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big deals

Encana Corp. is among the largest gas companies ripe for a joint venture. Seen here, drilling under way at Ridge Bank operations.Photographer - Brian Harder

Ask even the most bullish energy executive and they will give it to you straight: Natural gas prices aren't climbing out of the gutter any time soon. Ask an investment banker what this means for deals, and the answer isn't as clear cut.

With prices hovering around a 10-year low, capital-crunched companies will need financing, so joint ventures could continue to flourish. On the flip side, there's a chance deal activity could fizzle because companies want to stay as far away from natural gas as possible.

And while Canada's bankers think gas companies will string together joint ventures – some voluntarily, others out of necessity – this strategy could backfire on the companies themselves in years to come.

Joint ventures provide instant relief for natural gas companies that have enough land to spare. The deals are typically structured so the landholder's new partner forks over a bucket load of cash up front and then covers a portion of its partner's expenses in the following five years or so.

That means gas companies can chew through land they otherwise wouldn't have the money to explore and produce. They also get cash right away to help them weather today's gas prices.

The plan works well so long as the buyers – often Asian players who can afford to ride out low prices – are covering the bill. But what happens when these deals expire?

"Then you have to run as fast as your partner," Shane Fildes, global head of BMO Nesbitt Burns' energy group, said. In short: Unless gas prices rally, companies that turn to joint ventures could be back in trouble a few years from now if they can't keep pace with the spending ambitions of their teammates.

Nevertheless, a number of energy companies – oil as well as gas – have publicly stated they are on the hunt for mates. Encana Corp. and Talisman Energy Inc. are among the largest companies with assets to share.

With natural gas prices leaving some companies desperate for capital, Mr. Fildes thinks 2012 could be outstanding for bankers. Energy companies hunting for deals will have to find financing, which will keep investment bankers busy.

But not everyone in Calgary agrees.

Giants such as Encana and Talisman can pull off joint ventures because they have millions of acres of gas properties to spare, are financially better off than many of their smaller counterparts and, in the case of Talisman, have oil properties to fall back on.

Executives running mid-size or small natural gas companies may try to emulate Encana's recent partnership with Mitsubishi Corp., but these smaller players are more likely to run into trouble after their subsidies from their new partners run out, Mr. Fildes said. But despite the dangers, he thinks 2012 could be a banner year for bankers. Joint ventures, after all, aren't the only financing options available. Old-school asset sales, for example, could also happen.

Unfortunately, doubts linger about those deals, too.

Small companies, especially those with mediocre assets and potential debt problems, will be especially pinched. But that doesn't necessarily mean they will be able to turn to new joint-venture partners. For companies that are struggling, the cost of capital will be high, making it difficult for them to swoop in on weaker competitors. Further, healthy buyers with access to cheaper capital are going to be extra fussy as natural gas prices remain low.

"Producers that have a low cost of capital or a competitive advantage are not going to buy assets from distressed companies unless the drilling inventory from those assets can displace their current drilling inventory on a rate-of-return basis," said Sandy Edmonstone, head of National Bank Financial's global energy business.

And that, in turn, shuts down a segment of the bankers' potential market. "I think deal flow is going to be slow. We're coming off a slow year," Mr. Edmonstone said.

Because it is unclear where prices will go – many companies, Encana included, have already been wrong about a natural gas comeback – some may choose to sit on their hands and wait out the pain, Calgary-based Bill Sembo, vice-chair of RBC Dominion Securities, said.

Even so, the deal market may not entirely shrivel. A variety of financial players are pondering their natural gas options with an eye to buying assets, Mr. Sembo said.

The one thing executives and bankers agree on? Natural gas companies won't be sailing through 2012 without stress.