Baytex Energy has growing speculative appeal
But debt needs to come down and hedging needs to stop
After the acquistion of Aurora Oil & Gas in 2014, the then CAD$50 share price of Baytex (BTE.TO) dropped below CAD$3.00 and the company teetered on the edge of failure. Like many oil companies, Baytex management believed its own headlines and bet the company on oil prices remaining at close to CAD$100 a Barrel of oil equivalent indefinitely. The only investors who benefited were those prescient enough to short the stock.
Baytex flirted with failure for several years but made a strategic and beneficial acquisition when the company merged with Raging River, a low cost producer with exellent landholdings. That bought Baytex some time.
Baytex stock languished for the next few years in the doldrums of too much debt and not many choices to rebuild. That changed when global leaders embraced the CO2 scam and took so many actions to curtial hydrocarbon use that a global energy shortage resulted with natural gas and oil prices surging and Baytex cash flow in parallel. Current management is now extolling the virtues of less debt but not quite ready to commit to zero debt. At the same time, management has fallen victim to the “hedging disease” where it caps the benefit of higher commodity prices to protect itself from lower prices. The current Baytex hedge book saw CAD$250 million of losses in Q1 2022 and I would expect more losses through the balance of year.
I had the good fortune to attend a #COM meeting with Baytex officer Brian Ector today where Ector reinforced Baytex commitment to lower debt. I would have been more impressed had he stated management was targeting zero debt and would defer any share buybacks until that had been realized. I suspect the “hedge book” reflects demands from Baytex’s bankers and I suspect the banks are counterparties to those hedges - leave aside the obvious conflict of interest if that is the case, which would make it something the OSFI should review before it erupts as a banking scandal of any consequence.
Ector spoke about DCF and NPV values of Baytex reserves, based on independent forecasts of commodity prices. In reality, however independent, third parties are no better at forecasting world commodity prices than Daffy Duck. Those prices are volatile but fortunately are log normally distributed and the probability of a given price in a given timeframe can be reasonably estimated. Modern valuation techniques of resource reserves use a modified Black Scholes approach which reflects the distribution of commodity prices directly and provides a more reliable valuation than NPV or DCF. I quickly did such a valuation of Baytex reported reserves and came up with a value of CAD$8.24 a share. That valuation does not take into account the likely losse of ~CAD$500 million on the current “hedges” which, assuming no more hedges are contracted, reduces the valuation to about CAD$7.00 a share. The market currently values BTE.TO at CAD$6.88 so the market has it right.
What is not valued is the prolific assets Baytex has started developing in the Clearwater and Duvernay plays. Those assets have much higher returns on capital than Baytex’s other Canadian or U.S. holdings and offer speculative appeal. I put the value of a BTE.TO share at CAD$10.00 and as debt comes down, value rises by about CAD$2.00 per share as the debt approaches zero. I expect that could happen by year end 2023.
I hold a small position in Baytex comprising 2,000 shares purchased for US$1.80 and 7,000 options at strike prices of CAD$4 and CAD$5 with expiry dates December 2022 and March 2023. I would add materially to this holding if Baytex announced a firm commitment to zero debt, zero hedging and Clearwater and Duvernay expansion.