Epsilon Energy Ltd. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Our consolidated balance sheets as of December 31, 2022 and 2021, and the consolidated statements of operations and comprehensive income, changes in shareholders’ equity and cash flows for years ended December 31, 2022 and 2021 included in this annual report have been prepared in accordance with U.S. GAAP. ​ ​ 41 ​ ​ ​ Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors Epsilon Energy Ltd. Houston, Texas Opinion on the Consolidated Financial Statements 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 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. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. 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. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ BDO USA, LLP We have served as the Company’s auditor since 2017. Houston, Texas March 23, 2023 ​ ​ 42 ​ ​ EPSILON ENERGY LTD. Consolidated Balance Sheets ​ ​ ​ ​ ​ ​ ​ ​ December 31, December 31, ​ ​ 2022 ​ 2021 ASSETS ​ ​ ​ ​ ​ ​ Current assets ​ ​ ​ ​ ​ ​ Cash and cash equivalents ​ $ 45,236,584 ​ $ 26,497,305 Accounts receivable ​ ​ 7,201,386 ​ ​ 4,596,931 Fair value of derivatives ​ ​ 1,222,090 ​ ​ — Prepaid income taxes ​ ​ 1,140,094 ​ ​ — Other current assets ​ ​ 632,154 ​ ​ 569,870 Operating lease right-of-use assets ​ ​ 31,383 ​ ​ — Total current assets ​ ​ 55,463,691 ​ ​ 31,664,106 Non-current assets ​ ​ ​ ​ ​ ​ Property and equipment: ​ ​ ​ ​ ​ ​ Oil and gas properties, successful efforts method ​ ​ ​ ​ ​ ​ Proved properties ​ ​ 148,326,265 ​ ​ 138,032,413 Unproved properties ​ ​ 18,169,157 ​ ​ 21,700,926 Accumulated depletion, depreciation, amortization and impairment ​ ​ ( 107,729,293 ) ​ ​ ( 102,480,972 ) Total oil and gas properties, net ​ ​ 58,766,129 ​ ​ 57,252,367 Gathering system ​ ​ 42,639,001 ​ ​ 42,475,086 Accumulated depletion, depreciation, amortization and impairment ​ ​ ( 34,500,740 ) ​ ​ ( 33,443,949 ) Total gathering system, net ​ ​ 8,138,261 ​ ​ 9,031,137 Land ​ ​ 637,764 ​ ​ 637,764 Buildings and other property and equipment, net ​ ​ 286,035 ​ ​ 309,102 Total property and equipment, net ​ ​ 67,828,189 ​ ​ 67,230,370 Other assets: ​ ​ ​ ​ ​ ​ Restricted cash ​ ​ 570,363 ​ ​ 568,118 Total non-current assets ​ ​ 68,398,552 ​ ​ 67,798,488 Total assets ​ $ 123,862,243 ​ $ 99,462,594 ​ ​ ​ ​ ​ ​ ​ LIABILITIES AND SHAREHOLDERS' EQUITY ​ ​ ​ ​ ​ ​ Current liabilities ​ ​ ​ ​ ​ ​ Accounts payable trade ​ $ 1,695,353 ​ $ 1,189,905 Gathering fees payable ​ ​ 935,012 ​ ​ 963,546 Royalties payable ​ ​ 2,223,043 ​ ​ 1,853,508 Income taxes payable ​ ​ — ​ ​ 1,098,425 Accrued capital expenditures ​ ​ 41,694 ​ ​ 1,016,830 Accrued compensation ​ ​ 598,351 ​ ​ 343,348 Other accrued liabilities ​ ​ 690,655 ​ ​ 754,779 Fair value of derivatives ​ ​ — ​ ​ 239,824 Asset retirement obligations ​ ​ — ​ ​ 85,207 Operating lease liabilities ​ ​ 35,299 ​ ​ — Total current liabilities ​ ​ 6,219,407 ​ ​ 7,545,372 Non-current liabilities ​ ​ ​ ​ ​ ​ Asset retirement obligations ​ ​ 2,780,237 ​ ​ 2,748,449 Deferred income taxes ​ ​ 10,617,394 ​ ​ 9,905,440 Total non-current liabilities ​ ​ 13,397,631 ​ ​ 12,653,889 Total liabilities ​ ​ 19,617,038 ​ ​ 20,199,261 Commitments and contingencies (Note 10) ​ ​ ​ ​ ​ ​ Shareholders' equity ​ ​ ​ ​ ​ ​ 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 ​ ​ 123,904,965 ​ ​ 131,815,739 Treasury shares, at cost, 0 at December 31, 2022 and 534,015 at December 31, 2021 ​ ​ — ​ ​ ( 2,423,007 ) Additional paid-in capital ​ ​ 9,856,229 ​ ​ 8,835,203 Accumulated deficit ​ ​ ( 39,290,540 ) ​ ​ ( 68,783,207 ) Accumulated other comprehensive income ​ ​ 9,774,551 ​ ​ 9,818,605 Total shareholders' equity ​ ​ 104,245,205 ​ ​ 79,263,333 Total liabilities and shareholders' equity ​ $ 123,862,243 ​ $ 99,462,594 ​ ​ The accompanying notes are an integral part of these consolidated financial statements ​ 43 ​ ​ ​ EPSILON ENERGY LTD. Consolidated Statements of Operations and Comprehensive Income ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Revenues from contracts with customers: ​ ​ ​ ​ ​ ​ Gas, oil, NGL, and condensate revenue ​ $ 61,877,197 ​ $ 34,538,167 Gas gathering and compression revenue ​ ​ 8,085,512 ​ ​ 7,865,825 Total revenue ​ ​ 69,962,709 ​ ​ 42,403,992 ​ ​ ​ ​ ​ ​ ​ Operating costs and expenses: ​ ​ ​ ​ ​ ​ Lease operating expenses ​ ​ 7,128,631 ​ ​ 6,303,055 Gathering system operating expenses ​ ​ 2,287,763 ​ ​ 2,321,329 Development geological and geophysical expenses ​ ​ 9,545 ​ ​ 40,299 Depletion, depreciation, amortization, and accretion ​ ​ 6,438,511 ​ ​ 6,627,016 Impairment expense ​ ​ — ​ ​ 153,058 Gain on sale of oil and gas properties ​ ​ ( 221,642 ) ​ ​ ( 484,902 ) General and administrative expenses: ​ ​ ​ ​ ​ ​ Stock based compensation expense ​ ​ 1,021,026 ​ ​ 956,084 Other general and administrative expenses ​ ​ 6,325,412 ​ ​ 5,875,732 Total operating costs and expenses ​ ​ 22,989,246 ​ ​ 21,791,671 Operating income ​ ​ 46,973,463 ​ ​ 20,612,321 ​ ​ ​ ​ ​ ​ ​ Other income (expense): ​ ​ ​ ​ ​ ​ Interest income ​ ​ 452,877 ​ ​ 38,865 Interest expense ​ ​ ( 50,782 ) ​ ​ ( 101,382 ) Gain (loss) on derivative contracts ​ ​ 236,077 ​ ​ ( 4,482,909 ) Other income (expense) ​ ​ ( 99,469 ) ​ ​ 1,130 Other income (expense), net ​ ​ 538,703 ​ ​ ( 4,544,296 ) ​ ​ ​ ​ ​ ​ ​ Net income before income tax expense ​ ​ 47,512,166 ​ ​ 16,068,025 Income tax expense ​ ​ 12,157,487 ​ ​ 4,440,508 NET INCOME ​ $ 35,354,679 ​ $ 11,627,517 Currency translation adjustments ​ ​ ( 44,054 ) ​ ​ ( 2,042 ) NET COMPREHENSIVE INCOME ​ $ 35,310,625 ​ $ 11,625,475 ​ ​ ​ ​ ​ ​ ​ Net income per share, basic ​ $ 1.52 ​ $ 0.49 Net income per share, diluted ​ $ 1.51 ​ $ 0.49 Weighted average number of shares outstanding, basic ​ ​ 23,319,633 ​ ​ 23,705,193 Weighted average number of shares outstanding, diluted ​ ​ 23,406,189 ​ ​ 23,857,102 ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements ​ 44 ​ ​ ​ EPSILON ENERGY LTD. Consolidated Statements of Changes in Shareholders’ Equity ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Other ​ ​ ​ Total ​ ​ Common Shares Issued ​ Treasury Shares ​ Additional ​ Comprehensive ​ Accumulated ​ Shareholders' ​ ​ Shares ​ Amount ​ Shares ​ Amount ​ paid-in Capital ​ Income ​ Deficit ​ Equity Balance at December 31, 2020 ​ 23,985,799 ​ $ 131,730,401 ​ — ​ $ — ​ $ 7,879,119 ​ $ 9,820,647 ​ $ ( 80,410,724 ) ​ $ 69,019,443 Net income ​ — ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 11,627,517 ​ ​ 11,627,517 Stock-based compensation expenses ​ — ​ ​ — ​ — ​ ​ — ​ ​ 956,084 ​ ​ — ​ ​ — ​ ​ 956,084 Buyback of common shares ​ — ​ ​ — ​ ( 534,015 ) ​ ​ ( 2,423,007 ) ​ ​ — ​ ​ — ​ ​ — ​ ​ ( 2,423,007 ) Exercise of stock options ​ 16,250 ​ ​ 85,338 ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 85,338 Vesting of shares of restricted stock ​ 200,169 ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — Other comprehensive income ​ — ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ ( 2,042 ) ​ ​ — ​ ​ ( 2,042 ) Balance at December 31, 2021 ​ 24,202,218 ​ $ 131,815,739 ​ ( 534,015 ) ​ $ ( 2,423,007 ) ​ $ 8,835,203 ​ $ 9,818,605 ​ $ ( 68,783,207 ) ​ $ 79,263,333 Net income ​ — ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 35,354,679 ​ ​ 35,354,679 Dividends ​ — ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ ( 5,862,012 ) ​ ​ ( 5,862,012 ) Stock-based compensation expenses ​ — ​ ​ — ​ — ​ ​ — ​ ​ 1,021,026 ​ ​ — ​ ​ — ​ ​ 1,021,026 Buyback of common shares ​ — ​ ​ — ​ ( 982,500 ) ​ ​ ( 6,234,879 ) ​ ​ — ​ ​ — ​ ​ — ​ ​ ( 6,234,879 ) Retirement of treasury shares ​ ( 1,516,515 ) ​ ​ ( 8,657,886 ) ​ 1,516,515 ​ ​ 8,657,886 ​ ​ — ​ ​ — ​ ​ — ​ ​ — Exercise of stock options ​ 138,750 ​ ​ 747,112 ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 