Have you heard the one about the natural gas price falling so low it sports a one-handle? It’s not that funny really, especially for North American E&Ps counting on gas-levered cash flows to fund capex. With the beleaguered commodity bouncing around between $3 and $5 for the past couple of years, many pundits believed it had found its floor in this cycle, with nowhere to go but up.

Ah, no. Since November, facing a tepid winter and ballooning storage, the spot price has fallen 20%. And as gas sinks into the mid-$2 range at press time, a one-point-something price seems much too near. Jefferies & Co. analyst Subash Chandra agrees.

“Gas prices have been crushed by a nonexistent winter, but we think they could get even worse,” he said in a January 13 research note. “We are on track to exit the 2011-12 heating season at record storage levels. We suspect we will witness gas prices with a $1 MMBtu handle in shoulder and injection seasons.”

Which begs the question: how will falling prices affect A&D this fresh year?

Pretty significantly, says Sylvia Barnes, KeyBanc Capital Markets managing director, segment head of oil and gas.

First up, sellers. A dour sentiment has pervaded the industry in the past few weeks since gas dropped below $3, she says, and potential sellers are adopting the opinion that now may be a really bad time to sell gas.

“Sellers are disappointed with the degree of interest in the market,” she says, resulting in an increased reluctance to go to market at all.

So, expect sellers to hold tight to producing gas unless otherwise motivated. Who might that be? Most affected by an anemic price are the numerous privately held companies holding solely natural gas assets and production. In such a price environment, operating expenses are squeezed by cash flow, with scarce other means to access capital. “They’re in a tough spot,” says Barnes.

Not to mention lender borrowing-base redeterminations looming on the horizon. Most banks’ gas-price forecasts are well above the strip, which is not sustainable and forebodes a downsizing of borrowing capacity this spring, she says. “It makes everybody uncomfortable.”

In addition, more than half the gas hedges made in more favorable times are rolling off in 2012, exposing more and more gas-weighted companies to the pain at the meter.

Distressed selling could emerge, which leads to buyers.

While currently it is essentially uneconomic to drill for gas about anywhere in North America outside of the Tier 1 Marcellus shale, buying production can make sense, Barnes says. “At these prices people do buy.” But few public independent E&Ps have the stomach to touch gas in today’s gas-averse world, focusing instead on oil and associated liquids to appease Wall Street.

Instead, expect some privates to focus on gas, suggests Adrian Goodisman, managing director and co-head, U.S., with Scotia Waterous. He says private-equity-backed players are clearly concentrating on gas assets, particularly conventional assets. And private equity is ready to play the contrarian—at the right price.

But, “sellers will be sorely surprised if they put conventional gas assets on the market expecting last year’s metrics,” says Goodisman. “The bids they could expect would be a lot lower.”

Master limited partnerships and institutional-investor-backed E&Ps are also interested in such long-lived gas assets. Consider EnerVest’s recent acquisition of Encana Corp.’s more mature Barnett shale-gas assets, and Legend Natural Gas’ similar Bar-nett deal with Range Resources Corp.

Corporate M&A, rather, might prove to be a better option for companies desiring cheap gas assets, says Goodisman. Backing this up, Wells Fargo Securities analyst David Tameron notes that the top 10 gas-exposed names he covers have underperformed the top 10 oil names by 26% in just over two months.

This arbitrage between equity value and asset value provides an opportunity, says Goodisman. “As their stock prices drop, some companies will be trading at less than the net value of the assets in the company. In effect they become cheaper buys.”

Goodisman points to Asia and Europe as sources of well-capitalized buyers.

Barnes doesn’t necessarily buy into the inevitable one-handle on natural gas prices, and believes the current icy trip below $3 will last as long as mild weather in Chicago.

So, let the gas assets flow.

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