Baytex Energy - Q1 2018

Transcript

Operator (participant)

Welcome to the Baytex Energy first quarter 2018 conference call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Brian Ector, Senior Vice President, Capital Markets and Public Affairs. Please go ahead.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

Thank you, Ariel. Good morning, ladies and gentlemen, and thank you for joining us today to discuss our first quarter 2018 financial and operating results. With me today are Ed LaFehr, our President and Chief Executive Officer, Rod Gray, our Chief Financial Officer, and Rick Ramsey, our Chief Operating 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 would 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 I would now like to turn the call over to Ed.

Ed LaFehr (CEO and Director)

Thanks, Brian, and good morning, everyone. I'd like to welcome you to our first quarter 2018 conference call. I'm pleased to report that we have successfully executed our first quarter plan, which puts us on track to deliver our 2018 guidance. In the Eagle Ford, we achieved record production rates from new wells and our strongest operating netback since 2014. In Canada, we continued to focus on cost and capital efficiency while managing WCS pricing volatility through active hedging, crude by rail, and operational optimization. Our first quarter production was 69,500 BOEs per day, consistent with our expectations. We delivered adjusted funds flow of $84 million, and exploration and development capital expenditures totaled $94 million for the quarter. Excluding realized financial derivative gains and losses, adjusted funds flow in Q1 2018 was $94 million, compared to $104 million in Q4 2017.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

This was achieved despite headwinds from wide heavy oil differentials, which averaged $24-$28 per barrel. This represents our highest, our second-highest quarterly adjusted funds flow on an unhedged basis since mid-2015. These results demonstrate the benefit of our heavy-and-light oil-dominated asset portfolio. Let's turn now our attention to operations. In the Eagle Ford, well performance in Karnes County remains exceptional. In addition, early results from Atascosa County are encouraging as we exploit the oil window on the western portion of our lands. We directed 45% of our capital expenditures toward these assets during the first quarter, and production averaged 36,000 BOEs per day.

Eagle Ford wells that commenced production during the quarter have established 30-day initial gross production rates of approximately 1,750 BOEs per day per well, which represents a 20% improvement over wells brought on production in 2017. This strong well performance is largely attributable to enhanced completions. During the first quarter, we averaged 6,200-foot laterals with 29 effective frack stages and approximately 2,100 pounds of proppant per foot. At $65 WTI, these wells yield greater than 100% IRRs, with payouts of less than one year. Turning to Canada, we are executing our 2018 drilling program as planned, while also driving our cost structure lower. At Peace River, production was stable during the first quarter, averaging 16,500 BOEs per day.

We drilled three net wells in the quarter, including two multilateral horizontal wells at Reno and one on our Northern Seal acreage, the acreage that was acquired in January of 2017. Given the wide WCS differentials in Q1, we deferred the completion of these wells until second quarter. At Lloydminster, production averaged 10,000 BOEs per day, up from 9,600 BOEs per day in the fourth quarter. We drilled 20 net crude oil wells in the first quarter. Four operated wells drilled in late 2017 established an average 30-day initial production rate of approximately 200 barrels per day per well. Additionally, we completed the drilling of three net SAGD well pairs at our Karrobert Thermal Project. Production at Karrobert averaged 700 BOEs per day in the first quarter, and we expect to exit 2018 producing approximately 2,000 BOEs a day from this project area.

Let's now shift to our financial results. Before I discuss our corporate-level operating netback, I would like to take a minute and remind everyone of the strong pricing environment we are seeing in the Eagle Ford. Our light oil and condensate production is priced off of LLS, which is a function of Brent price. As a result, we are currently benefiting from a widening of the Brent WTI spread. In addition, increased competition for physical fuel supplies has resulted in improved price realizations relative to LLS. During the first quarter, our light oil and condensate price in the Eagle Ford of $63.16 per barrel represented a premium to WTI. This strong pricing environment contributed to an exceptional operating netback of $32.48 per BOE in the Eagle Ford, a level we have not seen since 2014.

As of today, current Eagle Ford price realizations have further increased to approximately $68 per barrel. In Canada, we generated an operating netback of $8.04 per BOE, which was driven by the wider WCS differentials I alluded to earlier. Subsequent to quarter end, the WCS price differential has improved, with the May index averaging $16.92 per barrel, and early trading for the June index is even tighter. In aggregate, our diversified oil portfolio generated a corporate level operating netback of $20.71 per BOE, excluding hedging. We also continue to drive cost and capital efficiency in our business. During the first quarter, our operating, transportation, and G&A expenses totaled $13.65 per BOE, 3% below or better than the midpoint of our annual guidance.

