UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10‑Q10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 20192022
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 001-38770
EPSILON ENERGY LTD.
(Exact name of registrant as specified in its charter)
| | |
Alberta, Canada | | 98-1476367 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S Employer Identification No.) |
116701 Greenspoint Park16945 Northchase Drive, Suite 1951610
Houston, Texas77060
(281) 670‑0002(281) 670-0002
(Address of principal executive offices including zip code and
telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| | |
Title of each class | Trading Symbol | Name of each exchange on which registered |
Common Shares, no par value | “EPSN” | NASDAQ Global Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒⌧ No ☐◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒
Yes⌧ No ☐◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑212b-2 of the Exchange Act.
Large accelerated filer | Accelerated filer | Non-accelerated filer |
Smaller reporting company ☒ | Emerging growth company ☒ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Yes ☐ No ☒⌧
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑212b-2 of the Exchange Act).
Yes ☐ No ☒⌧
Securities registered pursuant to Section 12(b) of the Act:
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As of May 10, 20192022, there were 27,355,24723,773,203 Common Shares outstanding.outstanding.
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Contents |
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| 5 | ||
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| 5 | ||
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) | | 6 | |
Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity | | 7 | |
| 8 | ||
Notes to the Unaudited Condensed Consolidated Financial Statements | | 9 | |
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | | 24 | |
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| Depletion, Depreciation, Amortization and Accretion (“DD&A”) | | 28 |
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Contents |
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| 4 | ||
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Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income |
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Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity |
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Notes to the Unaudited Condensed Consolidated Financial Statements |
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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| Depletion, Depreciation, Amortization and Accretion (“DD&A”) |
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | | 32 | |
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ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS | | 34 | |
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| 35 |
Certain statements contained in this report constitute forward-looking statements. The use of any of the words ‘‘anticipate,’’ ‘‘continue,’’ ‘‘estimate,’’ ‘‘expect,’’ ‘‘may,’’ ‘‘will,’’ ‘‘project,’’ ‘‘should,’’ ‘‘believe,’’ and similar expressions and statements relating to matters that are not historical facts constitute ‘‘forward looking information’’ within the meaning of applicable securities laws. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated. Such forward-looking statements are based on reasonable assumptions, but no assurance can be given that these expectations will prove to be correct and the forward-looking statements included in this report should not be unduly relied upon. These statements are made only as of the date of this report. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future — including statements relating to oilnatural gas and natural gasoil production rates, commodity prices for crude oil or natural gas, supply and demand for oilnatural gas and natural gas;oil; the estimated quantity of oilnatural gas and natural gasoil reserves, including reserve life; future development and production costs, and statements expressing general views about future operating results — are forward-looking statements. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in our Annual Report on Form 10-K for the year ended December 31, 2018,2021, and those described from time to time in our future reports filed with the Securities and Exchange Commission.You should consider carefully the statements under Item 1A. Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2021. Our Annual Report on Form 10-K for the year ended December 31, 2021 is available on our website at www.epsilonenergyltd.com.
4
Unaudited Condensed Consolidated Balance Sheets
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| March 31, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
ASSETS |
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Current assets |
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Cash and cash equivalents |
| $ | 16,591,331 |
| $ | 14,401,257 |
Accounts receivable |
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| 3,981,775 |
|
| 5,042,134 |
Prepaid income taxes |
|
| 785,739 |
|
| 205,711 |
Other current assets |
|
| 419,201 |
|
| 244,233 |
Total current assets |
|
| 21,778,046 |
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| 19,893,335 |
Non-current assets |
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Property and equipment: |
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Oil and gas properties, successful efforts method |
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Proved properties |
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| 120,179,795 |
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| 118,851,574 |
Unproved properties |
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| 20,357,273 |
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| 19,498,666 |
Accumulated depletion, depreciation, and amortization |
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| (85,131,120) |
|
| (83,807,401) |
Total oil and gas properties, net |
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| 55,405,948 |
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| 54,542,839 |
Gathering system |
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| 41,065,956 |
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| 41,040,847 |
Accumulated depletion, depreciation, and amortization |
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| (28,609,797) |
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| (28,137,573) |
Total gathering system, net |
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| 12,456,159 |
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| 12,903,274 |
Total property and equipment, net |
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| 67,862,107 |
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| 67,446,113 |
Other assets: |
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Restricted cash |
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| 558,597 |
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| 558,261 |
Fair value of derivatives |
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| 190,428 |
|
| — |
Total non-current assets |
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| 68,611,132 |
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| 68,004,374 |
Total assets |
| $ | 90,389,178 |
| $ | 87,897,709 |
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LIABILITIES AND SHAREHOLDERS' EQUITY |
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Current liabilities |
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Accounts payable trade |
| $ | 4,108,523 |
| $ | 2,585,324 |
Royalties payable |
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| 1,178,331 |
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| 1,300,539 |
Other accrued liabilities |
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| 683,651 |
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| 2,156,304 |
Fair value of derivatives |
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| 813,961 |
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| 297,023 |
Total current liabilities |
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| 6,784,466 |
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| 6,339,190 |
Non-current liabilities |
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Asset retirement obligation |
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| 1,654,944 |
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| 1,625,154 |
Deferred income taxes |
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| 10,735,874 |
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| 9,989,278 |
Total non-current liabilities |
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| 12,390,818 |
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| 11,614,432 |
Total liabilities |
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| 19,175,284 |
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| 17,953,622 |
Commitments and contingencies (See Note 8) |
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Shareholders' equity |
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Common shares, no par value, unlimited shares authorized and 27,355,247 shares and 27,385,133 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively; 0 and 26,953 treasury shares at March 31, 2019 and December 31, 2018, respectively. |
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| 143,362,642 |
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| 143,611,023 |
Additional paid-in capital |
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| 6,652,748 |
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| 6,519,028 |
Accumulated deficit |
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| (88,610,218) |
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| (89,983,894) |
Accumulated other comprehensive income |
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| 9,808,722 |
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| 9,797,930 |
Total shareholders' equity |
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| 71,213,894 |
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| 69,944,087 |
Total liabilities and shareholders' equity |
| $ | 90,389,178 |
| $ | 87,897,709 |
| | | | | | |
|
| March 31, |
| December 31, | ||
| | 2022 | | 2021 | ||
ASSETS | | | | | | |
Current assets | | | | | | |
Cash and cash equivalents | | $ | 30,070,813 | | $ | 26,497,305 |
Accounts receivable | | | 6,468,261 | | | 4,596,931 |
Other current assets | | | 465,694 | | | 569,870 |
Total current assets | | | 37,004,768 | | | 31,664,106 |
Non-current assets | | | | | | |
Property and equipment: | | | | | | |
Oil and gas properties, successful efforts method | | | | | | |
Proved properties | | | 140,557,389 | | | 138,032,413 |
Unproved properties | | | 21,793,526 | | | 21,700,926 |
Accumulated depletion, depreciation, amortization and impairment | | | (103,558,669) | | | (102,480,972) |
Total oil and gas properties, net | | | 58,792,246 | | | 57,252,367 |
Gathering system | | | 42,490,479 | | | 42,475,086 |
Accumulated depletion, depreciation, amortization and impairment | | | (33,727,110) | | | (33,443,949) |
Total gathering system, net | | | 8,763,369 | | | 9,031,137 |
Land | | | 637,764 | | | 637,764 |
Buildings and other property and equipment, net | | | 300,318 | | | 309,102 |
Total property and equipment, net | | | 68,493,697 | | | 67,230,370 |
Other assets: | | | | | | |
Restricted cash | | | 568,854 | | | 568,118 |
Total non-current assets | | | 69,062,551 | | | 67,798,488 |
Total assets | | $ | 106,067,319 | | $ | 99,462,594 |
| | | | | | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | |
Current liabilities | | | | | | |
Accounts payable trade | | $ | 1,820,112 | | $ | 1,189,905 |
Gathering fees payable | | | 843,523 | | | 963,546 |
Royalties payable | | | 1,956,002 | | | 1,853,508 |
Income taxes payable | | | 3,255,717 | | | 1,098,425 |
Accrued capital expenditures | | | 732,523 | | | 1,016,830 |
Other accrued liabilities | | | 802,188 | | | 1,098,127 |
Fair value of derivatives | | | — | | | 239,824 |
Asset retirement obligations | | | 11,209 | | | 85,207 |
Total current liabilities | | | 9,421,274 | | | 7,545,372 |
Non-current liabilities | | | | | | |
Asset retirement obligations | | | 2,774,709 | | | 2,748,449 |
Deferred income taxes | | | 9,928,126 | | | 9,905,440 |
Total non-current liabilities | | | 12,702,835 | | | 12,653,889 |
Total liabilities | | | 22,124,109 | | | 20,199,261 |
Commitments and contingencies (Note 9) | | | | | | |
Shareholders' equity | | | | | | |
Common shares, 0 par value, unlimited shares authorized and 23,706,953 issued and outstanding at March 31, 2022 and 24,202,218 issued and 23,668,203 shares outstanding at December 31, 2021. | | | 129,602,044 | | | 131,815,739 |
Treasury shares, 0 at March 31, 2022 and 534,015 at December 31, 2021 | | | — | | | (2,423,007) |
Additional paid-in capital | | | 8,977,505 | | | 8,835,203 |
Accumulated deficit | | | (64,460,346) | | | (68,783,207) |
Accumulated other comprehensive income | | | 9,824,007 | | | 9,818,605 |
Total shareholders' equity | | | 83,943,210 | | | 79,263,333 |
Total liabilities and shareholders' equity | | $ | 106,067,319 | | $ | 99,462,594 |
The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements
5
EPSILON ENERGY LTD.
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
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| Three months ended March 31, |
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| 2019 |
| 2018 |
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Revenues: |
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Oil, gas, NGLs and condensate revenue |
| $ | 5,507,663 |
| $ | 5,001,796 |
|
Gas gathering and compression revenue |
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| 2,438,351 |
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| 2,776,206 |
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Total revenue |
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| 7,946,014 |
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| 7,778,002 |
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Operating costs and expenses: |
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Lease operating expenses |
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| 1,718,293 |
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| 1,930,214 |
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Gathering system operating expenses |
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| 312,787 |
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| 429,764 |
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Depletion, depreciation, amortization, and accretion |
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| 1,825,731 |
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| 1,790,619 |
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General and administrative expenses: |
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Stock based compensation expense |
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| 133,720 |
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| 83,047 |
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Other general and administrative expenses |
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| 1,339,562 |
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| 724,874 |
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Total operating costs and expenses |
|
| 5,330,093 |
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| 4,958,518 |
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Operating income |
|
| 2,615,921 |
|
| 2,819,484 |
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Other income and (expense): |
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Interest income |
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| 42,691 |
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| 907 |
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Interest expense |
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| (27,609) |
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| (45,396) |
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Gain (loss) on derivative contracts |
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| (510,754) |
|
| 370,981 |
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Other income |
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| 23 |
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| 293 |
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Other income (expense), net |
|
| (495,649) |
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| 326,785 |
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Income before tax |
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| 2,120,272 |
|
| 3,146,269 |
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Income tax expense |
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| 746,596 |
|
| 987,042 |
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NET INCOME |
| $ | 1,373,676 |
| $ | 2,159,227 |
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Currency translation adjustments |
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| 10,792 |
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| (56,509) |
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NET COMPREHENSIVE INCOME |
| $ | 1,384,468 |
| $ | 2,102,718 |
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Net income per share, basic |
| $ | 0.05 |
| $ | 0.08 |
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Net income per share, diluted |
| $ | 0.05 |
| $ | 0.08 |
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Weighted average number of shares outstanding, basic |
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| 27,392,755 |
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| 27,521,504 |
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Weighted average number of shares outstanding, diluted |
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| 27,408,374 |
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| 27,532,557 |
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| | Three months ended March 31, | ||||
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| 2022 |
| 2021 | ||
Revenues from contracts with customers: | | | | | | |
Gas, oil, NGL, and condensate revenue | | $ | 11,479,325 | | $ | 6,439,155 |
Gas gathering and compression revenue | | | 2,120,773 | | | 2,002,157 |
Total revenue | | | 13,600,098 | | | 8,441,312 |
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Operating costs and expenses: | | | | | | |
Lease operating expenses | | | 1,770,654 | | | 1,594,188 |
Gathering system operating expenses | | | 159,211 | | | 190,947 |
Development geological and geophysical expenses | | | 2,386 | | | 11,539 |
Depletion, depreciation, amortization, and accretion | | | 1,389,219 | | | 1,682,860 |
General and administrative expenses: | | | | | | |
Stock based compensation expense | | | 142,302 | | | 202,499 |
Other general and administrative expenses | | | 1,171,132 | | | 1,327,161 |
Total operating costs and expenses | | | 4,634,904 | | | 5,009,194 |
Operating income | | | 8,965,194 | | | 3,432,118 |
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Other income (expense): | | | | | | |
Interest income | | | 15,221 | | | 7,813 |
Interest expense | | | (15,319) | | | (27,073) |
(Loss) gain on derivative contracts | | | (971,904) | | | 465,341 |
Other (expense) income | | | (5,406) | | | 1,941 |
Other (expense) income, net | | | (977,408) | | | 448,022 |
| | | | | | |
Net income before income tax expense | | | 7,987,786 | | | 3,880,140 |
Income tax expense | | | 2,181,898 | | | 1,144,573 |
NET INCOME | | $ | 5,805,888 | | $ | 2,735,567 |
Currency translation adjustments | | | 5,402 | | | 242 |
NET COMPREHENSIVE INCOME | | $ | 5,811,290 | | $ | 2,735,809 |
| | | | | | |
Net income per share, basic | | $ | 0.25 | | $ | 0.11 |
Net income per share, diluted | | $ | 0.24 | | $ | 0.11 |
Weighted average number of shares outstanding, basic | | | 23,677,842 | | | 23,947,222 |
Weighted average number of shares outstanding, diluted | | | 23,862,428 | | | 24,030,104 |
The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements
6
EPSILON ENERGY LTD.
Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity
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| Accumulated |
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| | | | | | | | | | | | | | Other | | | | Total | ||||
| | Common Shares Issued | | Treasury Shares | | Additional | | Comprehensive | | Accumulated | | Shareholders' | ||||||||||
| | Shares | | Amount | | Shares | | Amount | | paid-in Capital | | Income | | Deficit | | Equity | ||||||
Balance at January 1, 2022 | | 24,202,218 | | $ | 131,815,739 | | (534,015) | | $ | (2,423,007) | | $ | 8,835,203 | | $ | 9,818,605 | | $ | (68,783,207) | | $ | 79,263,333 |
Net income | | — | | | — | | — | | | — | | | — | | | — | | | 5,805,888 | | | 5,805,888 |
Dividends | | — | | | — | | — | | | — | | | — | | | — | | | (1,483,027) | | | (1,483,027) |
Stock-based compensation expenses | | — | | | — | | — | | | — | | | 142,302 | | | — | | | — | | | 142,302 |
Exercise of stock options | | 38,750 | | | 209,312 | | — | | | — | | | — | | | — | | | — | | | 209,312 |
Retirement of treasury shares | | (534,015) | | | (2,423,007) | | 534,015 | | | 2,423,007 | | | — | | | — | | | — | | | — |
Other comprehensive income | | — | | | — | | — | | | — | | | — | | | 5,402 | | | — | | | 5,402 |
Balance at March 31, 2022 | | 23,706,953 | | $ | 129,602,044 | | — | | $ | — | | $ | 8,977,505 | | $ | 9,824,007 | | $ | (64,460,346) | | $ | 83,943,210 |
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| Accumulated |
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| Other |
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| Total | |||||
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| Share |
| Additional |
| Comprehensive |
| Accumulated |
| Shareholders' | |||||
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| Capital |
| paid-in Capital |
| Income (Loss) |
| Deficit |
| Equity | |||||
Balance at December 31, 2017 |
| $ | 144,292,238 |
| $ | 6,171,525 |
| $ | 9,913,236 |
| $ | (96,645,954) |
| $ | 63,731,045 |
Net income |
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| — |
|
| — |
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| — |
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| 2,159,227 |
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| 2,159,227 |
Stock-based compensation expenses |
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| — |
|
| 83,047 |
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| — |
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| — |
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| 83,047 |
Buyback and retirement of common shares |
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| (71,582) |
|
| 17,271 |
|
| — |
|
| — |
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| (54,311) |
Other comprehensive income |
|
| — |
|
| — |
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| (56,509) |
|
| — |
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| (56,509) |
Balance at March 31, 2018 |
| $ | 144,220,656 |
| $ | 6,271,843 |
| $ | 9,856,727 |
| $ | (94,486,727) |
| $ | 65,862,499 |
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| Accumulated |
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| Other |
|
|
| Total | |||||
|
| Share |
| Additional |
| Comprehensive |
| Accumulated |
| Shareholders' | |||||
|
| Capital |
| paid-in Capital |
| Income (Loss) |
| Deficit |
| Equity | |||||
Balance at December 31, 2018 |
|
| 143,611,023 |
|
| 6,519,028 |
|
| 9,797,930 |
|
| (89,983,894) |
|
| 69,944,087 |
Net income |
|
| — |
|
| — |
|
| — |
|
| 1,373,676 |
|
| 1,373,676 |
Stock-based compensation expenses |
|
| — |
|
| 133,720 |
|
| — |
|
| — |
|
| 133,720 |
Buyback and retirement of common shares |
|
| (248,381) |
|
| — |
|
| — |
|
| — |
|
| (248,381) |
Other comprehensive loss |
|
| — |
|
| — |
|
| 10,792 |
|
| — |
|
| 10,792 |
Balance at March 31, 2019 |
| $ | 143,362,642 |
| $ | 6,652,748 |
| $ | 9,808,722 |
| $ | (88,610,218) |
| $ | 71,213,894 |
| | | | | | | | | | | | | | | | | | | | | | |
|
| |
| | |
| |
| | |
| |
| Accumulated |
| |
| | ||||
| | | | | | | | | | | | Other | | | | Total | ||||||
| | Common Shares Issued | | Treasury Shares | | Additional | | Comprehensive | | Accumulated | | Shareholders' | ||||||||||
| | Shares | | Amount | | Shares | | Amount | | paid-in Capital | | Income | | Deficit | | Equity | ||||||
Balance at January 1, 2021 | | 23,985,799 | | $ | 131,730,401 | | — | | $ | — | | $ | 7,879,119 | | $ | 9,820,647 | | $ | (80,410,724) | | $ | 69,019,443 |
Net income | | — | | | — | | — | | | — | | | — | | | — | | | 2,735,567 | | | 2,735,567 |
Stock-based compensation expenses | | — | | | — | | — | | | — | | | 202,499 | | | — | | | — | | | 202,499 |
Buyback of common shares | | — | | | — | | (123,200) | | | (492,479) | | | — | | | — | | | — | | | (492,479) |
Other comprehensive income | | — | | | — | | — | | | — | | | — | | | 242 | | | — | | | 242 |
Balance at March 31, 2021 | | 23,985,799 | | | 131,730,401 | | (123,200) | | | (492,479) | | | 8,081,618 | | | 9,820,889 | | | (77,675,157) | | $ | 71,465,272 |
The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements
7
EPSILON ENERGY LTD.
Unaudited Condensed Consolidated Statements of Cash Flows
|
|
|
|
|
|
|
|
| Three months ended March 31, | ||||
|
| 2019 |
| 2018 | ||
Cash flows from operating activities: |
|
|
|
|
|
|
Net income |
| $ | 1,373,676 |
| $ | 2,159,227 |
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
Depletion, depreciation, amortization, and accretion |
|
| 1,825,731 |
|
| 1,790,619 |
(Gain) loss on derivative contracts |
|
| 510,754 |
|
| (370,981) |
Cash received (paid) from settlements of derivative contracts |
|
| (184,244) |
|
| 106,456 |
Stock-based compensation expense |
|
| 133,720 |
|
| 83,047 |
Deferred income tax expense (benefit) |
|
| 746,596 |
|
| (161,774) |
Changes in current assets and liabilities: |
|
|
|
|
|
|
Accounts receivable |
|
| 1,060,359 |
|
| (515,214) |
Prepaid income taxes and other current assets |
|
| (754,996) |
|
| 69,987 |
Accounts payable, royalties payable and other accrued liabilities |
|
| (772,879) |
|
| (774,088) |
Other long-term liabilities |
|
| — |
|
| 35,431 |
Net cash provided by operating activities |
|
| 3,938,717 |
|
| 2,422,710 |
Cash flows from investing activities: |
|
|
|
|
|
|
Acquisition of unproved oil and gas properties |
|
| (596,500) |
|
| — |
Additions to unproved oil and gas properties |
|
| (262,107) |
|
| (164,518) |
Additions to proved oil and gas properties |
|
| (586,815) |
|
| (147,407) |
Additions to gathering system properties |
|
| (65,296) |
|
| (6,239) |
Changes in restricted cash |
|
| (336) |
|
| (539) |
Net cash used in investing activities |
|
| (1,511,054) |
|
| (318,703) |
Cash flows from financing activities: |
|
|
|
|
|
|
Buyback of common shares |
|
| (248,381) |
|
| (54,311) |
Net cash used in financing activities |
|
| (248,381) |
|
| (54,311) |
Effect of currency rates on cash and cash equivalents |
|
| 10,792 |
|
| (56,509) |
Increase in cash and cash equivalents |
|
| 2,190,074 |
|
| 1,993,187 |
Cash and cash equivalents, beginning of year |
|
| 14,401,257 |
|
| 9,998,853 |
Cash and cash equivalents, end of year |
| $ | 16,591,331 |
| $ | 11,992,040 |
|
|
|
|
|
|
|
Supplemental cash flow disclosures: |
|
|
|
|
|
|
Income taxes paid |
| $ | 580,000 |
| $ | 1,376,493 |
Interest paid |
| $ | 31,391 |
| $ | 45,396 |
|
|
|
|
|
|
|
Non-cash investing activities: |
|
|
|
|
|
|
Change in proved properties accrued in accounts payable and accrued liabilities |
| $ | 741,406 |
| $ | 18,785 |
Change in gathering system accrued in accounts payable and accrued liabilities |
| $ | (40,187) |
| $ | 14,969 |
Asset retirement obligation asset additions and adjustments |
| $ | 2 |
| $ | 46 |
| | | | | | |
| | Three months ended March 31, | ||||
|
| 2022 |
| 2021 | ||
Cash flows from operating activities: | | | | | | |
Net income | | $ | 5,805,888 | | $ | 2,735,567 |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | |
Depletion, depreciation, amortization, and accretion | | | 1,389,219 | | | 1,682,860 |
Plug and abandon of proved properties | | | (73,998) | | | — |
Loss (gain) on derivative contracts | | | 971,904 | | | (465,341) |
Settlement (paid) received on derivative contracts | | | (1,211,728) | | | 64,200 |
Settlement of asset retirement obligation | | | — | | | (3,483) |
Stock-based compensation expense | | | 142,302 | | | 202,499 |
Deferred income tax expense | | | 22,686 | | | 805,359 |
Changes in assets and liabilities: | | | | | | |
Accounts receivable | | | (1,871,330) | | | 454,740 |
Prepaid income taxes and other current assets | | | 104,177 | | | 161,374 |
Accounts payable, royalties payable and other accrued liabilities | | | 267,058 | | | (349,705) |
Income taxes payable | | | 2,157,292 | | | 336,798 |
Net cash provided by operating activities | | | 7,703,470 | | | 5,624,868 |
Cash flows from investing activities: | | | | | | |
Additions to unproved oil and gas properties | | | (92,600) | | | (23,702) |
Additions to proved oil and gas properties | | | (2,771,925) | | | (481,021) |
Additions to gathering system properties | | | 3,612 | | | (40,963) |
Additions to land, buildings and property and equipment | | | — | | | (5,745) |
Prepaid drilling costs | | | — | | | 156 |
Net cash used in investing activities | | | (2,860,913) | | | (551,275) |
Cash flows from financing activities: | | | | | | |
Buyback of common shares | | | — | | | (492,479) |
Exercise of stock options | | | 209,312 | | | — |
Dividends | | | (1,483,027) | | | — |
Net cash used in financing activities | | | (1,273,715) | | | (492,479) |
Effect of currency rates on cash, cash equivalents and restricted cash | | | 5,402 | | | 242 |
Increase in cash, cash equivalents and restricted cash | | | 3,574,244 | | | 4,581,356 |
Cash, cash equivalents and restricted cash, beginning of period | | | 27,065,423 | | | 13,836,771 |
Cash, cash equivalents and restricted cash, end of period | | $ | 30,639,667 | | $ | 18,418,127 |
| | | | | | |
Supplemental cash flow disclosures: | | | | | | |
Interest paid | | $ | 17,501 | | $ | 29,562 |
| | | | | | |
Non-cash investing activities: | | | | | | |
Change in unproved properties accrued in accounts payable and accrued liabilities | | $ | — | | $ | (65,000) |
Change in proved properties accrued in accounts payable and accrued liabilities | | $ | (253,632) | | $ | 468,972 |
Change in gathering system accrued in accounts payable and accrued liabilities | | $ | 19,005 | | $ | (27,679) |
Asset retirement obligation asset additions and adjustments | | $ | 6,684 | | $ | (21,554) |
The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements
8
Epsilon Energy Ltd. (the “Corporation”“Company” or “Epsilon” or “we”) was incorporated under the laws of the Province of Alberta, Canada on March 14, 2005. On October 24, 2007, the CorporationCompany became a publicly traded entity trading on the Toronto Stock Exchange (“TSX”) in Canada. On February 14, 2019, Epsilon’s registration statement on Form 10 was declared effective by the United States Securities and Exchange Commission and on February 19, 2019, wethe Company began trading in the United States on the NASDAQ Global Market under the trading symbol “EPSN.” Effective as of the close of trading on March 15, 2019 Epsilon voluntarily delisted its common shares from the TSX. The CorporationCompany is engaged in the acquisition, development, gathering and production of primarily natural gas reserves in the United States.
The address of its registered office is 14505 Bannister Road SE, Suite 300, Calgary, AB, Canada T2X 3J3.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the appropriate rules and regulations of the SEC. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. All adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented have been included. The interim financial information and notes hereto should be read in conjunction with the Corporation’sCompany’s consolidated financial statements as of and for the yearsyear ended December 31, 2018 and 2017.2021. The results of operations for interim periods are not necessarily indicative of results to be expected for a full fiscal year.
The Corporation’sCompany’s unaudited condensed consolidated financial statements include the accounts of the CorporationCompany and its wholly owned subsidiary, Epsilon Energy USA, Inc. and its wholly owned subsidiaries, Epsilon Midstream, LLC, Dewey Energy GP, LLC, and Dewey Energy Holdings, LLC, Epsilon Operating, LLC, and Altolisa Holdings, LLC. With regard to the gathering system, in which Epsilon owns an undivided interest in the asset, proportionate consolidation accounting is used. All inter-company transactions have been eliminated.
The preparation of financial statements in conformity with GAAPaccounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved oilnatural gas and natural gasoil reserves and related cash flow estimates used in impairment tests of oilnatural gas and natural gasoil, and gathering system properties, asset retirement obligations, accrued oilnatural gas and natural gasoil revenues and operating expenses, accrued gathering system revenues and operating expenses, as well as the valuation of commodity derivative instruments. Actual results could differ from those estimates.
Recently Issued Accounting Standards
The Corporation,Company, an emerging growth company (“EGC”), has elected to take advantage of the benefits of the extended transition period provided for in Section 7(a)(2)(B) of the Securities Act, for complying with new or revised accounting standards which allows the CorporationCompany to defer adoption of certain accounting standards until those standards would otherwise apply to private companies.
