North American natural gas currently sells for half its five-year average price on the near-term New York Mercantile Exchange futures contract.

And that’s after a rally the past two weeks from a low point of just USD1.90 per million British thermal units, reached Apr. 19.

Gas is still more than 20 percent lower than where it began 2012 and one-third less than the trading range it held six months ago.

And it’s more than 80 percent off the high it hit in mid-2008.

The fact that unprecedented production of natural gas in North America is pushing prices lower is hardly news. The technological advance known as hydraulic fracturing has opened up whole new areas for gas and oil development.

Hydrocarbon reserves that were previously inaccessible or prohibitively expensive to get at are now among the cheapest sources of energy anywhere.

The result is that natural gas production has hit all-time highs in North America. This, combined with an extremely mild winter, has pushed inventories in storage 50 percent above their five-year average to all-time highs for the traditional spring “refill” season. Winter-summer gas price spreads are at all-time lows and barely cover the cost of storing the gas.

Oil and natural gas liquids (NGLs) such as ethane, butane and propane–which are found with gas in many areas–can be easily refined and exported from North America. There are supply bottlenecks, such as the link between Oklahoma’s Cushing hub and Gulf Coast refineries and the lack of adequate shipping capacity out of shale-rich areas like the Marcellus in Appalachia. But enough product can leave the continent for prices to mirror global demand.

Consequently, the massive ramp-up in production of oil and NGLs the past few years hasn’t triggered a corresponding price decline, as it did with natural gas. Rather, liquids are basically following the ups and downs of global oil prices, mostly ups lately with the exception of weather-battered propane.

And producers continue ramp up output of NGLs, with the liquids-rich Marcellus Shale basically doubling gas production in 2011. Ditto the Eagle Ford Shale region of Texas, where some gas wells are as much as 70 percent liquids.

In stark contrast, the unprecedented new supplies of “dry” natural gas currently can’t be exported outside North America. The reason is all of the liquefied natural gas facilities were built when gas prices were pushing USD10 per million British thermal units in the middle of the last decade.

All are consequently geared for imports, for which there is absolutely zero demand.

Several companies–including the consortium led by EnCana Corp (TSX: ECA, NYSE: ECA) to build a facility at the Kitimat site in British Columbia–are planning to build liquefied natural gas (LNG) export facilities. When they do gas will be exported from North America, and prices will likely begin to mirror global demand, as prices for oil and NGLs do now.

Chilling gas to liquefy it is a hugely complicated and expensive process. It’s likely to be late decade before there is any meaningful capacity for export. And until then gas prices in the North America will be set by supply and demand in the US and Canada alone.

To be sure, low gas prices have set off their own dynamic. Already, we’re seeing shut-ins of wells in areas where gas is “driest,” i.e. contains the least liquids. Weather muted the impact of the ongoing switch of industrial companies and power generators to natural gas.

But the trend has definitely accelerated, particularly in electricity, where companies on both sides of the border are shutting older coal plants and stepping on the gas.

Coal-fired generation, for example, has fallen from 51 percent of the US power supply in 2002 to 44 percent now, even as gas has doubled its share to 20 percent. Coal fell to just 39 percent in December 2011. And, despite aggressive subsidies for renewable energy, the vast majority of new power-generating capacity under construction is now gas.

Sooner or later every commodity cycle turns. The greatest bull markets always fade as higher prices spur development of new supplies, conservation and switching to alternatives. Similarly, the biggest bear markets always eventually turn, as lower prices stimulate demand, spur switching to the fallen commodity and dry up excess supply by discouraging higher cost production.

In other words, the natural gas bear market will eventually end. But it’s almost certainly going to take more time, and not all of the current players are going to make it out. After all, everyone makes money at USD6 gas and most do at USD4 gas. But very few do so at USD2, and only a tiny handful can at USD1.

Moreover, the full fallout of falling gas has almost certainly yet to be felt across the broad range of sectors affected, which includes power generators and pipeline operators as well as propane distributors and others.

Now more than ever it’s critical for investors to know where their companies are vulnerable to natural gas’ crash and how they might benefit. Below I look at several Canadian Edge sectors, how they’re affected and who the likely winners and losers are.

