGS revenues earned were gathering fees, while 19% were compression fees. Gathering revenues from third-party customers represented approximately 8% of revenues and third-party compression revenues represented 3% of revenues. Revenues derived from Epsilon’s production which have been eliminated from gathering system revenues amounted to $0.37 million and $0.38 million for the three months ended March 31, 2022 and 2021.

Upstream natural gas revenue for the three months ended March 31, 2022 increased by $4.4 million, or 69%, over the same period in 2021. This was primarily a result of higher natural gas prices; however, this was partially offset by lower volumes being produced due to natural decline of the wells.

Upstream oil and other liquids revenue for the three months ended March 31, 2022 increased by $0.7 million, or 625%, over the same period in 2021. This was a result of increased production from new wells in addition to higher prices.

The Company’s share of gathering system revenue increased by $0.1 million, or 6%, during the three months ended March 31, 2022 over the same period in 2021. The Auburn GGS is subject to a cost of service model, whereby the Anchor Shippers dedicate acreage and reserves to the Auburn GGS. In exchange for this dedication, the owners of the Auburn system agree to a fixed rate of return on capital invested which cannot be exceeded. Therefore, rather than being subject to a fixed gathering rate, the Shippers are subject to a fluctuating gathering rate which is redetermined annually in order to produce the contractual return on capital to the Auburn GGS owners. The term of the model is fixed from 2012 to 2026. Each year, actual throughput, revenue, operating expenses and capital are captured in the model, and the remaining years are forecasted. The model then resolves a gathering rate that yields the contractual rate of return. All else being equal, to the extent that throughput is higher or capital is lower than the preceding year’s forecast, the gathering rate will decline.

### Operating Costs

The following table presents total cost and cost per unit of production (Mcfe), including ad valorem, severance, and production taxes for the three months ended March 31, 2022 and 2021:

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | --- | --- | --- |
| Lease operating costs | ​ | $1,770,654 | ​ | $1,594,188 |
| Gathering system operating costs | ​ | ​ 159,211 | ​ | ​ 190,947 |
| **​** | **​** | **$1,929,865** | **​** | **$1,785,135** |
| ​ | ​ | ​ **​** | **​** | **​** **​** |
| Upstream operating costs—Total $/Mcfe | ​ | ​ 0.73 | ​ | ​ 0.64 |
| Gathering system operating costs $ / Mcf | ​ | ​ 0.09 | ​ | ​ 0.10 |

Upstream operating costs consist of lease operating expenses necessary to extract natural gas and oil, including gathering and treating the natural gas and oil to ready it for sale.

Upstream operating costs for the three months ended March 31, 2022 increased $0.2 million, or 11%, over the same period in 2021. The increase in total cost was primarily due to rising prices for services leading to a $0.9/Mcfe, or 13%, increase, in the cost associated with operating the wells.

Gathering system operating costs consist primarily of rental payments for the natural gas fueled compression units. Other significant gathering system operating costs include chemicals (to prevent corrosion and to reduce water vapor in the gas stream), saltwater disposal, measurement equipment / calibration and general project management.

The gathering system total per unit operating costs reported include the effects of elimination entries to remove the gas gathering fees billed by the gas gathering system operator to Epsilon’s upstream operations, and the volume associated with those fees. The elimination entries amounted to $0.37 million and $0.38 million for the three months ended March 31, 2022 and 2021, respectively (see Note 11, ‘‘Operating Segments,’’ of the Notes to Unaudited Condensed Consolidated Financial Statements).

Gathering system costs (net of intercompany elimination) for the three months ended March 31, 2022 decreased $0.03 million, or 17%, over the same period in 2021. The Company’s share of total gathering system costs decreased $0.02 million, or 5%, for the three months ended March 31, 2022 over 2021. This decrease is primarily due to a decrease in throughput volumes into the gathering system.

### Depletion, Depreciation, Amortization and Accretion (“DD&A”)

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: |
| **Depletion, depreciation, amortization and accretion** | **​** | **$1,389,219** | ​ | **$1,682,860** |

Natural gas and oil and gathering system assets are depleted and depreciated using the units of production method aggregating properties on a field basis. For leasehold acquisition costs and the cost to acquire proved and unproved properties, the reserve base used to calculate depreciation and depletion is total proved reserves. At this time, the Company has only minimal leasehold acquisition costs. For natural gas and oil development and gathering system costs, the reserve base used to calculate depletion and depreciation is proved developed reserves. A reserve report is prepared as of December 31, each year.

