UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~September~~June 30, ~~2022~~2023

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-38770

EPSILON ENERGY LTD.

(Exact name of registrant as specified in its charter)


Alberta, Canada		98-1476367
(State or other jurisdiction of incorporation or organization)		(I.R.S Employer Identification No.)

~~16945 Northchase Drive~~500 Dallas Street, Suite ~~1610~~1250

Houston, Texas ~~77060~~77002

(281) 670-0002

(Address of principal executive offices including zip code and

telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol	Name of each exchange on which registered
Common Shares, no par value	EPSN	NASDAQ Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ⌧ No ◻

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ⌧ No ◻

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ◻	Accelerated filer ◻	Non-accelerated filer ⌧	Smaller reporting company ☒	Emerging growth company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Yes ☐ No ⌧

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ⌧

As of ~~November~~August 10, ~~2022,~~2023, there were ~~23,027,441~~22,164,843 Common Shares outstanding.

Table of Contents


Contents	Contents		Contents

FORWARD-LOOKING STATEMENTS	FORWARD-LOOKING STATEMENTS	4	FORWARD-LOOKING STATEMENTS	4
PART I-FINANCIAL INFORMATION	PART I-FINANCIAL INFORMATION	5	PART I-FINANCIAL INFORMATION	5
ITEM 1. FINANCIAL STATEMENTS	ITEM 1. FINANCIAL STATEMENTS	5	ITEM 1. FINANCIAL STATEMENTS	5
Unaudited Condensed Consolidated Balance Sheets	Unaudited Condensed Consolidated Balance Sheets	5	Unaudited Condensed Consolidated Balance Sheets	5
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	6	Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	6
Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity	Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity	7	Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity	7
Unaudited Condensed Consolidated Statements of Cash Flows	Unaudited Condensed Consolidated Statements of Cash Flows	9	Unaudited Condensed Consolidated Statements of Cash Flows	9
Notes to the Unaudited Condensed Consolidated Financial Statements	Notes to the Unaudited Condensed Consolidated Financial Statements	10	Notes to the Unaudited Condensed Consolidated Financial Statements
1.	Description of Business	10	Description of Business	10
2.	Basis of Preparation	10	Basis of Preparation	10
	Interim Financial Statements	10	Interim Financial Statements	10
	Principles of Consolidation	10	Principles of Consolidation	10
	Use of Estimates	10	Use of Estimates	10
	Recently Issued Accounting Standards	10	Reclassification	10
			Recently Issued Accounting Standards	10
3.	Cash, Cash Equivalents, and Restricted Cash	11	Cash, Cash Equivalents, and Restricted Cash	11
4.	Property and Equipment	12	Short Term Investments	11
5.			Property and Equipment	12
	Property Impairment	12	Property Impairment	13
5.	Revolving Line of Credit	12
6.	Shareholders’ Equity	13	Revolving Line of Credit	13
7.	Revenue Recognition	17	Shareholders’ Equity	13
8.	Income Taxes	19	Revenue Recognition	17
9.	Commitments and Contingencies	19	Income Taxes	18
10.			Commitments and Contingencies	18
	Litigation	19	Litigation	18
10.	Net Income Per Share	20
11.	Operating Segments	21	Leases	19
12.	Risk Management Activities	24	Net Income Per Share	20
13.			Operating Segments	21
14.			Commodity Risk Management Activities	24
	Commodity Price Risks	24	Commodity Price Risks	24
	Commodity Derivative Contracts	24	Commodity Derivative Contracts	24
13.	Asset Retirement Obligations	26
14.	Fair Value Measurements	26
15.			Asset Retirement Obligations	25
16.			Fair Value Measurements	25
17.			Current Expected Credit Loss	26
18.			Subsequent Events	26
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	27	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	27
	Overview	27	Overview	27
	Business Strategy	27	Business Strategy	27
	Operational Highlights	27	Operational Highlights	28
	Non-GAAP Financial Measures-Adjusted EBITDA	28	Non-GAAP Financial Measures-Adjusted EBITDA	28
	Net Operating Revenues	30	Net Operating Revenues	30
	Operating Costs	31	Operating Costs	31
	Loss on Derivative Contracts	32	Depletion, Depreciation, Amortization and Accretion	31
	Capital Resources and Liquidity	32
	Cash Flow	32
	Credit Agreement	33
	Repurchase Transactions	33
	Derivative Transactions	34

Table of Contents

	General and Administrative	32
	Loss on Derivative Contracts	33
	Capital Resources and Liquidity	33
	Cash Flow	33
	Credit Agreement	33
	Repurchase Transactions	34
	Derivative Transactions	34
	Contractual Obligations	34
	~~Off-Balance Sheet Arrangements~~	34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		3435
	Gathering System Revenue Risk	35
	Interest Rate Risk	35
	Derivative Contracts	35
ITEM 4. CONTROLS AND PROCEDURES		35
	Disclosure Controls and Procedures	35
	Changes in Internal Control Over Financial Reporting	3536
	Inherent Limitations on Effectiveness of Controls	3536
PART II OTHER INFORMATION		36
ITEM 1. LEGAL PROCEEDINGS		36
ITEM 1A. RISK FACTORS		36
ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS		36
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		37
ITEM 4. MINE SAFETY DISCLOSURES		37
ITEM 5. OTHER INFORMATION		37
ITEM 6. EXHIBITS		38
SIGNATURES		38

Table of Contents

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report constitute forward-looking statements. The use of any of the words ‘‘anticipate,’’ ‘‘continue,’’ ‘‘estimate,’’ ‘‘expect,’’ ‘‘may,’’ ‘‘will,’’ ‘‘project,’’ ‘‘should,’’ ‘‘believe,’’ and similar expressions and statements relating to matters that are not historical facts constitute ‘‘forward looking information’’ within the meaning of applicable securities laws. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated. Such forward-looking statements are based on reasonable assumptions, but no assurance can be given that these expectations will prove to be correct and the forward-looking statements included in this report should not be unduly relied upon. These statements are made only as of the date of this report. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future — including statements relating to natural gas and oil production rates, commodity prices for crude oil or natural gas, supply and demand for natural gas and oil; the estimated quantity of natural gas and oil reserves, including reserve life; future development and production costs, and statements expressing general views about future operating results — are forward-looking statements. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in our Annual Report on Form 10-K for the year ended December 31, ~~2021,~~2022, and those described from time to time in our future reports filed with the Securities and Exchange Commission. You should consider carefully the statements under Item 1A. Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022. Our Annual Report on Form 10-K for the year ended December 31, ~~2021~~2022 is available on our website at www.epsilonenergyltd.com.

Table of Contents

PART I-FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Balance Sheets

September 30,

December 31,

2022

2021
ASSETS

Current assets

Cash and cash equivalents

$
40,254,729

$
26,497,305
Accounts receivable

10,069,516

4,596,931
Fair value of derivatives

32,326

—
Other current assets

775,587

569,870
Total current assets

51,132,158

31,664,106
Non-current assets

Property and equipment:

Oil and gas properties, successful efforts method

Proved properties

147,196,218

138,032,413
Unproved properties

18,085,385

21,700,926
Accumulated depletion, depreciation, amortization and impairment

(106,457,257)

(102,480,972)
Total oil and gas properties, net

58,824,346

57,252,367
Gathering system

42,617,954

42,475,086
Accumulated depletion, depreciation, amortization and impairment

(34,262,838)

(33,443,949)
Total gathering system, net

8,355,116

9,031,137
Land

637,764

637,764
Buildings and other property and equipment, net

295,446

309,102
Total property and equipment, net

68,112,672

67,230,370
Other assets:

Restricted cash

569,883

568,118
Total non-current assets

68,682,555

67,798,488
Total assets

$
119,814,713

$
99,462,594

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities

Accounts payable trade

$
2,203,443

$
1,189,905
Gathering fees payable

1,020,921

963,546
Royalties payable

2,827,880

1,853,508
Income taxes payable

3,119,671

1,098,425
Accrued capital expenditures

398,026

1,016,830
Other accrued liabilities

1,001,792

1,098,127
Fair value of derivatives

—

239,824
Asset retirement obligations

—

85,207
Total current liabilities

10,571,733

7,545,372
Non-current liabilities

Asset retirement obligations

2,758,831

2,748,449
Deferred income taxes

10,345,297

9,905,440
Total non-current liabilities

13,104,128

12,653,889
Total liabilities

23,675,861

20,199,261
Commitments and contingencies (Note 9)

Shareholders' equity

Common shares, no par value, unlimited shares authorized and 23,571,108 issued and 23,011,608 outstanding at September 30, 2022 and 24,202,218 issued and 23,668,203 shares outstanding at December 31, 2021

127,231,845

131,815,739
Treasury shares, 559,500 at September 30, 2022 and 534,015 at December 31, 2021

(3,326,880)

(2,423,007)
Additional paid-in capital

9,672,152

8,835,203
Accumulated deficit

(47,208,598)

(68,783,207)
Accumulated other comprehensive income

9,770,333

9,818,605
Total shareholders' equity

96,138,852

79,263,333
Total liabilities and shareholders' equity

$
119,814,713

$
99,462,594


	June 30,		December 31,
	2023		2022
ASSETS
Current assets
Cash and cash equivalents	$	9,488,094	$	45,236,584
Accounts receivable		4,355,076		7,201,386
Short term investments		26,804,482		—
Fair value of derivatives		1,286,070		1,222,090
Prepaid income taxes		1,233,669		1,140,094
Other current assets		391,007		632,154
Operating lease right-of-use assets		—		31,383
Total current assets		43,558,398		55,463,691
Non-current assets
Property and equipment:
Oil and gas properties, successful efforts method
Proved properties		152,014,489		148,326,265
Unproved properties		25,989,679		18,169,157
Accumulated depletion, depreciation, amortization and impairment		(109,996,874)		(107,729,293)
Total oil and gas properties, net		68,007,294		58,766,129
Gathering system		42,673,506		42,639,001
Accumulated depletion, depreciation, amortization and impairment		(35,026,730)		(34,500,740)
Total gathering system, net		7,646,776		8,138,261
Land		637,764		637,764
Buildings and other property and equipment, net		312,830		286,035
Total property and equipment, net		76,604,664		67,828,189
Other assets:
Operating lease right-of-use assets, long term		495,842		—
Restricted cash		495,000		570,363
Total non-current assets		77,595,506		68,398,552
Total assets	$	121,153,904	$	123,862,243

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable trade	$	1,334,008	$	1,695,353
Gathering fees payable		498,438		935,012
Royalties payable		1,511,168		2,223,043
Accrued capital expenditures		134,224		41,694
Accrued compensation		405,448		598,351
Other accrued liabilities		467,387		690,655
Operating lease liabilities		24,748		35,299
Total current liabilities		4,375,421		6,219,407
Non-current liabilities
Asset retirement obligations		2,777,847		2,780,237
Deferred income taxes		10,847,721		10,617,394
Operating lease liabilities, long term		519,652		—
Total non-current liabilities		14,145,220		13,397,631
Total liabilities		18,520,641		19,617,038
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 22,649,290 shares issued and 22,554,169 shares outstanding at June 30, 2023 and 23,117,144 issued and outstanding at December 31, 2022		121,348,004		123,904,965
Treasury shares, at cost, 95,121 at June 30, 2023 and 0 at December 31, 2022		(497,814)		—
Additional paid-in capital		10,215,725		9,856,229
Accumulated deficit		(38,158,726)		(39,290,540)
Accumulated other comprehensive income		9,726,074		9,774,551
Total shareholders' equity		102,633,263		104,245,205
Total liabilities and shareholders' equity	$	121,153,904	$	123,862,243

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

Table of Contents

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income

Three months ended September 30,

Nine months ended September 30,


2022

2021

2022

2021
Revenues from contracts with customers:

Gas, oil, NGL, and condensate revenue

$
19,171,121

$
11,062,443

$
48,566,282

$
22,740,352
Gas gathering and compression revenue

2,072,806

2,038,616

6,180,747

5,891,868
Total revenue

21,243,927

13,101,059

54,747,029

28,632,220

Operating costs and expenses:

Lease operating expenses

2,399,092

2,240,259

6,791,496

5,618,585
Gathering system operating expenses

225,809

138,887

556,515

503,381
Development geological and geophysical expenses

2,387

11,583

7,159

34,573
Depletion, depreciation, amortization, and accretion

1,706,030

1,846,911

4,898,988

5,175,865
Gain on sale of oil and gas properties

—

—

(221,642)

—
General and administrative expenses:

Stock based compensation expense

500,597

300,249

836,949

738,789
Other general and administrative expenses

2,015,272

1,461,703

4,651,547

4,837,164
Total operating costs and expenses

6,849,187

5,999,592

17,521,012

16,908,357
Operating income

14,394,740

7,101,467

37,226,017

11,723,863

Other income (expense):

Interest income

89,638

11,070

126,804

27,786
Interest expense

(17,501)

(16,962)

(33,565)

(66,380)
Loss on derivative contracts

(929,637)

(5,055,130)

(1,124,547)

(6,417,123)
Other (expense) income

(32,777)

(907)

(99,896)

756
Other income (expense), net

(890,277)

(5,061,929)

(1,131,204)

(6,454,961)

Net income before income tax expense

13,504,463

2,039,538

36,094,813

5,268,902
Income tax expense

3,896,010

643,072

10,097,484

1,621,894
NET INCOME

$
9,608,453

$
1,396,466

$
25,997,329

$
3,647,008
Currency translation adjustments

(34,524)

(15)

(48,272)

(1,256)
NET COMPREHENSIVE INCOME

$
9,573,929

$
1,396,451

$
25,949,057

$
3,645,751

Net income per share, basic

$
0.42

$
0.06

$
1.11

$
0.15
Net income per share, diluted

$
0.41

$
0.06

$
1.11

$
0.15
Weighted average number of shares outstanding, basic

23,011,729

23,564,288

23,419,666

23,757,895
Weighted average number of shares outstanding, diluted

23,169,658

23,772,943

23,524,574

23,871,495


	Three months ended June 30,				Six months ended June 30,
	2023		2022		2023		2022
Revenues from contracts with customers:
Gas, oil, NGL, and condensate revenue	$	4,298,072	$	17,915,836	$	11,267,653	$	29,395,161
Gas gathering and compression revenue		2,202,064		1,987,168		4,588,759		4,107,941
Total revenue		6,500,136		19,903,004		15,856,412		33,503,102

Operating costs and expenses:
Lease operating expenses		1,440,521		2,252,017		2,844,800		3,657,507
Gathering system operating expenses		570,934		541,228		1,222,275		1,065,603
Development geological and geophysical expenses		—		2,386		—		4,772
Depletion, depreciation, amortization, and accretion		1,615,728		1,803,739		3,388,734		3,192,958
Loss (gain) on sale of oil and gas properties		1,449,871		(221,642)		1,449,871		(221,642)
General and administrative expenses:
Stock based compensation expense		179,748		194,050		359,496		336,352
Other general and administrative expenses		1,596,626		1,465,143		3,620,399		2,636,275
Total operating costs and expenses		6,853,428		6,036,921		12,885,575		10,671,825
Operating income (loss)		(353,292)		13,866,083		2,970,837		22,831,277

Other income (expense):
Interest income		433,201		21,945		923,963		37,166
Interest expense		(34,422)		(745)		(62,859)		(16,064)
Gain (loss) on derivative contracts		628,178		776,994		1,696,838		(194,910)
Other income (expense)		3,066		(61,713)		4,701		(67,119)
Other income (expense), net		1,030,023		736,481		2,562,643		(240,927)

Net income before income tax expense		676,731		14,602,564		5,533,480		22,590,350
Income tax expense		246,142		4,019,576		1,573,064		6,201,474
NET INCOME	$	430,589	$	10,582,988	$	3,960,416	$	16,388,876
Currency translation adjustments		1,129		(19,150)		(1,471)		(13,748)
Unrealized loss on securities		(47,006)		—		(47,006)		—
NET COMPREHENSIVE INCOME	$	384,712	$	10,563,838	$	3,911,939	$	16,375,128

Net income per share, basic	$	0.02	$	0.45	$	0.17	$	0.69
Net income per share, diluted	$	0.02	$	0.44	$	0.17	$	0.69
Weighted average number of shares outstanding, basic		22,749,322		23,576,746		22,869,440		23,627,015
Weighted average number of shares outstanding, diluted		22,783,987		23,822,123		22,904,922		23,796,166

