Earnings Call Transcript - BTE Q1 2022

Operator, Conference Operator

Thank you for your patience. This is the conference operator. Welcome to the Baytex Energy Corp. First Quarter 2022 Financial and Operating Results Conference Call. I would now like to turn the conference over to Brian Ector, Vice President, Capital Markets. Please proceed.

Brian Ector, Vice President, Capital Markets

Thank you, Shareese. Good morning, ladies and gentlemen, and thank you for joining us to discuss our first quarter 2022 financial and operating results. Today, I am joined by Ed LaFehr, our President and Chief Executive Officer; Rod Gray, our 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 today are in Canadian dollars, unless otherwise specified. And with that, I would now like to turn the call over to Ed.

Edward LaFehr, President and Chief Executive Officer

Thanks, Brian, and good morning, everyone. I'd like to welcome everybody to our first quarter 2022 conference call. During the first quarter, we remained focused on capital discipline, generating free cash flow and reducing debt. We delivered strong operating and financial results with production of almost 81,000 BOEs per day, free cash flow of $121 million and a 10% reduction in our net debt to $1.28 billion. I'm very pleased to announce that given the strength of our balance sheet and consistent with our desire to offer direct shareholder returns, the Board of Directors has approved the filing of a normal course issuer bid application with the Toronto Stock Exchange for a share buyback program of up to 56 million common shares, representing 10% of our public float. We expect to commence the buyback program in May, which is consistent with the shareholder return framework we discussed last quarter. These are exciting times for Baytex. In addition to the share buyback announcement, we have a number of positive developments to share with you today. First is the success of our Clearwater development at Peavine, second is our increased 2022 guidance, and third is the update we've made to our 5-year plan. Let's start with our Clearwater results. We followed up our 2021 Appraisal Program on our Peavine acreage with exceptional Q1 2022 drilling program. We have now started up all 10 wells drilled during the first quarter and production has increased from 0 at the beginning of 2021 to approximately 8,000 barrels per day today. During the first quarter, we successfully executed our first 6 extended reach horizontal wells, which are utilized to provide appropriate setbacks to residents and environmentally sensitive areas. These ERH wells are among the first of their type to be drilled in Western Canada and consist of 4 2-mile long laterals versus a more traditional well design comprised of 8 1-mile laterals. Our first 3 ERH wells on the 4-25 pad have established average 30-day initial production rates of approximately 1,100 barrels per day per well and are the strongest wells ever drilled in the Clearwater play. In addition, 4 wells on the 5-33 pad were brought on stream in March and April and are expected to generate 30-day initial production rates of 300 to 400 barrels per day per well. Initial well performance continues to outperform our type curve assumptions, and we now have 7 of the top 10 initial rate wells drilled to date across the Clearwater play. As we continue to progress our development plan, we have committed to drill 6 additional Clearwater wells during the fourth quarter. We now intend to run a full 1 rig program at Peavine through year-end. As a result, we expect to drill 24 net wells in 2022, up from our original budget of 18 net wells. Maintaining a consistent 1-rig program level loading activity in the second half of 2022 will drive further efficiencies and set the stage for continued strong operating momentum heading into 2023. At current commodity prices, the Clearwater generates among the strongest economics within our portfolio with payouts of less than 3 months and has the ability to grow organically while enhancing our free cash flow profile. To date, we have derisked 50 sections of our 80 section Peavine land base, and our updated plans include the drilling of approximately 120 net wells through 2026. When combined with our legacy acreage position in Northwest Alberta, we estimate that over 125 sections are highly prospective for Clearwater development. With this updated view of our land base, we expect Clearwater production to increase to approximately 10,000 barrels per day during our 5-year plan period, while generating over $400 million of cumulative free cash flow. With continued success, we believe the play ultimately holds the potential for over 200 drilling locations that could support production increasing to over 15,000 barrels per day. We are very excited with the Q1 program and what it means for our business going forward. I will now turn to our 2022 outlook and guidance update. With continued strong operating momentum and production growth on our Clearwater lands, we are increasing our production guidance for 2022 to 83,000 to 85,000 BOE per day, up from 80,000 to 83,000 BOE per day previously. And we expect to exit 2022 producing approximately 87,000 to 88,000 BOE per day. Based on the forward strip, we now expect to generate approximately $700 million or $1.25 per basic share of free cash flow this year. As part of our previously announced return of capital framework, we expect to allocate approximately 25% of our annual free cash flow to direct shareholder returns through the share buyback program I mentioned earlier. The remainder of our free cash flow will continue to be allocated to debt reduction until we achieve a net debt level of $800 million, which represents an expected net debt-to-EBITDA ratio of 1x at a USD 55 WTI price. This level of net debt will provide us with flexibility to run our business through the commodity price cycles and generate meaningful returns to our shareholders. At current prices, we expect to achieve this net debt level in early 2023. At which point, we will consider steps to further enhance shareholder returns. Our operational success, the continued strong economics of our drilling program and the inflationary pressures being experienced throughout our industry caused us to review our capital program for the year. We are now forecasting 2022 exploration and development expenditures of $450 million to $500 million, up from $400 million to $450 million, which was set in a USD 65 pricing environment. The incremental capital reflects the additional activity on our Clearwater lands and 2 to 3 net incremental wells in the Eagle Ford. This increased activity set will result in $30 million of incremental exploration and development expenditures, which is offset by approximately $10 million of reduced light oil activity. We also updated our 2022 plan to reflect an incremental 8% expected capital cost inflation, which increases our exploration and development expenditures by approximately $30 million. This reflects industry cost pressures related to labor, logistics, fuel, and tangible items such as steel, frac sand and chemicals. In aggregate, we are now assuming 18% capital cost inflation in 2022 as compared to 2021. Lastly, we have fine-tuned several of our cost assumptions to reflect increased royalties due to higher commodity prices, inflationary pressures and inflationary pressures on operating and transportation expenses. Offsetting these cost pressures to a certain extent is increased production and a reduction in our interest expense as our net debt is reduced. With a strong outlook for 2022 unfolding, I want to now turn it over to Rod, who will provide a brief update on our 5-year plan and liquidity and capital structure.

