# Epsilon Energy Ltd.: Form 10-Q for the period ended Sep 30, 2022

- Company: [Epsilon Energy Ltd.](/companies/epsn.md) (CIK 1726126)
- Form: 10-Q
- Filed: 2022-11-10
- Accepted by EDGAR: Nov 10, 2022, 17:18 ET
- Period: 2022-09-30
- Accession: 0001558370-22-017472
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1726126/000155837022017472/epsn-20220930x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1726126/000155837022017472/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2022-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2022-07-01 to 2022-09-30 | $21.2m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Revenue | 9 months, 2022-01-01 to 2022-09-30 | $54.7m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Operating income | 3 months, 2022-07-01 to 2022-09-30 | $14.4m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2022-01-01 to 2022-09-30 | $37.2m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2022-07-01 to 2022-09-30 | $17.5k | us-gaap:InterestExpense |
| Interest expense | 9 months, 2022-01-01 to 2022-09-30 | $33.6k | us-gaap:InterestExpense |
| Income tax | 3 months, 2022-07-01 to 2022-09-30 | $3.9m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2022-01-01 to 2022-09-30 | $10.1m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2022-07-01 to 2022-09-30 | $9.6m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2022-01-01 to 2022-09-30 | $26.0m | us-gaap:ProfitLoss |
| Diluted EPS | 3 months, 2022-07-01 to 2022-09-30 | $0.41 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2022-01-01 to 2022-09-30 | $1.11 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2022-07-01 to 2022-09-30 | $0.42 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2022-01-01 to 2022-09-30 | $1.11 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2022-07-01 to 2022-09-30 | 23,169,658 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2022-01-01 to 2022-09-30 | 23,524,574 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2022-01-01 to 2022-09-30 | $29.4m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Share repurchases | 9 months, 2022-01-01 to 2022-09-30 | $6.2m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2022-09-30 | $40.3m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2022-09-30 | $51.1m | us-gaap:AssetsCurrent |
| Total assets | at 2022-09-30 | $119.8m | us-gaap:Assets |
| Current liabilities | at 2022-09-30 | $10.6m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2022-09-30 | $23.7m | us-gaap:Liabilities |
| Shareholders' equity | at 2022-09-30 | $96.1m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 29,386 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 September 30, 2022 and 2021 and for the three and nine 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 areas of operations are the Marcellus shale section of the Appalachian basin in Pennsylvania and the NW Anadarko basin in Oklahoma. Our assets are in areas with established hydrocarbon resources with significant existing production. In Pennsylvania, we hold 4,597 net acres producing 25 MMcf/d. In Oklahoma, we hold 8,579 net acres producing 2.7 MMcfe/d.

In Pennsylvania, the Company owns a 35% interest in the 52 mile Auburn Gas Gathering System (“Auburn GGS") which is operated by a subsidiary of Williams Partners, LP.

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

### Business Strategy

The Company is focused on high rate of return capital investments in onshore North American natural gas and oil basins. We are committed to disciplined capital allocation which should include shareholder returns in the form of dividends and share buybacks. We expect that our strong balance sheet and large liquidity position will allow us to opportunistically invest in both our existing project areas and potential new projects.

To date, our investments have been focused in our position in the prolific Marcellus unconventional reservoir in Pennsylvania (“PA”). Our PA assets are supported by our 35% ownership in the Auburn GGS. More recently, we have been active in our position in the NW Stack area of Oklahoma. We have a substantial remaining drillable location inventory within our existing leaseholds.

The Company also seeks to identify new opportunities in onshore North American natural gas and oil basins.

### Three and nine months ended September 30, 2022 Highlights

### Operational Highlights

#### Marcellus Shale – Pennsylvania

- During the three months ended September 30, 2022, Epsilon’s realized natural gas price was $7.34 per Mcf compared to $3.43 per Mcf over the same period in 2021, a 114% increase. During the nine months ended September 30, 2022, Epsilon’s realized natural gas price was $6.25 per Mcf compared to $2.65 per Mcf over the same period in 2021, a 136% increase.
- During the three months ended September 30, 2022, Epsilon’s natural gas production was 2.3 Bcf compared to 2.6 Bcf during the same period in 2021, a 12% decrease. During the nine months ended September

30, 2022, Epsilon’s natural gas production was 6.7 Bcf compared to 7.5 Bcf during the same period in 2021, an 11% decrease. This decrease is due to natural decline in well production.

