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Baytex Energy (NYSE:BTE)

Q2 2013 Earnings Call

August 14, 2013 11:00 am ET

Executives

Brian G. Ector - Vice President of Investor Relations

James L. Bowzer - Chief Executive Officer, President and Director

Marty L. Proctor - Chief Operating Officer

W. Derek Aylesworth - Chief Financial Officer

Analysts

Mark J. Friesen - RBC Capital Markets, LLC, Research Division

Cristina Lopez - Macquarie Research

Travis Wood - TD Securities Equity Research

Dirk M. Lever - AltaCorp Capital Inc., Research Division

Gordon Tait - BMO Capital Markets Canada

Operator

Good morning, ladies and gentlemen, welcome to the Baytex Energy Corp. Second Quarter 2013 Results Conference Call. Please be advised that this call is being recorded. I will now like to turn the meeting over to Mr. Brian Ector, Vice President, Investor Relations. Please go ahead, Mr. Ector.

Brian G. Ector

Thank you, Jade. Good morning, ladies and gentlemen, and thank you for joining us today to discuss our second quarter financial and operating results. With me today are James Bowzer, President and Chief Executive Officer; Derek Aylesworth, our Chief Financial Officer; and Marty Proctor, 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 refer you to our advisories regarding forward-looking statements and non-GAAP financial measures contained in today's press release.

I would now like to turn the call over to Jim.

James L. Bowzer

Thanks, Brian, and good morning, everyone. During the second quarter, we generated production of 58,200 BOEs per day, an increase of 12% over the first quarter of this year. This is the highest quarterly production rate in company history. Our strong operating results, combined with an improving pricing environment for heavy oil, resulted in a 53% increase in our funds from operations versus the first quarter to $155.8 million or $1.26 per basic share. This represents the second highest quarterly FFO in company history.

Our operating net back during the second quarter of $31.71 per BOE represented a 27% increase over the first quarter. We expect continued strong operating and financial results in the second half of this year. In recognition of this, we are tightening our production guidance range for 2013 to 57,000 to 58,000 BOEs per day, up from our previously disclosed range of 56,000 to 58,000 BOEs per day.

In the first half of 2013, our capital spending has progressed as planned in our key development areas. Spending for exploration and development activities totaled $178 million during the second quarter with year-to-date spending of $344 million. About 70% of our capital spending to date has been directed toward drilling and completion activities, with 30% being equipment and construction-related, which does include our thermal expenditures.

Consistent with our previous guidance, exploration and development expenditures for 2013 are forecast to be approximately $520 million. We are very pleased with the execution of our capital program through the first 6 months of this year and to summarize, we drilled 17 multilateral wells at Peace River during the second quarter, bringing the year-to-date drilling to 23 wells.

From this year's program, we have achieved average 30-day peak production rates of approximately 700 barrels per day. We drilled 63 net wells in our Lloydminster area year-to-date with a 98% success rate.

We completed one successful thermal infill well at Kerrobert SAGD project, which added incremental production of approximately 400 barrels per day. And we continue to progress our thermal development with facility construction now underway at both our Cliffdale, 15 well CSS module and our Gemini SAGD pilot project.

With respect to our balance sheet, we ended the quarter with total monetary debt of $771 million, which represents a debt to funds from operations ratio of 1.2x based on second quarter 2013 FFO annualized. At the end of the quarter, we had $625 million in undrawn credit facilities with no long-term debt maturities until 2021. With our capital spending weighted towards the first half of the year and assuming continued strength in production levels and commodity prices, we expect that total debt levels will reduce over the balance of 2013.

Production from our Peace River area properties averaged approximately 23,000 barrels per day in the second quarter, an increase of 22% over the first quarter. We drilled 23 cold horizontal producers in the first half and plan to drill approximately 14 more wells in the second half.

In the Cliffdale area, successful operations continued on our 10-well CSS module, with production averaging approximately 400 barrels per day. During the second quarter, the initial Cliffdale pilot well completed its fifth steaming cycle and was returned to production in mid-June. Current production from the 10-well module is approximately 700 barrels per day.

Facility construction at our new Cliffdale 15-well CSS module is well underway, and drilling operations commenced in the second quarter. We expect to complete construction of the plant and commence cold production in the fourth quarter. First per cycle steaming of the wells is expected to occur in the first half of 2014.