Depreciation expense includes primarily amounts pertaining to our office furniture and fixtures, leasehold improvements, and computer hardware. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 7 years. Also included in depreciation expense is an amount pertaining to buildings owned by the Company. Depreciation for the buildings is calculated using the straight-line method over an estimated useful life of 30 years.

Accretion expense is related to the asset retirement obligations.

DD&A expense decreased $0.33 million, or 20% for the three months ended March 31, 2022 compared to the same period in 2021. This was primarily due to the increase in reserves reported and a decrease in production volumes. The lower volumes spread over the increased reserves resulted in lower DD&A.

### Impairment

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: |
| **Impairment** | **​** | **$—** | ​ | **$—** |

Epsilon performs a quantitative impairment test quarterly or whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable, over proved properties using the published NYMEX forward prices, timing, methods and other assumptions consistent with historical periods. When indicators of impairment are present, GAAP requires that the Company first compares expected future undiscounted cash flows by asset group to their respective carrying values. If the carrying amount exceeds the estimated undiscounted future cash flows, a reduction of the carrying amount of the natural gas properties to their estimated fair values is required, which is determined based on discounted cash flow techniques using significant assumptions including projected revenues, future commodity prices, and a market-specific weighted average cost of capital which are affected by expectations about future market and economic conditions.

During the three months ended March 31, 2021 and 2020, no impairment was required.

### General and Administrative

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: |
| **General and administrative** | **​** | **$1,313,434** | ​ | **$1,529,660** |

G&A expenses consist of general corporate expenses such as compensation, legal, accounting and professional fees, consulting services, travel and other related corporate costs such as stock options and restricted stock granted and the related non-cash compensation.

G&A expenses for the three months ended March 31, 2022 and 2021 decreased $0.2 million or 14%. This was mainly due to the decreased legal fees related to the complaint filed against Chesapeake, and decreased stock-based compensation as a result of no new stock grants.

### Interest Expense

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: |
| **Interest expense** | **​** | **$15,319** | ​ | $27,073 |

Interest expense relates to the commitment fees paid on the revolving line of credit.

Interest expense for the three months ended March 31, 2022 and 2021 decreased $0.01 million, or 43%. The decrease is due to the reduction in the borrowing base on our line of credit during this time.

### (Loss) Gain on Derivative Contracts

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: |
| **(Loss) gain on derivative contracts** | **​** | **$(971,904)** | **​** | **$465,341** |

For the three months ended March 31, 2022 and 2021, Epsilon entered into NYMEX Henry Hub Natural Gas Futures swap, Dominion basis swap, and two-way costless collar derivative contracts for the purpose of hedging its physical natural gas sales revenue. During the three months ended March 31, 2022 we had net cash settlements of

$1,211,728 on the settlement of contracts. During the three months ended March 31, 2021, we received net cash settlements of $64,200.

For the three months ended March 31, 2022, realized losses on derivative contracts increased primarily due to the rally in NYMEX Henry Hub Natural Gas Futures resulting in an increased liability for the short call portion of the two-way costless collar position. These increases in realized losses were minimally offset by realized gains on Dominion basis swap contracts. As of March 31, 2022, the Company had no derivative contracts.

### Other Income (Expense)

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended March 31, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: |
| **Interest income and other income** | **​** | **$9,815** | **​** | **$9,754** |

For the three months ended March 31, 2022 and 2021, other income consisted primarily of interest income and was consistent over the periods.

### Capital Resources and Liquidity

### Cash Flow

The primary source of cash for Epsilon during the three months ended March 31, 2022 and 2021 was funds generated from operations. In addition to operations, the primary uses of cash for the three months ended March 31, 2022 were development of natural gas properties and the distribution of dividends. The primary uses of cash for the three months ended March 31, 2021 were development of natural gas properties and the repurchase of shares of common stock.

At March 31, 2022, we had a working capital surplus of $27.6 million, an increase of $3.5 million over the $24.1 million surplus at December 31, 2021. The surplus increased from December 31, 2021 due mainly to the cash that is continually being generated by operations. The Company anticipates its current cash balance, cash flows from operations, and available sources of liquidity to be sufficient to meet its cash requirements for at least the next twelve months.

#### Three months ended March 31, 2022 compared to 2021

During the three months ended March 31, 2022, $7.7 million was provided by the Company’s operating activities, compared to $5.6 million provided during the same period in 2021, a $2.1 million, and 38% increase. The increase was mainly due to increased cash operations as a result of increased commodity prices, partially offset by the losses created on the hedges as they matured.

