BTEGF - Baytex Energy Corporation (BTEGF) Q3 2022 Earnings Call Transcript

Baytex Energy Corporation (BTEGF)

Q3 2022 Earnings Conference Call

November 04, 2022, 11:00 ET

Company Participants

Brian Ector - VP, Capital Markets

Edward LaFehr - President, CEO & Director

Rodney Gray - EVP & CFO

Eric Greager - Incoming President & CEO

Chad Lundberg - Chief Operating & Sustainability Officer

Conference Call Participants

Patrick O'Rourke - ATB Capital Markets

Menno Hulshof - TD Securities

Dennis Fong - CIBC

Presentation

Operator

Thank you for standing by. This is the conference operator. Welcome to the Baytex Energy Third Quarter 2022 Financial Results and Operating Results Conference Call. [Operator Instructions]. I would now like to turn the conference over to Brian Ector, Vice President, Capital Markets. Please go ahead.

Brian Ector

Thank you, Gaylene. Good morning, ladies and gentlemen, and thank you for joining us to discuss our third quarter 2022 financial and operating results.

Today's call is somewhat unique in that we are saying goodbye to Ed LaFehr, who has led our organization for the past 6 years, and we are welcoming Eric Greager as our new President and Chief Executive Officer. We will hear from both Ed and Eric today. And we are also joined by Rod Gray, Executive VP and Chief Financial Officer; and Chad Lundberg, our Chief Operating and Sustainability Officer.

While listening, please keep in mind that some of our remarks will contain forward-looking statements within the meaning of applicable securities laws. I refer you to the advisories regarding forward-looking statements, oil and gas information and non-GAAP financial and capital management measures in yesterday's press release. All dollar amounts referenced in our remarks are in Canadian dollars unless otherwise specified.

And with that, I would now like to turn the call over to Ed.

Edward LaFehr

Thanks, Brian, and good morning, everyone. I'd like to welcome everybody to our third quarter 2022 conference call. And at the same time, I'm truly excited to welcome Eric to Baytex. Throughout his career, Eric has been focused on organic development and engaging and inspiring organizations to create value, key traits that I know will fit in well here. I will remain with Baytex in an advisory capacity until the end of January, at which point, my retirement will officially begin.

Today is certainly a bittersweet moment for me. When I joined Baytex 6 years ago, I remember stating on my first quarterly earnings call how impressed I was with the Baytex team and how committed and focused they were on driving value. This was a strong team with high-quality assets that I knew could build a great future. 6 years and 24 conference calls later, the team and the portfolio are stronger than ever before. I am enormously proud of the entire Baytex team and our accomplishments.

Together, we successfully repositioned Baytex through the downturn, strengthened our balance sheet, and we discovered one of the most exciting new Clearwater oil fields that our industry has ever seen. And we are progressively increasing direct returns to shareholders, something we are all immensely proud of.

Before I turn the call over to Rod and Eric, let me review, for one last time, our quarterly results. During the third quarter, we delivered strong operating and financial results which has set the stage for continued momentum as we approach 2023. In addition, we advanced our Clearwater play at Peavine with results from our second half drilling program, continuing to deliver among the best wells drilled in the play.

Production during the third quarter averaged over 83,000 BOEs per day and we generated quarterly free cash flow of $112 million, which brings our year-to-date free cash flow to $478 million. Capital expenditures totaled $167 million and we participated in the drilling of 86 gross or 72 net wells. Production in October increased to over 87,000 BOEs per day, which puts us on track to achieve our targeted exit rate of 87,000 to 88,000 BOEs per day. For 2022, we expect to average approximately 84,000 BOEs per day, which represents 5% annual production growth or 6% on a per share basis.

We are now forecasting full year 2022 exploration and development expenditures of $515 million, up 3% from our previously targeted $500 million, which represented the high end of our prior guidance range. The incremental capital largely reflects the impact of a strengthening U.S. dollar relative to the Canadian dollar on our U.S. operations and further level loading of activity through year-end to maintain the efficiency of our operations.