Producers: Getting Liquid

In the January 2012 Feature Article I admonished investors to “stay liquid” with their Canadian energy producers. That was basically a forecast that oil and NGLs would stay stronger than natural gas in the coming year and that portfolios were best off focusing on producer stocks that did more with liquids than dry gas.

As it’s turned out gas proved much more of a boondoggle than even I thought.

Happily, most gas-focused producers haven’t been as badly beaten up as Perpetual Energy Inc (TSX: PMT, OTC: PMGYF), which is selling off assets in order to pay off maturing debt that could only be refinanced at loan shark rates. But we’ve already seen a couple of dividend cuts, including at NAL Energy Corp (TSX: NAE, OTC: NOIGF), which at that time I rated a sell.

Even some of the sector’s stronger gas companies have seen some vicious selling, including Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF). North America’s lowest-cost producer of gas has seen a decent recovery since early April. But the stock is still my biggest loser this year, dropping nearly 25 percent, including dividends.

It’s the nature of markets that the good is always thrown out with the bad and ugly in a sector correction. That’s become even more the case with the rise of exchange traded funds, which when sold require selling all of their components.

The key is what happens when conditions turn for the better. Stocks of companies that hold things together as businesses–preferably maintaining or increasing their dividends–will rally hard, wiping out down market losses. It’s always best to hold them, no matter bad the volatility may get in the near term.

Unfortunately, there’s no such assurance of recovery for stocks of companies that succumb to the downturn by cutting dividends, or worse. Selling companies that have lost ground already is always painful and can be emotionally difficult. But if an underlying business is indeed sinking, it’s always best to sell and take a loss rather to hold on and hope against hope for the cavalry to come charging over the hill.

Natural gas prices have bounced off their lows for the year as I write. And judging from some of the questions I received during our May 2 monthly chat, more than a few investors are ready to bet that we’ve now seen the bottom.

That’s also the message behind the rebound in natural gas producer stocks, including Perpetual Energy, which is up nearly 50 percent from its Apr. 17 low of just CAD0.55.

Unfortunately, this rally could just as easily prove to be a dead-cat bounce for gas, depending on how the weather, the economy or production levels come out. More important, even if gas does hold above USD2 per million British thermal units it will still be trading well below any price at which many producers can sell it for a decent profit. In fact, that would be true if gas rallied back to the USD3 to USD4 range.

The upshot is it’s absolutely critical for investors to get a handle on where their companies stand with regard to current levels of natural gas prices. That’s the purpose of the table “Gas Exposure,” which has data for all 31 of the energy producers I track in How They Rate.

The data reflect what’s current as of the end of the fourth quarter of 2011, owing to the fact that we’re still waiting on first-quarter results from the vast majority of the companies. But this is one very real case where past numbers can be overwhelmingly predictive of future results.

The table lists five key items. Starting from the left, I first show each company’s natural gas production as a percentage of its total energy output by volume. The second item shows sales of gas as a percentage of total company revenue. Item three is the average selling price of each company’s natural gas output in the fourth quarter of 2011.

Item four shows the approximate amount of 2012 gas sales that are hedged, or for which the price is already locked in. And the far right hand column shows the dollar amount of debt coming due between now and the end of 2013.

If there’s one general positive for all 31 of these companies, it’s that management has been extremely mindful of debt, particularly what’s coming due in the near term. That’s no doubt the legacy of 2008-09, when companies slashed dividends at an unprecedented rate to keep capital budgets on track and debt under control.

There’s a real aversion to piling up debt at most companies. And the happy result is despite the steep crash in natural gas prices this year, only Advantage Oil & Gas (TSX: AAV, NYSE: AAV) and Perpetual Energy are in any real danger of having to file for bankruptcy, even if natural gas prices do crater to USD1 this summer, as many fear.

That doesn’t mean, however, that dividends aren’t in danger, particularly at the more gas-dependent companies. Producers that have hedged large amounts of their energy into the future are less exposed than those that have no hedging.

That’s a big reason Pengrowth Energy Corp (TSX: PGF, NYSE: PGH) is a safer buy right now than Enerplus Corp (TSX: ERF, NYSE: ERF), though both companies produce large amounts of natural gas. Hedging data is always changing, as contracts come on and come off, and management activity isn’t always reported in a timely manner. That’s why the third column is probably the most important in the table in assessing exposure to falling gas prices.

