What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2022-03-24 compared with 2021-03-25 · 294 added, 258 removed, 763 unchanged (42% of the section changed)

1 unchanged sentence

Our consolidated balance sheets as of December 31, 2021 and 2020, and the consolidated statements of operations and comprehensive income, changes in shareholders’ equity and cash flows for years ended December 31, 2021 and 2020 included in this annual report have been prepared in accordance with U.S.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Report of Independent Registered Public Accounting Firm

4 unchanged sentences

We have audited the accompanying consolidated balance sheets of Epsilon Energy Ltd.

(the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of operations and comprehensive income, changes in shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”).

(the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations and comprehensive income, changes in shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2021, and the related notes (collectively referred to as the “consolidated financial statements”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.

22 unchanged sentences

Accounts receivable

Fair value of derivatives

Prepaid income taxes

7 unchanged sentences

Accumulated depletion, depreciation, amortization and impairment

( 102,480,972 )

( 98,200,111 )

Total oil and gas properties, net

1 unchanged sentence

Accumulated depletion, depreciation, amortization and impairment

( 33,443,949 )

( 32,101,624 )

Total gathering system, net

8 unchanged sentences

Accounts payable trade

Gathering fees payable

Royalties payable

Income taxes payable

Accrued capital expenditures

Accrued gathering fees

Other accrued liabilities

Fair value of derivatives

Asset retirement obligations

8 unchanged sentences

Common shares, no par value, unlimited shares authorized and 24,202,218 issued and 23,668,203 outstanding at December 31, 2021, and 23,985,799 shares issued and outstanding at December 31, 2020.

Treasury shares, 534,015 at December 31, 2021

( 2,423,007 )

Additional paid-in capital

Accumulated deficit

( 68,783,207 )

( 80,410,724 )

Accumulated other comprehensive income

6 unchanged sentences

Revenues from contracts with customers:

Gas, oil, NGLs and condensate revenue

Gas, oil, NGL, and condensate revenue

Gas gathering and compression revenue

5 unchanged sentences

Depletion, depreciation, amortization, and accretion

Impairment of proved properties

Gain on sale of property

Impairment expense

Gain on sale of oil and gas properties

General and administrative expenses:

6 unchanged sentences

Interest expense

Gain on derivative contracts

(Loss) gain on derivative contracts

( 4,482,909 )

Other income (expense)

Other income, net

Other (expense) income, net

( 4,544,296 )

Net income before income tax expense

15 unchanged sentences

Balance at December 31, 2019

( 81,285,895 )

Stock-based compensation expenses

Exercise stock options

Purchase of treasury shares

( 1,927,198 )

Retirement of treasury shares

( 1,927,198 )

Shares retired through tender offer

( 2,337,034 )

( 7,151,324 )

Vesting of shares of restricted stock

1 unchanged sentence

Balance at December 31, 2020

( 80,410,724 )

Stock-based compensation expenses

Purchase of treasury shares

Retirement of treasury shares

Shares retired through tender offer

( 2,423,007 )

Exercise of stock options

Vesting of shares of restricted stock

1 unchanged sentence

Balance at December 31, 2021

( 2,423,007 )

( 68,783,207 )

The accompanying notes are an integral part of these consolidated financial statements

5 unchanged sentences

Depletion, depreciation, amortization, and accretion

Impairment of proved properties

Gain on sale of properties

Gain on derivative contracts

Cash received from settlements of derivative contracts

Impairment expense

Loss (gain) on derivative contracts

( 2,503,655 )

Gain on sale of oil and gas properties

Settlement of derivative contracts

( 4,243,085 )

Settlement of asset retirement obligation

Stock-based compensation expense

Deferred income tax expense (benefit)

Deferred income tax benefit

( 2,298,612 )

Changes in assets and liabilities:

2 unchanged sentences

Accounts payable, royalties payable and other accrued liabilities

Income taxes payable

Net cash provided by operating activities

Cash flows from investing activities:

Acquisition of unproved oil and gas properties

Additions to unproved oil and gas properties

Additions to proved oil and gas properties

( 4,435,945 )

( 4,870,976 )

Additions to gathering system properties

Additions to land, buildings and property and equipment

Proceeds from sale of oil and gas properties

Prepaid drilling costs

Proceeds from sale of leases

Net cash used in investing activities

( 4,438,014 )

( 6,524,953 )

Cash flows from financing activities:

Buyback of common shares

( 2,423,007 )

( 9,078,522 )

Exercise of stock options

Net cash used in financing activities

( 2,337,669 )

( 9,078,522 )

Effect of currency rates on cash, cash equivalents and restricted cash

(Decrease) in cash, cash equivalents and restricted cash

Increase in cash, cash equivalents and restricted cash

Cash, cash equivalents and restricted cash, beginning of period

4 unchanged sentences

Non-cash investing activities:

Change in unproved properties accrued in accounts payable and accrued liabilities

Change in proved properties accrued in accounts payable and accrued liabilities

( 1,097,257 )

( 1,825,230 )

Change in gathering system accrued in accounts payable and accrued liabilities

11 unchanged sentences

Recent Developments

The significant demand declines caused by the global response to the coronavirus 2019 pandemic (“COVID-19”) as well as the actions taken by a number of global oil producers has contributed to steep declines in the demand and pricing for oil, natural gas and NGLs, negatively impacting U.S.

While Epsilon did not incur significant disruptions to operations during the year ended December 31, 2020 as a result of the COVID-19 pandemic, the Company did need to recognize an impairment on its legacy Oklahoma producing assets due to the historically low commodity prices.

The full impact of the COVID-19 pandemic continues to evolve as of the date of this report.

As such, the full magnitude that the pandemic will have on the Company’s financial condition, liquidity, and future results of operations is uncertain.

Management is actively monitoring the impact of the COVID-19 pandemic on the Company's financial condition, liquidity, operations, suppliers, industry and ability to obtain financing in future reporting periods.

Given the daily evolution of the COVID-19 pandemic and the global responses to curb its spread, the Company is currently not able to estimate the effects of the COVID-19 pandemic on its results of operations, financial condition, or liquidity for the future.

The federal government has passed a series of relief and stimulus packages, including the CARES Act, for the country, but Epsilon has not and does not anticipate that it will apply for assistance under such programs.

Accordingly, these programs have no effect on Epsilon’s financial statements.

On June 28, 2020, Chesapeake Energy Corporation (“CHK”) filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code (“Petition”).

Chesapeake Energy Marketing, Inc., a subsidiary of CHK, is one of the Anchor Shippers under the Anchor Ship Gas Gathering Agreement (“ASGGA”) for the Auburn GGS with a 43.8750% voting percentage.

The Williams Companies Inc.

