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Baytex Energy Corporation (NYSE:BTE)

CIBC 2014 Whistler Institutional Investor Conference Call

January 22, 2014 7:00 PM ET

Executives

James Bowzer – President and CEO

Analysts

Jeremy Kaliel – CIBC World Markets

Jeremy Kaliel – CIBC World Markets

Okay. Well, we’ll get going with our next presentation. From Baytex Energy, we’re very happy to have Mr. James Bowzer, President and CEO with us today. James is going to give a quick five or 10 minute presentation. Then we’re going to settle into moderated Q&A.

And my name is Jeremy Kaliel. I am the intermediate dividend-paying E&P analyst at CIBC, forgot my work for a second. And will be glad to moderate this event. I will hand it over to James.

James Bowzer

Good afternoon. Thanks, Jeremy, and thanks to CIBC for hosting this. We’re happy to be here and glad to share our story, trying to keep with your annual fireside chat theme. I am going to go over a few slides before we start here, and we’ll get into more fulsome Q&A after that.

And before I begin, please note the forward-looking statements and oil and gas information on these three slides. Moving right into our presentation, just a quick overview. I know most of you are probably familiar with this, but we do trade both on the New York and Toronto Stock Exchanges. Baytex has got an enterprise value right at $6 billion. Our monthly dividend sits at $0.22 and that gives approximate current yield of about 6.3%.

In the middle of that slide, you can see our reserves and contingent resources there. Our total reserves are about 292 million barrels of oil equivalent, and we have a contingent resource base of almost 800 million barrels. Towards the lower portion of the slide, you can see our 2014 guidance is suggesting 60,000 to 62,000 BOEs per day, 89% weighted toward crude oil with capital expenditures of about $485 million for 2014.

This is down from what we spent in 2015, as we are spending significantly less on thermal projects as two new wins are underway.

As illustrated on page 20 of our full booklet. And if you don’t have it, Brian Ector is in the room and he can get you one. It talks – shows cash flow, FFO matrix versus strip pricing, and we really believe 2014 is setting up to be a good year and could potentially generate an excess of $700 million of cash flow, which means that we are essentially fully funded our capital and dividend as we move through time this year.

Shifting slides here. There are three or four key things about Baytex that I want to get out, about our business model. First, we’ve got a solid set of assets with exceptional capital efficiencies in what we put our future capital dollars into. There is a large resource potential that exists, that’s all organic base in Baytex, nearly all oil focused and a well-defined path going forward.

Second, we have historically maintained a good dividend and are committed to paying a meaningful dividend to our shareholders as we move through time. And third, as you can see by those two graphs on the bottom of this slide, we have a long-term track record of value creation and a strong balance sheet and conservative payout ratio.

We believe we’re in great shape as we enter ’14 here. We have a targeted growth rate of 6%. And with the 6% plus dividend yield and an effective payout ratio right around 100%, that gets into double-digit return with our stock. We do have a good balance sheet with a debt-to-FFO ratio of about 1.1 times based on the forward strip.

For those of you, not familiar with our company, this highlights the key areas of Baytex. You can see in there largely on the map, Peace River in the Northeast, Northwest portion of Alberta. Llloydminster area is straddling the Saskatchewan and Alberta border, and our Light Oil play in largely North Dakota and the north portion of United States there.

The charts on the right illustrate our oil focus as a producer. Approximately 89% of our production, 93% of our reserves are weighted to crude oil. Of that amount, about 75% of our production is heavy oil. And our key heavy oil assets are the Peace River and Lloydminster areas that I referenced before. And significantly, these two regions provide some of the highest rate of return projects in North America.

And I’ll give you an example that, at Peace River based on our 30-day IP averages were under $10,000 a day barrel for investments going forward and rates of return are typically triple digit. Those wells payout in less than a year. At Lloydminster, capital efficiencies there range from $11,000 to $13,000 a day barrel with rates of return in the 80% to 100% range as well.

Briefly talk about our operating plan for 2014. And as I just mentioned the two key areas where we will spend the large portion of our capital is here, about 70% of our expenditures will go to the high rate of return areas that I mentioned. In total this year, we’ll drill about 200 wells. If you look at our operating plans for ’14, it’s very similar to how we allocated capital last year. As I mentioned, there is one exception, reduced thermal spend this year.

