BATL - Battalion Oil: Savings From Acid Gas Injection Project May Reach $30 Million Per Year

2023-06-14 22:43:35 ET

Summary

• Battalion's acid gas injection project is online and Battalion believes the cost savings could be up to $2.5 million per month after full ramp up.
• It also has cut cash G&A costs by approximately $6 million per year.
• However, Battalion's interest costs still hamper its ability to quickly pay down its debt.
• Battalion's well results have been good, but well payback will probably still take 1.5 to 2 years at current strip.
• This makes additional development questionable at current strip with its term loan maturity in November 2025.

Battalion Oil's ( BATL ) cost structure should be significantly improved soon. It believes that it can save up to $2.5 million per month once its acid gas injection project is fully online (aiming for Q2 2023). It has also been cutting G&A costs, aiming for a 40% reduction in cash G&A, which could save it around $6 million per year.

Despite these savings though, Battalion still has relatively high costs for production that has a 50% oil cut. As well, Battalion's wells probably take around 1.5 to 2 years to pay back at current strip, which makes it uncertain whether it will drill more wells in the current environment with its term loan maturing in November 2025.

I remain neutral on Battalion due to its interest costs and preferred share PIK dividends, making it difficult for it to pay down debt quickly enough. With a minimal capex budget, I project Battalion to end 2024 with around $130 million in net debt, but then it would have a November 2025 term loan maturity date to deal with.

Savings From The Acid Gas Injection Project

Battalion mentioned in May 2023 that its acid gas injection project had started operations and that it has been ramping up throughput processing. Battalion estimates savings of up to $2.5 million per month once the project is fully online.

Battalion's gathering and other expense was $11.33 per BOE in Q1 2023. A $2.5 million per month reduction would have reduced Q1 2023's gathering and other expense to $6.18 per BOE instead. At $2.5 million per month, this is a 45% reduction in gathering and other costs per BOE.

Battalion had initially mentioned ( in May 2022 ) that this project was expected to result in a 20% to 30% reduction in gathering and other costs per BOE, so it remains to be seen whether it can deliver a full $2.5 million per month in savings.

If it can deliver that amount of savings, Battalion's combined LOE and gathering and other costs will go down from approximately $20 per BOE to approximately $15 per BOE. That would be a big improvement that would have the same impact on Battalion's margins as a $10 increase in oil prices. Battalion's cost structure would still be relatively high for production that is 50% oil though.

In addition to these savings, Battalion has been reducing its G&A costs, potentially leading to a $6 million per year reduction (about $1 per BOE at Q1 2023 production levels) in cash G&A.

Well Performance

Battalion also noted that its most recent two wells are performing quite well after three full calendar months online. Battalion's Fortress well has produced over 106,000 BOE to date, while its Parnassus well has produced over 125,000 BOE to date.

These wells are also the "furthest East in the program", pointing to Battalion's ability to generate solid results throughout its Monument Draw acreage.

From a production perspective, Battalion's Monument Draw wells are pretty good, but the sour gas treatment costs have resulted in weaker than average economics for Delaware Basin wells once those costs were factored in. The reduced costs should help narrow that gap.

That being said, the combination of relatively high service costs and high-$60s oil strip means that Battalion's wells should payback in around 1.5 to 2 years (not including interest costs related to capex). Since Battalion's term loan matures in November 2025, that payback period may not be quick enough to warrant near-term development.

Battalion probably needs $80s oil with minimal further service cost inflation for significant near-term development to make sense with its late 2025 credit facility maturity.

Potential Future Outlook

I've attempted to model Battalion's result for the 12 month period from April 2023 to March 2024. If it does minimal development, it may average around 12,500 BOEPD (48% oil) in production during this period.

At current strip, Battalion would then be able to generate $187 million in revenues after hedges.

I've assumed that Battalion's lease operating and workover expenses go up to $10.50 per BOE (from $8.93 per BOE in Q1 2023) to reflect the impact of lower production volumes. I've also assumed that gathering and other costs end up at $7.50 per BOE for this period.

This leads to a projection of $53 million in free cash flow during this period. Battalion had $207 million in net debt at the end of Q1 2023, so this would reduce its net debt to $154 million at the end of Q1 2024.

Battalion's oil hedges have a lower swap price in 2024, so the combination of weaker hedges and lower production levels (assuming it continues to do minimal development) would reduce its free cash flow. Battalion may end 2024 with around $130 million in net debt based on current strip and a minimal capex budget.

Battalion's PIK dividends would increase the liquidation preference on its preferred shares to $29 million by the end of Q1 2024 and $33 million by the end of 2024.

Conclusion

Battalion's cost structure should improve due to its G&A reductions and the ramp up of its acid gas injection project. Those two items could save Battalion up to $36 million per year.

However, Battalion still appears to be in a tough spot due to its significant interest costs combined with declining production levels. Battalion has not provided more information about its 2023 development plans yet, but at high-$60s WTI oil and with a November 2025 term loan maturity, the case for near-term development doesn't make much sense.

I remain neutral on Battalion due to the impact of interest costs in slowing down its ability to pay down its debt. At current strip it could reduce its net debt by close to 40% by the end of 2024. However, that scenario would also result in its production declining by a similar percentage.

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