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

Table of Contents

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity


									Accumulated														Accumulated
									Other				Total										Other				Total
	Common Shares Issued			Treasury Shares			Additional		Comprehensive		Accumulated		Shareholders'		Common Shares Issued			Treasury Shares			Additional		Comprehensive		Accumulated		Shareholders'
	Shares	Amount		Shares	Amount		paid-in Capital		Income		Deficit		Equity		Shares	Amount		Shares	Amount		paid-in Capital		Income		Deficit		Equity
Balance at January 1, 2022	24,202,218	$	131,815,739	(534,015)	$	(2,423,007)	$	8,835,203	$	9,818,605	$	(68,783,207)	$	79,263,333
Balance at January 1, 2023															23,117,144	$	123,904,965	—	$	—	$	9,856,229	$	9,774,551	$	(39,290,540)	$	104,245,205
Net income	—		—	—		—		—		—		5,805,888		5,805,888	—		—	—		—		—		—		3,529,827		3,529,827
Dividends	—		—	—		—		—		—		(1,483,027)		(1,483,027)
Stock-based compensation expenses	—		—	—		—		142,302		—		—		142,302
Exercise of stock options	38,750		209,312	—		—		—		—		—		209,312
Retirement of treasury shares	(534,015)		(2,423,007)	534,015		2,423,007		—		—		—		—
Other comprehensive income	—		—	—		—		—		5,402		—		5,402
Balance at March 31, 2022	23,706,953	$	129,602,044	—	$	—	$	8,977,505	$	9,824,007	$	(64,460,346)	$	83,943,210
Net income	—		—	—		—		—		—		10,582,988		10,582,988
Dividends	—		—	—		—		—		—		(1,486,650)		(1,486,650)
Stock-based compensation expenses	—		—	—		—		194,050		—		—		194,050
Exercise of stock options	72,500		399,475	—		—		—		—		—		399,475
Dividends paid															—		—	—		—		—		—		(1,412,455)		(1,412,455)
Stock-based compensation expense															—		—	—		—		179,748		—		—		179,748
Buyback of common shares	—		—	(697,100)		(4,554,822)		—		—		—		(4,554,822)	—		—	(237,920)		(1,367,425)		—		—		—		(1,367,425)
Retirement of treasury shares	(423,000)		(2,907,999)	423,000		2,907,999		—		—		—		—	(190,700)		(1,115,306)	190,700		1,115,306		—		—		—		—
Other comprehensive loss	—		—	—		—		—		(19,150)		—		(19,150)	—		—	—		—		—		(2,600)		—		(2,600)
Balance at June 30, 2022	23,356,453	$	127,093,520	(274,100)	$	(1,646,823)	$	9,171,555	$	9,804,857	$	(55,364,008)	$	89,059,101
Balance at March 31, 2023															22,926,444	$	122,789,659	(47,220)	$	(252,119)	$	10,035,977	$	9,771,951	$	(37,173,168)	$	105,172,300
Net income	—		—	—		—		—		—		9,608,453		9,608,453	—		—	—		—		—		—		430,589		430,589
Dividends	—		—	—		—		—		—		(1,453,043)		(1,453,043)
Stock-based compensation expenses	—		—	—		—		500,597		—		—		500,597
Exercise of stock options	27,500		138,325	—		—		—		—		—		138,325
Dividends paid															—		—	—		—		—		—		(1,416,147)		(1,416,147)
Stock-based compensation expense															—		—	—		—		179,748		—		—		179,748
Buyback of common shares	—		—	(285,400)		(1,680,057)		—		—		—		(1,680,057)	—		—	(325,055)		(1,687,350)		—		—		—		(1,687,350)
Vesting of shares of restricted stock	187,155		—	—		—		—		—		—		—
Other comprehensive loss	—		—	—		—		—		(34,524)		—		(34,524)
Balance at September 30, 2022	23,571,108	$	127,231,845	(559,500)	$	(3,326,880)	$	9,672,152	$	9,770,333	$	(47,208,598)	$	96,138,852
Retirement of treasury shares															(277,154)		(1,441,655)	277,154		1,441,655		—		—		—		—
Other comprehensive income															—		—	—		—		—		(45,877)		—		(45,877)
Balance at June 30, 2023															22,649,290	$	121,348,004	(95,121)	$	(497,814)	$	10,215,725	$	9,726,074	$	(38,158,726)	$	102,633,263

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

Table of Contents


									Accumulated														Accumulated
									Other				Total										Other				Total
	Common Shares Issued			Treasury Shares			Additional		Comprehensive		Accumulated		Shareholders'		Common Shares Issued			Treasury Shares			Additional		Comprehensive		Accumulated		Shareholders'
	Shares	Amount		Shares	Amount		paid-in Capital		Income		Deficit		Equity		Shares	Amount		Shares	Amount		paid-in Capital		Income		Deficit		Equity
Balance at January 1, 2021	23,985,799	$	131,730,401	—	$	—	$	7,879,119	$	9,820,647	$	(80,410,724)	$	69,019,443
Balance at January 1, 2022															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	—		—	—		—		—		—		2,735,567		2,735,567	—		—	—		—		—		—		5,805,888		5,805,888
Stock-based compensation expenses	—		—	—		—		202,499		—		—		202,499
Dividends paid															—		—	—		—		—		—		(1,483,027)		(1,483,027)
Stock-based compensation expense															—		—	—		—		142,302		—		—		142,302
Exercise of stock options															38,750		209,312	—		—		—		—		—		209,312
Retirement of treasury shares															(534,015)		(2,423,007)	534,015		2,423,007		—		—		—		—
Other comprehensive income															—		—	—		—		—		5,402		—		5,402
Balance at March 31, 2022															23,706,953	$	129,602,044	—	$	—	$	8,977,505	$	9,824,007	$	(64,460,346)	$	83,943,210
Net income															—		—	—		—		—		—		10,582,988		10,582,988
Dividends paid															—		—	—		—		—		—		(1,486,650)		(1,486,650)
Stock-based compensation expense															—		—	—		—		194,050		—		—		194,050
Exercise of stock options															72,500		399,475	—		—		—		—		—		399,475
Buyback of common shares	—		—	(123,200)		(492,479)		—		—		—		(492,479)	—		—	(697,100)		(4,554,822)		—		—		—		(4,554,822)
Other comprehensive income	—		—	—		—		—		242		—		242
Balance at March 31, 2021	23,985,799	$	131,730,401	(123,200)	$	(492,479)	$	8,081,618	$	9,820,889	$	(77,675,157)	$	71,465,272
Net loss	—		—	—		—		—		—		(485,025)		(485,025)
Stock-based compensation expenses	—		—	—		—		236,041		—		—		236,041
Buyback of common shares	—		—	(141,015)		(568,989)		—		—		—		(568,989)
Retirement of treasury shares															(423,000)		(2,907,999)	423,000		2,907,999		—		—		—		—
Other comprehensive loss	—		—	—		—		—		(1,484)		—		(1,484)	—		—	—		—		—		(19,150)		—		(19,150)
Balance at June 30, 2021	23,985,799	$	131,730,401	(264,215)	$	(1,061,468)	$	8,317,659	$	9,819,405	$	(78,160,182)	$	70,645,816
Net income	—		—	—		—		—		—		1,396,466		1,396,466
Stock-based compensation expenses	—		—	—		—		300,249		—		—		300,249
Buyback of common shares	—		—	(261,400)		(1,315,713)		—		—		—		(1,315,713)
Vesting of shares of restricted stock	20,834		—	—		—		—		—		—		—
Other comprehensive loss	—		—	—		—		—		(15)		—		(15)
Balance at September 30, 2021	24,006,633	$	131,730,401	(525,615)	$	(2,377,181)	$	8,617,908	$	9,819,391	$	(76,763,716)	$	71,026,803
Balance at June 30, 2022															23,356,453	$	127,093,520	(274,100)	$	(1,646,823)	$	9,171,555	$	9,804,857	$	(55,364,008)	$	89,059,101

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

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EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Cash Flows

Nine months ended September 30,

2022

2021
Cash flows from operating activities:

Net income

$
25,997,329

$
3,647,008
Adjustments to reconcile net income to net cash provided by operating activities:

Depletion, depreciation, amortization, and accretion

4,898,988

5,175,865
Loss on derivative contracts

1,124,547

6,417,123
Gain on sale of oil and gas properties

(221,642)

—
Settlement paid on derivative contracts

(1,396,697)

(2,488,702)
Settlement of asset retirement obligation

(118,260)

—
Stock-based compensation expense

836,949

738,789
Deferred income tax expense (benefit)

439,857

(651,606)
Changes in assets and liabilities:

Accounts receivable

(5,472,585)

(3,558,519)
Other current assets

(205,717)

(6,920)
Accounts payable, royalties payable and other accrued liabilities

1,511,652

3,237,559
Income taxes payable

2,021,246

1,016,153
Net cash provided by operating activities

29,415,667

13,526,750
Cash flows from investing activities:

Additions to unproved oil and gas properties

(226,439)

(140,498)
Additions to proved oil and gas properties

(5,528,037)

(3,479,386)
Additions to gathering system properties

(129,985)

(199,801)
Additions to land, buildings and property and equipment

(13,258)

(5,745)
Proceeds from sale of oil and gas properties

200,000

—
Prepaid drilling costs

—

379
Net cash used in investing activities

(5,697,719)

(3,825,051)
Cash flows from financing activities:

Buyback of common shares

(6,234,879)

(2,377,181)
Exercise of stock options

747,112

—
Dividends

(4,422,720)

—
Net cash used in financing activities

(9,910,487)

(2,377,181)
Effect of currency rates on cash, cash equivalents and restricted cash

(48,272)

(1,257)
Increase in cash, cash equivalents and restricted cash

13,759,189

7,323,261
Cash, cash equivalents and restricted cash, beginning of period

27,065,423

13,836,771
Cash, cash equivalents and restricted cash, end of period

$
40,824,612

$
21,160,032

Supplemental cash flow disclosures:

Income taxes paid

$
7,626,000

$
1,164,025
Interest paid

$
50,872

$
78,980

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

$
(194,391)

$
(18,150)
Change in gathering system accrued in accounts payable and accrued liabilities

$
12,882

$
16,225
Asset retirement obligation asset additions and adjustments

$
10,821

$
(29,853)


	Six months ended June 30,
	2023		2022
Cash flows from operating activities:
Net income	$	3,960,416	$	16,388,876
Adjustments to reconcile net income to net cash provided by operating activities:
Depletion, depreciation, amortization, and accretion		3,388,734		3,192,958
Accretion of discount on available for sale securities		(343,328)		—
Gain on available for sale securities		(47,659)		—
Loss (gain) on sale of oil and gas properties		1,449,871		(221,642)
(Gain) loss on derivative contracts		(1,696,838)		194,910
Settlement received (paid) on derivative contracts		1,632,858		(1,375,287)
Settlement of asset retirement obligation		—		(118,259)
Stock-based compensation expense		359,496		336,352
Deferred income tax expense (benefit)		230,327		319,326
Changes in assets and liabilities:
Accounts receivable		2,846,310		(5,333,960)
Prepaid income taxes and other assets and liabilities		332,214		328,872
Accounts payable, royalties payable and other accrued liabilities		(1,910,674)		738,023
Income taxes payable		—		1,312,365
Net cash provided by operating activities		10,201,727		15,762,534
Cash flows from investing activities:
Additions to unproved oil and gas properties		(7,821,248)		(162,445)
Additions to proved oil and gas properties		(5,653,284)		(4,935,370)
Additions to gathering system properties		(30,264)		(82,855)
Additions to land, buildings and property and equipment		(47,933)		(1,234)
Purchases of short term investments		(32,812,974)		—
Proceeds from short term investments		6,352,473		—
Proceeds from sale of oil and gas properties		12,498		200,000
Net cash used in investing activities		(40,000,732)		(4,981,904)
Cash flows from financing activities:
Buyback of common shares		(3,054,775)		(3,956,403)
Exercise of stock options		—		608,787
Dividends paid		(2,828,602)		(2,969,677)
Debt issuance costs		(140,000)		—
Net cash used in financing activities		(6,023,377)		(6,317,293)
Effect of currency rates on cash, cash equivalents, and restricted cash		(1,471)		(13,748)
(Decrease) increase in cash, cash equivalents, and restricted cash		(35,823,853)		4,449,589
Cash, cash equivalents, and restricted cash, beginning of period		45,806,947		27,065,423
Cash, cash equivalents, and restricted cash, end of period	$	9,983,094	$	31,515,012

Supplemental cash flow disclosures:
Income taxes paid	$	1,432,000	$	4,566,000
Interest paid	$	80,075	$	33,885

Non-cash investing activities:
Change in proved properties accrued in accounts payable and accrued liabilities	$	72,999	$	(1,097,247)
Change in gathering system accrued in accounts payable and accrued liabilities	$	4,240	$	8,554
Change in share buybacks accrued in accounts payable and accrued liabilities	$	—	$	598,419
Asset retirement obligation asset additions and adjustments	$	4,640	$	7,666

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

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

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, ~~the Company~~we began trading in the United States on the NASDAQ Global Market under the trading symbol “EPSN.” ~~The Company~~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 ~~primarily~~ natural gas ~~reserves in the United States.~~and oil reserves.

2. Basis of Preparation

Interim Financial Statements

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the appropriate rules and regulations of the SEC. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. All adjustments which are, in the opinion of management, necessary for a fair statement of the financial position and results of operations for the interim periods presented have been included. The interim financial information and notes hereto should be read in conjunction with the Company’s consolidated financial statements as of and for the year ended December 31, ~~2021.~~2022. The results of operations for interim periods are not necessarily indicative of results to be expected for a full fiscal year.

Principles of Consolidation

The Company’s unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Epsilon Energy USA, Inc. and its wholly owned subsidiaries, Epsilon Midstream, LLC, Dewey Energy GP, LLC, Dewey Energy Holdings, LLC, Epsilon Operating, 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 and oil reserves and related cash flow estimates used in impairment tests of natural gas and oil, 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.

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 March 2020, the FASB issued ASU No. 2020-04 - Reference Rate Reform (Topic 848), codified as ASC 848 (“ASC 848”). This was followed by ASU No. 2021-01, Reference Rate Reform (Topic 848): Scope (“ASU 2021-01”), issued in January 2021. The purpose of ASC 848 is to provide optional guidance to ease the potential effects on financial reporting of the market-wide migration away from Interbank Offered Rates (“IBORs”) to alternative reference rates. ASC

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

~~848 applies only~~accounting standards which allows the Company to contracts, hedging relationships, and other transactions that reference a reference rate expected to be discontinued because of reference rate reform. The guidance may be applied upon issuance of ASC 848 through December 31, 2022. We do not expect a material impact from thedefer adoption of ~~this ASU.~~certain accounting standards until those standards would otherwise apply to private companies.

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~~removes all recognition thresholds and ~~will require~~requires 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 ~~will adopt~~has adopted ASU 2016-13 as of January 1, 2023. ~~We do not expect a material~~There was no impact from the adoption of this ASU.

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), which will require lessees to recognize a right of use asset and a lease liability on their balance sheet for all leases, including operating leases, with a term of greater than 12 months. In July 2018,2020, the FASB issued ASU ~~2018-11, which adds a transition option permitting entities to apply the provisions~~2020-04, Facilitation of the ~~new standard at its adoption date instead~~Effects of Reference Rate Reform on Financial Reporting, which, for a limited period of time, adds ASC 848 to the ~~earliest comparative period presented~~Codification providing entities with certain practical expedients and exceptions from applying modification accounting if certain criteria are met. The amendments are designed to reduce operational challenges that entities will face in ~~the consolidated financial statements. Under this transition option, comparative reporting would not be required, and the provisions of the standard would be applied prospectively~~applying modification accounting to ~~leases in effect at the date of adoption.~~

~~The Company has determined its portfolio of leased assets and is completing its review of~~ all ~~related~~ contracts to determine the impact the adoption will have on its consolidated financial statements and related disclosures. Upon adoption, the Company will recognize a right of use asset and lease liability for certain commitments related to office space that will be ~~accounted for as an operating lease. To track these lease arrangements~~revised due to reference rate reform. The guidance in ASC 848 was triggered by the pending discontinuation of certain benchmark reference rates and, ~~facilitate compliance with this ASU,~~in some cases, their replacement by new rates that are more observable or transaction-based and, therefore, less susceptible to manipulation, than certain interest-rate benchmark reference rates commonly used today, including the ~~Company is in the~~London Interbank Offered Rate (LIBOR). This process of ~~designing processes~~reference rate reform will require entities to modify certain contracts by removing the discontinued rates and ~~internal controls.~~

~~The adoption of this~~including new rates. Epsilon has adopted ASU will increase asset and liability balances on the consolidated balance sheets due to the required recognition of a right of use asset and corresponding lease liabilities. The Company plans to elect the available package practical expedients provided in the standard and adopt Topic 8422020-04 as of January 1, ~~2022 at December 31, 2022 on its Form 10-K for~~2023. There was no impact from the ~~year ending December 31, 2022, using the optional transition method provided by ASU 2018-11 and continues to assess potential effects~~adoption of ~~the standard.~~this ASU.

