Epsilon Energy Ltd. 2020 Form 10-K Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is an Alberta-incorporated, North American onshore oil and natural gas company focused primarily on Pennsylvania. Its operations include upstream production and a 35% interest in the Auburn Gas Gathering System in northeastern Pennsylvania, with additional oil, natural gas liquids and natural gas assets in Oklahoma. This filing covers the fiscal year ended December 31, 2020, with comparisons to 2019. All amounts are in U.S. dollars unless otherwise stated.
- Net proved reserves at year-end: 88,658 MMcf of natural gas and 371,343 barrels of oil and other liquids.
- Leasehold position: 78,298 gross acres and 13,285 net acres; 270 gross wells and 57.81 net wells.
- Approximately 97% of production and gathering-system revenue originated in Pennsylvania.
- The Auburn GGS operating agreement runs through December 31, 2026 and provides for an 18% contractual return on invested capital under a cost-of-service model.
Key Financial and Operating Metrics
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Total revenue | $24.4 million | $26.7 million | Down 8.5% |
| Natural gas revenue | $15.2 million | $16.9 million | Down 10.3% |
| Gathering and compression revenue | $8.9 million | $9.3 million | Down 4.7% |
| Operating income (loss) | $(1.0) million | $8.2 million | Declined $9.2 million |
| Net income | $0.9 million | $8.7 million | Down 89.9% |
| Adjusted EBITDA | $15.7 million | $18.0 million | Down 13.0% |
| Cash flow from operations | $14.8 million | $13.0 million | Up 14.1% |
| Capital expenditures and additions | $6.5 million | $10.5 million | Down $4.0 million |
| Cash and cash equivalents | $13.3 million | $14.1 million | Down $0.8 million |
| Total assets | $86.7 million | $97.7 million | Down 11.3% |
| Total long-term liabilities | $13.1 million | $13.8 million | Down 4.8% |
- Natural gas production increased to 11.0 Bcf from 7.6 Bcf, while the realized gas price fell to $1.36/Mcf from $2.18/Mcf.
- Oil and other liquids production was 14.9 MBOE versus 14.5 MBOE; the realized price declined to $22.66/Bbl from $29.24/Bbl.
- Pennsylvania gas exit rate increased to 32.8 MMcf per day from 30.5 MMcf per day.
- Auburn GGS throughput declined to 69.5 Bcf, or 190 MMcf per day, from 87.8 Bcf, or 241 MMcf per day.
- Gross margins were pressured by lower commodity prices, higher lease operating costs and increased depreciation, depletion, amortization and accretion. The filing does not present a single consolidated gross-margin percentage.
- The company had no borrowings under its revolving credit facility. The facility had a $23 million borrowing base, within a total commitment of up to $100 million, and matured March 1, 2022.
Material Changes Versus 2019
- Revenue declined despite higher production, primarily because of lower natural gas, oil and liquids prices.
- Operating costs increased to $8.5 million from $7.9 million, driven mainly by higher upstream volumes and operating costs for newly producing wells.
- DD&A increased 29.4% to $9.6 million, reflecting higher production and additions to the producing asset base.
- Epsilon recorded a $1.76 million impairment of legacy Oklahoma assets in the first quarter of 2020 due to historically low oil and NGL prices.
- General and administrative expense increased 24.2% to $5.6 million, reflecting tender-offer costs, legal and administrative fees, and higher stock-based compensation.
- Derivative gains decreased to $2.5 million from $4.2 million, although cash received from settlements increased to $4.5 million from $1.9 million. No derivative contracts were outstanding at year-end 2020.
- Cash flow from operations improved, but the company spent $9.1 million on share repurchases, including a $7.15 million tender offer for 2,337,034 shares. Year-end shares outstanding declined to 23.99 million from 26.79 million.
- Proved natural gas reserves declined by 35,503 MMcf, primarily because of lower Pennsylvania gas prices and reserve revisions. The standardized measure of discounted future net cash flows fell to $16.0 million from $49.6 million.
Guidance, Outlook, Risks and Unusual Items
- Management expects 2021 local production in the Appalachian region to be broadly flat with 2020. Its stated objective is to maintain current production or grow modestly, subject to adequate natural gas prices and meeting internal return thresholds.
- Management believes current cash, operating cash flow and available credit will fund operating and development requirements for the next 12 months and beyond, but cautions that sustained commodity-price deterioration or COVID-19 impacts could require additional liquidity.
- The company participated in drilling and completion of eight gross, or 0.19 net, Pennsylvania wells in 2020. One additional well drilled in 2020 was completed and placed into production in January 2021.
- Oklahoma development was deferred; one well drilled in 2019 remained awaiting completion.
- COVID-19 and the 2020 commodity-price collapse caused the Oklahoma impairment and created continuing uncertainty regarding demand, prices, liquidity, operations and access to financing.
- Chesapeake Energy filed for Chapter 11 in June 2020. Chesapeake later affirmed the Auburn gathering agreement and paid past-due amounts; Epsilon reversed an $0.8 million allowance and reported that all cash had been received by year-end.
- On March 10, 2021, Epsilon sued Chesapeake Appalachia, alleging breaches of a settlement agreement and joint operating agreements relating to development of the Auburn Development. Epsilon requested a preliminary injunction; the filing does not provide an estimated financial exposure or outcome.
- Key structural risks include dependence on Pennsylvania gas prices and transportation capacity, significant geographic concentration, negative regional basis differentials, reliance on third-party operators and anchor shippers, reserve-estimation uncertainty, environmental and hydraulic-fracturing regulation, and potential reductions in borrowing capacity.
- Contractual commitments at year-end totaled $11.3 million, including $8.8 million of undiscounted asset-retirement obligations, $2.3 million of capital expenditure commitments and $0.2 million of operating leases.
Most Important Facts for Investors to Verify
- Whether Pennsylvania gas prices, regional basis differentials and takeaway constraints support management’s production and cash-flow expectations.
- The sustainability of cash flow after the large 2020 share repurchases and the company’s ability to fund development without drawing on its credit facility.
- The reserve decline and the substantial reduction in standardized reserve value from $49.6 million to $16.0 million.
- The status and potential financial impact of the Chesapeake Appalachia litigation and the company’s ability to develop the Auburn acreage.
- The timing and economics of converting proved undeveloped reserves into producing reserves within five years.
- The effect of the Auburn GGS rate reset and agreement renegotiation expected before the current term expires in 2026.
- Potential additional impairments if commodity prices remain depressed, including impacts on Oklahoma assets and other long-lived assets.
- The company’s reliance on non-GAAP Adjusted EBITDA; the filing does not identify Adjusted EBITDA as a substitute for GAAP net income or operating cash flow.