We remain intensely focused on capital discipline and maximizing free cash flow. Taking into account our year-to-date results and based on the forward strip for the fourth quarter, we expect to generate approximately $650 million or $1.16 per basic share of free cash flow this year.

Operationally, the highlight of our business continues to be our Clearwater development at Peavine. This is an asset that at current commodity prices generates among the strongest economics within our portfolio and has the ability to grow organically while enhancing our free cash flow profile. During the third quarter, our Clearwater production averaged 8,200 barrels per day. And in October, we produced approximately 10,000 barrels per day from 24 producing wells.

The first 4 wells from our second half 2022 drilling program generated average 30-day initial production rates of 1,100 barrels per day per well. Initial well performance continues to outperform type curve assumptions and we now hold 13 of the top 15 initial rate wells drilled across the play.

Following further detailed reservoir and economic analysis of the Peavine Clearwater, our second half wells are all drilled at 40-meter interlateral spacing, whereas our initial wells were drilled at 50-meter interlateral spacing. This tighter spacing enables the drilling of 5 wells per section versus 4 wells per section and creates the potential for a 20% increase in our prospective drilling inventory, yielding meaningfully improved resource recovery and value.

To date, we have derisked 50 sections of our 80-section Peavine land base and believe the lands hold the potential for greater than 250 locations with production increasing to approximately 15,000 barrels per day. When combined with our legacy acreage position in Northwest Alberta, we estimate that over 125 sections of our lands are highly prospective for Clearwater development.

I want to now turn it over to Rod, who will provide a brief update on our liquidity and capital structure.

Rodney Gray

Thanks, Ed, and good morning, everyone. Our liquidity and capital structure have never been stronger. And with the established debt targets we now have in place, we are building a business that will be resilient throughout the commodity price cycles. Our net debt, which includes our credit facilities, long-term notes and working capital, totaled $1.1 billion at September 30, 2022, down from $1.4 billion at December 31, 2021. We expect to exit 2022 with net debt of under $1 billion.

Our net debt was largely unchanged from the second quarter due to our active share buyback program and the impact of a strengthening U.S. dollar relative to the Canadian dollar on our U.S. dollar-denominated debt. The change in the Canadian U.S. exchange rate from June 30 to September 30 impacted our net debt in Canadian dollar terms by approximately $50 million during the quarter.

During the third quarter, we also repurchased and canceled USD 27 million of the 8.75% long-term notes due 2027, bringing the principal amount outstanding to USD 473 million. As of September 30, 2022, we had about $714 million of undrawn capacity on our credit facilities, resulting in liquidity net of working capital of $699 million. This improved financial position has enabled us to implement the second phase of our enhanced shareholder return framework in May of this year.

We are now allocating 25% of our annual free cash flow to a share buyback program. Through September, we repurchased 21.6 million common shares for $141 million, representing 3.8% of our shares outstanding at an average price of $6.53 per share.

During the month of October, we were subject to a special blackout given the pending announcement of Eric joining Baytex. And as a result, our buybacks were limited during the month. For November and December, we expect to resume buying back our shares as we target 25% of our annual free cash flow for this activity.

And now I'd like to turn the call over to Eric and officially introduce him to our analysts and shareholders on the call today.

Eric Greager

Thanks, Rod, and thanks, Ed, for your opening remarks as well. And good morning, everyone. I'm excited to be joining Baytex. I've already had the opportunity to engage with the executive team and meet many employees, including the Peace River, Viking and Duvernay teams. And I can't wait to get out to the field in a couple of weeks.

I've been impressed with the quality of the assets and the people here at Baytex. I've also spoken with our top shareholders, and I can tell you that we are well aligned on driving returns in the business. Baytex has in place a strong shareholder return framework that is focused on continued deleveraging and over time, as our debt targets are achieved, increasing the allocation of free cash flow to direct shareholder returns.

