2023-11-03 09:57:46 ET
Summary
- Baytex Energy Corp. has the choice between developing a profitable Eagle Ford basin or a more profitable Clearwater acreage.
- Clearwater play has low breakeven points and could generate cash flow, but heavy oil production may be shut in during commodity price downturns.
- Management has prioritized a low debt ratio balance sheet and light oil production to ensure reasonable results during weak commodity prices.
- The newly acquired Eagle Ford acreage appears to be in a position to show material production improvement.
- Current high prices make the latest acquisition more of a bargain while allowing an earlier debt reduction to desired levels.
(Note: Baytex Energy is a Canadian company that reports using Canadian dollars unless otherwise stated.)
Ever since Baytex Energy Corp. (BTE) acquired Ranger Oil, the company has the choice of developing a very profitable Eagle Ford basin (acreage) or a more profitable Clearwater acreage. Sometimes life can be really tough when you have to choose between a lot of profits and more profits. No matter how you look at it, with the price of WTI oil benchmark (CL1:COM) heading towards $100, this company is one of several that has (in effect) a license to print money. But on an IRR basis, it will be printing a lot more than much of the industry. At some point, that could make this well-run company a takeover target.
The Clearwater Play
The Clearwater play is relatively new. But it has some of the lowest breakeven points in the industry even though this is a heavy oil play. Since heavy oil does sell at a discount to light oil, that is quite an accomplishment.
The risk is that in commodity price downturns, the discount to light oil often expands to the point that heavy oil production is shut in. Now, whether the low breakeven would generate cash flow in a cyclical downturn remains to be seen as this basin is a relatively new discovery.
Baytex Energy Presents The Superior Aspects Of The Clearwater Play (Baytex Energy Second Quarter (August) 2022, Corporate Earnings Presentation)
The above comes from an older presentation. The rate of return depends upon your own calculations, as different companies use different assumptions (like time periods that are relevant). More recent company presentations cut that rate of return in about half or less. But the basin is still the most profitable basin I follow.
The average could also change as new discoveries extend the basin limits. The latest earnings and presentation focus on the acquisition. But that acquisition is likely to serve as a base cash flow which would allow for further development of this very profitable play.
What management has not changed in recent presentations is the payback period which is darn short.
Baytex Energy Portfolio Profitability And Cost Presentation (Baytex Energy Corporate Presentation November 2023)
The time length used to calculate the IRR is undoubtedly more conservative than the first slide . Plus, rising costs likely have something to do with this as well. But that return is still one of the best I can find. In terms of profitability (which means cash generation), this company is now at the top of my industry list. Even some of that Permian acreage does not have the return shown above for Clearwater. (However, the Permian acreage in the past was more profitable during a cyclical downturn than the legacy acreage. We will have to see how the Clearwater acreage does in a cyclical downturn.)
Remember that in any basin, profitability will vary throughout the acreage. Here, it may be too soon to tell that. But it is probably good for the investor to plan on the idea that most presentations are some sort of average. Actual results will vary around the number shown on the slide.
Oftentimes, when people ask me about heavy oil, I need to explain that heavy oil generally makes its money at oil price peaks. For many companies, heavy oil is not that profitable over the whole business cycle. Exxon Mobil ( XOM ), for example, has been plugging and abandoning any heavy oil finds in Guyana. You need quite a bit of profitability to make it through the downcycle when the discount expands (compared to light oil).
However, the profit volatility does make a priority for either a debt-free balance sheet or light oil production to ensure a reasonable result during a time of weak commodity prices. That consideration alone was likely behind the Ranger Oil acquisition. Light oil profits are superior in a commodity price downturn, while heavy oil profits are like "winning the lottery" during times of robust commodity prices.
What is even better is that this management will hedge some production to keep collecting that very profitable pricing well into the future.
No matter how you look at it, though, the company will cash flow quite a bit for the current stock price in the current environment. This company has clearly hit the jackpot.
Eagle Ford
The Eagle Ford acreage is likely to show considerable improvement after the acquisition. Baytex was a passive owner in the acreage operated by Marathon Oil ( MRO ). Marathon is one of the best in the industry. Baytex, as a partner, even a passive one, has access to the information on any relevant acreage. It is probably a safe assumption that the acquired acreage will be performing better in the future.