The Company used $2.9 million and $0.6 million of cash for investing activities during the three months ended March 31, 2022 and 2021, respectively. This was spent primarily on leasehold and development costs targeting increasing production in Pennsylvania and Oklahoma.

The Company used $1.3 million of cash for financing activities during the three months ended March 31, 2022. This was spent primarily on dividend payments. The Company used $0.5 million of cash for financing activities during the three months ended March 31, 2021. This cash was spent on the repurchase of common shares of the Company.

### Credit Agreement

In addition, the Company has a senior secured credit facility which includes a total commitment of up to $100 million. The current effective borrowing base is $14 million, which is subject to semi-annual redetermination. There are currently no borrowings under the facility. If Epsilon decided to access the facility, depending on the level of borrowing, the Company might need to increase its hedging activity. Borrowings from the Facility may be used for the acquisition and development of oil and gas properties, investments in cash flow generating assets complimentary to the production of oil and gas, and for letters of credit and other general corporate purposes. Upon each advance, interest is charged at the highest of a) rate of LIBOR plus an applicable margin (3.25%-4.25% based on the percent of the line of credit utilized) with the minimum being 0.25%, b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5%.

Effective April 6, 2021 the agreement was amended to extend the maturity date to March 1, 2024. In addition, the agreement was amended to include a *Benchmark Replacement* definition and transition plan to be used at such time when the LIBOR rate is discontinued.

On November 23, 2021, the borrowing base of $14 million was reaffirmed until May 1, 2022, the next periodic redetermination of the borrowing base.

The bank has a first priority security interest in the tangible and intangible assets of Epsilon Energy USA, Inc. to secure any outstanding amounts under the agreement. Under the terms of the agreement, the Company must maintain the following covenants:

- Interest coverage ratio greater than 3 based on income adjusted for interest, taxes and non-cash amounts.
- Current ratio, adjusted for line of credit amounts used and available and non-cash amounts, greater than 1.
- Leverage ratio less than 3.0 based on income adjusted for interest, taxes and non-cash amounts.

Epsilon was in compliance with the financial covenants of the agreement as of March 31, 2022 and expect to be in compliance for the next 12 months. We expect to remain in compliance as we currently have no borrowings under the facility and funded all operations for 2021 and all operations through March 31, 2022 out of operating cash flow and cash on hand and expect to continue to do so through 2022.

| ​ ​ ​ ​ | ​ ​ ​ | ​ ​ Balance at March 31, 2022 | ​ ​ ​ | ​ ​ Balance at December 31, 2021 | ​ ​ ​ | ​ ​ ​ ​ Borrowing Base March 31, 2022 | ​ ​ ​ ​ ​ Interest Rate |
| --- | --- | ---: | --- | ---: | --- | ---: | --- |
| **Revolving line of credit** | **​** | **$—** | **​** | **$—** | **​** | **$14,000,000** | **3 mo. LIBOR + 3.25%** |

### Repurchase Transactions

Commencing on January 1, 2022, the Company entered into a share repurchase program on the NASDAQ conducted in accordance with Rule 10b-18 promulgated under the Securities Exchange Act of 1934. The Company is authorized to repurchase up to 1,183,410 of its outstanding common shares up to an aggregate purchase price limit of $8 million, representing 5% of the outstanding common shares of Epsilon as of January 1, 2022. The program will end on December 31, 2022 unless the common shares or purchase price limits are reached before then or Epsilon provides earlier notice of termination. For the three months ended March 31, 2022, no shares have been repurchased.

Commencing on January 1, 2021, Epsilon conducted a normal course issuer bid (“NCIB”) to repurchase our issued and outstanding common shares, when doing so was accretive to management's estimates of intrinsic value per share. The NCIB ended on December 31, 2021. The Company used discretionary cash to fund these repurchases. During the year ended December 31, 2021, Epsilon repurchased 534,015 common shares of the authorized 1,193,000 purchase amount and spent $2,423,007 under the NCIB. The repurchased stock had an average price of $4.54 per share and were subsequently cancelled.

### Derivative Transactions

The Company has entered into hedging arrangements to reduce the impact of natural gas price volatility on operations. By removing the price volatility from a significant portion of natural gas production, the potential effects of changing prices on operating cash flows have been mitigated, but not eliminated. While mitigating the negative effects of falling commodity prices, these derivative contracts also limit the benefits we might otherwise receive from increases in commodity prices.

