Baytex Energy Corp. Q3 FY2022 Earnings Call

Thank you for waiting. This is the conference operator. Welcome to the Baytex Energy Third Quarter 2022 Financial Results and Operating Results Conference Call. I will now turn the conference over to Brian Ector, Vice President, Capital Markets. Please proceed.

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 six 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.

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 am 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 six 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. Six 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 have 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 four 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 five wells per section versus four 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.

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.

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, wishes you all the best in retirement. And now operator, we are ready to open the call for questions.

Our first question is from Patrick O'Rourke with ATB Capital Markets.

First, I want to congratulate Ed on a successful career here, and I hope you enjoy your retirement, even though I know you'll stay busy. Eric, I hope you're enjoying the weather in Calgary this week. Now, regarding Clearwater, you've made several adjustments to the wells, using configurations like 1 x 8 and 2 x 4, and reduced the interlateral spacing from 50 meters to 40 meters. I have a couple of questions about that. First, is there a preferred design between the 1 x 8 and 2 x 4 configurations that you're leaning towards? How well do you understand the technology, and what do you think the optimal configuration might be? Secondly, concerning the reduction in interwell spacing from 50 to 40 meters, you mentioned a potential increase in inventory of 20%. Would this configuration apply throughout the entire reservoir, or does it vary based on geological factors? Also, is there potential for further downspacing, and what indications do you see regarding interwell communication among the wells?

Yes, there's a lot in that question, Patrick. I will share my thoughts and then hand it over to Chad Lundberg, our Chief Operating Officer. First, we've been drilling multilaterals in this region for two decades, and we consider ourselves among the best in multilateral open hole drilling configurations. In Peace River, for example, we have tested scenarios ranging from 25 to 50 meters over the last decade. We also conducted small scale tests with spacing from 15 meters to 150 meters in the early Harmon Valley days. We've explored various geometries and complex configurations to maximize resource extraction in different parts of the Bluesky play. We're rapidly learning and advancing in Peavine, where we currently have 24 wells producing 10,000 barrels a day. Recently, we shifted to four lateral extended reach drills, and we currently have around 10 of these, with nine in operation since the second half of the year. This setup is our preferred configuration for most of the upcoming development, at least for now. The reasons for this are partly technical and partly related to social considerations. These wells allow us to drill efficiently, minimizing the number of times we pull out of the hole, which optimizes costs and enables us to remain in the reservoir longer. Geosteering is crucial to our success, with over 99 percent of our drills successfully hitting the target zone. These two-mile laterals positively impact us both technically and economically, and they also hold social significance. Having social license in the Métis Settlement is essential, especially as we approach the Hamlets in residential areas, allowing us to avoid environmentally and socially sensitive locations. Our team is very creative and tenacious, consistently leading innovative trends in multilateral drilling. So, we believe we can continue to progress further. Chad, do you want to add anything to my comments?

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 four laterals where there are fewer trips out of the well. Fifty meters to 40-meter spacing, I think is pretty key for us. 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.

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

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.

The next question is from Menno Hulshof with TD Securities.

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.

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 cored 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 two or three 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 three wells, but those three 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 five-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.

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?

Yes. In the first quarter, we decided to increase our capital, and we noticed inflation rates in Canada and Eagle Ford that were quite high and consistent. Since then, there has been a significant rise in inflation in Eagle Ford and Texas overall, while Canada has seen less impact. Currently, we are observing a 20% inflation in Canada compared to our budget numbers for 2022 as we look ahead to 2023. In Eagle Ford, we are experiencing a 30% inflation increase, partly due to the level of pressure pumping in our frac operations. Chad, would you like to provide any additional insights on the inflation differences?

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 in the second half, 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.

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

I want to add my congratulations to Ed on the CEO transition. My first question is regarding Seal. I understand there is another well being drilled in the fourth quarter to further assess that asset. I'm curious about your approach to balancing the continued evaluation of the Seal asset with the development activities at Peavine.

Yes, Seal is an exciting area with a significant increase in activity expected, driven both by our initiatives and competitor actions. We plan to drill a second well on the Seal trend, which spans about two townships of our land. We anticipate having results by the end of this year. We're also observing competitors drilling close to our lease lines, with permitted wells appearing near our leases around Seal and the larger Harmon Valley area. There is more potential there, and data collection is ongoing. Seal and Harmon Valley are multi-zone areas, in contrast to Peavine which is primarily focused on the E zone. We are closely evaluating the D through A zones in Seal and Harmon Valley. We aim to complete the second well by year-end and have plans for two additional wells in 2023. In the meantime, we are fully engaged in Peavine and looking to expand that asset. Currently, we have one rig operating in Peavine, which will increase to two rigs in the first quarter of next year, and we will also have a rig operating throughout the broader Peace River area in 2023. So, you can expect more activity from us up there, and the presence of competitors will assist us in learning more and reducing risks in a more complex area compared to Peavine.

Great. Shifting my focus, I have a question regarding the term debt. The market appears to be in a favorable position for repurchasing that continually. I'm curious about your thoughts on the current capital structure of the company. Is the credit facility going to be the main focus, considering these term notes are relatively more expensive? I'm interested in your perspective on the overall capital structure of the company.

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.

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?

We will keep monitoring the situation, Dennis. Our main focus has been on reducing debt and we believe our shares are undervalued, which is why we prefer buybacks. We remain open to all ways of returning value to shareholders, but we plan to dedicate about 75% of our free cash flow back to them in some form. We will look for opportunities to differentiate ourselves in the market as we move forward and optimize our approach when the time is right. Since we are currently behind our peers in reaching these goals, we will have some insights to help us implement our strategy. Ultimately, we are committed to returning value directly to our shareholders.

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

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

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