3 Canadian Energy Plays for Your Watchlist

Alberta, the Canadian province that sits above Montana, prides itself on its environmental reputation. It is the only jurisdiction on the North American continent to establish mandatory greenhouse gas emission reduction rates for all industries. Sounds pretty responsible, and yet Alberta finds itself among the front-runners for the "Miss Most Contentious Energy Source Pageant." Fortunately for investors, the talent portion of the competition includes three stock ideas.

Oh, Canada
Alberta is home to the Athabasca oil sands, the third-largest proved oil reserves in the world, and the province currently exports 1.5 million barrels of oil a day. The nature of oil sands (oil stuck in sand and clay) makes it trickier to produce than conventional oil, however.

One process, in situ recovery, involves pumping steam into the ground to decrease viscosity and encourage oil to flow to a well. The other, less common, process is surface mining. It necessitates buying the largest trucks in the world from Caterpillar (NYSE: CAT) , loading them up with 380 tons of oily sand and dumping it off at a processing plant to separate the oil from the sand.

With so many refineries on the Gulf Coast and not so many in Canada, the ideal situation for a Canadian oil sands producer would involve a company finding a way to move the crude from Alberta down through the United States. TransCanada (NYSE: TRP) is that company.

Pipeline time
You've probably heard of TransCanada by now, the Canadian pipeline outfit that is trying to get U.S. approval to expand its Keystone pipeline system from Alberta down to the Gulf of Mexico. Though it has delayed its decision before, the State Department insists it will make a determination on the Keystone XL project by the end of the year. For real this time.

Though some people consider the oil sands the greatest thing to come to the U.S. from Alberta since Wayne Gretzky, others are quite up in arms about it. The refrain is the same as always: Those for the pipeline preach job creation and a decreasing dependence on "foreign" oil; those against claim irrevocable environmental damage. In reality, both sides have very valid arguments, but only one dream will be realized.

Now that we may or may not have a pipeline in our future, let's get back to that sandy oil. The largest energy company in Canada is Suncor Energy (NYSE: SU) . High oil prices are directly responsible for Suncor's claim to record cash flows this year: The company expects cash flow to top the $5.5 billion it hauled in last year.

CEO Rick George acknowledges that when the price of oil is above $70 a barrel, margins are great for the company. It costs anywhere from $18 to $40 per barrel to process oil sands. Considering that the average price of crude was about $102 during the second quarter of this year, who can blame the company for having high hopes for cash flow?

Production is also going very, very well. In 2007, Suncor estimated it would produce roughly 350,000 barrels of oil equivalent per day by 2010. In actuality, the company produced over 600,000. Though the number has dipped through the first two quarters of 2011, it is still higher than the initial 2007 estimate. Suncor expects that number to rise by year's end now that several planned maintenance projects have been completed.

Other players
Suncor has been in the oil sands since 1967, but that doesn't mean it's the only game in town. Calgary-based Imperial Oil (AMEX: IMO) is there, too. ExxonMobil (NYSE: XOM) has nearly a 70% stake in the company, and together they are developing technology that allows about 95% of the water from the oil sands production process to be reused. As I've said before, Imperial has a great balance sheet, boasting the highest return on capital employed among its competitors in Canada, and it's been that way for the last five years. It's hard not to consider a company so closely tied to ExxonMobil.

ConocoPhillips (NYSE: COP) and Chevron (NYSE: CVX) are also active in the sands. ConocoPhillips actually once co-owned the Keystone pipeline (the existing piece, different route) with TransCanada. Chevron recently joined ExxonMobil and several other oil companies contributing funds to lobby for Keystone XL approval.

Going forward
New technology may improve the ability to extract oil from the sands in an environmentally acceptable way. A closely held Canadian company, E-T Energy, is developing a process to use electricity to extract oil from the sand and clay. The process uses less energy, does less environmental damage, and costs significantly less than the methods employed today. Not only that, but it can reach oil that today's conventional methods cannot. It's like the next generation of fracking, Fools!

In all seriousness, if this technology proves to be commercially viable, as many think it will, Alberta's oil sands are a resource I am happy to place bets on. I like Suncor and Imperial the best out of the lot; they are on my watchlist and you can click here to add them to yours.

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