Baytex Energy: Increasing Heavy Oil Production (TSX:BTE:CA)

Baytex Energy (OTCPK:BTEGF) is currently projected to generate around US$424 million in positive cash flow in 2023 while growing production modestly. It is growing heavy oil production the most, as heavy oil is expected to account for 41% of its total production in 2023, up from 35% in Q3 2022.

Baytex’s estimated value is thus affected by heavy oil differentials. In a scenario with long-term US$75 WTI oil and negative US$12.50 WCS differentials, I’d estimate Baytex’s value at approximately US$6 per share. In a scenario with long-term US$75 WTI oil and WCS differentials at wider than negative US$20, Baytex’s estimated value decreases to around US$5 per share.

This report uses US dollars unless noted otherwise, and uses an exchange rate of US$1.00 to CAD$1.35.

Baytex’s 2023 Outlook

Baytex expects to average approximately 87,500 BOEPD in production in 2023 with a production split of 41% heavy oil, 36% light oil, 8% NGLs and 15% natural gas.

The current strip for 2023 is approximately US$81 to US$82 WTI oil, along with a WCS differential of negative US$22 and an MSW differential of negative US$3.00. NYMEX gas strip is around US$3.50, while AECO strip is approximately US$2.60.

At those commodity prices, Baytex is projected to generate US$1.737 billion in revenues before hedges. Baytex’s 2023 hedges have a slight amount of positive value currently.

	Units	$ Per Unit	$ Million USD
Heavy Oil	13,094,375	$52.00	$681
Light Oil and Condensate	11,497,500	$78.00	$897
NGLs	2,555,000	$31.00	$79
Natural Gas	28,743,750	$2.80	$80
Hedge Value			$2
Total			$1,739

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Baytex expects to spend approximately US$454 million in 2023 on capital expenditures. This leads to a projection that Baytex will generate US$424 million in positive cash flow at current strip (low-$80s WTI oil).

	$ Million USD
Royalties	$365
Operating Expenses	$340
Transportation	$47
Cash General And Admin	$39
Cash Interest	$48
Capital Expenditures	$454
Leasing Expenditures	$3
Asset Retirement Obligations	$19
Total Expenses	$1,315

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Return Of Capital

Baytex expects to return approximately 40% of its free cash flow in 2023 to shareholders. This would mean approximately US$170 million would get put towards share repurchases in 2023, while US$254 million would go towards debt reduction.

This should be able to reduce Baytex’s net debt below US$500 million by the end of 2023. Baytex’s credit facility would thus be paid off (or very close to being paid off) by the end of the year, leaving it with US$473 million in 8.75% unsecured notes due 2027.

Baytex had 545 million shares outstanding in early 2023, and share repurchases may reduce this total to around 510 million shares by the end of the year.

Notes On Valuation

Baytex believes that it can average approximately US$400 million per year in after-tax free cash flow at US$75 WTI oil between 2024 and 2026. This also incorporates modest (around 3% per year) production growth over that timeframe.

This is based on a significant improvement in the WCS differential after 2023 though, assuming a negative US$12.50 differential for 2024 to 2026. The current strip for WCS differentials in 2024 is currently around negative US$21.

In a scenario where the WCS differential improves to US$12.50 after 2023, I’d estimate Baytex’s value at around US$6 per share with long-term US$75 WTI oil. However, a scenario where the WCS differential remains a bit wider than US$20 after 2023 would reduce Baytex’s estimated value to approximately US$5 per share with long-term US$75 WTI oil.

Conclusion

Baytex is projected to generate US$424 million in positive cash flow in 2023 at current strip (low-$80s WTI oil). Based on its capital return framework, Baytex could essentially pay off its credit facility debt by the end of 2023, while also repurchasing around 37 million to 38 million shares (at its current share price).

Baytex has been investing in growing its heavy oil production. Heavy oil accounted for 28% of Baytex’s total production in Q3 2021, increasing to 35% of its total production in Q3 2022. Baytex now expects heavy oil to account for 41% of its total production in 2023.

The increased importance of heavy oil to Baytex’s results means that WCS differentials have a noticeable impact on Baytex’s estimated value. If WCS differentials go back down to negative US$12.50 in the long-term, then Baytex’s estimated value is around US$6 at long-term US$75 WTI oil. If the WCS differential stays above negative US$20, then Baytex’s value is reduced to approximately US$5 with long-term US$75 WTI oil.

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