13. 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 oil and natural gas 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.

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 gain (loss) on derivative contracts on the consolidated statements of operations and comprehensive income. The related cash flow impact is reflected in cash flows from operating activities. During 2019, Epsilon recognized gains on financial commodity derivative contracts of $4,246,057. This amount included cash received on settlements of these contracts of $1,949,232. For 2018, Epsilon recognized losses on financial commodity derivative contracts of $1,938,465. This amount included cash paid on settlements of these contracts of $1,381,898.

Commodity Derivative Contracts

Epsilon’s outstanding natural gas price swap contracts as of December 31, 2019 consisted of:



		Weighted Average Price ($/MMbtu)					Fair Value
	Volume				Basis		December 31,
Derivative Type	(Mmbtu)		Swaps		Differential		2019
2020
Fixed price swap	4,637,500		$	2.71	$	—		2,001,496
Basis swap	4,637,500		$	—	$	(0.43)		(1,694)
							$	1,999,802

As of December 31, 2019 and 2018, 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.


	Fair Value of Derivative Assets
	December 31,		December 31,
	2019		2018
Current
Basis swap	$	162,844	$	76,075
Fixed price swap		2,001,496		125,790
	$	2,164,340	$	201,865


	Fair Value of Derivative Liabilities
	December 31,		December 31,
	2019		2018
Current
Basis swap	$	(164,538)	$	(337,438)
Fixed price swap		—		(161,450)
	$	(164,538)	$	(498,888)


Net Fair Value of Derivatives	$	1,999,802	$	(297,023)

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



	Year ended December 31,
	2019		2018
Fair value of asset (liability), beginning of year	$	(297,023)	$	259,544
Gains (losses) on derivative contracts included in earnings		4,246,057		(1,938,465)
Settlement of commodity derivative contracts		(1,949,232)		1,381,898
Fair value of asset (liability), end of year	$	1,999,802	$	(297,023)