Epsilon Energy Ltd. — Q3 2021 Form 10-Q Summary
Business context and reporting period
Epsilon Energy Ltd. is a U.S.-focused independent natural gas and oil company engaged in acquisition, development, production and gathering. Its primary assets are Pennsylvania Marcellus properties and a 35% interest in the Auburn Gas Gathering System, supplemented by Oklahoma production. This unaudited report covers the three and nine months ended September 30, 2021, compared with the same 2020 periods.
Financial and operating metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Total revenue | $13.1 million | $5.8 million | $28.6 million | $18.5 million |
| Operating income | $7.1 million | $(0.7) million | $11.7 million | $(2.4) million |
| Operating margin | 54.2% | (12.4%) | 40.9% | (13.2%) |
| Net income (loss) | $1.4 million | $(0.3) million | $3.6 million | $(0.5) million |
| Adjusted EBITDA | $6.8 million | $3.9 million | $15.2 million | $11.7 million |
| Operating cash flow | $5.5 million | $3.8 million | $13.5 million | $12.1 million |
| Capital expenditures | $2.1 million | $1.4 million | $3.8 million | $5.5 million |
- Natural gas, oil, NGL and condensate revenue increased to $11.1 million in Q3 and $22.7 million in the first nine months, while gathering and compression revenue declined to $2.0 million and $5.9 million, respectively.
- Q3 Pennsylvania natural gas production was 2.6 Bcf versus 3.0 Bcf in the prior-year quarter; nine-month production was 7.5 Bcf versus 8.5 Bcf. Higher realized prices more than offset lower volumes. Oklahoma production increased substantially following two new wells entering production.
- Q3 realized natural gas price was $3.46/Mcf versus $1.18/Mcf; the nine-month average was $2.70/Mcf versus $1.33/Mcf.
- Cash, cash equivalents and restricted cash totaled $21.2 million at September 30, 2021, including $20.6 million of unrestricted cash. Working capital surplus was approximately $16.0 million.
- The company had no borrowings under its revolving credit facility. The borrowing base was $14.0 million, with maturity extended to March 1, 2024. The company reported compliance with all financial covenants.
- Total assets were $96.2 million and total liabilities were $25.2 million at September 30, 2021. Asset retirement obligations totaled $3.2 million on the balance sheet.
- The company repurchased 525,615 common shares for $2.4 million during the first nine months, with 667,385 shares remaining authorized under the 2021 repurchase program.
Material changes versus the prior comparable period
- Nine-month revenue increased 55%, driven primarily by substantially higher natural gas and liquids prices and higher Oklahoma production. Q3 revenue increased 125%.
- Net income improved from a $0.5 million loss to $3.6 million of income for the nine-month period, despite a $6.4 million derivative-contract loss compared with a $2.1 million gain in 2020.
- Adjusted EBITDA increased 30% for the first nine months, while operating cash flow increased 12%.
- DD&A declined 33% to $5.2 million for the first nine months, reflecting higher reserves and lower production volumes. No impairment was recorded in 2021, compared with a $1.8 million Oklahoma impairment in 2020.
- General and administrative expense increased 34% for the first nine months, primarily because of higher legal fees related to the Chesapeake litigation, CEO compensation and stock-based compensation.
- The revolving facility’s borrowing base was reduced from $23 million at the beginning of the period to $18 million in April and $14 million in June. The company remained undrawn.
Guidance, outlook, risks and unusual items
- No formal quantitative earnings or production guidance is provided. Management targets maintaining current production or growing modestly, subject to commodity prices and internal return thresholds.
- Management expects cash on hand, operating cash flow and available credit to meet operating, development and other liquidity requirements for at least the next 12 months.
- Management expects Appalachian production in 2021 to be broadly flat with 2020 and views longer-term natural gas demand as supported by LNG exports, Mexican exports and coal-to-gas switching. Oklahoma Meramec appraisal activity is planned on an opportunistic basis.
- Derivative contracts produced a $5.1 million Q3 loss and a $6.4 million nine-month loss, including $2.5 million of nine-month cash settlements. At September 30, the company had a net derivative liability of $3.9 million and collars covering 1.51 million MMBtu through 2022.
- Commodity-price volatility remains the principal market risk. Hedging reduces downside exposure but limits benefits from higher prices and can create significant mark-to-market losses.
- The company has $1.8 million of capital expenditure commitments and reported total future commitments of $14.6 million, including derivative liabilities and undiscounted asset retirement obligations.
- Epsilon filed litigation against Chesapeake Appalachia concerning alleged breaches of settlement and operating agreements relating to the Auburn Development. A preliminary injunction was denied, Chesapeake’s motion to dismiss was granted on a narrow issue without prejudice, and Epsilon’s motion for reconsideration was pending as of the filing.
- Disclosure controls were deemed ineffective at September 30, 2021 because of a material weakness in the accounts payable/accrual process involving realized hedge losses. Management stated that the reporting error was corrected and planned additional training, transaction review and account-reconciliation procedures.
- The filing states that COVID-19 effects remain difficult to estimate. No material changes to previously disclosed risk factors were reported.
Most important facts to verify
- Whether natural gas and liquids prices remain sufficient to offset declining Pennsylvania volumes and gathering-system throughput.
- The magnitude, timing and cash impact of future derivative settlements and mark-to-market changes.
- The outcome of the Chesapeake litigation and any effect on Auburn development plans or gathering economics.
- Progress in remediating the material weakness and whether subsequent filings report effective disclosure controls.
- The next borrowing-base redetermination, covenant compliance and continued availability of the $14 million revolving facility.
- Whether planned capital expenditures and Oklahoma appraisal activity remain fully funded from operating cash flow without new debt.