I'm very pleased to confirm at this time that upon hitting our ultimate debt target of $400 million, we will increase direct shareholder returns to 75% of our free cash flow. We've laid out a detailed summary of this updated shareholder return framework in our November Investor Relations presentation, which is available on our website and includes a slide showing $3.2 billion of free cash flow generation, returning $1.8 billion to shareholders over our 5-year plan period at USD 80 WTI.

I'm very excited to get started. Ed, thank you for your leadership and support through this transition. It is greatly appreciated. You've had a tremendous career and I know everyone at Baytex, including myself, wish you all the best in retirement.

And now operator, we are ready to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question is from Patrick O'Rourke with ATB Capital Markets.

Patrick O'Rourke

First, I'd like to say congratulations to Ed on a successful tenure here and hopefully, in your retirement, you enjoy your time away, but I'm sure you'll keep very busy. And then to Eric, hopefully, you're enjoying the weather here in Calgary this week, and nice little start. Just to shift over to the Clearwater here, you guys have obviously -- there's been a lot of configurations in terms of the wells. You've done 1 x 8, 2 x 4. You've gone from 50 meters to 40 meters on the Interlake spacing now.

Just a couple of quick questions with respect to that. Number one, is there an ideal design in terms of the 1 x 8, 2 x 4 that you're settling on? Where do you think you are in terms of understanding the technology and what the optimal sort of configuration is? And then second, with respect to the interwell Interlake downspacing from 50 to 40 meters. You talked about the potential increased inventory 20%.

Is that a configuration that would be pervasive across the entire reservoir? Does that only work in certain spots depending on the geology? And then is there the potential for further downspacing what the signals are in terms of Interlake communication in the wells?

Edward LaFehr

Yes, there's a lot in that question, Patrick. So I'll say what I have on my mind there and then pass it over to Chad Lundberg, our Chief Operating Officer. The first thing is you're aware we've been drilling multilaterals up here in this region for 2 decades. And we believe we're, if not the best, certainly one of the best in multilateral open hole drilling configuration. So we've -- in Peace River, for example, we have tested 25 to 50 meters over the last decade. But actually, we've run little pilots from 15-meter spacing into 150-meter spacing back up in the early Harmon Valley days.

So we've also drilled a variety of geometries and really wild configurations to maximize the resource within whatever part of the Bluesky play we've been in. We're learning and growing in the Peavine very rapidly. We've only got 24 wells on and we're at 10,000 barrels a day. And you saw us move to the 4 lateral extended reach drills fairly recently.

We probably got 10 of those on now, certainly 9 since the second half. So that is our preferred configuration for the majority of the remaining development, at least for now. And the reason for that is partly technical and partly social issues. We can drill these wells with the big ROPs. We get drilling in the sand. We pull out of the hole for a fewer times.

It's a cost optimization, and it's also one where we're seeing the ability to stay in reservoir longer. And geosteering here, by the way, I think, is one of the critical success factors, and we've got 99-plus percent in zone drill success here. So these 2-mile laterals are making a big difference for us technically and from a cost standpoint, they're also important from a social standpoint.

And social license there in the Métis Settlement is very, very important as we move towards the Hamlets in the residential areas, and we're able to undershoot environmentally and socially sensitive areas. And that's critical to us. But is there another -- that's -- the team is very creative. They're very tenacious. We're always leading kind of the innovative trends on multilateral drilling. So we certainly we'll probably go further. But Chad, do you want to add anything to what I said there?

Chad Lundberg

I'll just add, whether you're drilling 1 x 8 or 2 x 4, you're essentially drilling the same amount of rock. There could be some operational efficiencies with, as Ed described, the 4 laterals where there are less trips out of the well. 50 meters to 40-meter spacing, I think is pretty key for us. Let's say that it all comes down to rock quality. So when we think about Clearwater, it comes down to mobility and the thickness of the rock, and that will ultimately dictate if we are able to push this even further.