Our financial liquidity remains strong, with our $575 million revolving credit facilities, 70% undrawn, and our first long-term note maturity not until 2021. In April, we extended the maturity of our revolving credit facilities by one year to June 2020. These facilities are covenant-based and do not require annual or semiannual reviews. We also elected to end the covenant relief period that was set to expire on December 31, 2018, to benefit from reduced borrowing costs. We are well within the revised financial covenants of these facilities. We also continue to manage financial risk through an active hedging program. For the balance of 2018, we have hedges of approximately 55% of our net crude oil exposure and 36% of our net heavy oil differential exposure.

For 2019, we have entered into hedges on approximately 15% of our net crude oil exposure. You will find the details of our hedge program in our press release and the notes to our financial statements. As part of our risk management program, we also transport crude oil to markets by rail when economics warrant. In Q1, we delivered 6,500 barrels per day, or 25% of our heavy oil volumes to market by rail, up 5,000 barrels a day in 2017. We have secured additional rail capacity, which will increase our crude by rail oil volumes to 8,000 barrels per day in Q2, 2018. Let me now conclude by saying our first quarter results are on track to achieve our 2018 guidance.

While the widening of the WCS differential created some headwinds in the first quarter, we achieved the second highest quarterly adjusted funds flow on an unhedged basis since mid-2015. This demonstrates the quality and resiliency of our oil portfolio. Our 2018 production guidance range is unchanged at 68,000-72,000 BOEs per day, with budgeted exploration and development capital expenditures of $325-$375 million. As oil prices rise, we are poised to generate significant free cash flow going forward. We are excited for the remainder of 2018 as we continue to execute our plans for the ongoing benefit of all of our stakeholders, and with that, I will ask the operator to please open the call for questions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To join the question queue, you may press star, then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. Our first question comes from Greg Pardy of RBC Capital Markets.

Greg Pardy (Managing Director and Head of Global Energy Research)

Thanks. Good morning. Ed, could you talk just a little bit about the running room that you see in the Eagle Ford, and then specifically what the program might look for in terms of the Austin Chalk this year?

Ed LaFehr (CEO and Director)

Yeah, sure, Greg. It's an exciting program we have. In Q1, we ran three rigs and two frack crews. For the rest of the year, we're running actually two to three rigs and one to two frack crews. We'll probably add a third frack crew, a spot crew in 3Q to work down the DUC inventory. So we do have an inventory of wells we want to bring online as efficiently as possible, and we need frack crews to do that, not rigs. So we expect to bring on about 30 net wells. Plan is unchanged, as per what we announced some time ago, and we're pretty excited about the results we're seeing. On Austin Chalk, we'll drill five to six wells this year.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

Three will be direct offsets to the twenty-four hundred barrel a day wells that we brought on a few months ago. Those we're really excited to see. And three will be appraisal wells, really, testing the extent of the play to the further to the west across the Excelsior block or in towards that area, not onto the Excelsior block yet, but towards that area. And then also, how far south does this trend move away from the main Karnes Trough Central Fault? And that will delineate kind of the question on how big is this inventory. But overall, inventory hasn't really changed.

We announced our reserves increases on 2P reserves back in February, March, and it's looking like a decade of wells at this pace, 30 net wells per year at a net well count of about 400. So that's over a decade of inventory.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay, perfect. And then maybe just as a second, a few questions just coming up about, just your debt levels as of March thirty-first, and, despite the cash flow, not really seeing the deleveraging. But to what extent is the, is just FX playing into that?

Ed LaFehr (CEO and Director)

Rod, did you wanna speak to FX and changes, and not really been that big a change, actually?

Rodney Gray (EVP and CFO)

Not significant. Greg, it's Rod here. The FX rate is moving around, and a good majority of our debt would be based in U.S. dollars, and so we revalue that at every quarter end, and so you see the movement in our overall aggregate debt level as those get restated.