747,112 Vesting of shares of restricted stock ​ 292,691 ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — Other comprehensive income ​ — ​ ​ — ​ — ​ ​ — ​ ​ — ​ ​ ( 44,054 ) ​ ​ — ​ ​ ( 44,054 ) Balance at December 31, 2022 ​ 23,117,144 ​ $ 123,904,965 ​ — ​ $ — ​ $ 9,856,229 ​ $ 9,774,551 ​ $ ( 39,290,540 ) ​ $ 104,245,205 ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements ​ 45 ​ ​ ​ EPSILON ENERGY LTD. Consolidated Statements of Cash Flows ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Cash flows from operating activities: ​ ​ ​ ​ ​ ​ Net income ​ $ 35,354,679 ​ $ 11,627,517 Adjustments to reconcile net income to net cash provided by operating activities: ​ ​ ​ ​ ​ ​ Depletion, depreciation, amortization, and accretion ​ ​ 6,438,511 ​ ​ 6,627,016 Impairment expense ​ ​ — ​ ​ 153,058 Loss (gain) on derivative contracts ​ ​ ( 236,077 ) ​ ​ 4,482,909 Gain on sale of oil and gas properties ​ ​ ( 221,642 ) ​ ​ ( 484,902 ) Settlement (paid) received on derivative contracts ​ ​ ( 1,225,837 ) ​ ​ ( 4,243,085 ) Settlement of asset retirement obligation ​ ​ ( 118,260 ) ​ ​ — Stock-based compensation expense ​ ​ 1,021,026 ​ ​ 956,084 Deferred income tax expense (benefit) ​ ​ 711,954 ​ ​ ( 197,412 ) Changes in assets and liabilities: ​ ​ ​ ​ ​ ​ Accounts receivable ​ ​ ( 2,604,455 ) ​ ​ ( 679,643 ) Other current assets ​ ​ ( 58,368 ) ​ ​ 20,000 Accounts payable, royalties payable and other accrued liabilities ​ ​ 1,182,348 ​ ​ 646,410 Income taxes payable ​ ​ ( 2,238,519 ) ​ ​ 1,098,425 Net cash provided by operating activities ​ ​ 38,005,360 ​ ​ 20,006,377 Cash flows from investing activities: ​ ​ ​ ​ ​ ​ Additions to unproved oil and gas properties ​ ​ ( 310,211 ) ​ ​ ( 148,862 ) Additions to proved oil and gas properties ​ ​ ( 7,562,502 ) ​ ​ ( 4,435,945 ) Additions to gathering system properties ​ ​ ( 184,032 ) ​ ​ ( 297,841 ) Additions to land, buildings and property and equipment ​ ​ ( 13,258 ) ​ ​ ( 5,745 ) Proceeds from sale of oil and gas properties ​ ​ 200,000 ​ ​ 450,000 Prepaid drilling costs ​ ​ — ​ ​ 379 Net cash used in investing activities ​ ​ ( 7,870,003 ) ​ ​ ( 4,438,014 ) Cash flows from financing activities: ​ ​ ​ ​ ​ ​ Buyback of common shares ​ ​ ( 6,234,879 ) ​ ​ ( 2,423,007 ) Exercise of stock options ​ ​ 747,112 ​ ​ 85,338 Dividends ​ ​ ( 5,862,012 ) ​ ​ — Net cash used in financing activities ​ ​ ( 11,349,779 ) ​ ​ ( 2,337,669 ) Effect of currency rates on cash, cash equivalents and restricted cash ​ ​ ( 44,054 ) ​ ​ ( 2,042 ) Increase in cash, cash equivalents and restricted cash ​ ​ 18,741,524 ​ ​ 13,228,652 Cash, cash equivalents and restricted cash, beginning of period ​ ​ 27,065,423 ​ ​ 13,836,771 Cash, cash equivalents and restricted cash, end of period ​ $ 45,806,947 ​ $ 27,065,423 ​ ​ ​ ​ ​ ​ ​ Supplemental cash flow disclosures: ​ ​ ​ ​ ​ ​ Income taxes paid ​ $ 13,669,000 ​ $ 3,444,025 Interest paid ​ $ 68,328 ​ $ 95,942 ​ ​ ​ ​ ​ ​ ​ Non-cash investing activities: ​ ​ ​ ​ ​ ​ Change in unproved properties accrued in accounts payable and accrued liabilities ​ $ — ​ $ ( 65,000 ) Change in proved properties accrued in accounts payable and accrued liabilities ​ $ ( 1,100,041 ) ​ $ ( 1,097,257 ) Change in gathering system accrued in accounts payable and accrued liabilities ​ $ ( 20,118 ) ​ $ ( 25,399 ) Asset retirement obligation asset additions and adjustments ​ $ 12,053 ​ $ 33,234 ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements ​ 46 ​ ​ Epsilon Energy Ltd. Notes to the Consolidated Financial Statements For the years ended December 31, 2022 and 2021 1. Description of Business Epsilon Energy Ltd. (the “Company” or “Epsilon” or “we”) was incorporated under the laws of the Province of Alberta, Canada on March 14, 2005. On October 24, 2007, the Company became a publicly traded entity trading on the Toronto Stock Exchange (“TSX”) in Canada. 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. 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. ​ 2. Basis of Preparation Principles of Consolidation 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, 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. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved natural gas reserves and related cash flow estimates used in impairment tests of oil and natural gas and gathering system properties, asset retirement obligations, accrued natural gas and oil revenues and operating expenses, accrued gathering system revenues and operating expenses, as well as the valuation of commodity derivative instruments. 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. ​ ​ ​ 47 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 3. Summary of Significant Accounting Policies Cash, Cash Equivalents and Restricted Cash Cash and cash equivalents include cash on hand and short-term, highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Restricted cash consists of amounts deposited to back bonds or letters of credit for potential well liabilities. The Company presents restricted cash with cash and cash equivalents in the Consolidated Statements of Cash Flows. The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the Consolidated Balance Sheets to the total of the amounts in the Consolidated Statements of Cash Flows as of December 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, December 31, ​ ​ 2022 ​ 2021 Cash and cash equivalents ​ $ 45,236,584 ​ $ 26,497,305 Restricted cash included in other assets ​ ​ 570,363 ​ ​ 568,118 Cash, cash equivalents and restricted cash in the statement of cash flows ​ $ 45,806,947 ​ $ 27,065,423 ​ Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are primarily from purchasers of oil and natural gas, counterparties to our financial instruments, and revenues earned for compression and gathering services. Both oil and natural gas receivables are generally collected within 30 days after the end of the month. Compression and gathering receivables are generally collected within 60 days after the end of the month. 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. Our allowance for doubtful accounts was nil as of December 31, 2022 and 2021. Oil and Natural Gas Properties Epsilon accounts for its crude oil and natural gas exploration and production activities under the successful efforts method of accounting. Oil and natural gas lease acquisition costs are capitalized when incurred. Unproved properties with acquisition costs that are not individually significant are aggregated. If the unproved properties are determined to be productive, the appropriate related costs are transferred to proved oil and natural gas properties. Lease delay rentals are expensed as incurred. Oil and natural gas exploration costs, other than the costs of drilling exploratory wells, are expensed as incurred. The costs of drilling exploratory wells are capitalized pending determination of whether Epsilon has discovered proved commercial reserves. If proved commercial reserves are not discovered, such drilling costs are expensed. In some circumstances, it may be uncertain whether proved commercial reserves have been discovered when drilling has been completed. Such exploratory well drilling costs may continue to be capitalized if the reserve quantity is sufficient to justify its completion as a producing well and sufficient progress in assessing the reserves and the economic and operating viability of the project is being made. 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). 48 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. The reserve base used to calculate depreciation, depletion and amortization for leasehold acquisition costs and the cost to acquire proved properties is the sum of proved developed reserves and proved undeveloped reserves. 