Quarterly Report – September 30, 2004

October 22, 2004

We continue to be positive on the outlook for energy-related investments especially those in the oil and gas exploration and production and oil service and drilling sectors. With oil and gas supplies tight as we move into the winter heating season, investors have been “warming” up to the energy stocks although the sector still accounts for less than 7% of the S & P’s 500 Index’s market capitalization while delivering roughly 20% of the earnings. Furthermore, individual company valuations appear to reflect oil and gas prices of roughly $28-$30 per barrel and $4.50 per mcf, which is a significant discount from current levels. In contrast, there is a growing consensus that oil prices will remain higher than $40 into 2005 and $30 per barrel in 2006. Therefore, assuming that the strong commodity market is maintained, we believe this sector should continue to offer above average capital appreciation potential.

While there is obvious speculation built into a $50.00 per barrel oil price related to such factors as terrorism and hedge funds becoming increasingly involved in the trading of oil, the big surprise that most forecasters missed is the extraordinary strength in energy demand which is attributable largely to Asia, and in particular, China and India. Specifically, China’s consumption of crude oil in August, 2004 alone increased by 37% year over year reaching 6.4 million barrels per day. Assuming 5% growth annually, which is probably conservative, China’s demand could reach 8 million barrels per day by 2010, 1.2 million barrels per day over estimates made by the International Energy Association in 2002. It is significant that on October 7th, Energy Secretary Spencer Abraham stated the federal government had done “everything” it can to moderate crude oil prices, which has climbed from $10 per barrel in the 1990’s to over $50 in 2004.

The forecast for natural gas similarly is for higher prices as the consensus long term normalized forecast has risen to around $5.00/Mmbtu from a range of $3.00 to $4.00. Realizations for November and December currently exceed $7.00 and $8.00, respectively, even through storage levels going into the winter are above last year and above the five year average. Although the number of rigs drilling for gas are at an all time high, new reserves and production have actually been declining. Given the strong commodity pricing, and the ability of companies to lock in high prices through hedging, we expect very positive absolute and relative earnings and cash flow reports for the third and fourth quarters of 2004. Additionally, the profit outlooks for 2005 and 2006 are encouraging reflecting a positive longer-term supply/demand macro environment. This is expected to allow management to continue to pay down debt, buy back stock, increase cash dividends and make acquisitions on terms that add to shareholder value.

The Fund’s performance has been aided by investments in energy Master Limited Partnerships (MLPs). These tax-advantaged equities are gaining favor with income and value oriented investors. Offering dividend yields as high as 7-9%, this relatively new investment class has delivered an average total pre-tax return of 14.1% in the first nine months of 2004, and 12.7% in the third quarter.

As noted regularly in the past, our investments include the entire energy chain, which provides diversification and reduces risk. As such, there are companies in the portfolio that are more sensitive to the general stock market and therefore, the S & P 500 Index rather than the “pure play” natural resource and utility sector indices. We believe that this broader approach, as compared to a narrower sector type investing style, has contributed to our record of outperforming the indices.

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 (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.