Ed LaFehr (CEO and Director)

I would say, Greg, on the kind of direction of your question, with respect to debt, I said when I came in, it was a high priority. It was. I had a one A and a one B, if you wanna call it that. The first one was to sustain the business and ensure that we could hold the relevance and profitability of the business at around 70,000 barrels a day. We were in decline for a couple of years through the downturn. Second priority, right on the heels of that, and in fact, this year, we believe we have an opportunity to take a step towards deleveraging.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

But the first step in that, given my view on the macro picture, which I talked extensively about yesterday at our AGM, was bullish, and we needed to be patient to see prices move up, which then give us more optionality and better valuations on our properties, if and when we decide to move into an A and D, you know, a portfolio maneuvering process. So that's still on the cards very much, Greg, and you know, we're pursuing all options still, but this is a much better time for it than in mid-2017 or even late 2017, when we were still not seeing a $60 price handle on WTI.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay, great. And then, the last piece, notwithstanding what you just said, is to the extent you have free cash flow this year, is your inclination to take spending up or generally to think about, you know, putting that on the balance sheet?

Ed LaFehr (CEO and Director)

Right. I know you and others have pushed us on that before. I really like our level-loaded plan now. We kind of haven't waffled since the WCS blew out in Q1. It's tightened back, kind of the way we saw it coming, full cost to rail at $17-$20. So we're sticking with our plan, both in the Eagle Ford and in Canada. We think it's a properly loaded plan this year, almost regardless of price. So we're gonna stay with it. If we see prices continue to stay up and move up, at this point in the year, it's still a bit early, we would probably put that money back to the revolver.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

We, you know, if it's 20 million, it'd be a nice problem to have because then we can look at our options to grow further and add another rig to Peace River, for example, or to pay down debt. My current inclination is we would put it towards paying down the debt.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay. Very good. Thanks very much, guys.

Ed LaFehr (CEO and Director)

Thanks, Greg.

Operator (participant)

Our next question comes from Phil Skolnick of Eight Capital.

Phil Skolnick (Managing Director of Equity Research)

Yeah, thanks. On your rail, how much of it goes down to the Gulf Coast? And can you comment anything about the costs? And more importantly, you know, what kind of realized pricing you're getting, like, relative to Maya in particular?

Ed LaFehr (CEO and Director)

Yeah, we'll have to be a little careful on pricing, but we can say a few words on that, just with respect to competitive dynamics within the industry and also, you know, protecting the people we do business with. But we're today railing about 7,000 barrels a day out of Peace River. Those are manifest trains that move to the Hunt Refinery in Tuscaloosa, Alabama. So that's basically on, right on the Gulf Coast, and receiving attractive pricing. The other 1,000 barrels a day are more piggybacking train availability or carload availability in the Lloydminster, Lashburn, or Altex area. We've been able to secure 1,000 barrels a day. We're hesitant to go too long term on this stuff, but right now, we've, you know, we were railing 5,000 barrels a day in December last year.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

I said then I wanted to double it to ten thousand. This year, we've gotten to eight, and we're still moving it. That, the Lloydminster barrels, correct me if I'm wrong here, guys, but I think the Lloydminster barrels move towards PADD 2, don't make it to the Gulf Coast. We actually don't know. We don't control where that product goes directly to the market. In terms of pricing, need to be a little careful what we say there, but there is certainly a benefit to the WCS volatility, it's what? In the order of $3-$5 kind of range.

I hate to say anything too much more than that, but it is certainly a benefit, and it's part of our hedging mechanism for continuing to produce our barrels at attractive profitability.

Phil Skolnick (Managing Director of Equity Research)

Okay, thanks. Just another question. On the Eagle Ford, I mean, you've mentioned in the past that you know, you could look to sell a good portion of that to help accelerate the deleveraging. I mean, are you-- in your last call, you said that the bid asks are kind of getting out to an attractive point. Are they even more attractive now, where you know, especially given your-- what your comments about the pricing in Eagle Ford, you know, like, why not now try to do something like that and really-

Ed LaFehr (CEO and Director)

Right.

Phil Skolnick (Managing Director of Equity Research)

you know, accelerate that debt reduction?

Ed LaFehr (CEO and Director)

That's a great question, Phil, and it's one that I sort of addressed with Greg, but yours is more specific. I think the bid ask spread is coming together. Our cash flows are also increasing quite dramatically. So our view in terms of, you know, if you wanna put a five times cash flow, a multiple on our cash flow or a number based on transactions in the area, we have higher expectations of what these properties are worth. Are we looking at diluting? I would say we're looking at everything, including dilution, but we're also looking at if these cash flows gives us opportunities to consider other options. And our debt to cash flow, as I think one of you mentioned, has moved from seven times last year to four point eight times at the beginning of this year.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

We're looking at a three handle now, moving into twenty nineteen, and I know we're not back in the peer group yet, but I think it could be. It's a, perhaps a different transaction than what we might have been contemplating in a fifty dollar world than today. So we don't talk about M&A, Phil, as you know, but we're in active dialogue around how we can, you know, move our debt to cash flow back into a competitive run.