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 (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 which considers estimated discounted future cash flows. Gas Gathering System Properties Epsilon’s 35 % portion of asset development costs are capitalized when incurred. All other costs are expensed. Depreciation, depletion and amortization of the cost of gathering system properties is calculated using the unit-of- production method. The reserve base used to calculate depreciation, depletion and amortization for the gathering system includes only proved Pennsylvania, natural gas developed reserves. When circumstances indicate that the gathering system properties may be impaired, Epsilon compares expected undiscounted future cash flows related to the gathering system to the unamortized capitalized cost of the asset. 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, 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. Revenue recognition is evaluated through the following five steps: (i) identification of the contract, or contracts, with a customer; (ii) identification of the performance obligations in the contract; (iii) determination of the transaction price; (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. Accounting Policies Revenue is recognized when performance obligations under the terms of a contract with a customer are satisfied. The Company recognizes upstream revenue at the point in time when control has been transferred to the customer, generally at the time natural gas reaches an agreed-upon delivery point and collectability is reasonably assured. Upstream revenue is generally based upon a fixed price, based on a market index, and is measured as the amount of consideration the Company expects to receive in exchange for the transferring of the natural gas. The services provided by the gas gathering system take place continuously and as a practical expedient, the revenues are recognized monthly for the volumes that are processed and transported for the upstream producers during that period of time. Revenue for the services performed are based on the rates outlined in the cost of service agreement that governs all volumes gathered and processed by the system. The gathering rates are adjusted, and fixed annually. 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. 49 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 Natural Gas Revenues The Company’s natural gas purchase contracts are generally structured such that Epsilon commits and dedicates for sale its proportionate share of natural gas production per day to a purchaser. 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 third-party sales transportation pipeline. The Company recognizes revenue proportionate to its entitled share of volumes sold. 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. In this capacity, the third-party is responsible for carrying out marketing activities such as submission of nominations, receipt of payments, submission of invoices and negotiation of contracts. Commissions payable to the third-party broker for these services are treated as lease operating expenses in the financial statements. Gas Gathering System Revenue The Company has a 35 % ownership interest in the Auburn Gas Gathering System (“Auburn GGS”). This system aggregates the natural gas from the various pads in the field and transports the natural gas to the inlet of the Auburn compression facility where it is dehydrated, compressed and injected into Tennessee Gas Pipeline. 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 third-party sales transmission point. 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 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 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. Buildings and Other Property and Equipment Buildings are depreciated on a straight-line basis over the estimated useful life of the property, 30 years . Other property and equipment consists of computer hardware and software, and furniture and fixtures. Other property and equipment is generally depreciated on a straight-line basis over the estimated useful lives of the property and equipment, which range from 3 years to 7 years . Financial Instruments and Fair Value 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 consist of commodity derivatives. 50 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. Level 1—Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 2—Pricing inputs are other than quoted prices in active markets included in Level 1. Prices in Level 2 are either directly or indirectly observable as of the reporting date. Level 2 valuations are based on inputs, including quoted forward prices for commodities, time value and volatility factors, which can be substantially observed or corroborated in the marketplace. Level 3—Valuations in this level are those with inputs for the asset or liability that are not based on observable market data. The Company makes its own assumptions about how market participants would price the assets and liabilities. 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. The Company’s derivative contracts are valued based on an income approach. 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. Derivative Instruments The Company enters into derivative contracts to hedge price risk associated with a portion of natural gas production. 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. Our derivative transactions have included the following: ● Fixed-price swaps—where a fixed-price is received for production and a variable market price is paid to the contract counterparty. ● Basis swap contracts—which guarantee a specified price differential between the price at Henry Hub and our physical pricing points. If the settled price differential is greater than the swapped basis, then we receive a payment from the counterparty in the amount of the difference between the two. 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. ● 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. Hedge accounting is not used for our derivative assets and liabilities. 51 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 Asset Retirement Obligations The Company records a liability for asset retirement obligations at fair value in the period in which the liability is incurred if a reasonable estimate of fair value can be made. The associated asset retirement cost is capitalized as part of the carrying amount of the long-lived asset. Subsequently, the asset retirement cost is allocated to expense using a systematic and rational method of the asset’s useful life. Recognized asset retirement obligations relate to the plugging and abandonment of oil and natural gas wells and decommissioning of the gas gathering system. Management reviews the estimates of the timing of well abandonments as well as the estimated plugging and abandonment costs, which are discounted at the credit adjusted risk free rate. These adjustments are recorded to the asset retirement obligations with an offsetting change to oil and gas properties. An ongoing accretion expense is recognized for changes in the value of the liability as a result of the forecast inflation due to the passage of time, which is recorded in depreciation, depletion, amortization, and accretion expense in the consolidated statements of operations and comprehensive income. Concentrations of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, accounts receivable and derivative contracts. 