Investment Solutions

Quarterly Report – March 31, 2014

April 23, 2014

Results for the first quarter benefitted from an investment increase in companies that apparently benefitted from a strengthening in the price of natural gas and a decrease in ownership of sectors such as deep water drillers. This group had outperformed the market in the past, but was vulnerable to an anticipated oversupply of equipment and lower day rates as old contracts expired. Our short positions in the drillers aided the Fund’s performance because the major offshore drillers, as a group, were down 15% during the quarter.

Our long held belief that WTI oil prices would hold up better than the consensus, paid off as it averaged in the mid-90’s causing an increasing number of investors to rethink their bearish views. This is very significant because lower consensus earnings, cash flows, and equity target prices of the oil and gas exploration and production sector were keyed off at an average price closer to $80 a barrel at year end 2013.

A major objective in managing an energy related portfolio is reducing volatility and this is accomplished in various ways such as Master Limited Partnerships (MLPs). The MLPs, as in the past, provided a counter weight to the volatility. As concerns increased that the slow U.S. economic recovery could be stalled as the Federal Reserve began to taper its policy of quantitative easing, investors turned their focus more to yield sensitive securities, particularly to the MLPs which offered the highest dividend returns. Also, the 10 year Treasury, a major MLP benchmark, continues to yield at around 2.7%. This asset class (MLPs) significantly contributed to the Fund’s performance during a more challenging stock market period. Additionally, MLPs benefitted from strong secular trends. Most are involved in energy infrastructure businesses that are benefitting from the growing development of oil and gas shale drilling, such as pipelines, gathering, processing, storage, and terminals. Therefore, the outlook for midstream investments remains robust which is very positive for MLPs

In our judgment, U.S. energy independence, and natural gas, oil, and coal related exportation will be important themes in the future. We have commented for some time that low cost U.S. shale drilling is a significant game changer revitalizing many important U.S. industries. Since we believe the country is “short” essential infrastructure assets, significant capital will have to be earmarked for the energy space thereby increasing investment opportunities.

The recent annexation of Ukraine’s Crimea region by Russia resulted in the most serious confrontation between that country and the West since the end of the Cold War. Russia’s economy is dominated by energy, and it is the major supplier of natural gas to Europe, providing about 40% of its needs. To reach Europe, the gas has to be transported through pipelines located in Ukraine. Given this dependence by the European countries, and the reality that Russia has cut off deliveries in the past in the winter and doubled the price, there is mounting political pressure in Congress and the Obama Administration to speed up liquefied natural gas (LNG) and oil exports. We believe these developments are very positive for our space as it should increase demand for infrastructure projects and expansion of oil and gas production.

As noted in prior reports, we believe that the energy sector should outperform over the longer term. Expanded drilling and lower costs are positively impacting many areas of the ecomony, and we therefore continue to benefit from the Fund’s “energy chain” approach to investing in the space. It provides the necessary flexibility to navigate the changes that are occurring in such industries as chemicals, railroads, engineering, and shipping to mention just a few. In fact, we approximate that the Fund’s portfolio holdings currently encompasses at least 50% of the S&P 500 Index.

In summary, our space has many moving parts, and while it is encouraging to post a strong first quarter performance, we are mindful of portfolio volatility and continue to be active in hedging and taking profits.

Certain statements contained herein may contain "forward-looking statements" within the meaning of the Private Securities and Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Fund to be materially different from any future results, performance or achievements expressed or implied by such forward- looking statements. Such factors include, among others, risks and uncertainties associated with the timing and costs of energy sector production, the demand for and prices of oil/gas products, the timing and amount of capital spending in the nation and world wide, and general economic factors. This report is not a recommendation to either buy or sell any securities mentioned.

 

« Library »

 

About ELCO Management, LLC
Established in 1995 and based in New York, ELCO Management (www.elcomanagement.com) offers investment solutions to high net worth individuals and institutions. ELCO also manages two highly specialized energy funds: the ELCO Energy Fund, L.P. and the ELCO Select Fund L.P.