The most important takeaway from this column is the often-wide variation between companies’ percentage of revenue from gas and their percentage of output by volume from gas. With the exception of those producing more than 80 percent gas–such as Advantage, Perpetual, Peyto and Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF)–the vast majority have a much higher percentage of volumes coming from gas than they do revenue.

Pengrowth, for example, gets nearly half its daily output by volume from dry natural gas. However, in the fourth quarter of 2011 only 12 percent of revenue came from selling gas. That dependence dropped even more in the first quarter of 2012, as the company realized just 2 percent of its operating profit–known as “netback”–from producing gas, down from 20 percent from a year ago.

Pengrowth, which has reported its first-quarter numbers and is reviewed in Portfolio Update, is in the middle of a major effort to increase its production of oil and higher-priced NGLs, while spending only the minimum to keep its dry natural gas flowing.

That’s the key objective behind the merger with NAL Energy, which will be voted on by shareholders on May 23.

First-quarter funds from operations (FFO) did suffer from the drop in natural gas profit, as well as higher royalty expenses for oil sales.

But FFO nonetheless covered the dividend comfortably with a payout ratio of just 67.7 percent–and that’s with gas contributing practically nothing to profit.

Pengrowth also has considerable upside if gas prices recover. Buy Pengrowth up to USD10 if you haven’t yet.

Will other oil and gas producers fare as well as they announce earnings for the first quarter and later for the second quarter?

All else equal, companies that depended less on gas for revenue in our table certainly stand to fare much better than those that depend more. The likely exception is Peyto, mainly because it has operating costs that are a fraction of its rivals’ at just CAD2.13 per million barrels of oil equivalent at last count.

That’s less than 40 percent the operating costs of its nearest rival Progress. And it equates to a costs of just USD0.355 per million British thermal units. Peyto management has consistently maintained it can earn a 30 percent return on capital invested even if gas prices dip to CAD1 or lower in the coming months.

This cost advantage–and the leverage the company has to a gas price recovery–are why I continue to own the stock in the Portfolio. Peyto is a hold, however, until we see first-quarter results on or about May 11.

Unfortunately, not every gas company is so blessed. Although I’ve rated only a handful as outright sells, conservative investors should generally be very careful of any of these stocks that derived significantly more than 20 percent of revenue from natural gas production in the fourth quarter of 2011.

As for any company with 20 percent or less of revenue from gas in our table, Pengrowth’s first-quarter earnings are a pretty good indication we can expect at least some shortfall coming from the gas side when numbers are released.

The question is if there are other factors that will offset the decline.

My view remains that ARC Resources Ltd (TSX: ARX, OTC: AETUF) will weather its first-quarter storm. The company gets nearly two-thirds of its production volumes from natural gas but only pulled down 25 percent of fourth-quarter revenue from the fuel. Moreover, it’s hedged 70 percent of its expected output for 2012 at an average price of CAD3 per million British thermal units.

That was the basis for management’s statement in mid-April that the dividend is secure this year. ARC Resources remains a buy up to USD26 for those who don’t already own it.

Equally, Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) now pulls down just 20 percent of revenue from gas, despite more than 60 percent of output coming from the fuel. The stock seems to be carrying more dividend fears than ARC, with a yield just a bit shy of 8 percent, perhaps because information on its hedges is less accessible.

But management has been no less comforting that its focus on NGLs is paying off and that the dividend would be “the last thing” management would consider cutting if the company had to tighten its belt. I now rate Bonavista Energy a buy up to USD18.

As for other gas-focused producers, Bellatrix Exploration Ltd (TSX: BXE, OTC: BLLXF) is worth a look for speculators owing to its increasing focus on liquids and rising production. Bellatrix is a speculation for the aggressive up to USD6.

Virtually everything else so gas-weighted, however, is a hold or sell. Advantage and Perpetual are definitely sells, as both face bankruptcy.

Meanwhile, I continue to advise investors swap Dividend Watch List member Enerplus Corp (TSX: ERF, NYSE: ERF) for Pengrowth. We still don’t know the damage to the company’s cash flows from not hedging its natural gas during the quarter, and debt continues to rise. Sell Enerplus.