At Peace River, we’re budgeting about 36 multilateral cold wells with several stratigraphic wells that set up our multilateral programs in future years and also the strat wells shown on the chart there delineate our lands for thermal development out into the future as well.

In the Lloyd region, we’ll drill around 100 wells. About three quarters of those are horizontals. Our horizontal program and inventory has continued to expand at Llloydminster. And in North Dakota, we have approximately a one rig program for about 10 wells in North Dakota.

Before we go into our fireside chat, this is my last slide. It is a bit of a breakout year we believe for heavy oil. This isn't a year that has been hiding away. It’s been anticipated by the industry for a long time. And before I wrap up my comments here, I want to touch on a few key things around heavy pricing. And we certainly believe 2014 is going to be a breakout year.

If you take a look at the catalyst from an infrastructure standpoint, we and others have been talking about this, and those things are unfolding this year, and it includes the recently commissioned BP refinery which is now in commissioning and taking additional heavy volumes, ramping up to its full volumes. There are the two big massive expansions in heavy rail capacity are coming on, the unit trains. And there are number of pipeline expansions this year certainly led by the cushing to superior expansion that we participate in.

And if you take a look at what the market says about this moving forward here, the February WCS index, of course we’re not in driving season, it is the beginning of a turnaround season. It’s already down trading in the minus $18 to $20 range off of WTI. And for the first time in a long time, the entire forward curve for 2014 is right around that 20% level or $19 a barrel off of WTI and we haven't seen that in many years.

We’ve taken advantage of that curve and locked in some of our volumes. We’re also in the process of essentially continually renewing the various rail deals that we have. We hope that those will get better as a result of this as well. And significantly to Baytex, it’s good to remember that a 1% change in WCS differential is material. It impacts our funds from operations by about $11 million.

So we are very encouraged by what we’re seeing. We have a solid plan, we’re well into. The rig is up and running right now.

And with that, Jeremy, I’ll turn it back over to you for Q&A.

Question-and-Answer Session

Jeremy Kaliel – CIBC World Markets

Thank you, James. Have a seat by the fire with me. I will be moderating the Q&A, but as always, really do encourage you guys be active. Just raise your hand if you have a question. So in the last slide you ended on, you gave your outlook for Canadian heavy. Like, should we be thinking of Enbridge and BP Whiting refinery – Enbridge Flanagan pipeline and BP Whiting refinery coming on as being the key catalyst in 2014 or should something else we should be focused on?

James Bowzer

Those two things – well there is – is my mike on here? Can people hear me? There is really four key projects, if you will, or areas of projects. And you’ve hit on two of them, and you have the biggest expansion we’ve seen in a long time in pad two [ph] with BP Whiting taking essentially all heavy when it gets fully up and running.

The second one is the Flanagan pipeline as I referenced in my remarks. The third one are a bunch of small pipeline projects that are continuing. There is the XL South up and running this year. In addition, you’ve got several lines, 6 and 6B and lines 67 that are coming out of Canada that feed into that superior network that are all having various expansions done on them, and there are in various phases of it. They are relative small each one of them, but its additive. So that’s the third area that I am focused on.

And the fourth one is probably as big as any. Rail continues to expand. The two large unit trains will be commissioned this year. And in the past, when large new projects came online, they fought for space on pipe. This year is going to be the first year. There is additional space on pipe, significant additional space. And part of that – a majority of that crude that’s heavy will be taking a rail because the companies have locked those in, because they are large projects unit trails that they were essentially take a pay.

Jeremy Kaliel – CIBC World Markets

Okay. And how much of your heavy oil volumes are you moving via rail currently, and do you expect to move more than this going forward? And then can you speak about what your capacity is and then how much you had to lock in to get that capacity?

James Bowzer

Okay. We’re a little different in that, Baytex doesn’t have a single large SAGD project that’s 15,000 barrels a day or 30,000 barrels a day. There is not something large that’s coming on that we’re tied into a unit train. As a result, we’re a bit advantaged because both in Peace River and Lloydminster, it’s farm country and the rail network is there moving grain, logging and other industry products. And all you need to do is establish a small loading site, a transloading site for trucks to pull up.

