Epsilon Energy .(EPSN) - 2023 Q4 - Annual Report

FORM 10-K PART I FORWARD LOOKING STATEMENTS This report contains forward-looking statements regarding future operating performance, oil and gas production rates, commodity prices, reserves, and development costs, based on reasonable assumptions but subject to significant risks and uncertainties, with no obligation for public updates unless legally required - Forward-looking statements cover oil and gas production rates, commodity prices, reserves, and development costs, based on reasonable assumptions but subject to known and unknown risks and uncertainties[8] - The company assumes no obligation to publicly update or revise any forward-looking statements unless legally required[8] DEFINED TERMS This section defines key terms used in the report, primarily professional vocabulary from the oil and natural gas industry, ensuring clear understanding of the content - This section defines professional terms in the oil and natural gas industry, including 3-D seismic, BOE, completion, development well, exploratory well, free cash flow, gross/net acres, lease operating expenses, proved reserves (developed and undeveloped), PV-10, reasonable certainty, reservoir, royalty, and standardized measure[9][10][11][12][13][15][16][17][18][19][20][21][22][25][26][27][28][29][30][31][32][33][34][35][36][37][38][39] ITEM 1. BUSINESS Summary Epsilon Energy Ltd. is a North American onshore independent natural gas and oil company focused on the acquisition, development, gathering, and production of natural gas and oil reserves across key basins - Epsilon Energy Ltd. is a North American onshore independent natural gas and oil company, focused on the acquisition, development, gathering, and production of natural gas and oil reserves[41] | Metric | December 31, 2023 | | :--- | :--- | | Net Proved Natural Gas Reserves | 65,916 MMcf | | Net NGL Reserves | 383,174 Bbls | | Net Oil and Other Liquid Reserves | 341,286 Bbls | | Total Leased Acreage (Gross/Net) | 84,684 / 15,463 Acres | - The company produces in the Marcellus Shale in Pennsylvania, the Permian Basin in Texas and New Mexico, and the Anadarko Basin in Oklahoma[41] Business highlights of 2023 In 2023, Epsilon experienced a significant decline in Marcellus Shale natural gas sales prices and volumes, while expanding into the Permian Basin and facing price drops in Anadarko Operational Highlights Properties | Region | 2023 Natural Gas Sales Price (Excl. Hedges) | 2022 Natural Gas Sales Price (Excl. Hedges) | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Marcellus Shale (Pennsylvania) | $1.74 / Mcf | $5.96 / Mcf | -71% | | Anadarko (Oklahoma) | $5.35 / Mcfe | $8.68 / Mcfe | -38% | | Region | 2023 Gross Natural Gas Sales Volume | 2022 Gross Natural Gas Sales Volume | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Marcellus Shale (Pennsylvania) | 7.9 Bcf | 9.0 Bcf | -12.2% | | Anadarko (Oklahoma) | 0.60 Bcfe | 0.93 Bcfe | -35.5% | - In 2023, the company participated in drilling 7 gross wells (0.74 net wells) and completing 2 gross wells (0.02 net wells) in Pennsylvania[47] - In 2023, the company acquired 12,373 gross acres (3,093 net acres) of undeveloped leases in the Permian Basin and participated in drilling and completing 4 gross wells (0.7 net wells)[53] Business Segments Epsilon's operations are divided into three segments: Upstream (acquisition, exploration, development, production), Gathering System (natural gas gathering operations), and Corporate (corporate and governance functions) - The company's operations are divided into three segments: Upstream (acquisition, exploration, development, and production of oil and natural gas reserves), Gathering System (operating natural gas gathering systems in partnership with two companies), and Corporate (corporate and governance functions)[56][57][58] Oil and Natural Gas Production and Revenues and Gathering System Revenues Total revenue in 2023 decreased by 56% to $30.7 million, primarily due to a 71% drop in Pennsylvania natural gas prices, partially offset by a 21% increase in gathering system revenue and new Permian Basin contributions | Metric | 2023 | 2022 | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Total Revenue | $30,729,752 | $69,962,709 | -56% | | Pennsylvania Natural Gas Revenue | $13,733,052 | $53,759,354 | -74.4% | | Pennsylvania Average Natural Gas Price ($/Mcf) | $1.74 | $5.96 | -70.8% | | Gathering System Revenue (Net) | $9,790,531 | $8,085,512 | +21.1% | | Permian Basin Total Revenue | $3,971,822 | $0 | New | | Oklahoma Total Revenue | $3,234,347 | $8,117,843 | -60.2% | | Region | 2023 Production (MMcf/MBOE/MBbl) | 2022 Production (MMcf/MBOE/MBbl) | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Pennsylvania Natural Gas | 7,906 MMcf | 9,026 MMcf | -12.4% | | Oklahoma Natural Gas | 354 MMcf | 477 MMcf | -25.8% | | Oklahoma NGL | 21 MBOE | 44 MBOE | -52.3% | | Oklahoma Oil and Other Liquids | 21 MBbl | 32 MBbl | -34.4% | | Permian Basin Natural Gas | 80 MMcf | - | New | | Permian Basin NGL | 18 MBOE | - | New | | Permian Basin Oil and Other Liquids | 44 MBbl | - | New | Gathering System Operations Epsilon Midstream holds a 35% interest in the Auburn natural gas gathering system, operating on a cost-of-service model with a contracted 18% return on invested capital for anchor shippers - Epsilon Midstream owns a 35% interest in the Auburn natural gas gathering system, located in Pennsylvania, providing services to anchor