Because they don’t produce much gas to begin with–and rely on it even less for revenue–Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF) and PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF) have been pretty much unaffected by the gas price crash. That doesn’t mean their share prices can’t be volatile. But it does mean Crescent should post robust first-quarter results later this month.

The company announced yet another acquisition this week, snapping up Reliable Energy Ltd’s 1,000 barrels of oil equivalent per day of light oil production in the Bakken of southwest Manitoba as well as a land base of 135 net sections. Crescent Point is a buy up to USD48.

PetroBakken, meanwhile, has announced its first-quarter numbers, which I review in Portfolio Update.

Highlights included a 12 percent boost in first-quarter production, a 7 percent boost in funds from operations per share to CAD0.99 and a reduction in amounts drawn on its CAD1.1 billion credit facility to just CAD218 million.

The payout ratio based on funds from operations was just 24 percent, or 14 percent including the dividend reinvestment plan (available only to Canadians).

Despite some production interruptions in April owing to an early spring breakup, output is still on track with management projections for full-year 2012.

Buy PetroBakken up to USD18 if you haven’t yet.

Finally, Vermilion Energy Inc (TSX: VET, OTC: VEMTF) continues to benefit from selling the majority of its energy outside North America. Just 2 percent of fourth-quarter revenue was from gas produced in Canada, while the bulk of its sales of the fuel fetched robust global prices averaging USD6.50 per million British thermal units.

A mid-April conference call confirmed results were on track and that management intends to begin “regular” dividend increases, once its output from the Corrib project starts to come on stream in 2015. Buy Vermilion Energy, among the steadiest of all Canadian energy producers, up to USD50 if you haven’t yet.

Power, Pipes and Services

In the US, coal companies have suffered equally with natural gas producers, as the price of the black mineral they produce has dropped amid worries about demand.

Coal was already under attack in North America from more strict enforcement of environmental regulations. But the steep drop in the price of its chief rival gas has provided a much cheaper alternative, particularly for generating electricity.

The only coal producer in the How They Rate coverage universe is Teck Resources Ltd (TSX: TCK/B, NYSE: TCK), which is primarily focused on metallurgical coal. Met or “coking” coal is used to make steel rather than run power plants, so there’s no real exposure there. Teck, which produces a range of resources, is a buy up to USD40.

Coal-using power producers such as TransAlta Corp (TSX: TA, NYSE: TAC), however, are a different story. The company posted disappointing first-quarter 2012 earnings, as wholesale power prices fell due to weather as well as falling natural gas prices and the cost at its coal plants rose. It also took a CAD22 million charge to write down the value of its coal inventory and abandoned a carbon capture project for its coal plants for the time being.

The company’s Centralia power station in the US Pacific Northwest experienced a 75 percent plunge in selling prices in the first quarter from year-earlier levels. That alone cut into funds from operations by CAD37 million. Funds from operations–the primary measure of profits on which dividends have been based–still came in at CAD0.84 per share, enough to cover the distribution by nearly a 3-to-1 margin. But they were still off 16.4 percent, with the prospect of further declines later in the year.

TransAlta, which currently gets more than half its power from coal, also faces a major uncertainty regarding a dispute with TransCanada Corp (TSX: TRP, NYSE: TRP) over terms of a power sales contract. This case is now being arbitrated, and a negative outcome could lead to a further reduction in the company’s credit rating.

On the plus side, there’s still a cushion of funds from operations protecting the dividend. And the company’s plants are running well at 91.7 percent availability. But both company and stock are facing headwinds this year. TransAlta now rates a hold.

The good news is none of the power producers in the Canadian Edge Portfolio have that problem. The main reason is they rely on long-term contracts with government authorities and major utilities, the terms of which aren’t affected by gas prices.

Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF) and Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF) are hydro producers with some wind power capacity. Hydro is about the only source of energy cheaper than gas now, while wind is favored by government policy.

Brookfield Renewable has at last filed its Form 20-F registration statement with the US Securities and Exchange Commission. That’s the critical step toward applying for listing its units on the New York Stock Exchange (NYSE), which now looks likely sometime in the second quarter.