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, 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 Approximately 91 % and 93 % of our production during fiscal 2022 and 2021, respectively was derived from natural gas production and gathering system revenues in the state of 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 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 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. Gains and losses on translation of balances denominated in Canadian dollars are included in accumulated other comprehensive income. 52 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 Stock-Based Compensation The Company mainly estimates the fair value of all stock options awarded to employees and directors using the Black-Scholes option pricing model. Other models are used for options with more complex vesting criteria. Compensation expense and a corresponding increase to additional paid-in capital are recorded over the vesting period based on the fair value of the options granted using a graded vesting approach. When stock options are exercised for common shares, consideration paid by the stock option holders and additional paid-in capital associated with the stock options are recorded. The Company estimates a forfeiture rate and adjusts the corresponding expense each period based on an updated forfeiture estimate (see Note 6). 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 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 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. Leases 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. 53 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 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. 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): Measurement of Credit Losses on Financial Instruments”, which removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s contractual life. ASU 2016-13 is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years, and must be applied retrospectively. Early adoption is permitted. Epsilon is currently assessing the expected impact and will adopt ASU 2016-13 as of January 1, 2023. We do not expect a material effect from the adoption of this ASU. ​ ​ 4. Property and Equipment The following table summarizes the Company’s property and equipment at December 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, December 31, ​ ​ 2022 ​ 2021 Property and equipment: ​ ​ ​ ​ ​ ​ Oil and gas properties, successful efforts method ​ ​ ​ ​ ​ ​ Proved properties ​ $ 148,326,265 ​ $ 138,032,413 Unproved properties ​ ​ 18,169,157 ​ ​ 21,700,926 Accumulated depletion, depreciation, amortization and impairment ​ ​ ( 107,729,293 ) ​ ​ ( 102,480,972 ) Total oil and gas properties, net ​ ​ 58,766,129 ​ ​ 57,252,367 Gathering system ​ ​ 42,639,001 ​ ​ 42,475,086 Accumulated depletion, depreciation, amortization and impairment ​ ​ ( 34,500,740 ) ​ ​ ( 33,443,949 ) Total gathering system, net ​ ​ 8,138,261 ​ ​ 9,031,137 Land ​ ​ 637,764 ​ ​ 637,764 Buildings and other property and equipment, net ​ ​ 286,035 ​ ​ 309,102 Total property and equipment, net ​ $ 67,828,189 ​ $ 67,230,370 ​ 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 . 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. When indicators of impairment are present, the Company first 54 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. ​ ​ ​ 5. Revolving Line of Credit 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 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) 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 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 (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. ​ ​ ​ 55 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 6. Shareholders’ Equity (a) Authorized shares 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. (b) Purchases of Equity Shares 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. ​ (c) Equity Incentive Plan Epsilon’s board of directors (the “Board”) adopted the 2020 Equity Incentive Plan (the “2020 Plan”) on July 22, 2020 subject to approval by Epsilon’s shareholders at Epsilon’s 2020 Annual General and Special Meeting of shareholders, which occurred on September 1, 2020 (the “Meeting”). Shareholders approved the 2020 Plan at the Meeting. Following Epsilon’s listing on the NASDAQ Global Market, the Board determined that it is in the best interest of the shareholders to approve a new incentive plan that is compliant with U.S. public company equity plan rules and practices that would replace Epsilon’s Amended and Restated 2017 Stock Option Plan (including its predecessors) and the Share Compensation Plan (collectively referred to as the “Predecessor Plans”). No further awards will be granted under the Predecessor Plans. 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 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. 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. 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. 56 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 The following table summarizes restricted stock for the years ended December 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended ​ Year ended ​ ​ December 31, 2022 ​ December 31, 2021 ​ ​ Number of ​ Weighted ​ Number of ​ Weighted ​ ​ Restricted ​ Average ​ Restricted ​ Average ​ ​ Shares ​ Remaining Life ​ Shares ​ Remaining Life ​ Outstanding (years) Outstanding (years) Balance non-vested Restricted Stock at beginning of period ​ 166,002 ​ 1.38 ​ 290,070 ​ 1.60 Granted ​ 289,231 ​ 1.86 ​ 48,000 ​ 1.67 Vested ​ ( 157,023 ) ​ — ​ ( 137,668 ) ​ — Forfeited ​ — ​ — ​ ( 34,400 ) ​ — Balance non-vested Restricted Stock at end of period ​ 298,210 ​ 1.74 ​ 166,002 ​ 1.38 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Stock compensation expense for the granted Restricted Stock is recognized over the vesting period. Stock compensation expense recognized during the year ended December 31, 2022 was $ 776,939 (for the year ended December 31, 2021, $ 554,249 ). At December 31, 2022, the Company had unrecognized stock-based compensation related to these shares of $ 1,668,564 to be recognized over a weighted average period of 1.55 years. Performance Share Unit Awards (“PSU”) The Company grants PSUs, which are paid in stock to certain key employees. The PSUs will vest on the last day of the performance period. 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 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; and 2) the actual share count at year end. ● 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 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: ​ 57 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended ​ Year ended ​ ​ December 31, 2022 ​ December 31, 2021 ​ ​ Number of ​ Weighted ​ Number of ​ Weighted ​ ​ Performance ​ Average ​ Performance ​ Average ​ ​ Shares ​ Remaining Life ​ Shares ​ Remaining Life ​ Outstanding (years) Outstanding (years) Balance non-vested PSUs at beginning of period ​ 151,500 ​ 3.84 ​ 193,167 ​ 1.60 Granted ​ — ​ — ​ 20,834 ​ 5.04 Vested ​ ( 135,667 ) ​ — ​ ( 62,501 ) ​ — Balance non-vested PSUs at end of period ​ 15,833 ​ 1.00 ​ 151,500 ​ 3.84 ​ Stock compensation expense for the granted PSUs is recognized over the vesting period. Stock compensation expense recognized during the year ended December 31, 2022 related to PSUs was $ 244,087 (for the year ended December 31, 2021, $ 401,835 ). At December 31, 2022, the Company had unrecognized stock-based compensation related to these shares of $ 63,328 to be recognized over a weighted average period of 0.63 years (at December 31, 2021: $ 310,790 over 1.01 years). Stock Options As of December 31, 2022, the Company had outstanding stock options covering 70,000 common shares at an overall average exercise price of $ 5.03 per common share to directors, officers, and employees of the Company and its subsidiaries. These 70,000 options have a weighted average expected remaining term of approximately 1.05 years. The following table summarizes stock option activity for the years ended December 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended ​ Year ended ​ ​ December 31, 2022 ​ December 31, 2021 ​ ​ ​ ​ Weighted ​ ​ ​ Weighted ​ ​ Number of ​ Average ​ Number of ​ Average ​ ​ Options ​ Exercise ​ Options ​ Exercise Exercise price in US$ Outstanding Price Outstanding Price (1) Balance at beginning of period ​ 218,750 ​ $ 5.28 ​ ​ 245,000 ​ $ 5.27 Exercised ​ ( 138,750 ) ​ $ 5.38 ​ ​ ( 16,250 ) ​ $ 5.25 Expired/Forfeited ​ ( 10,000 ) ​ $ 5.51 ​ ​ ( 10,000 ) ​ $ 5.50 Balance at period-end ​ 70,000 ​ $ 5.03 ​ ​ 218,750 ​ $ 5.28 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Exercisable at period-end ​ 70,000 ​ $ 5.03 ​ ​ 218,750 ​ $ 5.28 ​ ​ At December 31, 2022, the Company had unrecognized stock-based compensation related to these options of nil (for the year ended December 31, 2021: nil ). The aggregate intrinsic value at December 31, 2022 was $ 112,000 (at December 31, 2021: nil ). During the years ended December 31, 2022 and 2021, the Company awarded no stock options. 