China throws down the gauntlet over oil

China needs oil, and lots of it, to keep its economy growing. And it isn't shy about challenging the US for control of the globe's resources to get it. Mike Anderson looks at how investors can benefit

On 20 January 2005, most of the world's journalists had their eyes firmly on the Washington inauguration of President Bush. But if they'd been looking a little further east, they might have noticed something just as profoundly important happening in Beijing. The leaders of China and Canada, Paul Martin and Wen Jiaboa, were meeting to sign a 13-point energy pact. Why? Because China's fast-growing economy needs oil and Canada has plenty of it.

A vast northern country sharing a 5,000-mile border with the US, Canada is an unlikely newcomer to the energy big leagues. It's not in the Middle EastIt's not a member of Opec. It is not one of the world's low-cost producers and ranks only number eight in terms of production. However, when it comes to proven reserves, Canada does rather better: after Saudi Arabia, it has the most in the world. Canada's Rocky Mountain province of Alberta is overflowing with oil sands. Concentrated in northern Alberta, in a region as big as Florida, the sands contain vast quantities of so-called bitumen, or super-heavy oil, says the San Francisco Chronicle. Dig up two tons of sand, heat it and process it and you'll have enough oil to fill a 42-gallon barrel of oil. Official estimates put Canada's extractable total at 180 billion barrels. The problem ­ up until recently ­ has been the cost: it costs about $20 a barrel to turn sand into liquid oil, so during the long bear market in oil no one was much interested in Canadas assets.

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Today they are. With oil trading at nearly $60 a barrel and demand from all over Asia promising to keep prices high for the foreseeable future, Canada's oil sands suddenly look very attractive indeed. In a few years, two million barrels of oil a day are expected to flow from the tar sands in the Rockies to a seaport in British Columbia to be loaded on to tankers. And it was this oil that ­ back on 20 January ­ China's two biggest oil companies, PetroChina and Sinopec, made a deal to get a share of. In the same month, PetroChina (PTR: NYSE), struck a deal with Enbridge, one of Canada's top energy firms. Enbridge is planning a $2bn, 750-mile pipeline stretching from Alberta ­ the province where Canadas oil sands are concentrated ­ to a Pacific seaport in British Columbia. And PetroChina now has tentative rights to use half the pipelines capacity of 400,000 barrels of oil a day. And it may take an equity stake in the pipeline.

Getting America worried

This is the kind of deal that should have the US worried. At the moment, the US buys more energy from its northern neighbour ­ mostly oil and natural gas from traditional sources in eastern Canada ­ than from any other single country, and several American companies (ChevronTexaco, Exxon Mobil ConocoPhilips and Suncor Energy) have major interests in Canada's oil sands. But China has made it very clear ­ not least in the audacious $18.5bn bid by its number three company, known as CNOOC, (CEO: NYSE) for US energy giant Unocal last week­ that it has no qualms at all about directly challenging the US for the oil resources it needs to keep growing. And Canada has no problem with that. 'What we're suggesting as China searches the world to find a secure and reliable supply of oil is they should be looking here,' Alberta's premier Ralph Klein told The Wall Street Journal last year. Canada's leaders can see 'which way the wind is blowing ­ and which country will be its best meal ticket for years to come', says Outstanding Investments. Demand for oil in the US rose 15% between 1994 and 2004. Demand in China is expected to grow that much this year alone.

The top stocks to buy

Still, whether Canada's oil is going east or south, it's going somewhere, and that means smart investors should be considering adding some exposure to Canadian oil to their portfolio. One to consider, says Jim Jubak on MSNs Money Central, is Canadian Natural Resources (CNQ: NYSE). Natural gas is a crucial ingredient in the process of extracting oil from sand and the firm is Canada's number two natural-gas producer. And it has more than just gas. The firm also has oil-sand deposits and extraction technology that will pay off as long as oil prices remain above $35.

But that's not to say there aren't risks, says Jubak. The firm will spend about $8bn to develop its Horizon Oil Sands Project. Production wont start until 2008 and won't reach full production until 2012. Still, the firm does make an operating profit and has estimated oil sand reserves of about six billion barrels. That means that when the company is up and running, it could pump about 230,000 barrels a day for at least 40 years, says Jubak. The shares have soared 85% so far this year, but still trade on a forecast p/e of only about 15 times, making them look reasonable value.

Canada's largest oil-sands producer is Syncrude, a joint venture of North American companies and limited partnerships. Smaller companies with oil-sand reserves include Deer Creek Energy and UTS Energy, both of which come with the added bonus of being possible acquisition targets, mainly because they need cash to develop their bitumen, notes Michael Brush of MSN Money Central. But the companies dont trade on major American exchanges and are surely more speculative bets than Canadian Resources.

The power of pipelines

Getting oil from sand is only part of the battle. Getting it to where it's needed is just as important, if not more so. Here, Enbridge (ENB: NYSE) is the company to watch. Its key partner for the new oil-sands pipeline is China's largest oil company, PetroChina. The Gateway Pipeline is not a sure bet. Increasing competition between China and the US for Canadian resources could reshape the project, which also faces opposition from some indigenous people. But Enbridge's financials are strong. The company reported latest quarter earnings of $221m, nearly double the figure of a year ago. For the year, it expects earnings per share of about $3.20, putting it on a p/e of around 20 times expected earnings.

Finally, keep an eye on oil and gas shipping companies serving Canada, says Outstanding Investments. OMI Corp (OMI: NYSE) is an up-and-comer. The company's key advantage is that its entire fleet is double-hulled (new regulations this year call for the replacement of single-hull oil tankers) and strong demand meant that the firm's net revenues rose by a third in the last quarter. Another possibility is Teekay Shipping (TK: NYSE). The firm's financial results have been mixed. But its fleet ­ mostly double hulled ­ is well positioned to handle both oil and liquid natural-gas shipments, says Outstanding Investments.