In August 2018,March 2020, the Financial Accounting Standards Board (“FASB”)FASB issued ASU 2018-13, ‘‘Fair Value MeasurementNo. 2020-04 - Reference Rate Reform (Topic 820)848), codified as ASC 848 (“ASC 848”). This was followed by ASU No. 2021-01, Reference Rate Reform (Topic 848): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement,’’ theScope (“ASU 2021-01”), issued in January 2021. The purpose of whichASC 848 is to improveprovide optional guidance to ease the effectiveness of fair value measurement disclosures. The amendments in this ASU are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, which the Board finalizedpotential effects on August 28, 2018. The Board used thefinancial
9
reporting of the market-wide migration away from Interbank Offered Rates (“IBORs”) to alternative reference rates. ASC 848 applies only to contracts, hedging relationships, and other transactions that reference a reference rate expected to be discontinued because of reference rate reform. The guidance in the Concepts Statement to improve the effectiveness of ASC 820’s disclosure requirements. ASU 2018-13 is effective for all entities for fiscal years beginning after December 15, 2019, including interim periods therein. Early adoption is permitted for any eliminated or modified disclosuresmay be applied upon issuance of this ASU.ASC 848 through December 31, 2022. We have examined the provisions and do not anticipate anyexpect a material impact from the adoption of them to materially affect our financial statements.this ASU.
In FebruaryJune 2016 the FASB issued ASU 2016-02, “Leases2016-13, Financial Instruments – Credit Losses (Topic 842)” (ASU 2016-02),326): Measurement of Credit Losses on Financial Instruments, which significantly changes accountingremoves the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for leases by requiring that lessees recognize a right of use asset and a related lease liability representingcredit losses for the obligation to make lease payments, for all lease transactions with terms greater than one year. Additional disclosures about an entity’s lease transactions will also be required. ASU 2016-02 defines a lease as “a contract, or partdifference between the amortized cost basis of a contract,financial instrument and the amount of amortized cost that conveys the rightCompany expects to controlcollect over the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”instrument’s contractual life. ASU 2016-022016-13 is effective for fiscal years beginning after December 15, 2019,2022, and interim periods within those fiscal years, beginning after December 15, 2020. Lessees and lessors are requiredmust be applied retrospectively. Early adoption is permitted. Epsilon will adopt ASU 2016-13 as of January 1, 2023.
In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), which will require lessees to recognize a right of use asset and measurea lease liability on their balance sheet for all leases, including operating leases, with a term of greater than 12 months. In July 2018, the FASB issued ASU 2018-11, which adds a transition option permitting entities to apply the provisions of the new standard at the beginningits adoption date instead of the earliest comparative period presented in the consolidated financial statements using a modified retrospective approach. Epsilon is reviewingstatements. Under this transition option, comparative reporting would not be required, and the provisions of ASU 2016-02the standard would be applied prospectively to leases in effect at the date of adoption.
The Company has determined its portfolio of leased assets and is completing its review of all related contracts to determine the impact the adoption will have on its consolidated financial statements and related disclosures. We do not anticipateUpon adoption, the Company will recognize a right of use asset and lease liability for certain commitments related to office space that will be accounted for as an operating lease. To track these lease arrangements and facilitate compliance with this ASU, the Company is in the process of designing processes and internal controls.
The adoption of this ASU will increase asset and liability balances on the consolidated balance sheets due to materially affect our financial statements. In July 2018, the FASB issued ASU 2018-11, ‘‘required recognition of a right of use asset and corresponding lease liabilities and will result in changes to provide entities with relief from the costs of implementing certain aspects ofCompany’s existing accounting policies, business processes, and internal controls. The Company plans to elect the new leasingavailable package practical expedients provided in the standard ASU 2016-02. Under ASU 2018-11, adopters will take a prospective approach, rather than a retrospective approach as initially prescribed, when transitioning to ASU 2016-02. Instead of recording the cumulative impact of all comparative reporting periods presented within retained earnings, we will now assess the facts and circumstances of all leasing contractsadopt Topic 842 as of January 1, 2020.2022 at December 31, 2022 on its Form 10-K for the year ending December 31, 2022, using the optional transition method provided by ASU 2018-11 does not changeand continues to assess potential effects of the effective dates for ASU 2016-02. We still do not anticipate this to materially affect our financial statements.standard.
In May 2014, the FASB issued ASU 2014-09, ‘‘Revenue from Contracts with Customers’’ (ASU 2014-09), which will require entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 will supersede most current guidance related to revenue recognition when it becomes effective. The new standard also will require expanded disclosures regarding the nature, amount, timing
3. Cash, Cash Equivalents, and certainty of revenueRestricted Cash
Cash and cash flows from contractsequivalents include cash on hand and short term, highly liquid investments with customers. In August 2015, the FASB issued ASU 2015-14, ‘‘Revenue from Contractsoriginal maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.
Restricted cash consists of amounts deposited to back bonds or letters of credit for potential well liabilities. The Company presents restricted cash with Customers’’ (‘‘ASU 2015-14’’), which approved a one-year delay of the standard’s effective date. In accordance with ASU 2015-14, the standard is effective for the Corporation for annual reporting periods beginning after December 15, 2018cash and interim periods within fiscal years beginning after December 15, 2019, and early adoption is permitted. The new standard permits adoption through the use of either the full retrospective approach or a modified retrospective approach. In May 2016, the FASB issued ASU 2016-11 which rescinds certain SEC guidancecash equivalents in the ASC, including guidance related to the useConsolidated Statements of the ‘‘entitlements’’ method of revenue recognition. Epsilon did not early-adopt ASU 2014-09. Epsilon is currently determining the impacts of the new standard on our sales contract portfolio. Our approach includes performing a detailed review of key contracts representative of our business and comparing historical accounting policies and practices to the new standard. Also, in May 2016, the FASB issued ASU No. 2016-12, ‘‘Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients’’ (ASU 2016-12). The amendments under this ASU provide clarifying guidance in certain narrow areas and adds some practical expedients. These amendments are also effective at the same date that ASU 2014-09 is effective. Additionally, in March 2016, the FASB issued ASU No. 2016-08, ‘‘Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net).’’
Cash Flows.
10
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
| | | | | | |
|
| March 31, |
| December 31, | ||
| | 2022 | | 2021 | ||
Cash and cash equivalents | | $ | 30,070,813 | | $ | 26,497,305 |
Restricted cash included in other assets | | | 568,854 | | | 568,118 |
Cash, cash equivalents and restricted cash in the statement of cash flows | | $ | 30,639,667 | | $ | 27,065,423 |
| | | | | | |
The following table summarizes the Corporation’sCompany’s property and equipment as atof March 31, 20192022 and December 31, 2018:
|
|
|
|
|
|
|
|
| March 31, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
Property and equipment: |
|
|
|
|
|
|
Oil and gas properties, successful efforts method |
|
|
|
|
|
|
Proved properties |
| $ | 120,179,795 |
| $ | 118,851,574 |
Unproved properties |
|
| 20,357,273 |
|
| 19,498,666 |
Accumulated depletion, depreciation, and amortization |
|
| (85,131,120) |
|
| (83,807,401) |
Total oil and gas properties, net |
|
| 55,405,948 |
|
| 54,542,839 |
Gathering system |
|
| 41,065,956 |
|
| 41,040,847 |
Accumulated depletion, depreciation, and amortization |
|
| (28,609,797) |
|
| (28,137,573) |
Total gathering system, net |
|
| 12,456,159 |
|
| 12,903,274 |
Total property and equipment, net |
| $ | 67,862,107 |
| $ | 67,446,113 |
2021:
| | | | | | |
|
| March 31, |
| December 31, | ||
| | 2022 | | 2021 | ||
Property and equipment: | | | | | | |
Oil and gas properties, successful efforts method | | | | | | |
Proved properties | | $ | 140,557,389 | | $ | 138,032,413 |
Unproved properties | | | 21,793,526 | | | 21,700,926 |
Accumulated depletion, depreciation, amortization and impairment | | | (103,558,669) | | | (102,480,972) |
Total oil and gas properties, net | | | 58,792,246 | | | 57,252,367 |
Gathering system | | | 42,490,479 | | | 42,475,086 |
Accumulated depletion, depreciation, amortization and impairment | | | (33,727,110) | | | (33,443,949) |
Total gathering system, net | | | 8,763,369 | | | 9,031,137 |
Land | | | 637,764 | | | 637,764 |
Buildings and other property and equipment, net | | | 300,318 | | | 309,102 |
Total property and equipment, net | | $ | 68,493,697 | | $ | 67,230,370 |
Property AdditionsImpairment
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 Acquisitions
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 oil and 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, 20192022 and the year ended December 31, 2018, the Corporation acquired additional acres in the Anadarko Basin for $596,500 and $260,000, respectively. Included in additions to proved oil and gas properties for the year ended December 31, 2018 was an aproximately $0.5 million cash call refund for wells previously drilled.
At March 31, 2019 and December 31, 2018, the Corporation evaluated its proved and unproved oil and gas properties, and its gathering system assets for impairment. As a result of these assessments, no2021, 0 impairment was required as of March 31, 2019 and December 31, 2018.required.
Effective July 30, 2013, Epsilon Energy USA Inc.,The Company has a wholly owned subsidiary of the Corporation, executed a three year senior secured revolving credit facility with a bank (‘‘Credit Facility’’(“Facility”) forwhich includes a total commitment of up to $100 million. The current 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’’. The applicable margin ranges from 2.75 - 3.75% and is(2.75%-3.75% based on the percent of the line of credit utilized.utilized), b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5%.
11
The terms “Borrowing Base” and “Mortgaged Properties” include the Corporation’s gathering system assets in additionEpsilon Energy Ltd.
Notes to the oil and gas properties. The “Required Reserve Value” isUnaudited Condensed Consolidated Financial Statements
Effective April 6, 2021, the lesser of 90% of the recognized value of all proved oil and gas properties or 150% of the then current borrowing base.
On January 7, 2019,agreement was amended to extend the maturity date of the Credit Facility was extended to March 1, 20222024. 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 increased from $15 million to $23 million. The borrowing base is subject toreaffirmed until the next periodic redetermination by the lenders based on, among other things, their evaluation of the Corporation’s natural gas reserves. Additionally, the Corporation is required to maintain acceptable commodity hedging agreements covering at least 25% of projected production of natural gas for the succeeding calendar year, along with the 50% for the current calendar year.borrowing base.
The lender under the Credit facilityFacility has a first priority security interest in the tangible and intangible assets, including the gathering system, of Epsilon Energy USA, Inc. to secure any outstanding amounts under the agreement. Under the terms of the agreement, the CorporationCompany 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 3.53.0 based on income adjusted for interest, taxes and non-cash amounts.
11
The CorporationCompany was in compliance with the financial covenants of the Credit Facility as of March 31, 20192022 and December 31, 2018 and we expectexpects to be in compliance with the financial covenants for the next 12 months.
A commitment fee of 0.50% is assessed quarterly on the daily average unused commitmentsborrowing base on the Credit Facility.
| | | | | | | | | | | | |
|
| Balance at |
| Balance at |
| |
| | ||||
| | March 31, |
| December 31, | | Current | | Interest Rate | ||||
|
| 2022 | | 2021 |
| Borrowing Base |
| 3 mo. | ||||
Revolving line of credit | | $ | — | | $ | — | | $ | 14,000,000 | | | LIBOR + 3.25% (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance at |
| Balance at |
|
|
|
| ||||
|
| March 31, |
| December 31, |
| Current |
| Interest Rate | ||||
|
| 2019 |
| 2018 |
| Borrowing Base |
| 3 mo. | ||||
Revolving line of credit |
| $ | — |
| $ | — |
| $ | 23,000,000 |
|
| LIBOR + 2.75% (1) |
(1) | At March 31, |
(a)Authorized shares
The CorporationCompany is authorized to issue an unlimited number of Common Shares with no0 par value and an unlimited number of Preferred Shares with no0 par value.
(b)IssuedPurchases of Equity Shares
Normal Course Issuer Bid
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 following table summarizesCompany 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 componentsoutstanding common shares of share capital forEpsilon 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, 20192022, 0 shares had 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, 2018.
|
|
|
|
|
|
|
| Number of shares |
|
| |
|
| issued |
| Amount | |
Balance at January 1, 2018 |
| 27,522,852 |
| $ | 144,292,238 |
Buyback of Shares (net of 26,953 shares of stock retired February 1, 2019) |
| (137,719) |
|
| (681,215) |
Balance at December 31, 2018 |
| 27,385,133 |
| $ | 143,611,023 |
Vesting of restricted shares of stock |
| 54,167 |
|
| — |
Buyback of Shares (includes 26,953 shares purchased in 2018, but retired February 1, 2019) |
| (84,053) |
|
| (248,381) |
Balance at March 31, 2019 |
| 27,355,247 |
| $ | 143,362,642 |
Through a normal-course issuer bid (“NCIB”) program, the Corporation2021, Epsilon repurchased 57,100534,015 common shares of common stock through the three months ended March 31, 2019.authorized 1,193,000 purchase
12
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
amount and spent $2,423,007 under the NCIB. The repurchased stock had an average price of $4.26$4.54 per share.share and were subsequently cancelled during the three months ended March 31, 2022.
Repurchases may be made at management’s discretion from time to time through the facilities of the NASDAQ Global Market. The average share price (convertedpaid for the common shares will be, subject to US$ using a rateapplicable securities laws, the prevailing market price of Cdn$1.33 to US$1)such common shares on the TSX from JanuaryNASDAQ Global Market at the time of such purchase. The Company intends to fund the purchase out of available cash and does not expect to incur debt to fund the share repurchase program. The shares are accounted for as treasury shares until such a time as they are cancelled.
(c)Equity Incentive Plan
Epsilon’s board of directors (the “Board”) adopted the 2020 Equity Incentive Plan (the “2020 Plan”) on July 22, 2020 subject to approval by Epsilon’s shareholders at Epsilon’s 2020 Annual General and Special Meeting of Shareholders, which occurred on September 1, 2019 through the last day of trading on the TSX, March 15, 2019, was $4.22 (for the year ended December 31, 2018, $3.98)2020 (the “Meeting”).
