Investment Solutions

Quarterly Report – December 31, 2012

January 30, 2013

While 2012 was a difficult year as energy was out of favor and underperformed the S&P, we believe that 2013 could see above average stock performance of energy if oil prices remain stable. The overall macro economic outlook is showing us signs of strengthening, marked by better economic industry data, especially in housing. Continued low interest rates and a rising stock market helped to shore up consumer and business confidence while the European Union financial problems seem to have abated.

As noted in past partner letters, it is our opinion that the outlook for energy investment continues to dramatically improve as innovational developments provide unprecedented opportunities. In fact, the energy sector has become increasingly a technology sector. Fracking is the most obvious technology change that has awakened the sector. It has been a “game changer”; but there have been other dramatic breakthroughs that have impacted the industry. A recent article in Huffington Post home mentions, in this regard, “development of oil sands, the use of solar in extraction technologies and use of biomaterials in fracking fluids.”

In the United States, as noted in the past, huge quantities of oil and gas found in shale rock is transforming the country into a net energy exporter as companies such as Chicago Bridge and Iron build LNG infrastructure to move the U.S. into liquids exportation.

In 2013, we expect to continue to seek out stocks with above average income coupled with dividend and earnings growth and strong capital expenditure programs. Master Limited Partnerships (MLPs), fall into this category and whenever possible, we like to own well positioned General Partners (GPs), with asset dropdown potential and double digit dividend growth. Examples are Williams Companies, Targa Resources, Kinder Morgan, Crosstex, and Susser Petroleum.

Although, exploration and production and drillers are commodity linked, we look to add companies that have asset positions in key strategic basins with heavy exposure to liquids, i.e. either oil or natural gas liquids (NGLs). Examples are the Bakken, Eagleford, and Marcellus/Utica. However, over the past few years, because of low prices brought on by shale drilling, we have largely avoided pure play gas companies. Oil related infrastructure and gas gathering and processing companies should continue to expand. We have raised the allocation in this group because of an improving outlook in these businesses that include pipelines, gathering, terminals, and storage to name a few. While acquisitions have long been a major driver of growth, given the rise in deal costs, we typically emphasize buying companies that offer organic growth potential.

We remain positive regarding electric generation and transmission opportunities in 2013 and beyond. Use of natural gas, which not long ago was only used as a fuel for electricity peaking because of supply limitations and price volatility, has changed dramatically. Shale drilling has significantly expanded production thereby reducing prices by about two-thirds over the past three years. As a consequence, gas fired generation, with its lower cost and less emissions, has begun to replace coal, and, more recently even some nuclear plants. Also, electric transmission lines must be expanded and better maintained. Hurricane Sandy was a vivid example of the weakness of the grid in the Northeast. We believe this sector will be a significant part of Select’s energy portfolio over the near and long term. Our major holdings include Flour, Foster Wheeler, Mastec, Quanta, and, with the proposed acquisition of Shaw, Chicago Bridge and Iron should be a major industry player.

Master Limited Partnerships, have grown significantly in investor recognition over the past few years. Valuations declined somewhat in 2012, and for the first time in twelve years, MLPs did not outperform the S&P 500 Index in total return. Lower NGL prices, tax issues associated with the fiscal cliff debate and record numbers of equity issuances were important factors. In contrast, MLPs have begun 2013 with strong stock performance. Billions in new projects add to cash flow and distributions (dividend) growth. We remain very bullish in this asset class and its heavy involvement in energy infrastructure. However, we have long recognized that the MLPs are not a homogenic group because many different businesses are involved; therefore, stock selection is particularly important. Also, we now focus more than in the past on companies with contracts that are fee based and very well hedged if they are in the oil and gas processing businesses.

In conclusion, we are excited about the future for diversified energy and strongly believe that the “time is right” for our space and appreciate your continued support. As Jack Welch, former CEO of General Electric recently commented, “This gas thing (shale) is huge. The gas that we have found is in the first inning, it is like the internet in the 1990’s”.

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.