Canadian oil sands player MEG Energy Corp (Toronto: MEG.TO) debuted on the Toronto Stock Exchange (TSX) in late July, the second initial public offering (IPO) of 2010 connected to the vast bitumen deposits located in remote regions of Alberta.

As we’ve often noted in this space, the oil sands generally represent an incredible opportunity for Canada as a whole and for investors, and there are many particular ways for individuals to allocate their capital these days. The Canadian dollar, because of the strong fundamentals supporting it, is an attractive currency for American investors. You can partake of the loonie’s upward flight against the buck–and you can lock in sustainable and high yields at the same time.

There is no way to mitigate away all risk, but you can establish a continuum, at least, that distinguishes between “bets” and “investments.” At one end of the Canadian oil sands story at the moment are MEG Energy and Athabasca Oil Sands (Toronto: ATH.TO, Other OTC: ATHOF.PK). At the other are heavyweights such as Canadian Oil Sands Trust (Toronto: COS-UN.TO, Other OTC: COSWF.PK), the biggest pure play, and Suncor Energy (Toronto: SU.TO, NYSE: SU).

Of the latecomers to the public market, MEG is a better proposition than, Athabasca Oil Sands, which listed on the TSX back in April. We like Suncor and Canadian Oil Sands, though Suncor is a bit beyond value range right now. The best bet remains longtime Canadian Edge Portfolio Holding Pembina Pipeline Income Fund (Toronto: PIF-UN.TO, Other OTC: PMBIF.PK).

The MEG story includes many of the elements that make the broader case for Canada particularly compelling: a major piece of a key asset, the Canadian oil sands, and the 170.4 billion barrels of recoverable crude that distinguish Canada from the rest of the developed world; heavy participation by serious North American institutional players; and China.

The first investment by a Chinese government sponsored entity in a Canadian company was made by CNOOC Ltd (NYSE: CEO), one of China’s fleet of state-backed companies that’s staking claims, particularly on resource assets, all over the globe. The Middle Kingdom’s thirst for oil first led CNOOC to pay CAD150 million for 16.7 percent of then-private MEG Energy. CNOOC now owns 15.8 percent, as more capital has flowed into MEG over the last half-decade and diluted its stake.

When finally priced the IPO came in well below MEG’s original target of more than CAD1 billion. We’re not in the long-distance mind-reading game, but it’s safe to say the Athabasca Oil Sands experience colored investors’ view of this latest offering. Athabasca came to market in a much-ballyhooed deal but fell more than 33 percent during the 30 days following its IPO, the second-worst first month of any stock to debut on the Toronto Stock Exchange over the last five years. (Athabasca is in white in the graph below, Enerplus Resources Fund (Toronto: ERF-UN.TO, NYSE: ERF) is orange, the S&P/Toronto Stock Exchange Energy Index is yellow and the front-month crude oil futures contract is green.)

Source: Bloomberg

“Too many people with a 10-minute time horizon bought a 10-year story, and when it didn’t jump out of the gate for them to make their profits, they turned around and started selling. And selling begets more selling,” explained Kevin Sullivan, CEO of GMP Capital (Toronto: GMP.TO, Other OTC: GMPXF.PK), which co-sponsored the offering along with Morgan Stanley. One could argue, however, that going public with no track record of production is a little shortsighted, too. Whatever, Athabasca’s shortcomings right now, another Chinese entity, PetroChina (NYSE: PTR), dumped CAD1.9 billion into a joint venture with the company before the IPO.

At midway through its 10th trading day MEG had shed 7 percent from its CAD35 per share public open. What separates MEG from Athabasca Oil Sands is its track record; as in, MEG has one. It reported average production of 26,000 bbl/d for the second quarter, achieving that rate one year after commencing operations at its two commercial facilities.

MEG Energy owns 100 percent working interests in more than 800 sections of oil sands leases; as of Dec. 31, 2009, according to evaluations of certain of these assets by independent oil and gas engineering firm GLJ Petroleum Consultants Ltd, MEG’s lands hold 1.7 billion barrels of proved plus probable bitumen reserves and as much as 3.7 billion barrels of contingent bitumen resources. The company is currently running two commercial steam assisted gravity drainage (SAGD) extraction operations, one at Christina Lake, the other at Surmont. GLJ’s analysis suggests these two projects “will support 260,000 bbl/d of sustained bitumen production for over 30 years.”

For reference sake, Suncor reported year-to-date average oil sands output of 260,000 bbl/d through July. (The monthly rate for July, 322,000 bbl/d, indicates Suncor could approximate its 280,000 bbl/d target for 2010.) The Syncrude consortium, which includes Suncor and features Canadian Oil Sands Trust, reported second-quarter average production of 324,000 bbl/d, with an ultimate goal of achieving design capacity of 350,000 bbl/d.

