Investment Solutions

Quarterly Report – June 30, 2012

July 17, 2012

The Fund recorded a relatively modest decline for the first six months despite a very challenging period for almost all the energy subsectors, other than electric utilities. Given the weak U.S. economy, and other major issues, such as the European debt crisis and the negative global economic environments, the Fund came through the recent period in a relatively strong position. For example, oil was down 17.5% for the quarter, exploration and production stocks were down 11.89% and oil service stocks were down 15.18%. Most significantly, the drop in oil prices over the first six months was the largest decline in this commodity over such a short time period and was caused by a combination of factors that we believe were unprecedented. Positively, during the first two weeks of July, oil prices rebounded ~$8 per barrel from the low of $77 per barrel on June 28.

Looking ahead to the next 6-12 months, we believe oil prices should trade in the $80-$100 per barrel range based on supply and demand. However, given geopolitical risk factors, the near term direction is more difficult to predict. Also, it now appears that natural gas prices have bottomed as the rapid decline in the rig count (down 66% from an all time peak in 2008) is finally having an impact. We expect, based on the forward curve, that gas prices can average $3.00/MMBtu in 2013 and reach $4 by 2014, if not sooner, particularly if the winter weather is normal. Natural gas liquids (NGLs) prices declined ~20% in the second quarter and are currently priced at 30-40% of WTI crude oil versus a historic 60%. We believe the fundamental outlook should improve as demand rises as the seasonal turnaround of the petrochemical plants comes to an end and an anticipated doubling of export capacity in the /Houston Ship channel comes on line next year.

While we are cautious on the near term outlook for energy as result of macro economic uncertainties in the U.S., Europe, and China, we remain positive longer term and remain confident about navigating through the volatility associated with the sector. We expect second quarter earnings for some companies to be under pressure, especially those in the oil service and exploration and production industries. However, energy multiples have been pricing in significant earnings declines. As a consequence, the overall weighting of energy in the S&P 500 index has dropped from 16.2% in June 2008 to approximately 10.5% currently, a five year low and almost two-thirds below a peak of 28.1% in 1980.

In our opinion, the future continues to look bright for many subsectors, but we have been especially bullish on companies involved in energy infrastructure. This group of industries includes oil, gas, natural liquids, pipeline, energy conservation, engineering and construction, electric transmission, renewables, and, eventually, new electric generation. As noted in the past, we believe trillions of dollars will be spent on global infrastructure projects and anticipate that the impact could last decades. Pipeline capacity in the U.S. is tight, particularly during peak usage periods. Electric utilities are substituting natural gas generation for coal because of tightening environmental regulations and a more reliable visibility of supply. Between 2011 and 2030, we see a need for over $10 billion per year in infrastructure spending to connect new areas of natural gas supply. We believe that Master Limited Partnerships (MLPs), and their subcontractors will be responsible for most of this capital investment, which implies sustained distribution growth.

The electric power industry is also in the early stage of a new capital investment cycle which could approximate $20 trillion by 2030. Drivers include environmental requirements, transmission replacement and growth, renewables and distribution upgrades.

In summary, we remain positive on the Fund’s prospects and believe our energy chain approach to asset allocation will continue to enhance performance.

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.


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About ELCO Management, LLC
Established in 1995 and based in New York, ELCO Management ( 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.