Quarterly Report – June 30, 2011
July 15, 2011
We remain positive on the overall energy sector and the
Fund’s outlook in this year’s second half. We believe second
quarter earnings for the portfolio’s equity investments
should generally meet, or exceed, investor expectations. In
our opinion, the future looks especially bright for many sub
sectors, but we have been especially bullish on companies
that are specifically involved in energy infrastructure.
This group of industries includes oil, gas, natural gas
liquids, pipeline, energy conservation, engineering and
construction, electric transmission, renewables and
eventually, new electric generation. We envision trillions
of dollars that will have to be spent in domestic North
America markets (both United States and Canada), but also in
the global markets and we anticipate that the impact could
last decades. As an example, over the near term, pipeline
capacity in North America is tight, particularly during peak
usage periods. Electric utilities are substituting natural
gas generation for coal because of tightening environmental
regulations and more reliable visibility of supply. A recent
report by the Interstate Natural Gas Association (INGAA),
estimated that between 2011 and 2030, there will be a “need
for an average of $10.1 billion per year in midstream
infrastructure spending to connect new areas of natural gas
supply with end markets to meet the expected increase in
aggregate demand. We believe that Master Limited
Partnerships (MLPs), and their subcontractors, will be
responsible for most of this capital investment. Also
projections call for gas and oil pipelines and electric
transmission line capital requirements that will each exceed
gathering and processing over the same time frame.
The natural gas industry’s, domestic supply position, largely driven by new technology, and favorable environmental characteristics, has redrawn the fuel’s outlook and experts agree that we now have more than 100 years of recoverable reserves in the U.S. and Canada. This significant increase in supply largely reflects new production from unconventional shale and tight sands. Also, in addition to the need for gathering and processing North American investments, there will be a need for 28,900 to 61,600 miles of new natural gas pipelines through 2030, according to the INGAA study.
The electric power industry is also in the early stage of a new capital investment cycle which could exceed $1.5-1.8 trillion through 2030. Regulated electric utilities in the U.S. are now aggressively focusing on adding much needed infrastructure, particularly since the present average age of transmission and generation plant approximates 50 years. According to the Edison Electric Institute (EEI), total capital spending for the industry almost doubled from $44.7 billion in 2000 to $83 billion in 2008. Drivers include environmental requirements, transmission replacement and growth, renewables and distribution upgrades. The Fund’s holdings in the total infrastructure plays are benefiting from this major development. For example, MLPs, are portfolio’s largest sub sector, while Chicago Bridge and Iron, Halliburton, Mastec, Thomas & Betts, and MYR Group, to mention just a few of the companies that are beneficiaries.
While the Federal Reserve’s Quantitative Easing 2 (QE2) has ended, the government found a new way to increase liquidity, by releasing 30 million barrels of oil from the strategic petroleum reserve. This move, in our opinion, truly demonstrates how tight the current oil supply is and supports our bullish long term thesis. As stated in previous monthlies, a near term concern of ours was that high oil prices ($100 +) could result in demand destruction and jeopardize the economic recovery. However, relatively high oil prices should support strong second quarter earnings releases and upward earnings revisions in some of our companies. We recently increased our exposure to existing oil service positions, (Halliburton, Cameron Intl, and National Oilwell).
This emphasis on infrastructure expansion in this quarter’s report reflects our belief that it will be a major factor impacting the energy space. In our judgment, while the energy macro outlook is more positive than any other time in the past, individual micro “stock picking” remains critical, especially since volatility places more reliance on “bottoms up” analysis. We also believe that it is noteworthy that the first energy infrastructure REITs were formed in November, 2010, investment vehicles that included such financial “heavy weights” as John Hancock Life Insurance and TIAA-CREF. The group will invest up to $2.1 billion to develop and acquire electricity and gas transmission and distribution assets, primarily in Texas, the Great Plains, and in the Southwest. These were the first of their kind REITs in the electricity and gas transmission and distribution sectors. Finally, we anticipate an increasing emphasis on consolidation as reflected by the proposed mergers of Duke Energy and Progress Energy, Exelon and Constellation Energy and the bids by Energy Transfer Partners and Williams Companies for Southern Union Gas and, most recently, the acquisition of Petrohawk Energy by BHP. The Fund has positions in both Southern Union and Petrohawk Energy.
In summary, we remain optimistic about the
Fund’s prospects and believe its 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.
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.