Commodity Risk Management Activities

9 Months Ended

Sep. 30, 2021

Commodity Risk Management Activities

Commodity Risk Management Activities

12. Commodity Risk Management Activities

Commodity Price Risks

Epsilon engages in price risk management activities from time to time. These activities are intended to manage Epsilon’s exposure to fluctuations in commodity prices for natural gas by securing fixed price contracts for a portion of expected sales volumes.

Inherent in the Company’s fixed price contracts, are certain business risks, including market risk and credit risk. Market risk is the risk that the price of 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. The Company does not currently require collateral from any of its counterparties nor does its counterparties require collateral from the Company. Additionally, there is a risk that gas prices could fall to a level low enough to affect the volumes flowing through the gathering system.

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) 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 months ended September 30, 2021, Epsilon recognized losses on commodity derivative contracts of $5,055,130 and $6,417,123, respectively. This amount included settlements on these contracts of $2,461,242 and $2,488,702, respectively. For the three and nine months ended September 30, 2020, Epsilon recognized gains on commodity derivative contracts of $419,879 and $2,055,548, respectively. This amount included settlements on these contracts of $1,657,323 and $4,035,092, respectively.

Commodity Derivative Contracts

Presented below is a summary of Epsilon’s natural gas price and basis swap contracts as of September 30, 2021.

								Fair Value
	Volume	Ceiling		Floor		Basis		September 30,
Derivative Type	(MMbtu)	Price		Price		Differential		2021
2021
Basis swap	—					$	—		—
Two-way costless collar	610,000	$	3.34	$	2.80				(1,589,765)
2022
Two-way costless collar	900,000	$	3.34	$	2.80				(2,338,656)
								$	(3,928,421)

As of September 30, 2021, 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,
	2021		2020
Current
Basis swap	$	—	$	—
Two-way costless collar		87,218		—
	$	87,218	$	—

	Fair Value of Derivative  Liabilities
	September 30,		December 31,
	2021		2020
Current
Basis swap	$	—	$	—
Two-way costless collar		(4,015,639)		—
	$	(4,015,639)	$	—
Net Fair Value of Derivatives	$	(3,928,421)	$	—

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,
	2021		2020		2021		2020
Fair value of asset (liability), beginning of the period	$	(1,334,533)	$	1,257,702	$	—	$	1,999,802
Gains (losses) on derivative contracts included in earnings		(5,055,130)		419,879		(6,417,123)		2,055,548
Settlement of commodity derivative contracts		2,461,242		(1,657,323)		2,488,702		(4,035,092)
Fair value of asset, end of the period	$	(3,928,421)	$	20,258	$	(3,928,421)	$	20,258