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Tim

Gui

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Commentary and Review by portfolio manager Tim Guinness

July 2009

REPORT HIGHLIGHTS

OIL • Oil traded in $66-$72 range in June. Settling into a $50 – $75 trading range?• OPEC production slightly (2%) up from May to June: compliance about 75%• OECD inventories (April number) still high; US inventories (June num-ber) now falling from peak• US non gasoline demand weak (June); China imports continue strong

GAS • Gas price still below $4. Storage 500 Bcf above 5 year average • Rig count decline – now down by 57% from 2008 peak (1,606 to 687)• US onshore production fell only slightly in April compared to March and effect of rig count decline not yet making itself felt• US demand soft but not collapsing, down 4% year on year

EQUITIES • MSCI World Energy index gave up some of April, May strong gains - down 5.2% in June. Since the end of March it is back level with the S&P 500 (+15.91%) return. For investors who like the energy story, recent weakness may offer the opportunity to buy on a dip

July 2009

briefEnergy


Oil market -- June 2009 in review

Oil market -- Outlook

Natural gas market -- June 2009 in review

Supply -- Outlook

Guinness Atkinson Global Energy Fund performance review

Guinness Global Energy Fund portfolio

Manager’s concluding comments

Appendix: oil and gas markets, historical context

Contents

CHARTS OF • YIN: US non-gasoline oil demand still weak

THE MONTH • YANG: CHINA oil imports strong

China oil imports 2004-2009 (barrels/day)

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

Feb-04

Apr-04

Jun-04

Aug-04

Oct-04

Dec-04

Feb-05

Apr-05

Jun-05

Aug-05

Oct-05

Dec-05

Feb-06

Apr-06

Jun-06

Aug-06

Oct-06

Dec-06

Feb-07

Apr-07

Jun-07

Aug-07

Oct-07

Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

barrels/day

• Chinese oil imports are back to around 4.0m b/day having slumped to 3.0m b/day in January and February 2009

Imports back at around 4.0m b/day

Total US petroleum demand vs US motor gasoline/non-gasoline products demand

5,000

7,000

9,000

11,000

13,000

15,000

17,000

19,000

21,000

23,000

Jul-2

009

Jan-2009

Jul-2

008

Jan-2008

Jul-2

007

Jan-2007

Jul-2

006

Jan-2006

Jul-2

005

Jan-2005

Jul-2

004

Jan-2004

Jul-2

003

Jan-2003

Jul-2

002

Jan-2002

Jul-2

001

Jan-2001

Jul-2

000

Jan-2000

Jul-1

999

Jan-1999

Jul-1

998

Jan-1998

Jul-1

997

Jan-1997

Jul-1

996

Jan-1996

Jul-1

995

Jan-1995

Jul-1

994

Jan-1994

Jul-1

993

Jan-1993

Jul-1

992

Jan-1992

Aug-1991

Feb-1991

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Total US products supplied (000s b/day) Total products supplied - 12 month moving averageWeekly motor gasoline supplied (000s b/day) Motor gasoline - 12 month moving averageTotal non-gasoline products supplied (000s barrels per day) Total non-gasoline products - 12 month moving average

Total gasoline and non-gasoline products combined

Total non-gasoline products

Total gasoline products

China oil imports 2004-2009 (barrels/day)

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

Feb-04

Apr-04

Jun-04

Aug-04

Oct-04

Dec-04

Feb-05

Apr-05

Jun-05

Aug-05

Oct-05

Dec-05

Feb-06

Apr-06

Jun-06

Aug-06

Oct-06

Dec-06

Feb-07

Apr-07

Jun-07

Aug-07

Oct-07

Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

barrels/day

• Chinese oil imports are back to around 4.0m b/day having slumped to 3.0m b/day in January and February 2009

Imports back at around 4.0m b/day

Total US petroleum demand vs US motor gasoline/non-gasoline products demand

5,000

7,000

9,000

11,000

13,000

15,000

17,000

19,000

21,000

23,000

Jul-2

009

Jan-2009

Jul-2

008

Jan-2008

Jul-2

007

Jan-2007

Jul-2

006

Jan-2006

Jul-2

005

Jan-2005

Jul-2

004

Jan-2004

Jul-2

003

Jan-2003

Jul-2

002

Jan-2002

Jul-2

001

Jan-2001

Jul-2

000

Jan-2000

Jul-1

999

Jan-1999

Jul-1

998

Jan-1998

Jul-1

997

Jan-1997

Jul-1

996

Jan-1996

Jul-1

995

Jan-1995

Jul-1

994

Jan-1994

Jul-1

993

Jan-1993

Jul-1

992

Jan-1992

Aug-1991

Feb-1991

Aug-1990

Tota

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per

day

)

Total US products supplied (000s b/day) Total products supplied - 12 month moving averageWeekly motor gasoline supplied (000s b/day) Motor gasoline - 12 month moving averageTotal non-gasoline products supplied (000s barrels per day) Total non-gasoline products - 12 month moving average

Total gasoline and non-gasoline products combined

Total non-gasoline products

Total gasoline products

Source: Bloomberg

Oil market – May 2009 in review

Figure 1: Oil price (WTI $/barrel) 18 months – December 31, 2007 to June 30, 2009Source: Bloomberg

The West Texas Intermediate (WTI) oil price opened the month at $66.31 and moved up nearly 10% to reach a nine-month high of $72.68 on June 11. It then weakened slightly to end the month at $69.89.

