What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2023-03-24 compared with 2022-03-24 · 310 added, 307 removed, 750 unchanged (45% of the section changed)

6 unchanged sentences

Opinion on the Consolidated Financial Statements

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

(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.

We have audited the accompanying consolidated balance sheets of Epsilon Energy, Ltd (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of operations and comprehensive income, changes in shareholders’ equity, and cash flows for each of the years then ended, 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, 2022 and 2021, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management.

Our responsibility is to express an opinion on the consolidated financial statements based on our audits.

Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S.

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We conducted our audits in accordance with the standards of the PCAOB.

Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.

14 unchanged sentences

Accounts receivable

Fair value of derivatives

Prepaid income taxes

Other current assets

Operating lease right-of-use assets

Total current assets

17 unchanged sentences

Restricted cash

Prepaid drilling costs

Total non-current assets

6 unchanged sentences

Accrued capital expenditures

Accrued compensation

Other accrued liabilities

1 unchanged sentence

Asset retirement obligations

Operating lease liabilities

Total current liabilities

6 unchanged sentences

Shareholders' equity

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

Preferred shares, no par value, unlimited shares authorized, none issued or outstanding

Common shares, no par value, unlimited shares authorized and 23,117,144 issued and outstanding at December 31, 2022 and 24,202,218 issued and 23,668,203 shares outstanding at December 31, 2021

Treasury shares, at cost, 0 at December 31, 2022 and 534,015 at December 31, 2021

( 2,423,007 )

25 unchanged sentences

Total operating costs and expenses

Operating income (loss)

Operating income

Other income (expense):

1 unchanged sentence

Interest expense

(Loss) gain on derivative contracts

Gain (loss) on derivative contracts

( 4,482,909 )

Other income (expense)

Other (expense) income, net

Other income (expense), net

( 4,544,296 )

18 unchanged sentences

Stock-based compensation expenses

Purchase of treasury shares

( 1,927,198 )

Retirement of treasury shares

( 1,927,198 )

Shares retired through tender offer

( 2,337,034 )

Buyback of common shares

( 2,423,007 )

Exercise of stock options

Vesting of shares of restricted stock

2 unchanged sentences

( 2,423,007 )

( 68,783,207 )

( 5,862,012 )

Stock-based compensation expenses

Purchase of treasury shares

Buyback of common shares

( 6,234,879 )

Retirement of treasury shares

( 1,516,515 )

( 8,657,886 )

Exercise of stock options

3 unchanged sentences

( 39,290,540 )

( 68,783,207 )

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

7 unchanged sentences

Loss (gain) on derivative contracts

( 2,503,655 )

Gain on sale of oil and gas properties

Settlement of derivative contracts

Settlement (paid) received on derivative contracts

( 1,225,837 )

( 4,243,085 )

Settlement of asset retirement obligation

Stock-based compensation expense

Deferred income tax benefit

( 2,298,612 )

Deferred income tax expense (benefit)

Changes in assets and liabilities:

Accounts receivable

Prepaid income taxes and other current assets

( 2,604,455 )

Other current assets

Accounts payable, royalties payable and other accrued liabilities

Income taxes payable

( 2,238,519 )

Net cash provided by operating activities

16 unchanged sentences

Exercise of stock options

( 5,862,012 )

Net cash used in financing activities

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On February 14, 2019, Epsilon’s registration statement on Form 10 was declared effective by the United States Securities and Exchange Commission and on February 19, 2019, we began trading in the United States on the NASDAQ Global Market under the trading symbol “EPSN.” Effective as of the close of trading on March 15, 2019, Epsilon voluntarily delisted its common shares from the TSX.

The Company is engaged in the acquisition, development, gathering and production of primarily natural gas reserves in the United States.

Recent Developments

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 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 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.

Epsilon is a North American on-shore focused independent natural gas and oil company engaged in the acquisition, development, gathering and production of natural gas and oil reserves.

Basis of Preparation

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The Company’s consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Epsilon Energy USA, Inc.

and its wholly owned subsidiaries, Epsilon Midstream, LLC, Dewey Energy GP, LLC, Dewey Energy Holdings, LLC and Altolisa Holdings, LLC.

and its wholly owned subsidiaries, Epsilon Midstream, LLC, Epsilon Operating, LLC, Dewey Energy GP, LLC, Dewey Energy Holdings, LLC and Altolisa Holdings, LLC.

With regard to the gathering system, in which Epsilon owns an undivided interest in the asset, proportionate consolidation accounting is used.

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

3 unchanged sentences

Actual results could differ from those estimates.

Reclassification

The consolidated financial statements for the prior periods include certain reclassifications that were made to conform to the current period presentation.

Such reclassifications have no impact on previously reported consolidated financial position, results of operations or cash flows.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

Summary of Significant Accounting Policies

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Our allowance for doubtful accounts was nil as of December 31, 2022 and 2021.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Oil and Natural Gas Properties

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Costs to develop proved reserves, including the costs of all development wells and related equipment used in the production of crude oil and natural gas, are capitalized (see Note 4).