At Lloydminster, production averaged approximately 19,500 barrels per day during the second quarter, which was up just over 5% from the first quarter. Drilling activity in our Lloydminster region is usually pretty quiet during the second quarter due to spring breakup. We drilled 3.6 net oil wells, which brings our year-to-date total drilling to 63.3 net wells.

As you may recall, we drilled one thermal infill well at our Kerrobert SAGD project during the first quarter. This well commenced production in the second quarter, adding an incremental production of 400 barrels per day. We are pleased with the performance of this well and plan to drill one more thermal infill well, along with one SAGD well pair at Kerrobert during the second half of this year. In total, we expect to drill approximately 50 net wells in the Lloydminster area in the remainder of 2013.

At Angling Lake, construction of the Gemini SAGD pilot project facilities commenced in late in the second quarter. Construction of the drilling pad is complete. Mechanical crews have been mobilized and major equipment is being moved on site. We expect to drill a SAGD well pair during the third quarter and on our -- and are on track for steaming late this year or in early 2014.

In our Bakken/Three Forks development in North Dakota, production averaged 3,100 barrels per day, which is up 5% from the first quarter. We drilled 8 gross or 4.5 net horizontal oil wells and fracture-stimulated 10 gross or 5.1 net wells.

During the second quarter, 9 operated wells on 1,280-acre spacing established average 30-day peak rates of approximately 360 barrels per day. We plan to drill approximately 2 gross or 1 net well in North Dakota during the remainder of 2013.

I want to spend a few minutes on heavy oil pricing and our marketing efforts. I think most everyone is aware that the benchmark price for our heavy oil in Canada is Western Canadian Select or WCS, which trades at a discount WTI. This discount during the second quarter, as measured by the price differential between WTI and WCS, averaged 20%. This is a significant improvement from the 34% price differential in the first quarter. As heavy oil differentials narrowed, our realized oil and NGL price of $66 per barrel increased by 14% from the first quarter.

WCS and Mayan crudes have recently been trading closer to their transportation differential. We are optimistic that this will continue as refinery demand grows in the U.S. Midwest, and transportation capacity expands to the U.S. Gulf Coast and Northeast through both pipeline projects and increased rail deliveries. The forward market for the second half of 2013 suggests a WCS to WTI differential of approximately 20%.

We have taken advantage of the recent strength in WTI prices and a weaker Canadian dollar to add to our hedge portfolio. For the second half of 2013, we have entered into hedges on approximately 63% of our WTI exposure at a weighted average price of just over USD 99 per barrel, 42% of our exposure to WCS, heavy oil differentials through a combination of long-term physical supply contracts and rail delivery, 54% of our natural gas price exposure and 51% of our exposure to currency movements between the U.S. and Canadian dollars.

As part of our hedging program, we are focused on opportunities to further mitigate the volatility in WCS price differentials by transporting crude oil to higher value markets by rail. During the second quarter, approximately 17,000 barrels per day of our heavy oil volumes were delivered to market by rail, as compared to 7,500 barrels per day for full year 2012. For the third quarter, we expect to deliver approximately 20,000 barrels per day of our heavy oil volumes by rail, and we continue to explore additional opportunities for rail deliveries.

So in summary, our operational execution remains on track. We expect continued strong operating and financial results in the second half of this year, and we are confident in achieving our full year production guidance. We remain committed to a growth in income model and its 3 fundamental principles, delivering organic production growth, paying a meaningful dividend to our shareholders and maintaining capital discipline. We will continue to manage our business with a focus on creating shareholder value through effective capital allocation and quality project execution. We maintain a conservative balance sheet with low debt levels and adequate liquidity to support our growth and income model.

So with that, I will conclude my formal remarks and ask the operator to, please, open the call now for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Mark Friesen from RBC Capital Markets.

Mark J. Friesen - RBC Capital Markets, LLC, Research Division

Just want to focus on Seal, obviously a very strong performance from the drilling in the first half. It looks like the wells that have been licensed are on trend with the wells that were drilled in the first half. Is it reasonable to expect similar IP 30 rates in that 700 range from the continued drilling program? Or does this go into thinner reservoir and return more to average type curves?

James L. Bowzer

Marty, our Chief Operating Officer, why don't you address that question?

Marty L. Proctor

Sure. We haven't changed our model for our expectations going forward. We're still anticipating 300 to 700-barrel per day IPs for our new wells there. We have gotten good results, maybe slightly better than that model up until now or in the upper end of that model. But we're anticipating similar results within that range going forward. We've got a good inventory for the remainder of this year, plus for years beyond as well.