shippers[62] - The gathering system operates on a cost-of-service model, with anchor shippers committed to an 18% return on invested capital over a 15-year period (2012-2026)[63] | Metric | 2023 | 2018 | Change | | :--- | :--- | :--- | :--- | | Auburn CF Total Throughput | 6.62 Bcf | 10.01 Bcf | -34% | | Anchor Shipper Gas as % of Total Throughput | 74% | 57% | +17% | | Gathering System Revenue (2018-2023) | - | - | -2% | - The current system capacity of Auburn CF is approximately 220,000 Mcf/day, with potential for expansion by adding compression units or increasing design suction pressure[66] Proved Reserves As of December 31, 2023, Epsilon's total net proved reserves decreased by 25% to 70,262 MMcfe, primarily due to commodity price revisions, despite an increase in undeveloped proved reserves | Reserve Type | December 31, 2023 | December 31, 2022 | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Total Proved Reserves (MMcfe) | 70,262 | 94,255 | -25.5% | | Developed Proved Reserves (MMcfe) | 50,681 | 80,796 | -37.3% | | Undeveloped Proved Reserves (MMcfe) | 19,581 | 13,459 | +45.5% | - The decrease in developed proved reserves is primarily attributed to commodity price revisions[70][229] - In 2023, 7 gross wells (0.74 net wells) were drilled and 2 gross wells (0.02 net wells) were completed in Pennsylvania, with net development capital expenditures of $2.5 million[71] - In Oklahoma, 1 gross well (0.11 net well) was completed, with net development capital expenditures of $0.7 million[72] Internal Controls Over Reserves Estimation Process and Qualifications of Technical Persons with Oversight for the Company's Overall Reserve Estimation Process Epsilon's reserve estimates are prepared by independent consultants and overseen by the COO, ensuring compliance with SEC regulations and industry standards, with qualified personnel involved - Reserve estimates are prepared by the independent engineering firm DeGolyer and MacNaughton and overseen by the company's Chief Operating Officer, ensuring compliance with SEC regulations and industry standards[73][74] - The company's Chief Operating Officer holds a Bachelor of Science in Petroleum Engineering and an MBA, with over 30 years of upstream exploration and production experience[73] - Independent consultant Dilhan Ilk is a registered professional engineer with over 13 years of experience in oil and gas reservoir studies and reserve evaluations[76] Marketing and Major Customers Epsilon faces intense competition in Pennsylvania natural gas marketing due to limited interstate capacity and ample supply, relying on third-party services, with two major customers accounting for over 10% of 2023 total revenue - Natural gas marketing in northeastern Pennsylvania is highly competitive, primarily due to limited interstate transportation capacity and abundant natural gas supply[77] - The company markets natural gas through a third-party service, ARM Energy Management LLC[78] - In 2023, Direct Energy Business Marketing, LLC and EQT Energy, LLC each accounted for 10% or more of the company's total revenue[80] Geographic Locations of Operations Epsilon's revenue is highly concentrated in Pennsylvania, but the company is strategically reallocating capital to upstream opportunities outside the Marcellus Shale, particularly the Permian Basin, to enhance market flexibility | Region | 2023 Revenue Contribution | 2022 Revenue Contribution | | :--- | :--- | :--- | | Pennsylvania | 77% | 88% | - Company management is actively reallocating capital to upstream opportunities outside the Marcellus Shale, particularly the Permian Basin, to enhance flexibility in responding to changing market conditions[81] Competition The oil and gas industry is highly competitive, potentially leading to shortages of drilling and completion equipment, services, and personnel, which could increase costs and delay development activities - The oil and gas industry is highly competitive, which may lead to shortages of drilling and completion equipment, services, and personnel, thereby increasing costs and delaying development activities[83] Our Status as an Emerging Growth Company Epsilon operates as an 'Emerging Growth Company' under the JOBS Act, benefiting from simplified reporting and regulatory requirements, and has opted to delay new accounting standards adoption until its status ends by December 31, 2024 - The company is an "Emerging Growth Company," enjoying simplified reporting and regulatory requirements, including exemptions from auditor attestation on internal controls, delayed adoption of new accounting standards, exemption from new PCAOB requirements, and reduced executive compensation disclosure[84][86] - The company has elected to delay the adoption of new accounting standards and will cease to be an Emerging Growth Company no later than December 31, 2024[84][85] Employees As of December 31, 2023, Epsilon employed 10 full-time staff in Houston, Texas, none subject to collective bargaining, fostering a values-driven culture to attract and retain high-performing talent - As of December 31, 2023, the company had 10 full-time employees in Houston, Texas, none of whom were subject to collective bargaining agreements[86][87] - The company is committed to building a values-driven culture that prioritizes safety, ethics, inclusion, and diversity to attract and retain high-performing talent[88][89] Legal Proceedings Epsilon filed a lawsuit against Chesapeake Appalachia, LLC