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

Depreciation, depletion and amortization of the cost of proved oil and natural gas properties is calculated using the unit-of-production method.

1 unchanged sentence

With respect to lease and well equipment costs, which include development costs and successful exploration drilling costs, the reserve base includes only proved developed reserves.

When circumstances indicate that proved oil and natural gas properties may be impaired, Epsilon compares expected undiscounted future cash flows at a depreciation, depletion and amortization group level to the carrying value of the asset.

When circumstances indicate that proved (developed and undeveloped) oil and natural gas properties may be impaired, Epsilon compares expected undiscounted future cash flows at a depreciation, depletion and amortization group level to the carrying value of the asset.

If the expected undiscounted future cash flows, based on Epsilon’s estimate of future crude oil and natural gas prices, operating costs, anticipated production from proved reserves and other relevant data, are lower than the carrying value of the asset, the capitalized cost is reduced to fair value.

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

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

Gas Gathering System Properties

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

(iii) determination of the transaction

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

(iii) determination of the transaction price;

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

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Typically, the Company sells its natural gas directly to customers, under agreements with payment terms less than 30 days after delivery and 60 days on the revenue generated by the gas gathering system.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

Natural Gas Revenues

1 unchanged sentence

Natural gas is sold at a percentage of index prices of each component, less any stated deductions.

Control transfers at the delivery point specified in the contract, which typically is stated as the inlet of the 3rd party sales transportation pipeline.

Control transfers at the delivery point specified in the contract, which typically is stated as the inlet of the third-party sales transportation pipeline.

The Company recognizes revenue proportionate to its entitled share of volumes sold.

Currently, almost all of Epsilon’s natural gas production comes from the Marcellus Field in Northeastern Pennsylvania.

Currently, the vast majority of Epsilon’s natural gas production comes from the Marcellus Field in Northeastern Pennsylvania.

Epsilon uses a third-party service for its natural gas marketing.

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The gathering and compression services operate under fee-based contracts.

The producers in the area served by the gathering system pay fees to the system owners based on the services provided to them in getting their share of the gas production to the 3rd party sales transmission point.

The producers in the area served by the gathering system pay fees to the system owners based on the services provided to them in getting their share of the gas production to the third-party sales transmission point.

Revenue is recognized over time as the services are provided.

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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.

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.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

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.

6 unchanged sentences

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.

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

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

The Company classifies the fair value of financial instruments according to the following hierarchy based on the amount of observable inputs used to value the instrument.

6 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, 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.

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

These financial instruments are therefore designated as Level 1 within the valuation hierarchy.

Commodity derivative instruments consist of fixed-price swaps, and basis swap contracts for natural gas.

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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

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.

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.

Our derivative transactions have included the following:

7 unchanged sentences

Hedge accounting is not used for our derivative assets and liabilities.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

Asset Retirement Obligations

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Exposure to credit risk associated with these instruments is controlled by (i) placing assets and other financial interests with credit-worthy financial institutions, (ii) maintaining policies over credit extension that include the evaluation of customers’ financial condition and monitoring paying history, although the Company does not have collateral requirements and (iii) netting derivative assets and liabilities for counterparties with a legal right of offset.

At December 31, 2021 and 2020, the cash and cash equivalents were primarily concentrated in two financial institutions, one in Canada and one in the US.

At December 31, 2022 and 2021, the cash and cash equivalents were primarily concentrated in one financial institution the U.S.

We currently have $ 7.2 million in excess of the federally insured limits.

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

For the years ended December 31, 2022 and 2021, the Company had three customers that accounted for 95.7 % and 85.9 %, respectively, of the total trade accounts receivable.

Geographic Locations of Operations

1 unchanged sentence

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.

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.

5 unchanged sentences

Gains and losses on translation of balances denominated in Canadian dollars are included in accumulated other comprehensive income.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

Stock-Based Compensation

5 unchanged sentences

The Company has issued time-based restricted stock and performance share units (“PSU”) to employees and directors of the Company.

The fair value of the time-based restricted stock is determined using the fair value of the Company’s common stock on the date of grant.

The fair value of the time-based restricted stock is determined using the fair value of the Company’s common shares on the date of grant.

The fair value of the PSUs is determined by the performance requirements.

Based on the performance requirements, either the fair value of the Company’s common stock on the date of grant, or a Monte Carlo valuation is used to determine fair value of the shares at the date of the grant.

Based on the performance requirements, either the fair value of the Company’s common shares on the date of grant, or a Monte Carlo valuation is used to determine fair value of the shares at the date of the grant.

These awards vest ratably over a three-year period.

Compensation expense and a corresponding increase to additional paid in capital are recorded over the vesting period.