Mark J. Friesen - RBC Capital Markets, LLC, Research Division

Okay. So you see a steady -- like you talk about multi-year drilling inventory and you see that as being relatively consistent across the years?

Marty L. Proctor

Yes.

Mark J. Friesen - RBC Capital Markets, LLC, Research Division

In terms of quality?

Marty L. Proctor

Yes, you bet.

Mark J. Friesen - RBC Capital Markets, LLC, Research Division

I know you summarized your second half drilling plans in your comments, Jim, but maybe you can summarize just very high level how you expect the corporate overall production rates to remain steady over the second half or even grow, I guess, based on lower spending activity over the second half of the year?

James L. Bowzer

Certainly. As you know, and we had projected, our first half was heavily weighted towards increased capital spending, so we're about 2/3 spent through the first part of the year, with the remaining 1/3 of our capital throughout the rest of the year. So the number of oils as we've quoted are lower than what they were in the first half of the year. Given those facts, we do expect that the production growth will continue, albeit at probably a lighter pace than what you saw between the first and second quarters.

Mark J. Friesen - RBC Capital Markets, LLC, Research Division

Okay. And so now that you've kind of got back on to that growth trajectory coming out of the weaker Q1 and operations are going well and you've highlighted that you'll be repaying some debt on the balance sheet over the second half, is the corporate model looking at acquisition opportunities or asset acquisition opportunities changing at all? Is it becoming perhaps more active, or are you becoming more aggressive in that area?

James L. Bowzer

Mark, we've been pretty consistent with our comments regarding acquisitions. We have been and continue to look for things that fit our business model and minimize the risk in bringing something new in, and that is most easily done by trying to target things in and around our current property base. And secondly, with something that fits our skill sets in terms of execution capabilities. So there's no real change in what we've been looking at or targeting over time. So still looking for kind of the right things to add more in largely what we already have.

Operator

The next question is from Cristina Lopez from Macquarie.

Cristina Lopez - Macquarie Research

It's actually a follow-up to Mark's question with respect to production in the back half of the year. But in particularly going into next year, we did see some drop in inventory in Q4 of '12, which led to a drop in inventory in -- of volumes in Q1. Are you expecting that again in 2014 where you have a lower Q1 and build up through the rest of the year?

Marty L. Proctor

It's Marty again. You're right, we had a very slow pace of building in the end of last year. We expect it to be a bit better and different this year. As Jim said, we've spent about 2/3 of our capital program in the first half. The second half is going to be pretty measured and more evenly paced, albeit at a lower total spend than in our first half. But we expect -- whereas in Q2, we were actually -- we had 5 building rigs working in the Peace River area, which, of course, are responsible for a good part of our capital spend but it also really contributed to our production growth. We've now tapered that back to where we're going to have probably 2 rigs drilling through most of the remainder of the year, including right up to the end of the year. So we should have some Peace River wells coming on in the first part of 2014, which is a little different than we had last year. So I think measured growth through the end of the year and we should be growing into the New Year.

Cristina Lopez - Macquarie Research

So just to clarify, because last year, I believe you drilled 15 wells in the Peace River area in that second half of the year. But all of those were actually in the third quarter. So this year, you'll be spreading those out between the 2 quarters, am I interpreting that correctly?

Marty L. Proctor

Yes, exactly so. That's our intent and that's what we've got scheduled with our drilling rigs.

Cristina Lopez - Macquarie Research

So then, does that get you sort of a flat production volume from Q4 into Q1 and then keep building again through 2014? And then in 2014, do you have more of a consistent spend program? Or is it still going to be a front-end loaded program? I know that it's early to talk about 2014.

Marty L. Proctor

I'd rather not get too specific. All I'll do is reinforce what I had said. I think we're going to have fairly modest growth through the end of this year, and we expect to be increasing slightly into Q4 -- or sorry, Q1 2014.

Cristina Lopez - Macquarie Research

And then speaking on rail, moving to 20,000 barrels a day being shipped by rail in the third quarter, can you talk about the difference in pricing that you're receiving right now on rail versus pipe?