(c)Stock Options
The Corporation maintains a stock option plan for directors, officers, employees and consultants of the Corporation and its subsidiaries. Epsilon shareholders Shareholders approved the “2007 Stock Option Plan”2020 Plan at a shareholders’ meeting held on July 16, 2007 prior to Epsilon becoming a reporting issuer andthe Meeting. Following Epsilon’s listing on the TSX. AtNASDAQ Global Market, the 2010 Annual General Meeting in May 2010 (2010 Annual Meeting), an amendment to the 2007 Stock Option Plan was presented and the plan became the “Amended and Restated 2010 Stock Option Plan.” The Board approved the amendments to the Plan to allow the period for exercise of optionsdetermined that it is in the case of resignation or termination of an optionee to be increased from 10 days following resignation or termination to 30 days following resignation or termination, and in case of retirement, from 30 days to 60 days following retirement. July 9, 2012, the plan was revised by the Board to add a cashless exercise of vested options. This allowed the optionee to effectively exercise and sell the options for the difference between the market valuebest interest of the stockshareholders to approve a new incentive plan that is compliant with U.S. public company equity plan rules and the strike price of the options. At the 2017 Annual General Meeting in April 2017,practices that would replace Epsilon’s shareholders approved the Amended and Restated 2017 Stock Option Plan. The AmendedPlan (including its predecessors) and Restatedthe Share Compensation Plan (i) reduced(collectively referred to as the maximum number Common Shares available“Predecessor Plans”). No further awards will be granted under the Predecessor Plans.
The 2020 Plan fromprovides for incentive compensation in the form of stock options, stock appreciation rights, restricted stock and stock units, performance shares and units, other stock-based awards and cash-based awards. Under the 2020 Plan, Epsilon will be authorized to issue up to 2,000,000 Common Shares. As of December 31, 2021, the Company granted, after the Compensation Committee approved the terms, target formulas, and peer group applicable to the performance incentive awards, 20,834 common shares and 48,000 time-based restricted shares to the CEO and the board of directors.
Restricted Stock Awards
For the three months ended March 31, 2022, 0 shares of Restricted Stock were awarded. For the year ended December 31, 2021, 48,000 common shares of Restricted Stock with a limitweighted average market price at the grant date of 10%$5.04 were awarded to the Company’s board of directors. These shares vest over a three-year period, with one-third of the totalshares being issued and outstanding
12
per period on the anniversary of the award resolution. The vesting of the shares is contingent on the individuals’ continued employment or service. The Company determined the fair value of the granted Restricted Stock-based on the market price of the common shares of the Company on the date of grant.
13
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
The following table summarizes Restricted Stock activity for the three months ended March 31, 2022, and the year ended December 31, 2021:
| | | | | | | | |
| | Three months ended | | Year ended | ||||
| | March 31, 2022 | | December 31, 2021 | ||||
| | | | Weighted | | | | Weighted |
| | Number of | | Average | | Number of | | Average |
| | Shares | | Remaining Life | | Shares | | Remaining Life |
|
| Outstanding |
| (years) |
| Outstanding |
| (years) |
Balance non-vested Restricted Stock at beginning of period | | 166,002 | | 1.38 | | 290,070 | | 1.60 |
Granted | | — | | — | | 48,000 | | 3.00 |
Vested | | — | | — | | (137,668) | | — |
Forfeited | | — | | — | | (34,400) | | — |
Balance non-vested Restricted Stock at end of period | | 166,002 | | 1.13 | | 166,002 | | 1.38 |
| | | | | | | | |
Stock compensation expense for the granted Restricted Stock is recognized over the vesting period. Stock compensation expense recognized during the three months ended March 31, 2022 and 2021 was $95,112 and $137,206, respectively.
At March 31, 2022, the Company had unrecognized stock-based compensation related to these shares of $534,748 to be recognized over a weighted average period of 1.01 years (at December 31, 2021: $696,833 over 1.11 years).
Performance Share Unit Awards (“PSU”)
For the three months ended March 31, 2022, 0 PSUs were awarded. For the year ended December 31, 2021, a total of 62,501 common shares vested and were issued, of which 20,834 of the common shares were granted as a result of the Company exceeding its 2020 TSR performance target. The Company grants PSUs, which are paid in stock, to certain key employees. PSUs are based on a three-year performance period with performance being measured each year at December 31. The PSUs will vest on the last day of the performance period. The number of PSUs that will ultimately vest is based on 2 performance targets as follows:
● | The targets for the PSUs are based on (i) the relative total stockholder return (“TSR”) percentile ranking and (ii) the relative cash flow per debt adjusted share – growth (“CFDAS Growth”) percentile ranking of the Company, each as compared to the Company’s Performance Peer Group during the applicable one-year performance period ending on December 31. |
● | Cash Flow per Debt Adjusted Share (“CFDAS”) is defined as EBITDA (earnings before interest, taxes, depreciation and amortization) divided by the sum of the 1) the total debt plus the value of preferred stock minus cash and the amount of dividends paid for the year divided by the share price at the end of the year; and 2) the actual share count at year end. |
● | The vesting of each PSU Award will be based 50% on TSR performance and 50% based on CFDAS Growth performance. |
● | The recipient of the award must be employed with the Company at the time of vesting. |
The number of shares ultimately issued under these awards can range from 0 to 200% of target award amounts.
The PSUs are accounted for as equity awards. The fair value of the 50% for performance based on CFDAS Growth was determined as the market price of the common shares of the Company on the date of grant. Weighted average fair value of CFDAS PSUs granted during the year ended December 31, 2021 was $3.41 per unit. The fair value of the 50% for performance based on TSR was determined on the grant date by the application of a Monte Carlo simulation
14
Common SharesTable of Contents
Epsilon Energy Ltd.
Notes to a fixed maximumthe Unaudited Condensed Consolidated Financial Statements
model. For the year ended December 31, 2021, the Compensation Committee did not approve the issuance of 1,000,000 Common Shares, and (ii) deleted some redundant definitions and clarified existing wordingany new PSU’s.
The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the Plan.performance stock awards, to calculate the fair value of the awards. Expected volatilities in the model were estimated using a historical period consistent with the expected term for each annual performance period of the awards. The risk-free interest rate was based on the United States Treasury rate measured over a term commensurate with the expected term for each annual performance period of the awards. The expected term is based on the time between the valuation date and the end of each annual performance period of the awards. The valuation model assumes dividends are immediately reinvested.
The following table summarizes PSUs for the three months ended March 31, 2022 and the year ended December 31, 2021:
| | | | | | | | |
| | Three months ended | | Year ended | ||||
| | March 31, 2022 | | December 31, 2021 | ||||
| | | | Weighted | | | | Weighted |
| | Number of | | Average | | Number of | | Average |
| | Shares | | Remaining Life | | Shares | | Remaining Life |
|
| Outstanding |
| (years) |
| Outstanding |
| (years) |
Balance non-vested PSUs at beginning of period | | 151,500 | | 0.75 | | 193,167 | | 1.60 |
Granted | | — | | — | | 20,834 | | — |
Vested | | — | | — | | (62,501) | | — |
Balance non-vested PSUs at end of period | | 151,500 | | 0.72 | | 151,500 | | 0.75 |
Stock compensation expense for the granted PSUs is recognized over the vesting period. Stock compensation expense recognized during the three months ended March 31, 2022 and 2021 related to PSUs was $47,190 and $65,293, respectively.
At March 31, 2022, the Company had unrecognized stock-based compensation related to these shares of $260,225 to be recognized over a weighted average period of 0.90 years (at December 31, 2021: $310,790 over 1.01 years).
Stock Options
Through March 31, 2019,2022, the CorporationCompany had issuedoutstanding stock options covering 280,000180,000 Common Shares at an overall average exercise price of $5.01$5.25 per Common Share to directors, officers, and employees of the CorporationCompany and its subsidiaries. A maximum amountThese 180,000 options have a weighted average expected remaining term of 720,000 Common Shares is available for future issuances.approximately 1.07 years.
The following table summarizes stock option activity for the three months ended March 31, 20192022 and the year ended December 31, 2018:2021:
| | | | | | | | | | | |
| | Three months ended | | Year ended | |||||||
| | March 31, 2022 | | December 31, 2021 | |||||||
| | | | Weighted | | | | Weighted | |||
| | Number of | | Average | | Number of | | Average | |||
| | Options | | Exercise | | Options | | Exercise | |||
Exercise price in US$ |
| Outstanding |
| Price (1) |
| Outstanding |
| Price (1) | |||
Balance at beginning of period | | 218,750 | | $ | 5.28 | | | 245,000 | | $ | 5.27 |
Exercised | | (38,750) | | $ | 5.40 | | | (16,250) | | $ | 5.25 |
Expired/Forfeited | | — | | | | | | (10,000) | | $ | 5.50 |
Balance at period-end | | 180,000 | | $ | 5.25 | | | 218,750 | | $ | 5.28 |
| | | | | | | | | | | |
Exercisable at period-end | | 180,000 | | $ | 5.25 | | | 218,750 | | $ | 5.28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| Three months ended |
| Year ended | |||||||
|
| March 31, 2019 |
| December 31, 2018 | |||||||
|
|
|
| Weighted |
|
|
| Weighted | |||
|
| Number of |
| Average |
| Number of |
| Average | |||
|
| Options |
| Exercise |
| Options |
| Exercise | |||
Exercise price in US$ |
| Outstanding |
| Price (1) |
| Outstanding |
| Price (1) | |||
Balance at beginning of period |
| 290,750 |
| $ | 5.02 |
|
| 330,750 |
| $ | 5.14 |
Expired/Forfeited |
| (10,750) |
| $ | 5.24 |
|
| (40,000) |
| $ | 6.00 |
Balance at period-end |
| 280,000 |
| $ | 5.01 |
|
| 290,750 |
| $ | 5.02 |
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at period-end |
| 241,670 |
| $ | 5.00 |
|
| 210,249 |
| $ | 5.02 |
15
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
(1) | Exercise price has been converted to US$ using the rate of Cdn$1.33 to US$1, the rate on March 15, 2019, the date Epsilon Energy, Ltd was delisted from the |
At March 31, 2019,2022, using the CorporationBlack Scholes model, the Company had unrecognized stock basedstock-based compensation, related to these options, of $20,770 to be recognized over a weighted average period of 0.53 yearsNaN (at December 31, 2018: $27,877 over 1.1 years)2021: NaN). The aggregate intrinsic value at March 31, 20192022 was $53,250NaN (at December 31, 2018: $58,664)2021: NaN).
During the three months ended March 31, 2022 and the year ended December 31, 2021, the Company awarded 0 stock options.
(d) Dividends
On February 25, 2022, the Board declared a quarterly dividend of $0.0625 per common share (annualized $0.25 per common share) totaling in aggregate an amount of approximately $1.5 million that was paid on March 31, 2022.
7. Revenue Recognition
Revenues are comprised primarily of sales of natural gas along with the revenue generated from the Company’s ownership interest in the gas gathering system in the Auburn field in Northeastern Pennsylvania. Also included is natural gas, crude oil and NGLs from Oklahoma.
Overall, product sales revenue generally is recorded in the month when contractual delivery obligations are satisfied, which occurs when control is transferred to the Company’s customers at delivery based on contractual terms and conditions. In addition, gathering and compression revenue generally is recorded in the month when contractual service obligations are satisfied, which occurs as control of those services is transferred to the Company’s customers.
The following table details revenue for the three months ended March 31, 2022 and 2021.
| | | | | | |
| | Three Months Ended March 31, | ||||
|
| 2022 |
| 2021 | ||
Operating revenue | | | | | | |
Natural gas | | $ | 10,703,084 | | $ | 6,332,099 |
Natural gas liquids | | | 314,428 | | | 45,621 |
Oil and condensate | | | 461,813 | | | 61,435 |
Gathering and compression fees | | | 2,120,773 | | | 2,002,157 |
Total operating revenue | | $ | 13,600,098 | | $ | 8,441,312 |
Product Sales Revenue
The Company enters into contracts with third party purchasers to sell its natural gas, oil, NGLs and condensate production. Under these product sales arrangements, the sale of each unit of product represents a distinct performance obligation. Product sales revenue is recognized at the point in time that control of the product transfers to the purchaser based on contractual terms which reflect prevailing commodity market prices. To the extent that marketing costs are incurred by the Company prior to the transfer of control of the product, those costs are included in lease operating expenses on the Company’s consolidated statements of operations.
Settlement statements for product sales, and the related cash consideration, are received from the purchaser within 30 days. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the natural gas, oil, NGLs, or condensate. Estimated revenue due to the Company is recorded within the receivables line item on the accompanying consolidated balance sheets until payment is received.
16
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
Gas Gathering and Compression Revenue
The Company also provides natural gas gathering and compression services through its ownership interest in the gas gathering system in the Auburn field. For the provision of gas gathering and compression services, the Company collects its share of the gathering and compression fees per unit of gas serviced and recognizes gathering revenue over time using an output method based on units of gas gathered.
The settlement statement from the operator of the Auburn Gas Gathering System is received two months after transmission and compression has occurred. As a result, the Company must estimate the amount of production that was transmitted and compressed within the system. Estimated revenue due to the Company is recorded within the receivables line item on the accompanying consolidated balance sheets until payment is received.
Allowance for Doubtful Accounts
The Company records an allowance for doubtful accounts on a case-by-case basis once there is evidence that collection is not probable. For the three months ended March 31, 2019 $6,301 of stock compensation expense2022, there were 0 accounts for which collection was recognized (for the three months ended March 31, 2018, $25,644).
The average share price during the three months ended March 31, 2019 was $4.22 (for the year ended December 31, 2018: $3.98).
During the three months ended March 31, 2019 and the year ended December 31, 2018, the Corporation awarded no stock options.
(d)Share Compensation Plan
A Share Compensation Plan (the “Plan”) was adopted by the Board on April 13, 2017 and approved by the shareholders at the Annual General Meeting in April, 2017. The Plan provides that designated participants may, as determined by the Board, be issued Common Shares in an amount up to 100% of the participant’s compensation paid by the Corporation in consideration of the participant’s service for the Current Year divided by the market price of the Common Shares on the NASDAQ at the date of issuance of the Common Shares in the Current Year.