- Gathered and delivered 16.0 Bcf gross (5.6 Bcf net to Epsilon’s interest) during the three months ended September 30, 2022, or 174 MMcf/d through the Auburn Gas Gathering System. Gathered and delivered 50.9 Bcf gross (17.8 Bcf net to Epsilon’s interest) during the nine months ended September 30, 2022, or 187 MMcf/d through the Auburn Gas Gathering System.

#### Anadarko, NW Stack Trend – Oklahoma

- During the three months ended September 30, 2022, Epsilon’s realized price for all Oklahoma production was $9.42 per Mcfe compared to $6.17 per Mcfe over the same period in 2021, a 53% increase. During the nine months ended September 30, 2022, Epsilon’s realized price for all Oklahoma production was $8.82 per Mcfe compared to $4.55 per Mcfe over the same period in 2021, a 54% increase.
- Total production for the three months ended September 30, 2022 included natural gas, natural gas liquids, and oil and condensate and was 0.25 Bcfe, as compared to 0.37 Bcfe during the same period in 2021, a 32% decrease. This decrease is due to natural decline in well production. Total production for the nine months ended September 30, 2022 included natural gas, natural gas liquids, and oil and condensate and was 0.74 Bcfe, as compared to 0.50 Bcfe during the same period in 2021, a 48% increase. This increase is due to three new wells turned in line during the nine months ended September 30, 2022 compared to one new well over the same period in 2021.
- At September 30, 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 and nine months ended September 30, 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 September 30, 2022 | ​ | ​ ​ 2021 | ​ ​ | ​ ​ Nine months ended September 30, 2022 | ​ | ​ ​ 2021 |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| **Net income** | **​** | $9,608,453 | ​ | $1,396,466 | ​ | $25,997,329 | ​ | $3,647,008 |
| Add Back: | ​ | ​ ​ | ​ | ​ ​ | ​ | ​ ​ | ​ | ​ ​ |
| Net interest expense | ​ | ​ (72,137) | ​ | ​ 5,892 | ​ | ​ (93,239) | ​ | ​ 38,595 |
| Income tax expense | ​ | ​ 3,896,010 | ​ | ​ 643,072 | ​ | ​ 10,097,484 | ​ | ​ 1,621,894 |
| Depreciation, depletion, amortization, and accretion | **​** | **​** 1,706,030 | ​ | ​ 1,846,911 | **​** | **​** 4,898,988 | ​ | ​ 5,175,865 |
| Stock based compensation expense | ​ | ​ 500,597 | ​ | ​ 300,249 | ​ | ​ 836,949 | ​ | ​ 738,789 |
| Loss on derivative contracts net of cash received or paid on settlement | ​ | ​ 908,227 | ​ | ​ 2,593,888 | ​ | ​ (272,150) | ​ | ​ 3,928,421 |
| Foreign currency translation loss | ​ | ​ (4,750) | ​ | ​ 907 | ​ | ​ (419) | ​ | ​ 1,517 |
| **Adjusted EBITDA** | ​ | $16,542,430 | ​ | $6,787,384 | ​ | $41,464,942 | ​ | $15,152,089 |

### Results of Operations

### Net Operating Revenues

For the nine months ended September 30, 2022 revenues increased $26.1 million, or 91%, to $54.7 million from $28.6 million during the same period of 2021.

Revenue and volume statistics for the three and nine months ended September 30, 2022 and 2021 were as follows:

| ​ ​ ​ ​ Revenues | ​ ​ ​ ​ | ​ ​ Three months ended September 30, 2022 ​ ​ | ​ ​ | ​ ​ 2021 ​ ​ | ​ ​ ​ ​ | ​ ​ Nine months ended September 30, 2022 ​ ​ | ​ ​ | ​ ​ 2021 ​ ​ |
| --- | --- | ---: | --- | ---: | --- | ---: | --- | ---: |
| **Natural gas revenue** | **​** | **$17,893,822** | **​** | **$9,511,357** | **​** | **$44,581,254** | **​** | **$20,950,378** |
| Volume (MMcf) | ​ | 2,419 | ​ | 2,753 | ​ | 7,094 | ​ | 7,767 |
| Avg. Price ($/Mcf) | ​ | $7.40 | ​ | $3.46 | ​ | $6.28 | ​ | $2.70 |
| **Natural gas liquids revenue** | **​** | **$497,843** | **​** | **$490,535** | **​** | **$1,500,668** | **​** | **$588,685** |
| Volume (MBO) | ​ | 12.5 | ​ | 14.4 | ​ | 38.5 | ​ | 18.9 |
| Avg. Price ($/Bbl) | ​ | $39.91 | ​ | $34.02 | ​ | $38.96 | ​ | $31.13 |
| **Oil and condensate revenue** | **​** | **$779,456** | **​** | **$1,060,551** | **​** | **$2,484,360** | **​** | **$1,201,289** |
| Volume (MBO) | ​ | 7.6 | ​ | 15.0 | ​ | 24.1 | ​ | 17.4 |
| Avg. Price ($/Bbl) | ​ | $102.26 | ​ | $70.80 | ​ | $103.21 | ​ | $69.04 |
| **Gathering system revenue** | **​** | **$2,072,806** | **​** | **$2,038,616** | **​** | **$6,180,747** | **​** | **$5,891,868** |
| **Total Revenues** | **​** | **$21,243,927** | **​** | **$13,101,059** | **​** | **$54,747,029** | **​** | **$28,632,220** |