58 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted ​ ​ ​ ​ ​ ​ Option ​ Average ​ ​ Number of ​ Number of ​ Pricing ​ Remaining ​ ​ Options ​ Options ​ Model ​ Contractual Life Exercise Price Outstanding Exercisable Valuations (in years) As of December 31, 2022 ​ ​ ​ ​ ​ ​ ​ ​ ​ $ 5.03 70,000 70,000 ​ $ 165,185 1.05 Total 70,000 70,000 ​ $ 165,185 1.05 ​ 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, 2022 was nil (for the year ended December 31, 2021: nil ). ​ ​ 7. Revenue Recognition Revenues are comprised primarily of sales of natural gas along with the revenue generated from the Company’s ownership interest in the gas gathering system in the Auburn field in Northeastern Pennsylvania. 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 points 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, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ 2022 2021 Operating revenue ​ ​ ​ ​ ​ ​ Natural gas ​ $ 56,948,734 ​ $ 31,708,185 Natural gas liquids ​ ​ 1,733,130 ​ ​ 1,053,486 Oil and condensate ​ ​ 3,195,333 ​ ​ 1,776,496 Gathering and compression fees ​ ​ 8,085,512 ​ ​ 7,865,825 Total operating revenue ​ $ 69,962,709 ​ $ 42,403,992 ​ Product Sales Revenue The Company enters into contracts with third party purchasers to sell its natural gas, oil, NGLs and condensate production. Under these product sales arrangements, the sale of each unit of product represents a distinct performance obligation. Product sales revenue is recognized at the point in time that control of the product transfers to the purchaser based on contractual terms which reflect prevailing commodity market prices. 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 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. 59 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 Gas Gathering and Compression Revenue The Company also provides natural gas gathering and compression services through its ownership interest in the gas gathering system in the Auburn field. 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 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. Estimated revenue due to the Company is recorded within the receivables line item on the accompanying consolidated balance sheets until payment is received. Allowance for Doubtful Accounts The Company records an allowance for doubtful accounts on a case-by-case basis once there is evidence that collection is not probable. 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, December 31, ​ ​ 2022 ​ 2021 Accounts receivable ​ ​ ​ ​ ​ ​ Natural gas and oil sales ​ $ 5,696,419 ​ $ 2,996,344 Joint interest billing ​ ​ 20,454 ​ ​ 60,134 Gathering and compression fees ​ ​ 1,483,956 ​ ​ 1,539,976 Other ​ ​ 557 ​ ​ 477 Total accounts receivable ​ $ 7,201,386 ​ $ 4,596,931 ​ ​ ​ 8. Accumulated Other Comprehensive Income Accumulated other comprehensive income includes certain transactions that have generally been reported in the consolidated statements of changes in shareholders’ equity. The activity in Accumulated Other Comprehensive Income during the years ended December 31, 2022 and 2021 consisted of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ ​ 2022 2021 ​ Balance at beginning of period ​ $ 9,818,605 ​ $ 9,820,647 ​ Translation (loss) gain ​ ​ ( 44,054 ) ​ ​ ( 2,042 ) ​ Balance at end of period ​ $ 9,774,551 ​ $ 9,818,605 ​ ​ ​ ​ ​ 60 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 9. Income Taxes Net income (loss) before income taxes is as follows for the periods indicated: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Foreign $ ( 700,255 ) ​ $ ( 571,646 ) U.S. ​ 48,212,421 ​ 16,639,671 ​ ​ $ 47,512,166 ​ $ 16,068,025 ​ 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Current: ​ ​ ​ ​ ​ ​ Federal ​ $ 7,788,302 ​ $ 3,152,866 State ​ ​ 3,657,231 ​ ​ 1,485,054 Total current income tax expense ​ ​ 11,445,533 ​ ​ 4,637,920 Deferred: ​ ​ ​ ​ ​ ​ Federal ​ ​ 1,587,935 ​ ​ 84,631 State ​ ​ ( 875,981 ) ​ ​ ( 282,043 ) Total deferred tax expense ​ ​ 711,954 ​ ​ ( 197,412 ) Income tax expense ​ $ 12,157,487 ​ $ 4,440,508 ​ 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 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 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. ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended ​ Year Ended ​ ​ ​ December 31, ​ Effective ​ December 31, ​ Effective ​ ​ 2022 Tax Rate 2021 Tax Rate Income tax provision computed at the statutory federal tax rate ​ $ 9,977,555 21.00 % $ 3,377,625 21.00 % Difference in Canadian and U.S. tax rate ​ ( 14,005 ) ( 0.03 ) % ( 11,433 ) ( 0.07 ) % Adjustment of Canadian deferred tax balances ​ ​ 39,839 ​ 0.08 % ​ 762,000 ​ 4.74 % Valuation allowance on Canadian loss ​ 121,220 0.26 % ( 688,388 ) ( 4.28 ) % Return to provision adjustment ​ ( 4,538 ) ( 0.01 ) % 57,875 0.36 % State taxes ​ 2,304,218 4.85 % 1,057,924 6.58 % State valuation allowance ​ ​ ( 107,030 ) ​ ( 0.23 ) % ​ ( 107,545 ) ​ ( 0.67 ) % Miscellaneous other items ​ ( 159,772 ) ( 0.34 ) % ( 7,550 ) ( 0.05 ) % Income tax expense ​ $ 12,157,487 25.58 % $ 4,440,508 27.61 % ​ 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. 61 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ As of December 31, ​ 2022 2021 Deferred tax assets: ​ ​ ​ ​ ​ ​ State net operating loss carryforwards ​ $ 313,018 ​ $ 244,582 Canadian net operating loss carryforwards ​ 11,113,319 ​ 11,669,601 ARO ​ ​ 702,522 ​ ​ 796,339 Unrealized derivatives/other ​ 92,785 ​ 255,852 Gross deferred tax assets ​ 12,221,644 ​ 12,966,374 Valuation allowance ​ ( 11,158,602 ) ​ ( 11,821,914 ) Total deferred tax assets ​ 1,063,042 ​ 1,144,460 Deferred tax liabilities: ​ ​ Oil and gas property ​ ( 9,336,638 ) ​ ( 8,558,064 ) Partnership ​ ( 2,034,995 ) ​ ( 2,491,836 ) Unrealized derivatives/other ​ ​ ( 308,803 ) ​ ​ — Gross deferred tax liabilities ​ ( 11,680,436 ) ​ ( 11,049,900 ) Net deferred tax liability ​ $ ( 10,617,394 ) ​ $ ( 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. ​ ​ 62 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 10. Commitments and Contingencies Leases 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): ​ ​ ​ ​ ​ Amount Asset ​ ​ ​ Operating lease right-of-use assets ​ $ 31,383 Total operating lease right-of-use assets ​ $ 31,383 ​ ​ ​ ​ Liabilities ​ ​ ​ Operating lease liabilities ​ $ 35,299 Total operating lease liabilities ​ $ 35,299 ​ ​ ​ ​ Operating lease costs ​ $ 32,097 ​ ​ ​ ​ Cash paid for amounts included in the measurement of lease liabilities ​ ​ ​ Operating cash flows from operating leases ​ $ 106,798 ​ ​ ​ ​ Weighted average remaining lease term - operating lease ​ ​ 0.33 Weighted average discount rate (annualized) - operating lease ​ ​ 8.09 % ​ 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 2023 ​ $ 36,013 Total minimum lease payments ​ ​ 36,013 Less: effect of discounting ​ ​ 714 Present value of future minimum lease payments ​ ​ 35,299 Less: current obligations under leases ​ ​ 35,299 Long-term lease obligations ​ $ — ​ The Company’s future minimum lease commitments as of December 31, 2021 are summarized in the following table: ​ ​ ​ ​ ​ ​ ​ Year ended ​ ​ ​ December 31, ​ Payments 2022 ​ $ 106,797 2023 ​ ​ 36,013 ​ ​ $ 142,810 ​ 63 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 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. Litigation 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. 