(“Williams”), including its subsidiary Appalachia Midstream Services, L.L.C.

(“AMS”), is listed in the petition as a top 30 creditor of CHK, with an amount due by CHK under the ASGGA.

On June 28, 2020 unpaid fees attributable to CHK for the ASGGA for May and June 2020 gathering fees were $1.1 million and $1.3 million respectively.

On December 15, 2020, a global resolution between Williams and CHK was approved by the United States Bankruptcy Court.

As a part of the agreement, CHK affirmed the ASGGA for the Auburn GGS and agreed to pay all pre-petition and past due receivables related to midstream expenses, per the existing contracts.

We have received our share of the pre-petition amounts and as such, reversed our $0.8 million previously established allowance for doubtful accounts related to the Company’s share of those payments as of December 31, 2020.

On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC (“Chesapeake”) in the United States District Court for the Middle District of Pennsylvania, Scranton, Pennsylvania.

1 unchanged sentence

Epsilon asserts that Chesapeake has failed to cooperate with Epsilon’s efforts to develop resources in the Auburn Development, located in North-Central Pennsylvania, as required under both the settlement agreement and JOAs.

Epsilon has requested a preliminary injunction, among other requests for relief.

Accordingly, a hearing on that request is expected to be heard in Spring 2021.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Epsilon requested a preliminary injunction but was unsuccessful in obtaining that injunction.

Epsilon filed a motion to amend its original Complaint.

Chesapeake opposed.

The Court ruled in Epsilon’s favor and allowed Epsilon’s amendment.

Chesapeake moved to dismiss the amended Complaint.

The Court granted the motion to dismiss without prejudice to Epsilon’s right to file a new lawsuit based on new proposals made after the Court’s decision.

Epsilon filed a motion for reconsideration of that decision.

The motion for reconsideration was fully briefed in November 2021.

Epsilon filed a notice of additional evidence to the motion for reconsideration on January 4, 2022.

The motion for reconsideration was denied on January 18, 2022.

Epsilon filed a notice of appeal on February 15, 2022 challenging both the motion to dismiss and motion for reconsideration decisions.

Chesapeake filed a cross-appeal on March 1, 2022.

A briefing schedule has not yet been set but a decision on the appeal is expected in the fourth quarter of 2022.

On February 25, 2022, the Board of Directors approved a quarterly cash dividend of $ 0.0625 per common share, payable on March 31, 2022, to shareholders of record at the close of business on March 8, 2022.

With the initiation of a cash dividend, Epsilon intends to pay regular quarterly dividends, with future dividend payments subject to quarterly review and approval by its Board of Directors.

At this quarterly dividend rate, the annual dividend rate for the fiscal year 2022 is $ 0.25 per share.

The Board of Directors also authorized the repurchase of up to 1,183,410 of the outstanding common shares, representing 5 % of the outstanding common shares of Epsilon, for an aggregate purchase price of not more than US $ 8.0 million, pursuant to a normal course issuer bid, during the one-year period commencing on March 8, 2022.

The program will end on March 7, 2023 unless the maximum amount of common shares is purchased before then or Epsilon provides earlier notice of termination.

Basis of Preparation

The accounts are maintained and the consolidated financial statements have been prepared using the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“U.S.

All amounts presented are in US$ unless otherwise indicated.

Principles of Consolidation

3 unchanged sentences

All inter-company transactions have been eliminated.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Use of Estimates

16 unchanged sentences

Compression and gathering receivables are generally collected within 60 days after the end of the month.

We review all outstanding accounts receivable balances and record a reserve for amounts that we expect will not be fully recovered.

Estimated losses on accounts receivable are provided through an allowance for doubtful accounts.

We estimate the allowance for doubtful accounts through various procedures, including review of our trade receivable balances by counterparty, assessing economic events and conditions, our historical experience with counterparties, the counterparty’s financial condition and the amount and age of past due accounts.

Actual balances are not applied against the reserves until substantially all collection efforts have been exhausted.

3 unchanged sentences

For the years ended December 31, 2021 and 2020

For the year ended December 31, 2020, we recognized an $819,000 bad debt expense, but then reversed it at December 31, 2020.

There was no bad debt expense recognized for the year ended December 31, 2019.

Oil and Natural Gas Properties

17 unchanged sentences

Gas Gathering System Properties

Epsilon accounts for its gas gathering system asset using the proportionate consolidation method of accounting.

Epsilon’s 35 % portion of asset development costs are capitalized when incurred.

4 unchanged sentences

If the expected undiscounted future cash flows are lower than the unamortized capitalized cost, the capitalized cost is reduced to fair value.

Fair value is generally calculated using the Income Approach described in Fair Value Measurement Topic ASC 820, which considers estimated discounted future cash flows.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Fair value is generally calculated using the Income Approach, which considers estimated discounted future cash flows.

Revenue Recognition

Revenues are comprised primarily of sales of natural gas and to a much lesser degree crude oil and NGLs, along with the revenue generated from the Company’s ownership interest in the gas gathering system in the Auburn field in Northeastern Pennsylvania.

We adopted Accounting Standards Codification (“ASC”) topic 606 on January 1, 2019.

The standard requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.

The ASU replaced most existing revenue recognition guidance in GAAP when it became effective and was incorporated into GAAP as Accounting Standards Codification (“ASC”) Topic 606.

Revenue recognition is evaluated through the following five steps:

1 unchanged sentence

(ii) identification of the performance obligations in the contract;

(iii) determination of the transaction price;

(iii) determination of the transaction

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

(iv) allocation of the transaction price to the performance obligations in the contract;

and (v) recognition of revenue when or as a performance obligation is satisfied.

The Company applied the guidance to the contracts in effect at January 1, 2019 and used the modified retrospective transition method.

There was no material impact to our net income related to the adoption of this standard.

Based on ASC 606, the Company adheres to the following revenue recognition policies and procedures.

Accounting Policies

21 unchanged sentences

Revenue is recognized over time as the services are provided.

Oil and Other Liquids Revenue

The source of the Company’s oil and other liquids revenue is its ownership interest in wells in Oklahoma.

The Company does not operate the wells and has elected not to receive its proportionate share of the production.

As such, under the Joint Operating Agreement, the operators have control of the marketing of this production at current market prices and remits our net revenue interest less taxes and fees on a monthly basis.

The Company recognizes revenue with a monthly accrual of its proportionate share of volumes produced at an estimated market price.

Accounts Receivable and Other

Accounts receivable – Oil, natural gas liquid and natural gas receivables consist of amounts due from purchasers for commodity sales from our revenue interest in the leases in Northwestern Pennsylvania and Oklahoma.

Payments from purchasers are typically due by the last day of the month following the month of delivery.

