On Jun. 28, 2012, Malaysia’s state-owned oil and gas company Petroliam Nasional Berhad, better known as Petronas, announced it would pay 77 percent above market price to acquire Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF).

That’s the latest affirmation of the extreme values in Canada’s energy patch now and provides an equally clear warning to investors that the strongest producers’ stock prices won’t stay this low forever.

Petronas had already invested more than CAD1 billion in Progress’ efforts to develop its immense natural gas reserves in the Montney Shale. In announcing the merger it confirmed plans to build and operate a liquefied natural gas (LNG) export facility in British Columbia by 2018, with a target market of energy-starved Asia.

The Petronas-Progress facility is the third LNG export project to be announced in Western Canada thus far. It complements recently announced plans by TransCanada Corp (TSX; TRP, NYSE: TRP) to build a CAD4 billion pipeline to the Pacific Coast, for the purpose of transporting output of Canada’s shale-rich regions for export.

It will still be some years before LNG exports provide a meaningful opportunity to arbitrage the difference between North America’s rock-bottom natural gas prices and those in Asia, which are five times as high. But Petronas making this acquisition so far in advance of that date is still more handwriting on the wall indicating that the days of sub-CAD2 per million British thermal unit gas are numbered.

In fact, odds are growing the four-year decline in prices is either at an end or pennies away from a bottom.

On the other hand, natural gas supplies in storage are still at or near record levels despite the hot summer, and prices are unlikely to recover to 2008 levels anytime soon.

Not every gas producer is going to make it. Rather, successful companies must have the financial power and low-cost operations to survive the current low-price environment and to take advantage of rivals’ weakness to boost their own reserves and future production.

No pair of Canadian gas producers is better positioned than CE Portfolio Aggressive Holdings ARC Resources Ltd (TSX: ARX, OTC: AETUF) and Peyto Exploration & Development Corp (TSX: PEY, OTCL PEYUF).

Like Progress Energy, ARC has a huge and growing stake in the liquids-rich Montney Shale of British Columbia. The company also has growing stakes in the light oil-focused Cardium trend as well as in the Ante Creek, Dawson, Parkland and Pembina trends.

That oil and natural gas liquids (NGL) development is the primary driver of profit now, and it ensures there will be cash flow to fund further development and the dividend while keeping debt at low levels.

ARC’s reserve life–based on proven plus probable reserves produced at the current annual rate of 90-95,000 barrels of oil equivalent per day–is roughly 17 years. That’s the highest in ARC’s history and is testament to the success of the past few years’ strategy of developing a new generation of deep-pool, low-decline reserves in Alberta, British Columbia and Saskatchewan.

Impressively, much of the reserves now being developed are on lands purchased when oil sold for CAD20 to CAD30 a barrel. That’s the payoff from management’s long-term focus on return on investment rather than trying to be the biggest player in the industry.

ARC’s costs are among the lowest in the industry at CD8.75 per barrel of oil equivalent (boe), down from CD10.12 per boe a year ago. This advantage should actually grow going forward, as less capitalized and higher-cost producers cut back on their output, freeing up energy services companies’ capacity and bringing down drilling rates.

ARC’s first-quarter production was a record 94,970 boe per day, up sharply from 73,880 a year earlier. Despite a drop in realized selling prices for natural gas from CAD4.05 to CAD2.67 per thousand cubic feet, management has stuck to its full-year output targets as well as exit 2012 output projections of nearly 100,000 boe per day.

That’s also despite a planned reduction in full-year capital spending from CAD760 to CAD600 million, not including as yet unbudgeted but anticipated purchases of valuable lands from distressed owners.

That demonstrates an extraordinary flexibility for the company when it comes to dealing with volatile energy prices.

It’s further underscored by aggressive hedging (better than 50 percent of oil and NGLs and 60 percent of gas have been sold forward), more than 2-to-1 coverage of distributions by distributable cash flow and no debt maturities until a CAD1 billion credit line matures on Aug. 3, 2015.

Peyto’s operating costs came in at just CAD1.96 per boe in the first quarter, a 15 percent reduction from the prior year and by far the lowest in the industry.

The company’s reserve life is also near the top of the industry at 16 years on a proved-plus-probable basis, after a 25 percent increase in first-quarter production per share from year-earlier levels.

Output was 40,903 boe per day and is on track to meet management’s expanded end-year guidance of 57,000 boe.

Peyto’s all-in cash costs would still yield a 30 percent profit margin were gas prices to fall to CAD1 per million British thermal units. That’s in large part because the company operates its own properties, giving it extraordinary control over expenses.

As for pricing, the superior heat content of the company’s gas means it always fetches a premium–15 percent in the first quarter to the average regional price. And management continues to push ahead with new drilling opportunities in more liquids-rich areas.

Some 45 percent of expected natural gas production for 2012 is hedged at an average price of CAD4.23 per thousand cubic feet. And the company has adopted a similar conservative strategy of locking in pricing for its NGLs output as well.

