After two challenging years, Baytex Energy (NYSE:BTE) was decidedly more optimistic heading into 2017. That's evident from its decision to boost capital spending nearly 50% this year, which would enable the company to restart its drilling activities in its home country of Canada and finally reverse its steady production decline. That said, the key to Baytex Energy's optimism was a belief that oil would average more than $50 per barrel, providing it with enough cash flow to finance its capex program so that it didn't drill itself any deeper into debt.

Unfortunately, rising oil output from Baytex Energy and its peers has put downward pressure on crude prices, which recently tumbled below $45 per barrel. It's a concerning price point for Baytex because the company isn't built to handle another market downturn. Because of that, the company might need to pull back the reins on spending, so its stock doesn't sink any further due to the weight of its debt.

Oil pumps in Canada with a red sunset.

Image source: Getty Images.

Walking a tightrope

When Baytex Energy released its 2017 budget, the company anticipated that it could generate enough cash flow at $50 oil to finance between 300 million Canadian dollars and CA$350 million ($225 million-$265 million) in capital spending, which was enough capital to boost output 3%-4% by year's end. The company has since ratcheted up that growth rate to 5%-6% after reporting robust drilling results in the first quarter. However, the driller's better-than-expected production rates on new wells are both a blessing and a curse because it's contributing to the glut of oil on the market these days, which has been putting pressure on oil prices.

That pricing pressure is a problem because at $45 oil, Baytex Energy would consume nearly CA$100 million ($75 million) more cash that it generates, meaning it might need to borrow money so it can bridge the gap. While the company does have more than CA$500 million ($376.5 million) available under its credit facility, it would be unwise for Baytex to tack any more debt on its balance sheet. That's because the oil company already has nearly CA$2 billion ($1.5 billion) in debt outstanding, which is way too much considering it's just a CA$3 billion ($2.26 billion) company. In fact, at its current run rate, Baytex's debt-to-funds from operations was nearly 6.0 times last quarter. For perspective, rival Crescent Point Energy (NYSE:CPG) only has CA$4 billion ($3 billion) in debt, and it's an CA$11 billion ($8.3 billion) company, which is why it has a much more conservative 1.8 times leverage ratio.

Because of that lower leverage, Crescent Point Energy has the resources to grow production at a faster pace this year. The company currently expects to increase output 10% by year's end, which is a healthy growth rate for a company that's producing twice as much oil and gas as Baytex Energy. Furthermore, the company can finance that growth and pay its dividend while living within cash flow at $52 oil. Add to the fact that Crescent Point has a cash-rich balance sheet, and it has plenty of cushion should oil run below that level.

An oil pump in Canada.

Image source: Getty Images.

What this might mean for Baytex Energy

Baytex Energy, on the other hand, doesn't have any breathing room. Because of that, it might not have any choice but to cut back on capital spending. That's a tactic it employed last year when oil prices sold off, cutting its budget 33% below initial expectations in March and by another 13% in July. In addition to that, the company started shutting down older wells with weak economics to preserve cash flow. While oil prices haven't fallen low enough this year to require the shut-in of wells, it has dropped to the point where Baytex needs to think about revising its capex budget, with it potentially needing to narrow its range down closer to the CA$300 million ($225 million) mark.

However, cutting spending still won't address Baytex Energy's troubled balance sheet. While the company doesn't have any near-term bond maturities, its credit facility will mature in two years. That's a concern because the company has already utilized a third of its capacity and is at risk of racking up more debt given its projected outspending at current oil prices. It's a situation that could cause the company problems down the road as this maturity date draws near, which is why the driller should consider tackling the issue before it gets out of hand.

That's exactly what happened to fellow Canadian producer Pengrowth Energy (NYSE:PGH), which previously eschewed asset sales, choosing to address its balance sheet woes by slashing spending and using that cash flow to pay down upcoming debt maturities. However, with the clock ticking away toward a doomsday deadline, Pengrowth Energy started unloading assets in recent months to stay afloat. Those transactions have enabled Pengrowth to reduce debt 60% since the end of last year, buying it more time to replace existing debt with less restrictive borrowings so that it can start developing the second phase of its promising Lindbergh project. That said, the company might have gotten more cash for its assets if it weren't pressured by the clock to get deals done, which is a lesson Baytex Energy needs to take to heart.

Investor takeaway

As things stand right now, Baytex Energy can't handle another market downturn because the company has too much debt on its balance sheet to operate comfortably at current oil prices, let alone even lower prices. Because of that, Baytex will likely need to slash spending given that prices have fallen below its breakeven. Meanwhile, it should give serious thought to addressing its debt situation now by selling assets so that it doesn't face a potentially disastrous situation of having to unload assets into a collapsing oil market under a time constraint.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.