Rodney Gray, Executive VP and Chief Financial Officer

Thanks, Ed, and good morning, everyone. We introduced our 5-year plan 1 year ago in April 2021 to highlight our financial and operational sustainability and our ability to generate meaningful free cash flow. We continue to benchmark our results to this 5-year plan and intend to update as warranted based on the macro environment, drilling results and activity across our land base. We are now rolling our 5-year plan forward to capture the period 2022 to 2026. Through this planned period, we are committed to a disciplined returns-based capital allocation philosophy, targeting exploration and development expenditures at less than 50% of our adjusted funds flow. We expect to generate annual production growth of 2% to 4%, with production reaching approximately 95,000 BOE a day in 2026. Year 1 of the 5-year plan is based on our 2022 guidance and the forward strip commodity prices. And years 2 through 5, 2023 to 2026, are based on a constant USD 75 WTI price. Our focus on delivering free cash flow is unchanged. Under these pricing assumptions, we expect to generate approximately $3 billion of cumulative free cash flow during the planned period. In our May Investor Relations presentation, available on our website, you'll find more details regarding our 5-year plan, including free cash flow sensitivities at USD 85 and USD 95 WTI prices. Turning to our liquidity position at March 31. We had approximately $600 million of liquidity on hand at March 31. On April 1, we announced that we received strong support from our lending syndicate to extend and amend our bank credit facilities. The revolving credit facilities have been extended by 2 years from April 2024 to April 2026 and have been increased modestly from approximately USD 815 million to USD 850 million. The revolving credit facilities are not borrowing base facilities and do not require annual or semiannual reviews. Our net debt, which includes our credit facilities, long-term notes and working capital, totaled $1.28 billion at March 31, 2022, down from $1.41 billion at December 31, 2021. At current prices, we expect to exit 2022 with net debt of less than $900 million. We also intend to repurchase and cancel the remaining USD 200 million principal amount of 5.625% long-term notes due 2024 at par on June 1, 2022. And with that, I'll turn the call back over to Ed.