Agreements under which the Company makes payments to owners in return for the right to use an asset for a period are accounted for as leases.

Leases that transfer substantially all the risks and rewards of ownership to third parties are recorded at inception as finance leases within property and equipment and debt.

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 on a straight-line basis over the term of the lease.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”, which significantly changed accounting for leases by requiring that lessees recognize a right of use asset and a related lease liability representing the obligation to make lease payments, for all lease transactions with terms greater than one year.

Additional disclosures about an entity’s lease transactions are also 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.” The Company adopted ASU 2016-02 for the year beginning in January 2022.

We have chosen the transition using the comparative report at adoption method of applying the provisions of the new standard at the beginning of the period of adoption instead of the earliest comparative period presented in the consolidated financial statements.

There was no material effect from the adoption.

The Company leases office space to be used for general, administrative, and executive offices with terms typically ranging from five to seven years , subject to certain renewal options as applicable.

The Company considers renewal or termination options that are reasonably certain to be exercised in the determination of the lease term and initial measurement of lease liabilities and right-of-use assets.

Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.

Interest expense for finance leases is incurred based on the carrying value of the lease liability.

Leases with an initial term of 12 months or less are not recorded on the Company’s Consolidated Balance Sheets and lease agreements with lease and non-lease components are generally accounted for as a single lease component.

The Company determines whether a contract is, or contains, a lease at inception of the contract and whether that lease meets the classification criteria of a finance or operating lease.

When available, the Company uses the rate implicit in the lease to discount lease payments to present value;

however, most of the Company’s leases do not provide a readily determinable implicit rate.

Therefore, the Company must discount lease payments based on an estimate of its incremental borrowing rate based on prevailing financial market conditions at the later of date of adoption or lease commencement, credit analysis of comparable companies and management judgments to determine the present values of its lease payments.

(see Note 10).

Joint Interests

The majority of the Company’s oil and natural gas exploration, development and production activities, and the gathering system, are conducted jointly with others and, accordingly, these financial statements reflect only the Company’s proportionate interest in such jointly controlled assets.

Recently Issued Accounting Standards

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.

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

Recently Issued Accounting Standards

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 Company adopted ASU 2019-12 for the year beginning in January 2021.

There was no immediate impact from the adoption.

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

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Epsilon is currently assessing the expected impact and will adopt ASU 2016-13 as of January 1, 2023.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (ASU 2016-02), which significantly changes accounting for leases by requiring that lessees recognize a right of use asset and a related lease liability representing the obligation to make lease payments, for all lease transactions with terms greater than one year.

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.” 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.

Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented in the financial statements using a modified retrospective approach.

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

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

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Total property and equipment, net

Property Acquisitions

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 April 2022, the Company completed a well bore only sale and conveyance and partial release of oil and gas leases in Oklahoma for $ 200,000 .

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 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.

If the carrying amount exceeds the estimated undiscounted future cash flows, a reduction of the carrying amount of the natural gas properties to their estimated fair values is required.

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 or for the year ended December 31, 2021.

Epsilon performs a quantitative impairment test whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable.

When indicators of impairment are present, the Company first

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

compares expected future undiscounted cash flows by asset group to their respective carrying values.

If the carrying amount exceeds the estimated undiscounted future cash flows, a reduction of the carrying amount to the estimated fair values is required.

This is determined based on discounted cash flow techniques using significant assumptions including production volumes, 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, are charged to expense.

For unproved properties, such as leasehold, expected current and future market prices for similar assets are considered relative to carrying values in evaluating impairment.

No impairment was recorded for the year ended December 31, 2022.

For the year ended December 31, 2021, the Company recognized dry hole costs of $ 0.15 million.

Revolving Line of Credit

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.

The Company has a senior secured credit facility which includes a total commitment of up to $ 100 million.

The effective borrowing base is $ 30 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.

If we decide to access the facility, depending on the level of borrowing, we might need to increase our 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 %.

Upon each advance, interest is charged at the highest of a) the Prime Rate, or b) the sum of the Federal Funds Rate plus 0.5 %, plus an applicable margin ( 0.25 %- 1.25 %, based on percentage utilization on the facility).

The facility matures on March 1, 2024.

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.

On February 10, 2023, Epsilon Energy USA entered into the Ninth Amendment of the Credit Agreement.

The borrowing base was increased to $ 30 million.

LIBOR was removed as a reference option in the calculation of interest.

Hedging requirements were amended to be between 0 %- 62.5 % of the 24-month projected production volumes, based on percentage utilization on the facility.

Also, cash distributions to the parent company (Epsilon Energy Ltd.) were allowed if the facility is < 80 % utilized and the leverage ratio (total debt / income adjusted for interest, taxes and non-cash amounts) is less than 2 .

The bank has a first priority security interest in the tangible and intangible assets of Epsilon Energy USA, Inc.

to secure any outstanding amounts under the agreement.