in March 2021 for breach of settlement and operating agreements, but the case was voluntarily dismissed without prejudice in September 2023 - Epsilon filed a lawsuit against Chesapeake Appalachia, LLC on March 10, 2021, alleging breach of settlement and operating agreements for failing to cooperate in developing resources in the Auburn development area[90] - After an unsuccessful preliminary injunction and the court dismissing some claims, Epsilon obtained court approval to dismiss the case without prejudice in September 2023[91][92] Regulation Epsilon's operations are subject to federal, state, and local environmental regulations that may increase costs and restrict activities, with potential future impacts from climate change and hydraulic fracturing regulations Environmental Regulation Climate Change Hydraulic Fracturing Gathering System Regulation - Epsilon's operations are subject to federal, state, and local environmental regulations, which may increase costs, restrict activities, and require remedial measures[93][96] - The company currently complies with regulations and does not anticipate significant environmental expenditures in the near term, but future regulatory changes could have unpredictable impacts[94][97] - Regulations related to climate change and hydraulic fracturing could significantly impact the company's business, including reduced demand and increased compliance costs[98][106][109][110] Market for Our Common Equity and Related Stockholder Matters Epsilon's common stock trades on Nasdaq under 'EPSN' since February 2019, with approximately 975 registered shareholders as of March 2024, and the company paid $5.6 million in quarterly dividends in 2023 Market Information Shareholders Dividends Securities Authorized for Issuance under Equity Incentive Plans - Epsilon common stock has traded on the Nasdaq Global Market under the symbol "EPSN" since February 19, 2019[113] - As of March 19, 2024, the last reported sales price of the common stock was $5.01 per share[113] - As of March 1, 2024, the company had approximately 975 registered shareholders[114] | Metric | December 31, 2023 | | :--- | :--- | | Total Quarterly Dividends | $5.6 Million | | Dividend Per Share | $0.25 | | Stock Options Outstanding | 57,500 | | Common Stock Outstanding Under 2020 Equity Incentive Plan | 491,536 | - The company plans to maintain its quarterly dividend[114] Recent Developments On January 30, 2024, the company repurchased 248,700 shares of its common stock at $4.82 per share under its existing stock repurchase program - On January 30, 2024, the company repurchased 248,700 shares of its common stock at $4.82 per share (excluding commissions) under its existing stock repurchase program[120] ITEM 1A. RISK FACTORS Risks Related to Oil and Natural Gas Reserves Company success is highly dependent on volatile oil and gas prices, which can impact financial performance and reserve values, while exploration and production inherently carry significant operational and estimation uncertainties - The company's revenue, profitability, liquidity, financing capabilities, and future growth prospects are highly dependent on oil and natural gas prices, and price volatility or declines could severely impact operating results and financial condition[122] - Oil and natural gas exploration, development, and production involve inherent risks, including dry wells, insufficient production, increased operating costs, and environmental damage, and the company is not fully insured against all risks[126][127] - Reserve estimates involve inherent uncertainties, and actual production, revenue, taxes, and development expenditures may differ significantly from estimates, with future reserve and production growth highly dependent on the successful discovery and development of new reserves[128][131] Risks Related to Stage of Development, Structure and Capital Resources Economic downturns and capital intensity pose significant risks, potentially limiting financing, reducing borrowing capacity, and exposing the company to operational and market concentration risks due to its reliance on third-party operators and Pennsylvania operations - An economic downturn or recession could lead to lower oil and natural gas prices, severely impacting the company's operating results, and the company may not be able to obtain the additional capital needed to implement its business plan[132][133][134] - The borrowing base under the credit facility may be reduced due to declining commodity prices, potentially forcing the company to immediately repay a portion of its debt[137] - The company's operations are concentrated in Pennsylvania, potentially exposing it to regional supply and demand factors, government regulations, transportation capacity limitations, market restrictions, weather events, or production disruptions[152][153] - Approximately 99% of the company's oil and natural gas assets are operated by third-party operators, limiting its control over their activities, and operator failures could reduce production and revenue or increase costs[156] Risks Related to Commodity Prices, Hedging and Marketing Volatile oil and gas prices, potential limitations or losses from hedging activities, market access challenges, and negative investor sentiment regarding fossil fuels all pose significant risks to Epsilon's business and financial health - Oil and natural gas prices are highly volatile, and prolonged low prices could have a significant