Gathering fee revenue consists of fees due from the operator of the Auburn GGS, as an agent for the Company fulfilling the operations of the gathering

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2021 and 2020

Accounts Receivable and Other

Accounts receivable – Oil, natural gas liquid and natural gas receivables consist of amounts due from purchasers for commodity sales primarily from our revenue interest in the leases in Northwestern Pennsylvania.

Payments from purchasers are typically due by the last day of the month following the month of delivery.

Gathering fee revenue consists of fees due from the operator of the Auburn GGS, as an agent for the Company fulfilling the operations of the gathering system.

Payments from the operator are typically due 60 days from the last day of the month of transmission.

The Company’s operations do not result in any contract assets or liabilities on the accompanying consolidated balance sheets.

Allowance for Doubtful Accounts

Estimated losses on accounts receivable are provided through an allowance for doubtful accounts.

Buildings and Other Property and Equipment

3 unchanged sentences

Financial Instruments and Fair Value

Epsilon’s financial instruments consist of cash, cash equivalents, restricted cash, commodity derivative contracts, accounts receivable, accounts payable, accrued liabilities, and long-term debt.

Epsilon’s financial instruments consist of cash, cash equivalents, restricted cash, commodity derivative contracts, accounts receivable, accounts payable, and long-term debt.

Our financial instruments that are accounted for at fair value measurement consist of commodity derivatives.

7 unchanged sentences

The Company makes its own assumptions about how market participants would price the assets and liabilities.

Cash, cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities are carried at cost, which approximates their fair value because of the short-term maturity of these instruments.

Cash, cash equivalents, restricted cash, accounts receivable, and accounts payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments.

The Company’s revolving line of credit has a recorded value that approximates its fair value since its variable interest rate is tied to current market rates and the applicable margins represent market rates.

1 unchanged sentence

The Company’s derivative contracts are valued based on an income approach.

The model considers various assumptions, such

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

as quoted forward prices for commodities, time value and volatility factors.

The model considers various assumptions, such as quoted forward prices for commodities, time value and volatility factors.

These assumptions are observable in the marketplace throughout the full term of the contract, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace, and are therefore designated as Level 2 within the valuation hierarchy.

The Company utilizes its counterparties’ valuations to assess the reasonableness of its own valuations.

Derivative Instruments

1 unchanged sentence

While it is never management’s intention to hold or issue derivative instruments for speculative trading purposes, conditions sometimes arise where actual production is less than estimated, which has, and could, result in over-hedged volumes.

Natural gas production is primarily sold under market sensitive contracts which are typically priced at a differential to the NYMEX or the published natural gas index prices for the producing area due to the natural gas quality and the proximity to major consuming markets.

Natural gas production is primarily sold under market sensitive contracts which are typically priced

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

at a differential to the NYMEX or the published natural gas index prices for the producing area due to the natural gas quality and the proximity to major consuming markets.

Our derivative transactions have included the following:

3 unchanged sentences

If the settled price differential is less than the swapped basis, then we make a payment to the counterparty for the difference between the two.

Derivative assets and liabilities are initially measured at fair value and then re-valued at each reporting period.

Using this method, derivative instruments are recorded on the consolidated balance sheets at fair value as either current or non-current assets or liabilities based on their anticipated settlement date.

● Two-way collar contracts—which guarantee a specified price range for NYMEX by using the proceeds of selling a call option at a specified strike price (the “Ceiling”) to finance the purchase of a put option at a specified strike price (the “Floor”).

Derivative instruments are recorded on the consolidated balance sheets at fair value as either current or non-current assets or liabilities based on their anticipated settlement date.

Gains or losses on derivative contracts are recorded as gain (loss) on commodity contracts in the consolidated statements of operations and comprehensive income.

13 unchanged sentences

The Company periodically assesses the financial condition of these institutions and believe that any possible credit risk is minimal.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Geographic Locations of Operations

Approximately 93 % and 97 % of our production during fiscal 2021 and 2020, respectively was derived from natural gas production and gathering system revenues in the state of Pennsylvania.

Our asset in Pennsylvania has not yet reached the mature stage, but at some point we may need to acquire and develop other producing assets to maintain our current level or to grow.

To this end, we have begun to acquire leases and to expand our holdings in Pennsylvania.

As a result of this geographic concentration, we may be disproportionately exposed to the effect of regional supply and demand factors, delays or interruptions of production from wells in this area caused by governmental regulation, processing or transportation capacity constraints, market limitations, weather events or interruption of the processing or transportation of crude oil or natural gas.

Income taxes are accounted for using the asset and liability approach.

Under this approach, deferred tax assets and liabilities are recognized based on anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax basis.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Deferred tax assets and liabilities are recognized based on anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax basis.

Epsilon assesses the realizability of deferred tax assets and recognizes valuation allowances as appropriate (see Note 9).

Foreign Currency Transactions

The United States dollar is the functional currency for all of Epsilon’s consolidated subsidiaries.

Even though the Canadian dollar is the functional currency of Epsilon Energy Ltd.

(the parent entity), the United States dollar is the reporting currency for all of Epsilon’s consolidated subsidiaries.

Any gains or losses on transactions or monetary assets or liabilities in currencies other than the functional currency are included in net income in the current period.

15 unchanged sentences

Assets acquired under capital leases are amortized over the estimated useful lives of the underlying assets.

All other leases are accounted for as operating leases and the related lease payments are charged to expense as incurred.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

All other leases are accounted for as operating leases and the related lease payments are charged to expense as incurred on a straight-line basis over the term of the lease.

Joint Interests

2 unchanged sentences

The Company, an emerging growth company (“EGC”), has elected to take advantage of the benefits of the extended transition period provided for in Section 7(a)(2)(B) of the Securities Act, for complying with new or revised accounting standards which allows the Company to defer adoption of certain accounting standards until those standards would otherwise apply to private companies.

In March 2020, the FASB issued ASU No.

2020-04 - Reference Rate Reform (Topic 848), codified as ASC 848 (“ASC 848”).

The purpose of ASC 848 is to provide optional guidance to ease the potential effects on financial reporting of the market-wide migration away from Interbank Offered Rates (“IBORs”) to alternative reference rates.

ASC 848 applies only to contracts, hedging relationships, and other transactions that reference a reference rate expected to be discontinued because of reference rate reform.

The guidance may be applied upon issuance of ASC 848 through December 31, 2022.

We do not expect a material impact from the adoption of this ASU.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

In December 2019, the Financial Accounting Standards Board (“FASB”) issued ASU 2019-12, “Income Taxes (Topic 740):

Simplifying the Accounting for Income Taxes,” which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740, Income Taxes.

The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020.

Early adoption is permitted.

The Company is currently assessing the impact of adopting this new guidance.