Under the terms of the agreement, the Company must maintain the following covenants:

● Interest coverage ratio greater than 3 based on income adjusted for interest, taxes and non-cash amounts.

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

● Interest coverage ratio greater than 3 (income adjusted for interest, taxes and non-cash amounts / cash interest expense)

● Current ratio greater than 1 (current assets / current liabilities)

● Leverage ratio less than 3.5 (total debt / income adjusted for interest, taxes and non-cash amounts)

We were in compliance with the financial covenants of the agreement as of December 31, 2022.

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

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

The Company was in compliance with the financial covenants of the Credit Facility as of December 31, 2021 and we expect to be in compliance with the financial covenants for the next 12 months.

A commitment fee of 0.50 % is assessed quarterly on the daily average unused borrowing base on the Credit Facility

Interest Rate

Borrowing Base

Revolving line of credit

LIBOR + 3.25 % (1)

(1) At December 31, 2021, the interest rate was 3.50 % .

Shareholders’ Equity

2 unchanged sentences

(b) Purchases of Equity Shares

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, 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

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.

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.

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.

The Company canceled all common shares taken up and paid for under the tender offer.

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:

Maximum number

of shares that

Average price

purchased under

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

January 2021 (1)

February 2021 (1)

March 2021 (1)

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

Commencing on March 8, 2022, we implemented a plan to repurchase our issued and outstanding common shares and to return capital to our shareholders.

We used cash on hand to fund these repurchases.

During the year ended December 31, 2022, we repurchased 982,500 common shares of the maximum of 1,183,410 authorized for repurchase and spent $ 6,234,879 under the plan.

The repurchased stock had an average price of $ 6.32 per share (excluding commissions) and was subsequently retired during the year ended December 31, 2022.

In 2023, we repurchased 190,700 common shares at an average price of $ 5.82 per share (excluding commissions) before the plan terminated on March 7, 2023.

Commencing on January 1, 2021, we implemented a plan to repurchase our issued and outstanding common shares.

The plan terminated on December 31, 2021.

We used cash on hand to fund these repurchases.

During the year ended December 31, 2021, we repurchased 534,015 common shares of the maximum of 1,193,000 authorized for repurchase and spent $ 2,423,007 under the plan.

The repurchased stock had an average price of $ 4.51 per share (excluding commissions) and was subsequently retired during the year ended December 31, 2022.

On March 9, 2023, the Board of Directors authorized a new share repurchase program of up to 2,292,644 common shares, representing 10% of the outstanding common shares of Epsilon, for an aggregate purchase price of not more than US $15.0 million.

The program is pursuant to a normal course issuer bid and will be conducted in accordance with Rule 10b-18 under the Exchange Act.

The program will commence on March 27, 2023 and end on March 26, 2024, unless the maximum amount of common shares is purchased before then or Epsilon provides earlier notice of termination.

5 unchanged sentences

The 2020 Plan provides for incentive compensation in the form of stock options, stock appreciation rights, restricted stock and stock units, performance shares and units, other stock-based awards and cash-based awards.

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

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.

Under the 2020 Plan, Epsilon is authorized to issue up to 2,000,000 common shares.

Restricted Stock Awards

For the year ended December 31, 2022, 289,231 common shares of Restricted Stock with a weighted average market price at grant date of $ 6.28 were awarded to the Company’s officers, employees, and board of directors.

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.

These shares vest over a three-year period, with one-third of the shares being issued per period on the anniversary of the award resolution.

These shares vest over a three or four-year period, with an equal number of shares being issued per period on the anniversary of the award resolution.

The vesting of the shares is contingent on the individuals’ continued employment or service.

17 unchanged sentences

The number of PSUs that will ultimately vest is based on two performance targets as follows:

● The targets for the PSUs are based on (i) the relative total stockholder return (“TSR”) percentile ranking and (ii) the relative cash flow per debt adjusted share – growth (“CFDAS Growth”) percentile ranking of the Corporation, each as compared to the Corporation’s Performance Peer Group during the applicable one-year performance period ending on December 31.

● The targets for the PSUs are based on (i) the relative total stockholder return (“TSR”) percentile ranking and (ii) the relative cash flow per debt adjusted share – growth (“CFDAS Growth”) percentile ranking of the Company, each as compared to the Company’s peer group as specified in the award agreement during the applicable one-year performance period ending on December 31.

● Cash Flow per Debt Adjusted Share (“CFDAS”) is defined as EBITDA (earnings before interest, taxes, depreciation and amortization) divided by the sum of the 1) the total debt plus the value of preferred stock minus cash and the amount of dividends paid for the year divided by the share price at the end of the year;

1 unchanged sentence

● The vesting of each PSU Award will be based 50 % on TSR performance and 50 % based on CFDAS Growth performance.

● The recipient of the award must be employed with the Corporation at the time of vesting.