3. 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 ~~September~~June 30, ~~2022~~2023 and December, 31 ~~2021:~~2022:


	September 30,		December 31,		June 30,		December 31,
	2022		2021		2023		2022
Cash and cash equivalents	$	40,254,729	$	26,497,305	$	9,488,094	$	45,236,584
Restricted cash included in other assets		569,883		568,118		495,000		570,363
Cash, cash equivalents and restricted cash in the statement of cash flows	$	40,824,612	$	27,065,423
Cash, cash equivalents, and restricted cash in the statement of cash flows					$	9,983,094	$	45,806,947

4. Short Term Investments

Short term investments are highly liquid investments with original maturities between three and twelve months. The Company’s short term investments consist of US Treasury Bills. These investments were previously classified as held-to-maturity. In May 2023, as a result of a change in business investment strategy, the Company transferred all of its held-to-maturity short term investments to the available-for-sale category. The securities transferred had a total amortized cost of $33,026,959, fair value of $33,021,293 and unrealized losses of $5,666 at the time of transfer. The unrealized loss was recorded as accumulated other comprehensive income at the time of transfer.

Available-for-sale short term investments are reported at fair value in the Consolidated Balance Sheets. Unrealized gains and losses are excluded from earnings and are reported in accumulated other comprehensive income in the Consolidated Statements of Operations and Comprehensive Income. There were no transfers out of accumulated other comprehensive income and no other-than-temporary impairment has been recognized as of June 30, 2023.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

The following table summarizes the available-for-sale short term investments as of June 30, 2023 and December 31, 2022.


	June 30, 2023						December 31, 2022
	Amortized		Unrealized		Fair		Amortized		Unrealized		Fair
	Cost		Losses		Value		Cost		Losses		Value
U.S. Treasury Bills	$	26,851,488	$	(47,006)	$	26,804,482	$	—	$	—	$	—

During the three and six months ended June 30, 2023, the Company sold securities with a carrying amount of $6,304,814 for total proceeds of $6,352,473. The realized gains on these sales were $47,659. These securities were sold to raise cash during the quarter to fund capital expenditures.

4.5. Property and Equipment

The following table summarizes the Company’s property and equipment as of ~~September~~June 30, ~~2022~~2023 and December 31, ~~2021:~~2022:


	September 30,		December 31,		June 30,		December 31,
	2022		2021		2023		2022
Property and equipment:
Oil and gas properties, successful efforts method
Proved properties	$	147,196,218	$	138,032,413	$	152,014,489	$	148,326,265
Unproved properties		18,085,385		21,700,926		25,989,679		18,169,157
Accumulated depletion, depreciation, amortization and impairment		(106,457,257)		(102,480,972)		(109,996,874)		(107,729,293)
Total oil and gas properties, net		58,824,346		57,252,367		68,007,294		58,766,129
Gathering system		42,617,954		42,475,086		42,673,506		42,639,001
Accumulated depletion, depreciation, amortization and impairment		(34,262,838)		(33,443,949)		(35,026,730)		(34,500,740)
Total gathering system, net		8,355,116		9,031,137		7,646,776		8,138,261
Land		637,764		637,764		637,764		637,764
Buildings and other property and equipment, net		295,446		309,102		312,830		286,035
Total property and equipment, net	$	68,112,672	$	67,230,370	$	76,604,664	$	67,828,189

Asset Acquisitions

During the three and six months ended June 30, 2023, Epsilon made the following three acquisitions:

●

a 10% interest in two wellbores located in Eddy County, New Mexico for $2.1 million.

●

a 25% working interest in 1,297 gross acres in Ector County, Texas including the drilling of one well for $3.7 million and a commitment for the completion of that well for $1.6 million.

●

a 25% working interest in 11,067 gross acres in Ector County, Texas for $6.3 million.

There were no acquisitions during the three and six months ended June 30, 2022.

Property Sale

During the three and six months ended June 30, 2023, Epsilon sold two wellbore-only Oklahoma assets for $12,498. This sale resulted in a loss of $1.45 million. During the three and six months ended June 30, 2022, Epsilon sold one wellbore-only Oklahoma asset for $200,000. This sale resulted in a gain of $0.22 million.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

Property Impairment

Epsilon uses the successful efforts method of accounting for crude oil and natural gas producing activities. Under this method, exploration costs, such as exploratory geological and geophysical costs, expiration of unproved leasehold, delay rentals and exploration overhead are expensed as incurred. All costs related to production, general corporate overhead and similar activities are also expensed as incurred. All property acquisition costs and development costs are capitalized when incurred.

~~Epsilon performs~~We perform a quantitative impairment test ~~quarterly or~~ whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable, over proved properties using the published NYMEX forward prices, timing, methods and other assumptions consistent with historical periods. When indicators of impairment are present, GAAP requires that the Company first ~~compares~~compare expected future undiscounted cash flows by asset group to their respective carrying values. If the carrying amount exceeds the estimated undiscounted future cash flows, a reduction of the carrying amount of the ~~oil and~~ natural gas properties to their estimated fair values is ~~required, which~~required. Additionally, if an exploratory well is determined ~~based on discounted cash flow techniques using significant assumptions including projected revenues, future commodity prices, and a market-specific weighted average cost~~not to have found proved reserves, the costs incurred, net of ~~capital which are affected by expectations about future market and economic conditions.~~ any salvage value, should be charged to expense.

During the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021,~~2022, no impairment was ~~required.~~recorded.

5~~. Revolving Line of Credit~~

The Company has a senior secured revolving credit facility (“Facility”) which includes a total commitment of up to $100 million. The current borrowing base is $14 million, which is subject to semi-annual redetermination. There are currently no borrowings under the Facility. If Epsilon decided to access the Facility, depending on the level of borrowing, the Company might need to increase its hedging activity. Borrowings from the Facility may be used for the acquisition and development of oil and gas properties, investments in cash flow generating assets complimentary to the production of oil and gas, and for letters of credit and other general corporate purposes. Upon each advance, interest is charged at the highest of a) rate of LIBOR plus an applicable margin (2.75%-3.75% based on the percent of the line of credit utilized), b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5%.

~~Table of Contents~~

~~Epsilon Energy Ltd.~~

~~Notes to the Unaudited Condensed Consolidated Financial Statements~~

~~Effective April~~ 6 ~~2021,~~. Revolving Line of Credit

The Company closed a senior secured reserve based revolving credit facility on June 28, 2023 with Frost Bank as issuing bank and sole lender. The new facility replaced the ~~agreement was amended~~Company’s previous facility. The initial commitment and borrowing base is $35 million, supported by the Company’s upstream assets in Pennsylvania and subject to ~~extend the~~semi-annual redeterminations with a 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 August 2, 2022, the borrowing base of $14 million was reaffirmed until the next periodic redetermination~~ of the ~~borrowing base.~~

earlier of June 28, 2027 or the date that the commitments are terminated. The ~~lender under~~next redetermination will be October 1, 2023. Interest will be charged at the ~~Credit Facility has~~Daily Simple SOFR rate plus a ~~first priority security interest in~~margin of 3.25%. The facility is secured by the ~~tangible and intangible~~ assets ~~including~~of the ~~gathering system, of~~Company’s Epsilon Energy USA ~~Inc. to secure any outstanding amounts~~subsidiary (Borrower). There are currently no borrowings under the ~~agreement.~~ facility.

Under the terms of the ~~agreement,~~facility, the Company must ~~maintain~~adhere to the following financial covenants:

●

Current ratio of 1.0 to 1.0 (current assets / current liabilities)

●

Leverage ratio of less than 2.5 to 1.0 (total debt / income adjusted for interest, taxes and non-cash amounts)

●~~Interest coverage~~Additionally, if the Leverage ratio is greater than ~~3 based on income adjusted for interest, taxes and non-cash amounts.~~

●~~Current ratio, adjusted for line of credit amounts used and available and non-cash amounts,~~1.0 to 1.0, or the borrowing base utilization is greater than 1.50%, the Company is required to hedge 50% of the anticipated production from PDP reserves for a rolling 24 month period.

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

~~The Company was~~We were in compliance with the financial covenants of the ~~Credit Facility~~agreement as of ~~September~~June 30, ~~2022 and expects to be in compliance with the financial covenants for the next 12 months.~~

~~An annual commitment fee of 0.50% is assessed and paid quarterly on the daily average unused borrowing base on the Credit Facility.~~2023.

Balance at

Balance at




September 30,

December 31,

Current

Interest Rate


2022

2021

Borrowing Base

3 mo.
Revolving line of credit

$
—

$
—

$
14,000,000

LIBOR + 3.25%⁽¹⁾

~~(1)~~

~~At September 30, 2022, the interest rate was 6.394%.~~

Balance at

June 30,

December 31,

Current

2023

2022

Borrowing Base

Interest Rate

Revolving line of credit

—

35,000,000

SOFR + 3.25%

6.7. 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

Normal Course Issuer Bid

~~Commencing on~~On March ~~8, 2022,~~9, 2023, the ~~Company conducted~~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 ~~(“NCIB”) to repurchase our issued~~ and ~~outstanding~~will be conducted in accordance with Rule 10b-18 under the Exchange Act. The program commenced on March 27, 2023 and will end on March 26, 2024, unless the maximum amount of common shares ~~when doing so was accretive to management’s estimates~~is purchased before then or Epsilon provides earlier notice of intrinsic value per share. The NCIB ends on March 7, 2023. The Company uses discretionary cash to fund these repurchases. During the three and nine months ended September 30, 2022, Epsilon repurchased 285,400 common shares and 982,500 common shares, respectively, of the authorized 1,183,410 purchase amount and spent $1,680,057 and $6,234,879, respectively, under the NCIB. The repurchased stock had an average price of $6.32 per share (excluding commissions). During the three and nine months ended September 30, 2022, the Company cancelled zero and 423,000 common shares, respectively.

Commencing on January 1, 2021, Epsilon conducted a normal course issuer bid (“NCIB”) to repurchase our issued and outstanding common shares, when doing so was accretive to management's estimates of intrinsic value per share. The NCIB ended on December 31, 2021. The Company used discretionary cash to fund these repurchases.termination. During

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

the six months ended June 30, 2023, we repurchased 372,275 common shares at an average price of $5.19 per share (excluding commissions) under the new plan.

The previous share repurchase program commenced on March 8, 2022. During the year ended December 31, ~~2021, Epsilon~~2022, we repurchased ~~534,015~~982,500 common shares of the maximum of 1,183,410 authorized ~~1,193,000 purchase amount~~for repurchase and spent ~~$2,423,007~~$6,234,879 under the ~~NCIB.~~plan. The repurchased stock had an average price of ~~$4.51~~$6.32 per share (excluding commissions) and ~~were~~was subsequently ~~cancelled~~retired during the ~~three~~year ended December 31, 2022. In 2023, we repurchased and retired 190,700 common shares at an average price of $5.82 per share (excluding commissions) before the plan terminated on March 7, 2023.

During the six months ended ~~March 31, 2022.~~

~~Repurchases may be made~~June 30, 2023, the Company repurchased 562,975 shares at management’s discretion from time to time through the facilities of the NASDAQ Global Market. The price paid for the common shares will be, subject to applicable securities laws, the prevailing marketan average price of ~~such common shares on~~$5.40 per share (excluding commissions) under the ~~NASDAQ Global Market at the time of such purchase. The Company intends to fund the purchase out of available cash and does not expect to incur debt to fund the share~~two consecutive repurchase ~~program. The shares are accounted for as treasury shares until such a time as they are cancelled.~~programs.

The following table contains activity relating to our acquisition of equity securities during the ~~nine~~six months ended ~~September~~June 30, ~~2022:~~2023:

Maximum number

of shares that

may yet be

Total number

Average price

purchased under

of shares

paid per

the plans or


purchased

share

programs
Beginning of normal-course issuer bid, March 8, 2022

1,183,410
March 2022⁽¹⁾

—

$
—

April 2022⁽¹⁾

23,700

$
6.63

May 2022⁽¹⁾

254,500

$
6.99

June 2022⁽¹⁾

418,900

$
6.21

July 2022⁽¹⁾

249,800

$
5.83

August 2022⁽¹⁾

33,200

$
6.09

September 2022⁽¹⁾

2,400

$
6.00

Total as of September 30, 2022

982,500

$
6.32

200,910


				Maximum number
				of shares
	Total number	Average price		remaining to be
	of shares	paid per		purchased under
	purchased	share		the program
Beginning of normal-course issuer bid, March 8, 2022⁽¹⁾					1,183,410
January 2023	125,200	$	5.96
February 2023	65,500	$	5.63
Total as of March 7, 2023	190,700	$	5.82		10,210

Beginning of normal-course issuer bid, March 27, 2023⁽²⁾					2,292,644
March 2023	47,220	$	5.32
April 2023	70,406	$	5.35
May 2023	83,097	$	5.11
June 2023	171,552	$	5.13
Total as of June 30, 2023	372,275	$	5.11		1,920,369

(1)

Epsilon repurchased these shares under its 2022-2023 share repurchase program that commenced on March 8, 2022 and terminated on March 7, 2023, as described above.

(2)

Epsilon repurchased these shares under its 2023-2024 share repurchase program that commenced on March 27, 2023, as described above.

(c)~~(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 had determined that it iswas 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 will be authorized to issue up to 2,000,000 Common Shares. As

Restricted Stock Awards

For the six months ended June 30, 2023, no shares of Restricted Stock were awarded to the Company’s board of directors and employees. For the year ended December 31, ~~2021, the Company granted, after the Compensation Committee approved the terms, target formulas, and peer group applicable to the performance incentive awards, 20,834~~2022, 289,231 common shares ~~and 48,000 time-based restricted shares to the CEO and the board~~ of ~~directors.~~Restricted Stock with a

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

~~Restricted Stock Awards~~

~~For the nine months ended September 30, 2022, 246,135 shares of Restricted Stock with a~~ weighted average market price at the grant date of ~~$6.22~~$6.28 were awarded to the Company’s ~~board of directors~~officers, employees, and ~~employees. For the year ended December 31, 2021, 48,000 common shares of Restricted Stock with a weighted average market price at the grant date of $5.04 were awarded to the Company’s~~ board of directors. These shares vest over a ~~three-year~~three or four-year period, with ~~one-third~~an equal number of ~~the~~ 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.

The following table summarizes Restricted Stock activity for the ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, and the year ended December 31, ~~2021:~~2022:


	Nine months ended		Year ended		Six months ended		Year ended
	September 30, 2022		December 31, 2021		June 30, 2023		December 31, 2022
	Number of	Weighted	Number of	Weighted	Number of	Weighted	Number of	Weighted
	Restricted	Average	Restricted	Average	Restricted	Average	Restricted	Average
	Shares	Remaining Life	Shares	Remaining Life	Shares	Remaining Life	Shares	Remaining Life
	Outstanding	(years)	Outstanding	(years)	Outstanding	(years)	Outstanding	(years)
Balance non-vested Restricted Stock at beginning of period	166,002	1.38	290,070	1.60	298,210	1.74	166,002	1.38
Granted	246,135	1.91	48,000	3.00	—	—	289,231	1.86
Vested	(83,155)	—	(137,668)	—	—	—	(157,023)	—
Forfeited	—	—	(34,400)	—
Balance non-vested Restricted Stock at end of period	328,982	1.59	166,002	1.38	298,210	1.24	298,210	1.74

Stock compensation expense for the granted Restricted Stock is recognized over the vesting period. Stock compensation expense recognized during the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 was ~~$366,763~~$165,064 and ~~$608,735,~~$330,128, respectively (for the three and ~~nine~~six months ended ~~September~~June 30, ~~2021, $127,834~~2022, $146,860 and ~~$402,247,~~$241,972, respectively).