For the three months ended March 31, 2019 no shares of Restricted Stock were awarded. For the year ended December 31, 2018, 174,500 common shares of Restricted Stock were awarded to the Corporation’s officers, employees, and board of directors. These shares vest over a three year period, with one-third of the shares being issued per period on the anniversary of the award resolution. The vesting of the shares is contingent on the individuals’ continued employment or service. The Corporation determined the fair value of the granted Restricted Stock based on the market price of the common shares of the Corporation on the date of grant. Stock compensation expense for the granted Restricted Stock is
13
recognized over the vesting period. Stock compensation expense recognized during the three months ended March 31, 2019 was $127,419 (for the three months ended March 31, 2018, $57,403).not probable.
The following table summarizes Restricted Stock activity for the three months endeddetails accounts receivable as of March 31, 2019,2022 and the year ended December 31, 2018:
|
|
|
|
|
|
|
|
|
|
| Three months ended |
| Year ended | ||||
|
| March 31, 2019 |
| December 31, 2018 | ||||
|
|
|
| Weighted |
|
|
| Weighted |
|
| Number of |
| Average |
| Number of |
| Average |
|
| Shares |
| Remaining Life |
| Shares |
| Remaining Life |
|
| Outstanding |
| (years) |
| Outstanding |
| (years) |
Balance non-vested Restricted Stock at beginning of period |
| 282,833 |
| 2.56 |
| 162,500 |
| 1.87 |
Granted |
| — |
| — |
| 174,500 |
| 3.00 |
Vested |
| — |
| — |
| (54,167) |
| — |
Balance non-vested Restricted Stock at end of period |
| 282,833 |
| 1.55 |
| 282,833 |
| 2.56 |
2021.
| | | | | | |
|
| March 31, |
| December 31, | ||
| | 2022 | | 2021 | ||
Accounts receivable | | | | | | |
Natural gas and oil sales | | $ | 4,702,314 | | $ | 2,996,344 |
Joint interest billing | | | 96,459 | | | 60,134 |
Gathering and compression fees | | | 1,545,035 | | | 1,539,976 |
Other | | | 124,453 | | | 477 |
Total accounts receivable | | $ | 6,468,261 | | $ | 4,596,931 |
Accumulated other comprehensive income (loss) includes certain transactions that have generally been reported in the condensed consolidated statements of changes in shareholders’ equity, including translation gains (losses) related to the convertible debentures that will remain frozen in accumulated other comprehensive income until such time Epsilon Energy Ltd. is liquidated. Activity within Accumulated other comprehensive income (loss) for the three months ended March 31, 2019 and 2018 consisted of the following:
|
|
|
|
|
|
|
|
|
| Three Months Ended March 31, |
| ||||
|
| 2019 |
| 2018 |
| ||
Balance at beginning of period |
| $ | 9,797,930 |
| $ | 9,913,236 |
|
Translation gain (loss) other |
|
| 10,792 |
|
| (56,509) |
|
|
| $ | 9,808,722 |
| $ | 9,856,727 |
|
Income tax provisions for the three months ended March 31, 20192022 and 20182021 are as follows:
|
|
|
|
|
|
|
|
| Three months ended March 31, | ||||
|
| 2019 |
| 2018 | ||
Current: |
|
|
|
|
|
|
Federal |
| $ | — |
| $ | 858,406 |
State |
|
| — |
|
| 290,410 |
Total current income tax expense |
|
| — |
|
| 1,148,816 |
Deferred: |
|
|
|
|
|
|
Federal |
|
| 537,040 |
|
| (214,084) |
State |
|
| 209,556 |
|
| 52,310 |
Total deferred tax expense (benefit) |
|
| 746,596 |
|
| (161,774) |
Income tax expense |
| $ | 746,596 |
| $ | 987,042 |
| | | | | | |
| | Three months ended March 31, | ||||
|
| 2022 |
| 2021 | ||
Current: | | | | | | |
Federal | | $ | 1,466,896 | | $ | 155,370 |
State | | | 692,316 | | | 183,844 |
Total current income tax expense | | | 2,159,212 | | | 339,214 |
Deferred: | | | | | | |
Federal | | | 22,015 | | | 663,202 |
State | | | 671 | | | 142,157 |
Total deferred tax expense | | | 22,686 | | | 805,359 |
Income tax expense | | $ | 2,181,898 | | $ | 1,144,573 |
We fileThe Company files federal income tax returns in the United States and Canada, and various returns in state and local jurisdictions.
We believe we haveThe Company believes it has appropriate support for the income tax positions taken and to be taken on our tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of various factors including past experience and interpretations of tax law applied to the facts of each matter. The Company's tax returns are
17
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
open to audit under the statute of limitations for the years ending December 31, 20152018 through December 31, 2018.2021. To the extent we utilize net operating losses generated in earlier years, such earlier years may also be subject to audit.
14
Our effective tax rate will typically differ from the statutory federal rate primarily as a result of state income taxes and the valuation allowance against the Canadian net operating loss. The effective tax rate for the three months ended March 31, 20192022 was higher than the statutory federal rate as a result of the state income taxes and the valuation allowance against the Canadian net operating loss.
The Corporation’sCompany’s future minimum lease commitments as of March 31, 20192022 are summarized in the following table:
|
|
|
|
Year ended |
|
| |
December 31, |
| Payments | |
2019 |
|
| 60,562 |
2020 |
|
| 6,729 |
|
| $ | 67,291 |
| | | |
Year ended |
| | |
December 31, |
| Payments | |
2022 | | $ | 140,189 |
2023 | | | 62,444 |
| | $ | 202,633 |
The CorporationCompany enters into commitments for capital expenditures in advance of the expenditures being made. As of March 31, 2019, we2022, the Company had no commitments of $1.03 million for capital expenditures.
On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC (“Chesapeake”) in the United States District Court for the Middle District of Pennsylvania, Scranton, Pennsylvania (“Middle District”). Epsilon claims that Chesapeake has breached a settlement agreement and several operating agreements (“JOAs”) to which Epsilon and Chesapeake are parties. Epsilon asserts that Chesapeake has failed to cooperate with Epsilon’s efforts to develop resources in the Auburn Development, located in North-Central Pennsylvania, as required under both the settlement agreement and JOAs.
Epsilon requested a preliminary injunction but was unsuccessful in obtaining that injunction. Epsilon filed a motion to amend its original Complaint. Chesapeake opposed. The CorporationCourt ruled in Epsilon’s favor and allowed Epsilon’s amendment. Chesapeake moved to dismiss the amended Complaint. The Court granted the motion to dismiss on a narrow issue without prejudice to Epsilon’s right to file a new lawsuit based on new proposals made after the Court’s decision. Epsilon filed a motion for reconsideration of that decision, but the court denied the motion for reconsideration on January 18, 2022.
Epsilon filed a notice of appeal on February 15, 2022 challenging both the motion to dismiss and motion for reconsideration decisions. Chesapeake filed a cross-appeal on March 1, 2022. A court-mandated mediation was set for June 9, 2022. A briefing schedule has not yet been set, and accordingly, a decision on the appeal is not currently involvedexpected until early to mid-2023.
Epsilon re-filed a complaint against Chesapeake in any litigation. Managementthe Middle District on May 9, 2022. Epsilon generally asserts the similar claims as in the previous suit, pursuing declaratory judgment claims regarding Chesapeake’s obligation to Epsilon to cooperate with Epsilon’s efforts in the Auburn Development and regarding Chesapeake’s obstruction of Epsilon’s efforts with the Pennsylvania Department of Environmental Protection permitting process. Chesapeake’s response to the complaint is of the opinion that the potential for litigation is remote, without merit and would not have a material adverse impact on the Corporation’s financial position or results of operations.expected in June 2022.
Basic net income per share is computed on the basis of the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed based upon the weighted-average number of
18
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
common shares outstanding during the period plus the assumed issuance of common shares for all potentially dilutive securities.
The net income used in the calculation of basic and diluted net income per share is as follows:
|
|
|
|
|
|
|
|
| Three months ended March 31, | ||||
|
| 2019 |
| 2018 | ||
Net income available to shareholders |
| $ | 1,373,676 |
| $ | 2,159,227 |
| | | | | | |
| | Three months ended March 31, | ||||
|
| 2022 |
| 2021 | ||
Net income available to shareholders | | $ | 5,805,888 | | $ | 2,735,567 |
In calculating the net income per share, basic and diluted, the following weighted-average shares were used:
|
|
|
|
|
|
| Three months ended March 31, | ||
|
| 2019 |
| 2018 |
Basic weighted-average number of shares outstanding |
| 27,392,755 |
| 27,521,504 |
Dilutive stock options |
| 12,204 |
| 11,053 |
Unvested restricted shares granted |
| 3,415 |
| — |
Diluted weighted average shares outstanding |
| 27,408,374 |
| 27,532,557 |
| | | | |
| | Three months ended March 31, | ||
|
| 2022 |
| 2021 |
Basic weighted-average number of shares outstanding | | 23,677,842 | | 23,947,222 |
Dilutive stock options | | 16,728 | | — |
Unvested time-based restricted shares |
| 65,395 |
| 29,034 |
Unvested performance-based restricted shares |
| 102,463 |
| 53,848 |
Diluted weighted average shares outstanding |
| 23,862,428 |
| 24,030,104 |
WeThe company excluded the following shares from the diluted EPS because their inclusion would have been anti-dilutive.
|
|
|
|
|
|
| Three months ended March 31, | ||
|
| 2019 |
| 2018 |
Anti dilutive options |
| 267,796 |
| 279,697 |
Anti dilutive unvested restricted shares |
| 279,418 |
| 162,500 |
Total Anti-dilutive shares |
| 547,214 |
| 442,197 |
| | | | |
| | Three months ended March 31, | ||
|
| 2022 |
| 2021 |
Anti-dilutive options | | 163,272 | | 245,000 |
Anti-dilutive unvested time-based restricted shares | | 100,607 | | 239,036 |
Anti-dilutive unvested performance-based restricted shares | | 49,037 | | 139,319 |
Total Anti-dilutive shares |
| 312,916 |
| 623,355 |
15
Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker, who is responsible for allocating resources and assessing performance of the operating segments, has been identified as executive management. Segment performance is evaluated based on operating profit or loss as shown in the table below. Interest income and expense, and income taxes are managed separately on a group basis.