Edward LaFehr, President and Chief Executive Officer

Thanks, Rod. We are incredibly excited to be in this position today. To summarize, we remain focused on capital discipline, generating free cash flow and reducing debt. We materially advanced our Clearwater development during the first quarter, and these exceptional wells have enabled us to more than double our Clearwater production to 8,000 barrels per day. As a result, we are pleased to increase our 2022 production guidance and add 6 new Clearwater wells late this year. Our focus on delivering substantial free cash flow is unchanged. Our updated 5-year plan is expected to generate approximately $3 billion of cumulative free cash flow. And once again, I'm very excited that our Board of Directors has approved a share buyback program that is expected to commence in May. Our business is strong, and we look forward to executing our plans for the ongoing benefit of all stakeholders. And with that, I will ask the operator to please open the call for questions.

Operator, Conference Operator

The first question comes from Patrick O'Rourke with ATB Capital Markets.

Patrick O'Rourke, Analyst

Really impressive results on those most recent pads in the Clearwater. Question with respect to the scale and scope of the project here. I know you've taken it up to 10,000 barrels a day, and you're talking about potential for that play to be a 15,000 barrel a day right now. I'm just wondering if you can sort of give us a little bit more color in terms of that 15,000 barrel a day number, and what percentage or number of sections within your acreage that encompasses as of right now?

Edward LaFehr, President and Chief Executive Officer

We're really excited about the rapid progress in this area, which has increased from 3,000 barrels a day in January to 8,000 barrels a day. We now have performance data indicating that 50 sections in the central part of our Peavine play are derisked. With private companies operating nearby, along with our significant activity in the central and western areas, we’ve established that these 50 sections are secure within our entire 80-section land block. We have planned for 200 wells, based on a conservative estimate of four wells per section, and have included 120 of those wells in our 5-year plan to achieve 10,000 barrels a day. Previously, we had planned to develop 80 wells for a target of 6,000 barrels a day, but we've revised this higher to 10,000 barrels. Given that we have 200 locations derisked, we can maintain this output for a considerable time. Over the next six months, we’ll explore the potential to the east, southeast, and northeast. This will allow us to assess those areas further. For now, our 5-year plan is based on the center of this play potentially achieving higher type curves, which could lead us to 15,000 barrels a day. The key factors will be the pace, timing, and derisking of the eastern areas. While it seems achievable to exceed 15,000 barrels a day, we are currently committing to the 10,000 barrel a day plan for a portion of those 50 sections in the west.

Patrick O'Rourke, Analyst

So is the gap between the 10,000 and the 15,000 there then, is that primarily derived from sort of a derisking of the well results and potential sort of aerial delineation? Or is it more so derived from pace of capitalization and the amount of capital directed to the play?

Edward LaFehr, President and Chief Executive Officer

I believe it’s a combination of both factors. As I mentioned, I think we can achieve 15,000 barrels a day. We are unsure about the full size of the field. If the field extends significantly to the east and northeast, it would provide us with options to increase production to 15,000 barrels a day or even higher and explore various development strategies. Currently, our plan is to utilize a portion of those 50 sections within a five-year framework. It will involve reducing risks to the east and determining our desired production levels and timeline for blowdown versus potentially more extensive development that could last over a decade. We must address the larger risks related to this bigger question first. However, I am confident we can reach 15,000 barrels a day; the key consideration is the overall size of the field.

Patrick O'Rourke, Analyst

Okay. Just a final question regarding that. You have a 5-year plan in place. What is the expected pace or time frame for the derisking you mentioned?

Edward LaFehr, President and Chief Executive Officer

I think the major part of the east and northeast derisking will be first quarter next year. We need some winter access up to the northeast. It's a more remote area up there. And so we'll need to get out there on some ice roads over jeep roads essentially and are not ready to go beyond that until we get some strap wells down.

Operator, Conference Operator

The next question comes from Eric Nuttall with Ninepoint Partners.

