Quarterly Report – December 31, 2011
January 31, 2012
Since inception, the Fund has posted gains in 9 out of 10 years. In 2011, performance was aided by a combination of factors, including low interest rates, high oil prices, and most importantly, timely asset allocation moves and thorough research. However, there were many challenges to overcome, i.e. a weak economy, a 47% annual decline in the price of natural gas, and the difficulties in Europe to mention some of the most obvious issues.
As noted in the October 2011 partners’ letter, we believe the outlook for energy investments continues to dramatically improve as technological developments drive unprecedented opportunities. Oil and natural gas have rarely, if ever, been so plentiful. In the United States, the significant deposits of oil and natural gas found in shale rock have the potential to transform the country into a net energy exporter. Expanding gas reserves have resulted in a dramatic increase in supply, and as a consequence, significantly lowered prices and enhanced long term visibility. This is a real “game changer” for certain industries such as the petrochemicals which can now count on competitively priced commodities, and their derivative liquids, such as ethane, butane and propane in their manufacturing processes. Until recently, it was less costly for the major petrochemical companies to manufacture abroad whereas now, more are planning for new plants and expansions in the United States thereby adding thousands of needed jobs.
The outlook for overall energy investment continues to improve. Industry sources such as the Interstate Natural Gas Association (INGAA) forecast 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. Diversified utilities and independent power producers appear well positioned to produce strong returns as electric reserve margins decline given that there has been only minimal new plant capacity added over the past decade while transmission and distribution investments requires significant expansion and upgrading.
President Obama devoted a meaningful portion of his State of the Union Address to call for a new era for American energy, which included promoting natural gas production and usage. This represents a departure from his past over-emphasis on renewables given the necessity to provide subsidies during a recovering economy and past mistakes in government funding of investments in areas such as solar energy. Noteworthy, the lower natural gas prices are driving any economics, if there were any, out of renewables. We are hearing of possible cancellations of renewable projects.
In summary, we look for a reasonably positive year for energy with oil prices at or close to $100/barrel and massive infrastructure investment needed across the sub sectors including accessing shale gas and oil, new pipelines, electric transmission to mention just a few of the opportunities. Capital is available to most companies at a reasonable cost. We continue to be highly selective in our portfolio choices with growing confidence that 2012 will turn out to be another strong earnings year. Valuations remain attractive and we have been able to purchase such high quality large cap companies such as CBI, Halliburton, Weatherford and Sunoco, as well as high dividend Master Limited Partnerships and Royalty Trusts to bolster the portfolio’s overall yield.
We continue to anticipate additional company consolidations and restructurings across the subsectors following the recent announced acquisition of El Paso Corp. and Southern Union Corp by Kinder Morgan and Energy Transfer Partners, the split up of the Williams Company into three separate entities and the recent tender offer of Thomas and Betts by ABB, all of which enhance shareholder value.
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.