In the meantime, Brookfield Renewable Energy Partners–which will report first-quarter earnings on May 7–is a buy on dips of USD27 or lower. Innergex reports a week later, on May 14, and is a buy until then on dips to USD10.

AltaGas Ltd (TSX: ALA, OTC: ATGFF) has already reported first-quarter results, as noted in an Apr. 26 Flash Alert, that were wholly unaffected by falling natural gas prices.

On the power side (35 percent of first-quarter operating income), the company does operate gas-fired power plants. The bulk of capacity, however, is hydro, including the 195-megawatt Forrest Kerr run-of-the-river project in British Columbia. The facility is expected to be operational in July 2014, is ahead of schedule and on budget, and will sell its output under a 60-year Electricity Purchase Agreement with BC Hydro at a rate fully indexed to the Canadian Consumer Price Index.

Management also hedges commodity price exposure at all of its operations, including its growing natural gas liquids infrastructure operations (39 percent) and gas/power utilities (26 percent). The latter are set to grow dramatically with the acquisition of SEMCO Energy later this year. They make their money on gas use, which will likely benefit from lower prices.

As for the NGLs business, AltaGas aggressively hedges its exposure to frac spreads at its extraction/transmission operation. That’s kept results basically dependent on the company’s ability to bring new assets on stream and shielded against commodity price swings.

The company has a steady stream of new projects in this area slated to come on stream this year, and it even expects higher volumes in the field processing business.

If gas prices fail to recover there will likely be some impact on power unit earnings, as the company has only 50 percent of volumes exposed to Alberta Power Pool prices hedged for the second half of 2012. That, however, should be more than offset by strong results at the utilities and NGLs business as well as power generation additions that are locked up under long-term contracts.

The upshot is AltaGas’ earnings should keep on rising this year, with a dividend increase likely late in the year. AltaGas is a buy up to USD32.

Rising profit also seems set for Atlantic Power Corp (TSX: ATP, NYSE: AT), a power seller in the US as well as Canada that relies much more heavily on natural gas generation.

The company sells 46 percent of its output under contractural capacity payments, which aren’t affected by commodity price swings. Most of the rest it sells under contracts designed to pass though the cost of fuel to the off takers, and the balance it hedges.

Last year’s merger with the former Capital Power LP has altered the equation somewhat by adding operating employees to what had been simply ownership interests in plants. But the greatest commodity price risk lies in rolling over power sales contracts that expire the next few years. Those include the Lake, Auburndale and Greeley projects, all of which are on contracts that expire in 2013.

On the plus side, all three of these plants will be debt-free when their contracts expire. That builds in some flexibility for contract negotiations and limits the risk to overall cash flows. We’ll know more after May 7, when Atlantic reports earnings. And CEO Barry Welch will be a featured speaker at the Investing Daily Wealth Summit, a conference sponsored by Canadian Edge’s publisher.

In the meantime, Atlantic Power is a buy up to USD16 for those who don’t already own it.

Traffic in some long-haul natural gas pipelines has declined in the past year or so, as the rapid growth in production at the Marcellus Shale in the Eastern US has limited the need to ship in gas from regions such as the Rocky Mountains.

But the pipeline business’ reliance on long-term contracts–regulated and/or based on capacity–has kept this business remarkably steady as gas has crashed. Meanwhile, companies are discovering new growth in transporting and processing oil and NGLs.

Both are right in the wheelhouse of energy midstream player Pembina Pipeline Corp (TSX: PPL, NYSE: PBA), which became a major NGLs player by acquiring the former Provident Energy Ltd earlier this year.

The company had another solid quarter, as numbers were reported May 3. The company’s conference call followed on May 4; we’ll have more on Pembina’s results in a Flash Alert next week. Like the major US master limited partnerships, it’s now large enough to have a strong presence in several different areas at once.

The only problem is price, but Pembina Pipeline would be a solid buy for those who don’t already own it on any dip to USD28 or lower.

The picture also looks bright for High Yield of the Month Keyera Corp (TSX: KEY, OTC: KEYUF), which continues to build out its own NGLs infrastructure in wet gas-rich areas. The stock is again below my buy target of USD42 and ripe for purchase by anyone who doesn’t already own it.

