Epsilon Energy Ltd. — Fiscal 2023 Form 10-K Summary
Reporting period: Year ended December 31, 2023, compared with fiscal 2022. The filing is an annual Form 10-K and does not provide a separate fourth-quarter income statement.
Business context
Epsilon is a North American onshore natural gas and oil company operating in Pennsylvania’s Marcellus Shale, the Permian Basin in Texas and New Mexico, and the Anadarko Basin in Oklahoma. Its activities include upstream acquisition, development and production, together with a 35% ownership interest in the Auburn Gas Gathering System in Pennsylvania.
- Year-end net proved reserves were 70,262 MMcfe, comprising 65,916 MMcf of natural gas, 383 MBbl of NGLs and 341 MBbl of oil and other liquids.
- The company held approximately 84,684 gross and 15,463 net acres and had 362 gross and 37.47 net wells.
- Approximately 77% of 2023 revenue came from Pennsylvania production and gathering activities.
Financial and operating performance
| Metric | 2023 | 2022 | Change |
|---|---|---|---|
| Total revenue | $30.7 million | $70.0 million | Down 56% |
| Operating income | $5.4 million | $47.0 million | Down 88% |
| Net income | $6.9 million | $35.4 million | Down 80% |
| Adjusted EBITDA | $18.8 million | $52.9 million | Down 64% |
| Net income margin | 22.6% | 50.5% | Down 27.9 points |
| Operating margin | 17.6% | 67.1% | Down 49.5 points |
| Cash flow from operations | $18.2 million | $38.0 million | Down 52% |
| Capital expenditures and prepaid drilling | Approximately $20.3 million | $6.9 million | Higher investment |
| Dividends paid | $5.6 million | $5.9 million | Down 4% |
Revenue pressure was driven primarily by lower Pennsylvania natural gas prices and volumes. Pennsylvania realized natural gas price fell 71% to $1.74/Mcf from $5.96/Mcf, while production declined to 7.9 Bcf from 9.0 Bcf. Gathering system revenue increased 21% to $9.8 million, helped by a greater proportion of anchor-shipper throughput and a one-time compressor fee adjustment.
- Permian revenue was $4.0 million, including $3.5 million of oil and condensate revenue from new production.
- Oklahoma revenue declined to $3.2 million from $8.1 million as production and realized prices decreased.
- Lease operating expenses declined 10% to $6.4 million, while DD&A increased 19% to $7.7 million because of lower reserves and new Permian wells.
- The company recorded a $1.45 million loss on the sale of Oklahoma assets, compared with a $0.22 million gain in 2022.
- Interest income increased to $1.7 million from $0.5 million, reflecting investment in higher-yielding financial instruments.
- Derivative contracts generated a $3.1 million accounting gain and $3.3 million of net cash settlements, compared with a $1.2 million cash payment in 2022.
Liquidity, capital structure and shareholder returns
- Cash and cash equivalents were $13.4 million at December 31, 2023, compared with $45.2 million at year-end 2022.
- Short-term U.S. Treasury investments were $18.8 million, versus none at year-end 2022. Cash, cash equivalents and restricted cash totaled $13.9 million.
- Working capital surplus was $33.2 million, down from $49.2 million.
- The company had no borrowings under its new $35 million senior secured reserve-based revolving credit facility with Frost Bank. The facility matures no later than June 28, 2027, bears interest at Daily Simple SOFR plus 3.25%, and is subject to semiannual borrowing-base redeterminations.
- Total liabilities were $23.4 million and shareholders’ equity was $100.6 million at year-end.
- The company repurchased 1.16 million shares for $6.1 million during 2023 and paid $5.6 million in dividends, or $0.25 per share quarterly.
- Management stated that cash, short-term investments, available borrowings and operating cash flow should be sufficient for at least the next twelve months.
Material changes versus 2022
- Revenue, operating income, net income, adjusted EBITDA and operating cash flow all declined substantially because of lower natural gas prices and lower Pennsylvania and Oklahoma production.
- The company shifted capital toward the Permian Basin, acquiring interests in New Mexico wells and approximately 12,373 gross Texas acres; four gross Permian wells entered production during 2023.
- Upstream capital investment increased to approximately $20.2 million from $6.8 million, primarily for acquisitions, drilling and completions.
- Total proved reserves declined 25% to 70,262 MMcfe, primarily because of price-related revisions. Proved developed reserves declined 37% to 50,681 MMcfe.
- Standardized measure of discounted future net cash flows fell to $33.0 million from $145.8 million, largely due to lower commodity prices.
- A new $35 million credit facility replaced the prior facility, with no year-end borrowings.
- The Auburn GGS gathering arrangement remains subject to the cost-of-service model through 2026 and is expected to transition to fixed rates in January 2027.
Guidance, outlook, risks and unusual items
Management emphasizes disciplined capital allocation, maintenance of liquidity and continued evaluation of opportunities outside the Marcellus, particularly in the Permian Basin. The filing does not provide formal production, revenue or earnings guidance.
- Natural gas prices, especially discounted Pennsylvania Zone 4 pricing and limited interstate takeaway capacity, remain the most significant operating and financial risks.
- Approximately 99% of oil and gas properties are operated by third parties, limiting Epsilon’s control over development timing and capital allocation.
- Auburn GGS throughput was 66.2 Bcf in 2023, substantially below 2018 levels. Future throughput depends on Anchor Shipper development and replacement of natural production declines.
- Hedging reduces downside price exposure but limits upside and creates counterparty and potential over-hedging risks. At year-end, Epsilon had 1.905 Bcf of NYMEX Henry Hub swaps and 1.905 Bcf of Tennessee Zone 4 basis swaps for 2024 volumes.
- Environmental, climate-change, methane, hydraulic-fracturing, permitting, regulatory, operational, cybersecurity and third-party credit risks could increase costs or disrupt operations.
- Asset retirement obligations increased to $3.5 million from $2.8 million, including a $1.18 million change in estimates.
- The Chesapeake litigation was dismissed without prejudice in September 2023. The filing reports no material capital expenditure commitments at year-end.
- After year-end, Epsilon repurchased 248,700 shares for $4.82 per share and acquired a 25% interest in three producing wells and 3,246 gross undeveloped acres in Ector County, Texas for $15 million, funded with cash.
- Management reported effective disclosure controls and internal control over financial reporting; the auditor was not required to attest to internal control effectiveness because Epsilon qualifies as a non-accelerated filer and emerging growth company.
Most important facts to verify
- Reconcile the filing’s MD&A reference to approximately $7.9 million of 2023 net income with the audited financial statements’ reported net income of $6.945 million.
- Assess whether the sharp decline in Pennsylvania gas prices and proved reserves is temporary or indicative of continuing regional pricing and development constraints.
- Evaluate liquidity after the $15 million February 2024 Permian acquisition, ongoing dividends, share repurchases and planned capital investment.
- Review borrowing-base redetermination risk and compliance with the credit facility’s current-ratio, leverage and hedging covenants.
- Examine the sustainability of Auburn GGS revenue and throughput as the cost-of-service arrangement approaches its December 2026 expiration.
- Review the assumptions underlying the independent reserve report and the $33.0 million standardized measure, particularly commodity prices, development timing and reserve revisions.
- Confirm the effect of 2024 share repurchases and equity awards on diluted share count and per-share value.