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, 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 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. ​ 11. Net Income Per Share Basic net income per share is computed on the basis of the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed based upon the weighted-average number of common shares outstanding during the period plus the assumed issuance of common shares for all potentially dilutive securities. The net income used in the calculation of basic and diluted net income per share are as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Net income available to shareholders ​ $ 35,354,679 ​ $ 11,627,517 ​ 64 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: ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Basic weighted-average number of shares outstanding ​ 23,319,633 ​ 23,705,193 Dilutive stock options ​ 15,831 ​ — Unvested time-based restricted shares — 82,958 Unvested performance-based restricted shares 70,725 68,951 Diluted weighted average shares outstanding 23,406,189 23,857,102 ​ We excluded the following shares from the diluted EPS because their inclusion would have been anti-dilutive. ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Anti-dilutive options ​ 54,169 ​ 218,750 Anti-dilutive unvested time-based restricted shares ​ 273,448 ​ 83,044 Anti-dilutive unvested performance-based restricted shares ​ 28,519 ​ 82,549 Total Anti-dilutive shares 356,136 384,343 ​ ​ ​ ​ 12. Operating Segments Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker, who is responsible for allocating resources and assessing performance of the operating segments, has been identified as executive management. Segment performance is evaluated based on operating profit or loss as shown in the table below. Interest expense, interest income and income taxes are managed separately on a group basis. The Company’s reportable segments are as follows: a. The Upstream segment activities include acquisition, development and production of primarily natural gas reserves on properties within the United States; b. The Gas Gathering segment partners with two other companies to operate a natural gas gathering system; and c. The Corporate segment activities include corporate listing and governance functions of the Company. 65 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Upstream Gas Gathering Corporate Elimination Consolidated As of and for the year ended December 31, 2022 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating revenue ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Natural gas ​ $ 56,948,734 ​ $ — ​ $ — ​ $ — ​ $ 56,948,734 Natural gas liquids ​ ​ 1,733,130 ​ ​ — ​ ​ — ​ ​ — ​ ​ 1,733,130 Oil and condensate ​ ​ 3,195,333 ​ ​ — ​ ​ — ​ ​ — ​ ​ 3,195,333 Gathering and compression fees ​ ​ — ​ ​ 9,609,172 ​ ​ — ​ ​ ( 1,523,660 ) ​ ​ 8,085,512 Total operating revenue (1) ​ ​ 61,877,197 ​ ​ 9,609,172 ​ ​ — ​ ​ ( 1,523,660 ) ​ ​ 69,962,709 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating costs ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating costs ​ ​ 15,079,783 ​ ​ 2,287,763 ​ ​ 706,849 ​ ​ ( 1,523,660 ) ​ ​ 16,550,735 Depletion, depreciation, amortization and accretion ​ ​ 5,375,225 ​ ​ 1,063,286 ​ ​ — ​ ​ — ​ ​ 6,438,511 Operating income ​ ​ 41,422,189 ​ ​ 6,258,123 ​ ​ ( 706,849 ) ​ ​ — ​ ​ 46,973,463 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Other income (expense) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest income ​ ​ 447,128 ​ ​ — ​ ​ 5,749 ​ ​ — ​ ​ 452,877 Interest expense ​ ​ ( 50,782 ) ​ ​ — ​ ​ — ​ ​ — ​ ​ ( 50,782 ) Gain (loss) on derivative contracts ​ ​ 236,077 ​ ​ — ​ ​ — ​ ​ — ​ ​ 236,077 Other (expense) income ​ ​ ( 100,315 ) ​ ​ — ​ ​ 846 ​ ​ — ​ ​ ( 99,469 ) Other income (expense), net ​ ​ 532,108 ​ ​ — ​ ​ 6,595 ​ ​ — ​ ​ 538,703 Net income before income tax expense ​ $ 41,954,297 ​ ​ 6,258,123 ​ ​ ( 700,254 ) ​ ​ — ​ ​ 47,512,166 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Segment assets ​ $ 112,450,893 ​ ​ 10,603,000 ​ ​ 808,350 ​ ​ — ​ ​ 123,862,243 Capital expenditures (2) ​ ​ 6,785,930 ​ ​ 163,914 ​ ​ — ​ ​ — ​ ​ 6,949,844 Proved properties ​ ​ 40,596,972 ​ ​ — ​ ​ — ​ ​ — ​ ​ 40,596,972 Unproved properties ​ ​ 18,169,157 ​ ​ — ​ ​ — ​ ​ — ​ ​ 18,169,157 Gathering system ​ ​ — ​ ​ 8,138,261 ​ ​ — ​ ​ — ​ ​ 8,138,261 Operating lease right-of-use asset ​ ​ 31,383 ​ ​ — ​ ​ — ​ ​ — ​ ​ 31,383 Other property and equipment ​ ​ 923,799 ​ ​ — ​ ​ — ​ ​ — ​ ​ 923,799 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ As of and for the year ended December 31, 2021 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating revenue ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Natural gas ​ $ 31,708,185 ​ ​ — ​ ​ — ​ ​ — ​ ​ 31,708,185 Natural gas liquids ​ ​ 1,053,486 ​ ​ — ​ ​ — ​ ​ — ​ ​ 1,053,486 Oil and condensate ​ ​ 1,776,496 ​ ​ — ​ ​ — ​ ​ — ​ ​ 1,776,496 Gathering and compression fees ​ ​ — ​ ​ 9,460,508 ​ ​ — ​ ​ ( 1,594,683 ) ​ ​ 7,865,825 Total operating revenue (1) ​ ​ 34,538,167 ​ ​ 9,460,508 ​ ​ — ​ ​ ( 1,594,683 ) ​ ​ 42,403,992 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating costs ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating costs ​ ​ 13,867,817 ​ ​ 2,321,329 ​ ​ 570,192 ​ ​ ( 1,594,683 ) ​ ​ 15,164,655 Depletion, depreciation, amortization and accretion ​ ​ 5,278,617 ​ ​ 1,348,399 ​ ​ — ​ ​ — ​ ​ 6,627,016 Operating income ​ ​ 15,391,733 ​ ​ 5,790,780 ​ ​ ( 570,192 ) ​ ​ — ​ ​ 20,612,321 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Other income (expense) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest income ​ ​ 38,865 ​ ​ — ​ ​ — ​ ​ — ​ ​ 38,865 Interest expense ​ ​ ( 101,382 ) ​ ​ — ​ ​ — ​ ​ — ​ ​ ( 101,382 ) Gain (loss) on derivative contracts ​ ​ ( 4,482,909 ) ​ ​ — ​ ​ — ​ ​ — ​ ​ ( 4,482,909 ) Other (expense) income ​ ​ 2,585 ​ ​ — ​ ​ ( 1,455 ) ​ ​ — ​ ​ 1,130 Other income (expense), net ​ ​ ( 4,542,841 ) ​ ​ — ​ ​ ( 1,455 ) ​ ​ — ​ ​ ( 4,544,296 ) Net income before income tax expense ​ $ 10,848,892 ​ ​ 5,790,780 ​ ​ ( 571,647 ) ​ ​ — ​ ​ 16,068,025 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Segment assets ​ $ 85,828,508 ​ ​ 13,506,775 ​ ​ 127,311 ​ ​ — ​ ​ 99,462,594 Capital expenditures (2) ​ ​ 4,638,448 ​ ​ 272,442 ​ ​ — ​ ​ — ​ ​ 4,910,890 Proved properties ​ ​ 35,551,441 ​ ​ — ​ ​ — ​ ​ — ​ ​ 35,551,441 Unproved properties ​ ​ 21,700,926 ​ ​ — ​ ​ — ​ ​ — ​ ​ 21,700,926 Gathering system ​ ​ — ​ ​ 9,031,137 ​ ​ — ​ ​ — ​ ​ 9,031,137 Other property and equipment ​ ​ 946,866 ​ ​ — ​ ​ — ​ ​ — ​ ​ 946,866 (1) Segment operating revenue represents revenues generated from the operations of the segment. Inter-segment sales during the years ended December 31, 2022 and 2021 have been eliminated upon consolidation. 