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canada competes

Oil, steam and natural gas pipelines are seen in this file photo.TODD KOROL/Reuters

Canadian junior oil and gas companies have had a rough ride in the past few years due to low gas prices and a cramped financing market, but experts say 2013 could be the year that sees these companies make some headway through mergers and acquisitions (M&A). And size may be the global attraction factor for foreign buyers under new foreign investment rules, experts predict.

Oil and gas companies on the TSX have been battling an equity crunch for a couple of years now. Back in 2010, these companies raised $11.2-billion in equity, but this number dropped 20 per cent to $8.9-billion by 2012.

On top of that, the country's oil and gas juniors have also been suffering these past couple of years due to wide pricing gaps between low North American gas prices and their international counterparts.

But while these issues have been plaguing smaller companies for some time, it appears experts are starting to take a 'something's got to give' attitude toward this unfriendly environment.

"The principle drivers for this [environment], the absence of equity access and the desperation on the gas price side ... has now continued for such a long time that you have to think that something's got to break," says Chris Nixon, a partner at law firm Stikeman Elliott.

"We've been predicting for a few years…a significant need for consolidation so [juniors] could bring themselves to scale where, in fact, they could attract equity again and be able to internally accommodate the price drought on the gas side," he says.

Mr. Nixon acknowledges that many observing the M&A trends in this sector have predicted this need for consolidation in past years with no result. "But things are getting more and more desperate and there's less optimism that the gas price curb will change."

According to Stikeman Eliott's report released recently, called Top Ten Energy M&A Trends in Canada 2013, many junior oil and gas companies are looking to pursue opportunities in some of the newer energy markets, such as shale gas. But these efforts require a good deal of money and come at a time when investors have not shown much interest in this sector's smaller and medium sized companies.

But there could be a shift in attitude among investors, which could foster some interest from potential junior buyers.

"The question now is whether or not there is a coming change in perception in respect to this being near the bottom," says Mr. Nixon. "In which case money will come in to capture the opportunities and presumably benefit from the upside and that may also drive opportunities."

Then, of course, there is the strong foreign interest in Canada's oil and gas sector, which could be refocused into the junior sector. In 2012, the federal government authorized a $15.1-billion takeover of Nexen by China's CNOOC Ltd. and the more than $5-billion acquisition of Progress Energy Resources by Malaysia's Petronas.

After that, the government said it would make it tougher for future deals of that size to go through. These revamped guidelines for state-owned enterprise (SOEs) may make M&A deals with junior companies the new target for foreign buyers, explains Kai Li, a professor of finance at the University of British Columbia.

"With foreign buyers, there might be hope," says Dr. Li. "With the very high-profile Nexen case, the deal was in billions [of dollars], so it was on the radar screen of the policy makers."

In order to avoid this scrutiny, foreign buyers could be looking at smaller companies so they can employ "more free market behaviour," she says.

Geoff Hill, national oil and gas leader for Deloitte, agrees that these redefined guidelines involving SOEs could swing the spotlight on smaller oil and gas operators.

"I think the new foreign investment rules make it difficult for a state-owned enterprise to have controlling interest in an asset, so we would suspect they will be looking at other joint ventures in large assets or acquiring some smaller ones," says Mr. Hill. "So, depending on the size of the junior, they probably will be more susceptible or more amenable to M&A opportunities than perhaps we've seen in the past."