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) 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 nine months ended September 30, 2022, approximately 78% of the Auburn GGS revenues earned were gathering fees, while 22% were compression fees. For the three months ended September 30, 2022, approximately 79% of the Auburn GGS revenues earned were gathering fees, while 21% were compression fees. For the nine months ended September 30, 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 4.8% of total gathering revenues and third-party compression revenues represented 2.6% of total compression revenues. For the three months ended September 30, 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 2.4% of revenues and third-party compression revenues represented 2.2% of revenues. Revenues derived from Epsilon’s production which have been eliminated from gathering system revenues amounted to $0.37 million and $1.1 million for the three and nine months ended September 30, 2022, respectively, and $0.43 million and $1.2 million for the three and nine months ended September 30, 2021, respectively.

Upstream natural gas revenue for the nine months ended September 30, 2022 increased by $23.6 million, or 113%, over the same period in 2021. This was primarily a result of higher natural gas prices. For the nine months ended September 30, 2022, the average gas price increased by $3.58/Mcf, or 133%, over the same period in 2021. However, this revenue increase was partially offset by lower volumes being produced due to natural decline of the wells. Production for the nine months ended September 30, 2022 decreased by 673 Mcf, or 9%, over the same period in 2021. Upstream natural gas revenue for the three months ended September 30, 2022 increased by $8.4 million, or 88%, over the same period in 2021. This was also primarily a result of higher natural gas prices partially offset by lower volumes being produced due to natural decline of the wells. For the three months ended September 30, 2022, the average gas price increased by $3.94/Mcf, or 114%, over the same period in 2021. Production for the three months ended September 30, 2022 decreased by 334 Mcf, or 12%, over the same period in 2021.

Upstream natural gas liquids revenue for the nine months ended September 30, 2022 increased by $0.9 million, or 155%, over the same period in 2021. This was a result of increased production from new wells in Oklahoma in addition to higher prices. Natural gas liquids production for the nine months ended September 30, 2022 increased by 19.6 MBO, or 104%, over the same period in 2021. For the nine months ended September 30, 2022, the average price for natural gas liquids increased by $7.83/Bbl, or 25%, over the same period in 2021. Upstream natural gas liquids revenue for the three months ended September 30, 2022 increased by $0.7 million, or 1%, over the same period in 2021. This was a result of higher prices offset by lower volumes being produced due to natural decline of the wells. For the three months ended September 30, 2022, the average price for natural gas liquids increased by $5.89/Bbl, or 17%, over the same period in 2021. Natural gas liquids production for the three months ended September 30, 2022 decreased by 1.9 MBO, or 13% over the same period in 2021.

Upstream oil and condensate revenue for the nine months ended September 30, 2022 increased by $1.3 million, or 107%, over the same period in 2021. This was a result of increased production from new wells in Oklahoma in addition to higher prices. Oil and condensate production for the nine months ended September 30, 2022 increased by 6.7 MBO, or 38%, over the same period in 2021. For the nine months ended September 30, 2022, the average price for oil and condensate increased by $34.17/Bbl, or 49%, over the same period in 2021. Upstream oil and condensate revenue for the three months ended September 30, 2022 decreased by $0.3 million, or 27%, over the same period in 2021. This was a result of higher prices offset by decreased production from new wells in Oklahoma due to natural decline of the wells. For the three months ended September 30, 2022, the average price for oil and condensate increased by $31.46/Bbl, or 44%, over the same period in 2021. Oil and condensate production for the three months ended September 30, 2022 decreased by 7.4 MBO, or 49% over the same period in 2021.