In June 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326):

8 unchanged sentences

Additional disclosures about an entity’s lease transactions will also be required.

ASU 2016-02 defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.” ASU 2016-02 is effective for the Company for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.

In July, the FASB voted to extend the adoption date by one year for private and non-profit companies, and thus emerging growth companies as well.

ASU 2016-02 defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.” In July, the FASB voted to extend the adoption date by one year for private and non-profit companies, and thus emerging growth companies as well.

As an emerging growth company, Epsilon plans to defer adoption of ASU 2016-02 until the fiscal year beginning after December 15, 2021.

1 unchanged sentence

Epsilon is currently assessing the expected impact on our financial statements and will adopt for the year beginning in January 2022.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

We do not expect a material effect from the adoption of this ASU.

Property and Equipment

5 unchanged sentences

Accumulated depletion, depreciation, amortization and impairment

( 102,480,972 )

( 98,200,111 )

Total oil and gas properties, net

1 unchanged sentence

Accumulated depletion, depreciation, amortization and impairment

( 33,443,949 )

( 32,101,624 )

Total gathering system, net

2 unchanged sentences

Property Acquisitions

During the years ended December 31, 2019 the Company acquired additional acreage in the Anadarko Basin for $596,500.

No acquisitions occurred in 2020.

During the years ended December 31, 2021 and 2020, no additional acreage was acquired.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Property Sale

In June 2019, the Company completed the first part of a sale of undeveloped, stranded leases in Pennsylvania.

At that time, the Company received $1.0 million.

The sale was completed in July 2019 with a final payment of $0.4 million for a total of $1.4 million received for the stranded leases.

In December 2021, the Company completed the sale of its shallow rights leases and wells in Oklahoma for $ 450,000 .

No property sales occurred in 2020.

Property Impairment

Epsilon performs a quantitative impairment test quarterly or whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable, over proved properties using the published NYMEX forward prices, timing, methods and other assumptions consistent with historical periods.

Epsilon performs a quantitative impairment test whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable, over proved properties using the published NYMEX forward prices, timing, methods and other assumptions consistent with historical periods.

When indicators of impairment are present, tests require that the Company first compare expected future undiscounted cash flows by asset group to their respective carrying values.

1 unchanged sentence

This is determined based on discounted cash flow techniques using significant assumptions including projected revenues, future commodity prices, and a market-specific weighted average cost of capital which are affected by expectations about future market and economic conditions.

Additionally, GAAP requires that if an exploratory well is determined not to have found proved reserves, the costs incurred, net of any salvage value, should be charged to expense.

During the three months ended March 31, 2020, Epsilon recognized certain indicators of impairments specific to our Oklahoma assets related to historically low oil and NGL prices and determined that the carrying value of those assets was not recoverable.

As a result of this assessment, a $ 1.76 million impairment was assessed on the Company’s Oklahoma assets at March 31, 2020.

No further impairment was required for the year ended December 31, 2020.

No impairment was required for the year ended December 31, 2019.

No further impairment was required for the year ended December 31, 2020 or for the year ended December 31, 2021.

Revolving Line of Credit

Effective July 30, 2013, Epsilon Energy USA Inc., a wholly owned subsidiary of the Company, executed a three-year senior secured revolving credit facility with a bank (‘‘Credit Facility’’) for a total commitment of up to $100 million.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Upon each advance, interest is charged at the rate of LIBOR plus an ‘‘applicable margin’’.

The applicable margin ranges from 2.75 - 3.75% and is based on the percent of the line of credit utilized.

The terms “Borrowing Base” and “Mortgaged Properties” include the Company’s gathering system assets in addition to the natural gas and oil properties.

The “Required Reserve Value” is the lesser of 90% of the recognized value of all proved natural gas and oil properties or 150% of the then current borrowing base.

On January 7, 2019, the maturity date of the Credit Facility was extended to March 1, 2022 and the borrowing base was increased from $13.5 million to $23 million.

The borrowing base is subject to redetermination by the lenders based on, among other things, their evaluation of the Company’s natural gas reserves.

Additionally, the Company is required to maintain acceptable commodity hedging agreements covering at least 25% of projected production of natural gas for the succeeding calendar year, along with the 50% for the current calendar year.

On August 14, 2019 the borrowing base was reaffirmed at $23 million.

Additionally, the commodity hedging requirements were updated.

Currently, when the Company’s utilization exceeds 25%, the Company must have in place acceptable commodity hedging agreements covering at least 75% of projected production for the first full twelve months after such occurrence and 50% of projected production of natural gas for the succeeding six months.

On February 11, 2020 the borrowing base was reaffirmed at $23 million and hedging requirements remained unchanged.

If we have a need to access the line of credit in the future, we will be sure that all hedging requirements are met.

The Company has a senior secured revolving credit facility (“Facility”) which includes a total commitment of up to $ 100 million.

The current borrowing base is $ 14 million, which is subject to semi-annual redetermination.

There are currently no borrowings under the Facility.

If Epsilon decided to access the Facility, depending on the level of borrowing, the Company might need to increase its hedging activity.

Borrowings from the Facility may be used for the acquisition and development of oil and gas properties, investments in cash flow generating assets complimentary to the production of oil and gas, and for letters of credit and other general corporate purposes.

Upon each advance, interest is charged at the highest of a) rate of LIBOR plus an applicable margin ( 2.75 %- 3.75 % based on the percent of the line of credit utilized), b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5 %.

Effective April 6, 2021, the agreement was amended to extend the maturity date to March 1, 2024.

In addition, the agreement was amended to include a Benchmark Replacement definition and transition plan to be used at such time when the LIBOR rate is discontinued.

On June 28, 2021, the borrowing base was decreased from $ 18 million to $ 14 million.

On November 23, 2021, the borrowing base of $ 14 million was reaffirmed until May 1, 2022, the next periodic redetermination of the borrowing base.

The lender under the Credit Facility has a first priority security interest in the tangible and intangible assets, including the gathering system, of Epsilon Energy USA, Inc.

3 unchanged sentences

● Current ratio, adjusted for line of credit amounts used and available and non-cash amounts, greater than 1 .

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

● Leverage ratio less than 3.0 based on income adjusted for interest, taxes and non-cash amounts.

9 unchanged sentences

The Company is authorized to issue an unlimited number of Common Shares with no par value and an unlimited number of Preferred Shares with no par value.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

(b) Purchases of Equity Shares

Prior to moving the Company listing from the TSX to the NASDAQ, and prior to the purchase of the equity shares on the NASDAQ shown below, the Company purchased shares through a normal-course issuer bid (“NCIB”) program with the TSX, which expired February 28, 2019.

On the TSX, the Company repurchased and retired 57,100 shares of common stock through the year ended December 31, 2019.