MEG Energy is a better proposition simply because in the high-cost environment that is oil sands production a track record of any length certainly beats no output. Heavy Chinese interest is further indication that the Middle Kingdom–and Asia generally–will drive oil consumption during the next decade. Demand from these new economic powers mitigated the declines in consumption in the developed world from 2007 to 2009 and set the table for a new era of permanently high, relative to old norms, crude prices.

And from an income investing perspective, a dividend of any kind beats no payout. Getting paid on a regular basis, even a little bit, builds a cushion for investors. Dividends smooth market volatility and contribute mightily to total return over the long term, and the regimen of cutting checks to investors establishes a discipline for management that prevents misguided expenditures. Canadian Oil Sands’ quarterly distribution validates the company’s business proposition by putting something in your brokerage account every quarter, even if all it does is offset some of a capital loss. Every little bit counts.

A side note about dividends, with a segue into another on measuring safety: Only those Canada-based companies traded on a major exchange such as the New York Stock Exchange (NYSE) or the Nasdaq allow permitted by US securities laws to allow reinvestment participation for American investors. You can’t automatically put these dividends back to work, but you can sweep the cash into your account and enforce your own “discipline-plus:” Use limit orders to put that money back to work at a level of your choosing, preferably set according the value-based buy targets listed in the Canadian Edge Portfolio and How They Rate tables.

In those tables you’ll also find a CE Safety Rating for each company, an index based on seven criteria directly impacting dividend sustainability; a high Safety Rating doesn’t always mean “buy,” nor does a low Rating imply “sell.”

The relative risk reflected in a company’s Safety Rating may or may not be priced into its stock. A perfect “7” (seven-for-seven on the Safety Rating criteria) may be overpriced. Likewise, though rarely, a company hitting two or even just one benchmark can still merit a “buy” in the advice column. Some things are cheap for good reasons, others because they suffer for short-term or easily correctible flaws. You can lock in a compelling yield when the market overreacts to perceived risk, and you can overpay and crimp your long-term wealth-building, too. We like to lock in safety at value-based buy targets.

Pembina Pipeline Income Fund, about as secure and sound a dividend-payer as there is, according to the CE Safety Rating System, holds an exclusive contract to transport production from the Syncrude consortium to terminals in Edmonton, Alberta. Pembina Pipeline’s cash flow is based on throughput; its fee-for-service revenue is not directly tied to the price of crude oil.

In the graph below, Pembina Pipeline is represented by the white line, Canadian Oil Sands by the orange, the S&P/Toronto Stock Exchange Energy Index by the yellow and the front-month crude oil futures contract the green. As you can plainly see, Pembina Pipeline has far outperformed over the trailing year.

Source: Bloomberg

It’s important to consider as well the distinction between the US and Canadian recessions and what it means for American investors looking to maximize returns over the next decade. The US is digging itself out of a balance-sheet recession; there’s no easy way to get rid of debt except to pay it back, and that requires more savings and less spending. Recovering from this mess will be a long, slow grind. (Imagine: Fifteen years ago John Fund, writing in The Wall Street Journal, described Canada as an honorary member of the Third World because of its exorbitant public debt. Perhaps the path of austerity championed by so many will have such an outcome as that in the Great White North.)

Canada’s recession was caused by a sudden deterioration in its terms of trade caused by a collapse in commodity prices. When commodity prices rebounded so did Canada’s terms of trade and so did its economy. New demand from emerging markets has replaced demand destroyed in the US (and other major developed economies) during the downturn. This trend toward new engines of global economic growth actually evidenced itself before 2007; the collapse of 2008-09 only accelerated the process. Canada has already narrowed its output gap–the difference between potential GDP and actual GDP–by half in its recovery phase.

The Bank of Canada (BoC) has lifted interest rates twice and is on track to push its target rate above 1 percent by mid-2011, when the Canadian federal government’s stimulus measures will have wound up. Should soft employment numbers and slackening trade terms threaten overall growth during the latter half of 2011 the BoC will have room to trim its target overnight interest rate.

These are all consequences of Canada’s relative discipline during the Roaring 2000s. Canada didn’t underpin home ownership growth with dodgy subprime loans. Public debt–after more than a decade of spending cuts at the federal and provincial levels–came down from near 70 percent of GDP in 1995 to below 30 percent before the global crisis forced officials to compensate for lost private demand in the short term.  

Once again, the relative ease of Canada’s path is set in stark contrast to what stands before US policymakers. Canada’s federal government will let its fiscal stimulus package expire on schedule in the first quarter of 2011. The BoC and monetary policy will then be left to provide any counter-cyclical propping of the economy. In other words, Canada will handle what was for it a better-than-ordinary recession with ordinary responses. Still, Canada’s debt-to-GDP ratio is projected to peak below 40 percent before resuming its long-term downward trend.

This, along with the hard asset that is the Canadian oil sands, is bullish for the Canadian dollar. For the latest and best word on how to play the Canadian oil sands and gain exposure to the best economic story on the planet, consult Canadian Edge.

Editor’s Note: For additional information on this topic, check out Roger Conrad’s latest report on Canadian Income Trusts.