PGS Global Energy Edge

The Investment Opportunity in The Global Restructuring of The Energy and Natural Resources Sector through

a multi-Strategy Value Focused Fund of Hedge Funds

Introduction

PGS Global Energy Edge is designed to capitalize on the structural issues in the energy and natural resources (including hard commodities) markets, including rising volatility and a significant supply/demand imbalance driven by increasing global demand, limited current and foreseeable supply, market fragmentation, political and event risk, and strong industry pricing power. This increasing market volatility and growing supply/demand imbalance is being driven in part by world GDP and population growth, particularly in emerging markets. Growing demand for world energy and natural resource supplies will drive long-term sector growth in both first and second derivative industries throughout the energy and natural resources sectors. China and India’s populations alone are forecasted to increase by 149 million people by 2010 and, along with other non-OECD countries, will continue to demand increasing amounts of energy and natural resources to fuel their economic growth and meet subsequent increasing power demands. Taken together, these factors along with market inefficiencies and industry consolidation should create excellent opportunities over the next decade for skilled hedge fund managers focused on this sector.

Structural Imbalances – Metals & Mining

Copper

In 2004, world mine production of copper rose by about 6.6% with just two countries, Chile and Peru, accounting for almost two-thirds of that gain. However, according to the Copper Study Group1, world refined copper production grew by only 560,000 tons (3.7%) last year, while world use grew by almost 900,000 tons (5.7%). As a result, the production deficit almost doubled from 385,000 tons in 2003 to 716,000 tons in 20042, with most of the increased demand originating in the U.S., Japan, and China. In fact, China is now the largest global consumer of copper with demand set to increase 8-10% annually to 6 million tons by 2010.3 Although world demand has slowed thus far in 2005, production deficits have continued. Despite increased production of 4% from a year ago, the International Copper Study Group estimates that world copper demand exceeded production by 59,000 tons in Q1 20054 and according to BCA Research the recent price rally "is consistent with the ongoing drawdown in copper inventories, which are now negligible."5 Although Chile, the world’s largest producer, is expected to increase output by 2% this year, the supply-side backdrop remains favorable for copper prices, which are up 15.5% thus far in 2005.6

Zinc

Zinc has trended sharply upwards since 2002, when it reached its lowest level in 15 years, due in large part to industry consolidation. In addition, smaller industry players that were unable to absorb the financial burden of lower prices were either forced to close down less profitable mines or halt production altogether. Larger mining companies, such as Anglo American, which were able to capitalize on economies of scale and produce at lower per ton costs were left in better competitive positions as the price of zinc recovered throughout 2003 and 2004. Zinc is used to coat steel to prevent rust and, like copper, has also benefited from strong Chinese demand. Zinc prices soared to a seven-year high of $1,279.80 on the LME in January as China’s demand for galvanized steel grew faster than supply. Companies such as Zhuzhou Smelter Group, China’s largest zinc producer, announced they were forced to cut production by up to a third due to power shortages. These shortages became severe enough that the country, which produces about 25% of the world’s supply of refined zinc, became a net importer of the metal in 2004 after having been a net exporter in 2003. Imports surged 48% to 459, 237 tons of zinc and alloy in 2004 while exports fell 46% to 263,149 tons. Furthermore, Chinese demand should be underpinned this year by double-digit car growth in vehicle and appliance manufacturing. According to Robin Bhar, a metals analyst at Standard Bank London Ltd., world output of refined zinc will lag demand by 180,000 tons in 2005, growing to a global deficit of 205,000 tons in 2006.