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. For the year 66 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. (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. ​ ​ 13. Commodity Risk Management Activities Commodity Price Risks Epsilon engages in price risk management activities from time to time. These activities are intended to manage Epsilon’s exposure to fluctuations in commodity prices for natural gas by securing fixed price contracts for a portion of expected sales volumes. Inherent in the Company’s fixed price contracts, are certain business risks, including market risk and credit risk. Market risk is the risk that the price of oil and natural gas will change, either favorably or unfavorably, in response to changing market conditions. Credit risk is the risk of loss from nonperformance by the Company’s counterparty to a contract. The Company does not currently require collateral from any of its counterparties nor does its counterparties require collateral from the Company. The Company enters into certain commodity derivative instruments to mitigate commodity price risk associated with a portion of its future natural gas production and related cash flows. The natural gas revenues and cash flows are affected by changes in commodity product prices, which are volatile and cannot be accurately predicted. The objective for holding these commodity derivatives is to protect the operating revenues and cash flows related to a portion of the future natural gas sales from the risk of significant declines in commodity prices, which helps ensure the Company’s ability to fund the capital budget. Epsilon has historically elected not to designate any of its financial commodity derivative contracts as accounting hedges and, accordingly, accounts for these financial commodity derivative contracts using the mark-to-market accounting method. Under this accounting method, changes in the fair value of outstanding financial instruments are recognized as gains or losses in the period of change and are recorded as g ain (loss) on derivative contracts on the consolidated statements of operations and comprehensive income. The related cash flow impact is reflected in cash flows from operating activities. 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 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, 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 Assets ​ December 31, December 31, ​ ​ 2022 ​ 2021 Current ​ ​ NYMEX Henry Hub swap $ 1,219,865 ​ $ — Tennessee Z4 basis swap ​ 181,775 ​ ​ — Two-way costless collar ​ — ​ ​ 13,312 ​ $ 1,401,640 ​ $ 13,312 ​ 67 Epsilon Energy Ltd. Notes to the Consolidated Financial Statements (Continued) For the years ended December 31, 2022 and 2021 ​ ​ ​ ​ ​ ​ ​ ​ ​ Fair Value of Derivative Liabilities ​ December 31, December 31, ​ ​ 2022 ​ 2021 Current ​ ​ Tennessee Z4 basis swap $ ( 179,550 ) ​ $ — Two-way costless collar ​ — ​ ​ ( 253,136 ) ​ $ ( 179,550 ) ​ $ ( 253,136 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net Fair Value of Derivatives $ 1,222,090 ​ $ ( 239,824 ) ​ The following table presents the changes in the fair value of Epsilon’s commodity derivatives for the periods indicated: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Fair value of asset (liability), beginning of the period ​ $ ( 239,824 ) ​ $ — Gains (losses) on derivative contracts included in earnings ​ 236,077 ​ ( 4,482,909 ) Settlement of commodity derivative contracts ​ 1,225,837 ​ 4,243,085 Fair value of asset (liability), end of the period ​ $ 1,222,090 ​ $ ( 239,824 ) ​ ​ ​ 14. Asset Retirement Obligations 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. The following table presents the activity in Epsilon’s asset retirement obligations for the periods indicated: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended ​ Year ended ​ ​ ​ December 31, ​ ​ December 31, ​ ​ 2022 2021 Balance beginning of period ​ $ 2,833,656 ​ $ 3,150,243 Liabilities acquired ​ ​ 12,053 ​ ​ 7,009 Liabilities disposed of ​ ​ ( 25,835 ) ​ ​ ( 381,346 ) Wells plugged and abandoned ​ ​ ( 118,260 ) ​ ​ ( 31,945 ) Change in estimates ​ ​ — ​ ​ ( 8,299 ) Accretion ​ ​ 78,623 ​ ​ 97,994 Balance end of period ​ $ 2,780,237 ​ $ 2,833,656 ​ ​ ​ 68 EPSILON ENERGY LTD. Supplemental Information to Consolidated Financial Statements (Unaudited) NATURAL GAS AND OIL PRODUCING ACTIVITIES Natural gas and oil Reserves Users of this information should be aware that the process of estimating quantities of ‘‘proved,’’ ‘‘proved developed’’ and ‘‘proved undeveloped’’ crude oil, natural gas liquids (NGLs) and natural gas reserves is complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors, including, but not limited to, additional development activity; evolving production history; crude oil and condensate, NGL and natural gas prices; and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions (upward or downward) to existing reserve estimates may occur from time to time. Although reasonable effort is made to ensure that reserve estimates reported represent the most accurate assessments possible, the significance of the subjective decisions required and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented in connection with financial statement disclosures. Proved reserves represent estimated quantities of crude oil, NGLs and natural gas, which, by analysis of geoscience and engineering data, can be estimated, with reasonable certainty, to be economically producible from a given date forward from known reservoirs under then-existing economic conditions, operating methods and government regulations before the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Proved developed reserves are proved reserves expected to be recovered under operating methods being utilized at the time the estimates were made, through wells and equipment in place or if the cost of any required equipment is relatively minor compared to the cost of a new well. Proved undeveloped reserves (PUDs) are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility at greater distances. PUDs can be recorded in respect of a particular undrilled location only if the location is scheduled, under the then-current drilling and development plan, to be drilled within five years from the date that the PUDs are to be recorded, unless specific factors (such as those described in interpretative guidance issued by the Staff of the SEC) justify a longer timeframe. Likewise, absent any such specific factors, PUDs associated with a particular undeveloped drilling location shall be removed from the estimates of proved reserves if the location is scheduled, under the then-current drilling and development plan, to be drilled on a date that is beyond five years from the date that the PUDs were recorded. Epsilon has formulated development plans for all drilling locations associated with its PUDs at December 31, 2022. Under these plans, each PUD location will be drilled within five years from the date it was recorded. 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, 2022 and 2021 and changes for each of the two years in the year ended December 31, 2022. Net proved reserves at December 31 are estimated by the Company’s independent petroleum engineers, DeGolyer and MacNaughton. 