# Message to Shareholders

_Source: `DeepSeekOCR_Ardian_pruned_1k/energy-oil-gas-e-p/NYSE_BTE_2017/NYSE_BTE_2017.mmd` · pages 1-7_

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Message to Shareholders

4

Management's Discussion and Analysis
6

Management's Report
36

Auditors' Reports
37

Consolidated Financial Statements
40

Reserves Information

68

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## SUMMARY

<table><tr><td rowspan="2"></td><td colspan="2">Years Ended</td></tr><tr><td>December 31, 2017</td><td>December 31, 2016</td></tr><tr><td>FINANCIAL (thousands of Canadian dollars, except per common share amounts)</td><td></td><td></td></tr><tr><td>Petroleum and natural gas sales</td><td>1,091,534</td><td>780,095</td></tr><tr><td>Adjusted funds flow(1)</td><td>347,641</td><td>276,251</td></tr><tr><td>Per share - basic</td><td>1.48</td><td>1.30</td></tr><tr><td>Per share - diluted</td><td>1.47</td><td>1.30</td></tr><tr><td>Net income (loss)</td><td>87,174</td><td>(485,184)</td></tr><tr><td>Per share - basic</td><td>0.37</td><td>(2.29)</td></tr><tr><td>Per share - diluted</td><td>0.37</td><td>(2.29)</td></tr><tr><td>Exploration and development</td><td>326,266</td><td>224,783</td></tr><tr><td>Acquisitions, net of divestitures</td><td>59,857</td><td>(63,120)</td></tr><tr><td>Total oil and natural gas capital expenditures</td><td>386,123</td><td>161,663</td></tr><tr><td>Bank loan(2)</td><td>213,376</td><td>191,286</td></tr><tr><td>Long-term notes(2)</td><td>1,489,210</td><td>1,584,158</td></tr><tr><td>Long-term debt</td><td>1,702,586</td><td>1,775,444</td></tr><tr><td>Working capital (surplus) deficiency</td><td>31,698</td><td>(1,903)</td></tr><tr><td>Net debt(3)</td><td>1,734,284</td><td>1,773,541</td></tr><tr><td>OPERATING</td><td></td><td></td></tr><tr><td>Daily production</td><td></td><td></td></tr><tr><td>Heavy oil (bbl/d)</td><td>25,326</td><td>23,586</td></tr><tr><td>Light oil and condensate (bbl/d)</td><td>21,314</td><td>21,377</td></tr><tr><td>NGL (bbl/d)</td><td>9,206</td><td>9,349</td></tr><tr><td>Total oil and NGL (bbl/d)</td><td>55,846</td><td>54,312</td></tr><tr><td>Natural gas (mcf/d)</td><td>86,375</td><td>91,182</td></tr><tr><td>Oil equivalent (boe/d @ 6:1)(4)</td><td>70,242</td><td>69,509</td></tr><tr><td>Benchmark prices</td><td></td><td></td></tr><tr><td>WTI oil (US$/bbl)</td><td>50.95</td><td>43.33</td></tr><tr><td>WCS heavy oil (US$/bbl)</td><td>38.97</td><td>29.49</td></tr><tr><td>Edmonton par oil ($/bbl)</td><td>62.92</td><td>53.01</td></tr><tr><td>LLS oil (US$/bbl)</td><td>53.26</td><td>43.82</td></tr><tr><td>Baytex average prices (before hedging)</td><td></td><td></td></tr><tr><td>Heavy oil ($/bbl)(5)</td><td>38.46</td><td>26.46</td></tr><tr><td>Light oil and condensate ($/bbl)</td><td>63.74</td><td>50.32</td></tr><tr><td>NGL ($/bbl)</td><td>25.86</td><td>17.16</td></tr><tr><td>Total oil and NGL ($/bbl)</td><td>46.03</td><td>34.25</td></tr><tr><td>Natural gas ($/mcf)</td><td>3.24</td><td>2.69</td></tr><tr><td>Oil equivalent ($/boe)</td><td>40.58</td><td>30.29</td></tr><tr><td>CAD/USD noon rate at period end</td><td>1.2518</td><td>1.3427</td></tr><tr><td>CAD/USD average rate for period</td><td>1.2979</td><td>1.3256</td></tr></table>