Commencing on January 1, 2021, Epsilon has conducted a normal course issuer bid (“NCIB”) to repurchase our issued and outstanding common shares, when doing so has been accretive to management's estimates of intrinsic value per share.

The NCIB ended on December 31, 2021.

The Company used discretionary cash to fund these repurchases.

During the year ended December 31, 2021, Epsilon has repurchased 534,015 common shares of the authorized 1,193,000 purchase amount and spent $ 2,423,007 under the NCIB.

The repurchased stock had an average price of $ 4.54 per share.

Commencing on May 20, 2019, the Company entered into a share repurchase program on the NASDAQ conducted in accordance with Rule 10b-18 promulgated under the Securities Exchange Act of 1934.

The Company was authorized to repurchase up to 1,367,762 of its outstanding common shares, representing 5% of the outstanding common shares of Epsilon as of May 20, 2019, for an aggregate purchase price of not more than $5.0 million.

The program ended on May 19, 2020, but Epsilon’s final repurchase under this program occurred on May 8, 2020.

Repurchases were made at management’s discretion from time to time through the facilities of the NASDAQ Global Market.

The price paid for the common shares was, subject to applicable securities laws, the prevailing market price of such common shares on the NASDAQ Global Market at the time of such purchase.

The Company funded the purchases out of available cash and did not incur debt to fund the share repurchase program.

Commencing on May 20, 2019, Epsilon conducted a normal course issuer bid (“NCIB”) to repurchase up to 1,367,762 issued and outstanding common shares.

The NCIB ended on May 19, 2020.

Additionally, on May 14, 2020, the Company’s Board of Directors announced its intention to commence a substantial issuer bid/issuer tender offer to purchase for cash up to an aggregate of approximately $ 6.2 million of its common shares.

The tender offer expired on June 30, 2020.

During the year ended December 31, 2020, the Company repurchased 2,994,348 common shares and spent $ 9,062,089 , excluding fees and expenses The Company canceled all common shares taken up and paid for under the NCIB and tender offer.

The Company funded the repurchases with cash on hand and did not incur debt to fund the share repurchase program.

Substantial Issuer Bid/Issuer Tender Offer

1 unchanged sentence

In May 2020, upon the terms and subject to the conditions described in the Offer to Purchase dated May 19, 2020, as amended, the Company offered to repurchase up to 2,000,000 of its common shares for $ 3.06 per share, excluding taxes and interest, for a total cost of approximately $ 6.1 million, excluding expenses of the tender offer.

As permitted under Rule 13e-4(f) and Rule 14e-1(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and as stated in its Offer to Purchase, Epsilon was permitted to take up and pay for 2,000,000 Common Shares plus 2% of its issued and outstanding Common Shares, or an aggregate total of up to 2,522,673 Common Shares.

The tender offer expired on June 30, 2020, and on July 6, 2020 the Company announced that it accepted 2,337,034 shares for repurchase under the terms of the Offer to Purchase for an aggregate consideration of $ 7,151,324 , or $ 3.06 per share, excluding fees and expenses.

1 unchanged sentence

The Company funded the repurchases under the tender offer with cash on hand.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

The following table contains information about our repurchase of equity securities during the year ended December 31, 2021:

2 unchanged sentences

Average price

part of publicly

purchased under

announced plans

or programs (4)

Beginning of normal-course issuer bid, May 20, 2019

Shares purchased through December 31, 2019 (1) (2)

Beginning of normal-course issuer bid, January 1, 2021

January 2021 (1)

2 unchanged sentences

April 2021 (1)

June 2021 (1)

July 2021 (1)

August 2021 (1)

September 2021 (1)

October 2021 (1)

November 2021 (1)

December 2021 (1)

Total as of December 31, 2021

(1) Shares purchased through December 31, 2019 were cancelled prior to the year ended December 31, 2019.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

(2) Epsilon repurchased these shares under its share repurchase program that commenced on May 20, 2019, as described above.

(3) Epsilon repurchased these shares under its substantial issuer bid/issuer tender offer dated May 19, 2020, as described above.

(4) The Company announced its intention to commence a substantial issuer bid/issuer tender offer on May 14, 2020, and the substantial issuer bid/issuer tender offer commenced May 19, 2020, as described above.

(5) The normal-course issuer bid expired on May 19, 2020, and the substantial issuer bid/issuer tender offer expired on June 30, 2020.

(1) Epsilon repurchased these shares under its share repurchase program that commenced on January 1, 2021, as described above.

6 unchanged sentences

Under the 2020 Plan, Epsilon will be authorized to issue up to 2,000,000 Common Shares.

As of December 31, 2020, the Company granted, after the Compensation Committee approved the terms, target formulas, and peer group applicable to the performance incentive awards, 214,000 performance stock units (“PSUs”), and 111,900 time-based restricted shares to employees, leaving 1,674,100 shares available to be granted under the 2020 Plan.

No shares subject to awards currently outstanding under the Predecessor Plans that expire or are forfeited will become available for issuance under the 2020 Plan.

As of December 31, 2021, the Company granted, after the Compensation Committee approved the terms, target formulas, and peer group applicable to the performance incentive awards, 20,834 common shares and 48,000 time-based restricted shares to the CEO and the board of directors.

Restricted Stock Awards

For the year ended December 31, 2021, 48,000 common shares of Restricted Stock with a weighted average market price at grant date of $ 5.04 were awarded to the Company’s board of directors.

For the year ended December 31, 2020, 111,900 common shares of Restricted Stock with a weighted average market price at the grant date of $ 3.71 were awarded to the Company’s officers, employees, and board of directors.

2 unchanged sentences

The Company determined the fair value of the granted Restricted Stock-based on the market price of the common shares of the Company on the date of grant.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

The following table summarizes restricted stock for the years ended December 31, 2021 and 2020:

5 unchanged sentences

Balance non-vested Restricted Stock at end of period

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Stock compensation expense for the granted Restricted Stock is recognized over the vesting period.

Stock compensation expense recognized during the year ended December 31, 2021 was $ 554,249 (for the year ended December 31, 2020, $ 655,924 ).

At December 31, 2020, the Company had unrecognized stock-based compensation related to these shares of $1,068,819 to be recognized over a weighted average period of 1.20 years (at December 31, 2019:

$1,641,295 over 1.12 years).

At December 31, 2021, the Company had unrecognized stock-based compensation related to these shares of $ 696,833 to be recognized over a weighted average period of 1.11 years.

Performance Share Unit Awards (“PSU”)

The Company grants PSUs, which are paid in stock to certain key employees.

For the year ended December 31, 2020, 214,000 PSUs with a weighted average market price at the grant date of $3.42 were awarded.