At ~~September~~June 30, ~~2022,~~2023, the Company had unrecognized stock-based compensation related to these shares of ~~$1,551,041~~$1,338,437 to be recognized over a weighted average period of ~~1.62~~1.34 years (at December 31, ~~2021: $696,833~~2022: $1,668,564 over ~~1.11~~1.55 years).

Performance Share Unit Awards (“PSU”)

For the ~~nine~~six months ended ~~September~~June 30, ~~2022, 104,000~~2023, no PSUs vested and were issued. For the year ended December 31, ~~2021,~~2022, a total of ~~62,501~~135,667 common shares vested and were ~~issued, of which 20,834 of the common shares were~~issued. Previously granted as a result of the Company exceeding its 2020 TSR performance target. The Company grants PSUs, which are paid in stock, to certain key employees. PSUs are based on a three-year performance period with performance being measured each year at December 31. The PSUs will vest on the last day of the performance period. 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 Performance Peer Group 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.

~~Table of Contents~~

~~Epsilon Energy Ltd.~~

~~Notes to the Unaudited Condensed Consolidated Financial Statements~~

●

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.

~~The PSUs are accounted for as equity awards. The fair value~~15

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Epsilon Energy Ltd.

Notes to the 50% for performance based on CFDAS Growth was determined as the market price of the common shares of the Company on the date of grant. Weighted average fair value of CFDAS PSUs granted during the year ended December 31, 2021 was $3.41 per unit. The fair value of the 50% for performance based on TSR was determined on the grant date by the application of a Monte Carlo simulation model. For the year ended December 31, 2021, the Compensation Committee did not approve the issuance of any new PSU’s.Unaudited Condensed Consolidated Financial Statements

The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the performance stock awards, to calculate the fair value of the awards. Expected volatilities in the model were estimated using a historical period consistent with the expected term for each annual performance period of the awards. The risk-free interest rate was based on the United States Treasury rate measured over a term commensurate with the expected term for each annual performance period of the awards. The expected term is based on the time between the valuation date and the end of each annual performance period of the awards. The valuation model assumes dividends are immediately reinvested.

The following table summarizes PSUs for the ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and the year ended December 31, ~~2021:~~2022:

Nine months ended

Year ended

Six months ended

Year ended

September 30, 2022

December 31, 2021

June 30, 2023

December 31, 2022

Number of

Weighted

Number of

Weighted

Number of

Weighted

Number of

Weighted

Performance

Average

Performance

Average

Performance

Average

Performance

Average

Shares

Remaining Life

Shares

Remaining Life

Shares

Remaining Life

Shares

Remaining Life

Outstanding

(years)

Outstanding

(years)

Outstanding

(years)

Outstanding

(years)

Balance non-vested PSUs at beginning of period

151,500

0.75

193,167

1.60

15,833

1.00

151,500

3.84

Granted

—

20,834

—

Vested

(104,000)

—

(62,501)

—

(135,667)

—

Balance non-vested PSUs at end of period

47,500

0.67

151,500

0.75

15,833

0.50

15,833

1.00

Stock compensation expense for the granted PSUs is recognized over the vesting period. Stock compensation expense recognized during the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 related to PSUs was ~~$133,834~~$14,684 and ~~$228,214,~~$29,368, respectively (for the three and ~~nine~~six months ended ~~September~~June 30, ~~2021, $172,415~~2022, $47,190 and ~~$336,542, respectively.~~$94,380, respectively).

At ~~September~~June 30, ~~2022,~~2023, the Company had unrecognized stock-based compensation related to these shares of ~~$79,202~~$29,368 to be recognized over a weighted average period of ~~0.75~~0.38 years (at December 31, ~~2021: $310,790~~2022: $63,328 over ~~1.01~~0.63 years).

Stock Options

As of ~~September~~June 30, ~~2022,~~2023, 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 ~~1.30~~0.55 years.

The following table summarizes stock option activity for the six months ended June 30, 2023 and the year ended December 31, 2022:


	Six months ended			Year ended
	June 30, 2023			December 31, 2022
		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	70,000	$	5.03		218,750	$	5.28
Exercised	—	$	—		(138,750)	$	5.38
Expired/Forfeited	—	$	—		(10,000)	$	5.51
Balance at period-end	70,000	$	5.03		70,000	$	5.03

Exercisable at period-end	70,000	$	5.03		70,000	$	5.03

At June 30, 2023, the Company had unrecognized stock-based compensation, related to these options, of nil (at December 31, 2022: nil). The aggregate intrinsic value at June 30, 2023 was $21,700 (at December 31, 2022: $112,000).

During the six months ended June 30, 2023 and the year ended December 31, 2022, the Company awarded no stock options.

(d) Dividends

On March 3, 2023 and June 6, 2023, the Board declared quarterly dividends of $0.0625 per common share (annualized $0.25 per common share) totaling in aggregate an amount of approximately $2.8 million that has been paid for the six months ended June 30, 2023.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

~~The following table summarizes stock option activity for the nine months ended September 30, 2022 and the year ended December 31, 2021:~~

Nine months ended

Year ended

September 30, 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 September 30, 2022, using the Black Scholes model, the Company had unrecognized stock-based compensation, related to these options, of nil (at December 31, 2021: nil). The aggregate intrinsic value at September 30, 2022 was $90,300 (at December 31, 2021: nil).

~~During the nine months ended September 30, 2022 and the year ended December 31, 2021, the Company awarded no stock options.~~

~~(d)~~ ~~Dividends~~

On February 25, 2022, May 26, 2022, and August 16, 2022, the Board declared quarterly dividends of $0.0625 per common share (annualized $0.25 per common share) totaling in aggregate an amount of approximately ~~$4.4~~ ~~million that has been paid for the nine months ended September 30, 2022.~~

7.8. Revenue Recognition

Revenues are comprised ~~primarily~~ of sales of natural gas, oil and NGLs, along with the revenue generated from the Company’s ownership interest in the ~~Auburn~~ gas gathering system in the Auburn field in Northeastern Pennsylvania. ~~Also included are natural gas, crude oil and NGL revenues 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 three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021.~~2022.


	Three months ended September 30,				Nine Months Ended September 30,				Three months ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Operating revenue
Natural gas	$	17,893,822	$	9,511,357	$	44,581,254	$	20,950,378	$	3,006,695	$	15,984,348	$	9,262,873	$	26,687,432
Natural gas liquids		497,843		490,535		1,500,668		588,685		244,988		688,397		441,283		1,002,825
Oil and condensate		779,456		1,060,551		2,484,360		1,201,289		1,046,389		1,243,091		1,563,497		1,704,904
Gathering and compression fees		2,072,806		2,038,616		6,180,747		5,891,868		2,202,064		1,987,168		4,588,759		4,107,941
Total operating revenue	$	21,243,927	$	13,101,059	$	54,747,029	$	28,632,220	$	6,500,136	$	19,903,004	$	15,856,412	$	33,503,102

~~Table of Contents~~

~~Epsilon Energy Ltd.~~

~~Notes to the Unaudited Condensed Consolidated Financial Statements~~

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.

Gas Gathering and Compression Revenue

The Company also provides natural gas gathering and compression services through its ownership interest in the ~~Auburn~~ gas gathering ~~system.~~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 ~~Gas Gathering System~~GGS is received two months after ~~transmission~~gathering and compression has occurred. As a result, the Company must estimate the amount of production that was ~~transmitted~~gathered 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~~Credit Losses

The Company records an allowance for ~~doubtful accounts~~credit losses on a case-by-case basis once there is evidence that collection is not probable. For the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, there were no accounts for which collection was not probable.

~~The following table details accounts receivable as of September 30, 2022 and December 31, 2021.~~

September 30,

December 31,

2022

2021
Accounts receivable

Natural gas and oil sales

$
8,241,664

$
2,996,344
Joint interest billing

20,328

60,134
Gathering and compression fees

1,613,597

1,539,976
Other

193,927

477
Total accounts receivable

$
10,069,516

$
4,596,931

1817

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

The following table details accounts receivable as of June 30, 2023 and December 31, 2022.


	June 30,		December 31,
	2023		2022
Accounts receivable
Natural gas and oil sales	$	2,238,717	$	5,696,419
Joint interest billing		17,476		20,454
Gathering and compression fees		1,604,093		1,483,956
Commodity contract		449,810		—
Interest		44,980		557
Total accounts receivable	$	4,355,076	$	7,201,386

8.9. Income Taxes

Income tax provisions for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021~~2022 are as follows:


	Three months ended September 30,				Nine months ended September 30,				Three months ended June 30,				Six months ended June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Current:
Federal	$	2,566,416	$	1,016,953	$	6,564,117	$	1,491,880	$	86,279	$	2,530,805	$	1,046,787	$	3,997,702
State		1,209,063		508,588		3,093,510		781,620		(82,572)		1,192,131		295,950		1,884,446
Total current income tax expense		3,775,479		1,525,541		9,657,627		2,273,500		3,707		3,722,936		1,342,737		5,882,148
Deferred:
Federal		98,367		(679,361)		353,980		(467,203)		395,326		233,599		378,048		255,614
State		22,164		(203,108)		85,877		(184,403)		(152,891)		63,041		(147,721)		63,712
Total deferred tax expense		120,531		(882,469)		439,857		(651,606)		242,435		296,640		230,327		319,326
Income tax expense	$	3,896,010	$	643,072	$	10,097,484	$	1,621,894	$	246,142	$	4,019,576	$	1,573,064	$	6,201,474

The Company files federal income tax returns in the United States and Canada, and various returns in state and local jurisdictions.

The Company believes it has ~~appropriate support for the~~no uncertain income tax positions taken and to be taken on our tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of various factors including past experience and interpretations of tax law applied to the facts of each matter.positions. The Company's tax returns are open to audit under the statute of limitations for the years ending December 31, ~~2018~~2019 through December 31, ~~2021.~~2022. To the extent we utilize net operating losses generated in earlier years, such earlier years may also be subject to audit.

Our effective tax rate will typically differ from the statutory federal rate primarily as a result of state income taxes and the valuation allowance against the Canadian net operating loss. The effective tax rate for the ~~three and nine~~six months ended ~~September~~June 30, ~~2022~~2023 was higher than the statutory federal rate as a result of the state income taxes ~~excess officer compensation,~~ and the valuation allowance against the Canadian net operating loss.

Starting in 2023, distributions of Epsilon Energy USA Inc. earnings to Epsilon Energy Ltd. are anticipated to incur a 5% U.S. dividend withholding tax, provided the Company is eligible for benefits under the U.S. / Canada income treaty.

109.. Commitments and Contingencies

~~The Company’s future minimum lease commitments as of September 30, 2022 are summarized in the following table:~~

Year ended

December 31,

Payments
2022

$
46,833
2023

62,444

$
109,277

The Company enters into commitments for capital expenditures in advance of the expenditures being made. As of ~~September~~June 30, ~~2022,~~2023, the Company had commitments of ~~$0.4~~$1.6 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 ~~North-Central~~Northeast Pennsylvania, as required under both the settlement agreement and JOAs.

1918

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

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. AOral arguments were held in January 2023. We are awaiting a decision on the ~~appeal is not expected until early to mid-2023.~~appeal.

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. Leases

Under ASC 842, Leases, the Company recognized an operating lease related to its corporate office as of June 30, 2023 summarized in the following table:


	June 30,		December 31,
	2023		2022
Asset
Operating lease right-of-use assets	$	-	$	31,383
Operating lease right-of-use assets, long term		495,842		-
Total operating lease right-of-use assets	$	495,842	$	31,383

Liabilities
Operating lease liabilities	$	24,748	$	35,299
Operating lease liabilities, long term		519,652		-
Total operating lease liabilities	$	544,400	$	35,299

Operating lease costs	$	71,652	$	32,097

Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	27,010	$	106,798

Weighted average remaining lease term (years) - operating lease		3.27		0.33
Weighted average discount rate (annualized) - operating lease		8.25%		8.09%

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

The Company had one office lease that expired in April 2023. On March 1, 2023, the Company commenced a new office lease with a 70 month lease term and 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. Lease expense for operating leases was $0.07 million and $0.03 million as of June 30, 2023 and December 31, 2022, respectively. This lease expense is presented in other general and administrative expenses in the consolidated statements of operations and comprehensive income.

Future minimum lease payments as of June 30, 2023 are as follows:


	Operating Leases
2023	$	—
2024		134,750
2025		173,550
2026		177,021
2027		180,492
Thereafter		183,963
Total minimum lease payments		849,776
Less: imputed interest		(305,376)
Present value of future minimum lease payments		544,400
Less: current obligations under leases		(24,748)
Long-term lease obligations	$	519,652

~~10.~~12. 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 is as follows:


	Three months ended September 30,				Nine months ended September 30,				Three months ended June 30,				Six months ended June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Net income available to shareholders	$	9,608,453	$	1,396,466	$	25,997,329	$	3,647,008
Net income									$	430,589	$	10,582,988	$	3,960,416	$	16,388,876

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


	Three months ended September 30,		Nine months ended September 30,		Three months ended June 30,		Six months ended June 30,
	2022	2021	2022	2021	2023	2022	2023	2022
Basic weighted-average number of shares outstanding	23,011,729	23,564,288	23,419,666	23,757,895	22,749,322	23,576,746	22,869,440	23,627,015
Dilutive stock options	15,914	—	14,725	—	2,027	25,405	5,394	19,630
Unvested time-based restricted shares	104,525	144,473	—	85,395	23,892	103,258	22,338	39,340
Unvested performance-based restricted shares	37,490	64,182	90,183	28,205	8,746	116,714	7,750	110,181
Diluted weighted average shares outstanding	23,169,658	23,772,943	23,524,574	23,871,495	22,783,987	23,822,123	22,904,922	23,796,166

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


	Three months ended June 30,		Six months ended June 30,
	2023	2022	2023	2022
Anti-dilutive options	67,973	72,095	64,606	77,870
Anti-dilutive unvested time-based restricted shares	274,318	146,740	275,872	169,127
Anti-dilutive unvested performance-based restricted shares	7,087	34,786	8,083	41,319
Total Anti-dilutive shares	349,378	253,621	348,561	288,316

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

Three months ended September 30,

Nine months ended September 30,


2022

2021

2022

2021
Anti-dilutive options

54,086

245,000

55,275

245,000
Anti-dilutive unvested time-based restricted shares

240,526

159,197

254,665

218,275
Anti-dilutive unvested performance-based restricted shares

22,445

87,318

30,347

123,295
Total Anti-dilutive shares

317,057

491,515

340,287

586,570

~~11.~~13. 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 income (loss) as shown in the table below. Interest income and expense, and income taxes are managed separately on a group basis. As of June 30, 2023, general and administrative costs and interest income were moved to the Corporate segment because they are entirely comprised of corporate expenses and are not allocated to the Upstream and Gas Gathering segments. To be consistent with this current presentation, the general administrative costs and interest income for the three and six months ended June 30, 2022 has been reclassed as well.

The Company’s reportable segments are as follows:

The Upstream segment activities include acquisition, development and production of oil, natural gas, and other liquid reserves on properties within the United States;

The Gas Gathering segment partners with two other companies to operate a natural gas gathering system; and

The Corporate segment activities include general and administrative costs, interest income, and corporate listing and governance functions of the Company.