The Company’s share of gathering system revenue increased by $0.3 million during the nine months ended September 30, 2022, increasing by 5% over the same period in 2021. The Company’s share of gathering system revenue stayed constant for the three months ended September 30, 2022 and 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 and nine months ended September 30, 2022 and 2021:

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended September 30, 2022 | ​ | ​ ​ 2021 | ​ ​ | ​ ​ Nine months ended September 30, 2022 | ​ | ​ ​ 2021 |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Lease operating costs | ​ | $2,399,092 | ​ | $2,240,259 | ​ | $6,791,496 | ​ | $5,618,584 |
| Gathering system operating costs | ​ | ​ 225,809 | ​ | ​ 138,887 | ​ | ​ 556,515 | ​ | ​ 503,381 |
| **​** | **​** | **$2,624,901** | **​** | **$2,379,146** | **​** | **$7,348,011** | **​** | **$6,121,965** |
| ​ | ​ | ​ **​** | **​** | **​** **​** | ​ | ​ **​** | **​** | **​** **​** |
| Upstream operating costs—Total $/Mcfe | ​ | ​ 0.93 | ​ | ​ 0.76 | ​ | ​ 0.91 | ​ | ​ 0.70 |
| Gathering system operating costs $/Mcf | ​ | ​ 0.07 | ​ | ​ 0.07 | ​ | ​ 0.05 | ​ | ​ 0.09 |

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 nine months ended September 30, 2022 increased $1.2 million, or 21%, over the same period in 2021. Upstream operating costs for the three months ended September 30, 2022 increased $0.2 million, or 7%, over the same period in 2021. The increase in total cost was primarily due to rising prices for services leading to a $0.93/Mcfe and $0.91/Mcfe for the three and nine months ended September 30, 2022, or 24% and 29%, increase, respectively 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 $1.1 million and $1.2 million for the nine months ended September 30, 2022 and 2021, respectively and $0.37 million and $0.43 million for the three months ended September 30, 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 nine months ended September 30, 2022 increased $0.05 million, or 11%, over the same period in 2021. Gathering system costs (net of intercompany elimination) for the three months ended March 31, 2022 increased $0.09 million, or 63%, over the same period in 2021.

The Company’s share of total gathering system costs increased $0.09 million, or 7%, for the nine months ended September 30, 2022 over 2021. The Company’s share of total gathering system costs increased $0.05 million, or 12%, for the three months ended September 30, 2022 over 2021. This increase is primarily due to an increase in throughput volumes into the gathering system.

### Loss on Derivative Contracts

| ​ ​ ​ | ​ ​ | ​ ​ Three months ended September 30, 2022 | ​ | ​ ​ 2021 | ​ ​ | ​ ​ Nine months ended September 30, 2022 | ​ | ​ ​ 2021 |
| --- | --- | ---: | --- | ---: | --- | ---: | --- | ---: |
| **Loss on derivative contracts** | **​** | **$(929,637)** | **​** | **$(5,055,130)** | **​** | **$(1,124,547)** | **​** | **$(6,417,123)** |

For the three and nine months ended September 30, 2022 and 2021, Epsilon entered into NYMEX Henry Hub two-way costless collar and Tennessee basis swap derivative contracts for the purpose of hedging its physical natural gas sales revenue. During the three and nine months ended September 30, 2022, we paid net cash settlements of $21,410 and $1,396,697, respectively. During the three and nine months ended September 30, 2021, we paid net cash settlements of $2,461,242 and $2,488,702, respectively.

For the three and nine months ended September 30, 2022, realized losses on derivative contracts decreased as the Company had less volume hedged and the NYMEX Henry Hub Natural Gas Futures price settled close to the strike prices of the Henry Hub collars. As of September 30, 2022, the Company had no derivative contracts beyond December 31, 2022.

### Capital Resources and Liquidity

### Cash Flow

The primary source of cash for Epsilon during the three and nine months ended September 30, 2022 and 2021 was funds generated from operations. The primary uses of cash for the three and nine months ended September 30, 2022 were development of natural gas properties, the repurchase of shares of common stock, and the distribution of dividends. The primary uses of cash for the three and nine months ended September 30, 2021 were development of natural gas properties and the repurchase of shares of common stock.

At September 30, 2022, we had a working capital surplus of $40.6 million, an increase of $16.4 million over the $24.1 million surplus at December 31, 2021. 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 the next twelve months and beyond.

