Executive Summary / Key Takeaways

• Epsilon Energy has successfully diversified beyond its historical Marcellus Shale focus, establishing positions in the Permian Basin and Western Canada, which is now yielding significant operational and financial benefits.
• The first quarter of 2025 marked a strong rebound for the Marcellus assets, with upstream cash flows increasing over 200% sequentially driven by a 58% production increase and 70% higher realized gas prices, alongside a 140% sequential increase in midstream cash flows.
• The company maintains a robust financial position with over $50 million in liquidity, including an undrawn $45 million credit facility, enabling disciplined capital allocation towards growth projects and consistent shareholder returns via dividends and share repurchases.
• Planned capital expenditures for the remainder of 2025 are focused on delineating and developing assets in Texas and Alberta ($9 million to $12 million total), with Marcellus development expected to resume in late 2026 or early 2027.
• While lacking proprietary technological moats compared to larger peers, Epsilon's competitive advantages lie in its strong balance sheet, diversified asset base mitigating commodity-specific risk, and opportunistic approach to acquiring and developing economic inventory.

A Strategic Pivot Paying Off: From Marcellus Anchor to Multi-Basin Player

Epsilon Energy Ltd. (NASDAQ:EPSN), an independent natural gas and oil company, has historically been anchored in the Marcellus Shale of Pennsylvania, where it holds a significant upstream position and a 35% interest in the Auburn Gas Gathering System. However, recent years have seen a deliberate and strategic evolution, transforming Epsilon into a more diversified North American onshore player with meaningful footprints in the Permian Basin of Texas and the Western Canadian Sedimentary Basin in Alberta. This pivot, driven by a commitment to disciplined capital allocation and opportunistic investment, is now demonstrably impacting the company's financial and operational trajectory.

The energy landscape is intensely competitive, populated by larger, often more technologically advanced operators. Giants like Chesapeake Energy (CHK) and EQT Corporation (EQT) dominate the Marcellus with vast scale and sophisticated operational techniques, including EQT's reported use of AI-driven optimization for faster well processing and lower costs. In oil-focused basins like the Permian and Anadarko, companies such as Devon Energy (DVN) leverage scale and efficiency to achieve lower extraction costs. CNX Resources (CNX) competes effectively in the Marcellus with a focus on cost efficiency and lower emissions.

In this environment, Epsilon does not primarily compete on proprietary technological differentiation. While the company utilizes standard industry practices, its competitive advantages stem from other pillars: a conservative financial structure, a diversified asset base that mitigates commodity-specific price risk, and a focus on acquiring and developing economic inventory at attractive entry costs. Compared to larger peers, Epsilon operates at a smaller scale, which can translate to higher operating costs per unit than the most efficient operators like EQT or CNX. For instance, competitive analysis suggests EQT can achieve 10-15% lower upfront well costs and 25-30% faster processing speeds, while CNX may have 15% lower operating costs per unit due to more efficient gathering systems. DVN reportedly achieves 20% greater efficiency in oil extraction than some smaller players. Epsilon's operational approach, while effective for its scale, does not currently incorporate the advanced technological optimizations seen in some larger rivals. Its strength lies in prudent financial management and strategic asset selection.

The company's history provides crucial context for this strategic shift. Facing challenging natural gas markets in 2024, characterized by sub-$2 per Mcf net wellhead pricing and significant production curtailments (estimated 20-25% net total) and deferred turn-in-lines in the Marcellus, Epsilon's Pennsylvania business experienced a trough in the second and third quarters of 2024. This environment underscored the importance of diversification.

Performance Reflecting Strategic Success and Market Recovery

The first quarter of 2025 showcased the benefits of this diversification and a significant recovery in the Marcellus. Total revenue surged by 102% to $16.16 million for the three months ended March 31, 2025, compared to $7.99 million in the same period of 2024. This dramatic increase was primarily fueled by the Pennsylvania assets.

Marcellus upstream cash flows saw a sequential increase of over 200%, driven by a 58% increase in net revenue interest natural gas production (2.6 Bcf in Q1 2025 vs. 1.56 Bcf in Q1 2024) and a 70% increase in realized natural gas prices ($3.92 per Mcf in Q1 2025 vs. $1.77 per Mcf in Q1 2024). This production increase resulted from previously delayed turn-in-line wells coming online and the cessation of operator-elected well shut-ins that impacted 2024 volumes. The realized price increase benefited from marketing flexibility and strong cash market conditions during the winter.

The Gas Gathering segment also benefited, with midstream cash flows increasing 140% sequentially. Although reported gathering system revenue (net of elimination) saw a slight decrease to $1.89 million in Q1 2025 from $1.94 million in Q1 2024, the segment's operating income increased by 8.3% to $1.57 million, reflecting improved operational leverage as throughput volumes increased. Total throughput on the Auburn GGS was 129 MMcf/d (4.1 Bcf net to Epsilon) in Q1 2025. The recent lowering of the Auburn GGS operating pressure to 450 psi from 550 psi is expected to provide a 15% uplift to proved developed producing volumes gathered on the system in 2025, further enhancing midstream performance.