And those have been appearing in increase in frequency over time as that capacity builds up because it’s relatively inexpensive to do that. We’re not participating in all that. It’s not our business. I wouldn’t want to try to compete in it, but as a result, we got to the point where there is more loading capacity than Baytex has crude. And just a few years ago, we were moving 3,000 or 4,000 barrels and it was out of one or two sites and we were essentially filling half of one site and that was all that was available.

And if we wanted to move another 5,000 barrels a day, we probably couldn’t if we wanted to. Today, there is enough 5,000 or 10,000 or 15,000 barrels a day sites in the area that we have the optionality to pick and choose, which is a big advantage going forward. We have been concerned about WCS coming in and the rail arbitrage going away. As a result of that, we’ve been taking shorter contracts, usually about six months, sometimes three, so that we can evergreen those and increase the competitiveness as time goes on, but moving on rail also saves the arbitrage on condensate that you would have to buy to put your crude into a pipe or won't move.

So we always have that savings in addition to the differential. And then you need quality discount, as you mix your crude in a pipe, the heavy producers pay for that quality discount, because then it could go to potentially any refinery, and rail is usually site-to-site. The refinery has the metallurgy to take the crude or they wouldn’t be doing the contract [indiscernible]. So those two savings – it isn't just a WCS differential.

Jeremy Kaliel – CIBC World Markets

Okay.

James Bowzer

You’ve got to overcome all three things. The differential itself, the cost of what it takes to mix and blend condensate. And the third one is the quality of differential if indeed there is one.

Jeremy Kaliel – CIBC World Markets

Got it. Any questions from the floor? Right, I’ll keep going then. Perhaps shifting gears here and talking about your dividend and CapEx level. How secure are they in the current price environment? And maybe to the upside, what WCS price do you think you would need to see to consider increasing your dividend?

James Bowzer

Well, in terms of the first portion of your question, security. It’s part of what Baytex does. It is part of our business model. We believe that you’re a better steward of capital when part of your return is almost guaranteed, sort of some sort of absolute collapse in oil prices or something, like that happened in 2008. So it is what we stand for.

So I think it’s about as secure as a dividend can be and we’re in good shape where we said today to be able to deliver that with our capital programs, and the high efficiencies that allow that to occur. In terms of continuing to increase the dividend, it’s something that we have full intentions of doing. You’d want to see the stabilized numbers of about where we are today. If you can stay in the sub-20 WTI – WCS off of WTI numbers, that’s the kind of environment that you’d want to see sustain through time to be able to do that, and it provides us the cash flow to be able to increase the dividends.

Jeremy Kaliel – CIBC World Markets

Right. I was looking at a few of your key assets here and still focusing first on your cold horizontal development. How has productivity changed on new wells drilled today versus those drilled, say a couple of years ago, and what are you doing differently today? And perhaps most importantly, how big do you believe your remaining cold inventory is still?

James Bowzer

Okay. In terms of the – let me get to the inventory question first. In terms of the inventory, at the pace we’re at, we’ve got about a five year inventory. We have been able to add to that over time and are continuing to work deals or set up new areas with stratigraphic tests. And what we’re really looking for, the crude is there, you need either a combination for the mobility to be there to have the multilateral successful, and that’s combination of two things; a lighter lower viscosity heavy crude that sits usually on top of the Bluesky in the upper third which is what we’re targeting our multilaterals; and our ultra-high permeability and that’s what’s led to the success of that.

In terms of the rates of the wells, ’13 was an exceptional year. A few years back, we had an exceptional year. We’ve kept our band into that 300 to 500 IP range with an average around 500. We hit up into the 700s many times, and many times we’ve had wells that are over that.

What really has changed in the way that we approached this, in the past, it was – we were pretty much targeting the middle of the lower viscosity portion and high portion – high permeability portions of the reservoir. And today, we’re actually finding through a little bit better strat work in typing the crude that they are actually within the lighter band of crude. And this is still heavy oil. That’s still up to 10,000, 20,000, 30,000 [indiscernible]. So it’s still heavy crude.