#### Three and nine months ended September 30, 2022 compared to 2021

During the nine months ended September 30, 2022, $29.4 million was provided by the Company’s operating activities, compared to $13.5 million provided during the same period in 2021, a $15.9 million, and 117% increase. The increase was mainly due to increased cash from operations as a result of increased commodity prices, partially offset by the losses created on the hedges as they matured. During the three months ended September 30, 2022, $13.7 million was provided by the Company’s operating activities, compared to $5.5 million provided during the same period in 2021, a $8.2 million, and 149% increase. The increase was mainly due to increased cash from operations as a result of increased commodity prices.

The Company used $0.7 million and $5.7 million of cash for investing activities during the three and nine months ended September 30, 2022, respectively. This was spent primarily on leasehold and development costs targeting increasing production in Pennsylvania and Oklahoma. The Company used $2.1 million and $3.8 million of cash for investing activities during the three and nine months ended September 30, 2021, respectively. This was spent primarily on leasehold and development costs targeting increasing production in Pennsylvania.

The Company used $3.6 million and $9.9 million of cash for financing activities during the three and nine months ended September 30, 2022, respectively. This was spent primarily on dividend payments and the repurchase of shares of common stock. The Company used $1.3 million and $2.4 million of cash for financing activities during the three and nine months ended September 30, 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 decides to access the facility, depending on the level of borrowing, the Company will 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 August 2, 2022, the borrowing base of $14 million was reaffirmed until 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 September 30, 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 September 30, 2022 out of operating cash flow and cash on hand, and expect to continue to do so through 2022.

| ​ ​ ​ ​ | ​ ​ ​ | ​ ​ Balance at September 30, 2022 | ​ ​ ​ | ​ ​ Balance at December 31, 2021 | ​ ​ ​ | ​ ​ ​ ​ Borrowing Base September 30, 2022 | ​ ​ ​ ​ ​ Interest Rate |
| --- | --- | ---: | --- | ---: | --- | ---: | --- |
| **Revolving line of credit** | **​** | **$—** | **​** | **$—** | **​** | **$14,000,000** | **3 mo. LIBOR + 3.25%** |

### Repurchase Transactions

Commencing on March 8, 2022, 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 ends on March 7, 2023. The Company used discretionary cash to fund these repurchases. During the nine months ended September 30, 2022, Epsilon repurchased 982,500 common shares of the authorized 1,183,410 purchase amount and spent $6,234,879 under the NCIB. The repurchased stock had an average price of $6.32 per share (excluding commissions). During the three and nine months ended September 30, 2022, the Company cancelled zero and 423,000 common shares, respectively.

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 nine months ended September 30, 2021, Epsilon repurchased 525,615 common shares of the authorized 1,193,000 purchase amount and spent $2,377,181 under the NCIB. The repurchased stock had an average price of $4.51 per share (excluding commissions).

### Derivative Transactions

The Company has entered into hedging arrangements to reduce the impact of natural gas price volatility on operations. By reducing 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.

At September 30, 2022, Epsilon’s outstanding natural gas commodity contracts consisted of the following:

| ​ ​ ​ ​ ​ ​ Derivative Type 2022 ​ | ​ ​ Volume (MMbtu) ​ | ​ ​ ​ ​ | ​ ​ ​ ​ Ceiling Price ​ ​ | ​ ​ ​ ​ | ​ ​ ​ ​ Floor Price ​ ​ | ​ ​ ​ ​ | ​ ​ ​ ​ Basis Differential ​ ​ | ​ ​ ​ ​ | ​ ​ ​ ​ Fair Value of Asset September 30, 2022 ​ ​ |
| --- | ---: | --- | ---: | --- | ---: | --- | ---: | --- | --- |
| Basis swap | 305,000 | ​ | $— | ​ | $— | ​ | $(1.15) |  | ​ (4,837) |
| Two-way costless collar | 305,000 | ​ | $8.20 | ​ | $6.50 | ​ | $— |  | ​ 37,163 |
| ​ | 610,000 | ​ | ​ ​ | ​ | ​ ​ | ​ | ​ ​ | ​ | $32,326 |

### Contractual Obligations

The Company enters into commitments for capital expenditures in advance of the expenditures being made. As of September 30, 2022, the Company had short term commitments of $0.4 million for capital expenditures and long term commitments of $7.4 million for asset retirement obligations.

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.

### Off-Balance Sheet Arrangements

As of September 30, 2022, the Company had no off-balance sheet arrangements.

## Market risk

As filed, 2,791 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 September 30, 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, 2,421 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 September 30, 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 September 30, 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 Nov 10, 2022.
Source: SEC EDGAR, the filing index for accession 0001558370-22-017472. Last ingested by Listed: Oct 24, 2026, 15:15 ET. No prices; not investment advice.