The Corporation’sCompany’s reportable segments are as follows:
a. | The Upstream segment activities include acquisition, development and production of oil, natural gas, and other liquid reserves on properties within the United States; |
b. | The Gas Gathering segment partners with |
c. | The |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Upstream |
| Gas Gathering |
| Canada |
| Corporate |
| Elimination |
| Consolidated | ||||||
As at and for the three months ended March 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural gas |
| $ | 5,434,935 |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | 5,434,935 |
Natural gas liquids |
|
| 13,491 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 13,491 |
Oil and condensate |
|
| 59,237 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 59,237 |
Gathering and compression fees |
|
| — |
|
| 2,701,244 |
|
| — |
|
| — |
|
| (262,893) |
|
| 2,438,351 |
Total operating revenue |
| $ | 5,507,663 | (1) | $ | 2,701,244 |
| $ | — |
| $ | — |
| $ | (262,893) |
|
| 7,946,014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings for the period |
| $ | 2,435,906 |
| $ | 1,653,297 |
| $ | — |
| $ | (2,715,527) | (3) |
| — |
| $ | 1,373,676 |
Operating costs |
|
| 1,718,293 |
|
| 575,680 |
|
| — |
|
| — |
|
| (262,893) |
|
| 2,031,080 |
Depletion, deprec., amortization and accretion |
|
| 1,353,464 |
|
| 472,267 |
|
| — |
|
| — |
|
| — |
|
| 1,825,731 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets |
| $ | 75,381,033 |
| $ | 14,813,978 |
| $ | 194,166 |
| $ | — |
|
| — |
| $ | 90,389,178 |
Capital expenditures(2) |
|
| 2,186,828 |
|
| 25,109 |
|
| — |
|
| — |
|
| — |
|
| 2,211,937 |
Proved properties |
|
| 35,048,675 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 35,048,675 |
Unproved properties |
|
| 20,357,273 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 20,357,273 |
Gathering system |
|
| — |
|
| 12,456,159 |
|
| — |
|
| — |
|
| — |
|
| 12,456,159 |
Other property and equipment |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As at and for the three months ended March 31, 2018 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural gas |
| $ | 4,846,187 |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | 4,846,187 |
Natural gas liquids |
|
| 28,879 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 28,879 |
Oil and condensate |
|
| 126,730 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 126,730 |
Gathering and compression fees |
|
| — |
|
| 3,094,473 |
|
| — |
|
| — |
|
| (318,267) |
|
| 2,776,206 |
Total operating revenue |
| $ | 5,001,796 | (1) | $ | 3,094,473 |
| $ | — |
| $ | — |
| $ | (318,267) |
|
| 7,778,002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings for the period |
| $ | 1,751,278 |
| $ | 1,876,127 |
| $ | — |
| $ | (1,468,178) | (3) | $ | — |
| $ | 2,159,227 |
Operating costs |
|
| 1,930,214 |
|
| 748,031 |
|
| — |
|
| — |
|
| (318,267) |
|
| 2,359,978 |
Depletion, deprec., amortization and accretion |
|
| 1,320,304 |
|
| 470,315 |
|
| — |
|
| — |
|
| — |
|
| 1,790,619 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets |
| $ | 65,134,646 |
| $ | 20,492,688 |
| $ | 2,071,071 |
| $ | — |
| $ | — |
| $ | 87,698,405 |
Capital expenditures(2) |
|
| 293,140 |
|
| (8,728) |
|
| — |
|
| — |
|
| — |
|
| 284,412 |
Proved properties |
|
| 38,772,503 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 38,772,503 |
Unproved properties |
|
| 17,616,070 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 17,616,070 |
Gathering system |
|
| — |
|
| 14,179,631 |
|
| — |
|
| — |
|
| — |
|
| 14,179,631 |
Other property and equipment |
|
| 136 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 136 |
19
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
Segment activity as of, and for the three months ended March 31, 2022 and 2021 is as follows:
| | | | | | | | | | | | | | | |
|
| Upstream |
| Gas Gathering |
| Corporate |
| Elimination |
| Consolidated | |||||
As of and for the three months ended March 31, 2022 | | | | | | | | | | | | | | | |
Operating revenue | | | | | | | | | | | | | | | |
Natural gas | | $ | 10,703,084 | | $ | — | | $ | — | | $ | — | | $ | 10,703,084 |
Natural gas liquids | | | 314,428 | | | — | | | — | | | — | | | 314,428 |
Oil and condensate | | | 461,813 | | | — | | | — | | | — | | | 461,813 |
Gathering and compression fees | | | — | | | 2,485,937 | | | — | | | (365,164) | | | 2,120,773 |
Total operating revenue (1) | | $ | 11,479,325 | | $ | 2,485,937 | | $ | — | | $ | (365,164) | | $ | 13,600,098 |
| | | | | | | | | | | | | | | |
Net earnings (loss) for the period | | $ | 8,601,788 | | $ | 1,676,840 | | $ | (4,472,740) | (3) | $ | — | | $ | 5,805,888 |
Operating costs | | | 1,770,654 | | | 524,375 | | | — | | | (365,164) | | | 1,929,865 |
Development geological and geophysical expenses | | | 2,386 | | | — | | | — | | | — | | | 2,386 |
Depletion, depreciation, amortization and accretion | | | 1,104,497 | | | 284,722 | | | — | | | — | | | 1,389,219 |
| | | | | | | | | | | | | | | |
Segment assets | | $ | 92,693,843 | | $ | 13,171,557 | | $ | 394,750 | | $ | — | | $ | 106,260,149 |
Capital expenditures (2) | | | 2,610,894 | | | 15,393 | | | — | | | — | | | 2,626,287 |
Proved properties (net) | | | 36,998,720 | | | — | | | — | | | — | | | 36,998,720 |
Unproved properties (net) | | | 21,793,526 | | | — | | | — | | | — | | | 21,793,526 |
Gathering system (net) | | | — | | | 8,763,369 | | | — | | | — | | | 8,763,369 |
Lease right-of-use-asset | | | — | | | — | | | — | | | — | | | — |
Other property and equipment (net) | | | 938,082 | | | — | | | — | | | — | | | 938,082 |
| | | | | | | | | | | | | | | |
As of and for the three months ended March 31, 2021 | | | | | | | | | | | | | | | |
Operating revenue | | | | | | | | | | | | | | | |
Natural gas | | $ | 6,332,099 | | $ | — | | $ | — | | $ | — | | $ | 6,332,099 |
Natural gas liquids | | | 45,621 | | | — | | | — | | | — | | | 45,621 |
Oil and condensate | | | 61,435 | | | — | | | — | | | — | | | 61,435 |
Gathering and compression fees | | | — | | | 2,386,588 | | | — | | | (384,431) | | | 2,002,157 |
Total operating revenue (1) | | $ | 6,439,155 | | $ | 2,386,588 | | $ | — | | $ | (384,431) | | $ | 8,441,312 |
| | | | | | | | | | | | | | | |
Net earnings (loss) for the period | | $ | 3,531,142 | | $ | 1,430,636 | | $ | (2,226,211) | (3) | $ | — | | $ | 2,735,567 |
Operating costs | | | 1,594,188 | | | 575,378 | | | — | | | (384,431) | | | 1,785,135 |
Development geological and geophysical expenses | | | 11,539 | | | — | | | — | | | — | | | 11,539 |
Depletion, depreciation, amortization and accretion | | | 1,302,286 | | | 380,574 | | | — | | | — | | | 1,682,860 |
| | | | | | | | | | | | | | | |
Segment assets | | $ | 76,473,690 | | $ | 13,674,102 | | $ | 54,567 | | $ | — | | $ | 90,202,359 |
Capital expenditures (2) | | | 979,440 | | | 13,284 | | | — | | | — | | | 992,724 |
Proved properties (net) | | | 35,361,937 | | | — | | | — | | | — | | | 35,361,937 |
Unproved properties (net) | | | 21,510,765 | | | — | | | — | | | — | | | 21,510,765 |
Gathering system (net) | | | — | | | 9,735,190 | | | — | | | — | | | 9,735,190 |
Other property and equipment (net) | | | 973,219 | | | — | | | — | | | — | | | 973,219 |
(1) | Segment operating revenue represents revenues generated from the operations of the segment. Inter-segment sales during the three months ended March 31, |
16
(2) | Capital expenditures for the Upstream segment consist primarily of the acquisition of properties, and the drilling and completing of wells while Gas Gathering consists of expenditures relating to the expansion and completion of the gathering and compression facility. |
(3) | Segment reporting for net earnings for the period does not include non-monetary compensation, general and administrative expense, interest income, interest expense, both gains and (losses) on derivative contracts, or income tax amounts as they are managed on a group basis and are instead included in the corporate column for reconciliation purposes. |
11.
20
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
12. Commodity Risk Management Activities
Epsilon engages in price risk management activities from time to time. These activities are intended to manage Epsilon’s exposure to fluctuations in commodity prices for natural gas by securing fixed price contracts for a portion of expected sales volumes.
Inherent in the Corporation’sCompany’s fixed price contracts, are certain business risks, including market risk and credit risk. Market risk is the risk that the price of oilnatural gas and natural gasoil will change, either favorably or unfavorably, in response to changing market conditions. Credit risk is the risk of loss from nonperformance by the Corporation’sCompany’s counterparty to a contract. The CorporationCompany does not currently require collateral from any of its counterparties nor dodoes its counterparties require collateral from the Corporation.Company. Additionally, there is a risk that gas prices could fall to a level low enough to affect the volumes flowing through the gathering system.
The CorporationCompany enters into certain commodity derivative instruments including fixed price swaps, basis swaps and costless collars, to mitigate commodity price risk associated with a portion of its future natural gas production and related cash flows. The natural gas revenues and cash flows are affected by changes in commodity product prices, which are volatile and cannot be accurately predicted. The objective for holding these commodity derivatives is to protect the operating revenues and cash flows related to a portion of the future natural gas sales from the risk of significant declines in commodity prices, which helps ensure the Corporation’sCompany’s ability to fund the capital budget.
Epsilon has historically elected not to designate any of its financial commodity derivative contracts as accounting hedges and, accordingly, accounts for these financial commodity derivative contracts using the mark-to-market accounting method. Under this accounting method, changes in the fair value of outstanding financial instruments are recognized as gains or losses in the period of change and are recorded as gain (loss)loss (gain) on derivative contracts on the condensed consolidated statements of operations and comprehensive income (loss). The related cash flow impact is reflected in cash flows from operating activities. During the three months ended March 31, 2019,2022, Epsilon recognized losses on commodity derivative contracts of $510,754.$971,904. This amount included cash paidsettlements on settlements of these contracts of $184,244.$1,211,728. For the three months ended March 31, 2018,2021, Epsilon recognized gains on commodity derivative contracts of $370,981, which were net of$465,341. This amount included cash received on settlements on these contracts of $64,200.
Commodity Derivative Contracts
At March 31, 2022, the Company had 0 outstanding commodity derivative contracts. At December 31, 2021, the Company had 2 outstanding natural gas derivative contracts of $106,456.commodity two-way costless collar contracts.
Commodity Derivative Contracts
| | | | | | |
| | Fair Value of Derivative | ||||
|
| March 31, |
| December 31, | ||
| | 2022 | | 2021 | ||
Current |
| |
|
| |
|
Two-way costless collar |
| $ | — | | $ | 13,312 |
|
| $ | — | | $ | 13,312 |
Presented below is a summary of Epsilon’s natural gas price and basis swap contracts as of March 31, 2019.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Weighted Average Price ($/MMbtu) |
| Fair Value | ||||||
|
| Volume |
|
|
| Basis |
| March 31, | |||
Derivative Type |
| (Mmbtu) |
| Swaps |
| Differential |
| 2019 | |||
2019 |
|
|
|
|
|
|
|
|
|
|
|
Fixed price swap |
| 4,287,500 |
| $ | 2.80 |
| $ | — |
|
| (13,020) |
Basis swap |
| 4,287,500 |
| $ | — |
| $ | (0.49) |
|
| (479,062) |
2020 |
|
|
|
|
|
|
|
|
|
|
|
Fixed price swap |
| 3,111,000 |
| $ | 2.73 |
| $ | — |
|
| (16,690) |
Basis swap |
| 3,111,000 |
| $ | — |
| $ | (0.47) |
|
| (114,761) |
|
|
|
|
|
|
|
|
|
| $ | (623,533) |
17
21
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
As of March 31, 2019, all of the Corporation’s derivative contracts were with large financial institutions, which are not known to the Corporation to be in default on their derivative positions. The Corporation is exposed to credit risk to the extent of non-performance by the counterparties in the derivative contracts discussed above; however, the Corporation does not anticipate non-performance by such counterparties. None of the Corporation’s derivative instruments contains credit-risk related contingent features. Derivatives are presented net on the balance sheet as they are subject to the right to offset the liabilities with the assets.
The following table summarizespresents the grosschanges in the fair valuesvalue of our derivative instruments, presentingEpsilon’s commodity derivatives for the impact of offsetting the derivative assets and liabilities on our condensed consolidated balance sheets as of the dates indicated below:
|
|
|
|
|
|
|
|
| Fair Value of Derivative | ||||
|
| March 31, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
Current |
|
|
|
|
|
|
Basis swap |
| $ | 34,781 |
| $ | 76,075 |
Fixed price swap |
|
| 260,239 |
|
| 125,790 |
Long-term |
|
|
|
|
|
|
Basis swap |
|
| 67,677 |
|
| — |
Fixed price swap |
|
| 225,619 |
|
| — |
|
| $ | 588,316 |
| $ | 201,865 |
|
|
|
|
|
|
|
|
| Fair Value of Derivative | ||||
|
| March 31, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
Current |
|
|
|
|
|
|
Basis swap |
| $ | (620,143) |
| $ | (337,438) |
Fixed price swap |
|
| (488,838) |
|
| (161,450) |
Long-term |
|
|
|
|
|
|
Basis swap |
|
| (76,138) |
|
| — |
Fixed price swap |
|
| (26,730) |
|
| — |
|
| $ | (1,211,849) |
| $ | (498,888) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Fair Value of Derivatives |
| $ | (623,533) |
| $ | (297,023) |
|
|
|
|
|
|
|
|
|
|
|
| ||
|
| Three months ended |
| Three months ended | ||
|
|
| March 31, |
|
| March 31, |
|
| 2019 |
| 2018 | ||
|
|
|
|
|
|
|
Fair value of asset (liability), beginning of year |
| $ | (297,023) |
| $ | 259,544 |
Gains (losses) on derivative contracts included in earnings |
|
| (510,754) |
|
| 370,981 |
Settlement of commodity derivative contracts |
|
| 184,244 |
|
| (106,456) |
Fair value of liability, end of year |
| $ | (623,533) |
| $ | 524,069 |
periods indicated:
| | | | | | |
| | Three months ended March 31, | ||||
|
| 2022 |
| 2021 | ||
Fair value of asset (liability), beginning of the period | | $ | (239,824) | | $ | — |
Gains (losses) on derivative contracts included in earnings | |
| (971,904) | |
| 465,342 |
Settlement of commodity derivative contracts | |
| 1,211,728 | |
| (64,201) |
Fair value of asset, end of the period | | $ | 0 | | $ | 401,141 |
13. Asset Retirement Obligations
Asset retirement obligations were estimated by management based on Epsilon’s net ownership interest in all wells and the gathering system, estimated costs to reclaim and abandon such assets and the estimated timing of the costs to be incurred in future periods.
18
The following tables summarize the changes in asset retirement obligations for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
| ||
|
| Three months ended |
| Year ended | ||
|
|
| March 31, |
|
| December 31, |
|
| 2019 |
| 2018 | ||
|
|
|
|
|
|
|
Balance beginning of period |
| $ | 1,625,154 |
| $ | 1,646,601 |
Liabilities from drilling of new wells |
|
| 2 |
|
| 1,590 |
Change in estimates |
|
| — |
|
| (137,490) |
Accretion |
|
| 29,788 |
|
| 114,453 |
Balance end of period |
| $ | 1,654,944 |
| $ | 1,625,154 |
| | | | | | |
| | Three Months Ended | | Year ended | ||
| | | March 31, | | | December 31, |
| | 2022 |
| 2021 | ||
Balance beginning of period | | $ | 2,833,656 | | $ | 3,150,243 |
Liabilities acquired (disposed of) | | | 6,684 | | | (374,337) |
Wells plugged and abandoned | | | (73,998) | | | (31,945) |
Change in estimates | | | — | | | (8,299) |
Accretion | | | 19,576 | | | 97,994 |
Balance end of period | | $ | 2,785,918 | | $ | 2,833,656 |
The methodologies used to determine the fair value of our financial assets and liabilities at March 31, 20192022 were the same as those used at December 31, 2018.2021.
Cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. The Corporation’sCompany’s revolving line of credit has a recorded value that approximates its fair value since its variable interest rate is tied to current market rates and the applicable margins represent market rates.
Commodity derivative instruments consist of fixed-price swaps,two-way costless collars,collar and basis swap contracts for natural gas. The Corporation’sCompany’s derivative contracts are valued based on an income approach. The model considers various assumptions, such as quoted forward prices for commodities, time value and volatility factors. These assumptions are observable in the
22
Epsilon Energy Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
marketplace throughout the full term of the contract, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace, and are therefore designated as Level 2 within the valuation hierarchy. The CorporationCompany utilizes its counterparties’ valuations to assess the reasonableness of its own valuations.