adverse impact on the company's business, including reserve values, borrowing capacity, revenue, and cash flow[163][165][166][167] - Hedging transactions may limit potential gains or result in losses, and the company faces credit risk from counterparties failing to perform on hedging transactions[168][169][170] - Investor sentiment regarding climate change, fossil fuels, and sustainability could negatively impact the company's business and stock price, and may limit access to financing[172][173] Risks Related to Cybersecurity Reliance on complex IT systems exposes the company to cybersecurity threats, which could lead to operational disruptions, data breaches, financial losses, and reputational damage, with potentially insufficient insurance coverage - The company relies on complex IT systems and is vulnerable to events such as fire, flood, power outages, telecommunications failures, human error, computer viruses, and cyberattacks, which could lead to operational disruptions and harm revenue and profitability[177] - Cyber incidents could result in information theft, data corruption, operational disruptions, and financial losses, incurring remediation costs, increased cybersecurity protection costs, lost revenue, litigation, and reputational damage[178][180] - The company's insurance may not be sufficient to cover all losses caused by cyberattacks[180] Risks Related to Internal Controls As an emerging growth company, Epsilon benefits from simplified reporting, but these exemptions may reduce investor appeal and increase stock volatility, while failure to maintain adequate internal controls could impair financial reporting accuracy - As an emerging growth company, the company enjoys simplified reporting requirements, including exemptions from certain internal control audits and delayed adoption of new accounting standards[181][182] - These exemptions may make the company's common stock less attractive to some investors, leading to an inactive trading market and stock price volatility[183] - If the company fails to establish and maintain appropriate disclosure or internal controls, it could affect its ability to prepare accurate financial statements and comply with applicable regulations[184][185][187] Risks Related to Gathering System The gathering system's success depends on anchor shipper development in the Marcellus Shale, facing risks from declining volumes, fluctuating cost-of-service rates, regional price volatility, competition, aging assets, and operational hazards - The success of the gathering system depends on the economic development of Marcellus Shale reserves by anchor shippers, and throughput will decline if new supply is not secured due to natural decline rates of existing wells[188] - Auburn GGS gathering rates are influenced by a cost-of-service model, and if throughput is lower than expected, rates may increase, leading to reduced development activity[189][190] - Natural gas prices in northeastern Pennsylvania are volatile and subject to significant discounts relative to Henry Hub, which could impact the company's financial performance, cash flow, and financing capabilities[191][196] - The company faces credit risk from customers and counterparties, and non-performance could result in losses, while gathering business operations are subject to various operational risks and unforeseen disruptions, and insurance may not cover all losses[195][199] ITEM 1B. UNRESOLVED STAFF COMMENTS The company has no unresolved staff comments - The company has no unresolved staff comments[200] ITEM 1C. CYBERSECURITY Risk Management and Strategy Epsilon integrates cybersecurity into its overall risk management, collaborating with IT consultants and auditors for mitigation, continuously monitoring third-party compliance, and has not experienced significant threats to date - The company integrates cybersecurity risks into its overall risk management process, working closely with IT consultants and auditors to mitigate potential risks[202] - The company engages a third-party IT consulting firm and conducts annual IT audits, continuously monitoring the compliance of third-party service providers[202][203] - To date, the company has not encountered any cybersecurity threats that have had a material impact on its business or operations[204] Governance The Board of Directors, with the Audit Committee as the primary governance body, actively oversees cybersecurity threat mitigation, reviewing annual IT audits, and ensuring management communication on potential threats - The company's Board of Directors focuses on potential cybersecurity threats and maintains close contact with management[205] - The Audit Committee is the primary governance body for evaluating and confirming the company's cybersecurity threat mitigation processes, responsible for reviewing annual IT audits and discussing potential threats[205] - The Chief Financial Officer, Chief Operating Officer, Controller, and Treasurer all participate in communications with IT consultants and auditors, with the Chief Financial Officer responsible for reporting any cybersecurity threats to the Audit Committee and Chief Executive Officer[206] ITEM 2. PROPERTIES The information required for this section is included in 'Item 1. Business – Properties' - The information required for this section is included in "Item 1. Business – Properties"[207] ITEM 3. LEGAL PROCEEDINGS This section reiterates the legal proceedings between the company and Chesapeake