Gold

Gold prices ended a 22-year bear market in February of 2001 when spot prices eventually hit 255.85. Since then, there has been a flurry of consolidation within the mining industry that will likely prevent gold prices from returning to those levels. In 2001, Barrick Gold bought Homesake Mining for $2.3 billion, becoming the world’s third largest gold producer. Then, in early 2002, Newmont Mining purchased Normandy Mining of Australia for $4.56 billion in cash and stock becoming the world’s largest gold producer.8 Later in August of 2003, South Africa’s AngloGold Ltd. bought Ashanti Goldfields. The advent of consolidation within the mining industry should ultimately lead to more disciplined production creating the foundation for continued higher prices, despite central bank sales and the IMF utilizing its reserves to relieve LCD debt. Likewise, strong physical demand, particularly from Asia, should provide continued support to global prices. In fact, end user consumption increased 32% year-over-year during Q1, 2005. These structural issues seem to be born out as the price of gold has trended strongly upwards since its nadir in 2001 to a current price of 426, an increase of 67%. Notwithstanding these structural themes within the mining industry, volatility in the gold markets should continue, creating excellent trading opportunities for nimble traders as the Euro, Dollar and Yen continue to oscillate against each other.

PGMs

Unlike gold, the platinum group metals are involved in many industrial applications. For example, platinum, palladium, and rhodium are all used in autocatalyts to control vehicle emissions. Platinum is also used in myriad chemical processes acting as a catalyst for producing nitric acid, silicones, power generation in fuel cells and the refinement of gasoline. The PGMs also have many useful applications in the electronics industry and are integral in the fabrication of computer hard disks, electronic components and even crucibles used to grow single crystals. This greater contribution to industrial processes and output, make the PGMs highly coupled to the global economic cycle. Although jewelry demand for platinum is more price elastic than industrial demand, total demand for PGMs should remain robust as countries such as China, India and Southeast Asia continue to ramp up their manufacturing in autos, electronics and heavy industry. For example, overall industrial demand for platinum grew by a substantial 11 percent to 1.53 million oz. in 2004 as the use of the metal in the glass industry, hard disks and chemical catalysts increased while the purchases of platinum for use in catalysts increased to a record last year as a result of higher demand from the light duty diesel sector in Europe.9

Structural Imbalances In Energy

Oil

In the oil market, both limited supply and increasing demand act as dual drivers of the market disequilibrium. As the world’s growing population attempts to allocate limited resources, the gap between supply and demand will continue to widen. The International Energy Agency (IEA) projects global oil demand will increase 2.4% to 84.44m b/d in 2005, while non-OPEC oil supply is expected to grow 1.4% to 50.74m b/d, resulting in a call on OPEC production of 34.07m b/d, a 3.37% increase from 2004. In the natural gas market, Global Insight projects US demand for natural gas will actually decrease 1.8% to 21.84 trillion cubic feet (Tcf) in 2005, but will then rise 4% to 22.72 Tcf in 2006. US natural gas supply is projected to decline 1.2% to 18.51 Tcf in 2005.10

Supply

In 2004, global oil supply was 83.02m b/d, and the IEA adjusted its non-OPEC supply estimates downward, reflecting delays and unscheduled outages in production that have caused output declines in recent months.11 Since 1976, no new refineries have been constructed in the United States, and according to ConocoPhilips, no new ones are in production or planned. Although capacity is expected to increase through 2050, due mostly to efficiency increases of existing plants, this capacity will not be able to keep up with demand. As a result, U.S. gasoline imports and other finished oil products are expected to rise from 10% to 20% of total supply. Importing more energy will put increasing pressure on exporting countries to produce.

Additionally, new environmental laws in the United States require lower SO2 emission levels. Now, U.S. refineries are spending more money on research in an attempt to find lower emission solutions, money that will not be spent on increasing efficiency of existing plants.

The rising demand and strains on production and refining capacity amongst non-OPEC suppliers will only increase reliance on OPEC. In response to the historically high crude oil prices of $60 a barrel reached in June, OPEC decided to raise its production quota by 500,000 b/d, with the possibility of increasing production another 500,000 b/d in September 2005. The world’s increasing reliance on OPEC, however, results in greater pricing power for the cartel and increased volatility in the markets. Furthermore, OPEC’s limited spare oil production capacity was cut by more than half in 2003 and 2004 from approximately $4m b/d to only $1.4m b/d, signifying that the world’s increasing demand may outpace OPEC’s ability to produce.12 According to data from the US Energy Information Agency, ("EAI") there will be over 100 million barrels of oil energy equivalent deficit per year until 2025.