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 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.

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

● The recipient of the award must be employed with the Company at the time of vesting.

The number of shares ultimately issued under these awards can range from zero to 200 % of target award amounts at the discretion of the Compensation Committee of the Board of Directors.

During the year ended December 31, 2022, a total of 31,667 common shares were vested and issued.

The following table summarizes PSUs for the years ended December 31, 2022 and 2021:

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

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

Expected life (in years)

Expected volatility

42.1 % - 53.6 %

Risk-free rate of return

0.10 % - 0.17 %

Weighted average grant-date fair value per PSU

The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the performance stock awards, to calculate the fair value of the awards.

Expected volatilities in the model were estimated using a historical period consistent with the expected term for each annual performance period of the awards.

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 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.

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

December 31, 2022

12 unchanged sentences

The following table summarizes stock option activity for the years ended December 31, 2022 and 2021:

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

December 31, 2022

6 unchanged sentences

At December 31, 2022, the Company had unrecognized stock-based compensation related to these options of nil (for the year ended December 31, 2021:

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

During the year ended December 31, 2021, the Company awarded no stock options (During the year ended December 31, 2020:

no stock options).

The aggregate intrinsic value at December 31, 2022 was $ 112,000 (at December 31, 2021:

During the years ended December 31, 2022 and 2021, the Company awarded no stock options.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

The following table summarizes information for stock options outstanding at December 31, 2022:

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, 2021 and 2020, was nil and $ 1,867 , respectively.

Stock-based compensation for the options, for the years ended December 31, 2022 was nil (for the year ended December 31, 2021:

Revenue Recognition

4 unchanged sentences

The following table details revenue for the years ended December 31, 2022 and 2021:

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Year Ended December 31,

9 unchanged sentences

To the extent that marketing costs are incurred by the Company prior to the transfer of control of the product, those costs are included in lease operating expenses on the Company’s consolidated statements of operations.

Settlement statements for product sales, and the related cash consideration, are received from the purchaser within 30 days .

Settlement statements for product sales, and the related cash consideration, are generally received from the purchaser within 30 days .

As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the natural gas, oil, NGLs, or condensate.

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, 2022 and 2021

Gas Gathering and Compression Revenue

1 unchanged sentence

For the provision of gas gathering and compression services, the Company collects its share of the gathering and compression fees per unit of gas serviced and recognizes gathering revenue over time using an output method based on units of gas gathered.

The settlement statement from the operator of the Auburn Gas Gathering System is received two months after transmission and compression has occurred.

The settlement statement from the operator of the Auburn GGS is received two months after transmission and compression has occurred.

As a result, the Company must estimate the amount of production that was transmitted and compressed within the system.

2 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.

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.

At December 31, 2022, there were no accounts for which collection was not probable.

The following table details accounts receivable as of December 31, 2022 and 2021:

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Accounts receivable

5 unchanged sentences

Accumulated other comprehensive income includes certain transactions that have generally been reported in the consolidated statements of changes in shareholders’ equity.

The activity in of Accumulated Other Comprehensive Income during the years ended December 31, 2021 and 2020 consisted of the following:

The activity in Accumulated Other Comprehensive Income during the years ended December 31, 2022 and 2021 consisted of the following:

Year Ended December 31,

2 unchanged sentences

Balance at end of period

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

Year ended December 31,

We file a federal income tax return in the United States, Canada, and various state and local jurisdictions.

We believe that we have appropriate support for the income tax positions taken and to be taken on the Company’s tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

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.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

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

Year ended December 31,

We file a federal income tax return in the United States, Canada, and various state and local jurisdictions.

We believe that we have appropriate support for the income tax positions taken and to be taken on the Company's tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

The Company's tax returns are open to audit under the statute of limitations for the years ending December 31, 2018 through December 31, 2022.

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 )

Total deferred tax expense

Income tax expense

1 unchanged sentence

Our effective tax rate for 2022 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.

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.

Income tax provision computed at the statutory federal tax rate

Difference in Canadian and U.S.

Correction of Canadian deferred tax balances

Adjustment 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, 2022 and 2021

Net deferred tax liabilities consisted of the following at December 31, 2022 and 2021:

15 unchanged sentences

( 2,491,836 )

Unrealized derivatives/other

Gross deferred tax liabilities

4 unchanged sentences

( 9,905,440 )

As of December 31, 2022, we have no U.S.

federal net operating loss carry-forwards and approximately $ 9.9 million of state net operating loss carry-forwards, of which $ 0.3 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 Internal Revenue Code Section 382 limitation.

A state valuation allowance of $ 0.05 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, 2022.

As of December 31, 2022, we have $ 40.6 million of Canadian net operating loss carry-forwards.

A separate valuation allowance of $ 11.1 million attributable to Canadian net operating losses and other tax carryovers is recorded because it is more likely than not to be utilized.