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

Segment activity as of, and for the ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021~~2022 is as follows:


	Upstream		Gas Gathering		Corporate		Elimination		Consolidated		Upstream		Gas Gathering		Corporate		Elimination		Consolidated
As of and for the nine months ended September 30, 2022
As of and for the six months ended June 30, 2023
Operating revenue
Natural gas	$	44,581,254	$	—	$	—	$	—	$	44,581,254	$	9,262,873	$	—	$	—	$	—	$	9,262,873
Natural gas liquids		1,500,668		—		—		—		1,500,668		441,283		—		—		—		441,283
Oil and condensate		2,484,360		—		—		—		2,484,360		1,563,497		—		—		—		1,563,497
Gathering and compression fees		—		7,290,507		—		(1,109,760)		6,180,747		—		5,328,617		—		(739,858)		4,588,759
Total operating revenue ⁽¹⁾		48,566,282		7,290,507		—		(1,109,760)		54,747,029		11,267,653		5,328,617		—		(739,858)		15,856,412

Operating costs		15,624,207		2,489,981		516,585		(1,109,760)		17,521,012
Operating income		32,942,075		4,800,526		(516,585)		—		37,226,017
Operating costs												5,034,529		1,222,305		3,979,865		(739,858)		9,496,841
Depletion, depreciation, amortization and accretion												2,859,358		529,376		—		—		3,388,734
Operating income (loss)												3,373,766		3,576,936		(3,979,865)		—		2,970,837

Other income (expense)
Interest income		125,311		—		1,494		—		126,804		—		—		923,963		—		923,963
Interest expense		(33,565)		—		—		—		(33,565)		(62,859)		—		—		—		(62,859)
Gain (loss) on derivative contracts		(1,124,547)		—		—		—		(1,124,547)		1,696,838		—		—		—		1,696,838
Other (expense) income		(100,315)		—		419		—		(99,896)		3,714		—		987		—		4,701
Other income (expense), net		(1,133,116)		—		1,913		—		(1,131,204)		1,637,693		—		924,950		—		2,562,643
Net income before income tax expense	$	31,808,959	$	4,800,526	$	(514,672)	$	—	$	36,094,813
Net income (loss) before income tax expense											$	5,011,459	$	3,576,936	$	(3,054,915)	$	—	$	5,533,480

Segment assets	$	108,223,413	$	10,813,847	$	777,453	$	—	$	119,814,713
Capital expenditures ⁽²⁾		5,573,343		142,867		—		—		5,716,210
Current assets, net											$	—	$	—	$	44,053,398	$	—	$	44,053,398
Proved properties		40,738,961		—		—		—		40,738,961		42,017,615		—		—		—		42,017,615
Unproved properties		18,085,385		—		—		—		18,085,385		25,989,679		—		—		—		25,989,679
Gathering system		—		8,355,116		—		—		8,355,116		—		7,646,776		—		—		7,646,776
Lease right-of-use-asset		—		—		—		—		—
Other property and equipment		933,210		—		—		—		933,210		950,594		—		—		—		950,594
Operating lease right-of-use asset												—		—		495,842		—		495,842
Total segment assets											$	68,957,888	$	7,646,776	$	44,549,240	$	—	$	121,153,904

As of and for the nine months ended September 30, 2021
As of and for the six months ended June 30, 2022
Operating revenue
Natural gas	$	20,950,378	$	—	$	—	$	—	$	20,950,378	$	26,687,432	$	—	$	—	$	—	$	26,687,432
Natural gas liquids		588,685		—		—		—		588,685		1,002,825		—		—		—		1,002,825
Oil and condensate		1,201,289		—		—		—		1,201,289		1,704,904		—		—		—		1,704,904
Gathering and compression fees		—		7,088,836		—		(1,196,968)		5,891,868		—		4,842,838		—		(734,897)		4,107,941
Total operating revenue ⁽¹⁾		22,740,352		7,088,836		—		(1,196,968)		28,632,220		29,395,161		4,842,838		—		(734,897)		33,503,102

Operating costs		14,905,645		2,754,927		444,753		(1,196,968)		16,908,357
Operating income		7,834,707		4,333,909		(444,753)		—		11,723,863
Operating costs												4,175,534		1,065,603		2,972,627		(734,897)		7,478,867
Depletion, depreciation, amortization and accretion												2,638,413		554,545		—		—		3,192,958
Operating income (loss)												22,581,214		3,222,690		(2,972,627)		—		22,831,277

Other income (expense)
Interest income		27,786		—		—		—		27,786		—		—		37,166		—		37,166
Interest expense		(66,380)		—		—		—		(66,380)		(16,064)		—		—		—		(16,064)
Gain (loss) on derivative contracts		(6,417,123)		—		—		—		(6,417,123)		(194,910)		—		—		—		(194,910)
Other (expense) income		2,273		—		(1,517)		—		756		(62,788)		—		(4,331)		—		(67,119)
Other income (expense), net		(6,453,444)		—		(1,517)		—		(6,454,961)		(273,762)		—		32,835		—		(240,927)
Net income before income tax expense	$	1,381,263	$	4,333,909	$	(446,270)	$	—	$	5,268,902
Net income (loss) before income tax expense											$	22,307,452	$	3,222,690	$	(2,939,792)	$	—	$	22,590,350

Segment assets
Capital expenditures ⁽²⁾	$	84,089,117	$	12,029,451	$	73,611	$	—	$	96,192,179
Current assets, net											$	—	$	—	$	42,627,454	$	—	$	42,627,454
Proved properties		3,542,479		216,026		—		—		3,758,505		40,649,783		—		—		—		40,649,783
Unproved properties		35,109,368		—		—		—		35,109,368		18,021,391		—		—		—		18,021,391
Gathering system		21,627,561		—		—		—		21,627,561		—		8,571,168		—		—		8,571,168
Lease right-of-use-asset		—		9,266,971		—		—		9,266,971
Other property and equipment		955,650		—		—		—		955,650		930,491		—		—		—		930,491
Total segment assets											$	59,601,665		8,571,168		42,627,454		—		110,800,287

(1)

Segment operating revenue represents revenues generated from the operations of the segment. Inter-segment sales during the ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021~~2022 have been eliminated upon consolidation. For the ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, Epsilon sold natural gas to 2330 unique customers. The two customers over 10% comprised ~~19.67%~~15%, and ~~12.20%~~10% of total revenue. For the ~~nine~~six months ended ~~September~~June 30, ~~2021,~~2022, Epsilon sold natural gas to 2621 unique customers. The two customers over 10% comprised ~~34%~~23% and ~~12%~~19% of total revenue.

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

Segment activity for the three months ended June 30, 2023 and 2022 is as follows:


	Upstream		Gas Gathering		Corporate		Elimination		Consolidated
For the three months ended June 30, 2023
Operating revenue
Natural gas	$	3,006,695	$	—	$	—	$	—	$	3,006,695
Natural gas liquids		244,988		—		—		—		244,988
Oil and condensate		1,046,389		—		—		—		1,046,389
Gathering and compression fees		—		2,578,114		—		(376,050)		2,202,064
Total operating revenue⁽¹⁾		4,298,072		2,578,114		—		(376,050)		6,500,136

Operating costs
Operating costs		3,266,442		570,934		1,776,374		(376,050)		5,237,700
Depletion, depreciation, amortization and accretion		1,365,603		250,125		—		—		1,615,728
Operating income (loss)		(333,973)		1,757,055		(1,776,374)		—		(353,292)

Other income (expense)
Interest income		—		—		433,201		—		433,201
Interest expense		(34,422)		—		—		—		(34,422)
Gain (loss) on derivative contracts		628,178		—		—		—		628,178
Other (expense) income		3,062		—		4		—		3,066
Other income (expense), net		596,818		—		433,205		—		1,030,023
Net income (loss) before income tax expense	$	262,845	$	1,757,055	$	(1,343,169)	$	—	$	676,731

Capital expenditures ⁽²⁾	$	12,450,319	$	12,880	$	—	$	—	$	12,463,199

For the three months ended June 30, 2022
Operating revenue
Natural gas	$	15,984,348	$	—	$	—	$	—	$	15,984,348
Natural gas liquids		688,397		—		—		—		688,397
Oil and condensate		1,243,091		—		—		—		1,243,091
Gathering and compression fees		—		2,356,901		—		(369,733)		1,987,168
Total operating revenue⁽¹⁾		17,915,836		2,356,901		—		(369,733)		19,903,004

Operating costs
Operating costs		2,402,494		541,228		1,659,193		(369,733)		4,233,182
Depletion, depreciation, amortization and accretion		1,533,916		269,823		—		—		1,803,739
Operating income (loss)		13,979,426		1,545,850		(1,659,193)		—		13,866,083

Other income (expense)
Interest income		—		—		21,945		—		21,945
Interest expense		(745)		—		—		—		(745)
Gain (loss) on derivative contracts		776,994		—		—		—		776,994
Other (expense) income		(62,788)		—		1,075		—		(61,713)
Other income (expense), net		713,461		—		23,020		—		736,481
Net income (loss) before income tax expense	$	14,692,887	$	1,545,850	$	(1,636,173)	$	—	$	14,602,564

Capital expenditures ⁽²⁾	$	1,390,908	$	76,016	$	—	$	—	$	1,466,924

(1)

Segment operating revenue represents revenues generated from the operations of the segment. Inter-segment sales during the three months ended June 30, 2023 and 2022 have been eliminated upon consolidation. For the three months ended June 30, 2023, Epsilon sold natural gas to 21 unique customers. The three customers over 10% comprised 25%, 14%, and 13% of total revenue. For the three months ended June 30, 2022, Epsilon sold natural gas to 19 unique customers. The four customers over 10% comprised 33%, 17%, 12% and 10% of total revenue.

(2)

Capital expenditures for the Upstream segment consist primarily of the acquisition of properties, and the drilling and completing of wells while Gas Gathering consists of expenditures relating to the expansion, completion, and ~~completion~~maintenance of the gathering and compression facility.

~~Segment activity for the three months ended September 30, 2022 and 2021 is as follows:~~

Upstream

Gas Gathering

Corporate

Elimination

Consolidated
For the three months ended September 30, 2022

Operating revenue

Natural gas

$
17,893,822

$
—

$
—

$
—

$
17,893,822
Natural gas liquids

497,843

—

—

—

497,843
Oil and condensate

779,456

—

—

—

779,456
Gathering and compression fees

—

2,447,669

—

(374,863)

2,072,806
Total operating revenue⁽¹⁾

19,171,121

2,447,669

—

(374,863)

21,243,927

Operating costs

6,175,538

869,833

178,679

(374,863)

6,849,187
Operating income

12,995,583

1,577,836

(178,679)

—

14,394,740

Other income (expense)

Interest income

88,145

—

1,494

—

89,638
Interest expense

(17,501)

—

—

—

(17,501)
Gain (loss) on derivative contracts

(929,637)

—

—

—

(929,637)
Other (expense) income

(37,527)

—

4,750

—

(32,777)
Other income (expense), net

(896,520)

—

6,244

—

(890,277)
Net income before income tax expense

$
12,099,063

$
1,577,836

$
(172,436)

$
—

$
13,504,463

Capital expenditures⁽²⁾

1,571,541

51,459

—

—

1,623,000

For the three months ended September 30, 2021

Operating revenue

Natural gas

$
9,511,357

$
—

$
—

$
—

$
9,511,357
Natural gas liquids

490,535

—

—

—

490,535
Oil and condensate

1,060,551

—

—

—

1,060,551
Gathering and compression fees

—

2,465,288

—

(426,672)

2,038,616
Total operating revenue⁽¹⁾

11,062,443

2,465,288

—

(426,672)

13,101,059

Operating costs

5,395,064

883,239

147,961

(426,672)

5,999,592
Operating income

5,667,379

1,582,049

(147,961)

—

7,101,467

Other income (expense)

Interest income

11,070

—

—

—

11,070
Interest expense

(16,962)

—
��

—

—

(16,962)
Gain (loss) on derivative contracts

(5,055,130)

—

—

—

(5,055,130)
Other (expense) income

—

—

(907)

—

(907)
Other income (expense), net

(5,061,022)

—

(907)

—

(5,061,929)
Net income before income tax expense

$
606,357

$
1,582,049

$
(148,868)

$
—

$
2,039,538

Capital expenditures⁽²⁾

1,164,881

145,521

—

—

1,310,402

~~(1)~~

Segment operating revenue represents revenues generated from the operations of the segment. Inter-segment sales during the three months ended September 30, 2022 and 2021 have been eliminated upon consolidation. For the three months ended September 30, 2022, Epsilon sold natural gas to 17 unique customers. The seven customers over 10% comprised 13.5%, 13.29%, 13.27%, 11.04%, 10.84%, 10.51%, and 10.25% of total revenue. For the three months ended September 30, 2021, Epsilon sold natural gas to 17 unique customers. The three customers over 10% comprised 25%, 22%, and 21% of total revenue.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

~~(2)~~

Capital expenditures for the Upstream segment consist primarily of the acquisition of properties, and the drilling and completing of wells while Gas Gathering consists of expenditures relating to the expansion and completion of the gathering and compression facility.

~~12.~~14. 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 derivative contracts for a portion of expected sales volumes.

Inherent in the Company’s ~~hedging program,~~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 ~~and oil~~ 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. ~~Additionally, there is a risk that gas prices could fall to a level low enough to affect~~The Company does not currently require collateral from any of its counterparties nor does its counterparties require collateral from the ~~volumes flowing through the gathering system.~~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 ~~loss (gain)~~gain (loss) on derivative contracts on the condensed consolidated statements of operations and comprehensive income (loss). The related cash flow impact is reflected in cash flows from operating activities. During the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, Epsilon recognized ~~losses~~gains on commodity derivative contracts of ~~$929,637~~$628,178 and ~~$1,124,547,~~$1,696,838, respectively. This amount included cash received on settlements on these contracts of $1,269,558 and $1,632,858 for the three and six months ended June 30, 2023, respectively. For the three and six months ended June 30, 2022, Epsilon recognized gains (losses) on commodity derivative contracts of $776,994 and ($194,910), respectively. This amount included cash paid on settlements on these contracts of ~~$21,410~~$163,559 and ~~$1,396,697, respectively. For~~$1,375,287 for the three and ~~nine~~six months ended ~~September~~June 30, 2021, Epsilon recognized losses on commodity derivative contracts of $5,055,130 and $6,417,123, respectively. This amount included cash paid on settlements on these contracts of $2,461,242 and $2,488,702,2022, respectively.

Commodity Derivative Contracts

~~Presented below is a summary of Epsilon’s natural gas commodity~~At June 30, 2023, the Company had outstanding NYMEX Henry Hub (“HH”) swaps totaling 0.46 Bcf and Tennessee Z4 basis ~~swap and two-way costless collar contracts as of September 30, 2022.~~swaps totaling 0.46 Bcf outstanding.


	Fair Value of Derivative Assets
	June 30,		December 31,
	2023		2022
Current
NYMEX Henry Hub swap	$	1,106,445	$	1,219,865
Tennessee Z4 basis swap		179,625		181,775
	$	1,286,070	$	1,401,640


	Fair Value of Derivative Liabilities
	June 30,		December 31,
	2023		2022
Current
Tennessee Z4 basis swap	$	—	$	(179,550)
	$	—	$	(179,550)


Net Fair Value of Derivatives	$	1,286,070	$	1,222,090

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

Fair Value

Volume

Ceiling

Floor

Basis

September 30,
Derivative Type

(MMbtu)

Price

Price

Differential

2022
2022

Basis swap

305,000

$
(1.15)

(4,837)
Two-way costless collar

305,000

$
8.20

$
6.50

37,163

$
32,326

As of September 30, 2022, all of the Company’s economic derivative hedge positions were with large financial institutions, which are not known to the Company to be in default on their derivative positions. The Company is exposed to credit risk to the extent of non-performance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate non-performance by such counterparties. None of the Company’s derivative instruments contains credit-risk related contingent features. Derivatives are net on the balance sheet as they are subject to the right to offset the liabilities with the assets.

The following tables summarize the gross fair values of our derivative instruments, presenting the impact of offsetting the derivative assets and liabilities on our condensed consolidated balance sheets as of the dates indicated below:

Fair Value of Derivative
Assets


September 30,

December 31,

2022

2021
Current




Basis swap

$
22,287

$
—
Two-way costless collar

$
203,518

$
13,312

$
225,805

$
13,312

Fair Value of Derivative
Liabilities


September 30,

December 31,

2022

2021
Current




Basis swap

$
(27,124)

$
—
Two-way costless collar

$
(166,355)

$
(253,136)

$
(193,478)

$
(253,136)

Net Fair Value of Derivatives

$
32,326

$
(239,824)

The following table presents the changes in the fair value of Epsilon’s commodity derivatives for the periods indicated:


	Three months ended September 30,				Nine months ended September 30,				Three months ended June 30,				Six months ended June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Fair value of asset (liability), beginning of the period	$	940,553	$	(1,334,533)	$	(239,824)	$	—	$	1,927,450	$	—	$	1,222,090	$	(239,824)
Losses on derivative contracts included in earnings		(929,637)		(5,055,130)		(1,124,547)		(6,417,123)
Gains (losses) on derivative contracts included in earnings										628,178		776,994		1,696,838		(194,910)
Settlement of commodity derivative contracts		21,410		2,461,242		1,396,697		2,488,702		(1,269,558)		163,559		(1,632,858)		1,375,287
Fair value of asset (liability), end of the period	$	32,326	$	(3,928,421)	$	32,326	$	(3,928,421)
Fair value of asset, end of the period									$	1,286,070	$	940,553	$	1,286,070	$	940,553

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~~Epsilon Energy Ltd.~~

~~Notes to the Unaudited Condensed Consolidated Financial Statements~~

~~13.~~15. Asset Retirement Obligations

Asset retirement obligations ~~were~~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.~~periods, and the forecast risk free cost of capital. Epsilon has estimated the value of its total asset retirement obligations to be $2.8 million as of June 30, 2023 ($2.8 million at December 31, 2022) based on a total net future undiscounted liability of approximately $7.4 million ($7.4 million at December 31, 2022). Each year we review, and to the extent necessary, revise our asset retirement obligations estimates.

