Tuesday, November 20, 2012

Bench strength


Baytex Energy has been developing heavy oil for more than two decades, and has the assets—people and oil—to stay in the game for the long run
This article appears in the December issue of Oilweek
By Peter McKenzie-Brown
The new kid on the oilpatch’s executive block is Jim Bowzer, who left his position as a production vice president for Marathon Oil Corporation to take the top job at Baytex Energy Corp. in September. Baytex is a pretty heavy hitter; in mid-October, shortly after Oilweek’s Supplier of the Year voting ended, the intermediate company’s market capitalization stood at around the $5.7-billion mark. That means the company was big enough to recruit a high-achiever from Houston-based Marathon Oil.

“By the asset mix that Baytex had, I knew it was a good fit,” Bowzer says of his decision to make the move. “In addition to growth and paying a healthy dividend, I was impressed because it’s a company that executes well on discovered assets.”

Before being recruited, Bowzer (a petroleum engineer by background) spent most of his career in the petroleum sector. Prior to joining Baytex, he was North American production operations vice-president for the venerable Marathon Oil—a company whose roots go back 125 years. To put the major’s legacy status into context, Marathon was once part of John D. Rockefeller’s Standard Oil Trust. Its longevity notwithstanding, though, at present the company’s market cap is only about three times that of Baytex.

Although he liked Baytex’s asset mix, Bowzer adds there was very little overlap with the assets he managed for Marathon. “However, I have done the same kind of development in many basins in the United States. I spent the majority of my career working on conventional onshore assets.”

Growing up
In the two decades since Baytex became a public company, says Ray Chan, the company’s executive chairman, it has followed business models that have reflected changing times. The company never followed the model used by operators who “start a company, grow it, sell it to a larger entity in and then start all over again,” he says.

Through its first decade as a publicly traded company, Baytex promised growth, but didn’t pay a dividend. Then, Chan says, “We became part of the income trust craze. That offered a tax-efficient income stream for investors. [In terms of] distribution plus capital appreciation, we were one of the best operators out there.” Of course, income trusts collapsed with the federal government’s infamous “Halloween Massacre” of 2006, which effectively proscribed the business model.

Under the new rules, Baytex switched back to the corporate model in 2010. No longer, though, is it an entity that promises growth. The company focuses now on “moderate growth plus dividend income,” says Chan. The company steadily increased its dividends from 2009 to 2011, and now pays 22 cents per month. Enthusiastic almost to a fault, Chan says the results are clear: “The Baytex income stream is [still] one of the best out there.” And it focuses on organic growth—increasing production from existing land assets.

A chartered accountant with three decades of direct oil and gas experience, Chan explains the lure of creating an attractive income stream for investors.

“I look at the bottom-line results,” he says. “When you have a smaller capital budget, you put your investment capital into the best-return projects. You high-grade them. This has made us much more disciplined in our capital investment. By being more selective in our capital investment, we are being better stewards of our shareholders’ capital.”

Then comes the tour de force. Chan pulls out a chart prepared by Scotia Capital comparing profit investment ratios (PIR) for the top 50 resource plays in North America. To calculate the PIR, which is a critical measure of the success of a company’s investments, divide the present value of its future cash flows by initial investment.

“We are involved in two of the top three plays,” Chan says enthusiastically. On closer study, though, he actually understated the case. Using Scotia Capital’s calculations for reference, Baytex does indeed have a presence in two of North America’s top three resource plays. One of those plays, at Seal in the Peace River oil sands, involves cold production from multilateral wells (#1). Another involves vertical heavy oil wells  in the Lloydminster area (#3). What he neglected to mention is that the company’s other major producing areas are also near the top: a heavy oil project at Lloydminster using horizontal wells (#7)  and another project at Redwater Viking (#10). These results put Baytex in the industry’s top quintile.

An obvious feature of this list is that the company decided early on to focus on oily assets. According to Chan, “almost 80 per cent of our production is heavy oil, and the larger part of our growth opportunities is there too. The Bakken portion of the light oil is growing as well. We have some SAGD [steam assisted gravity drainage] projects, too. Some of our [oilsands] assets have lower viscosity. This can bring a better return to our shareholders” since it is producible without the need for steam. Like other producers, Baytex “isn’t pouring a lot of money into natural gas.”