On August 16, 2022, legislation commonly known as the Inflation Reduction Act was signed into law.

Among other things, the Inflation Reduction Act includes a 1% excise tax on corporate stock repurchases applicable to repurchases after December 31, 2022, and also a new minimum tax based on book income.

While we do not currently expect the Inflation Reduction Act to have a material impact on our effective tax rate in 2022, our analysis of the impact of the Inflation Reduction Act on us is ongoing, and it is possible that the Inflation Reduction Act (or implementing regulations and other guidance, which have not yet been issued) could adversely impact our current and deferred federal tax liability in future periods.

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 $ 0 as of December 31, 2022 and 2021.

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

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.

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.

The FFCR Act and the CARES Act contain numerous tax provisions, such as deferring payroll tax payments, establishing a credit for the retention of certain employees, relaxing limitations on the deductibility of interest, updating the definition of qualified improvement property, modification of the utilization limitations on net operating losses, and the ability to accelerate timing of refundable AMT credits.

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

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

As a result of the adoption of Leases (Topic 842), the Company recognized an operating lease as of December 31, 2022 summarized in the following table (in thousands):

Operating lease right-of-use assets

Total operating lease right-of-use assets

Operating lease liabilities

Total operating lease liabilities

Operating lease costs

Cash paid for amounts included in the measurement of lease liabilities

Operating cash flows from operating leases

Weighted average remaining lease term - operating lease

Weighted average discount rate (annualized) - operating lease

Rent expense for operating leases for the year ended December 31, 2021 was $ 0.18 million as presented in other general and administrative expenses in the consolidated statements of operations and comprehensive income.

The following is a maturity analysis of the annual undiscounted cash flows of the operating lease liability as of December 31, 2022:

Amounts due in the year ended December 31,

Operating Leases

Total minimum lease payments

effect of discounting

Present value of future minimum lease payments

current obligations under leases

Long-term lease obligations

The Company’s future minimum lease commitments as of December 31, 2021 are summarized in the following table:

The Company enters into commitments for capital expenditures in advance of the expenditures being made.

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

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

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.

The expiration date of the current lease is April 2023 and the Company has chosen not to extend that lease.

As of December 31, 2022, the Company entered into a new office lease that commenced on March 1, 2023.

The lease is for 70 months with future lease payments estimated to be approximately $ 0.85 million.

There are no other pending leases, and no lease arrangements in which the Company is the lessor.

Other commitments

The Company also enters into commitments for capital expenditures in advance of the expenditures being made.

As of December 31, 2022, we had commitments of $ 0.8 million for capital expenditures.

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 (“Middle District”).

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

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

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

4 unchanged sentences

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 motion for reconsideration of that decision, but the court denied the motion for reconsideration 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.

A briefing schedule was set and briefing closed October 14, 2022.

Oral argument was held in January 2023.

A decision on the appeal is not expected until mid-2023.

Epsilon re-filed a complaint against Chesapeake in the Middle District on May 9, 2022.

Epsilon generally asserts similar claims as in the previous suit, pursuing declaratory judgment claims regarding Chesapeake’s obligation to Epsilon to cooperate with Epsilon’s efforts in the Auburn Development and regarding Chesapeake’s obstruction of Epsilon’s efforts with the Pennsylvania Department of Environmental Protection permitting process but not based on specific well proposals.

Chesapeake filed a motion to stay pending a decision on the Third Circuit appeal, which was granted.

The matter is stayed pending a decision from the Third Circuit.

Net Income Per Share

3 unchanged sentences

Year ended December 31,

Net income (loss) available to shareholders

Net income available to shareholders

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

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

1 unchanged sentence

Basic weighted-average number of shares outstanding

Dilutive stock options

Unvested time-based restricted shares

7 unchanged sentences

Total Anti-dilutive shares

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Operating Segments

7 unchanged sentences

The Corporate segment activities include corporate listing and governance functions of the Company.

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

Segment activity as of, and for the years ended December 31, 2022 and 2021 is as follows:

8 unchanged sentences

( 1,523,660 )

Net earnings (loss) for the period

( 15,331,718 )

Operating costs

( 1,523,660 )

Development geological and geophysical expenses

Depletion, depreciation, amortization and accretion

Operating income

Other income (expense)

Interest income

Interest expense

Gain (loss) on derivative contracts

Other (expense) income

Other income (expense), net

Net income before income tax expense

Segment assets

Capital expenditures (2)

Proved properties (net)

Unproved properties (net)

Gathering system (net)

Other property and equipment (net)

Proved properties

Unproved properties

Gathering system

Operating lease right-of-use asset

Other property and equipment

As of and for the year ended December 31, 2021

6 unchanged sentences

( 1,594,683 )

Net earnings (loss) for the period

( 1,692,091 )

( 3,737,088 )

Operating costs

( 1,594,683 )

Development geological and geophysical expenses

Depletion, depreciation, amortization and accretion

Bad Debt Expense

Operating income

Other income (expense)

Interest income

Interest expense

Gain (loss) on derivative contracts

( 4,482,909 )

Other (expense) income

Other income (expense), net

( 4,542,841 )

( 4,544,296 )

Net income before income tax expense

Segment assets

Capital expenditures (2)

Proved properties (net)

Unproved properties (net)

Gathering system (net)

Other property and equipment (net)

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

Proved properties

Unproved properties

Gathering system

Other property and equipment

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

1 unchanged sentence

For the year ended December 31, 2022, we sold natural gas to 26 unique customers.

