Quarterly Report - March 31, 2004

April 23, 2004

We remain very positive about the future outlook for the energy sector.

Our optimism can be summarized as follows:

• We believe for the first time in many years a secular case for energy investment can be made. Energy commodities have the price wind at their backs and are likely to trade significantly above their old 1980-2000 trading ranges. The price of oil is at a level not seen for over a decade, and gas is not far behind. Producer cash flow should continue to increase and encourage capital spending for additional capacity. Energy investments, therefore, should outperform in this environment and generate excitement as investor confidence in the higher prices and overall outlook solidifies.

• The strengthening economy should continue to positively impact energy equities. As the economy expands, and manufacturing levels increase, natural gas, oil, coal and electricity usage expands.

• Expect energy prices to remain at above historic levels. Limited supplies of natural gas, coupled with growing demand, some of which is inelastic, should maintain a firm price structure. Canadian gas exports, which account for about 17% of the total U.S. demand, are at a peak and not expected to continue to increase. LNG (liquefied natural gas) imports will help to offset some demand, but will not become meaningful until 2007-2008, or later. U.S. oil refining capacity is very tight, while environmental restrictions limit the mining of coal.

• Energy related consolidation activity is accelerating. Encana recently announced its intention to acquire Tom Brown, a large oil and gas independent producer, at a premium valuation. This followed on the heels of Kerr McGee's offer to purchase Westport Resources. Both acquirees are major players in the prolific natural gas fields of the Rocky Mountains.

• Energy stocks have historically outperformed the overall stock market during periods of rising interest rates. Should interest rates rise, as we expect, energy stocks remain one of the best groups to own. A study of 11 tightening periods since 1954, places the sector as the second best performer of all S&P 500 industry groups six months after the first Federal Reserve tightening and the top performer three months after the first rate rise.

• The North American natural gas supply position is deteriorating. Over the past several years, through 2003, production declined 2% to 3% annually, while monthly average natural gas prices have been rising with each peak higher than the previous one since 1990. Upward pressure on prices also reflects 170,000 megawatts of new gas fueled electric generating capacity over the 2001-2004 period.

• A Perfect Storm? Conditions in the West and East Coasts are such that there appears very little extra electricity reserves margin if the summer weather turns very hot for prolonged periods. Higher natural gas and power prices are expected in this eventuality. Upward price spikes can serve as a catalyst to bolster energy and merchant power stocks.

• Under-investment in energy stocks. The sector accounts for only about 6% of the S&P 500 Index compared to as high as 27% in the past. Given the strengthening outlook, and relative attractive valuations, investment in the sector is expanding.

In summary, we are bullish on the outlook for energy related securities. The sector is already gaining increased media focus and investor interest. It is also encouraging that “smart money” investors including KKR, Warren Buffet, Lazard Freres and Blackstone are interested in the sector, and more recently Carlyle Group and Riverstone Holdings raised over $1 billion in this space.

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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.