We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.

The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.

These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.

When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?

Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.

Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.

Home / Markets / Industries / Energy

Wednesday, September 03, 2008

Buy Order

Cubic Energy Could be a Buy if Natural Gas Prices Rise Again

Email this Story | Respond to Editor | Print

Ken Sweet

FOXBusiness

New York--In the oil and gas industry, where location is everything, one fund manager recommends a small oil and gas company because it sits on the "Park Avenue" of one of the nation’s largest oil and gas fields.

Craig Hodges, president of Texas-based Hodges Capital Management and portfolio manager of the Hodges Small Cap Fund, said Cubic Energy’s (QBC) highly desirable gas shale fields in Louisiana makes it an attractive takeover candidate and poised for significant growth.

“Because of technology, we are able to extract oil and gas in places where even 10 years ago it just wasn’t feasible,” Hodges said. “Cubic is new to the business, but they are sitting on a great location.”

The location that Hodges referred to is known as the Haynesville shale field, located in northwestern Louisiana and parts of east Texas. The Haynesville field is a large potential source of oil shale and gas shale, which are potential sources of raw crude oil and natural gas.

Cubic owns approximately 7,000 acres and 20 wells in the Haynesville field. It's surrounded on all sides by major oil and natural gas fields owned by some of the larger players in the business.

In its wells, Cubic said it has had a 100% success rate in extracting natural gas, according to the company’s most recent annual report.

To show the value of Cubic Energy’s holdings, Hodges said the company acquired the drilling leases for $200 to $300 an acre only a few years ago that are now going for $30,000 to $32,000 in the same area.

The risk that comes with oil and gas shale is the massive cost to convert shale into usual gas and oil, Hodges said. Also, the Haynesville field is very deep, and Cubic must drill an average of 10,000 feet down just to extract anything.

So, if oil were to fall to $40 -- or even $60 -- a barrel, or natural gas were to fall to $2.50 per million British Thermal Units, “none of those holdings would make sense,” he said.

“But at $100 oil and $8 natural gas, using Haynesville shale is very profitable,” he said.

Also, because Cubic Energy is new to the industry, Hodges said its number-one asset is the acres they have leased, not the company’s management.

“They don’t have extensive experience in the industry,” he said. “They are just starting to get royalties from the wells they own, but it’s going to be very expensive for them because they’re so small. The technology is complicated.”

Instead, Hodges believes the assets that Cubic owns would make it an attractive acquisition candidate for one of the bigger natural-gas drilling companies like Chesapeake Energy (CHK). On Tuesday, Chesapeake announced it would sell a 25% stake in its Fayetteville Shale assets in Arkansas to BP for $1.9 billion.

Because of Cubic’s exposure to the gas shale industry, it tends to move in tandem with natural gas prices. The company's stock has traded as high as $3.90 a share, but has dropped off to about $3.40 a share as both oil and natural gas have declined.

Hodges does warn that because Cubic is a small company -- its market capitalization is around $185 million -- it can be a highly volatile and risky investment.

“They are very small, but they have a very promising story,” he said. “If energy prices are going to continue to be high, we need to look to alternative ways of getting to gas and oil. This is one of those ways.”