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

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2022 and 2021

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

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.

(3) Segment reporting for net earnings for the period does not include non-monetary compensation, general and administrative expense, interest income, interest expense or income tax amounts as they are managed on a group basis and are instead included in the corporate column for reconciliation purposes.

Additionally, gains & (losses) from commodity hedging contracts are also included in the corporate column for reconciliation purposes.

Commodity Risk Management Activities

12 unchanged sentences

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

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

During 2022, Epsilon recognized gains on financial commodity derivative contracts of $ 236,077 .

This amount included settlements of these contracts of $ 1,225,837 .

For 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 .

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

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

Commodity Derivative Contracts

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

At December 31, 2022, the Company had outstanding NYMEX HH swaps totaling 1.07 Bcf and Tennessee Z4 basis swaps totaling 1.07 Bcf outstanding.

At December 31, 2021, Epsilon had two natural gas commodity two-way costless collar contracts totaling 0.59 Bcf outstanding.

Fair Value of Derivative

NYMEX Henry Hub swap

Tennessee Z4 basis swap

Two-way costless collar

Epsilon Energy Ltd.

1 unchanged sentence

For the years ended December 31, 2022 and 2021

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

Fair Value of Derivative

Two-way costless collar

Fair Value of Derivative

Tennessee Z4 basis swap

Two-way costless collar

6 unchanged sentences

Settlement of commodity derivative contracts

( 4,503,457 )

Fair value of asset, end of the period

Fair value of asset (liability), end of the period

Asset Retirement Obligations

Asset retirement obligations were estimated by management based on Epsilon’s net ownership interest in all wells and the gathering system, estimated costs to reclaim and abandon such assets and the estimated timing of the costs to be incurred in future periods, and the forecast risk free cost of capital.

Asset retirement obligations are estimated by management based on Epsilon’s net ownership interest in all wells and the gathering system, estimated costs to reclaim and abandon such assets and the estimated timing of the costs to be incurred in future periods, and the forecast risk free cost of capital.

Epsilon has estimated the net present value of its total asset retirement obligations to be $ 2.8 million as of December 31, 2022 ($ 2.8 million at December 31, 2021) based on a total net future undiscounted liability of approximately $ 7.4 million ($ 7.4 million at December 31, 2021).

Each year we review, and to the extent necessary, revise our asset retirement obligations estimates.

During 2021 and 2020, we reviewed the actual abandonment costs with previous estimates.

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

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

Epsilon Energy Ltd.

Notes to the Consolidated Financial Statements (Continued)

For the years ended December 31, 2021 and 2020

The following table presents the activity in Epsilon’s asset retirement obligations for the periods indicated:

Balance beginning of period

Liabilities acquired (disposed of)

Liabilities acquired

Liabilities disposed of

Wells plugged and abandoned

1 unchanged sentence

Balance end of period

Subsequent Events

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.

1 unchanged sentence

NATURAL GAS AND OIL PRODUCING ACTIVITIES

The following disclosures are made in accordance with Financial Accounting Standards Board Accounting Standards Update No.

2010-03 ‘‘Natural gas and oil Reserve Estimates and Disclosures’’ and the United States Securities and Exchange Commission’s (SEC) final rule on ‘‘Modernization of Natural gas and oil Reporting.’’

Natural gas and oil Reserves

21 unchanged sentences

All reserves located in United States

Net proved developed reserves at December 31, 2020

Revisions of previous estimates (1)(2)

Transfers from proved undeveloped

Net proved developed reserves at December 31, 2021

Revisions of previous estimates (3)(4)

Transfers from proved undeveloped

Net proved developed reserves at December 31, 2022

Net proved undeveloped reserves at December 31, 2020

Revisions of previous estimates (5)(6)

Extensions and discoveries (7)(8)

Transfers from proved undeveloped

Net proved undeveloped reserves at December 31, 2021

Revisions of previous estimates (9)(10)

Extensions and discoveries

Transfers from proved undeveloped

Net proved undeveloped reserves at December 31, 2022

Net proved reserves at December 31, 2020

Revisions of previous estimates

Extensions and discoveries

Net proved reserves at December 31, 2021

Revisions of previous estimates

Extensions (4)

Extensions and discoveries

Net proved reserves at December 31, 2022

7 unchanged sentences

At December 31, 2022

(1) Revisions of previous estimates in the proved producing category are primarily attributable to changes in the natural gas price and the reserves engineers' risking of reserves estimates.