The following tables summarize the changes in asset retirement obligations for the periods indicated:


	Nine Months Ended		Year ended		Six Months Ended		Year ended
		September 30,		December 31,		June 30,		December 31,
	2022		2021		2023		2022
Balance beginning of period	$	2,833,656	$	3,150,243	$	2,780,237	$	2,833,656
Liabilities acquired		9,840		7,009		4,640		12,053
Liabilities disposed of		(24,854)		(381,346)		(46,961)		(25,835)
Wells plugged and abandoned		(118,260)		(31,945)		—		(118,260)
Change in estimates		—		(8,299)
Accretion		58,449		97,994		39,931		78,623
Balance end of period	$	2,758,831	$	2,833,656	$	2,777,847	$	2,780,237

~~14.~~16. Fair Value Measurements

The methodologies used to determine the fair value of our financial assets and liabilities at ~~September~~June 30, ~~2022~~2023 were the same as those used at December 31, ~~2021.~~2022.

Cash and cash equivalents, restricted cash, accounts receivable, and accounts payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. The Company’s revolving line of credit has a recorded value that approximates its fair value since its variable interest rate is tied to current market rates and the applicable margins represent market rates. The revolving line of credit is classified within Level 2 of the fair value hierarchy.

The Company has investments in U.S. Treasury Bills, some of which mature over a period greater than 90 days and are classified as short term investments. The U.S. Treasury Bills are carried at fair value. The U.S. Treasury Bills are classified within Level 1 of the fair value hierarchy.

Commodity derivative instruments consist of ~~two-way costless collar~~NYMEX HH swap and basis swap contracts for natural gas. The Company’s derivative contracts are valued based on a marked to market approach. These assumptions are observable in the marketplace throughout the full term of the contract, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace, and are therefore designated as Level 2 within the valuation hierarchy. The Company utilizes its counterparties’ valuations to assess the reasonableness of its own valuations.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements


	June 30, 2023
	Level 1		Level 2		Level 3		Effect of Netting		Net Fair Value
Assets
Derivative contracts	$	—	$	1,286,070	$	—	$	—	$	1,286,070
Short term investments	$	26,804,482	$	—	$	—	$	—	$	26,804,482


	December 31, 2022
	Level 1		Level 2		Level 3		Effect of Netting		Net Fair Value
Assets
Derivative contracts	$	—	$	1,401,640	$	—	$	(179,550)	$	1,222,090
Liabilities
Derivative contracts	$	—	$	(179,550)	$	—	$	179,550	$	—

17. Current Expected Credit Loss

Under ASU 326, Financial Instruments – Credit Losses, estimated losses on financial assets are provided through an allowance for credit losses. The majority of our financial assets are invested in U.S. Treasury Bills. We also have accounts receivable which are primarily from purchasers of oil and natural gas, counterparties to our financial instruments, and revenues earned for compression and gathering services. Our oil, gas, and natural gas liquids accounts 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. We assess collectability 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. As of June 30, 2023 and December 31, 2022, we determined that our allowance for credit loss was nil.

18. Subsequent Events

On July 6, 2023, Epsilon repurchased 525,000 common shares a price of $5.00 per share (excluding commissions). There are 1,395,369 common shares remaining of the maximum of 2,292,644 authorized for repurchase under our current program.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in the understanding of trends and significant changes in or results of operations and the financial condition of Epsilon Energy Ltd. and its subsidiaries for the periods presented. The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto presented in this report, including the unaudited condensed consolidated financial statements as of ~~September~~June 30, ~~2022~~2023 and ~~2021~~2022 and for the ~~three and nine~~six months then ended together with accompanying notes, as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs, and expected performance. Actual results and the timing of events may differ materially from those contained in these forward- looking statements due to a number of factors. See “Part II. Item 1A. Risk Factors” and “Forward-Looking Statements.”

Overview

Epsilon Energy Ltd. (the “Company”) is a North American onshore focused independent natural gas and oil company engaged in the acquisition, development, gathering and production of natural gas and oil reserves. Our areas of operations are the Marcellus shale section of the Appalachian basin in Pennsylvania, ~~and~~ the NW Anadarko basin in ~~Oklahoma. Our assets are~~Oklahoma, and the Permian basin in ~~areas with established hydrocarbon resources with significant existing production.~~Eddy County, New Mexico and Ector County, Texas. In Pennsylvania, we hold ~~4,597~~5,098 net acres producing 25 MMcf/d.d net to our working interest. In Oklahoma, we hold ~~8,579~~7,228 net acres producing ~~2.7~~2.4 MMcfe/d. d net to our working interest. In Texas, we hold 3,093 net acres. In New Mexico, we hold wellbore interests producing 204 BOE/d net to our working interest.

In Pennsylvania, the Company owns a 35% interest in the ~~52 mile~~52-mile Auburn Gas Gathering System (“Auburn GGS") which is operated by a subsidiary of Williams Partners, LP.

Our common shares trade on the NASDAQ Global Market under the ticker symbol “EPSN.”

Business Strategy

The Company is focused on high rate of return capital investments in onshore North American natural gas and oil basins. We are committed to disciplined capital allocation which should include shareholder returns in the form of dividends and share buybacks. We expect that our strong balance sheet and ~~large~~ liquidity position will allow us to opportunistically invest in both our existing project areas and potential new projects.

To date, our investments have been focused in our position in the prolific Marcellus unconventional reservoir in Pennsylvania (“PA”). Our PA assets are supported by our 35% ownership in the Auburn GGS. ~~More recently, we have been active in our position in the NW Stack area of Oklahoma.~~ We have a substantial remaining drillable location inventory within our existing leaseholds.

On May 9, 2023, Epsilon acquired a 10% interest in two wellbores located in Eddy County, New Mexico from a private operator. The wells are currently on production. Total capital expenditure (net to Epsilon) was $2.1 million.

On May 16, 2023, Epsilon acquired a 25% working interest in 1,297 gross acres on the Central Basin Platform in Ector County, Texas from a private operator. The Company ~~also seeks~~will participate in the drilling and completion of 2 gross wells, both 10,000’ laterals, over the remainder of 2023. The first well is already drilled and first production from both wells is estimated for the fourth quarter of 2023. Total capital expenditure (net to ~~identify~~Epsilon) to date was $3.7 million.

On June 20, 2023, Epsilon acquired a 25% working interest in 11,067 gross acres on the Central Basin Platform in Ector County, Texas from a private operator. Initial plans call for 2-4 wells to be drilled on the position in 2024 with plans expected to be finalized by the end of 2023. Total capital expenditure (net to Epsilon) was $6.3 million.

We continue to evaluate new opportunities in numerous onshore North American natural gas and oil basins.

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Three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 Highlights

Operational Highlights

Marcellus Shale – Pennsylvania

● During the three months ended ~~September~~June 30, ~~2022, Epsilon’s~~2023, Epsilon's realized natural gas price was ~~$7.34~~$1.38 per Mcf, ~~compared to $3.43 per Mcf~~an 80% decrease over the ~~same period in 2021, a 114% increase.~~three months ended June 30, 2022. During the ~~nine~~six months ended ~~September~~June 30, ~~2022, Epsilon’s~~2023, Epsilon's realized natural gas price was ~~$6.25~~$2.01 per Mcf, ~~compared to $2.65 per Mcf over~~a 65% decrease from the ~~same period in 2021, a 136% increase.~~six months ended June 30, 2022.

● During the three months ended ~~September~~June 30, ~~2022,~~2023, Epsilon’s net revenue interest natural gas production was ~~2.3~~2.0 Bcf compared to ~~2.6~~2.2 Bcf during the same period in ~~2021,~~2022, a ~~12%~~9% decrease. During the ~~nine~~six months ended ~~September~~

~~Table of Contents~~

June 30, ~~2022,~~2023, Epsilon’s net revenue interest natural gas production was ~~6.7~~4.5 Bcf compared to ~~7.5~~4.6 Bcf during the same period in ~~2021, an 11%~~2022, a 2% decrease. ~~This decrease is due to natural decline in well production.~~

●

Gathered and delivered ~~16.0~~15.8 Bcf gross ~~(5.6 Bcf~~(5.5 net to ~~Epsilon’s~~Epsilon's interest) during the three months ended ~~September 30, 2022,~~June, 2023, or 174 MMcf/d through the Auburn Gas Gathering System. Gathered and delivered ~~50.9~~32.0 Bcf ~~gross (17.8 Bcf~~(11.2 net to ~~Epsilon’s~~Epsilon's interest) during the ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, or ~~187~~177 MMcf/d through the Auburn Gas Gathering System.

Anadarko, NW Stack Trend – Oklahoma

● During the three months ended ~~September~~June 30, ~~2022, Epsilon’s~~2023, Epsilon's realized price for all Oklahoma production was ~~$9.42~~$4.75 per Mcfe, ~~compared to $6.17 per Mcfe over~~a 47% decline from the ~~same period in 2021, a 53% increase.~~three months ended June 30, 2022. During the ~~nine~~six months ended ~~September~~June 30, ~~2022, Epsilon’s~~2023, Epsilon's realized price for all Oklahoma production was ~~$8.82~~$5.59 per Mcfe, ~~compared to $4.55 per Mcfe over~~a 34% decrease from the ~~same period in 2021, a 54% increase.~~six months ended June 30, 2022.

● Total net revenue interest production for the three months ended ~~September~~June 30, ~~2022~~2023 included natural gas, ~~natural gas~~oil and other liquids and ~~oil and condensate and~~ was ~~0.25~~0.18 Bcfe, ~~as compared to 0.37 Bcfe during~~a 44% decrease from the same period in ~~2021, a 32% decrease. This decrease is due to natural decline in well production.~~2022. Total net revenue interest production for the ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 included natural gas, ~~natural gas~~oil and other liquids and ~~oil and condensate and~~ was ~~0.74~~0.35 Bcfe, ~~as compared to 0.50 Bcfe during the same period in 2021,~~ a ~~48% increase. This increase is due to three new wells turned in line during the nine months ended September 30, 2022 compared to one new well~~29% decrease over the same period in ~~2021.~~2022.

●

In the second quarter of 2023, the Company completed 1 gross (.11 net) well. At ~~September~~June 30, ~~2022,~~2023, the Company had no further wells awaiting completion.

Permian Basin – New Mexico and Texas

●During the three and six months ended June 30, 2023, Epsilon's realized price for all New Mexico production was $47.45 per Boe.

●

Total net revenue interest production for the three and six months ended June 30, 2023 included natural gas, oil and other liquids and was 14.9 Mboe.

●In the second quarter of 2023, the Company drilled and completed 2 gross (.20 net) wells in New Mexico.

●

In Texas, the Company acquired a 25% undivided interest in 12,373 acres (3,093 net acres) in Ector County and drilled 1 gross (.25 net) well. At June 30, 2023, the Company had 1 gross ~~(.11~~(.25 net) well ~~waiting on~~awaiting completion.

Non-GAAP Financial Measures-Adjusted EBITDA

Epsilon defines Adjusted EBITDA as earnings before (1) net interest expense, (2) taxes, (3) depreciation, depletion, amortization and accretion expense, (4) impairments of natural gas and oil properties, (5) non-cash stock compensation expense, (6) gain or loss on sale of assets, (7) gain or loss on derivative contracts net of cash received or paid on settlement, and ~~(7)~~(8) other income. Adjusted EBITDA is not a measure of financial performance as determined

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under U.S. GAAP and should not be considered in isolation from or as a substitute for net income or cash flow measures prepared in accordance with U.S. GAAP or as a measure of profitability or liquidity.

Additionally, Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. Epsilon has included Adjusted EBITDA as a supplemental disclosure because its management believes that EBITDA provides useful information regarding its ability to service debt and to fund capital expenditures. It further provides investors a helpful measure for comparing operating performance on a normalized or recurring basis with the performance of other companies, without giving effect to certain non-cash expenses and other items. This provides management, investors and analysts with comparative information for evaluating the Company in relation to other natural gas and oil companies providing corresponding non-U.S. GAAP financial measures or that have different financing and capital structures or tax rates. These non-U.S. GAAP financial measures should be considered in addition to, but not as a substitute for, measures for financial performance prepared in accordance with U.S. GAAP.

The table below sets forth a reconciliation of net income to Adjusted EBITDA for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021,~~2022, which is the most directly comparable measure of financial performance calculated under U.S. GAAP and should be reviewed carefully.

~~Table of Contents~~


	Three months ended September 30,				Nine months ended September 30,				Three months ended June 30,				Six months ended June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Net income	$	9,608,453	$	1,396,466	$	25,997,329	$	3,647,008	$	430,589	$	10,582,988	$	3,960,416	$	16,388,876
Add Back:
Net interest expense		(72,137)		5,892		(93,239)		38,595
Interest (income) expense, net										(398,779)		(21,200)		(861,104)		(21,102)
Income tax expense		3,896,010		643,072		10,097,484		1,621,894		246,142		4,019,576		1,573,064		6,201,474
Depreciation, depletion, amortization, and accretion		1,706,030		1,846,911		4,898,988		5,175,865		1,615,728		1,803,739		3,388,734		3,192,958
Stock based compensation expense		500,597		300,249		836,949		738,789		179,748		194,050		359,496		336,352
Loss on derivative contracts net of cash received or paid on settlement		908,227		2,593,888		(272,150)		3,928,421
Loss (gain) on sale of assets										1,449,871		(221,642)		1,449,871		(221,642)
Loss (gain) on derivative contracts net of cash received or paid on settlement										641,380		(940,553)		(63,980)		(1,180,377)
Foreign currency translation loss		(4,750)		907		(419)		1,517		(5)		(1,071)		(987)		4,331
Adjusted EBITDA	$	16,542,430	$	6,787,384	$	41,464,942	$	15,152,089	$	4,164,674	$	15,415,887	$	9,805,510	$	24,700,870

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Results of Operations

Net Operating Revenues

For the ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 revenues ~~increased $26.1~~decreased $17.6 million, or ~~91%~~53%, to ~~$54.7~~$15.9 million from ~~$28.6~~$33.5 million during the same period of ~~2021.~~2022.