Eric Nuttall, Analyst

Confusing reaction on the share price today, not everybody gets to come out and say they just drilled some wells to pay back in 2 weeks. I don't think I've seen that in my career. I just wanted to turn the conversation to return of capital. As your larger shareholder, we fully support the debark to lower leverage, an amazing accomplishment to be able to talk about share buybacks now versus 2 years ago. But I want to focus on 2023. We've got you guys achieving net cash status by the end of next year. We've got you trading at a 38% free cash flow yield at $100 oil. I know you're using a lower price in your deck. So with 25% of free cash flow now, once you get and achieve your deleveraging status, you talked about further enhancing returns, what's a reasonable percentage of that as shareholders we should expect next year, like is 75% of free cash flow reasonable? Because if that's the case, and we dare to dream and believe in the current oil price, that's a 28% buyback dividend, some combination thereof. So I just wanted to get your sense of what you think a reasonable return to shareholders will be next year once you achieve your leverage target?

Edward LaFehr, President and Chief Executive Officer

Yes. Well, firstly, it's really great and very exciting that those debt targets have come up on us as quickly as they have, and we'll continue to, under current pricing. So I want to just first say for all callers onboard, I know you're aware of this, Eric, and we've talked fairly often, but just for everyone else, we are absolutely committed to returning significant returns to shareholders directly and in the form of 25% of our free cash flow this year to buybacks, in the form of share buybacks. And we had unanimous Board support over that. We're trading below our intrinsic NAV. We have an all-time low historical multiple despite the fact our portfolio has improved, pricing has improved, our asset performance has improved. And when we look at that formula in combination with where we are relatively or an absolute level on value, we want to buy our shares back all day long. This is a very exciting place to be. Now your question is really more about what happens when we hit the $800 million second target that we've announced, and we expect to be there by early next year, as I just said in the script. And at that point in time, we're going to be even more committed to providing direct returns to shareholders in the form of buybacks, if we're trading as we are today. Potentially in the form of a dividend as well, we have that to debate with the Board. Potentially in the form of Clearwater and generating more free cash flow through Clearwater development. So with that, I'm going to hand it over to Rod just to add any additional flavor on this, but we will have options there. As you say, being nearly debt-free in early 2023 to go far beyond where we are today, I just can't give you a specific number. Maybe, Rod, you can offer some additional context to help.

Rodney Gray, Executive VP and Chief Financial Officer

It's more just context, Eric. I see us driving the debt level lower, running with less leverage in the system, and that gives us optionality. But as Ed said, we are committed to providing direct shareholder returns, and I would expect we're going to have much more flexibility with that, as you've indicated, into 2023.

Eric Nuttall, Analyst

Like I look at you guys, debt-free, low to no growth, you've got a cash problem. So we've got Cenovus pledging 100% of free cash flow back to shareholders. So I would assume that 75%, but I know it's a board decision, you can't commit to anything right now, but it's just the numbers are truly eye-popping. I just don't think the average guy gets it just yet.

Edward LaFehr, President and Chief Executive Officer

Yes. And it could be a very, very large number. So thanks for the call and the question.

Operator, Conference Operator

The next question comes from Joshua Young with Bison.

Joshua Young, Analyst

Yes, those were great questions already, and this is a great report. Thank you for just fantastic results. Can you talk a little bit about what changed in the Clearwater in terms of yielding? So obviously, these are longer laterals, but there are fewer of them in each of these wells. What is it that drove these excellent kind of best-in-play results that you guys just announced? And what does it mean for additional inventory in this part of the field?

Edward LaFehr, President and Chief Executive Officer

A significant part of our strategy involves focusing on the central area of the field and advancing in that direction. Initially, we agreed to begin our operations in the Far West, understanding it wasn't in the center. We then progressed to the 14-36 pad, which was addressing a DST that showed promising results in some conventional logs. This indicated we might be in a more advantageous position. We confirmed this with the 903, which produced 900 barrels a day. As we continued south, we entered the core of the thicker, more permeable trend of the field. The exciting development is that with our new technology, we can utilize 4 laterals with the same meterage as the previous 8 lateral 1-mile wells. These new 2-mile wells allow us to minimize impacts on roads and small communities, facilitating full-scale development. Additionally, when drilling in this consistent and clean reservoir, we can achieve strong efficiencies in our drilling rates. Consequently, we were able to drill these wells more cost-effectively because we are located in the heart of the trend, and we anticipate the completion of our super pad facilities soon. We've completed these facilities, and the wells are ready for production. We executed this during breakup, which carried some risk, but by prioritizing the completion of the facilities and bringing the new 4 lateral wells online, we can transition to production with fewer challenges in the first few months. There's a substantial inventory available, with 3 wells currently producing 1,100 barrels a day, and we are bringing on 3 more from the same pad. All these wells are in Q2 and later, as none came online in Q1. The core area likely contains around 20 sections of land, which translates to about 80 potential wells as we continue to expand from the core. We are very enthusiastic about establishing a new benchmark for the entire basin with these 1,100 barrel a day wells.

