Epsilon Energy Ltd.

Good morning and welcome to the Epsilon Energy second quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Andrew Williamson, Chief Financial Officer. Please go ahead.

Thank you, operator, and on behalf of the management team, I would like to welcome all of you to today's conference call to review Epsilon's second quarter 2023 financial and operational results. Before we begin, I'd like to remind you that our comments may include forward-looking statements. It should be noted that a variety of factors could cause Epsilon's actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements. Today's call may contain certain non-GAAP financial measures. Please refer to the earnings release that we issued yesterday for disclosures on forward-looking statements and reconciliations of non-GAAP measures. With that, I'd like to turn the call over to Jason Stabell, our Chief Executive Officer.

Thank you, Andrew. Good morning to everyone, and thank you for participating in the Epsilon Energy Second Quarter 2023 Conference Call. Andrew and I are joined by Henry Clanton, our COO. We will be available to answer questions later in the call. I hope you have had a chance to review our press release, as I will not go through it in detail, but I would like to touch on a few highlights before I turn the call over to Andrew and Henry for their comments. I am pleased to report that we delivered a productive quarter, advancing several key initiatives, despite natural gas pricing headwinds in the Marcellus. We closed investments in two areas in the Permian Basin, adding geographic, operator, and commodity diversity to our business. We also expanded our liquidity by $5 million under a new $35 million credit facility with reduced costs and increased flexibility. Finally, our strong balance sheet allowed us to opportunistically purchase year-to-date almost 5% of our shares outstanding at an average cost of $5.21 per share. Net of our investments, we had no free cash flow in the quarter for the first time during my tenure. This is due to the depressed pricing for natural gas, especially in our area of the Marcellus, and the significant leasehold and drilling capital investments we made in the Permian. We have been active yet disciplined in our pursuit of new investments, and you should expect that to continue. Some opportunities, such as our recent one in New Mexico, will be accretive day one, while others, such as Ector County, will contribute over longer periods of time with the pace of development. What doesn't change is our focus on deploying our resources to create durable growth in our per share equity value. Now I'd like to turn the call over to Andrew and Henry for some comments on our finances and operations.

Thank you, Jason. I'd like to highlight the new credit facility with Frost Bank, which we closed in June. As evidenced by our balance sheet and history, we take a cautious approach to the use of leverage in our capital structure. That said, we think it's important to have available liquidity to take advantage of attractive opportunities. both acquisitions and investments in our existing asset base as they present themselves. We added four years of term and $5 million of liquidity with the new deal on what we believe are commercially attractive terms. On the recently announced transactions in the Permian, we've started to see contribution from the liquids volumes during the quarter with the New Mexico wells, partially offsetting the revenue declines in Pennsylvania on lower natural gas wellhead prices. And we expect to see more of this in the second half of the year as the first Texas wells come online. The large acreage position in Ector County provides a path for growth through the drill bit, in addition to our substantial remaining location inventory in the Marcellus. Now to Henry for comments on the operations.

Thank you, Andrew. In the northern Delaware Basin in Eddy County, New Mexico, the company participated in two horizontal Wolf Camp wells. Based upon flow back results today, we are pleased to report the productivity of these wells are exceeding projections. On the Central Basin platform in Ector County, the appraisal program in this Mississippi and Barnett project is ongoing. Following the drilling of the initial well in the second quarter, the second well is currently drilling with back-to-back completions planned for late in the third quarter and first production expected in the fourth quarter. As previously reported, The initial appraisal plans for this 12,000 plus acre project call for an additional two to four gross wells in 2024. Thank you, guys.

Operator, we can now open the line for questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble the roster. Once again, if you would like to ask a question, please press star, then one. Our first question will come from Tom McIntyre of MFF. Please go ahead.

Yes, good morning, gentlemen. Maybe you could just comment a little bit on your strategies and thoughts on natural gas pricing as we head into end of this year, next year, because I know you did some hedging, and I don't know if that's just going to roll off, or just if you have a strategy yet or how you think about it.

Thanks, Tom. Yeah. We had some fear that we'd see an overbuild on inventories as we were coming out of last winter, and clearly that's played out. We had put some hedges on as a precautionary hedge to that outcome. In retrospect, obviously we would have liked to have had more on hedge. At present, we don't have any additional hedges extending beyond October. We do We do agree that they will be a strengthening as we head into winter. I think that the key determinant at this point is where do we end fall inventory builds in early November. Right now, draws or builds have rolled over just a little bit. So I think there's some hope that we're going to come in in the winter here and realize something close to where we are on Strip. Short answer is we don't yet have any plans for additional hedges. It's something we watch very closely. We're going to be watching the inventories. For us in Marcellus, obviously, there's not a lot of in-basin demand, so really the weather coming into the shoulder season here is going to be a big determinant for us and how we might act proactively on a hedging basis.