Revenue and volume statistics for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021~~2022 were as follows:


	Three months ended				Nine months ended				Three months ended				Six months ended
	September 30,				September 30,				June 30,				June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Revenues
Pennsylvania
Natural gas revenue	$	17,893,822	$	9,511,357	$	44,581,254	$	20,950,378	$	2,756,313	$	15,089,325	$	8,609,038	$	25,220,340
Volume (MMcf)		2,419		2,753		7,094		7,767		2,004		2,174		4,290		4,439
Avg. Price ($/Mcf)	$	7.40	$	3.46	$	6.28	$	2.70	$	1.38	$	6.94	$	2.01	$	5.68
Natural gas liquids revenue	$	497,843	$	490,535	$	1,500,668	$	588,685
Gathering system revenue									$	2,202,064	$	1,987,168	$	4,588,759	$	4,107,941
Total PA Revenues									$	4,958,377	$	17,076,493	$	13,197,797	$	29,328,281
New Mexico
Natural gas revenue									$	34,444	$	—	$	34,444	$	—
Volume (MMcf)										19		—		19		—
Avg. Price ($/Mcf)									$	1.78	$	—	$	1.78	$	—
Natural liquids revenue									$	69,199	$	—	$	69,199	$	—
Volume (MBO)		12.5		14.4		38.5		18.9		3.9		—		3.9		—
Avg. Price ($/Bbl)	$	39.91	$	34.02	$	38.96	$	31.13	$	17.82	$	—	$	17.82	$	—
Oil and condensate revenue	$	779,456	$	1,060,551	$	2,484,360	$	1,201,289	$	603,415	$	—	$	603,415	$	—
Volume (MBO)		7.6		15.0		24.1		17.4		7.8		—		7.8		—
Avg. Price ($/Bbl)	$	102.26	$	70.80	$	103.21	$	69.04	$	77.48	$	—	$	77.48	$	—
Gathering system revenue	$	2,072,806	$	2,038,616	$	6,180,747	$	5,891,868
Total NM Revenues									$	707,058	$	—	$	707,058	$	—
Oklahoma
Natural gas revenue									$	215,939	$	895,023	$	619,392	$	1,467,092
Volume (MMcf)										94		150		190		235
Avg. Price ($/Mcf)									$	2.29	$	5.97	$	3.25	$	6.23
Natural liquids revenue									$	175,789	$	688,397	$	372,084	$	1,002,825
Volume (MBO)										7.5		16.3		13.6		26.0
Avg. Price ($/Bbl)									$	23.49	$	42.31	$	27.44	$	38.51
Oil and condensate revenue									$	442,973	$	1,243,091	$	960,081	$	1,704,904
Volume (MBO)										6.1		11.4		12.9		16.4
Avg. Price ($/Bbl)									$	72.57	$	109.51	$	74.45	$	103.66
Total OK Revenues									$	834,701	$	2,826,511	$	1,951,557	$	4,174,821
Total Revenues	$	21,243,927	$	13,101,059	$	54,747,029	$	28,632,220	$	6,500,136	$	19,903,004	$	15,856,412	$	33,503,102

We earn gathering system revenue as a 35% owner of the Auburn Gas Gathering system. This revenue consists of fees paid by Anchor Shippers (parties listed in Anchor Shipper Gas Gathering Agreement for Northern Pennsylvania, including Epsilon Midstream, LLC) of the system to transport gas from the wellhead to the compression facility, and then to the delivery meter at the Tennessee Gas Pipeline. For the nine months ended September 30, 2022, approximately 78% of the Auburn GGS revenues earned were gathering fees, while 22% were compression fees. For the three months ended September 30, 2022, approximately 79% of the Auburn GGS revenues earned were gathering fees, while 21% were compression fees. For the nine months ended September 30, 2021, approximately 81% of the Auburn GGS revenues earned were gathering fees, while 19% were compression fees. Gathering revenues from third-party customers represented approximately 4.8% of total gathering revenues and third-party compression revenues represented 2.6% of total compression revenues. For the three months ended September 30, 2021, approximately 81% of the Auburn GGS revenues earned were gathering fees, while 19% were compression fees. Gathering revenues from third-party customers represented approximately 2.4% of revenues and third-party compression revenues represented 2.2% of revenues. Revenues derived from Epsilon’s production which have been eliminated from gathering system revenues amounted to $0.37 million and $1.1 million for the three and nine months ended September 30, 2022, respectively, and $0.43 million and $1.2 million for the three and nine months ended September 30, 2021, respectively.

Upstream natural gas revenue for the ~~nine~~six months ended ~~September~~June 30, ~~2022 increased~~2023 decreased by ~~$23.6~~$17.4 million, or ~~113%~~65%, over the same period in ~~2021. This~~2022. A decrease of $16.4 million was ~~primarily~~due to lower natural gas prices and a decrease of $1.0 million was due to lower sales volumes as a result of higher natural gas prices. For the nine months ended September 30, 2022, the average gas price increased by $3.58/Mcf, or 133%, over the same period in 2021. However, this revenue increase was partially offset by lower volumes being produced due to natural decline ofin the wells. ~~Production for the nine months ended September 30, 2022 decreased by 673 Mcf, or 9%, over the same period in 2021.~~ Upstream natural gas revenue for the three months ended ~~September~~June 30, ~~2022 increased~~2023 decreased by ~~$8.4~~$13.0 million, or ~~88%~~81%, over the same period in ~~2021. This~~2022. A decrease of $11.6 million was ~~also primarily~~due to lower natural gas prices and a decrease of $1.4 million due to lower sales volumes as a result of ~~higher natural gas prices partially offset by lower volumes being produced due to~~ natural decline ofin the wells. For the three months ended September 30, 2022, the average gas price increased by $3.94/Mcf, or 114%, over the same period in 2021. Production for the three months ended September 30, 2022 decreased by 334 Mcf, or 12%, over the same period in 2021.

Upstream natural gas liquids revenue for the ~~nine~~six months ended ~~September~~June 30, ~~2022 increased~~2023 decreased by ~~$0.9~~$0.6 million, or ~~155%,~~56% over the same period in ~~2021. This~~2022. A decrease of $0.3 million was due to lower prices and a ~~result~~decrease of ~~increased production from new wells in Oklahoma in addition~~$0.3 million was due to ~~higher prices. Natural~~lower sales volumes. Upstream natural gas liquids ~~production~~revenue for the ~~nine~~three months ended ~~September~~June 30, ~~2022 increased~~2023 decreased by ~~19.6 MBO,~~$0.4 million, or ~~104%,~~64% over the same period in ~~2021. For the nine months ended September 30, 2022, the average price for natural gas~~2022. A decrease of $0.2 million was due to lower prices and a decrease of $0.2 million was due to lower sales volumes.

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liquids increased by $7.83/Bbl, or 25%, over the same period in 2021. Upstream natural gas liquids revenue for the three months ended September 30, 2022 increased by $0.7 million, or 1%, over the same period in 2021. This was a result of higher prices offset by lower volumes being produced due to natural decline of the wells. For the three months ended September 30, 2022, the average price for natural gas liquids increased by $5.89/Bbl, or 17%, over the same period in 2021. Natural gas liquids production for the three months ended September 30, 2022 decreased by 1.9 MBO, or 13% over the same period in 2021.

Upstream oil and condensate revenue for the ~~nine~~six months ended ~~September~~June 30, ~~2022 increased~~2023 decreased by ~~$1.3~~$0.1 million, or ~~107%,~~8% over the same period in ~~2021. This~~2022. An increase of $0.5 million was ~~a result of increased production from new wells in Oklahoma in addition~~due to higher ~~prices. Oil and condensate production for the nine months ended September 30, 2022 increased~~volumes offset by ~~6.7 MBO, or 38%, over the same period in 2021. For the nine months ended September 30, 2022, the average price for oil and condensate increased by $34.17/Bbl, or 49%, over the same period in 2021.~~a decrease of $0.6 million due to lower prices. Upstream oil and condensate revenue for the three months ended ~~September~~June 30, ~~2022~~2023 decreased by ~~$0.3~~$0.2 million, or ~~27%,~~16% over the same period in ~~2021. This~~2022. An increase of $0.3 million was ~~a result of~~due to higher ~~prices~~volumes offset by ~~decreased production from new wells in Oklahoma~~a decrease of $0.5 million due to ~~natural decline of the wells. For the three~~lower prices.

Gathering system revenue increased $0.5 million, or 12%, six months ended ~~September~~June 30, ~~2022, the average price for oil and condensate increased by $31.46/Bbl, or 44%,~~2023 over the same period in ~~2021. Oil and condensate production~~2022. This was the result of anchor shipper volumes, which pay the full gathering rate, increasing from 65% to 85% of total throughput. Gathering system revenue increased by $0.2 million, or 11%, for the three months ended ~~September~~June 30, ~~2022 decreased by 7.4 MBO, or 49%~~2023 over the same period in ~~2021.~~

~~The Company’s share~~2022. This was the result of anchor shipper volumes, which pay the full gathering rate, increasing from 68% to 82% of total throughput. Revenues derived from transporting and compressing our production, which have been eliminated from gathering system ~~revenue increased by $0.3~~revenues amounted to $0.4 million ~~during~~for each of the ~~nine~~three and six months ended ~~September~~June 30, ~~2022, increasing by 5% over the same period in 2021. The Company’s share of gathering system revenue stayed constant for the three months ended September 30, 2022~~2023 and 2021. The Auburn GGS is subject to a cost of service model, whereby the Anchor Shippers dedicate acreage and reserves to the Auburn GGS. In exchange for this dedication, the owners of the Auburn system agree to a fixed rate of return on capital invested which cannot be exceeded. Therefore, rather than being subject to a fixed gathering rate, the Shippers are subject to a fluctuating gathering rate which is redetermined annually in order to produce the contractual return on capital to the Auburn GGS owners. The term of the model is fixed from 2012 to 2026. Each year, actual throughput, revenue, operating expenses and capital are captured in the model, and the remaining years are forecasted. The model then resolves a gathering rate that yields the contractual rate of return. All else being equal, to the extent that throughput is higher or capital is lower than the preceding year’s forecast, the gathering rate will decline.2022.

Operating Costs

The following table presents total cost and cost per unit of production (Mcfe), including ad valorem, severance, and production taxes for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021:~~2022:


	Three months ended September 30,				Nine months ended September 30,				Three months ended June 30,				Six months ended June 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Lease operating costs	$	2,399,092	$	2,240,259	$	6,791,496	$	5,618,584	$	1,440,521	$	2,252,017	$	2,844,800	$	3,657,507
Gathering system operating costs		225,809		138,887		556,515		503,381		570,934		541,228		1,222,275		1,065,603
	$	2,624,901	$	2,379,146	$	7,348,011	$	6,121,965	$	2,011,455	$	2,793,245	$	4,067,075	$	4,723,110

Upstream operating costs—Total $/Mcfe		0.93		0.76		0.91		0.70		0.63		0.90		0.60		0.74
Gathering system operating costs $/Mcf		0.07		0.07		0.05		0.09		0.17		0.14		0.17		0.13

Operating costs include the effects of elimination entries to remove the gathering fees paid to Epsilon’s ownership in the gathering system.

Upstream operating costs consist of lease operating expenses necessary to extract natural gas and oil, including gathering and treating the natural gas and oil to ready it for sale.

~~Upstream operating costs for~~ For the ~~nine~~six months ended ~~September~~June 30, ~~2022 increased $1.2~~2023 these costs decreased by $0.8 million, or ~~21%~~22%, over the same period in ~~2021. Upstream operating costs for~~2022. For the three months ended ~~September~~June 30, ~~2022 increased $0.2~~2023 these costs decreased by $0.8 million, or 7%36%, over the same period in ~~2021. The increase~~2022. Operating costs in ~~total cost was primarily~~2022 were increased due to ~~rising prices for services leading~~extraordinary plugging and abandonment costs related to ~~a $0.93/Mcfe and $0.91/Mcfe for~~atypical wellbore conditions in two older vintage wells in Pennsylvania, which is not representative of the ~~three and nine months ended September 30, 2022, or 24% and 29%, increase, respectively in the cost associated with operating the~~other wells.

Gathering system operating costs consist primarily of rental payments for the natural gas fueled compression ~~units. Other significant~~units and overhead fees due to the system’s operator. For the six months ended June 30, 2023, gathering system operating costs ~~include chemicals (to prevent corrosion~~increased by $0.2 million, or 15% from the same period in 2022. For the three months ended June 30, 2023, gathering system operating costs increased by $0.03 million, or 5% from the same period in 2022. This increase is due to a CPI-U adjusted increase to the G&A fee on these volumes and compressor rentals.

Depletion, Depreciation, Amortization and Accretion (“DD&A”)

Three months ended June 30,

Six months ended June 30,

2023

2022

2023

2022

Depletion, depreciation, amortization and accretion

1,615,728

1,803,739

3,388,734

3,192,958

Natural gas and oil and gathering system assets are depleted and depreciated using the units of production method aggregating properties on a field basis. For leasehold acquisition costs and the cost to ~~reduce water vapor in~~acquire proved and unproved properties, the reserve base used to calculate depreciation and depletion is total proved reserves. For natural gas ~~stream), saltwater disposal, measurement equipment / calibration~~ and ~~general project management.~~oil development and gathering system costs, the reserve base used to calculate depletion and depreciation is proved developed reserves. A reserve report is prepared as of December 31, each year.

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~~The gathering system total per unit operating costs reported include~~Depreciation expense includes amounts pertaining to our office furniture and fixtures, leasehold improvements, computer hardware. Depreciation is calculated using the ~~effects~~straight-line method over the estimated useful lives of ~~elimination entries~~the assets, ranging from 3 to ~~remove the gas gathering fees billed~~7 years. Also included in depreciation expense is an amount pertaining to buildings owned by the ~~gas gathering system operator to Epsilon’s upstream operations, and the volume associated with those fees. The elimination entries amounted to $1.1 million and $1.2 million~~Company. Depreciation for the ~~nine months ended September~~buildings is calculated using the straight-line method over an estimated useful life of 30 ~~2022 and 2021, respectively and $0.37 million and $0.43 million~~years.

Accretion expense is related to the asset retirement costs.

DD&A expense for the three and six months ended ~~September~~June 30, ~~2022~~2023 was consistent compared to the same periods in 2022.

Loss (gain) on sale of assets

Three months ended June 30,

Six months ended June 30,

2023

2022

2023

2022

Loss (gain) on sale of assets

1,449,871

(221,642)

1,449,871

(221,642)

Epsilon sold two Oklahoma assets in April 2023 and ~~2021, respectively (see Note 11, ‘‘Operating Segments,’’~~one Oklahoma asset in April 2022. Loss on sale of assets increased by $1.7 million during the ~~Notes to Unaudited Condensed Consolidated Financial Statements).~~

~~Gathering system costs (net of intercompany elimination) for the nine~~three and six months ended ~~September~~June 30, 2023 from 2022 due to the assets sold in 2023 having a larger net book value than the asset sold in 2022.

General and Administrative (“G&A”)

Three months ended June 30,

Six months ended June 30,

2023

2022

2023

2022

General and administrative

1,776,374

1,659,193

3,979,895

2,972,627

G&A expenses consist of general corporate expenses such as compensation, legal, accounting and professional fees, consulting services, travel and other related corporate costs such as stock options granted and restricted shares of stock granted and the related non-cash compensation.

G&A expenses increased ~~$0.05~~by $1.0 million, or ~~11%~~35%, ~~over~~during the ~~same period in 2021. Gathering system costs (net of intercompany elimination) for the three~~six months ended ~~March 31, 2022 increased $0.09 million, or 63%, over the same period in 2021.~~

~~The Company’s share of total gathering system costs increased $0.09 million, or 7%, for the nine months ended September~~June 30, ~~2022 over 2021. The Company’s share of total gathering system costs increased $0.05 million, or 12%, for the three months ended September 30, 2022 over 2021.~~2023 from 2022. This ~~increase is~~was primarily due to an increase of $0.7 million in ~~throughput volumes into~~compensation, $0.6 million from management transition and $0.1 million from Board of Directors pay adjustment, and an increase of $0.3 million in other service fees. G&A expenses increased by $0.1 million, or 7%, during the ~~gathering system.~~three months ended June 30, 2023 from 2022. This was primarily due to a $0.3 million increase in compensation, $0.2 million from management transition and $0.1 million from Board of Directors pay adjustment, offset by a decrease of $0.2 million in legal fees.

Interest Expense

Three months ended June 30,

Six months ended June 30,

2023

2022

2023

2022

Interest expense

34,422

745

62,859

16,064

Interest expense relates to the fees paid on the revolving credit facility.

Interest expense for the three and six months ended June 30, 2023 and 2022 increased as a result of the reduction in the borrowing base during 2022 and an increase in the borrowing base in 2023.

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~~Loss~~Gain (Loss) on Derivative Contracts

Three months ended September 30,

Nine months ended September 30,

Three months ended June 30,

Six months ended June 30,

2022

2021

2022

2021

2023

2022

2023

2022

Loss on derivative contracts

(929,637)

(5,055,130)

(1,124,547)

(6,417,123)

Gain (loss) on derivative contracts

628,178

776,994

1,696,838

(194,910)

For the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023, Epsilon had NYMEX HH Natural Gas Futures swaps and ~~2021, Epsilon entered into NYMEX Henry Hub two-way costless collar and~~ Tennessee Gas Pipeline Zone 4 basis swap derivative contracts for the purpose of hedging a portion of its physical natural gas sales revenue. For the three and six months ended June 30, 2022, Epsilon had NYMEX HH two-way collars and Tennessee Gas Pipeline Zone 4 basis swap derivative contracts for the same hedging purpose. During the three and ~~nine~~six months ended ~~September~~June 30, 2023, we received cash settlements of $1,272,970 and $1,632,858, respectively. During the three and six months ended June 30, 2022, we paid net cash settlements of ~~$21,410~~$163,559 and ~~$1,396,697, respectively. During the three and nine months ended September 30, 2021, we paid net cash settlements of $2,461,242 and $2,488,702,~~$1,375,287, respectively.

For the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, realized ~~losses~~gains on derivative contracts ~~decreased as~~increased primarily due to the ~~Company had less volume hedged and the~~decrease in NYMEX ~~Henry Hub~~HH Natural Gas Futures ~~price settled close to the strike~~ prices resulting in an increase in value of the ~~Henry Hub collars.~~NYMEX HH swaps. As of ~~September~~June 30, ~~2022,~~2023, the Company had no derivative contracts beyond ~~December 31, 2022.~~October 2023.

