Epsilon Energy Ltd. — Q2 2021 Form 10-Q Summary
Business context and reporting period
Epsilon Energy Ltd. is a North American onshore natural gas and oil company focused primarily on Pennsylvania, with additional production in Oklahoma. Operations include upstream production and a 35% ownership interest in the Auburn Gas Gathering System in Pennsylvania. This unaudited Form 10-Q covers the three and six months ended June 30, 2021, compared with the corresponding 2020 periods.
Financial performance and liquidity
| Metric | Three months ended June 30, 2021 | Six months ended June 30, 2021 |
|---|---|---|
| Revenue | $7.1 million | $15.5 million |
| Operating income | $1.2 million | $4.6 million |
| Operating margin | Approximately 16.8% | Approximately 29.8% |
| Net income (loss) | $(0.5) million | $2.3 million |
| Net margin | Approximately (6.8)% | Approximately 14.5% |
| Adjusted EBITDA | $3.0 million | $8.4 million |
| Cash flow from operations | Quarterly amount not separately presented in the cash flow statement | $8.0 million |
- Natural gas, oil, NGL and condensate revenue was $5.2 million in the second quarter and $11.7 million for the first six months. Gathering and compression revenue was $1.9 million and $3.9 million, respectively.
- Cash and cash equivalents were $18.5 million at June 30, 2021; cash, cash equivalents and restricted cash totaled $19.1 million.
- Working capital surplus was approximately $16 million, compared with $13.3 million at December 31, 2020.
- The company had no borrowings under its revolving credit facility. The borrowing base was reduced to $14 million on June 28, 2021, with the next redetermination scheduled for November 1, 2021. The facility matures March 1, 2024.
- Capital expenditures were $1.7 million for the six months, while share repurchases used $1.1 million. The company repurchased 264,215 shares at an average price of $4.02 per share.
Material changes versus the prior comparable period
- Six-month revenue increased 22% to $15.5 million from $12.7 million, primarily because of higher commodity prices.
- Natural gas revenue increased 45% for the six months and 32% for the quarter, while production volumes declined. Six-month natural gas volume fell to 5,014 MMcf from 5,585 MMcf.
- Average natural gas price increased to $2.28/Mcf for the six months from $1.41/Mcf and to $2.00/Mcf for the quarter from $1.36/Mcf.
- Gathering system revenue decreased 16% for the six months and 18% for the quarter, reflecting lower throughput and natural well decline.
- Operating income improved from a $1.7 million loss to $4.6 million of income for the six months. The second quarter remained loss-making at the net income level because of derivative losses.
- Derivative contracts generated a $1.4 million loss for the six months and a $1.8 million loss for the quarter, compared with a $1.6 million gain for the first six months of 2020. The losses primarily reflected rising natural gas prices and mark-to-market losses on collars.
- General and administrative expense increased 47% for the six months, mainly due to higher legal fees related to the Chesapeake litigation, CEO compensation and stock-based compensation.
- DD&A decreased 33% for the six months, and no property impairment was recorded in 2021. The prior-year period included a $1.8 million impairment of Oklahoma assets.
- Production declined in Pennsylvania and Oklahoma, but realized prices increased materially. Pennsylvania gas production was 4.9 Bcf for the six months, compared with 5.5 Bcf in 2020; Oklahoma production declined 23.8% to 0.13 Bcfe.
Guidance, outlook, risks and unusual items
- Management expects cash on hand, operating cash flow and available liquidity to fund operating and development requirements for the next 12 months and beyond.
- The company targets maintaining current production or achieving modest growth, subject to commodity prices and internal investment return thresholds. Management expects 2021 regional production to be broadly flat compared with 2020.
- Management believes longer-term natural gas prices may benefit from LNG exports, exports to Mexico, coal-to-gas switching and moderated supply growth, but provides no formal earnings or production guidance.
- Outstanding commodity derivatives covered 3.04 million MMBtu and had a net liability fair value of $1.3 million at June 30, 2021. Contracts extended through March 31, 2022 and limit some benefit from higher prices while protecting a portion of cash flow from lower prices.
- The company filed litigation against Chesapeake Appalachia concerning alleged breaches of a settlement agreement and operating agreements related to development of the Auburn Development. Epsilon was unsuccessful in obtaining a preliminary injunction; Chesapeake moved to dismiss the amended complaint, and the litigation remained pending.
- Contractual obligations totaled approximately $10.4 million, including $8.6 million of undiscounted asset retirement obligations, $1.5 million of gross derivative liabilities, $0.1 million of capital expenditure commitments and $0.2 million of operating lease commitments.
- COVID-19 effects remained difficult for management to estimate. Principal ongoing risks include commodity-price volatility, production declines, gathering-system throughput, counterparty performance, litigation outcomes, reserve estimates and potential future impairment.
- Management reported effective disclosure controls as of June 30, 2021 and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the reduced $14 million borrowing base will be reaffirmed or further reduced at the November 2021 redetermination.
- The effect of derivative settlements and mark-to-market changes on future earnings, cash flow and liquidity as natural gas prices change.
- Production decline rates in Pennsylvania and Oklahoma and whether planned development offsets declines.
- The outcome and timing of the Chesapeake litigation and any effect on Auburn development opportunities.
- The sustainability of higher realized gas prices and the impact of regional basis differentials and Auburn gathering-system throughput.
- Future share repurchases, including the remaining authorization for 928,785 shares, and their effect on cash balances and outstanding shares.