Appalachia, LLC, where Epsilon's lawsuit for breach of agreement was voluntarily dismissed without prejudice in September 2023 - Epsilon filed a lawsuit against Chesapeake Appalachia, LLC on March 10, 2021, alleging breach of agreement for failing to cooperate in developing resources in the Auburn development area[207] - After an unsuccessful preliminary injunction and the court dismissing some claims, Epsilon obtained court approval to dismiss the case without prejudice in September 2023[208][209] ITEM 4. MINE SAFETY DISCLOSURES Not applicable - Not applicable[211] PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES This section supplements 'Item 1. Business' by detailing equity awards granted to executives and directors in 2023 and the board-authorized stock repurchase program, under which 70,874 shares were repurchased by December 2023 - On July 1, 2023, the Board of Directors granted 79,589 shares of common stock to the CEO and CFO, vesting in equal installments over three years[213] - On July 3, 2023, the Board of Directors granted 64,975 shares of common stock to directors, vesting in equal installments over three years[214] - On March 9, 2023, the Board of Directors authorized a new stock repurchase program, allowing for the repurchase of up to 2,292,644 shares of common stock (10% of outstanding shares at the time), with a total value not exceeding $15 million, commencing on March 27, 2023, and ending on March 26, 2024[216] | Period | Total Shares Purchased | Average Price Per Share | | :--- | :--- | :--- | | December 2023 | 70,874 | $5.06 | | Total | 70,874 | $5.06 | ITEM 6. [RESERVED.] This section is reserved - This section is reserved[219] ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Epsilon Energy Ltd., an independent North American oil and gas company, saw its net proved reserves and net income significantly decline in 2023 due to commodity price revisions, prompting a strategic shift in investment focus to the Permian Basin - Epsilon Energy Ltd. is a North American onshore independent oil and gas company, focused on the acquisition, development, gathering, and production of oil and gas[221] | Metric | December 31, 2023 | December 31, 2022 | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Net Proved Reserves (MMcfe) | 70,262 | 94,255 | -25% | | Net Developed Proved Reserves (MMcfe) | 50,681 | 80,796 | -37% | | Net Income | $7.9 Million | $35.4 Million | -77.7% | - The company is committed to prudent capital allocation, including dividends and stock repurchases, and plans to maintain a strong balance sheet and liquidity to invest in existing and potential new projects[223] - The company is shifting its investment focus from the Marcellus Shale in Pennsylvania to the Permian Basin, having acquired several assets in New Mexico and Texas in 2023[224][225][226][227] Results of Operations In 2023, total revenue decreased by 56% to $30.7 million, driven by a 71% drop in Pennsylvania natural gas prices, while operating costs decreased, DD&A increased, and interest income significantly grew Revenues Operating Costs Depletion, Depreciation, Amortization and Accretion (DD&A) Loss (gain) on Sale of Assets General and Administrative ("G&A") Interest Income Interest Expense Net gain (loss) on commodity contracts Income Tax Expense Net Income Compared to Adjusted EBITDA | Metric | 2023 | 2022 | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Total Revenue | $30,729,752 | $69,962,709 | -56% | | Pennsylvania Natural Gas Average Price ($/Mcf) | $1.74 | $5.96 | -71% | | Gathering System Revenue (Net) | $9,790,531 | $8,085,512 | +21% | | Total Operating Costs | $8,864,975 | $9,416,394 | -5.9% | | DD&A Expense | $7,685,084 | $6,438,511 | +19% | | Loss (gain) on Sale of Assets | ($1,449,871) (Loss) | $221,642 (Gain) | Change | | Interest Income | $1,673,241 | $452,877 | +269% | | Net Commodity Contracts Gain (Loss) | $3,130,055 (Gain) | $236,077 (Gain) | +1226% | | Income Tax Expense | $3,200,447 | $12,157,487 | -74% | | Adjusted EBITDA | $18,827,512 | $52,885,202 | -64.4% | - The increase in DD&A expense was primarily due to a higher depletion rate resulting from reduced reserves and the addition of four new producing wells in the Permian Basin[244] - The significant increase in interest income was primarily due to the utilization of additional financial instruments with higher prevailing interest rates in 2023[249] - The decrease in income tax expense was primarily due to reduced taxable income, driven by lower commodity prices[257] Capital Resources and Liquidity In 2023, operating cash flow decreased by 54% to $17.5 million, while investment cash outflows surged due to treasury bill investments and capital expenditures, and financing activities included stock repurchases and dividends, with no outstanding borrowings Cash Flow Credit Agreement Repurchase Transactions Derivative Transactions Contractual Obligations | Cash Flow Type | 2023 | 2022 | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Operating Activities Cash Flow | $17.5 Million | $38.0 Million | -54% | | Investing Activities Cash Flow | ($37.7 Million) | ($7.9 Million) | +379% | | Financing Activities Cash Flow | ($11.7 Million) | ($12.0 Million) | -2.5% | - The company closed a $35 million senior secured reserve-based revolving credit facility on June 28, 2023, and currently has no outstanding borrowings[266] - In 2023, the company repurchased 1,158,849 shares of common stock for $6.05 million, at