Capital Resources and Liquidity

Cash Flow

The primary source of cash for Epsilon during the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 and ~~2021~~2022 was funds generated from operations. The primary uses of cash for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022~~2023 were development of natural gas properties, investment in U.S. Treasury Bills, the repurchase of shares of common stock, and the distribution of dividends. The primary uses of cash for the three and ~~nine~~six months ended ~~September~~June 30, ~~2021~~2022 were development of natural gas properties, ~~and~~ the repurchase of shares of common ~~stock.~~stock, and the distribution of dividends.

At ~~September~~June 30, ~~2022,~~2023, we had a working capital surplus of ~~$40.6~~$39.2 million, ~~an increase~~a decrease of ~~$16.4~~$10.1 million ~~over~~from the ~~$24.1~~$49.2 million surplus at December 31, ~~2021.~~2022. The Company anticipates its current cash balance, short term investments, available borrowings, and cash flows from operations ~~and available sources of liquidity~~ to be sufficient to meet its cash requirements for at least the next twelve ~~months and beyond.~~months.

~~Three and nine~~Six months ended ~~September~~June 30, ~~2022~~2023 compared to ~~2021~~2022

During the ~~nine~~six months ended ~~September~~June 30, ~~2022, $29.4~~2023, $10.2 million was provided by the Company’s operating activities, compared to ~~$13.5~~$15.8 million provided during the same period in ~~2021,~~2022, a ~~$15.9~~$5.6 million, and 117% increase. The increase was mainly due to increased cash from operations as a result of increased commodity prices, partially offset by the losses created on the hedges as they matured. During the three months ended September 30, 2022, $13.7 million was provided by the Company’s operating activities, compared to $5.5 million provided during the same period in 2021, a $8.2 million, and 149% increase. The increase was mainly due to increased cash from operations as a result of increased commodity prices.35% decrease.

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The Company used ~~$0.7 million and $5.7~~$40.0 million of cash for investing activities during the ~~three and nine~~six months ended ~~September~~June 30, ~~2022, respectively.~~2023. The Company had a $26.5 million net investment in U.S Treasury Bills and $13.5 million on leasehold and development costs targeting increasing production in Pennsylvania, Texas, New Mexico, and Oklahoma. The Company used $5.0 million of cash for investing activities during the six months ended June 30, 2022. This was spent primarily on leasehold and development costs targeting increasing production in Pennsylvania and Oklahoma. The Company used $2.1 million and $3.8 million of cash for investing activities during the three and nine months ended September 30, 2021, respectively. This was spent primarily on leasehold and development costs targeting increasing production in Pennsylvania.

The Company used ~~$3.6 million and $9.9~~$5.9 million of cash for financing activities during the ~~three and nine~~six months ended ~~September~~June 30, ~~2022, respectively.~~2023 compared to $6.3 million during the same period in 2022. This was spent primarily on dividend payments and the repurchase of shares of common stock. The Company used $1.3 million and $2.4 million of cash for financing activities during the three and nine months ended September 30, 2021. This cash was spent on the repurchase of common shares of the Company.

Credit Agreement

~~In addition, the~~The Company ~~has~~closed a senior secured reserve based revolving credit facility ~~which includes a total~~on June 28, 2023 with Frost Bank as issuing bank and sole lender. The new facility replaced the Company’s previous facility. The initial commitment ~~of up to $100 million. The current effective~~and borrowing base is ~~$14~~$35 million, ~~which is~~supported by the Company’s upstream assets in Pennsylvania and subject to semi-annual ~~redetermination.~~redeterminations with a maturity date of the earlier of June 28, 2027 or the date that the commitments are terminated. Interest will be charged at the Daily Simple SOFR rate plus a margin of 3.25%. The facility is secured by the assets of the Company’s Epsilon Energy USA subsidiary (Borrower). There are currently no borrowings under the facility. If Epsilon decides to access the facility, depending on the level of borrowing, the Company will need to increase its hedging activity. Borrowings from the Facility may be used for the acquisition and development of oil and gas properties, investments in cash flow generating assets complimentary to the production of oil and gas, and for letters of credit and other general corporate purposes. Upon each advance, interest is charged at the highest of a) rate of LIBOR plus an applicable margin (3.25%-4.25% based on the percent of the line of credit utilized) with the minimum being 0.25%, b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5%.

~~Effective April 6, 2021 the agreement was amended to extend the maturity date to March 1, 2024. In addition, the agreement was amended to include a~~ ~~Benchmark Replacement~~ ~~definition and transition plan to be used at such time when the LIBOR rate is discontinued.~~

~~On August 2, 2022, the borrowing base of $14 million was reaffirmed until the next periodic redetermination of the borrowing base.~~

The bank has a first priority security interest in the tangible and intangible assets of Epsilon Energy USA, Inc. to secure any outstanding amounts under the agreement. Under the terms of the agreement, the Company must maintain the following covenants:

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

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

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

Epsilon was in compliance with the financial covenants of the agreement as of September 30, 2022 and expect to be in compliance for the next 12 months. We expect to remain in compliance as we currently have no borrowings under the facility and funded all operations for 2021 and all operations through September 30, 2022 out of operating cash flow and cash on hand, and expect to continue to do so through 2022.

Balance at

Balance at

September 30,

December 31,

Borrowing Base

Interest


2022

2021

September 30, 2022

Rate
Revolving line of credit

$
—

$
—

$
14,000,000

3 mo. LIBOR + 3.25%

~~Repurchase Transactions~~

Commencing on March 8, 2022, Epsilon conducted a normal course issuer bid (“NCIB”) to repurchase our issued and outstanding common shares, when doing so was accretive to management's estimates of intrinsic value per share. The NCIB ends on March 7, 2023. The Company used discretionary cash to fund these repurchases. During the nine months ended September 30, 2022, Epsilon repurchased 982,500 common shares of the authorized 1,183,410 purchase amount and spent $6,234,879 under the NCIB. The repurchased stock had an average price of $6.32 per share (excluding

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~~commissions). During~~Under the ~~three and nine months ended September 30, 2022,~~terms of the facility, the Company ~~cancelled zero and 423,000~~must adhere to the following financial covenants:

●

Current ratio of 1.0 to 1.0 (current assets / current liabilities)

●

Leverage ratio of less than 2.5 to 1.0 (total debt / income adjusted for interest, taxes and non-cash amounts)

Additionally, if the Leverage ratio is greater than 1.0 to 1.0, or the borrowing base utilization is greater than 50%, the Company is required to hedge 50% of the anticipated production from PDP reserves for a rolling 24 month period.

Repurchase Transactions

On March 9, 2023, the Board of Directors authorized a new share repurchase program of up to 2,292,644 common shares, ~~respectively.~~

~~Commencing on January 1, 2021,~~representing 10% of the outstanding common shares of Epsilon, ~~conducted~~for an aggregate purchase price of not more than US $15.0 million. The program is pursuant to a normal course issuer bid ~~(“NCIB”) to repurchase our issued~~ and ~~outstanding~~will be conducted in accordance with Rule 10b-18 under the Exchange Act. The program commenced on March 27, 2023 and will end on March 26, 2024, unless the maximum amount of common shares ~~when doing so was accretive to management's estimates~~is purchased before then or Epsilon provides earlier notice of ~~intrinsic value~~termination. During the six months ended June 30, 2023, we repurchased 372,275 common shares at an average price of $5.19 per ~~share.~~ share (excluding commissions) under the new plan.

The ~~NCIB~~previous share repurchase program commenced on March 8, 2022. During the year ended on December 31, ~~2021. The Company used discretionary cash to fund these repurchases. During the nine months ended September 30, 2021, Epsilon~~2022, we repurchased ~~525,615~~982,500 common shares of the maximum of 1,183,410 authorized ~~1,193,000 purchase amount~~for repurchase and spent ~~$2,377,181~~$6,234,879 under the ~~NCIB.~~plan. The repurchased stock had an average price of ~~$4.51~~$6.32 per share (excluding commissions). and was subsequently retired during the year ended December 31, 2022. In 2023, we repurchased and retired 190,700 common shares at an average price of $5.82 per share (excluding commissions) before the plan terminated on March 7, 2023.

During the six months ended June 30, 2023, the Company repurchased 562,975 shares at an average price of $5.40 per share (excluding commissions) under the two consecutive repurchase programs.

Derivative Transactions

The Company has entered into hedging arrangements to reduce the impact of natural gas price volatility on operations. By reducing the price volatility from a ~~significant~~ portion of natural gas production, the potential effects of changing prices on operating cash flows have been partially mitigated, but not eliminated. While mitigating the negative effects of falling commodity prices, these derivative contracts also limit the benefits we might otherwise receive from increases in commodity prices.

At ~~September~~June 30, ~~2022,~~2023, Epsilon’s outstanding natural gas commodity contracts consisted of the following:

Volume

Ceiling

Floor

Basis

Fair Value of Asset
Derivative Type

(MMbtu)

Price

Price

Differential

September 30, 2022
2022

Basis swap

305,000

$
—

$
—

$
(1.15)

(4,837)
Two-way costless collar

305,000

$
8.20

$
6.50

$
—

37,163

610,000

$
32,326


		Weighted Average Price ($/MMbtu)
	Volume			Basis		Fair Value of Asset
Derivative Type	(MMbtu)	Swaps		Differential		June 30, 2023
2023
NYMEX Henry Hub swap	460,000	$	5.21	$	—	$	1,106,445
Tennessee Z4 basis swap	460,000	$	—	$	(1.25)		179,625
	920,000					$	1,286,070

Contractual Obligations

The Company enters into commitments for capital expenditures in advance of the expenditures being made. As of ~~September~~June 30, ~~2022,~~2023, the Company had short term commitments of ~~$0.4~~$1.6 million for capital expenditures and long term commitments of $7.4 million for asset retirement obligations.

~~Based on current natural gas prices and anticipated levels~~34

Table of production, we believe that the estimated net cash generated from operations, together with cash on hand and amounts available under our credit agreement, will be adequate to meet liquidity needs for the next 12 months and beyond, including satisfying our financial obligations and funding our operating and development activities.Contents

~~Off-Balance Sheet Arrangements~~

~~As of September 30, 2022, the Company had no off-balance sheet arrangements.~~

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our earnings and cash flow are significantly affected by changes in the market price of commodities. The prices of natural gas and oil can fluctuate widely and are influenced by numerous factors such as demand, production levels, world political and economic events, and the strength of the US dollar relative to other currencies. Should the price of natural gas and oil decline substantially, the value of our assets could fall dramatically, impacting our future operations and exploration and development activities, along with our gas gathering system revenues. In addition, our operations are exposed to market risks in the ordinary course of our business, including interest rate and certain exposure as well as risks relating to changes in the general economic conditions in the United States.

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Gathering System Revenue Risk

The Auburn Gas Gathering System lies within the Marcellus Basin with historically high levels of recoverable reserves and low cost of production. We believe that a short-term low commodity price environment will not significantly impact the reserves produced and thus the revenue of our gas gathering system.

Interest Rate Risk

Market risk is estimated as the change in fair value resulting from a hypothetical 100 basis point change in the interest rate on the outstanding balance under our credit agreement. The credit agreement allows us to fix the interest rate for all or a portion of the principal balance for a period up to three months. To the extent that the interest rate is fixed, interest rate changes affect the instrument’s fair market value but do not affect results of operations or cash flows. Conversely, for the portion of the credit agreement that has a floating interest rate, interest rate changes will not affect the fair market value but will affect future results of operations and cash flows.

At ~~September~~June 30, ~~2022~~2023 and ~~2021,~~2022, the outstanding principal balance under the credit agreement was nil.

Derivative Contracts

The Company’s financial results and condition depend on the prices received for natural gas production. Natural gas prices have fluctuated widely and are determined by economic and political factors. Supply and demand factors, including weather, general economic conditions, the ability to transport the gas to other regions, as well as conditions in other natural gas regions, impact prices. Epsilon has established a hedging strategy and may manage the risk associated with changes in commodity prices by entering into various derivative financial instrument agreements and physical contracts. Although these commodity price risk management activities could expose Epsilon to losses or gains, entering into these contracts helps to stabilize cash flows and support the Company’s capital spending program.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Our principal executive officer and principal financial officer have concluded that our current disclosure controls and procedures were effective as of ~~September~~June 30, ~~2022~~2023 at the reasonable assurance level.

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Changes in Internal Control over Financial Reporting

No changes in our internal control over financial reporting occurred during the quarter ended ~~September~~June 30, ~~2022~~2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control

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over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that of limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, the risk.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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 on a narrow issue 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. AOral argument was held in January 2023. We are awaiting a decision on the ~~appeal is not expected until early to mid-2023.~~

appeal.

ITEM 1A. RISK FACTORS

There have been no material changes from the risk factors disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022.

ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table contains information about our acquisition of equity securities during the ~~nine~~six months ended ~~September~~June 30, ~~2022.~~2023.

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				Maximum number
				of shares
	Total number	Average price		remaining to be
	of shares	paid per		purchased under
	purchased	share		the program
Beginning of normal-course issuer bid, March 8, 2022⁽¹⁾					1,183,410
January 2023	125,200	$	5.96
February 2023	65,500	$	5.63
Total as of March 7, 2023	190,700	$	5.82		10,210

Beginning of normal-course issuer bid, March 27, 2023⁽²⁾					2,292,644
March 2023	47,220	$	5.32
April 2023	70,406	$	5.35
May 2023	83,097	$	5.11
June 2023	171,552	$	5.13
Total as of June 30, 2023	372,275	$	5.11		1,920,369

(1)

~~Commencing~~Epsilon repurchased these shares under its 2022-2023 share repurchase program that commenced on March 8, 2022 ~~the Company entered into a~~and terminated on March 7, 2023.

(2)

Epsilon repurchased these shares under its 2023-2024 share repurchase program on the NASDAQ conducted in accordance with Rule 10b-18 promulgated under the Securities Exchange Act of 1934. The Company is authorized to repurchase up to 1,183,410 of its outstanding common shares up to an aggregate purchase price limit of $8 million, representing 5% of the outstanding common shares. The program will endthat commenced on March ~~7, 2023 unless the common shares or purchase price limits are reached before then or Epsilon provides earlier notice of termination.~~27, 2023.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. —EXHIBITS




Exhibit No.		Description of Exhibit

31.1		Sarbanes-Oxley Section 302 certification of Principal Executive Officer.

31.2		Sarbanes-Oxley Section 302 certification of Principal Financial Officer.

32.1		Sarbanes-Oxley Section 906 certification of Principal Executive Officer.

32.2		Sarbanes-Oxley Section 906 certification of Principal Financial Officer.

101.INS		Inline XBRL Instance Document.

101.SCH		Inline XBRL Schema Document.

101.CAL		Inline XBRL Calculation Linkbase Document.

101.DEF		Inline XBRL Definition Linkbase Document.

101.LAB		Inline XBRL Labels Linkbase Document.

101.PRE		Inline XBRL Presentation Linkbase Document.

104		Cover Page Interactive Data File (embedded within the Inline XBRL document)

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


Epsilon Energy Ltd.
(Registrant)

Date: ~~November~~August 10, ~~2022~~2023	By:	/s/ J. Andrew Williamson
		J. Andrew Williamson
		Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)


				Maximum number
				of shares that
				may yet be
	Total number	Average price		purchased under
	of shares	paid per		the plans or
	purchased	share		programs
Beginning of normal-course issuer bid, March 8, 2022					1,183,410
March 2022⁽¹⁾	—	$	—
April 2022⁽¹⁾	23,700	$	6.63
May 2022⁽¹⁾	254,500	$	6.99
June 2022⁽¹⁾	418,900	$	6.21
July 2022⁽¹⁾	249,800	$	5.83
August 2022⁽¹⁾	33,200	$	6.09
September 2022⁽¹⁾	2,400	$	6.00
Total as of September 30, 2022	982,500	$	6.32		200,910


Year ended
December 31,	Payments
2022	$	46,833
2023		62,444
	$	109,277


								Fair Value
	Volume	Ceiling		Floor		Basis		September 30,
Derivative Type	(MMbtu)	Price		Price		Differential		2022
2022
Basis swap	305,000					$	(1.15)		(4,837)
Two-way costless collar	305,000	$	8.20	$	6.50				37,163
								$	32,326