### Contractual Obligations

The following table summarizes Epsilon’s contractual obligations at March 31, 2022:

| ​ ​ ​ ​ | ​ ​ ​ | ​ ​ Payments Due by Period ​ ​ Total | ​ ​ | ​ ​ Less than 1 Year | ​ ​ | ​ ​ 1 – 3 Years | ​ ​ | ​ ​ Greater than 3 Years |
| --- | --- | ---: | --- | ---: | --- | ---: | --- | ---: |
| Asset retirement obligations, undiscounted | ​ | $7,511,953 | ​ | $11,209 | ​ | $— | ​ | $7,500,744 |
| Capital expenditure commitments | ​ | 1,026,737 | ​ | 1,026,737 | ​ | — | ​ | — |
| Operating leases | ​ | 202,633 | ​ | 140,189 | ​ | 62,444 | ​ | — |
| **Total future commitments** | ​ | $8,741,323 | ​ | $1,178,135 | ​ | $62,444 | ​ | $7,500,744 |

We enter into commitments for capital expenditures in advance of the expenditures being made. At a given point in time, it is estimated that we have committed to capital expenditures equal to approximately one quarter of our capital budget by means of giving the necessary authorizations to the asset operator to incur the expenditures in a future period. Current commitments have been included in the contractual obligations table above.

Based on current natural gas prices and anticipated levels of production, we believe that the estimated net cash generated from operations, together with cash on hand and amounts available under our credit agreement, will be adequate to meet liquidity needs for the next 12 months and beyond, including satisfying our financial obligations and funding our operating and development activities. To that end, subsequent to quarter end, the Company hedged approximately 15% of its anticipated remaining 2022 production through NYMEX costless collars.

### Off-Balance Sheet Arrangements

As of March 31, 2022, the Company had no off-balance sheet arrangements.

## Market risk

As filed, 2,787 characters.

Our earnings and cash flow are significantly affected by changes in the market price of commodities. The prices of natural gas and oil can fluctuate widely and are influenced by numerous factors such as demand, production levels, world political and economic events, and the strength of the US dollar relative to other currencies. Should the price of natural gas and oil decline substantially, the value of our assets could fall dramatically, impacting our future operations and exploration and development activities, along with our gas gathering system revenues. In addition, our operations are exposed to market risks in the ordinary course of our business, including interest rate and certain exposure as well as risks relating to changes in the general economic conditions in the United States.

### Gathering System Revenue Risk

The Auburn Gas Gathering System lies within the Marcellus Basin with historically high levels of recoverable reserves and low cost of production. We believe that a short-term low commodity price environment will not significantly impact the reserves produced and thus the revenue of our gas gathering system.

### Interest Rate Risk

Market risk is estimated as the change in fair value resulting from a hypothetical 100 basis point change in the interest rate on the outstanding balance under our credit agreement. The credit agreement allows us to fix the interest rate for all or a portion of the principal balance for a period up to three months. To the extent that the interest rate is fixed, interest rate changes affect the instrument’s fair market value but do not affect results of operations or cash flows. Conversely, for the portion of the credit agreement that has a floating interest rate, interest rate changes will not affect the fair market value but will affect future results of operations and cash flows.

At March 31, 2022 and 2021, the outstanding principal balance under the credit agreement was nil.

### Derivative Contracts

The Company’s financial results and condition depend on the prices received for natural gas production. Natural gas prices have fluctuated widely and are determined by economic and political factors. Supply and demand factors, including weather, general economic conditions, the ability to transport the gas to other regions, as well as conditions in other natural gas regions, impact prices. Epsilon has established a hedging strategy and may manage the risk associated with changes in commodity prices by entering into various derivative financial instrument agreements and physical contracts. Although these commodity price risk management activities could expose Epsilon to losses or gains, entering into these contracts helps to stabilize cash flows and support the Company’s capital spending program.

## Controls and procedures

As filed, 2,413 characters.

### Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Our principal executive officer and principal financial officer have concluded that our current disclosure controls and procedures were effective as of March 31, 2022 at the reasonable assurance level.

### Changes in Internal Control over Financial Reporting

No changes in our internal control over financial reporting occurred during the quarter ended March 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

### Inherent Limitations on Effectiveness of Controls

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that of limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, the risk.

## Risk factors

As filed, 164 characters.

There have been no material changes from the risk factors disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2021.

Filed May 12, 2022.
Source: SEC EDGAR, the filing index for accession 0001558370-22-008381. Last ingested by Listed: Oct 24, 2026, 15:15 ET. No prices; not investment advice.