The strip for next year, next year, the rest of this year, next year, it looks to be quite better than what turned out to be reality this year. Is that good enough for you, or do you just want to see some more factors before you would make a decision?

Yeah, I think the key thing, obviously, will be weather, and what everybody's waiting for is some sort of moderation of production in the gas basins, primarily in the Haynesville and what's coming out of the midland. I think those are going to be the big drivers on inventories. We're starting to see some of that production moderate, or at least the growth moderate. So again, a combination of normal weather and continued moderation on the gas side is probably going to set us up for better pricing as we head into the winter. I'm certainly no expert. We watch it very closely, so we've been surprised. Again, what we tell people is our balance sheet affords us the opportunity to be opportunistic around the hedge program. That played out well in the position that we put on. That said, it's really hard to lean in on a big hedge position when you have the liquidity that we do. We monitor it closely. It's a big piece of our forward cash flow. So it's something that you may see us put some more hedges on. But at this point, we don't have any firm plans to do it. Right.

I guess one of the things I'm just trying to, in my own mind, forget either anybody's trying to outguess where the market's going to go. If it just went to where the strip is now, wouldn't that be a substantial uptick for you folks next year versus even what you did this year with the hedging that you did? Oh, absolutely.

Yes, absolutely. Our Marcellus net back average in the second quarter was something in the 135 and MCF range, so that's pretty ugly. We've had periods where we've been down near a dollar or below in the history of this company, but certainly that's as bad as we've been in the Marcellus since 2021, 2020. period. So certainly what happens in the Marcellus, because there's not a big in-basin demand, is we're at the very end of the demand structure. So the netbacks get pretty gnarly in the summertime when gas is flowing to the Gulf Coast and storage down there. And we're at the very end of that line where we sit in the northeastern part of the Marcellus on the takeaway.

Well, it seems to me, as you say, with your balance sheet and with the better stripped out to the future than what we experienced. Of course, the strip a year ago was great, too. But not knowing the future, it just seems like you're in a much better position. The industry is in a much better position. And you're in a stronger position to be cute with, not cute, but to wait to see how things play out in the event you do want to hedge or just want to play it. But I think as it is now, you would have a much improved winter, spring 24 than you had even with the hedges you put on in 23. So, and, you know, things can change, but it seems like they're changing in your favor, not the other way around like we were last year.

Yeah, I think that's a good bet when we're in the low single-digit dollars here on prices that we've got more upside exposure than we do downside. And as I said, Activity is really moderated in the Marcellus. Haynesville is starting to roll over. So given some normal weather, I think we're biased to the upside. But it's something we're just going to have to watch. And really the next 90 days is going to be critical to what the strip is going to look like in the winter and through next year.

And as far as the recent uptick, which might have some legs in oil itself, does that make it harder for you to find more expansion in the Permian or wherever you're looking? I imagine prices have risen to reflect that, but is there anything in your mind you want to say about that?

No. We're active at looking at things. We're excited about the Ector County. We'll have more to report on that on the next call. By that time, we should have completed those first two wells by the time we have our third quarter conference call. And as Henry mentioned, At this point, we're going to sit with the operator in the early part of the fourth quarter and lay out a plan for Ector County activity next year. But our initial guide on that is two to four gross wells. So we're a quarter of that. So that would be anywhere from a half to a full well. As far as additional opportunities, what we've been looking at most focused opportunities I think we'll continue to lean that way. Obviously the PDP market we find to be pretty unattractive just because it's so competitive. But we've looked at a constellation of different things and we'll continue to do so. But nothing imminent to report today on that front.

Thanks. I think, lastly, the press release referred to, after the quarter ended, I think, a buyback of a half a million share block in the stock. I kind of watched it carefully. I don't remember seeing a volume spike like that. Obviously, it happened. Was that a privately negotiated transaction, or was that done on the market? I don't remember seeing a block like that.

It was done on the market at the very beginning of July.

Right after the holiday, July 6th. Okay.

I'll go back and find out. It wasn't done with an insider or a major shareholder, I don't believe, but I can figure that out myself since I missed it. That's right. So I'm glad to see it. It got a good price. Thank you.

Thanks. Thanks, Tom.

This concludes our question and answer session. I would like to turn the conference back over to Jason Stabell, CEO, for any closing remarks.

Thank you, operator. I appreciate everybody taking the time to join us today for the call. And as always, appreciate your interest and support for Epsilon. And we look forward to hearing from you as we go forward. And have a great weekend. Thank you.

The conference is now concluded. Thank you for attending today's presentation and you may now disconnect.