PSUs are based on a three-year performance period with performance being measured each year at December 31.

The PSUs will vest on the last day of the performance period.

6 unchanged sentences

The number of shares ultimately issued under these awards can range from zero to 200 % of target award amounts.

For the year ended December 31, 2021, a total of 62,501 common shares were issued and vested, of which 20,834 of the common shares were granted as a result of the Company exceeding its 2020 TSR performance target.

The PSUs are accounted for as equity awards.

The fair value of the 50% for performance based on CFDAS was determined as the market price of the common shares of the Company on the date of grant.

Weighted average fair value of CFDAS PSUs granted during the year ended December 31, 2020 was $3.41 per unit.

The fair value of the 50 % for performance based on CFDAS is determined as the market price of the common shares of the Company on the date of grant.

The fair value of the 50 % for performance based on TSR was determined on the grant date by the application of a Monte Carlo simulation model.

Weighted average fair value of TSR PSUs granted during the year ended December 31, 2020 was $4.10 per share.

For the year ended December 31, 2021, the Compensation Committee did not approve the issuance of any new PSU’s.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

The Monte Carlo simulation model calculated grant date fair value using the following assumptions:

8 unchanged sentences

The risk-free interest rate was based on the United States Treasury rate measured over a term commensurate with the expected term for each annual performance period of the awards.

The expected term is

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

based on the time between the valuation date and the end of each annual performance period of the awards.

The expected term is based on the time between the valuation date and the end of each annual performance period of the awards.

The valuation model assumes dividends are immediately reinvested.

7 unchanged sentences

Stock compensation expense for the granted PSUs is recognized over the vesting period.

Stock compensation expense recognized during the year ended December 31, 2020 related to PSUs was $191,840 (for the year ended December 31, 2019, nil).

Stock compensation expense recognized during the year ended December 31, 2021 related to PSUs was $ 401,835 (for the year ended December 31, 2020, $ 191,840 ).

At December 31, 2021, the Company had unrecognized stock-based compensation related to these shares of $ 310,790 to be recognized over a weighted average period of 1.01 years (at December 31, 2020:

nil over nil years).

$ 568,585 over 1.37 years).

Stock Options

Through December 31, 2020, the Company had outstanding stock options covering 245,000 Common Shares at an overall average exercise price of $5.27 per Common Share to directors, officers, and employees of the Company and its subsidiaries.

As of December 31, 2021, the Company had outstanding stock options covering 218,750 Common Shares at an overall average exercise price of $ 5.28 per Common Share to directors, officers, and employees of the Company and its subsidiaries.

These 218,750 options have a weighted average expected remaining term of approximately 1.22 years.

The following table summarizes stock option activity for the years ended December 31, 2021 and 2020:

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

December 31, 2021

5 unchanged sentences

Exercisable at period-end

(1) Exercise price has been converted to US$ using the rate of Cdn$1.33 to US$1, the rate on March 15, 2019, the date Epsilon Energy, Ltd was delisted from the TSX

At December 31, 2021, the Company had unrecognized stock-based compensation related to these options of nil (for the year ended December 31, 2020:

$1,867 over 0.8 years).

The aggregate intrinsic value at December 31, 2021 was nil (at December 31, 2020:

1 unchanged sentence

no stock options).

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

The following table summarizes information for stock options outstanding at December 31, 2021:

3 unchanged sentences

The value of the options was recorded as stock-based compensation expense, with an offsetting amount to additional paid-in capital based on the vesting terms.

Stock-based compensation for the options, for the years ended December 31, 2020 and 2019, was $1,867 and $25,203, respectively.

Stock-based compensation for the options, for the years ended December 31, 2021 and 2020, was nil and $ 1,867 , respectively.

Revenue Recognition

1 unchanged sentence

Also included to a much lesser degree is natural gas, crude oil and NGLs from Oklahoma.

Overall, product sales revenue generally is recorded in the month when contractual delivery obligations are satisfied, which occurs when control is transferred to the Company’s customers at delivery based on contractual terms and conditions.

In addition, gathering and compression revenue generally is recorded in the month when contractual service obligations are satisfied, which occurs as control of those services is transferred to the Company’s customers.

The following table details revenue for the years ended December 31, 2021 and 2020:

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Year Ended December 31,

12 unchanged sentences

Estimated revenue due to the Company is recorded within the receivables line item on the accompanying consolidated balance sheets until payment is received.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Gas Gathering and Compression Revenue

6 unchanged sentences

The Company records an allowance for doubtful accounts on a case-by-case basis once there is evidence that collection is not probable.

For the year ended December 31, 2021, there were no accounts for which collection was not probable.

Due to the bankruptcy filed by Chesapeake Energy Corporation (“CHK”) on June 28, 2020, the Company recorded an allowance for possible uncollectable fees.

Unpaid fees attributable to CHK for May and June 2020 gathering system services were $ 1.1 million and $ 1.3 million respectively.

On December 15, 2020, a global resolution between Williams and CHK was approved by the United States Bankruptcy Court.

As a part of the agreement, CHK affirmed the ASGGA for the Auburn GGS and agreed to pay all pre-petition and past due receivables related to midstream expenses, per the existing contracts.

Epsilon recorded an allowance for doubtful accounts for the Company’s 35 % share of these payment for a total bad debt expense of $ 0.8 million.

In December 2020, a global resolution between Williams and CHK was approved by the United States Bankruptcy Court.

We received our share of the pre-petition amounts and as such, reversed our $ 0.8 million previously established allowance for doubtful accounts related to the Company’s share of those payments.

As of December 31, 2020, all cash has been received and revenue is included in the financial statements.

The following table details accounts receivable as of December 31, 2021 and 2020:

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Accounts receivable

8 unchanged sentences

Balance at beginning of period

Translation gain other

Translation (loss) gain

Balance at end of period

Substantially all of the accumulated other comprehensive income is related to the translation adjustment for the Canadian convertible debentures settled in 2017.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Income (loss) before income taxes is as follows for the periods indicated:

3 unchanged sentences

The Company’s tax returns are open to audit under the statute of limitations for the years ended December 31, 2018 through December 31, 2021.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

The following tables present the Company’s current and deferred tax expense (benefit) for the periods indicated:

1 unchanged sentence

Total current income tax expense

( 1,788,587 )

Total deferred tax expense (benefit)

( 2,298,612 )

Income tax expense

The following table presents the reconciliation of our income taxes calculated at the statutory federal tax rate to the income tax provision in our financial statements.

Our effective tax rate for 2020 differs from the statutory rate primarily due to the valuation allowance on our deferred tax assets relating to Canadian and Oklahoma operations.

Our effective tax rate for 2019 differs from the statutory rate primarily due to state taxes.