In natural gas, US production has experienced a downward trend and projected declines can be attributed to drops in production in Texas and the Gulf of Mexico. The EIA expects liquefied natural gas (LNG) imports to rise from 1.8 Bcf/d to 2.4 Bcf/d in 2005, but supply will remain constrained.

World Demand

Over the period 1993 through 2002, the demand for energy products has increased 16.5% globally,13 and analysts predict this trend to continue into much of the 21st century. According to the US Energy Information Administration, we should see a worldwide average annual increase in demand of 1.9% through the year 2025. Investments of $16 trillion will be needed to support this growth.

China

China’s demand for oil and gas is set to rise dramatically over the next two decades while its prospects for developing additional supply are limited. This growing imbalance will mean that China will become increasingly dependent on imports to satisfy its growing oil and gas requirements. China’s discomfort with its needs versus its own supplies is evidenced by the government’s purchase of companies rich with natural resources in Canada, and more recently its bid for Unocal.

China’s bourgeoning energy demand is the direct result of spectacular economic growth. From 1985 through 1995, the country’s average GDP growth rate was 9.5% per year. Although that growth rate should moderate somewhat, the World Bank is still predicting China’s growth will continue to increase at a robust 6.6% annual rate through 2020. That has already translated into a doubling of energy consumption, rising from 18 quadrillion Btu in 1980 to 37.1 quadrillion Btu in 1996. This figure is expected to rise to 98.3 quadrillion Btu by 2020, a level fast approaching that of the United States.14

China is now the second largest consumer of oil behind the United States, and has accounted for roughly 40% of world oil demand growth over the past four years. The Energy Information Agency estimates that China consumed 5.56mb/d in 2003 and is expected to soak up 6.24 mb/d in 2005.

By 2025, that figure is projected to grow to 12.8 mb/d, led in part by the need to curtail severe power shortages and to keep pace with double digit car sales. With up to 100 million cars on the road by 2020, fuel demand for the transport sector alone could rise to 260 million tons, equivalent to the country’s total 2003 oil consumption. However, with 22 percent of the world’s population and only 2.3% of the world’s proven reserves, China’s oil supply is grossly inadequate. The imbalance is worsening due to the fact that the major oil fields in the eastern part of the country, which account for 90% of the nation’s production, have already peaked and are now in decline.15 As China’s oil production is projected to remain steady at 3.4 mb/d for the next two decades, it will eventually become a net importer of 9.4 mb/d in 2025, up from roughly 2.1 mb/d today.

Government authorities in China are attempting to limit the nation’s oil appetite to 20% of total energy consumption, led in part by a concerted effort to develop natural gas demand and production. As a result, natural gas consumption is expected to grow 11.7% annually from 1 trillion cubic feet in 2001 to 9.5 trillion cubic feet in 2020. This represents growth from a current level of 3% of the country’s energy mix to 11% by 2020. To meet this demand, the government is rapidly growing the necessary natural gas infrastructure so that gas-fired plants can be utilized to generate electricity and meet environmental objectives. The government is also rapidly increasing the nation’s import capacity by developing the necessary distribution system. Massive pipeline projects currently underway by PetroChina and CNOOC will increase the country’s access to eastern Russian fields as well as the South China Sea. Nevertheless, the country’s supply of natural gas is even more precarious than its supply of oil. Its proven reserves were estimated at 53.3 trillion cubic feet in 2002, representing a meager 0.8% of the world’s total. Furthermore, increased exploration and production will only lift supply from 1.57 trillion cubic feet in 2002 to a projected 3.8 trillion cubic feet in 2020, far below the 9.5 trillion cubic feet that will be consumed.