The Permian Basin continued to contribute meaningfully. Upstream oil and condensate revenue increased by 20% in Q1 2025, driven by additional sales volumes from new wells drilled and acquired, partially offset by slightly lower prices ($72.72/Bbl in Q1 2025 vs. $73.87/Bbl in Q1 2024). Total Permian production rose 18% to 61.9 Mboe in Q1 2025. The seventh well in the Permian Barnett project, brought online in Q3 2024, is the southernmost drilled to date and provides confirmatory evidence of the prospectivity of the large undeveloped acreage block to the south, which holds significant potential (14,000 gross undeveloped acres, up to 40 two-mile Barnett locations).

Operating costs increased in Q1 2025, primarily due to higher volumes in the upstream segment. Gathering system unit operating costs were higher due to a temporary 17% decrease in throughput volumes compared to the prior year period, although sequential throughput improved significantly. Depletion, depreciation, amortization, and accretion expense also rose commensurate with higher produced volumes. General and administrative expenses increased due to higher compensation costs. The company recorded a $1.46 million loss on derivative contracts in Q1 2025, primarily due to the increase in Henry Hub prices, resulting in net cash settlements paid of $415,043. This highlights the double-edged nature of hedging in a rising price environment, though it provides crucial stability in downturns.

Net income for Q1 2025 was $4.02 million, a substantial increase from $1.51 million in Q1 2024. Adjusted EBITDA, a key metric for evaluating cash-generating ability, rose to $10.61 million in Q1 2025 from $4.60 million in Q1 2024, a 130% increase, underscoring the operational leverage to improved volumes and prices.

Financial Strength and Future Growth Avenues

Epsilon maintains a strong balance sheet, which is a core component of its competitive positioning, particularly against peers with higher debt loads like CHK. As of March 31, 2025, the company had a working capital surplus of $6.2 million and over $50 million in total liquidity, including an undrawn $45 million senior secured reserve-based revolving credit facility with a borrowing base redetermined in February 2025 and maturing in June 2027. This financial strength provides flexibility for opportunistic investments and navigating market volatility without relying on debt financing.

The company's capital allocation strategy is disciplined, balancing investment in growth with shareholder returns. For the remainder of 2025, Epsilon plans total capital expenditures of $9 million to $12 million, focused on drilling 0.5 net wells in both Texas and Alberta. This includes a $1.5 million drilling carry in favor of the operator in Alberta. Specifically, the Texas plan involves drilling two gross wells (to satisfy lease obligations), expected to spud in late May with completion in Q3 2025. In Canada, the initial focus is on the Garrington area JV, where two gross wells (0.5 net) have been drilled and are on flowback as of April 2025. The plan is to drill two additional gross wells in 2025, aiming for four gross wells (one net) on production in the Garrington area by year-end. Total CapEx in Canada for the 12 months from December 2024 is expected to be approximately $10 million, including the drilling carry.

In the Marcellus, no additional investment is expected in 2025. However, the operator has provided clarity on a multi-year development plan for 2026-2028, with drilling set to commence in 2026 on the substantial remaining undeveloped inventory (roughly 500,000 completed lateral feet gross), which Epsilon expects to be developed starting late 2026 or early 2027. This provides a clear runway for future growth in the basin once market conditions warrant.

Shareholder returns remain a priority. The company declared a quarterly dividend of $0.0625 per common share (annualized $0.25/share) in February 2025, paid in March. Midstream earnings are expected to continue underwriting most of this dividend. Additionally, the board authorized a new share repurchase program in February 2025, allowing for the repurchase of up to 2.2 million shares (10% of outstanding) for up to $13 million by February 2026. While no shares were repurchased under this program in Q1 2025, it represents a commitment to returning value opportunistically.

Key risks to the investment thesis include the inherent volatility of commodity prices, which directly impacts revenue and cash flow despite hedging efforts. The company's non-operated interests mean it is dependent on its operating partners' decisions regarding drilling schedules, capital allocation, and operational efficiency, which may not always align perfectly with Epsilon's preferences. The ongoing strategic alternatives review process of the operated interest in the Texas Permian assets introduces near-term uncertainty regarding future development timing in that specific area. While the company hedges a portion of its production (e.g., ~45% of forecasted PDP oil and ~30% of forecasted PDP gas for the remainder of 2025), these contracts can result in losses in a rising price environment, as seen in Q1 2025.

Conclusion

Epsilon Energy's strategic pivot toward diversification is proving timely and effective. The strong performance in the first quarter of 2025, particularly the significant rebound in the Marcellus driven by increased volumes and higher prices, underscores the operational leverage inherent in its assets. Coupled with the continued contribution from the Permian and the establishment of a new growth avenue in Western Canada, Epsilon has built a more resilient and dynamic business.

While not competing on the cutting edge of drilling technology like some larger peers, Epsilon's competitive strength is rooted in its robust financial health, diversified asset base, and disciplined capital allocation strategy. The company is well-positioned to fund its planned development activities in Texas and Canada, capitalize on the expected return to development in the Marcellus in the coming years, and continue providing returns to shareholders, all while maintaining a strong balance sheet. Investors should monitor commodity price trends, the pace of development activity by its operating partners in all basins, and the execution on the new Canadian joint venture as key indicators of future performance. The successful navigation of the challenging 2024 gas market and the subsequent Q1 2025 rebound highlight Epsilon's potential to generate significant cash flow in favorable market conditions and prudently invest for future growth.