canal: a passage of water *that* boats can travel

[What is the part of speech of *that* in the phrase?]

1. canal: a passage of water *that* boats can travel

[What is the part of speech of *that* in the phrase?]

2. Boats can travel a passage of water.
3. Boats can travel on a passage of water.
4. Boats can travel through a passage of water.
[Which one is grammatical of the three?]

I would not in English use that phrase, however, as it is, it connects two clauses, so conjunction .

My usage...
canal: a passage of water in which boats can travel.

4. through

Bob Pursley is right. The preposition "through" is the best one to use for this expression.

In any case, the word "that" (or "which") is a relative pronoun, introducing an adjective clause that modifies "water."
http://grammar.ccc.commnet.edu/grammar/pronouns1.htm#relative

The word "that" in the given phrase is functioning as a relative pronoun. Relative pronouns are used to connect clauses or phrases and show a relationship between them. In this case, "that" is introducing a relative clause, which provides additional information about the noun "passage." It helps to define the type of passage being referred to, specifying that it is a passage of water in which boats can travel.