BTE - Baytex Energy: Excellent Eagle Ford Acquisition Of Ranger Oil

Summary

• Baytex Energy will acquire Eagle Ford acreage that it controls.
• The current Eagle Ford acreage is operated by Marathon.
• Acquisition prices have declined quite a bit since the original Eagle Ford acquisition.
• The combined companies will have enough light oil production to financially safely develop the heavy oil Clearwater leases.
• The average asset level breakeven cost drops dramatically.

(Note: This article appeared in the newsletter on February 28, 2023.)

This is a Canadian company that reports in Canadian Dollars unless otherwise noted.

Baytex Energy ( BTE ) (BTE:CA) entered the Eagle Ford back in 2014 with the acquisition of Auroa Energy. Back in those days of boom pricing , the company paid C$2.6 billion for what is now about 28K BOED of production. At the present time, the company announced the acquisition of Ranger Oil ( ROCC ) for another C$3.4 billion (US$ 2.5 billion) to get about twice as much production added to the current operations. This offer shows how much prices have changed since the boom times. Juniper Capital controls the majority of Ranger Oil shares and has agreed to the deal as well as a hold period. So, the deal will go through and there will not be an immediate massive sale of shares by Juniper Capital.

Far more importantly, the deal will lower the average "asset level" breakeven of the company and it provides a lot more light oil production. This will allow rapid development of the very low cost (but heavy oil) Clearwater play. Generally heavy oil is very profitable during good times (like now). But oftentimes the heavy oil discount widens during downturns. Clearwater is an unusually profitable heavy oil play. So, this merger allows for a conservative financial structure with enough light oil production so that sufficient cash flow would be available during most cyclical downturns from premium products.

The Deal

It turns out that Baytex learned something since that original deal as well. The original acquisition back in 2014 used a lot of debt and hobbled the company for years (financially) after oil prices crashed back in 2015. There was a period when heavy oil literally made no money for many companies that I followed with heavy oil production. It really was not until now that heavy oil appeared to again have a material (as in sufficiently long) period of decent profitability.

The combined company will not be so hobbled with debt as this time management will be issuing shares as well as debt. Debt repayment clearly is a priority. But if oil prices crash as they did after the first acquisition, the company has more than enough light oil production to get through a typical industry downturn with decent debt ratios. That is a huge difference from 2015.

Now admittedly, debt ratios need to come down more and management appears to recognize this. But not having debt ratios at potentially crippling levels if there is a cyclical downturn (right after the acquisition) is a material change in strategy from "the good old days".

This acreage is actually worth a lot more because Baytex will control the acreage as the operator. The current Eagle Ford presence is operated by Marathon (as I have reported in several past articles). The market never really gave full value to acreage that the company did not operate. That is going to change now because this new acreage position is much greater and will dominate the financial picture. Most companies have non-operated acreage somewhere. Post acquisition, that will be the story here.

Rationale

The company gives the usual reasons.

The biggest thing to note is the large drop in breakeven with the merger. Baytex was a fairly low-cost operator. But heavy oil production was sold at a discount to light oil. That fact meant that WTI had to be higher for Baytex to breakeven on heavy oil production. If the discount for heavy oil widened during a downturn as was typically the case, then the WTI breakeven point rose more.

Baytex has some impressive heavy oil assets that do well during the current part of the cycle. But it does need production to offset what happens during cyclical downturns. This merger appears to fill that need.

Pro Forma Combined Opportunities

Obviously Baytex is now in a position to grow the low-cost Eagle Ford production. The Eagle Ford is one of the lowest-cost basins in North America. Better yet, it comes without all the Permian attention that often causes takeaway issues (and results in oil price discounting). In theory the Permian is the most profitable basin in the industry. In practice, too many producers noticed causing sky-high acreage prices and discounting of oil prices due to transportation bottlenecks. The result is that the promised profitability does not happen for a lot of producers. Baytex with this offer is avoiding all of that and more.

But there is more for the combined company.

The company can now pursue more Clearwater production with an assurance that the debt will be properly serviced during a downturn. As shown above, this is the most profitable part of the company lease holdings during the good times. But management has often had to shut-in the higher cost heavy oil production during cyclical downturns. That makes the cash flow and profitability of even a superior heavy oil play somewhat questionable when oil prices are weak. This is clearly a play where you "make your money all at once" and then have to wait to "rinse and repeat".

On the other hand, Baytex had these wonderful results from the Eagle Ford. The American dollars earned matched well to the American dollar denominated debt servicing (lately). That keeps meaningful unfavorable currency swings between debt and income differences to a minimum. But management could not control development of the net acreage because it was not the operator. Therefore, production really has not changed that much.

Now, light oil production that is extremely low cost can grow enough to offset the volatility of the heavy oil production growth at Clearwater. That is likely to be a potentially big change going forward. Management has a large acreage presence in Clearwater.

More importantly, Baytex will keep the current personnel in place. That mitigates a lot of acquisition risk. But those personnel will now have access to all the information that Baytex receives as a non-operating partner on the current acreage operated by Marathon. Marathon is widely regarded as one of the top operators in the industry. That is likely to result in superior well performance in the future on the acquired acreage.

The Future

This appears to be a win-win situation for both parties. Baytex had an important low-cost discovery it could not fully develop due to the profit volatility of heavy oil. Ranger Oil operations will gain access to the lease information operated by Marathon, one of the top operators around in my opinion. Shareholders of both companies are likely to see an improvement in the future that exceeds what would have happened independently thanks to the combination.

Baytex has other possibilities as well that may become significant in the future. But it appears to me that this combination is going to be very good for both companies for some time to come.

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