Battalion Oil: Caracara Services JV helps improve cost structure (BATL)

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Petroleum Battalion (NYSE: BATL) has taken a significant step towards reducing its costs and its competitiveness in the face of its joint venture agreement with Caracara Services to develop an acid gas treatment and carbon sequestration sector ease. This facility is expected to be operational in early 2023 and is expected to reduce muster and other battalion costs by 20-30%.

This could save Battalion about $3 per boe, which could translate to about the same impact on its cash flow as a $6 change in oil prices (at 2022 production levels) .

Battalion remains a high-risk security due to its debt, large number of hedges below strip prices and relatively high operating costs. However, it also trades at less than PDP PV-10 amid WTI oil’s $60 (adjusting the value of its hedges to SEC prices) and could generate over $200 million EBITDA in 2023 after the covers to the current strip.

Manufacturing Notes

Battalion production dropped significantly from 17,283 BOEPD (50% oil) in Q4 2021 to 14,767 BOEPD (50% oil) in Q1 2022. Battalion production was also negatively impacted by shutdowns temporary weather-related outages that reduced its production by approximately 1,300 BOEPD in Q1 2022. Battalion’s production would have been down 7% quarter-over-quarter without the weather-related outages.

Battalion mentioned on its first quarter 2022 earnings call that it had only brought two new wells online in the last twelve months, which resulted in lower production. Battalion plans to ramp up production later in the year, with its first three wells (as part of its new development plan) returning now and its two Keller wells expected to start flowing back in June.

joint venture

Battalion has entered into a joint venture agreement with Caracara Services. The joint venture will develop an acid gas treatment and carbon sequestration facility. This project should be operational in early 2023 and will delete hydrogen sulfide and carbon dioxide from natural gas production and store them in a depleted reservoir.

The facility will initially be able to process 30 million cubic feet per day of natural gas with combined concentrations of hydrogen sulphide and carbon dioxide of up to 10%. Battalion notes that there is potential for a Phase 2 expansion that would bring capacity to 50 million cubic feet per day.

This will process natural gas production from Battalion’s Monument Draw, and Battalion retains a right of first refusal on future capacity. Battalion expects this project to result in a 20% to 30% reduction in gathering and other costs per boe of production. Thus, savings on collection and other costs could be approximately $13-19 million per year (at 2022 production levels). This is a significant saving that would have the same effect on Battalion’s unhedged cash flow as an approximately $6 increase in oil prices.

The battalion provides a borehole with an approved permit for sour gas injection as well as surface land for the installation as well as road access rights. Caracara is providing all remaining capital for the facility and associated infrastructure, while Battalion’s costs are limited to workover costs for the sour gas injection well. Battalion also retains a 5% interest in the joint venture.

The benefit to Battalion of the joint venture is that it will significantly reduce its collection and other costs without having to spend capital to build the facility. Battalion’s liquidity is currently relatively limited as it spends to increase production and attempt to deleverage via production growth.

Other ratings

I previously discussed how Battalion’s very high costs for collection and other categories made its production less valuable than its Delaware Basin peers despite Monument Draw’s strong production performance.

I had estimated Battalion’s total production margins (in dollars) to be about 10% lower than its peers in the Delaware Basin at $85 WTI oil. This was estimated from a combination of margins per boe at $85 WTI oil and first year well performance in terms of production levels.

Reduced collection and other costs through the joint venture should reduce this gap to about 5% lower than its peers at $85 WTI oil.

Conclusion

Battalion shares remain high risk, but are better valued now at under $16 than they were a month ago at $19. Battalion’s cost structure should improve with the joint venture for an acid gas treatment facility. This should have the same impact on Battalion’s cash flow as a $6 increase in oil prices (before hedging). Given Battalion’s large amount of hedges, a reduction in its costs of $3 per boe could have the same impact on Battalion’s hedged cash flows as a $10+ increase in oil prices for 2023 and 2024.