There are small wedges of gravity gradients within the upper portion. So while we use to just pretty much keep all of our laterals at the same elevation, we now can change elevation within that upper Bluesky to target a little bit lighter crude or a little bit higher permeability streaks that allow us to improve the productivity of the wells and get even higher rates of return.

The second thing that has evolved over time and continues to evolve and I wish I had a map here to show you. The ability of our drilling people to expand the way we fill out a spacing unit is nothing short of amazing. Our typical well is well over eight or 10 laterals that used to be. And now we can drill 180 degrees back the other way to catch part of the spacing unit and we have at least six or seven spurge to fill out the spacing unit aside from the eight or 10 laterals that are going along – a mile along in the same direction. And that’s allowed for increased productivity. You’re essentially targeting part of the reservoir that was left behind. So those are the two big things that continue to expand for us.

Jeremy Kaliel – CIBC World Markets

And what sort of A&D opportunities do you see instilled? I mean given that you have a pretty big inventory of five years. I mean, are you actively looking at that?

James Bowzer

We always are actively looking. It’s something that the company does really well that we believe we do better than anybody else, and have an advantage by taking in additional lands that maybe people have not fully evaluated the way that we would see that. And it is difficult, because these are oil sands leases, so they are held for a long periods of time.

The flip side to that, if you don’t see the potential, we do. There have been several companies with various size positions, small and large, whether either an outright purchase, a trade with some other lands, we may have somewhere farm-ins those kind of things. We have continued to add small pieces, a few sections a year every year, and it’s been helpful in continuing that inventory. So we’re working hard and we’re at the table with a good deal if anybody is interested in taking a look at us. So some of our best wells in the past couple of years were drilled on lands that we didn’t have a few years ago.

Jeremy Kaliel – CIBC World Markets

Okay.

James Bowzer

Even though we had a large position for a very long period of time out there.

Jeremy Kaliel – CIBC World Markets

And in 2013 were some of those best wells…

James Bowzer

Yes, those were – a few of them were there last year as well, yes.

Jeremy Kaliel – CIBC World Markets

And I know this is a question you hear a lot, that how do you respond to investors that are concerned that the fact that you’re drilling on, are you updating to do thermal development on the sale [ph] which isn't as capital efficient as your cold wells which are excellent. Well, how do you respond to investors that are concerned that you’re running out of your cold in your inventory, because you’re moving to thermal?

James Bowzer

Well it’s…

Jeremy Kaliel – CIBC World Markets

Or that your capital efficiencies overall are going to come down?

James Bowzer

Well, we’ve been doing – for starters, we don’t have an aggressive massive switch to the thermal going on and haven't laid it out that way. And I think most of the investor base understands that. It’s paced with our cash flows. We started out with one module, that’s been up and running for over a full year. All the wells have been through their complete set of cycles now. The second module just got put in last year. So it will be ramping up.

So some of that spend is behind us now. And it will be at least 24 months as we submit the next modules before they get approved. So that’s about the pace we are. If you look at it over time and with the addition of our Gemini project which is in the Lloydminster area over in Cold Lake. It’s a SAGD project. There, we’re starting out with a single well pair as a pilot. If that’s successful, by the time 2016 rolls around, we’ll be a bigger company, differentials will come in. A lot of these things should provide that stable environment, our cash flows are bigger and allows us to spend a couple of hundred million dollars to then have that up and running.

And what that really does is, it builds a base of flat life production as our company grows so that the amount of decline isn't really changing through time. If you lookout through time, we build at a moderate pace, about 10,000 barrels a day by 2017, 2018, that timeframe, from zero a couple of years ago, right. So it does fit well with our business model and leads well to a dividend paying model to help sustain and not have to fight the treadmill of ever replacing wells that are only on decline.

