Quarterly Report – May, 2005

May, 2005

As noted in prior communications, we believe this energy cycle will be long and more demand driven than in the past. While there is increasing concern that excess world oil capacity is shrinking, the most significant change since the last major price spike of the 1970s is the phenomenon of China and India absorbing most, if not all, incremental production. For example in 2004, China 's oil consumption grew by almost 740,000 bbls/d to roughly 6.3 million bbls/d in incremental global demand and 16% above 2003.

First quarter 2005 earnings should be strong for most energy stocks since oil and gas prices have been higher than expected and rising day rates are driving oil field service profits. Although short-term interest rates increased during the period, utility shares and Master Limited Partnerships have performed well (+5.42% and roughly 1.00% as reported by the Wachovia MLP Composite Median), respectively, as managements generated significant cash flow, which, in many instances, were used to raise dividends and repurchase their common shares.

While crude oil prices have backed off from the recent high of $58 per barrel, the oil and gas businesses are, in our opinion, in a long-term positive cycle. There has been some recent concerns of excessive bullishness, such as the Goldman Sachs forecast of oil reaching $80-$105 a barrel over the next few years. Although possible, the media was quick to point out that such “over the top” type predictions heralded the end of the “dot com”/technology driven bull market. Bottom line, we believe the pullback is healthy and should present attractive equity buying opportunities.

Outlook

We remain positive on the outlook for energy investment. Reasons include the following:

a) Tightening Supply/Demand Outlook

While OPEC members plan on increasing capacity by about 1.0 million barrels per day, industry sources have indicated that worldwide demand is likely to expand by as much as 1.6 million barrels per day as electric generation and manufacturing consumption of oil, particularly in China , continues to rise dramatically. Therefore, the market is focusing beyond current higher than average inventory levels. Tightening supply/demand of natural gas in North America is also a major concern that is currently being addressed by Liquefied Natural Gas (LNG) projects. However, LNG is not expected to have a meaningful impact on supply before 2008-2010.

b) Rising Oil and Gas Capital Expenditures

The capital discipline shown by the oil service industry is virtually unprecedented in its history. Currently, following years of restrained capital expenditures by the exploration and production companies, a combination of higher commodity prices and reduced available capacity, is expected to result in at least a 10% increase in spending for drilling equipment and services in 2005. With rig availability extremely tight, day rates are increasing dramatically with demand beginning to outstrip supply. In contrast to past energy cycles, demand is becoming inelastic as prices increase. For example, day rates for shallow and deepwater offshore rigs are near or have exceeded the previous peak. Therefore, in our judgment, we are entering a multi-year period of increasing returns on capital by the oil service and drilling industries.

• Equity Valuations Still Attractive

Cash flow multiples for E&P stocks are less than 5 times for large cap and 4 times for mid and small cap, which is about 10% below historical average multiples, reflecting the strength and sustainability of energy prices. With consensus commodity price projections still lagging forward markets, we believe there is considerable upside potential in this sector of the energy chain. We also believe similar conditions exists in the oil service and drilling segments.

d) Master Limited Partnership Investments Continue to Offer Attractive Returns

While the ten-year treasury yield increased through the first quarter, selected MLPs should be able to produce total returns that are competitive and can average and/or exceed 8-10% when unit distribution growth is factored in.

Overall, we believe that for the first time in many years a longer-term case for energy investment can be made. The current cycle is unlike any others in that demand growth for oil and gas is outstripping incremental supply, a trend that is expected to continue over the foreseeable future. Our emphasis on the total energy chain provides diversification, a risk management tool, and wider exposure to investment opportunities.

Forward Looking Statements. Certain of the statements included above, including those regarding financial performance or results that are not historical facts, contain “forward-looking” information as that term is defined in the Securities Exchange Act of 1934, as amended. The words “believe”, “should”, “should be”, “in our opinion”, “indicated”, “likely”, “is expected”, “in our judgment”, “we believe” and similar expressions are intended to identify forward-looking statements. We caution readers that any such statements are not guarantees of future performance or events and that such statements involve risks, uncertainties and assumptions, including but not limited to industry conditions, general economic conditions, interest rates, competition, ability of companies in these industries to successfully manage their growth, and other economic factors discussed in this report. Should one or more of these risks or uncertainties materialize or should the underlying assumptions prove incorrect, actual results and outcomes may differ materially from those indicated in the forward-looking statements. Although we believe that the assumptions and estimates reflected in such forward-looking statements are reasonable, we cannot guarantee that our expectations will be achieved.

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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.