Baytex Energy Eagle Ford Production Comparison (Baytex Energy Corporate Presentation September 2023)
Already, it looks as though the new wells drilled will be outperforming past wells by a comfortable margin. Anytime a well reaches production of 200,000 BOE within a 2-year period, that well is likely extremely profitable. The most recent data would appear to confirm a profit uptick that will be combined with some very good commodity selling prices.
It needs to be noted that past articles mentioned that Marathon operated the non-operated acreage. That could mean that the newly acquired acreage could show improvement as Baytex Energy shares the partnership (or joint venture) information on the non-operated acreage with the personnel that runs the operated acreage. Marathon is largely regarded as a top-notch operator that definitely obtains above-average results from the acreage operated.
Anticipated strong commodity prices are "icing on the cake." Baytex could have some blowout quarters on the way.
This will likely lead to debt levels that will be attained ahead of guidance. This would increase the amount of money that would be available to shareholders. The Eagle Ford oil production often receives premium pricing in the area. That is just icing on the cake.
Cash Strategy
The priority is of course debt reduction to desirable levels. However, improving well performance as shown above in the Eagle Ford could lead to improvements offsetting some cost inflation or even a lower well breakeven cost for the light oil production.
The heavy oil wells are relatively cheap. But the Clearwater acreage would likely be the logical beneficiary of any extra cash. The other areas are relatively high cost compared to the Clearwater acreage. Therefore, for the time being, any wells drilled on that acreage would likely be required to hold the acreage rather than give it up.
As technology advances, those advances could favor another set of leases. Therefore, it would probably be wise to hang onto acreage that is not as competitive as Clearwater because that competitive situation can change.
Last but not least, the company does have a light oil discovery in the Duvernay that it is working on to get the wells cost-competitive. The company has been at it for a few years, which is not that unusual in this industry. The discovery was a light oil discovery. Therefore, management will allocate some money to that discovery in the hopes of finding a way to commercially produce that acreage sooner rather than later.
Key Ideas
Baytex began its corporate existence as a strictly heavy oil player, and it became known for that heavy oil production. An acquisition before the oil price decline in 2015 using mostly debt put the company in a financially stressed mode as heavy oil really made no money for the company from 2015-2020.
The company made another acquisition of Raging River before 2020 which improved the financial situation tremendously as it was a stock deal (and Raging River had a better balance sheet). That acquisition is represented largely by the Viking production. The final step was the acquisition of Ranger Oil. The company now has mostly light oil production, with a significant amount of heavy oil production.
That light oil production is mostly in the Eagle Ford. This is one of the lowest-cost basins in the United States. Furthermore, that acquisition was made before commodity prices rose in the latest quarter. The assumptions in valuing the Eagle Ford acquisition now look extremely conservative.
More importantly, the company now has two large above-average profit projects in the Eagle Ford leases and the Clearwater leases. This is a big change from a heavy oil operator with high costs. It will take the market some time to value the company in its new configuration. But management does not have to do anything extraordinary to get that valuation as a light oil producer.
What management has to do now is optimize operations. Based upon the Eagle Ford information shown above, it appears that is already underway. Should those graphs continue to show improvement, this is likely to be a more profitable company at various oil prices in the future.
The latest quarter shows a huge jump in cash flow that enables the comparison to the previous year to look very good on a per share basis despite the fact that fiscal year 2022 generally had higher commodity prices. I am a big believer in allowing things to "settle down" after an acquisition so that all the one-time costs get reported. However, the comparisons in the third quarter report show that this acquisition is off to a good start, with stronger commodity prices expected. Nothing makes management look smarter than higher-than-expected commodity prices soon after an acquisition closes.
There is always the risk of oil prices that are "lower for longer." But right now, that risk seems minimal.
This investment remains a strong buy based upon management's ability to optimize operations and the ability of Mr. Market to recognize that this is a far more profitable company than it was in the past. This stock has a lot more future potential than the original heavy oil producer I used to follow.
For further details see:
Baytex Energy: Choosing Between Profits And More Profits