This increased reliance on natural gas is responsible for the predicted drop in the use of coal from 75% of total energy consumption in 1996 to 65% in 2020.16 In fact, the government is reducing Beijing’s dependence on coal by bringing the city’s natural gas infrastructure to full operational capacity by 2008 as part of a $12 billion dollar program to clean up the city before the Olympic games. In addition, Shanghai province has stopped construction of coal-fired generation facilities in anticipation of being included in the natural gas transportation system. Nevertheless, coal will remain the primary source of energy for China’s industrial sector and is projected to grow 4.1 percent a year, from 10.7 quadrillion Btu in 2001 to 28.2 quadrillion Btu in 2025.

India

Energy consumption in India is projected to grow by the second fastest rate during the next 25 years, second only to China. The IEA predicts that oil demand in India will increase from 2.39 m barrels per day in 2002 to 5.4 m b/d by 2030, with more than 90% to be supplied by imports. Demand for gas in India is expected to increase 500% to 110 billion cubic meters by 2030. 17 India’s oil and gas reserves are being rapidly depleted, and will last only between 24 to 35 years at the current level of production.18 The result is a need for substantial investment in oil and gas infrastructure such as refineries, storage, and port facilities, as well as pipelines to import gas. In January 2005, India signed a $40 billion deal to import liquefied natural gas (LNG) from Iran, and is currently negotiating with Bangladesh and Burma for the construction of pipelines to import gas.

India has seen an 8% increase in industrial growth in the past 2 years and has yet to construct new power plants to keep up with the growing demand. As of now, India has a peak shortage of power of about 10,000 MW and is 40,000 million units energy deficient. In response, the Indian government plans to add additional capacity of 100,000 MW by the year 2012 costing an estimated $8 trillion. This capacity will include power generation equipment as well as the distribution networks required to transfer the energy.19

An additional consumption factor to India’s power supply problem is the enormous inefficiency in their energy network. They lose 40% of power during transmission and distribution as compared to 6% to 7% for the rest of the world. This means that either India will need to create plants capable of generating much more power than is needed to account for this loss or they will have to make heavy investments into copper cabling and other energy-efficient means of transmitting energy.

Emerging Markets

As we enter the next century, major developments are expected from many parts of the globe that until recently have economically lagged behind the industrialized world. By 2025, it is expected that the developing world of today will make up about 28% of the world’s GDP. Additionally, as today’s industrialized world becomes more service oriented and industry moves to the developing world, energy usage in the developing world is expected to increase faster its GDP. By 2025, 43% of all the energy consumed will be in today’s developing countries. We can expect to see overall energy consumption growth between 2001 and 2025 to be around 2.7% per year in comparison to 1.2% per year in the industrialized nations.

Pricing Inefficiencies

Energy stocks have recently experienced tremendous price growth, due in large part to historically high oil prices. Through June 24th 2005 YTD, the S&P’s Energy Sector Index has posted the strongest price advance of the 10 sectors comprising the S&P500, a 20.1% increase versus a 1.7% decline for the market.20 Over the past 12 months, the energy sector has returned 43.6%.21 Below is a chart of the Energy Index’s relative strength versus the market.22

Despite soaring returns that have left some investors uncertain whether energy securities can continue to rise, the case for investing in the sector remains extremely compelling. The current P/E on the S&P Integrated Oil & Gas Composite is 16.0 versus the S&P 500 P/E of 23.6, indicating these securities may be under-priced.23 Furthermore, Energy is a $2 trillion commodity market today and a $4 trillion physical market. Most commodities trade at 6 to 20 times the physical market.24 These pricing inefficiencies provide tremendous earnings opportunities for experienced hedge fund managers.

Second Derivative Investment Opportunities

The trends in the energy industry will continue to have profound trickle down effects on other related industries, which should also yield valuable investment opportunities for investors able to evaluate these companies. The bulk chemicals industry, for example, is one of the three largest consumers of energy for heat and power in the industrial sector. As oil and natural gas prices have increased, so have the input costs to the bulk chemical industry. In addition, the paper and pulp industry accounts for approximately 12% of total manufacturing energy use in the United States today, and this industry is projected to grow at 0.6% per year through 2040, resulting in increased energy usage. Finally, petroleum refining is one of the top three energy intensive industries in the US, and energy use for refineries is growing faster than any other industrial sector at 1.7% per year, which is expected to continue through 2025. As energy prices increase, it will cost more money for refineries to produce an end product.