14. Consolidation of Common Shares
To meet Nasdaq listing standards, the shareholders of the Corporation approved a Consolidation of the issued and outstanding common shares on the basis of one (1) new common share for up to every existing two (2) common shares issued and outstanding immediately prior to the Consolidation, which commenced trading on a post-Consolidation basis on the TSX on December 24, 2018. All share amounts and per share data are presented in these statements on a post-Consolidation basis.
19
23
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. This sectionThe 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, 20192022 and 20182021 and for the three months then ended together with accompanying notes.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 on-shoreonshore focused independent oilnatural gas and gasoil company engaged in the acquisition, development, gathering and production of oilnatural gas and gasoil reserves. Our primary areasarea of operation are Pennsylvaniais Pennsylvania. Additionally, we initiated a small appraisal program on our leases in the NW Anadarko basin of Oklahoma producing oil, natural gas, and Oklahoma.natural gas liquids. Our assets are concentrated in areas with known hydrocarbon resources, which are conducive to multi-well, repeatable drilling programs.
AllSubstantially all of the production from our Pennsylvania acreage (4,138(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. We ownEpsilon owns a 35% interest in the system which is operated by a subsidiary of Williams Partners, LP. In the three months ended March 31, 2019, we2022, Epsilon paid $0.26$0.37 million to the Auburn GGS to gather and treat our 1.82.3 Bcf, of natural gas production in Pennsylvania ($0.320.38 million for 1.8to the Auburn GGS to gather and treat our 2.4 Bcf of natural gas in the three months ended March 31, 2018)2021).
Epsilon realized net income of $1.4 million during the three months ended March 31, 2019 as compared to net income of $2.2$5.8 million for the three months ended March 31, 2018.2022, 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.”
Our ongoing business strategy involves focused targetingis 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 withinin the United States, to acquire leasehold interests and to develop our leasehold interests with the goal of converting our leasehold interests into proved natural gas and oil reserves, followed by production that optimizes cash flow and return on investment.
Since July 2013, we have narrowed our strategic focus to our core upstream and gathering system assets in the Marcellus shale in Pennsylvania, and the Anadarko Basin in Oklahoma, and have divested all non-core properties. As of March 31, 2019, we had $16.6 million in cash, and $23.0 million available on our Credit Facility. Also, we have implemented a number of initiatives operationally that have enhanced the value of our core assets in the Marcellus. These initiatives include working with the operator of our upstream asset to encourage improvements in completion productivity. In addition, we maintain an active dialogue with our gathering system partners with a view toward maximizing the long term value of our gathering assets.
Our strategy is twofold: maximize the value of our integrated Marcellus and Anadarko assets, and evaluate investment opportunities in non-Marcellus petroleum basins with attractive economics at the current commodity strip. When natural gas pricing improves in the Marcellus, we intend to investdeploying capital to increase production from both the lower and upper Marcellus reservoirs. We believe the upper Marcellus has the potential to meaningfully increase our current reserve value.earn attractive rates of return.
The operating environment remains challenging in our operating area of Pennsylvania. Thecore Marcellus Shale has proven to beis one of the most attractive dry gas resources in the lower United States and therefore, has attracted significant drillingdevelopment capital. Over the past several years, completionWell 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 areas,other basins throughout the US, the increase in natural gas deliverabilityproduction had historically outpaced demand. Over the past couple of years, this over supply condition has significantly outpacedbecome more balanced and demand growth from increased LNG exports and pipeline exports to Mexico have provided attractive markets improving the developmentprices for natural gas.
The operating environment remains challenging in Northeast Pennsylvania. We implemented a number of initiatives to enhance the infrastructure necessaryvalue 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 transportincrease
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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 to downstream markets. This phenomenon has resulted in localprice levels are sufficient and the capital deployed can achieve our internal hurdle rate of return.
In the longer term, we believe natural gas prices with abnormally large differentialswill 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 benchmark NYMEX Henry Hub. Our preferencecurrent ~ 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 to produce less natural gas in this unfavorable pricing environment as our acreage is largely held by
20
production, and our operating partner shares this view. The completion and commencing of operation of a large infrastructure project has begun to have a positive impactevaluating additional Meramec locations within the focus area for further exploitation on the local natural gas price.an opportunistically prudent timeline.
Three months ended March 31, 20192022 Highlights
Marcellus Shale – Pennsylvania
●During the three months ended March 31, 2019,2022, Epsilon’s realized natural gas price was $2.96$4.55 per Mcf, a 17%77% increase over the three months ended March 31, 2018.2021.
Total●During the three months ended March 31, 20192022, Epsilon’s natural gas production of 1.78was 2.4 Bcf, as compared to 1.842.4 Bcf during the same period in 2018.2021.
Anadarko, NW Stack Trend – Oklahoma Marcellus working interest (WI) gas averaged 22.8 MMcf/d for● 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. first three months of 2019.Gathered and delivered 24.9 BcfCompany had 1 gross (8.7 Bcf net to Epsilon’s interest) during the first three months of 2019 through the Auburn System which represents approximately 84% of maximum throughput.(0.18 net) well waiting on completion.●During the three months ended March 31, 2019,2022, Epsilon’s realized price for all Oklahoma production was $3.93$7.71 per Mcfe, a 6.9% decrease117% increase over the three months ended March 31, 2018.2021.●Total production for the three months ended March 31, 20192022 included natural gas, oil, and other liquids and was 0.310.17 Bcfe, a 9% decrease141% increase over the same period in 2018.2021.● 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.
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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 oil andnatural gas and gathering systemoil properties, (5) non-cash stock compensation expense, (6) gain or loss on derivative contracts net of cash received or paid on settlement, and (6) unrealized gains or losses on derivatives.(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"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 oilnatural gas and gasoil 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
21
reconciliation of net income to Adjusted EBITDA to net income,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.
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|
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| ||||||
(in thousands of dollars) |
| Three months ended March 31, | ||||||||||
|
| 2019 |
| 2018 | ||||||||
| | | | | | | ||||||
| | Three months ended March 31, | ||||||||||
|
| 2022 |
| 2021 | ||||||||
Net income |
| $ | 1,374 |
| $ | 2,159 | | $ | 5,805,888 | | $ | 2,735,567 |
Add Back: |
|
|
|
|
|
| | | | | | |
Net interest (income) expense |
|
| (15) |
|
| 44 | ||||||
Income tax provision |
|
| 747 |
|
| 987 | ||||||
Net interest expense | | | 98 | | | 19,260 | ||||||
Income tax expense | | | 2,181,898 | | | 1,144,573 | ||||||
Depreciation, depletion, amortization, and accretion |
|
| 1,826 |
|
| 1,791 | | | 1,389,219 | | | 1,682,860 |
Stock based compensation expense |
|
| 134 |
|
| 83 | | | 142,302 | | | 202,499 |
Net change in unrealized (gain) loss on commodity contracts |
|
| 327 |
|
| (264) | ||||||
Other income |
|
| — |
|
| — | ||||||
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 |
| $ | 4,393 |
| $ | 4,800 | | $ | 9,284,983 | | $ | 5,383,950 |
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Results of Operations
DuringFor the three months ended March 31, 2019,2022 revenues increased $0.16$5.2 million, or 2.2%61%, to $7.94$13.6 million from $7.78$8.4 million during the same period of 2018.2021.
Revenue and volume statistics for the three months ended March 31, 20192022 and 20182021 were as follows:
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|
|
|
|
|
| ||||||
(in thousands of dollars) |
| Three months ended March 31, | ||||||||||
|
| 2019 |
| 2018 | ||||||||
| | | | | | | ||||||
| | Three months ended | ||||||||||
| | March 31, | ||||||||||
|
| 2022 |
| 2021 | ||||||||
Revenues |
|
|
|
|
|
| | | | | | |
Natural gas revenue |
| $ | 5,435 |
| $ | 4,846 | | $ | 10,703,084 | | $ | 6,332,099 |
Volume (MMcf) |
|
| 1,823 |
|
| 1,900 | |
| 2,351 | |
| 2,466 |
Avg. Price ($/Mcf) |
| $ | 2.98 |
| $ | 2.55 | | $ | 4.55 | | $ | 2.57 |
Exit Rate (MMcfpd) |
|
| 24.6 |
|
| 23.3 | ||||||
PA Exit Rate (MMcfpd) | |
| 23.1 | |
| 32.8 | ||||||
Oil and other liquids revenue |
| $ | 73 |
| $ | 156 | | $ | 776,241 | | $ | 107,056 |
Volume (MBO) |
|
| 3.1 |
|
| 3.4 | |
| 14.9 | |
| 3.7 |
Avg. Price ($/Bbl) |
| $ | 23.81 |
| $ | 46.34 | | $ | 52.22 | | $ | 28.58 |
Gathering system revenue |
| $ | 2,438 |
| $ | 2,776 | | $ | 2,120,773 | | $ | 2,002,157 |
Total Revenues |
| $ | 7,946 |
| $ | 7,778 | | $ | 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, 2019,2022, approximately 85%76% of the Auburn GGS revenues earned were gathering fees, while 15%24% were compression fees. Third-partyGathering revenues from third-party customers represented approximately 18%10% of total gathering revenues and 7%third-party compression revenues represented 9% of total compression revenues. For the three months ended March 31, 2018,2021 approximately 89%81% of the Auburn GGS revenues earned were gathering fees, while 11%19% were compression fees. Third partyGathering revenues from third-party customers represented approximately 10%8% of gathering revenues and 5%third-party compression revenues represented 3% of compression revenues. Revenues derived from Epsilon’s production which have been eliminated from gathering system revenues amounted to $0.26$0.37 million and $0.32$0.38 million respectively for the three months ended March 31, 20192022 and 2018.2021.
Upstream natural gas revenue for the three months ended March 31, 20192022 increased by $0.6$4.4 million, or 12.1%69%, over the same period in 2018 as2021. This was primarily a result of higher natural gas prices, butprices; however, this was partially offset by slightly lower volumes being produced. Volumes were only slightly lower duringproduced due to natural decline of the wells.
Upstream oil and other liquids revenue for the three months ended March 31, 2019 because four2022 increased by $0.7 million, or 625%, over the same period in 2021. This was a result of increased production from new wells were brought on-line during this time which partially offset the natural declinein addition to higher prices.
The Company’s share of production rates over time that occurred.
Gatheringgathering system revenue decreased $0.4increased by $0.1 million, or 12.7%6%, during the three months ended March 31, 20192022 over the same period in 2018 due to a 24% decrease in the volumes flowing through the system. This was partially offset by an increase in the gathering and compression rate charged.2021. The gathering rate of the Auburn GGS is determined bysubject to a cost of
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service model, whereby the anchor shippers in the systemAnchor Shippers dedicate acreage and reserves to the gas gathering system inAuburn GGS. In exchange for this dedication, the owners of the Auburn GGS owners agreeingsystem agree to a contractualfixed rate of return on capital invested capital.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 this arrangementthe model is 15 years commencing infixed from 2012 and expiring in 2026 with an 18% rate of return.to 2026. Each year, the Auburn GGS historical and forecastactual throughput, revenue, operating expenses and capital expenditures are entered intocaptured in the cost of service model.model, and the remaining years are forecasted. The model then computes the newresolves a gathering rate that will yieldyields the contractual rate of return to the Auburn GGS owners. In 2026, prior to the end of the initial period on December 31, a new agreement governing rates will be negotiated between the Anchor Shippers and the gathering system owners.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.
27
The following table presents total cost and cost per unit of production (Mcfe), including ad valorem, severance, and production taxes for the three and three months ended March 31, 20192022 and 2018:2021:
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| Three months ended March 31, | ||||||||||
(in thousands of dollars) |
| 2019 |
| 2018 | ||||||||
| | | | | | | ||||||
| | Three months ended March 31, | ||||||||||
|
| 2022 |
| 2021 | ||||||||
Lease operating costs |
| $ | 1,718 |
| $ | 1,930 | | $ | 1,770,654 | | $ | 1,594,188 |
Gathering system operating costs |
|
| 313 |
|
| 430 | | | 159,211 | | | 190,947 |
|
| $ | 2,031 |
| $ | 2,360 | ||||||
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| ||||||
| | $ | 1,929,865 | | $ | 1,785,135 | ||||||
| | | | | | | ||||||
Upstream operating costs—Total $/Mcfe |
|
| 0.93 |
|
| 1.01 | | | 0.73 | | | 0.64 |
Gathering system operating costs $ / Mcf |
|
| 0.07 |
|
| 0.07 | | | 0.09 | | | 0.10 |
Upstream operating costs consist of lease operating expenses necessary to extract natural gas and oil, including gathering and treating the oilnatural gas and gasoil 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 and the associated $/Mcf 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 $0.26$0.37 million and $0.32$0.38 million for the three months ended March 31, 20192022 and 2018,2021, respectively (see Note 10,11, ‘‘Operating Segments,’’ of the Notes to Unaudited Condensed Consolidated Financial Statements).
Upstream operatingGathering system costs (net of intercompany elimination) for the three months ended March 31, 20192022 decreased $0.2$0.03 million, or 11.0%17%, fromover the same period in 2018.2021. The decrease inCompany’s share of total cost and $/Mcfe was mainly due to the decrease in volumes produced. Gatheringgathering system costs decreased $0.02 million, or 5%, for the three months ended March 31, 2019 decreased $0.1 million2022 over the same period in 2018 because of the2021. This decrease is primarily due to a decrease in costs related to lower throughput volumes.volumes into the gathering system.
Depletion, Depreciation, Amortization and Accretion (“DD&A”)
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| ||||||
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| Three months ended March 31, | ||||||||||
(in thousands of dollars) |
| 2019 |
| 2018 | ||||||||
| | | | | | | ||||||
| | Three months ended March 31, | ||||||||||
|
| 2022 |
| 2021 | ||||||||
Depletion, depreciation, amortization and accretion |
| $ | 1,826 |
| $ | 1,791 | | $ | 1,389,219 | | $ | 1,682,860 |
OilNatural gas and natural gasoil and gathering system assets are depleted and depreciated using the units-of-productionunits 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 oilnatural gas and gasoil 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. The depletion for the first three quarters of the next year is based on the reserve report prepared at the end of the previous year, taking into consideration the limited development of the reserves over these time periods. The fourth quarter depletion is calculated using the reserve volumes from the reserve report prepared as of December 31 of the current year.