69 EPSILON ENERGY LTD. Supplemental Information to Consolidated Financial Statements (Unaudited) NET PROVED RESERVE SUMMARY ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Pennsylvania ​ Oklahoma ​ ​ ​ ​ Natural ​ Natural ​ ​ ​ ​ ​ ​ All reserves located in United States ​ Gas ​ Gas ​ NGL ​ Oil ​ Total ​ (MMcf) (MMcf) (MBbl) (MBbl) (MMcfe) Net proved developed reserves at December 31, 2020 ​ 63,469 ​ 320 ​ - ​ 19 ​ 63,903 Revisions of previous estimates (1)(2) 15,950 ​ 903 ​ 186 ​ (10) ​ 17,909 Divestitures ​ - ​ (60) ​ - ​ (1) ​ (66) Transfers from proved undeveloped 513 ​ 1,364 ​ - ​ 83 ​ 2,375 Production (9,830) ​ (403) ​ (29) ​ (25) ​ (10,557) Net proved developed reserves at December 31, 2021 ​ 70,102 ​ 2,124 ​ 157 ​ 66 ​ 73,564 Revisions of previous estimates (3)(4) ​ 10,837 ​ (665) ​ (65) ​ 12 ​ 9,856 Divestitures ​ - ​ - ​ - ​ - ​ - Transfers from proved undeveloped ​ 4,389 ​ 1,682 ​ 150 ​ 61 ​ 7,334 Production ​ (9,026) ​ (477) ​ (44) ​ (32) ​ (9,959) Net proved developed reserves at December 31, 2022 ​ 76,302 ​ 2,664 ​ 198 ​ 107 ​ 80,795 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net proved undeveloped reserves at December 31, 2020 ​ 15,915 ​ 8,954 ​ 299 ​ 353 ​ 28,781 Revisions of previous estimates (5)(6) ​ 11,532 ​ (1,099) ​ 281 ​ (67) ​ 11,717 Extensions and discoveries (7)(8) ​ 4,388 ​ 930 ​ 83 ​ 36 ​ 6,032 Transfers from proved undeveloped ​ (513) ​ (1,364) ​ - ​ (83) ​ (2,375) Net proved undeveloped reserves at December 31, 2021 ​ 31,322 ​ 7,421 ​ 663 ​ 239 ​ 44,155 Revisions of previous estimates (9)(10) ​ (18,738) ​ (2,860) ​ (220) ​ (74) ​ (23,362) Extensions and discoveries ​ - ​ - ​ - ​ - ​ - Transfers from proved undeveloped ​ (4,389) ​ (1,682) ​ (150) ​ (61) ​ (7,334) Net proved undeveloped reserves at December 31, 2022 ​ 8,195 ​ 2,879 ​ 293 ​ 104 ​ 13,459 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net proved reserves at December 31, 2020 ​ 79,384 ​ 9,274 ​ 299 ​ 372 ​ 92,684 Revisions of previous estimates ​ 27,482 (196) ​ 467 ​ (77) ​ 29,626 Extensions and discoveries ​ 4,388 930 ​ 83 ​ 36 ​ 6,032 Divestitures ​ - ​ (60) ​ - ​ (1) ​ (66) Production ​ (9,830) ​ (403) ​ (29) ​ (25) ​ (10,557) Net proved reserves at December 31, 2021 ​ 101,424 9,545 ​ 820 ​ 305 ​ 117,719 Revisions of previous estimates ​ (7,901) ​ (3,525) ​ (285) ​ (62) ​ (13,506) Extensions and discoveries ​ - ​ - ​ - ​ - ​ - Divestitures ​ - ​ - ​ - ​ - ​ - Production ​ (9,026) ​ (477) ​ (44) ​ (32) ​ (9,959) Net proved reserves at December 31, 2022 ​ 84,497 ​ 5,543 ​ 491 ​ 211 ​ 94,254 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Proved developed reserves: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ At December 31, 2020 ​ 63,469 ​ 320 ​ - ​ 19 ​ 63,903 At December 31, 2021 ​ 70,102 ​ 2,124 ​ 157 ​ 66 ​ 73,564 At December 31, 2022 ​ 76,302 ​ 2,664 ​ 198 ​ 107 ​ 80,795 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Proved undeveloped reserves: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ At December 31, 2020 ​ 15,915 ​ 8,954 ​ 299 ​ 353 ​ 28,781 At December 31, 2021 ​ 31,322 ​ 7,421 ​ 663 ​ 239 ​ 44,155 At December 31, 2022 ​ 8,195 ​ 2,879 ​ 293 ​ 104 ​ 13,459 ​ (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. 70 EPSILON ENERGY LTD. Supplemental Information to Consolidated Financial Statements (Unaudited) (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 production and gathering activities at December 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Proved properties $ 148,326,265 ​ $ 138,032,413 Unproved properties ​ 18,169,157 ​ ​ 21,700,926 Gathering system properties ​ ​ 42,639,001 ​ ​ 42,475,086 Total Oil & Gas Properties ​ ​ 209,134,423 ​ ​ 202,208,425 Accumulated depreciation, depletion, amortization and impairment ​ ​ (142,230,033) ​ (135,924,921) Net capitalized costs ​ $ 66,904,390 ​ $ 66,283,504 ​ Costs incurred for oil and natural gas property acquisition, exploration and development activities The following table summarizes costs incurred and capitalized in oil and natural gas properties related to acquisition, exploration and development activities. 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 71 EPSILON ENERGY LTD. Supplemental Information to Consolidated Financial Statements (Unaudited) 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. ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Oil and Natural Gas Activities: ​ ​ ​ ​ ​ Unproved acquisition costs ​ $ 310,211 ​ $ 148,863 Development costs ​ ​ 6,426,037 ​ ​ 3,751,827 Total costs incurred for oil and natural gas activities ​ ​ 6,736,248 ​ ​ 3,900,690 Gathering System development costs ​ ​ 163,915 ​ 272,442 Total costs incurred ​ $ 6,900,163 ​ $ 4,173,132 ​ Results of Operations for Natural Gas and Oil Producing Activities 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, ​ 2022 2021 Oil and gas producing activities: ​ ​ ​ ​ ​ Gas sales $ 56,948,734 ​ $ 31,708,185 Oil and other liquid sales ​ ​ 4,928,463 ​ ​ 2,829,982 Total revenues ​ ​ 61,877,197 ​ ​ 34,538,167 Lease operating costs ​ ​ (7,128,631) ​ ​ (7,897,738) Depreciation, depletion, amortization, accretion and impairment ​ ​ (5,375,225) ​ ​ (5,431,675) Total costs ​ ​ (12,503,856) ​ ​ (13,329,413) Results of operations from oil and gas producing activities ​ $ 49,373,341 ​ $ 21,208,754 ​ 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 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. The following information may be useful for certain comparative purposes, but should not be solely relied upon in evaluating Epsilon or its performance. Further, information contained in the following table should not be considered as representative of realistic assessments of future cash flows, nor should the Standardized Measure of Discounted Future Net Cash Flows be viewed as representative of the current value of Epsilon. The future cash flows presented below are based on expense and cost rates in existence as of the date of the projections. It is expected that material revisions to some estimates of natural gas reserves may occur in the future, development and production of the reserves may occur in periods other than those assumed, and actual prices realized and costs incurred may vary significantly from those used. Estimated future income taxes are computed using current statutory income tax rates including consideration of the current tax basis of the properties and related carryforwards. The resulting tax-effected future net cash flows are reduced to present value amounts by applying a 10% annual discount factor. 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. 72 EPSILON ENERGY LTD. Supplemental Information to Consolidated Financial Statements (Unaudited) 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. ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Future cash inflows $ 529,886,325 ​ $ 353,162,054 Future production costs ​ (119,404,233) ​ ​ (104,161,488) Future development costs (1) ​ ​ (21,171,395) ​ ​ (36,751,965) Future income taxes (2) ​ ​ (97,165,344) ​ ​ (60,131,474) 10% annual discount for estimated timing of cash flows ​ ​ (146,368,246) ​ ​ (74,408,997) Standardized measure of discounted future net cash flows ​ $ 145,777,107 ​ $ 77,708,130 (1) Costs associated with the abandonment of proved properties are included in future development costs. (2) Future income taxes for 2022 and 2021 were estimated using a combined federal and state statutory tax rate of approximately 26%. Changes in Standardized Measure of Discounted Future Net Cash Flows The following table sets forth the changes in the standardized measure of discounted future net cash flows for the years ended December 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ Year ended December 31, ​ 2022 2021 Beginning balance $ 77,708,130 ​ $ 16,015,868 Revenue less production and other costs ​ ​ (53,224,969) ​ ​ (26,680,071) Changes in price, net of production costs ​ ​ 147,777,736 ​ ​ 70,063,892 Development costs incurred ​ ​ 10,396,380 ​ ​ 4,581,988 Net changes in future development costs ​ ​ 5,054,884 ​ ​ (8,732,332) Extensions and discoveries, less related costs ​ ​ — ​ ​ 3,705,395 Revisions of previous quantity estimates ​ ​ (31,515,746) ​ ​ 40,997,786 Accretion of discount ​ 9,790,852 ​ ​ 2,218,430 Net change in income taxes ​ ​ (17,827,596) ​ ​ (25,325,983) Purchases of reserves in place ​ ​ — ​ ​ 446,240 Timing differences and other technical revisions ​ ​ (2,382,564) ​ ​ 416,917 Ending balance ​ $ 145,777,107 ​ $ 77,708,130 ​ ​ 73 ​ ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ​ ​