Most segments of the transportation industry will also be profoundly affected by changes in the energy market. In 2002, the transportation sector accounted for about 68% of the total petroleum use in the United States. As prices are expected to climb over the next 20 years, predictions are that many Americans will opt for more economical vehicles, such as hybrids. In the airline industry, high fuel prices continue to be the main hindrance on airlines’ bottom line. The direction fuel prices take will largely dictate the future of this industry. The changes in these energy-related industries will create a wealth of investment opportunities for savvy investors. Even the retail sector could be affected, as rising energy costs will significantly impact disposable income.

Fixed Income Alternative

As investors’ appetite for yield continues and the direction of short- and long-term interest rates continues to confound both individual and institutional investors, quality investments in the energy and utility sectors delivering attractive income and the potential for capital appreciation, should provide attractive alternatives for yield-hungry investors. Energy and utility securities have historically paid higher dividends, and adept energy hedge funds should able to provide investors with income enhancement through the purchase of Royalty and Income Trusts as well as Master Limited Partnerships.

Industry Consolidation

Mergers and acquisitions have become an increasing trend in the U.S. electric power industry. Since 1992 and the National Energy Policy Act (NEPA), these companies have moved closer towards deregulation, and as a result have unlocked tremendous value through M&A activity. Additionally, many electric power companies have focused on diversifying their core businesses through the acquisition of gas utility companies. For example, the period between 1997 and 2000 witnessed several high profile deals in which electric and natural gas utilities combined their operations such as Dominion Resources and Consolidated Natural Gas Co., Duke Power and PanEnergy, Houston Industries and NorAm Energy, Texas Utilities and Ensearch, and Portland General and Enron Corp. Since then, there have been numerous additional mergers such as Wisconsin Energy Corp. and WICOR Inc., Delmarva Power & Light and Atlantic Energy, LG&E Energy and KU Energy, Long Island Lighting and KeySpan Energy, and Enova Corp. and Pacific Enterprises Inc.25 More recently, Duke announced the acquisition of Cinergy in a $9.1 billon deal, resulting in one of the nation’s largest power providers. This news comes on the tail of the announcement of the Exelon and PSEG $12 billion merger in December 2004.

However, recent M&A activity is not solely the result of companies vying for greater geographical coverage, it is also the result unlocking value through increased synergies and greater economies of scale. An indication of the opportunities in the energy sector is evidenced by Warren Buffet, who recently made his first acquisition in the past several years with the purchase of Pacificorp. Buffet has said he would be willing to invest more than $15 billion into utility companies and stated that "the energy field is the single most likely area in which Berkshire – through MidAmerican – can find places to put significant capital" to work. Mr. Buffet has said publicly he expects Berkshire to make power-related acquisitions for another 10 to 20 years. According to Standard and Poor’s, this type of M&A activity in the utility industry is set to continue as companies push to consolidate and gain access to larger regional markets. Additionally, the long awaited Energy Bill is expected to repeal the 1935 Public Utility Holding Company Act (PUHCA), which has thus far stifled M&A activity in the U.S. utility industry. Mr. Buffet and others believe the law will eventually be repealed allowing the industry to consolidate more quickly, remain competitive, and pave the way for considerable consolidation in a fragmented industry.

Mergers and acquisitions have by no means been specific to the utility industry. Consolidation has also been prevalent in the petroleum sector as evidenced by deals such as the merger between Whiting Petroleum Corporation and Equity Oil and the acquisition of Nuevo Energy by Plains Exploration and Production Co. Other high profile deals in 2004 included the joint venture between Halliburton Energy Services and Shell Technology Ventures "in an effort to more closely align the ventures with near-term priorities in the core businesses of the venture owners."26 This trend in consolidation is the result of the large integrated oil companies rationalizing the increasing costs of exploration and production through acquisitions rather than directly incurring the escalating expenses of new development projects. The economics of the industry will likely dictate that this trend continues into the foreseeable future as evidenced by the current bidding war between CNOOC’s $18.5 billion offer and ChevronTexaco’s $16.5 billion bid for Unocal.