First-quarter distributable cash flow covered the distribution by better than a 3-to-1 margin, leaving plenty of capital to invest in the business without rolling up debt. That’s another stark contrast with gas-focused producers such as Enerplus Corp (TSX: ERF, NYSE; ERF) which was forced to cut its distribution in half last month.

Peyto has already ratcheted up its expected capital spending once for 2012 to CAD400 million, with the option of ramping that up to CAD450 million if market conditions sufficiently improve. That’s more evidence of the company’s financial and operating flexibility. And both will be increasingly critical in the coming years, as North America’s gas industry continues to shake out, even as the day of global price arbitrage grows ever-closer.

The purchase of Open Range Energy Corp (TSX: ONR, OTC: ONRRF) in a CAD179.5 million stock swap this week is another coup for management. The deal is expected to raise the company’s 2013 production growth rate to 28 percent and cash flow per share by 4 percent in 2012 and 9 percent in 2013. That’s based on conservative estimates for energy prices and expected hedges, and it again demonstrates this company’s ability to take advantage of overall industry weakness to enhance its long-run position.

Both ARC and Peyto are priced considerably higher than Progress was prior its takeover by Petronas. ARC sells for 2.11 times book value, while Peyto sells for 2.76 times book. Both stocks, however, are still priced at a discount to the value of their reserves, which is more than CAD30 for both companies.

And these values are set to continue rising, as the companies enjoy success expanding positions at the drillbit and through acquisitions and benefit from what should be rising energy prices over the long term.

These are compelling reasons for a would-be acquirer to pay up for either company. The longer we wait for a bid, the more valuable this pair will become, and the higher the ultimate price.

What can go wrong at ARC and Peyto? Simply, every energy producer’s cash flows are at the mercy of what happens to energy prices.

Then organized as income trusts, both companies were forced to reduce distributions substantially in 2008-09, when oil crashed from over USD150 to barely USD30 a barrel and gas went from the low teens to low single-digits.

Those moves, combined with the general panic in the markets, took both stocks down sharply, with ARC hitting a low of USD9.38 per unit on Mar. 6, 2009 and Peyto bottoming out at USD5.06 a week later. And both stocks were also volatile in the second quarter of 2012, though they’ve fared better than more oil-focused producers since May.

Any further declines in energy prices going forward will no doubt have a similar impact on these stocks. Importantly, however, both ARC and Peyto are far better prepared for an environment of weak energy prices than they were in 2008, both financially and operationally.

A prolonged drop in oil prices to USD60 or lower–with a commensurate drop in NGLs prices–would no doubt cause management to rethink the current level of dividends. Even a much deeper drop, however, wouldn’t threaten the pair’s financial strength or ability to execute long-run growth strategies–just as the 2008 debacle did not.

The upshot is buying and holding ARC and Peyto is a great conservative way to garner solid dividends in growing enterprises built to withstand the worst for the North American natural gas industry. And there’s the possibility of windfall gains from a takeover, as global giants continue to move in on one of the last great energy treasure troves in a politically stable country.

We’ll get second-quarter numbers for both companies in early August. Meanwhile, both stocks trade below buy targets of USD26 (ARC) and USD20 (Peyto).

For those who want to use buy limit orders on the off chance market conditions worsen substantially later this summer, ARC’s low since January 2011 is a bit over USD18, Peyto’s is about USD15.

For more information on ARC and Peyto, go to the Oil and Gas section in How They Rate. Click on their US symbols to see all previous writeups in Canadian Edge and Maple Leaf Memo. Click on the Toronto Stock Exchange (TSX) symbol to go to their Google Finance pages for a wealth of information, ranging from news releases to price charts. Click on their names to go directly to company websites.

Both companies are reasonably large, which should make it very easy to buy them either in Canada or in the US. ARC has a market capitalization of CAD6.67 billion. Peyto is a bit smaller with a market cap of CAD2.83 billion.

Both stocks trade with substantial volume on their home market, the TSX. Both trade in the US over-the-counter (OTC) symbol market under the symbols AETUF and PEYUF, respectively, but should be liquid enough for any brokerage to purchase and already have substantial US ownership as well.

As is the case with all stocks in the Canadian Edge coverage universe, there’s no difference if you buy in the US or Canada. These stocks are priced in and pay dividends in Canadian dollars. Appreciation in the loonie will raise dividends as well as the value of your shares.

Dividends of both companies are 100 percent qualified for US income tax purposes and are taxed at a maximum rate of 15 percent. Both companies are former income trusts that have been organized as corporations since January 2011. Dividends paid into a US IRA are not subject to 15 percent Canadian withholding tax.

Dividends paid by both companies to non-IRA US accounts are withheld at the 15 percent rate. This can be recovered as a credit by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation. Canadian investors enjoy preferential tax treatment for dividends paid on all common stocks.