And as long as you place that properly as your company grows, it fits in well with what we do here. Is there a year like there was last year where we’re at a 120% payout ratio? Absolutely. But then it brings it in. And the good thing about it – the way we do thermal compared to some of the other projects people might take on, it’s relative flat life. So it is something that you put a bunch of money into upfront like an offshore project or something like that, and it takes two years to get your FPSO built or whatever maybe, your onshore gas facility, there is a variety of things people do. That’s going to go on decline from day one. This is going to stay flat once it gets there, and allows you to not require so much capital to maintain your base decline and grow the company.

Jeremy Kaliel – CIBC World Markets

So if we try to quantify the impact on your decline rates, if we looked out to say 2017 to 2018, what impact would you expect thermal to have in your decline rates, so maybe compare with your…

James Bowzer

We model that and we’re in the 28% to 29% on average right now base decline of our underlying base production. And as you look out through time with the thermal building up that gets you into the approximately 25% to 26%, just that small increments that I’ve talked about. And if you repeat that over the next four or five year period, you’re bringing those down into the low 20s with continued thermal expansions. So that was a good question to lead into what it does for a dividend paying company.

Jeremy Kaliel – CIBC World Markets

All right. Okay, great. And could you talk a bit about the issues you had with service rights owners [ph] at your Southern Reno property?

James Bowzer

Certainly.

Jeremy Kaliel – CIBC World Markets

And maybe talk a bit about the results of the environmental study that you’ve just done?

James Bowzer

Certainly. For those of you that don’t know and you should because it’s been out in the press, and it’s been going on really prior to when Baytex entered the Reno area which was late 2011. There were about 40 wells drilled prior to Baytex taking over operations there. It was making approximately 2,000 barrels a day. Today we’re making approximately 1,700 barrels a day.

And a few of the landowners began to complain about the odors in the atmosphere. The first thing we did was we essentially shutdown our drilling program. It’s less than 10% of our overall inventory that sets down on Reno. We don’t need to get to it for the next several years, so that was our first step to step back and look at what we need to do. And we put in a gas gathering system. And some of the complaints continued and we essentially went out and got some of the best experts independent from Baytex, brought them in and conducted the study, the first thing you want to make sure that none of the odors are containing contaminants that might be above the ambient air standards that Alberta have set.

And they are some of the toughest in the nation. They are tougher than the EPAs. And so we did that, and that study was concluded in last spring of 2013 and we’ve shared that with the AER and they are quite pleased. They’ve had air monitoring equipment out up in the area as well and their studies have shown this, but this was a site-specific with some of most sophisticated equipment you could – with people out onsite, upwind, downwind, bad conditions, good conditions to prove to ourselves and our employees that there was nothing really serious going on there, and it was just odors that we could do – take care of by putting in a gas gathering system.

Jeremy Kaliel – CIBC World Markets

Okay. And if we think about potential catalysts, what should investors have in their radar screens for Baytex throughout 2014, anything we could...

James Bowzer

The single biggest catalyst is keep your eye on WCS and think about the amount of – if you take a look and add up what I talked about in just the unit trains, BP’s refinery and Flanagan, that’s in excess of the Keystone that’s going to be available to Canada this year, and the impact that’s going to have on heavy differential. It’s already impacted – like I said before, we have never seen a forward curve below $20 differential for an entire year in a long time. And that is – if that sustains itself, that will put us in a different place in terms of cash flow capabilities as a heavy producer.

That’s the number one. The rest of it’s fairly routine. We drilled about 100 wells in Lloyd last year. We’re going to drill about 100 wells this year. We drilled 30 some odd multilaterals last year in Peace River. We’re going to drill 36 some odd laterals multilaterals in Peace River. We drilled about 10 wells, net wells in North Dakota last year. We have a one rig program to continue that this year.

So we’re improving place with solid technology and quality execution and you should expect that to continue from us.

Jeremy Kaliel – CIBC World Markets

Okay. So looking forward to Q4 and year-end results specifically, it should just be exactly what you said more of the same.

James Bowzer

More of the same.

Jeremy Kaliel – CIBC World Markets

Okay. All right. Well, are there any questions from the floor, we have time for maybe just one? If not, James we want to thank you and thank you to Baytex for coming.

James Bowzer

Thank you very much.

Jeremy Kaliel – CIBC World Markets

Thanks a lot. Great.

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