Proliferation of Energy Hedge Funds

The energy sector has come into full focus as the prices for oil, natural gas and coal have not only risen, but also become increasingly volatile creating significant investment opportunities. Investors are scrambling to capitalize as evidenced by the enormous capital inflows into energy-focused mutual funds and ETFs. There has also been an emergence of numerous hedge funds, as former energy traders launch new start-ups and existing hedge funds capitalize on the new environment by hiring small trading teams to complement their existing product offerings. According to UtiliPoint International, by the end of 2004 there were at least 330 energy hedge funds in the U.S. and Europe trading both commodities and equities as well as the arbitrage between both. Hedge fund product offerings are also becoming increasingly sophisticated as managers branch out into smaller, more highly specialized markets, which trade SO2, NOX, renewable energy credits (RECs), carbon dioxide and even water. Furthermore, the wave of new start-ups has continued unabated into 2005 with new energy hedge funds launching on a weekly basis. UtiliPoint International conservatively estimates that by year-end, the total number of energy and natural resource hedge funds will have grown to well over 600.

The Need For An Expert

This bourgeoning alternatives market necessitates relying on an expert fund-of-hedge funds team, one that has extensive manager relationships and a long history of investment success in manager selection and structuring diversified investment portfolios.

Virginia Reynolds Parker, PGS’ founder and CIO, has been making alternative investments since 1988. Over the past decade, she has assembled an investment team that has significant experience in the hedge fund industry, some of whom have been working together and allocating to hedge fund managers since 1995. This team has demonstrated strong success over many years in allocating to newer managers who have gone on to become among the best talent in the industry. The firm is known as a pioneer in the FoHF industry for its risk measurement, monitoring, and management skills, all of which have contributed to the development of its rigorous manager due diligence process. Since its inception, PGS has designed and managed over 22 FoHFs, representing allocations to over 140 managers, totaling more than US $1.75 billion in structured products, co-mingled vehicles and single-manager funds. The firm’s size allows it to allocate to smaller but outstanding hedge fund managers. This market agility, together with its experienced investment team, enables PGS to provide a discernable investment edge to its clients.

Although Parker Global Strategies believes that prices will continue to increase over the next several years as demand outstrips supply (Goldman Sachs recently predicted that the price of crude oil would reach $105 per barrel within the next several years), the fund is deliberately designed to be indifferent to market direction and to be profitable regardless of the price of underlying commodities. It will achieve this objective by investing in managers that are focused on different segments of the energy and natural resource sectors; most from an arbitrage, or multi-strategy approach and several from a directional, event-driven and activist perspective. The Global Energy Edge Fund will invest in global utilities (electric power, gas, water, and energy transmission), base metals, precious metals, basic materials, chemicals, timber, natural gas, crude oil, alternative generation, and exploration & production. In addition, it will also invest in second derivative opportunities further down the energy supply chain including power plant constructors, steel makers, exploration and production contractors, tank operators, fertilizer manufacturers, refiners, and other users of energy and/or suppliers to the first derivative investments.

Conclusion

Parker Global Strategies believes current structural issues in the energy and natural resources markets have created excellent investment opportunities, which should continue well into the next decade. Although we believe prices will continue to increase over the next several years as demand outstrips supply, we have constructed a highly diversified fund-of-funds that is not reliant on market direction for profits. Rather, it is a product intended to be a "stand alone" investment, designed to capitalize on these rapidly changing and exciting market opportunities.  The objective of the Fund will be to generate 12-15% annual returns in U.S. dollars with less than half of the volatility of the S&P 500 Energy Index. Energy Edge’s pro forma performance has had significant out performance of the S&P 500 Energy Index when the S&P 500 Energy Index has been down, with the average out performance being 3.19% for down months and cumulative out performance of 54% from January 2002 through March 2005.