The only potentially volatile part of Keyera’s or Pembina’s business is marketing. But even here efforts are closely tied to maximizing the value of the energy midstream assets, which limits risk and maximizes both companies’ “home court advantage.”

That’s a stark contrast to the nature of the energy services business, which is doubly leveraged to energy prices. Companies’ equipment and services are in heavy demand when energy prices are high and producers are anxious to ramp up output. That both increases the use of their assets and allows them to dictate price.

By contrast, when energy prices fall producers pull back their efforts. More capacity of service companies lies idle, and the cost for using their assets and services declines.

The worry for services companies such as Aggressive Holding PHX Energy Services Corp (TSX: PHX, OTC: PHXHF) is that lower gas prices will trigger a sharp decline in gas drilling, leaving more of its rigs and equipment idle and driving down earnings. That concern has driven down the stock price roughly 20 percent from its early March high, a level that was hit following a 50 percent dividend increase.

We won’t know for certain just how vulnerable PHX might be to these fears until the company announces first-quarter results, which is expected to happen on or about May 18. But there are several reasons to doubt any sort of revenue cliff.

First is simply the 50 percent dividend increase announced Feb. 28, a major sign of management confidence at a time when gas prices were only a few cents above where they are now.

Second, the company reported strong growth from outside North America when it released fourth-quarter earnings, with a forecast for more growth this year. Gas prices outside North America are considerably higher, and there’s been no drop-off in drilling.

Third, some 75 percent of PHX’ Canadian activity involved oil wells in 2011, with “the remainder of activity primarily related to liquids rich natural gas.” In the US oil and natural gas liquids drilling is equally dominant, with the remainder from areas such as Lower Huron and Marcellus, where operators are still drilling for dry gas.

That also argues strongly against any kind of drop off in revenue due to less natural gas drilling. Finally, if Precision Drilling Corp’s (TSX: PD, NYSE: PDS) first-quarter results are any indication, growth in demand for rigs in oil and NGLs drilling is far outpacing the drop in rigs to drill for gas.

We won’t know what happened at PHX until earnings are released. But at this point the stock and its 7.4 percent yield (paid monthly) look like a solid bargain. I continue to rate PHX Energy Services a buy up to USD14.

Note that Precision Drilling is still a hold, owing to its lack of a dividend.

Unregulated energy distributors are also potentially exposed to falling natural gas prices, mainly as they affect their ability to hold customers and attract new ones. Just Energy Group Inc (TSX: JE, NYSE: JE) has repeatedly demonstrated over the past year that it can continue to grow its business, even if low natural gas and power prices reduce the incentive of consumers and businesses to switch providers.

Earnings, due out on or about May 18, will provide the most severe test yet of its ability to keep growing amid crashing natural gas. And there are skeptics aplenty that it can, demonstrated by the fact that the stock still yields a lofty 9.4 percent. The company’s dividend, however, depends on existing contracts that have locked in both selling prices and the cost of commodity inputs.

That limits the near-term risk of holding Just Energy as we wait for the latest round of numbers. I still recommend the stock up to USD16 for those who don’t already own it.

Lastly, Superior Plus Corp (TSX: SPB, OTC: SUUIF) posted adjusted operating cash flow (AOCF) of CAD0.61 per unit in the first quarter of 2012. That was 10.3 percent off last year’s level; the primary reason was mild winter weather that hurt its Northeast US refined fuels business.

The surprise, however, was a bump up in the Canadian propane business profit, as better average sales margins more than offset reduced volumes due to weather. Propane competes with natural gas for heating in many areas, and it’s consistently traded at a higher price.

Superior’s exposure to weather was offset by strong results at its hydrochloric acid production facility in Wisconsin, for which it announced a doubling of capacity. As a result management was able to hold its full-year 2012 outlook of CAD1.45 to CAD1.80 per share for full-year adjusted operating cash flow.

That level is more than enough to continue covering the CAD0.05 monthly dividend quite comfortably while providing funds to cut debt and expand the more profitable parts of the business.

The construction products operation is still slumping due to continued weak conditions in the US home-building market. The division is no longer a threat to the payout, however, as it’s been restructured and downsized.

Still yielding over 8 percent and paying monthly, Superior Plus remains a buy for more aggressive investors up to USD8.