Quarterly Report – September 30, 2011
October 21, 2011
The outlook for energy investment continues to brighten dramatically as technological developments are presenting unprecedented opportunities. An October 18, 2011 Wall Street Journal article had the following headline: "It's official: Age of Shale Has Arrived. It is rocking the U.S. energy industry to its core. The technique of cracking open shale rock to release oil and natural gas has surpassed hundreds of billions of dollars worth of deals and has delivered enormous profits and revenues to those in its midst. Shale discoveries have reinvigorated U.S. oil and gas production that just a half dozen years ago was widely seen as in terminal decline".
Dramatically, increasing oil and low cost natural gas shale supplies are becoming significant drivers for job creation and energy independence. This is reflected by the decision by major companies such as Exxon to expand operations in the U.S. for the first time in years as reflected by the acquisition of XTO, one of the largest domestic gas producers. James Mulva, Chairman and CEO of Conoco Phillips made the following comments in a speech before the Detroit Economic Club: "not only does the U.S. have an abundant supply of natural gas, but it is environmentally friendly and inexpensive, with the potential to create hundreds and thousands of jobs".
The Fund has been an early investor in the beneficiaries of shale technology across many sectors of the energy chain. One of the largest asset allocations, namely the Master Limited Partnerships (MLPs) are heavily involved in building and operating the necessary infrastructure to move the incremental production from the well head to end markets. The Interstate Natural Gas Association (INGAA) indicated in a recent commissioned study that about $205 billion in new infrastructure will be needed over the next 25 years to process, store, compress and transport increased gas supplies coming largely from shale plays. The study projects shale production increasing 308% over the period. In our opinion, this could prove to be a conservative prediction given recent major discoveries such as the Utica formation in Ohio. The associated incremental necessary transmission pipelines are forecasted to total 36,000 miles.
In summary, we remain very positive on the overall energy space and strongly believe that it should be a core allocation in every portfolio. Third quarter earnings are being reported at or above expectations.
While we were writing this quarterly letter, Kinder Morgan announced the acquisition of El Paso Corporation. The price to be paid represents a significant premium over the stock's prior day's close as well as the valuation of its pipeline assets. This follows closely the offer of Energy Transfer Partners for Southern Union Corporation. Both of the companies to be taken over are in the Fund while El Paso, specifically, is one of its largest positions. To date, there have been five M&A deals that involve stocks the Fund holds, or has held, in its portfolio that are benefitting from the tremendous growth taking place in shale production. At a minimum, we believe that the valuations paid for energy related assets will continue to positively impact the Fund's performance.
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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.