Joshua Young, Analyst

That's great. That's helpful color. And then could you talk about, as a follow-up, what this means for your other heavy oil inventory at Peace River and at Lloydminster? And how applicable the technology and the techniques that you're using for these great results in the Clearwater might be for this other inventory?

Edward LaFehr, President and Chief Executive Officer

Yes, we consider ourselves the leading explorer, developer, and operator of multilateral heavy oil wells. We've been successfully operating in Lloydminster for many years and have a long history in Peace River, and now we're applying our expertise to the Clearwater area. We plan to drill a second Seal well in our established Peace River lands by the end of this year, likely in an appraisal mode with a 1-mile leg configuration instead of a 2-mile configuration, as we need to ensure the reservoir's consistency before extending further. In Lloydminster, we utilize various configurations of single and multilateral laterals based on our needs. This experience has given us insight into new methods for managing continuous reservoirs. We have a robust inventory in Lloydminster and will be conducting a full rig program there, starting just after breakup, as well as in Peace River. Additionally, we will be operating a full rig in Peavine for the remainder of the year, resulting in three full-time rigs working on our heavy oil properties, utilizing a range of lateral and multilateral configurations. We're truly excited about the developments happening, as they represent a significant shift in how Clearwater development will be approached.

Operator, Conference Operator

The next question comes from Jeremy McCrea with Raymond James.

Jeremy McCrea, Analyst

Just to follow up on Eric and Josh's questions, we've been closely monitoring the development of your Clearwater. It seems that every quarter you are revising the numbers upwards, and even today we see another upward revision. How conservative are you with your projections? What do you believe you can actually achieve heading into 2022? Are you considering any new technologies for your wells? I'm trying to understand the level of conservatism you have integrated into your forecasts. Additionally, could you provide a brief comment on the current M&A activities related to land sales?

Edward LaFehr, President and Chief Executive Officer

We do not comment on land sales, but we have mentioned that we possess 145 sections of highly promising land in the Clearwater, with 80 in Peavine and another 45 in the Northwest region of the Clearwater play. We provide these general figures but do not discuss land sales in detail. We are indeed conservative. We meet our marketing promises and consistently achieve our quarterly earnings and production targets, which we have maintained without missing any for the past 5 or 6 years. We prefer to set targets that we can exceed. Currently, we are producing 8,000 barrels a day, which relates to your question. Our exit rate in Peavine is projected to be between 8,000 and 10,000 barrels a day, and we are on track to reach the upper limit of our 5-year plan in the Clearwater of 10,000 barrels a day early in the plan. The next step will involve determining how much activity we want to incorporate into the plan to aim for a production level of 15,000 barrels a day or more. We aim to surpass our targets, especially in relation to the external market. Internally, we set ambitious goals and effectively manage our progress while innovating along the way, allowing us to identify optimal solutions quickly. The Clearwater play is relatively new, with only 80,000 barrels a day at the play level. We currently account for 10% of this production, and several analysts anticipate that this will increase to 200,000 barrels a day. We believe that production in Clearwater will eventually exceed 200,000 barrels a day in the regional area, and we aim to be a key player in this growth. Our goal is to be a builder, developer, and aggregator in the area and to achieve even greater results as we move forward.

Operator, Conference Operator

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

Brian Ector, Vice President, Capital Markets

Thank you, Shareese, and thanks, everyone, for participating in our first quarter 2022 conference call. Have a great day.

Operator, Conference Operator

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