an average price of $5.20 per share[272] - The company hedges natural gas price risk through commodity swap contracts, with 1.905 Bcf of NYMEX Henry Hub swaps and Tennessee Zone 4 basis swaps outstanding as of December 31, 2023[274][275] - As of December 31, 2023, the company had no capital expenditure commitments[277] Summary of Critical Accounting Estimates This section outlines Epsilon's critical accounting estimates, including proved reserves, asset impairments, asset retirement obligations, and income taxes, which involve significant judgment and assumptions about future events, subject to periodic review and adjustment Proved Natural Gas and Oil Reserves Impairments Asset Retirement Obligations ("ARO") Income Taxes Recently Issued Accounting Standards - Critical accounting estimates include proved natural gas and oil reserves, asset impairments, asset retirement obligations (ARO), and income taxes[279][280][286][287] - These estimates involve significant judgment and assumptions about future events, such as commodity prices, production levels, development costs, and discount rates, and actual results may differ materially from estimates[279][281][283][286] - The company regularly reviews and adjusts these estimates based on the latest activities and costs[279][284][285][286] ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Epsilon's earnings and cash flows are significantly exposed to volatile commodity prices, influenced by supply, demand, and geopolitical events, but gathering system revenue risk is lower, and the company uses derivatives to hedge price risk Gathering System Revenue Risk Derivative Contracts - Epsilon's earnings and cash flows are significantly affected by changes in commodity market prices, with oil and natural gas price volatility influenced by supply and demand, global political and economic events, and the U.S. dollar exchange rate[291] - The company's gathering system revenue risk is lower due to high Marcellus Shale reserves and low production costs[292] - The company uses derivative financial instruments to hedge commodity price risk, aiming to stabilize cash flows and support capital expenditure plans, but these contracts also limit potential gains when commodity prices rise[293] ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This section presents Epsilon Energy Ltd.'s consolidated financial statements for 2023 and 2022, prepared under U.S. GAAP, including balance sheets, income statements, cash flow statements, and notes, along with an independent auditor's report and unaudited oil and gas supplementary information Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations and Comprehensive Income Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows Notes to the Consolidated Financial Statements This section provides detailed notes to Epsilon Energy Ltd.'s consolidated financial statements, covering business description, basis of preparation, significant accounting policies, and specific financial statement items, offering comprehensive explanations and supporting information 1. Description of Business 2. Basis of Preparation 3. Summary of Significant Accounting Policies 4. Short Term Investments 5. Property and Equipment 6. Revolving Line of Credit 7. Shareholders' Equity 8. Revenue Recognition 9. Accumulated Other Comprehensive Income 10. Income Taxes 11. Commitments and Contingencies 12. Leases 13. Net Income Per Share 14. Operating Segments 15. Commodity Risk Management Activities 16. Asset Retirement Obligations 17. Fair Value Measurements 18. Current Expected Credit Loss 19. Subsequent Events - The notes detail the company's business description, basis of preparation, and significant accounting policies, including oil and gas properties, gathering systems, revenue recognition, financial instruments, derivatives, asset retirement obligations, concentrations of credit risk, income taxes, equity incentive plans, and leases[313][314][315][316][320][325][327][338][339][346][349][350][353][358][359][360][362][367][368] - The notes also cover short-term investments, property and equipment, revolving line of credit, shareholders' equity, revenue recognition, accumulated other comprehensive income, income taxes, commitments and contingencies, leases, net income per share, operating segments, commodity risk management activities, asset retirement obligations, fair value measurements, current expected credit loss, and subsequent events[377][383][389][392][413][425][426][438][439][444][446][451][456][464][467][474][475][476] SUPPLEMENTAL NATURAL GAS AND OIL PRODUCING ACTIVITIES (UNAUDITED) This section provides unaudited supplemental information on natural gas and oil producing activities, including complex reserve estimation, proved reserve changes, capitalized costs, operating results, and the standardized measure of discounted future net cash flows, which significantly declined in 2023 - The reserve estimation process is complex, involving significant subjective judgments and uncertainties, and actual results may differ materially from estimates[479][480] | Metric | December 31, 2023 | December 31, 2022 | Year-over-Year Change | | :--- | :--- | :--- | :--- | | Total Proved Reserves (MMcfe) | 70,262 | 94,255 | -25.5% | | Developed Proved Reserves (MMcfe) | 50,681 | 80,796 | -37.3% | | Undeveloped Proved Reserves (MMcfe) | 19,581 | 13,459 | +45.5% | | Standardized Measure (Millions of USD) | $33.0 | $145.8 | -77.4% | | Cost Type | 2023 | 2022 | | :--- | :--- | :--- | | Unproved Acquisition Costs | $7,335,716 | $310,211 | | Development Costs | $11,994,374 | $6,426,037 | | Gathering System Development Costs | $99,272 | $163,915 | | Total Revenue from Oil and Gas Producing Activities | $20,939,221 | $61,877,197 | | Operating Results from Oil and Gas Producing Activities | $5,325,333 | $37,215,854 | - The decrease in the standardized measure in 2023 was primarily due to changes in commodity prices (a decrease of $156 million) and net changes in future development costs (a decrease of $5.08 million)[507] - This section contains Epsilon Energy Ltd.'s consolidated financial statements as of December 31, 2023, and 2022, including consolidated balance sheets, consolidated statements of operations and comprehensive income, consolidated statements of changes in shareholders' equity, consolidated statements of cash flows, and notes thereto, all prepared in accordance with U.S. GAAP[294] - The independent registered public accounting firm BDO USA, P.C. issued an unqualified opinion on the consolidated financial statements[296] - This section also includes unaudited supplemental information on natural gas and oil producing activities, covering reserves, capitalized costs, exploration and development costs, operating results, and the standardized measure of discounted future net cash flows[478][479][485][493][494][496][499][503][507] ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The company has no changes in or disagreements with accountants on accounting and financial disclosure - The company has no changes in or disagreements with accountants on accounting and financial disclosure[508] ITEM 9A. CONTROLS AND PROCEDURES Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures As of December 31, 2023, company management, including the CEO and CFO, concluded that disclosure controls and procedures were effective at a reasonable assurance level - As of December 31, 2023, the company's management assessed and concluded that its disclosure controls and procedures were effective at a reasonable assurance level[509] Management's Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining effective internal control over financial reporting, which was deemed effective as of December 31, 2023, based on the COSO 2013 framework, with no independent auditor attestation due to emerging growth company status - Management is responsible for establishing and maintaining effective internal control over financial reporting, and based on the COSO 2013 framework assessment, internal controls were effective as of December 31, 2023[510][511] - This annual report does not include an attestation report of the independent registered public accounting firm regarding the effectiveness of internal control, as the company is exempt as an emerging growth company[512] Changes in Internal Control Over Financial Reporting There were no material changes in the company's internal control over financial reporting during the quarter ended December 31, 2023, that materially affected or are reasonably likely to materially affect internal control - There were no material changes in the company's internal control over financial reporting during the quarter ended December 31, 2023, that materially affected or are reasonably likely to materially affect internal control[513] ITEM 9B. OTHER INFORMATION No 'Rule 10b5-1 trading arrangements' or 'non-Rule 10b5-1 trading arrangements' were adopted or terminated by company directors or officers during the quarter ended December 31, 2023 - No "Rule 10b5-1 trading arrangements" or "non-Rule 10b5-1 trading arrangements" were adopted or terminated by company directors or officers during the quarter ended December 31, 2023[514] ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS None - None[515] PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE This section lists Epsilon Energy Ltd.'s directors and executive officers as of December 31, 2023, detailing their roles and biographies, and outlines the company's commitment to high corporate governance standards, including board composition, ethical conduct, and diversity Biographies of Corporate Directors and Executive Officers Corporate Governance Practices and Policies | Name | Age | Position | | :--- | :--- | :--- | | Jason Stabell | 49 | Chief Executive Officer and Director | | Henry N. Clanton | 61 | Chief Operating Officer | | Andrew Williamson | 35 | Chief Financial Officer | | John Lovoi | 63 | Chairman of the Board and Director | | Tracy Stephens | 63 | Director | | Jason Stankowski | 53 | Director | | David Winn | 61 | Director | | Nicola Maddox | 68 | Director | - The company's Board of Directors consists of six members, committed to high standards of corporate governance practices, and has an Audit Committee and a Compensation, Nominating and Corporate Governance Committee[518][530][544] - The Board regularly holds meetings to review strategic plans, financial performance, and risk management, and has established a Code of Ethics and a whistleblower policy, encouraging directors to disclose conflicts of interest[532][534][539] - The Board values diversity and selects directors based on individual and professional integrity, experience in corporate management, financial experience, expertise, and background[542][543] - All executive officers have employment agreements[553] ITEM 11. EXECUTIVE COMPENSATION This section details Epsilon Energy Ltd.'s executive