23
Depreciation expense includes primarily amounts pertaining to our office furniture and fixtures, leasehold improvements, and computer hardware and software.hardware. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 57 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.
As discussed above, 28
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 three quarterscompares 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 calculatedrequired, which is determined based on the reserve report from the prior year. 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, 2019, DD&A expense remained fairly consistent compared to the same period in 2018 mainly due to only minor adjustments to the amount of reserves reported in the December 31, 2018 reserve report as compared to the December 31, 2017 reserve report2021 and insignificant changes in production volumes.2020, no impairment was required.
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| ||||||
|
| Three months ended March 31, | ||||||||||
(in thousands of dollars) |
| 2019 |
| 2018 | ||||||||
| | | | | | | ||||||
| | Three months ended March 31, | ||||||||||
|
| 2022 |
| 2021 | ||||||||
General and administrative |
| $ | 1,473 |
| $ | 808 | | $ | 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 increased by $0.7 million, or 82.4%, duringfor the three months ended March 31, 2019 compared to the same period in 2018,2022 and 2021 decreased $0.2 million or 14%. This was mainly due to the additional costs incurred duringdecreased legal fees related to the processcomplaint filed against Chesapeake, and decreased stock-based compensation as a result of delisting from the TSX and listing on the NASDAQ. Also, additional fees were incurred for fulfilling requirements of US reporting, and for closing fees on the renewal of our revolving line of credit.no new stock grants.
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|
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| ||||||
|
| Three months ended March 31, | ||||||||||
(in thousands of dollars) |
| 2019 |
| 2018 | ||||||||
| | | | | | | ||||||
| | Three months ended March 31, | ||||||||||
|
| 2022 |
| 2021 | ||||||||
Interest expense |
| $ | 28 |
| $ | 45 | | $ | 15,319 | | $ | 27,073 |
Interest expense relates to the interestcommitment fees paid on the revolving line of credit.
Interest expense decreased duringfor the three months ended March 31, 20192022 and 2021 decreased $0.01 million, or 43%. The decrease is due to the paying off ofreduction in the revolvingborrowing base on our line of credit in December 2018.during this time.
Net(Loss) Gain (Loss) on CommodityDerivative Contracts
|
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|
|
|
|
|
| Three months ended March 31, | ||||
(in thousands of dollars) |
| 2019 |
| 2018 | ||
Gain (loss) on derivative contracts |
| $ | (511) |
| $ | 371 |
| | | | | | |
| | Three months ended March 31, | ||||
|
| 2022 |
| 2021 | ||
(Loss) gain on derivative contracts | | $ | (971,904) | | $ | 465,341 |
For the three months ended March 31, 20192022 and 2018, we2021, Epsilon entered into fixed priceNYMEX Henry Hub Natural Gas Futures swap, Dominion basis swap, and basis swaptwo-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
29
$1,211,728 on the settlement of contracts. During the three months ended March 31, 2019 we paid $184,244, and during the three months ended March 31, 20182021, we received $106,456 on the settlementnet cash settlements of contracts.
Miscellaneous Income (Expense)
|
|
|
|
|
|
|
|
| Three months ended March 31, | ||||
(in thousands of dollars) |
| 2019 |
| 2018 | ||
Miscellaneous income |
| $ | 43 |
| $ | 1 |
Miscellaneous income consists of interest income and other income.$64,200.
For the three months ended March 31, 20192022, 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 2018 miscellaneous2021, other income consisted primarily of interest income.income and was consistent over the periods.
24
Capital Resources and Liquidity
The primary source of cash for Epsilon during the three months ended March 31, 20192022 and 20182021 was funds generated from operations. In addition to operations, the primary uses of cash for the three months ended March 31, 20192022 were income tax pre-payments, and acquisitions and development of oilnatural 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. For 2018, funds were mainly used for operationsproperties and development expenditures.the repurchase of shares of common stock.
At March 31, 2019,2022, we had a working capital surplus of $15.0$27.6 million, an increase of $3.8$3.5 million over the $8.5$24.1 million surplus at MarchDecember 31, 2018.2021. The surplus increased over the last year because offrom 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, 20192022 compared to 20182021
During the three months ended March 31, 2019, $3.92022, $7.7 million was provided by the Corporation’sCompany’s operating activities, compared to $2.4$5.6 million provided during the same period in 2018,2021, a $1.5$2.1 million, and 62.6%38% increase. The increase was mainly due to increased cash operations as a result of increased commodity prices, partially offset by the collection of receivables outstanding at December 31, 2018.losses created on the hedges as they matured.
The CorporationCompany used $1.5$2.9 million and $0.6 million of cash for investing activities during the three months ended March 31, 2019.2022 and 2021, respectively. This was spent primarily on leashold costs in Oklahoma and Pennsylvania, and the acquisition of unproved properties in Oklahoma. For the three months ended March 31, 2018, the Corporation used $0.3 million, mainly on leasholdleasehold and development costs targeting increasing production in OklahomaPennsylvania and Pennsylvania.Oklahoma.
The $0.2 million and $0.1Company used $1.3 million of cash used for financing activityactivities during the three months ended March 31, 2019 and 2018 respectively2022. This was related tospent 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 Corporation.Company.
Effective July 30, 2013, our wholly owned subsidiary Epsilon Energy USA entered intoIn addition, the Company has a senior secured revolving credit facility. The terms of this agreement includefacility which includes a total commitment of up to $100 million. The current effective borrowing base is $23$14 million, which is subject to [semi-annual]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. The applicable margin ranges from 2.75% to 3.75% and is(3.25%-4.25% based on the percent of the line of credit utilized. utilized) with the minimum being 0.25%, b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5%.
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Effective January 7, 2019April 6, 2021 the agreement was amended to extend the maturity date to March 1, 2022.2024. 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 CorporationCompany 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 3.53.0 based on income adjusted for interest, taxes and non-cash amounts.
We wereEpsilon was in compliance with the financial covenants of the agreement as of March 31, 20192022 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 | | Balance at | | | | | | ||
| | March 31, | | December 31, | | Borrowing Base | | Interest | |||
|
| 2022 |
| 2021 |
| March 31, 2022 |
| 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, 2018.
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| Balance at |
| Balance at |
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| March 31, |
| December 31, |
| Borrowing Base |
| Interest | |||
|
| 2019 |
| 2018 |
| March 31, 2019 |
| Rate | |||
Revolving line of credit |
| $ | — |
| $ | — |
| $ | 23,000,000 |
| 3 mo. LIBOR + 2.75% |
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.
Available borrowing capacityCommencing 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 credit agreement is $23 million asNCIB. The repurchased stock had an average price of May 10, 2019.$4.54 per share and were subsequently cancelled.
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We haveThe Company has entered into hedging arrangements to reduce the impact of natural gas price volatility on operations. By removing the price volatility from a significant portion of natural gas production, the potential effects of changing prices on operating cash flows have been mitigated, but not eliminated. While mitigating the negative effects of falling commodity prices, these derivative contracts also limit the benefits we might otherwise receive from increases in commodity prices.
At March
31 2019, Epsilon’s outstanding natural gas commodity swap contracts consisted
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| Weighted Average Price ($/MMbtu) |
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| Volume |
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| Basis |
| Fair Value of Liability | ||
Derivative Type |
| (Mmbtu) |
| Swaps |
| Differential |
| March 31, 2019 | |||
2019 |
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Fixed price swap |
| 4,287,500 |
| $ | 2.80 |
| $ | — |
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| (13,020) |
Basis swap |
| 4,287,500 |
| $ | — |
| $ | (0.49) |
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| (479,062) |
2020 |
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|
Fixed price swap |
| 3,111,000 |
| $ | 2.73 |
| $ | — |
|
| (16,690) |
Basis swap |
| 3,111,000 |
| $ | — |
| $ | (0.47) |
|
| (114,761) |
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| 14,797,000 |
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| $ | (623,533) |
The following table summarizes Epsilon’s contractual obligations at March 31, 2019:2022:
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| Payments Due by Period | ||||||||||||||||||||||
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| 1 – 3 |
| Greater than | |||||||||||||||
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| Total |
| 1 Year |
| Years |
| 3 Years | ||||||||||||||||
Derivative liabilities(1) |
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| 1,211,849 |
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| 1,108,981 |
|
| 102,868 |
|
| — | ||||||||||||
Asset retirement obligation, undiscounted |
|
| 13,934,815 |
|
| — |
|
| — |
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| 13,934,815 | ||||||||||||
| | | | | | | | | | | | | ||||||||||||
| | Payments Due by Period | ||||||||||||||||||||||
| | | | | Less than | | 1 – 3 | | Greater than | |||||||||||||||
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| Total |
| 1 Year |
| Years |
| 3 Years | ||||||||||||||||
Asset retirement obligations, undiscounted | | $ | 7,511,953 | | $ | 11,209 | | $ | — | | $ | 7,500,744 | ||||||||||||
Capital expenditure commitments |
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| 131,184 |
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| 131,184 |
|
| — |
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| — | |
| 1,026,737 | |
| 1,026,737 | |
| — | |
| — |
Operating leases |
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| 67,291 |
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| 60,562 |
|
| 6,729 |
|
| — | |
| 202,633 | |
| 140,189 | |
| 62,444 | |
| — |
Total future commitments |
| $ | 15,345,139 |
| $ | 1,300,727 |
| $ | 109,597 |
| $ | 13,934,815 | | $ | 8,741,323 | | $ | 1,178,135 | | $ | 62,444 | | $ | 7,500,744 |
________________________
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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, Epsilon believeswe 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 future 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, 2019,2022, the CorporationCompany had no off-balance sheet arrangements.
Foreign Currency Exchange Rate Risk
We are exposed to risks arising from fluctuations in foreign currency exchange rates, primarily between Canadian and U.S. dollars. We do not utilize any foreign currency based derivatives. In order to manage this risk and to defer the
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realization of any resulting currency loss from converting Canadian dollars to U.S. dollars, we retain cash balances in both U.S. and Canadian dollars.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our earnings and cash flow are significantly affected by changes in the market price of commodities. The prices of oilnatural gas and natural gasoil 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 oil or natural gas and oil decline substantially, the value of our assets could fall dramatically, impacting our future optionsoperations 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.
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 termshort-term low commodity price environment will not significantly impact the reserves produced and thus the revenue of our gas gathering system.
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, 2019,2022 and 2021, the outstanding principal balance under the credit agreement was nil.
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Table of ContentsCommodity Contracts
Derivative Contracts
The Corporation’sCompany’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 Corporation’sCompany’s capital spending program.
ITEM 4. CONTROLS AND PROCEDURES
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 erquiredrequired 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, 20192022 at the reasonable assurance level.
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No changes in our internal control over financial reporting occurred during the quarter ended March 31, 20192022 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.
On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC (“Chesapeake”) in the United States District Court for the Middle District of Pennsylvania, Scranton, Pennsylvania (“Middle District”). Epsilon claims that Chesapeake has breached a settlement agreement and several operating agreements (“JOAs”) to which Epsilon and Chesapeake are parties. Epsilon asserts that Chesapeake has failed to cooperate with Epsilon’s efforts to develop resources in the Auburn Development, located in North-Central Pennsylvania, as required under both the settlement agreement and JOAs.
Epsilon requested a preliminary injunction but was unsuccessful in obtaining that injunction. Epsilon filed a motion to amend its original Complaint. Chesapeake opposed. The CorporationCourt ruled in Epsilon’s favor and allowed Epsilon’s amendment. Chesapeake moved to dismiss the amended Complaint. The Court granted the motion to dismiss on a narrow
33
issue without prejudice to Epsilon’s right to file a new lawsuit based on new proposals made after the Court’s decision. Epsilon filed a motion for reconsideration of that decision, but the court denied the motion for reconsideration on January 18, 2022.
Epsilon filed a notice of appeal on February 15, 2022 challenging both the motion to dismiss and motion for reconsideration decisions. Chesapeake filed a cross-appeal on March 1, 2022. A court-mandated mediation was set for June 9, 2022. A briefing schedule has not yet been set , and accordingly, a decision on the appeal is not currently involvedexpected until early to mid-2023.
Epsilon re-filed a complaint against Chesapeake in any litigation.the Middle District on May 9, 2022. Epsilon generally asserts the similar claims as in the previous suit, pursuing declaratory judgment claims regarding Chesapeake’s obligation to Epsilon to cooperate with Epsilon’s efforts in the Auburn Development and regarding Chesapeake’s obstruction of Epsilon’s efforts with the Pennsylvania Department of Environmental Protection permitting process. Chesapeake’s response to the complaint is expected in June 2022.
RiskThere have been no material changes from the risk factors relating to the Corporation are containeddisclosed in Item 1A1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2018. No material change to such risk factors has occurred during the three months ended March 31, 2019.2021.
ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Purchases of Equity Securities by Epsilon Energy Ltd.
For the three months ended March 31, 2022, no shares had been repurchased.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
None.Not applicable.
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34
Exhibit No. |
| Description of Exhibit |
| | |
31.1 | Sarbanes-Oxley Section 302 certification of Principal Executive Officer. | |
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| Sarbanes-Oxley Section 302 certification of Principal |
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| Sarbanes-Oxley Section |
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| Sarbanes-Oxley Section 906 certification of Principal Financial Officer. | |
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| Inline XBRL Instance Document. |
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| Inline XBRL Schema Document. |
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| Inline XBRL Calculation Linkbase Document. |
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| Inline XBRL Definition Linkbase Document. |
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| Inline XBRL Labels Linkbase Document. |
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| Inline XBRL Presentation Linkbase Document. |
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| Cover Page Interactive Data File (embedded within the Inline XBRL document) |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Epsilon Energy Ltd. | | | |
(Registrant) | | | |
| | | |
Date: May | | By: | /s/ B. Lane Bond |
| | | B. Lane Bond |
| | | Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer) |
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