Phil Skolnick (Managing Director of Equity Research)

Okay, thanks.

Ed LaFehr (CEO and Director)

Thanks, Phil.

Operator (participant)

Our next question comes from Patrick Bryden of Scotiabank.

Patrick Bryden (Managing Director and Head of Thematic and Sustainability Investment Research)

Morning, Ed and gentlemen, thanks very much for your time. Just a quick question. I noticed, Ed, the Alberta government's put together a working group on crude oil by rail, and I was just wondering if you could maybe lend us some of your perspectives, given, you got a background that's global, you got good perspectives on the U.S. Can you maybe give us a sense for how you're trying to navigate the pipeline issues and how much mitigation you think there ultimately is from, the crude by rail option? Thank you very much.

Ed LaFehr (CEO and Director)

Thanks, Patrick. We were as excited as anybody to see that the Premier and the Minister have called these meetings. We're not one of the companies that, at least to my knowledge, have been invited to these meetings at this point. But it'll probably be the three to five big, large producers and large railers. So we're not involved in that, but we are actively in many different ways. For example, yesterday at the AGM, you know, we're supporting Canada Action. I believe, having been around the world, that we produce some of the cleanest, greenest, most ethically responsible, socially responsible energy in the world, and that message is not getting out there. So we, as a team in Baytex and as a company, are very proud of what we've done.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

We were very pleased to see our name being cited on the Corporate Knights report, sponsored by The Globe and Mail and The Washington Post, ranked number 26, you know, in a group of elite companies. So we were quite pleased with that. But, you know, we're not, we're not there yet as a nation in terms of our energy policy, and I think TMX will go through. There's no reason Keystone should not go through, and for me, Line 3, Enbridge expansion should be the simplest and most obvious of all three of them, so I think it's very likely by 2020, 2021, we'll be looking at three pipelines, maybe one in the ground and one started and another one happening. It's very likely that will be the outcome, despite, we've got a bit of dysfunctionality, quite honestly, within the political regimes.

I think we'll get our act together. We're optimistic. We're bullish on the product is needed in the Gulf Coast more than any time I've seen in my history in the oil business, which is now thirty-plus years. The Canadian WCS heavy product, with the lack of Venezuelan, Mexican, Saudi heavy sours coming off the market and other products, are in need of a blend that requires Canadian heavy oil. The question is just how do we get our arms around getting these three lines built and moved down to the Gulf Coast. That's without mentioning anything about how attractive our product, both on the gas and the oil side, looks to Asia, coming off the west coast of Canada.

So with that, Patrick, it's a bit of a ramble, but we're very, very pro Canadian energy, playing a bigger role in the world oil mix that's due to cross a hundred million barrels a day usage consumption by mid this year.

Patrick Bryden (Managing Director and Head of Thematic and Sustainability Investment Research)

Thanks for that. And just maybe getting to the crude oil rail sort of mitigation more specifically, like, are you seeing more deals happen, more flow on that front that's helping out?

Ed LaFehr (CEO and Director)

I mentioned we've moved our 5,000, 8,000, but it's been in small tranches. We would like to do bigger tranches, but, you know, we've done a couple thousand barrel a day tranches in Peace River, and we've done another 1,000 now, as I mentioned, in Lloydminster. We could do more than that. We'd like to do more than that. We're seeing some availability come into play, but it's on a very selective and ad hoc basis. We're not getting the attention of the railers, we ourselves, because we're not a huge volume producer in heavy. Actually, everybody is sitting in the queue, in my mind, and this is my personal opinion. We're all sitting in the queue behind those two large producers who are in active negotiations with those railing companies.

Patrick Bryden (Managing Director and Head of Thematic and Sustainability Investment Research)

Understood. Appreciate the color. Thank you.

Operator (participant)

This concludes the question and answer session. I would like to turn the conference back over to Mr. Ector for any closing remarks.

Brian Ector (Senior VP of Capital Markets and Public Affairs.)

All right, thanks, operator, and thanks everyone for participating in our first quarter conference call. Have a great day.

Operator (participant)

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