Our effective tax rate for 2021 differs from the statutory rate primarily due to states taxes and the recognition of a valuation allowance on our Canadian and Oklahoma state deferred tax assets.

Our effective tax rate for 2020 differs from the statutory rate primarily due to the recognition of a valuation allowance on our Canadian and Oklahoma state deferred tax assets.

Income tax provision computed at the statutory federal tax rate

Difference in Canadian and U.S.

Correction of Canadian deferred tax balances

Valuation allowance on Canadian loss

4 unchanged sentences

Deferred income taxes primarily represent the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

Net deferred tax liabilities consisted of the following at December 31, 2021 and 2020:

6 unchanged sentences

Valuation allowance

( 11,821,914 )

( 12,617,846 )

Total deferred tax assets

1 unchanged sentence

Oil and gas property

Unrealized derivatives/other

( 8,558,064 )

( 8,459,810 )

( 2,491,836 )

( 2,773,443 )

Gross deferred tax liabilities

( 11,049,900 )

( 11,233,253 )

Net deferred tax liability

As of December 31, 2020, we have no federal net operating loss carry-forwards and approximately $7.4 million of state net operating loss carry-forwards, which can be carried forward indefinitely.

( 9,905,440 )

( 10,102,852 )

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

As of December 31, 2021, we have no federal net operating loss carry-forwards and approximately $ 7.7 million of state net operating loss carry-forwards, of which $ .3 million expires in 2037 and the remaining can be carried forward indefinitely.

These loss carryforwards may reduce future taxable income, however, the extent of which may be limited due to any IRC Section 382 limitation.

We evaluate all available evidence in determining the carrying value of our deferred tax assets based upon the more-likely-than-not standard of the accounting literature.

We have recorded a valuation allowance against the Canadian net operating losses as we do feel that it is more likely than not that they will not be utilized as the Company does not have any revenue producing activities in Canada.

In addition, we determined that our deferred tax assets associated with Oklahoma operations will not be realized.

As a result of the Company's analysis, management has determined that the Company does not have any material uncertain tax positions.

The Company recognizes interest expense and penalties related to the uncertain tax position in the income tax expense line in the accompanying consolidated statements of operations and comprehensive loss.

Accrued interest and penalties are included in other non-current liabilities in the consolidated balance sheets and were nil as of December 31, 2020 and 2019.

A valuation allowance of $ 0.2 million is applicable to the net state deferred tax assets attributable to Oklahoma because of objective negative evidence on the cumulative loss incurred in the state over the three-year period ended December 31, 2021.

As of December 31, 2021, we have $ 42.5 M of Canadian net operating loss carry-forwards.

A valuation allowance of $ 11.7 million attributable to Canadian net operating losses and other tax carryovers is recorded because it is more likely than not that they will not be utilized.

On March 18, 2020, the Families First Coronavirus Response Act ("FFCR Act"), and on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") were each enacted in response to the COVID-19 pandemic.

1 unchanged sentence

This legislation currently has no material impact to income tax expense on the Company’s financial statements.

The Company continues to monitor additional guidance issued by the U.S.

Treasury Department, the Internal Revenue Services and others.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2020 and 2019

As a result of the Company's analysis, management has determined that the Company does not have any material uncertain tax positions.

Accrued interest and penalties are included in other non-current liabilities in the consolidated balance sheets and were $ 0 as of December 31, 2021 and 2020.

Commitments and Contingencies

2 unchanged sentences

As of December 31, 2021, we had commitments of $ 3.7 million for capital expenditures.

From time to time, we may be involved in disputes or litigation arising in the normal course of doing business.

At December 31, 2020, we did not have any legal proceedings to which we were a party.

However, please see Note 15, Subsequent Events, for current litigation.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC (“Chesapeake”) in the United States District Court for the Middle District of Pennsylvania, Scranton, Pennsylvania.

Epsilon claims that Chesapeake has breached a settlement agreement and several operating agreements (“JOAs”) to which Epsilon and Chesapeake are parties.

Epsilon requested a preliminary injunction but was unsuccessful in obtaining that injunction.

Epsilon filed a motion to amend its original Complaint.

Chesapeake opposed.

The Court ruled in Epsilon’s favor and allowed Epsilon’s amendment.

Chesapeake moved to dismiss the amended Complaint.

The Court granted the motion to dismiss without prejudice to Epsilon’s right to file a new lawsuit based on new proposals made after the Court’s decision.

Epsilon filed a motion for reconsideration of that decision.

The motion for reconsideration was fully briefed in November 2021.

Epsilon filed a notice of additional evidence to the motion for reconsideration on January 4, 2022.

The motion for reconsideration was denied on January 18, 2022.

Epsilon filed a notice of appeal on February 15, 2022 challenging both the motion to dismiss and motion for reconsideration decisions.

Chesapeake filed a cross-appeal on March 1, 2022.

A briefing schedule has not yet been set but a decision on the appeal is expected in the fourth quarter of 2022.

Net Income Per Share

3 unchanged sentences

Year ended December 31,

Net income available to shareholders

Net income (loss) available to shareholders

In calculating the net income per share, basic and diluted, the following weighted-average shares were used:

Year ended December 31,

Basic and diluted weighted average shares outstanding

Basic weighted-average number of shares outstanding

Unvested time-based restricted shares

Unvested performance-based restricted shares

Diluted weighted average shares outstanding

We excluded the following shares from the diluted EPS because their inclusion would have been anti-dilutive.

23 unchanged sentences

Gathering and compression fees

( 1,594,683 )

Total operating revenue (1)

( 1,594,683 )

Net earnings (loss) for the period

( 15,331,718 )

Operating costs

( 1,594,683 )

Development geological and geophysical expenses

Depletion, deprec., amortization and accretion

Depletion, depreciation, amortization and accretion

Segment assets

Capital expenditures (2)

Proved properties

Unproved properties

Gathering system

Other property and equipment

Proved properties (net)

Unproved properties (net)

Gathering system (net)

Other property and equipment (net)

As of and for the year ended December 31, 2020

3 unchanged sentences

Gathering and compression fees

( 1,832,095 )

Total operating revenue (1)

Net earnings for the period

( 1,832,095 )

Net earnings (loss) for the period

( 1,692,091 )

( 3,737,088 )

Operating costs

( 1,832,095 )

Development geological and geophysical expenses

Depletion, deprec., amortization and accretion

Gain on sale of property

Depletion, depreciation, amortization and accretion

Bad Debt Expense

Segment assets

Capital expenditures (2)

Proved properties

Unproved properties

Gathering system

(1) Segment operating revenue represents revenues generated from the operations of the segment.

Inter-segment sales during the years ended December 31, 2020 and 2019 have been eliminated upon consolidation.

