Quarterly Report – September 30, 2005

October 28, 2005

Energy has been the best performing sector in the stock market in 2005 and was strong in 2003 and 2004. In fact, a recent Wall Street Journal article pointed out that only three industry sectors out of 100 were up through the first nine months of 2005, including energy.

While periodic stock corrections can be expected given the energy sector’s past market leadership, we continue to be positive regarding the longer term outlook. Our emphasis continues to be placed on natural gas, a North American based fuel, which is not subject to the kind of volatility associated with geo-political events.

In our opinion, there is a strong case to be made for taking a longer-term bullish position on energy. The U.S. economy is less vulnerable to the threat of “demand destruction” from high oil and gas prices because it takes about 50% less energy to impact GDP than 25-30 years ago. We expect overall industry gas production to trend flat-to-down over the foreseeable future and continue to focus on the entire “energy chain”. Our belief is that the strong cash flow that is being generated should result in increased capital spending, stock buy backs and higher dividends.

While energy stocks have experienced a “good run”, we are encouraged that as the winter heating season draws closer that there are a number of developments that should have a positive impact on the sector.  Supplies of both distillate (heating oil), and natural gas, continue to be tight which should keep prices firm. Also energy is experiencing the best record of positive company earnings revisions of any sector of the market. Importantly, current “street” consensus EPS estimates are believed to still reflect roughly $45 per barrel oil and $6 per mcf gas, compared with about $60 and $9 per mcf gas in the futures market. The ability of producers to more efficiently hedge production, and the expanding use of longer-term contracts, is enhancing the group’s cash flow and earnings transparency and visibility.

During the quarter, we selectively reduced our exposure in some of the E&P and oil service issues given their strong performances following the two hurricanes. However, given our bullish outlook for the sector over the longer term, we plan to continue to add to positions on any meaningful company stock corrections. Our emphasis is on E&P companies involved in unconventional natural gas exploration such as the Piceance Basin in the Rocky Mountains and the Barnett Shale in Forth Worth, Texas. This is because longstanding conventional basins in North America have matured i.e. for example the Gulf of Mexico outer continental shelf currently supplies only about 15% of total U.S. gas production, down from 25% a decade ago. Unconventional plays such as coal seam methane are becoming an increasingly important supply source.

Master Limited Partnerships and selected utilities have been core holdings in the Fund’s portfolio since inception and have enhanced the performance significantly. Our strategy with respect to electric utilities has been to invest in companies whose power plants are largely fueled by lower cost coal and/or nuclear, are generally non regulated, but where the electricity selling price is set more by higher priced gas. Examples are Dominion Resources, Exelon, Edison International and NRG Corporation.

We remain positive on the outlook for MLPs, a major beneficiary in the buildup of energy related infrastructure.  While rising interest rates have been a concern, the stocks have outperformed the S&P 500. While we continue to be bullish on this group, we are most heavily invested in companies that should be able to deliver above average distribution (dividend) growth, which should more than offset the impact of higher interest rates.

In summary, we remain optimistic on the longer-term outlook for energy investment, but recognize that oil and gas prices could decline over the near-term as the impact of the two hurricanes ease further. Importantly, we are anxious to take advantage of any pullbacks to invest in selected companies as valuations become more attractive recognizing that the winter heating season has not yet begun.

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.