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.

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 on derivative contracts on the condensed consolidated statements of operations and comprehensive income. The related cash flow impact is reflected in cash flows from operating activities. During the three months ended March 31, 2021, Epsilon recognized gains on commodity derivative contracts of $465,341. This amount included cash received on settlements of these contracts of $64,200. For the three months ended March 31, 2020, Epsilon recognized gains on commodity derivative contracts of $1,721,018. This amount included cash received on settlements of these contracts of $1,345,942.

Commodity Derivative Contracts

Presented below is a summary of Epsilon’s natural gas price and basis swap contracts as of March 31, 2021.


								Fair Value
	Volume	Ceiling		Floor		Basis		March 31,
Derivative Type	(MMbtu)	Price		Price		Differential		2021
2021
Basis swap	305,000					$	(1.10)		(27,181)
Two-way costless collar	2,755,000	$	3.27	$	2.78				411,801
2022
Two-way costless collar	900,000	$	3.34	$	2.80				16,521
								$	401,141

As of March 31, 2021 and 2020, 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
	March 31,		December 31,
	2021		2020
Current
Basis swap	$	—	$	—
Two-way costless collar		894,240		—
	$	894,240	$	—


	Fair Value of Derivative Liabilities
	March 31,		December 31,
	2021		2020
Current
Basis swap	$	(27,181)	$	—
Two-way costless collar		(465,918)		—
	$	(493,099)	$	—


Net Fair Value of Derivatives	$	401,141	$	—

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


	Three months ended March 31,
	2021		2020
Fair value of asset (liability), beginning of the period	$	—	$	1,999,802
Gains (losses) on derivative contracts included in earnings		465,341		1,721,018
Settlement of commodity derivative contracts		(64,200)		(1,345,942)
Fair value of asset, end of the period	$	401,141	$	2,374,878