compensation for 2023 and 2022, including salaries, bonuses, equity awards, and other compensation for the CEO, COO, and CFO, along with information on the 2020 Equity Incentive Plan and director compensation Summary Compensation Table Description of the 2020 Equity Incentive Plan Incentive Plan Awards for Named Executive Officers Incentive Plan Awards—Value Vested or Earned for Named Executive Officers DIRECTOR COMPENSATION Incentive Plan Awards—Value Vested or Earned During the Year for Directors (Other Than Named Executive Officers) Directors and Officers Liability Insurance | Name | Position | Year | Salary | Bonus | Equity Awards | Other Compensation | Total Compensation | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Jason Stabell | CEO | 2023 | $311,000 | $184,000 | $851,003 | $7,350 | $1,353,353 | | | | 2022 | $150,000 | $100,000 | $600,000 | $4,346 | $854,346 | | Henry N. Clanton | COO | 2023 | $272,000 | $92,000 | $92,004 | $15,752 | $471,756 | | | | 2022 | $262,500 | $117,000 | $173,187 | $15,250 | $567,937 | | Andrew Williamson | CFO | 2023 | $239,000 | $138,000 | $355,006 | $12,448 | $744,454 | | | | 2022 | $115,000 | $75,000 | $250,000 | $3,981 | $443,981 | - The company adopted an Equity Incentive Plan in 2020, authorizing the issuance of up to 2,000,000 shares of common stock, with 957,489 shares available for future issuance as of December 31, 2023[569][572] | Name | 2023 Value of Equity Awards Vested | | :--- | :--- | | Jason Stabell | $162,806 | | Henry N. Clanton | $80,985 | | Andrew Williamson | $67,834 | - Board members receive annual cash fees and equity awards, with additional cash fees for the Chairman, Audit Committee Chair, and Compensation Committee Chair[576][577] - The company has purchased Directors and Officers liability insurance with an aggregate limit of $35 million[580] ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS This section discloses beneficial ownership of Epsilon Energy Ltd. common stock as of March 20, 2024, including major shareholders Palo Duro Energy Fund, LP (6.67%) and Solas Capital Management LLC (17.20%), with all executive officers and directors collectively holding 5.44% Securities Authorized For Issuance under Equity Compensation Plans | Name/Entity | Number of Common Shares | Percentage of Common Share Ownership | | :--- | :--- | :--- | | Palo Duro Energy Fund, LP | 1,461,558 | 6.67% | | Solas Capital Management LLC | 3,768,467 | 17.20% | | All Executive Officers and Directors (8 individuals) | 1,194,495 | 5.44% | - The company is not aware of any arrangements that could result in a change of control[585] ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Since the start of fiscal year 2023, Epsilon has had no material related-party transactions beyond compensation arrangements, and the board has affirmed the independence of five directors in compliance with Nasdaq requirements, while also providing indemnification and liability insurance for officers and directors Certain Relationships and Related Transactions Independence of the Board of Directors Indemnification of Officers and Directors - Since the beginning of fiscal year 2023, the company has not engaged in or proposed any material related-party transactions involving directors, executive officers, or 5% or more shareholders and their immediate family members, other than compensation arrangements[587] - The Board of Directors has determined that John Lovoi, Tracy Stephens, Jason Stankowski, David Winn, and Nicola Maddox are independent directors, meeting Nasdaq Global Market listing requirements[589] - The company's articles of incorporation and bylaws provide for indemnification of officers and directors, and the company has purchased liability insurance to protect them from liability incurred while performing their duties[590][591][592][593][595][596] ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES This section summarizes the audit fees paid by Epsilon Energy Ltd. to its principal auditor, BDO USA, P.C., for the fiscal years 2023 and 2022, totaling $374,970 and $395,634 respectively | Fee Type | December 31, 2023 | December 31, 2022 | | :--- | :--- | :--- | | Audit Fees | $374,970 | $395,634 | PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES This section lists the financial statements, schedules, and exhibits included in Epsilon Energy Ltd.'s annual report, encompassing audited consolidated financial statements and various corporate documents - Financial statements include the report of independent registered public accounting firm, consolidated balance sheets, consolidated statements of operations and comprehensive income, consolidated statements of changes in shareholders' equity, consolidated statements of cash flows, and notes thereto[599] - Exhibits cover the company's articles of incorporation, bylaws, equity incentive plans, employment agreements, credit agreements, list of subsidiaries, auditor consent letter, and XBRL documents[599][600] SIGNATURES This section contains the signatures of Epsilon Energy Ltd.'s authorized representatives, including the CEO, CFO, and Board Chairman, for the report filed on March 20, 2024, as required by the Securities Exchange Act of 1934 - The report was signed by authorized representatives of Epsilon Energy Ltd. on March 20, 2024[602] - Signatories include Chief Executive Officer Jason Stabell, Chief Financial Officer J. Andrew Williamson, and Chairman of the Board John Lovoi, among other directors[604]