This fall Baytex announced a $120-million acquisition that illustrates the company’s growth strategy. The acquisition gave Baytex a 100 per cent working interest in 46 sections of undeveloped oilsands leases near Cold Lake. According to a company news release, these assets “are prospective for both thermal and cold development. Regulatory approval has been received for the construction and operation of a two-stage bitumen recovery scheme using steam assisted gravity drainage.” The company plans to begin steaming the SAGD wells next year. If successful, the company will develop a commercial SAGD project, which would begin producing in 2016.

The acquisition adds an approved SAGD project to Baytex’s asset portfolio, which currently includes thermal recovery projects at Seal in the Peace River oilsands region and in southwestern Saskatchewan. Once developed, thermal recovery projects provide a source of long-life, low-decline production. Developing these projects will reduce our corporate decline rate and enhance our ability to continue to execute our growth and income model over the long term.

In the years since Baytex took the plunge into heavy oil, the commodity “has become a much more acceptable and profitable business,” according to Chan. “But you can’t just be a part-time heavy oil player. You have to really focus on that, and we have done for quite a while. We have learned how to manage the heavy oil business, [and] we have some competitive advantages.”

Chan is a master of the spicy quote. “We’re not interested in getting bigger,” he says. “We are interested in being better. Sometimes when you get to a bigger size, it makes moving that bigger mass more difficult.” He signed off with a message for the future that has certainly worked well for the years since he joined the Baytex board. “Over the next 10 years, I’d rather be long oil than short oil,” he chuckles.

Differentials
As a Marathon executive, Jim Bowzer rarely gave a thought to the seasonal price differentials that plague Canada’s oil producers, but now that he has joined the clan he is sanguine about the problem. For one thing, it just makes sense for Canadians to price their heavier oils using the Western Canadian Select oil benchmark. That pricing arrangement reflects the value to refiners of a blend of heavy conventional and bitumen crude oils combined with sweet synthetic and condensate diluents. It trades at a discount—a differential—to West Texas Intermediate (WTI) because of the higher cost of refining the stuff.

“The transportation system is affecting northern oils disproportionately,” Bowzer acknowledges, and “there’s plenty of room for new [pipeline] capacity out there, and the cost of entry is not out of line.”

He stresses the cyclical nature of the oil price differentials. “There tend to be differentials for Canadian oils in the spring, but during the year they work themselves out.”

In the longer term, he says, “pipeline networks will get built out, and that will help balance the WTI price versus the ocean-bound markers like Brent. There is a huge gap between the amount of oil the United States needs and the amount it produces, [and] what will happen over time is that the United States will focus increasingly on oil from North America, and less on oil that it can bring in by ship from overseas. There will be more pipelines to the south. There are lots of northern oils, like the Bakken, and they’re all in the same boat….”

Maybe not the same boat, since Canadian oil still lacks easy access to tidewater. However, many of those oils are now in tanker cars.

“Rail [transportation] has opened up a doorway that just wasn’t there before,” according to Bowzer. “As the world has adjusted itself to heavier and sourer oils, refineries have installed a lot of units for refining those oil products. For example, on the Gulf coast they use a lot of Mayan oil [which is similar to Canadian heavy.] It consistently sells at a premium to West Texas intermediate. That’s [one of the factors] driving rail transportation all the way to the south. Oil transportation and delivery now feeds into a very sophisticated market.”
So does oil trading: Baytex hedges sales to reduce risk.

Greatest strengths
Ask these two executives about their company’s greatest strengths, and the answers are fairly predictable: assets and people.

“We have as good a group of people as any other heavy oil company in town,” says Chan, noting that the company has about 350 employees—“about half in Calgary and half in the field. People and assets are our top two things. It was our people that led to our business model and our asset quality.”

“What Baytex needs is our asset base,” Bowzer adds, before pausing for a few moments. “Baytex has assets and people that are outstanding. We also have a tremendous, interactive board of directors, and the combination of those things has made for a very successful history.”
“The Baytex story is unique, our industry is unique,” says Chan. “We’ve been a participant long enough in the Calgary space that we have something important to say.”

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