In the Peace region itself for 25 to 50 meters, we use that as a bit of an analogous to get going, being cautious to not overcapitalize early in the play. So we're actively modeling to help drive these decisions and then carefully calibrating the models with our production results as we continue to develop and drill and that will really dictate how we develop moving into the future from here.

Patrick O'Rourke

And I'm just curious how you measure that. Do you have technology downhole that can determine sort of competitive drainage between the legs?

Chad Lundberg

Well, certainly, while we're drilling, we have technology in the lateral that helps us to decode and understand the rock. We can deploy different levels of sophistication on the drill bit to help us to understand. And then on the back end, it comes down to production modeling as well as pressure surveys to help understand the drainage patterns.

Operator

The next question is from Menno Hulshof with TD Securities.

Menno Hulshof

And I would certainly echo Patrick's comments earlier. Maybe I'll just start with M&A. You sold 600 BOE/d of noncore nat gas in the quarter. And so my question is, are there other opportunities to core up the portfolio? Or should we assume that's pretty much it for the time being? And then more generally, how are you thinking about portfolio composition at the moment? And any thoughts on the market for acquisitions would be helpful as well.

Edward LaFehr

I'll start with that, Menno, and other people may want to comment. We've obviously got a new CEO who has a lot of experience in some of these basins as well. But we're pretty well poured up. We've been trying to monetize some of the non-core liquids-rich gas. The 600 BOE a day we just sold for $26 million, been trying to monetize that now for 2 or 3 years, and we got to a place where AECO had picked up to the point where we got a fair valuation on that property.

There is a little bit more in there. We still have some liquid-rich gas properties that don't fit as neatly as other places as I've said before. But we're pretty well cored up. We like our multi-basin diversification. As I said, we like being in South Texas attracting the phenomenal gas prices as well as oil prices down there. We're not seeing the fluctuations in pricing like the Permian does on Waha, for example, on the gas side.

The other thing is that the Duvernay I've talked about as being a question mark. We need to see a little bit more derisking and value enhancement. And we have. In fact, we did a ton of science this year. We only drilled 3 wells, but those 3 wells are roughly on type curve. The science is showing and sort of confirming that this is a 20,000 barrel a day opportunity.

It's one that has large reserve add potential and it's got 80% to 110% IRRs, I believe, on an $80 WTI price deck and it can grow within cash flow down to $70 WTI. So I would say now the Duvernay has moved more towards a strategic asset for Baytex, but it's still a go slow to go fast. We need to learn as much as we can and then determine the right time to bring it into the plan. It's not really in our 5-year plan. We've got a few wells we drill every year. But I would say that one is a bit more strategic now having done the work and calibrated it with new production data. We've only got 15 wells in the play. So I think we're pretty well cored up, Menno, but let the team continue to work it.

Menno Hulshof

Appreciate the color. And just moving on to the cost structure given your cross-border exposure, are you seeing any discernible differences between Canada and the U.S. when it comes to capital and OpEx and inflation? And how could that impact your capital allocation decisions into 2023?

Edward LaFehr

Yes. Well, we took a view in Q1 and increased our capital, and we saw inflation both in Canada and Eagle Ford running reasonably hot and reasonably consistent. Since that time, what we've seen is a very big pickup in inflation in Eagle Ford and in Texas in general and less so in Canada. So we're now showing 20% inflation in Canada from, call it, our budget numbers for 2022 into -- as we look at 2023. We're seeing a 30% increase in inflation in the Eagle Ford, and part of that is just because of the degree of pressure pumping we do on the frac side of the business. Chad, do you want to add any further color on the inflation deltas?

Chad Lundberg

Well, no. I mean, you draw radius around the Permian and that is definitely being impacted in a big way in the United States. We're seeing more inflation in the Eagle Ford versus Canada. In terms of capital allocation decisions, the Eagle Ford is still incredibly strong economics. So we're still generating good returns with the inflationary pressure. Net-net across the board in Q2, we've seen a 20% inflationary add overall. And we're probably running a little hotter than that half 2, where we've seen a little bit more through the back half of the year. And right now, we're just trying to anticipate what we look forward to through 2023 and our planning for budgetary purposes.

