Epsilon Energy Ltd. — FY2022 Form 10-K Summary
Business context and reporting period
Epsilon Energy Ltd. is an Alberta-incorporated, North American onshore oil and natural gas company with upstream operations in Pennsylvania’s Marcellus Shale and Oklahoma’s Anadarko Basin, plus a 35% interest in the Auburn Gas Gathering System in Pennsylvania. This filing covers the fiscal year ended December 31, 2022, with comparisons to fiscal 2021. The company had 75,954 gross acres, 13,625 net acres and 351 gross wells at year-end.
Key financial and operating metrics
| Metric | FY2022 | FY2021 | Change |
|---|---|---|---|
| Total revenue | $70.0 million | $42.4 million | +65% |
| Operating income | $47.0 million | $20.6 million | +128% |
| Net income | $35.4 million | $11.6 million | +204% |
| Net income margin | 50.5% | 27.4% | +23.1 points |
| Adjusted EBITDA | $53.1 million | $24.1 million | +120% |
| Adjusted EBITDA margin | 75.9% | 56.9% | +19.0 points |
| Cash flow from operations | $38.0 million | $20.0 million | +90% |
| Capital expenditures | $7.9 million cash investing outflow | $4.4 million | +77% |
| Cash and cash equivalents | $45.2 million | $26.5 million | +71% |
| Working capital surplus | $51.0 million | $24.1 million | +$26.9 million |
| Total debt outstanding | None | None | No borrowings |
- Production totaled 9.96 Bcfe, compared with 10.56 Bcfe in 2021. Pennsylvania natural gas production declined to 9.03 Bcf from 9.83 Bcf, while Oklahoma production increased to 0.94 Bcfe from 0.73 Bcfe.
- Realized Pennsylvania natural gas pricing increased to $5.96/Mcf from $3.04/Mcf. Oklahoma’s realized price for all production increased to $8.68/Mcfe from $6.34/Mcfe.
- Gas gathering revenue increased modestly to $8.1 million from $7.9 million. Auburn throughput increased to 66.3 Bcf from 63.2 Bcf.
- Lease operating expense was $7.1 million and gathering system operating expense was $2.3 million. Upstream operating costs included unusual plugging and abandonment costs relating to two older Pennsylvania wells.
- Income tax expense was $12.2 million, representing a 25.6% effective tax rate.
- Cash used for financing was $11.3 million, including $6.2 million of share repurchases and $5.9 million of dividends. The company repurchased and retired 982,500 shares during 2022.
- The senior secured credit facility has a $100 million total commitment and a $30 million effective borrowing base; no amounts were drawn at year-end. The facility matures March 1, 2024.
Material changes versus FY2021
- Revenue and profitability increased primarily because of substantially higher commodity prices, despite lower Pennsylvania gas volumes.
- Operating cash flow increased by $18.0 million, while development spending increased by $3.4 million, primarily for Pennsylvania and Oklahoma wells.
- Net proved reserves declined 20% to 94,254 MMcfe, largely because the company revised its development plan and moved reserves into the probable category due to development timing. Proved developed reserves increased 10% to 80,795 MMcfe.
- Proved undeveloped reserves declined to 13,459 MMcfe from 44,155 MMcfe, including a 23,362 MMcfe reduction from revisions to previous estimates and transfers of 7,334 MMcfe to proved developed reserves.
- The standardized measure of discounted future net cash flows increased to $145.8 million from $77.7 million, primarily reflecting higher commodity-price assumptions, partially offset by reserve revisions.
- The company began quarterly dividends in 2022 and continued its capital-return strategy through share repurchases. A new program authorizing repurchases of up to 2,292,644 shares for up to $15.0 million was approved in March 2023.
- Management changes occurred in July 2022, when Jason Stabell became CEO and Andrew Williamson became CFO.
Guidance, outlook, commentary and risks
Management expects existing cash, operating cash flow and available credit to be sufficient for operating and development requirements for the next 12 months and beyond. Current capital commitments were approximately $0.8 million, expected to be incurred in 2023. The company is evaluating selective acquisitions and indicated that it may expand its investment focus to other North American gas and oil basins.
- Two Pennsylvania wells were awaiting completion at year-end and were completed and placed online in January 2023. One Oklahoma well was awaiting completion and was scheduled for April 2023.
- At December 31, 2022, the company had 1.07 Bcf of NYMEX Henry Hub swaps and 1.07 Bcf of Tennessee Zone 4 basis swaps outstanding for April–October 2023, with a combined reported fair value asset of approximately $1.2 million.
- The Auburn gathering agreement provides an 18% contractual return under a cost-of-service model through 2026, after which the system is expected to transition to a fixed gathering rate. Throughput has declined materially since 2018, and future earnings depend on development by the Anchor Shippers and third-party volumes.
- Approximately 91% of production and gathering-related activity was concentrated in Pennsylvania. The company does not own firm interstate transportation and sells Pennsylvania gas at the Tennessee Gas Pipeline Shoemaker meter, exposing it to regional basis differentials and transportation constraints.
- Commodity-price volatility, reserve revisions, production declines, operator dependence, drilling and completion costs, environmental and hydraulic-fracturing regulation, climate-related regulation, infrastructure interruptions and customer credit risk could materially affect results.
- Epsilon is pursuing litigation against Chesapeake concerning alleged breaches of settlement and operating agreements and alleged obstruction of Auburn Development activities. The appeal was argued in January 2023, with a decision anticipated around mid-2023; a related lawsuit was stayed pending the appeal.
- The company reported effective disclosure controls and internal control over financial reporting, but its independent auditor was not required to provide an attestation because Epsilon qualifies as an emerging growth company.
Most important facts for investors to verify
- Whether 2023 natural gas and liquids prices, including Pennsylvania basis differentials, sustain the 2022 earnings and cash-flow improvement.
- The timing and economics of remaining Pennsylvania and Oklahoma well completions and the pace of future development by operators and Anchor Shippers.
- The basis for the substantial reduction in proved undeveloped reserves and whether those reserves can be reclassified or developed under the revised plan.
- The Auburn Gas Gathering System’s throughput trajectory, cost-of-service rates through 2026 and fixed-rate economics beginning in 2027.
- The maturity, borrowing-base redeterminations and covenant requirements of the $30 million effective credit facility.
- The outcome and potential operational effect of the Chesapeake litigation and related permitting disputes.
- The sustainability of dividends and share repurchases relative to operating cash flow, capital expenditures and commodity-price exposure.
- The extent of customer, counterparty and cash concentration risk, including $7.2 million of cash reported as exceeding federally insured limits.