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<table><tr><td rowspan="2"></td><td colspan="2">Years Ended</td></tr><tr><td>December 31, 2017</td><td>December 31, 2016</td></tr><tr><td>COMMON SHARE INFORMATION</td><td></td><td></td></tr><tr><td>TSX</td><td></td><td></td></tr><tr><td>Share price (Cdn\()</td><td></td><td></td></tr><tr><td>High</td><td>6.97</td><td>9.04</td></tr><tr><td>Low</td><td>2.76</td><td>1.57</td></tr><tr><td>Close</td><td>3.77</td><td>6.56</td></tr><tr><td>Volume traded (thousands)</td><td>823,591</td><td>1,677,986</td></tr><tr><td>NYSE</td><td></td><td></td></tr><tr><td>Share price (US\))</td><td></td><td></td></tr><tr><td>High</td><td>5.20</td><td>7.14</td></tr><tr><td>Low</td><td>2.13</td><td>1.08</td></tr><tr><td>Close</td><td>2.76</td><td>4.48</td></tr><tr><td>Volume traded (thousands)</td><td>356,263</td><td>707,973</td></tr><tr><td>Common shares outstanding (thousands)</td><td>235,451</td><td>233,449</td></tr></table>

Notes:

(1) Adjusted funds flow is not a measurement based on generally accepted accounting principles ("GAAP") in Canada, but is a financial term commonly used in the oil and gas industry. We define adjusted funds flow as cash flow from operating activities adjusted for changes in non-cash operating working capital and asset retirement obligations settled. Our determination of adjusted funds flow may not be comparable to other issuers. We consider adjusted funds flow a key measure of performance as it demonstrates our ability to generate the cash flow necessary to fund capital investments, debt repayment, settlement of our abandonment obligations and potential future dividends. In addition, we use the ratio of net debt to adjusted funds flow to manage our capital structure. We eliminate changes in non-cash working capital and settlements of abandonment obligations from cash flow from operations as the amounts can be discretionary and may vary from period to period depending on our capital programs and the maturity of our operating areas. The settlement of abandonment obligations are managed with our capital budgeting process which considers available adjusted funds flow. For a reconciliation of adjusted funds flow to cash flow from operating activities, see Management's Discussion and Analysis of the operating and financial results for the year ended December 31, 2017.

(2) Principal amount of instruments.

(3) Net debt is not a measurement based on GAAP in Canada, but is a financial term commonly used in the oil and gas industry. We define net debt to be the sum of monetary working capital (which is current assets less current liabilities (excluding current financial derivatives and onerous contracts)) and the principal amount of both the long-term notes and the bank loan.

(4) Barrel of oil equivalent ("boe") amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of oil. The use of boe amounts may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas to one barrel of oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

(5) Heavy oil prices exclude condensate blending.

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## Advisory Regarding Forward-Looking Statements and Initial Production Rates

This report contains forward-looking statements relating to but not limited to: our business strategies, plans and objectives; our strategy to target capital expenditures at a level that approximates our adjusted funds flow; our estimated net asset value; our Eagle Ford assets, including our assessment that it is a premier oil resource play, generates high cash netbacks and has a significant development inventory; that our Peace River assets can generate some of the strongest capital efficiencies in the oil and gas industry; that we expect to achieve further operating expense reductions on the assets acquired at Peace River in January 2017; our 2018 production and capital expenditure guidance; that we view the current price differential between West Texas Intermediate light oil and Canadian heavy oil as temporary; that we have operational flexibility to adjust our spending plans based on commodity prices; that we expect the Eagle Ford assets to generate significant free cash flow in 2018; and our ability to optimize our heavy oil netbacks through operational optimization, crude-by-rail and the use of financial and physical hedges. In addition, information and statements relating to reserves and contingent resources are deemed to be forward-looking statements, as they involve implied assessment, based on certain estimates and assumptions, that the reserves and contingent resources described exist in quantities predicted or estimated, and that they can be profitably produced in the future. We refer you to the end of the Management's Discussion and Analysis section of this report for our advisory on forward-looking statements.

