The recent pullback in crude, in which it fell below the psychologically important US$50-per-barrel mark, despite OPEC and key non-OPEC oil-producing nations to establish production caps, has surprised many pundits. It has also brought the spotlight back on the energy patch and heavily indebted upstream oil companies such as Baytex Energy Corp. (TSX:BTE)(NYSE:BTE).
In fact, some pundits have gone as far as to claim that Baytex’s current position is unsustainable, and it may very well not survive the oil slump.
Clearly, the key to Baytex’s survival is whether or not oil recovers. Despite the optimism that 2017 would be the year that crude would rally because of the OPEC production cuts, that outlook is not as certain as once thought.
You see, the U.S. shale oil industry has, surprisingly, shown itself to be profitable, even in the current harsh operating environment.
Meanwhile, the Trump administration has announced a range of policy measures that, if successfully enacted, would lift U.S. oil output and flood an already over-supplied market with additional crude.
Those factors will keep a cap on oil prices for some time.
This is certainly not good news for oil companies such as Baytex, which needs US$55-per-barrel oil to be free cash flow positive. And Baytex added $72 million to its bank debt and paid $28.5 million in financing costs during the quarter. Some pundits are concerned if the company can ultimately survive.
However, the assumptions made regarding Baytex’s financial position are flawed.
The company drew from its existing revolving credit facility to finance the $66 million acquisition of heavy oil acreage adjacent to its existing operations in Peace River. Those funds were not used to meet operational or financing costs, as some pundits have asserted.
That deal expanded Baytex’s production by 3,000 barrels daily with the acreage generating operating income of almost $3 million for the quarter, boosting cash flow and earnings.
Furthermore, financing costs for the quarter were almost 2% lower compared to a year earlier, and these were expensed against quarterly revenue, which came to $260.5 million — a massive 70% year-over-year increase.
Those pundits are also forgetting that Baytex has a well-laddered debt profile with no meaningful repayments due until 2021, giving plenty of time for oil to rebound and for the company to reduce its debt.
Another important consideration that some pundits have failed to consider is that Baytex’s Eagle Ford acreage, which is responsible for almost a third of its production’s breakeven costs of US$30 per barrel. Even with crude under US$50 per barrel, that acreage is profitable to operate and a powerful cash-generating machine.
While Baytex needs WTI to reach US$55 per barrel to be free cash flow positive, thereby allowing it to pay off its debt, there are several levers at its disposal to reduce that figure and ensure its survival.
Among them are making further asset sales — the proceeds of which could be used to reduce debt, leading to higher cash flow because of lower interest costs. It could also shutter its heavy oil production, reducing expenditures and the capital required to sustain its operations, again boosting cash flow.
Baytex is under considerable pressure and is a high-risk investment because of its debt and the need for WTI to reach US$55 per barrel for it to be free cash flow positive.
Nevertheless, it is inaccurate to claim that the company is in real trouble and in danger of bankruptcy if crude does not recover. The low breakeven costs of its Eagle Ford acreage, Baytex’s ability to reduce expenditures, and the fact that no material debt repayments are due until 2021 give it considerable breathing space and financial flexibility.
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Fool contributor Matt Smith has no position in any stocks mentioned.