James L. Bowzer

It hasn't changed a lot from our previous comments, Cristina. When we're in kind of this transaction 20%, 22% differential environment, depending on the variety of contracts we have. Of the 20,000 barrels a day that we moved, there's probably 10 or 11, maybe even 12 separate individual deals. So depending on those, it ranges when we're in this kind of a differential environment from kind of $2, to $4, maybe $5 a barrel is the increment you pick up with the various components that it isn't all just getting to a higher net back market, there's the quality discount you saved, the deal you want as well. So that's kind of the range we're in right now. So that's kind of where we're at.

Operator

The next question is from Travis Wood from TD Securities.

Travis Wood - TD Securities Equity Research

Just a question for the Peace River area. Of the 17 wells you've drilled through Q2, what's that lateral number attached to those 17 wells? And is that the same type of lateral count we can expect on the 14 wells set for the rest of this year?

Marty L. Proctor

This is Marty again, Travis. We have over 200 laterals with those 17 wells in the second quarter. We expect between 12 and the 13 laterals per well going forward, so right in that range, the stuff going for the rest of the year should be quite similar to the first half.

Travis Wood - TD Securities Equity Research

Okay. And then just expanding on the earlier question on the M&A front, are you thinking of that, are there any other themes or trends that you're seeing from some of the deal flow that's coming through the office? And then would you -- do see more opportunities on the oil sands/thermal type opportunities? Or are you more focused on the conventional whether that be light oil or heavy oil?

James L. Bowzer

Yes, Travis, we are seeing, and have been over the past 6 to 9 months, maybe increased number of opportunities. We're looking for things where we can see growth potential within them. It doesn't do us any good to really buy a decline curve. So there's quite a bit of those sort of opportunities out there. And we're open to additional acreage or production in and around our areas that leads to more coal drilling in Lloydminster, Peace River. And if there was quality SAGD project or something like that, that fits our thermal skill set, that would be okay as well.

Operator

The next question is from the Dirk Lever from AltaCorp Capital.

Dirk M. Lever - AltaCorp Capital Inc., Research Division

I wonder if you could touch on your Cliffdale. We've got the fifth steam, you're at 700 barrels a day, is this meeting your expectations? And through the work on your Cliffdale, have you learned anything that you're going to be applying to your plant that you're building? And you start steaming in the first half of 2014, when do you think you'll see production, like when you stop the steaming and you start producing?

Marty L. Proctor

It's Marty here. Yes, I would say, I guess first off, yes, we're completely satisfied with how Cliffdale wells are performing. They are pretty bang on with our expectations. You got to keep in mind that we actually didn't complete all of our steam generation building until the second half of last year, so although we've actually started this Cliffdale project in phases and we had a pilot late in 2009. We expand it, we had built some additional steam capacity in late 2011 added the rest of the steam capacity in second half of 2012. When we look at individual well performance, particularly, especially, let's say, the first well of our pilot or our commercial project, that first well that initially was a pilot well, it's performing bang on with our modeled expectation. So yes, it's ramping up as expected. We're going to see some lumpy performance going forward. Everything is kind of timed with our steam injection. So in the second quarter, we actually had the best well, this oldest well on steam for most of the quarter, so it didn't give us much contribution until late in the quarter. But it's really contributing now to our current performance. So yes, we're on track there. We're very satisfied. We are learning as we go. That's one of the benefits of going at the measured place that we are. So further at the end of your question there, we do anticipate steaming on the 15-well module early in 2014. And yes, we've learned from our current program and we think we can do better even with the next year. We expect we're going to be on track with that model that we've talking about all along.

Dirk M. Lever - AltaCorp Capital Inc., Research Division

Okay. And when would you expect then first round of production to come from the new module?

Marty L. Proctor

Well, we actually put these wells on cold production for a little bit before we can start to steam. So we'll get a small amount of cold production from those 15 wells, probably even beginning late this year. The steam production, we won't see much of it until mid next year. And then it takes a while to ramp up to our peak rates, so we still don't expect peak rates until 3 or 4 years after steaming begins. So we're anticipating hitting that model as expected.

Operator

[Operator Instructions] The next question is from Gordon Tait from BMO Capital Markets.

Gordon Tait - BMO Capital Markets Canada

Most of my questions have been answered. I just want to go back to Seal for a minute because it was a standout. With those -- the IP rates of 700, that looks like it's quite a big leap over where you were last year, say, and the year before, these 30-day IP rates. Can you maybe talk about what accounts for that difference? And secondly, what rate do you think these wells would be producing at after, say, 12 months?

