Earnings Call Transcript - EPSN Q2 2023

Andrew Williamson, CFO

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.

Jason Stabell, CEO

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 a 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 from 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.

Andrew Williamson, CFO

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 contributions 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.

Henry Clanton, COO

Thank you, Andrew. In the Northern Delaware Basin in Eddy County, New Mexico, the company participated in two horizontal Wolfcamp wells. Based upon flow-back results today, we are pleased to report that the productivity of these wells is exceeding projections. On the Central Basin platform in Ector County, the appraisal program in this Mississippian 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.

Andrew Williamson, CFO

Thank you, guys. Operator, we can now open the line for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question will come from Tom McIntyre of MFS. Please go ahead.

Tom McIntyre, Analyst

Good morning, gentlemen. Could you please share your strategies and insights on natural gas pricing as we approach the end of this year and into next year? I know you've implemented some hedging, and I'm curious whether that will be expiring soon or if you have a strategy in place regarding it.

Jason Stabell, CEO

Thanks, Tom. Yes, 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 agree that there will be a strengthening as we head into winter. I think 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 the strip. So 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 the 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.

Tom McIntyre, Analyst

The strip for next year versus this year, next year looks to be quite better than what turned out to be a 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?

Jason Stabell, CEO

Yes. I think the key thing, obviously, will be weather. And what everybody is 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 moderates. 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. But 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. So 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.

Tom McIntyre, Analyst

Right. I guess one of the things I'm just trying to, in my own mind say, 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?

Jason Stabell, CEO

Yes, absolutely. Our Marcellus netback average in the second quarter was something in the $1.35 per Mcf range. So that's pretty ugly. We've had periods where we've been down near $1 or below in the history of this company. But certainly, that's as bad as we've been in the Marcellus since the 2021-2020 period. So certainly, what happens in the Marcellus because it's not a big in-basin demand is, we're at the very end of the demand structure. So the netbacks get pretty challenging 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.

Tom McIntyre, Analyst

It seems to me that considering your balance sheet and the improved outlook compared to our previous experience, you are in a much better position. The industry as a whole is also in a stronger position. This allows you to be more strategic and wait to see how developments unfold, whether you decide to hedge or take other actions. I believe that you will have a significantly better winter and spring in 2024 compared to the hedges you implemented in 2023. Although things can change, it appears they are shifting in your favor, unlike last year.

Jason Stabell, CEO

Yes, 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 has really moderated in the Marcellus, Haynesville 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's going to look like in the winter and through next year.

Tom McIntyre, Analyst

As for the recent increase, which may have some staying power in the oil market, does that make it more difficult for you to pursue additional expansion in the Permian or other areas you are considering? I assume prices have climbed in response to this. Is there anything you would like to add about that?

Jason Stabell, CEO

We're active at looking at things. We're excited about 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 are mostly bit-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. So but nothing imminent to report today on that front.

Tom McIntyre, Analyst

Okay, I think lastly, the press release mentioned that after the quarter ended, there was a buyback of a 0.5 million share block in stock. I am watching it closely. I don't recall seeing a volume spike like that. Obviously, it happened. Was that a privately negotiated transaction or was it done on the market? I don't remember seeing a block like that.

Jason Stabell, CEO

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

Andrew Williamson, CFO

Right after the holiday, July 6.

Tom McIntyre, Analyst

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 that. So I'm glad to see you've got a good price. Thank you.

Andrew Williamson, CFO

Thanks. Thanks, Tom.

Operator, Operator

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

Jason Stabell, CEO

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.

Operator, Operator

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