Operator

The next question is from Dennis Fong with CIBC World Markets.

Dennis Fong

I'm going to third the congratulations to Ed and welcoming here in terms of the CEO transition. My first question here is just really around Seal. I know there's kind of a second net -- or another net well that's being drilled here in the fourth quarter to further evaluate that asset. Just curious as to how you're thinking about balancing further delineation and -- of the Seal asset while also balancing off development, obviously, within Peavine.

Edward LaFehr

Yes. Well, Seal is an exciting area. We're going to see a big uptick in activity, partly due to the competitor activity and partly due to our own. So we're going to drill second well on that Seal trend that you mentioned diagonally across roughly 2 townships of land that we own. So we'll get that done, and we'll have results on that by full year, end of this year. But we're also going to see some of the competitors come very close to our lease lines and we're already seeing permitted wells that juxtapose our leases very closely around Seal and, call it, the greater Harmon Valley area as well.

So there's more to go there. There's some data collection. It's a multi-zone area more so than Peavine. Peavine is the E and we've got the filler D through the filler A up in Seal and Harmon Valley that we're looking at very carefully. So we'll drill the second one by the end of the year, and then I think we've got 2 planned in 2023. Meantime, we're flat out in Peavine and we want to keep growing that asset.

So we've got 1 rig operating in Peavine and that's going to move to 2 rigs in Q1, and then we'll have a rig operating right throughout the area of Peace River -- broader Peace River in 2023 as well. So you can look for potentially more activity up there from us. Certainly, the competitors will help us learn and derisk our properties in a trickier area than Peavine.

Dennis Fong

Great. Great. Shifting my focus, and maybe this is a question for Rod. Is -- with respect to the term debt, like obviously, the market seems to be in a relatively favorable situation to be repurchasing that continuously. But just curious as to how you're thinking about the current capital structure of the company? Is the credit facility going to be the focus here for it, obviously, as this set of term notes are relatively more expensive. But just wanted -- curious as to how are you thinking about the entire capital structure of the company?

Rodney Gray

I think longer term, Dennis, I think we point to our overall debt targets. And right now, having the term debt in there probably doesn't fit within it. It tends to be more expensive than what we'd be paying on our bank line. Despite the increases that we've seen from the Fed, I think our variable rate debt is still just over 4%. So comparative to the 8.75% we'd be paying on the notes, we are better off to take out the notes when possible. I think the volatility in the market has given us some opportunity to advance on some of those purchases where we've stepped in and taken those out just over par. I think we'll continue to watch the market closely and look to optimize the position as we delever.

Dennis Fong

Great. Great. And my final question here is just on the capital return component. I understand, just given current valuation, the focus is on the buyback. And I know that in the past, there has been a, we'll call it, an expression of interest around a dividend. How should we be thinking about that, especially after you potentially cross that threshold of achieving that net debt floor?

Rodney Gray

Well, I think we're going to continue to monitor it, Dennis. I think our focus has been on delevering and also recognizing that we believe our shares have been undervalued, and so the buyback has been the preferred to us. I think if you look at our communication, we remain open to considering all forms of returns to shareholders. But when we think of it, we are committing to, call it, 75% of free cash flow going back in some form to shareholders.

And I think we're -- we continue to watch for some form of market differentiation around that, and we'll look to optimize that when the time comes. Given that we're still -- we're probably lagging peers in reaching those hurdles, I think we're going to have the benefit of some hindsight on that to be able to implement. But ultimately, we are committed to the direct shareholder returns.

Operator

This concludes the question-and-answer session. I'd like to turn the conference back over to Brian Ector for any closing remarks.

Brian Ector

All right. Thanks, operator. Thanks, everyone, for participating in our third quarter 2022 conference call. Have a great day.

Operator

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.

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Baytex Energy Corporation (BTEGF) Q3 2022 Earnings Call Transcript