James L. Bowzer

Sure, this is Jim. Yes, there's a few things that contribute to it. It's a little bit better reservoir rock. We've continued to improve our drilling capabilities there, in the number of laterals we can get out and I'd also throw out that we've also done a better job of really increasing the way that we target these laterals in certain portions of the reservoir. And all of that's led to what we're seeing today in some of these higher end rates of our portfolio.

Gordon Tait - BMO Capital Markets Canada

And where do you think that these wells would produce then, say, after 12 months on production?

James L. Bowzer

Yes, the first year decline, is that what you're asking?

Gordon Tait - BMO Capital Markets Canada

Yes.

James L. Bowzer

Yes, that first year on a new well is on the 50% to 55% range, Gord. It's what they decline out and then stabilize after that.

Gordon Tait - BMO Capital Markets Canada

All right. And then just quickly on your 2 steam projects, the 10-well pilot. What are the SORs you're seeing at Cliffdale plus on that first well part you drilled at Kerrobert?

James L. Bowzer

Right now, it's running about 2.6 is our cume [ph] to date. And that fluctuates depending on -- it will be a little higher right now because we've put a large load of steam into the most mature well, and now it's back on production just as we speak today. So that will fluctuate up and down as we go through the project. It starts out early and is expected to average about 3.0 as a target over the life.

Gordon Tait - BMO Capital Markets Canada

And that was for which, that was for Cliffdale?

James L. Bowzer

Yes, that's Cliffdale 10-well pilot.

Gordon Tait - BMO Capital Markets Canada

And that is consistent with what your modeling had forecast?

James L. Bowzer

Yes, it is.

Gordon Tait - BMO Capital Markets Canada

Okay. And then what would you expect at Kerrobert?

James L. Bowzer

The new well pairs are going to be in the range of 3 or so. We've got a fairly mature project at Kerrobert, and so some of the older wells, which have taken steam for a long time, they're cumulative steam-oil ratio is a little higher than that. But the new SAGD pairs that we drilled over the last couple of years and that we intend to drill in the second half of this year, they'll be around 3 steam-oil ratios.

Operator

The next question is from Mark Warner who's a private investor.

Unknown Shareholder

I want to compliment you all for the operations that the company has been performing, getting the oil out of there. I've called in several times, saying that the second leading periodical in the states, Investors Business Daily, rates Baytex with an extremely poor grade. And I've gotten very little response from the company, and if we want to market Baytex and do the most we can for stockholder value, it needs to be corrected. None of the metrics they show, Investors Business Daily, published every day, shows Baytex is actually the lowest of all the energy and exploration companies in North America. And I've gotten very little action, if any, on those. Would somebody please answer me directly on this? Or may I have Mr. Bowser, please call me offline if possible?

Unknown Executive

Mark, it's Derek here. I can call you offline after this call, if you like. We've spoken a couple of times, Mark, and I have actually talked to that publication that you referred to. We did point out to them miscalculations of some of the ratios that they had reported on Baytex. They did commit to correct them. But the reality is, even if they have correct data, they are an independent publication. And their ranking of us versus others, as I said to you on our previous call, if they've got errors in our numbers, they've probably got errors in other companies' numbers. So there's not much we can do about a ranking that have us ranked by an independent publication.

Unknown Shareholder

May I make another comment please? Derek, my dad used to say, "I don't care what the other students in class do. I care about what you do." And I noted Baytex spends hundreds of thousands of dollars going around the country promoting Baytex. And now as soon as an American investor goes on IBD and looks at the stats on Baytex, which are inaccurate, they immediately shut it down. So what I'm saying is for a few thousand dollars or for -- or with call from perhaps the legal department, this could be corrected. The company uses Reuters statistics. It does not do this subjectively. It is objective numbers. And it is correctable with the proper amount of effort. And I'm doing this as an advocate of Baytex, not an enemy of Baytex. I'm a shareholder and it's very important to me. And if you all want to get -- to be valued at the USD 50 you asked that you should be valued at, I'm humbly suggesting that someone aggressively take action to be sure this is corrected not because it's someone's opinion, not because it's because it's their opinion, it's because their figures are totally inaccurate.

W. Derek Aylesworth

Thanks. We appreciate your comments, and we'll follow up with the publication and I'll get back to you after the call.

Operator

There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Ector.

Brian G. Ector

Okay, thank you, Jade. And thanks, everyone, for participating today in our Second quarter conference call. Have a great day.

Operator

Thank you. The company's call has now ended. Please disconnect your lines at this time. And we thank you for your participation.

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