This report contains references to average 30-day initial production rates and other short-term production rates which are useful in confirming the presence of hydrocarbons, however, such rates are not determinative of the rates at which such wells will commence production and decline thereafter and are not indicative of long term performance or of ultimate recovery. While encouraging, readers are cautioned not to place reliance on such rates in calculating aggregate production for us or the assets for which such rates are provided. A pressure transient analysis or well-test interpretation has not been carried out in respect of all wells. Accordingly, we caution that the test results should be considered to be preliminary.

## Non-GAAP Financial and Capital Management Measures

Adjusted funds flow is not a measurement based on GAAP in Canada, but is a financial term commonly used in the oil and gas industry. We define adjusted funds flow as cash flow from operating activities adjusted for changes in non-cash operating working capital and asset retirement obligations settled. Our determination of adjusted funds flow may not be comparable to other issuers. We consider adjusted funds flow a key measure of performance as it demonstrates our ability to generate the cash flow necessary to fund capital investments, debt repayment, settlement of our abandonment obligations and potential future dividends. In addition, we use the ratio of net debt to adjusted funds flow to manage our capital structure. We eliminate changes in non-cash working capital and settlements of abandonment obligations from cash flow from operations as the amounts can be discretionary and may vary from period to period depending on our capital programs and the maturity of our operating areas. The settlement of abandonment obligations are managed with our capital budgeting process which considers available adjusted funds flow. For a reconciliation of adjusted funds flow to cash flow from operating activities, see Management's Discussion and Analysis of the operating and financial results for the year ended December 31, 2017.

Net debt is not a measurement based on GAAP in Canada. We define net debt to be the sum of monetary working capital (which is current assets less current liabilities (excluding current financial derivatives and onerous contracts)) and the principal amount of both the long-term notes and the bank loan. We believe that this measure assists in providing a more complete understanding of our cash liabilities.

Bank EBITDA is not a measurement based on GAAP in Canada. We define Bank EBITDA as our consolidated net income attributable to shareholders before interest, taxes, depletion and depreciation, and certain other non-cash items as set out in the credit agreement governing our revolving credit facilities. Bank EBITDA is used to measure compliance with certain financial covenants.

Operating netback is not a measurement based on GAAP in Canada, but is a financial term commonly used in the oil and gas industry. Operating netback is equal to petroleum and natural gas sales less blending expense, royalties, production and operating expense and transportation expense divided by barrels of oil equivalent sales volume for the applicable period. Our determination of operating netback may not be comparable with the calculation of similar measures for other entities. We believe that this measure assists in characterizing our ability to generate cash margin on a unit of production basis.

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## MESSAGE TO SHAREHOLDERS

2017 was a year about delivering on our commitments. Despite persistent low commodity prices, we delivered on our operational and financial targets, reduced our overall debt and acquired a strategic asset in Peace River. We continued to drive cost and capital efficiency in our business and increased our production, reserves and adjusted funds flow.

We achieved our best ever health, safety and environmental performance and strong regulatory compliance in all of our operating jurisdictions. We also published our third Corporate Responsibility Report, focusing on environmental, social and economic metrics. We believe that corporate responsibility is a key component to achieving enduring success in resource development.

We delivered annual production of 70,242 boe/d, above the high end of our guidance range while spending \(326 million in capital. When comparing actual results for the fourth quarter of 2017 to the fourth quarter of 2016, production increased 7%. We also delivered adjusted funds flow of \)348 million, an increase of 26% over 2016. Contributing to our adjusted funds flow was a reduction in cash costs (operating, transportation and general and administrative expenses) of 7.5% on a boe basis as compared to original guidance.