Proved properties (net)

Unproved properties (net)

Gathering system (net)

Other property and equipment (net)

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2021 and 2020

year ended December 31, 2020, we sold natural gas to 29 unique customers.

Alta Energy Marketing, LLC, EQT Energy LLC, South Jersey Resources Group, LLC, and Spotlight Energy LLC each accounted for 10% or more of our total revenue.

(1) Segment operating revenue represents revenues generated from the operations of the segment.

Inter-segment sales during the years ended December 31, 2021 and 2020 have been eliminated upon consolidation.

For the year ended December 31, 2021, we sold natural gas to 30 unique customers.

EQT Energy LLC, and Spotlight Energy LLC each accounted for 10% or more of our total revenue.

Direct Energy Business Marketing, LLC and SWN Energy Services Company, LLC each accounted for 10 % or more of our total revenue.

For the year ended December 31, 2020, we sold natural gas to 29 unique customers.

Alta Energy Marketing, LLC, EQT Energy LLC, South Jersey Resources Group, LLC, and Spotlight Energy LLC each accounted for 10 % or more of our total revenue.

(2) Capital expenditures for Upstream consist primarily of the drilling and completing of wells while Gas Gathering consists of expenditures relating to the installation of additional gathering facilities.

15 unchanged sentences

The related cash flow impact is reflected in cash flows from operating activities.

During 2020, Epsilon recognized gains on financial commodity derivative contracts of $2,503,655.

This amount included cash received on settlements of these contracts of $4,503,457.

During 2021, Epsilon recognized losses on financial commodity derivative contracts of $ 4,482,909 .

This amount included settlements of these contracts of $ 4,243,085 .

For 2020, Epsilon recognized gains on financial commodity derivative contracts of $ 2,503,655 .

1 unchanged sentence

Commodity Derivative Contracts

At December 31, 2020, we had no outstanding contracts.

As of December 31, 2019, all of the Company’s economic derivative hedge positions were with large financial institutions, which are not known to the Company to be in default on their derivative positions.

The Company is exposed to credit risk to the extent of non-performance by the counterparties in the derivative contracts discussed above;

however, the Company does not anticipate non-performance by such counterparties.

None of the Company’s derivative instruments

At December 31, 2021, Epsilon had two outstanding natural gas commodity two-way costless collar contracts.

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2021 and 2020

contains credit-risk related contingent features.

Derivatives are net on the balance sheet as they are subject to the right to offset the liabilities with the assets.

At December 31, 2020, we had no outstanding contracts.

Fair Value of Derivative

Fixed price swap

Two-way costless collar

Fair Value of Derivative

Fixed price swap

Two-way costless collar

Net Fair Value of Derivatives

3 unchanged sentences

Gains (losses) on derivative contracts included in earnings

( 4,482,909 )

Settlement of commodity derivative contracts

( 4,503,457 )

Fair value of asset, end of the period

5 unchanged sentences

As a result, estimates of abandonment costs remained constant in 2021.

Our overall liability increased due to the addition of new wells in Pennsylvania.

Our overall liability decreased due to the sale of the shallow acreage leases and wells in Oklahoma.

Epsilon Energy Ltd.

3 unchanged sentences

Balance beginning of period

Liabilities from drilling of new wells

Liabilities acquired (disposed of)

Wells plugged and abandoned

2 unchanged sentences

Subsequent Events

On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC (“Chesapeake”) in the United States District Court for the Middle District of Pennsylvania, Scranton, Pennsylvania.

Epsilon claims that Chesapeake has breached a settlement agreement and several operating agreements (“JOAs”) to which Epsilon and Chesapeake are parties.

Epsilon has requested a preliminary injunction, among other requests for relief.

Accordingly, a hearing on that request is expected to be heard during the first half of 2021.

With the initiation of a cash dividend, Epsilon intends to pay regular quarterly dividends, with future dividend payments subject to quarterly review and approval by its Board of Directors.

At this quarterly dividend rate, the annual dividend rate for the fiscal year 2022 is $ 0.25 per share.

The program will end on March 7, 2023 unless the maximum amount of common shares is purchased before then or Epsilon provides earlier notice of termination.

EPSILON ENERGY LTD.

20 unchanged sentences

Estimates for PUDs are not attributed to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual projects in the same reservoir or an analogous reservoir, or by other evidence using reliable technology establishing reasonable certainty.

The following tables set forth Epsilon’s net proved reserves at December 31, 2020 and 2019 and changes for each of the two years in the period ended December 31, 2020.

The following tables set forth Epsilon’s net proved reserves at December 31, 2021 and 2020 and changes for each of the two years in the year ended December 31, 2021.

Net proved reserves at December 31 are estimated by the Company’s independent petroleum engineers, DeGolyer and MacNaughton.

5 unchanged sentences

Revisions of previous estimates (1)(2)

Improved recoveries (3)

Net proved reserves at December 31, 2020

Revisions of previous estimates (1)(3)

Extensions (4)

Net proved reserves at December 31, 2021

9 unchanged sentences

(2) Revisions of previous estimates in the proved undeveloped category is attributable to undeveloped well locations being removed due to lease expiration and revised spacing assumptions.

(3) Reduced / improved recoveries in the proved producing category are primarily attributable to successful field operations changing the estimated recoveries.

(4) Revisions of previous estimates in natural gas reserves in 2020 is primarily attributable to a lower price of natural gas in Pennsylvania.

(5) Revisions of previous estimates in oil in 2020 is primarily attributable to the addition of proved, undeveloped locations.

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

(3) Revisions of previous estimates in natural gas reserves in 2021 are primarily attributable to a higher price of natural gas in Pennsylvania.

(4) Extensions in 2021 are primarily attributable to the successful production results of the Company’s Oklahoma well allowing for the booking of additional proved reserves on adjacent sections in which the Company owns leases.

Capitalized Costs Relating to Natural gas and oil Producing Activities

9 unchanged sentences

Net capitalized costs

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

Costs incurred for oil and natural gas property acquisition, exploration and development activities

19 unchanged sentences

Results of operations from oil and gas producing activities

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Natural gas and oil Reserves

7 unchanged sentences

The resulting tax-effected future net cash flows are reduced to present value amounts by applying a 10% annual discount factor.

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

Management does not rely upon the following information in making investment and operating decisions.

4 unchanged sentences

Future production costs

(104,161,488)

Future development costs (1)

4 unchanged sentences

(2) Future income taxes for 2021 and 2020 were estimated using a combined federal and state statutory tax rate of approximately 28%.

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

Changes in Standardized Measure of Discounted Future Net Cash Flows

10 unchanged sentences

Net change in income taxes

Purchases of reserves in place

Timing differences and other technical revisions

2 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 8. Financial Statements and Supplementary Data