Quarterly Report – September 30, 2007

October 10, 2007
In our last letter to partners we indicated that oil prices of $80 a barrel was a distinct possibility. On September 21, 2007, oil hit a high of $83.42 and currently trades around $80. However, we believe that the outlook for oil and gas continues to be very positive given the history of modest industry investment and record prices. For example, many of the companies that we follow confirm our belief that the oil industry is still in the early stages of current upstream exploration and production cycle. In contrast to past cycles, demand is largely being driven by developing countries, particularly China and India. Therefore, on the assumption that the oil price over the next few years does not decline below $40 – 50 a barrel, capital spending on infrastructure should continue to be robust. The fund holdings that should benefit from this incremental spending include: Chicago Bridge and Iron, North American Energy Partners and Willbros Group.

We have also recognized for some time that capital expenditures must increase to bolster electric power generation and long neglected transmission and distribution (T&D). The highly publicized decision by TXU to cancel 8 coal fueled power plants in Texas, and the rejection of fossil fueled plants in states such as Florida and Oklahoma are indications of the political difficulties in adding much needed capacity over the next few years. Gaining approval for new sites is becoming exceedingly difficult. Therefore, we foresee a need for significant new electric power construction.

The Fund’s portfolio has benefited from a theme of energy infrastructure growth, not only in oil and gas, but also in electric power. The Energy Policy Act of 2005 gives the Federal Energy Regulatory Commission (FERC) authority over electric transmission siteing, construction, and rates charged. With incentives that are similar to the treatment of interstate gas and oil pipelines, forecasts of capital expenditures have dramatically increased. The Edison Electric Institute projects transmission expenditures will jump from $5.8 billion in 2005 to $8.3 billion in 2009, and we estimate at least 15% growth per annum thereafter. In our judgment these projections are likely to prove to be conservative. There are currently over 700 transmission projects proposed across the U.S. covering roughly 24,000 miles and more are announced almost daily. A recent joint venture between the largest electric utility, American Electric Power, and Berkshire Hathaway, calls for 1000 miles and $3 billion to be spent on T&D in Texas over the next 8 years. The Fund has been an aggressive early player on this theme through investments in companies such as ABB, Emerson, Quantas Services, Shaw Group, and Thomas and Betts.

We are also bullish on the outlook for renewable power, which is attracting billions of dollars of new investment. Unlike traditional energy infrastructure, renewables are typically more speculative and require government subsidies to exist. However, there are exceptions, i.e. Zoltek and MEMC Electronics, which are important Fund holdings, and are currently profitable with significant participation in wind and solar energy.

The Fund’s strategy of investing in the entire energy chain paid off in the third quarter. Largely reflecting the impact from investor credit and capital concerns following the subprime mortgage problems, Energy Master Limited Partnerships, as measured by the Wachovia MLP Index, declined 13.06% between July 20th and August 6th. In our opinion, the group’s overall very positive fundamentals, high yields, and “street” consensus forecasts of average total returns of around 15% per annum, did not warrant the sell off. We attribute it to technical forced liquidation of institutional portfolio holdings, including MLPs. We believe this created a unique buying opportunity that should aid overall future performance. Once again, our diversification approach to the energy space enabled the Fund to deliver a positive total return in the third quarter.

As we move into the fourth quarter of 2007, we are maintaining a net long bias of about 75%. Our portfolio approach is based on a long held belief that the current energy cycle will be of long duration and more demand driven than in past years. In summary, as value investors, we take advantage of equity pullbacks and utilize all available tools to reduce volatility.

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.