Net debt was reduced to \(1.73 billion, down from \)1.78 billion at year-end 2016, and we maintained strong financial liquidity with our US\(575 million revolving credit facilities 70% undrawn. During 2017, we targeted capital expenditures to approximate adjusted funds flow in order to minimize additional bank borrowings. We exceeded this goal with adjusted funds flow exceeding capital expenditures by \)21 million.

We grew our reserves with a capital investment portfolio that demonstrated continued success in the Eagle Ford along with the resumption of activity in Canada. We replaced 201% of production and increased proved plus probable reserves 6% to 432 mmboe. Our finding and development costs, inclusive of changes in future development costs, were \(7.26/boe, generating a strong recycle ratio of 2.7x. Importantly, our net asset value increased 11% to \)10.08 per share (before tax and discounted at 10%).

Strong well performance in the Eagle Ford, driven by enhanced completions, led to 30-day initial gross production rates of approximately 1,450 boe/d. This represents a 12% improvement over 2016. In addition, the wells that commenced production during the fourth quarter represent some of the highest productivity wells drilled to-date on our lands. Two of these wells in our new northern Austin Chalk fracture trend demonstrated 30-day initial gross production rates of approximately 2,400 boe/d.

At Peace River, through our innovative multi-lateral horizontal drilling and production techniques, we are able to generate some of the strongest capital efficiencies in the oil and gas industry. Our 2017 drilling program in Peace River included 8 net multi-lateral horizontal wells.

We also successfully integrated our acquisition of additional heavy oil assets in the Peace River region that closed on January 20, 2017 and have made meaningful progress in reducing operating costs on the acquired assets. To-date, we have achieved a 35% reduction with further improvements anticipated in 2018 and beyond.

At Lloydminster, we adopted the multi-lateral well design and geosteering capability that we have successfully utilized at Peace River. Our 2017 drilling program in Lloydminster included 33 net wells, of which 45% were multi-lateral horizontal wells.

## Looking Forward

We will continue to focus on our strategic priorities as we move forward with the intention to build on our health, safety, environmental and compliance culture while we drive cost and capital efficiency in our operations. We will strive to further grow production and reserves while looking for opportunities to balance our capital structure. We have budgeted exploration and development capital expenditures of \(325 to \)375 million for 2018 and expect to deliver average annual production of 68,000 to 72,000 boe/d.

At the time of writing, commodity prices remain volatile with the price for WTI currently above US60/bbl and Canadian heavy oil differentials averaging US24/bbl for Q1/2018 due to transportation challenges. We anticipate these wide differentials to be temporary as the industry works to alleviate the bottlenecks through crude by rail and existing pipeline optimization and reconfigurations. We remain supporters of Canadian pipeline expansion as the medium term solution to market access. As we navigate this volatility, we continue to have the operational flexibility to adjust our spending plans based on changes in the commodity price environment.

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We are encouraged by our operating results in the Eagle Ford and the strong cash generating capability of this asset as the prices for Brent and LLS are above US\(63/bbl. During the fourth quarter, our netback in the Eagle Ford of \)30/boe was the highest we have realized since 2014. At current crude oil prices, we expect the Eagle Ford to generate significant free cash flow in 2018.

In Canada, we are executing our first quarter drilling and development program as planned with improved WTI pricing partially offsetting the widening of the Canadian heavy oil differential. We continue to manage our heavy oil sales portfolio through operational optimization, crude-by-rail and the use of financial and physical hedges to optimize our heavy oil netbacks.

Baytex's success is due to our dedicated and talented team of employees who align with our strategy, consistently deliver on our plans and drive value for our shareholders. Complementing our leadership team and committed employees, our Board of Directors is an indispensable source of guidance and support which contribute greatly to our success.

We look forward to executing our plans in 2018 for the ongoing benefit of all stakeholders and we thank you for your continued support.

Sincerely,

![](images/6_0.jpg)

Edward D. LaFehr

President and Chief Executive Officer
March 6, 2018