(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) 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.

(1) Revisions of previous estimates for Pennsylvania for 2021 include additions of 11,202 Mmcfe related to well performance and 4,748 Mmcfe related to commodity pricing.

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

(2) Revisions of previous estimates for Oklahoma for 2021 include additions of 2,160 Mmcfe related to well performance, 423 Mmcfe related to commodity pricing, and reduction of 624 Mmcfe related to property interest adjustments.

(3) Revisions of previous estimates for Pennsylvania for 2022 include additions of 6,261 Mmcfe related to well performance and 4,576 Mmcfe related to commodity pricing .

(4) Revisions of previous estimates for Oklahoma for 2022 include additions of 267 Mmcfe related to commodity pricing, 253 Mmcfe related to changes in previously adopted development plans, and reduction of 1,505 Mmcfe related to well performance.

(5) Revisions of previous estimates for Pennsylvania for 2021 include additions of 11,572 Mmcfe related to changes to the previously adopted development plan, 566 Mmcfe related to commodity pricing, and reductions of 606 Mmcfe related to well performance.

(6) Revisions of previous estimates for Oklahoma for 2021 include additions of 246 Mmcfe related to commodity pricing, 205 Mmcfe related to well performance, 107 Mmcfe related to property interest adjustments, and reduction of 373 Mmcfe from changes to the previously adopted development plan.

(7) Extensions and discoveries for Pennsylvania for 2021 include additions of 4,388 Mmcfe related to the proposal and development by the operator of a well that was not previously included in the development schedule.

(8) Extension and discoveries for Oklahoma for 2021 include additions of 865 Mmcfe related to recent offset development, and 779 Mmcfe related to exercising the Company’s option to participate in two new wells that were not previously included in the development schedule.

(9) Revisions of previous estimates for Pennsylvania for 2022 include reductions of 18,898 Mmcfe related to changes to the previously adopted development plan, reductions of 25 Mmcfe related to well performance, and additions of 185 Mmcfe related to commodity pricing.

(10) Revisions of previous estimates for Oklahoma for 2022 include additions of 41 Mmcfe related to commodity pricing, reductions of 58 Mmcfe related to well performance, and reduction of 4,607 Mmcfe from changes to the previously adopted development plan.

Capitalized Costs Relating to Natural gas and oil Producing Activities

The following table sets forth the capitalized costs relating to Epsilon’s crude oil and natural gas producing activities at December 31, 2021 and 2020:

The following table sets forth the capitalized costs relating to Epsilon’s crude oil and natural gas production and gathering activities at December 31, 2022 and 2021:

Year ended December 31,

7 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

1 unchanged sentence

Property acquisition costs are those costs incurred to lease property, including both undeveloped leasehold and the purchase of reserves in place.

Exploration costs include costs of identifying areas that may warrant examination and examining specific areas that are considered to have prospects containing oil and natural gas reserves, including costs of drilling exploratory wells, geological and geophysical costs and carrying costs on undeveloped properties.

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

undeveloped properties.

Development costs are incurred to obtain access to proved reserves, including the cost of drilling, as well as the costs to develop the gathering system.

7 unchanged sentences

Results of Operations for Natural Gas and Oil Producing Activities

The following table sets forth results of operations for gas producing activities for the years ended December 31, 2021 and 2020:

The following table sets forth results of operations for natural gas and oil producing activities for the years ended December 31, 2022 and 2021:

Year ended December 31,

6 unchanged sentences

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

The following information has been developed utilizing procedures prescribed by the Extractive Industries—Natural gas and oil Topic of the ASC and based on natural gas reserves and production volumes estimated by the reserve engineers of DeGolyer and MacNaughton.

The following information has been developed utilizing procedures prescribed by the Extractive Industries—Natural Oil and Gas Topic 932 of the ASC and based on natural gas reserves and production volumes estimated by our independent petroleum consultants, DeGolyer and MacNaughton.

The commodity prices estimated below were based on a 12-month average of first-day-of-the-month commodity prices for the years 2022 and 2021.

5 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.

Such decisions are based upon a wide range of factors, including estimates of probable and possible reserves as well as proved reserves, and varying price and cost assumptions considered more representative of a range of possible economic conditions that may be anticipated.

EPSILON ENERGY LTD.

Supplemental Information to Consolidated Financial Statements

The following table sets forth the standardized measure of discounted future net cash flows from projected production of Epsilon’s gas reserves as of December 31, 2022 and 2021.

3 unchanged sentences

(119,404,233)

(104,161,488)

Future development costs (1)

1 unchanged sentence

10% annual discount for estimated timing of cash flows

(146,368,246)

Standardized measure of discounted future net cash flows

18 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