DBRS Confirms Baytex Energy Trust at STA-5 (low)

DBRS has today confirmed the Stability Rating of Baytex Energy Trust (Baytex or the Trust) at STA-5 (low). The confirmation reflects the Trust’s improved balance sheet leverage and relatively strong cash flow coverage ratios, despite substantially lower commodity prices, satisfactory operating performance as well as its significant heavy oil development and drilling inventory, including its asset acquisition in southwest Saskatchewan during the second quarter 2009. The Trust also maintains one of the lowest payout ratios among its peers. Should the improved credit metrics and low payout be maintained, the Financial Profile as one of the key factors for assessing the stability rating will likely be upgraded to Moderate from Weak.

However, reserve replacement cost rose substantially in the past two years due to recent purchases, offsetting in part the benefits its previous lower cost structure provided in heavy oil focused operations. In July 2009, Baytex acquired the predominantly heavy oil assets in the Kerrobert and Coleville areas of Saskatchewan as well as some natural gas assets in west central Alberta for $86.2 million, net of adjustments. The acquisition added approximately 3,000 boe/d gross production weighted 72%/28% heavy oil to natural gas, an estimated 9.1 million boe of proved reserves and 111,000 net acres of land (63,300 net acres undeveloped). DBRS views the acquisition as positive as it is accretive to earnings and cash flow.

Baytex’s financial metrics remain within the parameters of the current rating. While its recent acquisition was fully funded by debt through drawdown of its credit facility, the Trust raised $109 million (net) of equity in Q2 2009 (through issuance of 7,935,000 trust units). For the last 12 months ended September 30, 2009 (LTM 9M 2009), debt-to-capital and debt-to-cash flow was at 30% and 1.46 times, respectively, with $200 million of undrawn credit facilities. In August, to enhance its liquidity and debt maturity profile, the Trust issued $150 million of 9.15% senior unsecured debentures into the Canadian high yield market, maturing in 2016 with net proceeds as well as funds drawn from its facility used to redeem approximately US$180 million of senior subordinated notes maturing in July 2010 (US$179.7 million) and February 2011 (US$0.2 million). This issue has also largely eliminated refinancing risk for its term debt.

Furthermore, with one of the lowest payout ratios in the industry (43% at 9M 2009), Baytex is in a better position to maintain stable distributions and fund ongoing capex. However, to maintain liquidity and respond to the decline of commodity prices over the last 15 months, the Trust decreased cash distribution per unit twice after increasing it to $0.25 per unit in June 2008, following the close of the Burmis Energy acquisition. In December 2008, monthly distributions were reduced to $0.18 per unit and to $0.12 per unit in February 2009. Baytex expects cash flow from operations to fully fund its $165 million capital program in 2009, which includes an agreement to pre-pay deferred acquisition payments for its Bakken-Three Forks project in North Dakota for $33.2 million in Q4 2009 (compared with $36 million over the next five to six quarters).

Baytex’s operational strengths reflect its growth in new areas and its ability to control production and operating costs fairly well through its high operatorship (90%) of its properties, which also allows for better cost control as the Trust maintains one of the lowest operating costs in the trust industry. The Trust has solid landholdings, including Seal (heavy oil) in the Peace River oil sands region and the Viking light oil resource play in Alberta, which provide significant development and drilling inventory. In addition, approximately 38% of proved reserves are undeveloped, representing opportunities to replace production at lower costs relative to purchasing assets in the market.

The Trust, however, continues to faces challenges going forward, including the following: (1) The significant concentration in heavy oil (59% at 9M 2009) will remain an issue due to pricing differentials and generally lower netbacks relative to light crude production. However, Baytex benefits from the narrowing differential in recent quarters as well as its relatively lower operating costs for heavy oil compared to light oil. Baytex partially manages its pricing differential risk through a series of physical sales contracts, which will fix the price differential of heavy oil received at about 16% of WTI price for approximately 43% of heavy crude production projected in 2010, leaving the remaining production exposed to market differential risks (current pricing differential is at approximately 15% of WTI). (2) Although net production has improved gradually since 2004, Baytex has experienced a dilution in per unit production, similar to its peers, from 0.16 boe/unit in 2004 to 0.12 per boe/unit at 9M 2009 in part due to equity issuance to support capital programs.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Oil and Gas Companies, which can be found on our website under Methodologies.

This is a Corporate rating.