Brent and WTI traded in close tandem in June. Brent opened the month at a slight discount and despite moving to a small premium for one day on June 8 continued at a discount for the rest of the month. At the month end the discount was $1.55, approximately 2%.

Factors which supported the price in June included:

• Geopolitical unrest. The disputed election in Iran and the continued violence in the Niger Delta in Nigeria threatened supply and brought the geopolitical risk premium back into play. The result of the Iranian election was formally announced on June 12, and the week that followed saw the worst civil unrest since the fall of the Shah in 1979. In Nigeria, the militant group MEND (Movement for the Emancipation of the Niger Delta) attacked pipelines and flow stations operated by Shell, Chevron and Agip despite President Umaru Yar’Adua’s calls for a 60-day amnesty. Iran and Nigeria together produce 5.5 million barrels/day, over 20% of OPEC-11’s output.

• IEA Oil Market Report. The Oil Market Report published on June 11 included an increased global oil demand forecast for 2009 on the back of stronger-than-expected 1Q09 OECD data. Although the total demand number is still down some 2.5m b/day from 2008, the upward revision was interpreted by some as a further sign of demand recovery in the OECD region.

• China oil imports. Following a sharp uplift in Chinese oil imports in March and April, the May data point showed another increase, from 16.2 million tonnes to 17.1 million. This represents physical (rather than speculative) demand growth of around 200,000 b/day.

July 2009

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Factors which weakened the WTI oil price in June included:

• Weak US oil demand. The Q2 numbers show that the pace of demand decline for total oil products in the US is increasing rather than slowing. The comparison between Q2 2009 versus Q2 2008 and Q1 2009 versus Q1 2008 reveals that total product demand is down 10% year-on-year in Q2 versus 6% in Q1, and that almost all of it can be attributed to products other than gasoline (kerosene, diesel, residual fuel, propane). While gasoline demand was down 2% year-on-year in both Q1 and Q2, de-mand for other products was down 18% in Q2, versus 9% in Q1.

• Oil inventories. US crude oil stocks (excluding the Strategic Petroleum Reserve) fell slightly in June from 365 million barrels to 350 million, but are still around their highest absolute levels since 1990. The April OECD stock level published in the June IEA Oil Market Report was 2.75 billion bar-rels, equivalent to 60.9 days of inventory cover. This is some way above the top end of the ten-year range.

Speculative and investment flowsThe New York Mercantile Exchange (NYMEX) net non-commercial crude oil futures open position did not move significantly during the month. Having ended May 40,000 contracts long, the position oscillated between 26,000 and 48,000 contracts long before ending the month at 41,000 long. As we have pointed out in the past, although this does not represent a huge overhang it would weaken the oil price if it were to fall away quickly.

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Figure 2: NYMEX Non-commercial net futures contracts: WTI November 2003 – June 2009Source: Bloomberg/Nymex


July 2009

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Analysis of commodity index tracking investor flows These calculations – which allow us to estimate roughly the fund flows into the two main commodity indices, the Goldman Sachs Commodity Index (GSCI) and Dow Jones AIG Commodity Index (DJAIG), and thus infer the fund flows into their separate constituents including crude oil - showed a net de-crease of 2,000 contracts in June into WTI and Brent oil futures.

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Inflows of 180,000 contractsInflows of

480,000 contracts

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Inflows of 170,000 contracts

Figure 3: Net crude oil (WTI and Brent) futures contracts held by index investorsSource: Guinness Asset Management calculations (2009)

Whilst the June outflow appears modest it is noteworthy that since October 2008 we have seen speculative inflows equivalent to just approximately 170,000 contracts, nearly matching the level of inflows seen between January and June 2008 when the oil price rose by 40% from $100 to $140. It seems plausible these most recent inflows have provided some impetus to the oil price recovery over the past 7 months.

OECD stocksThe April 2009 OECD total crude and product number published in the June IEA Oil Market Report was up slightly, showing an increase of 11 million barrels, giving a total stock of 2,753 million barrels (vs 2,560 million barrels in April 2008). When expressed as number of days of demand cover (60.9 days), however, we see that we are well above last year’s level (53.8 days) and well above the top of the tight/loose spread of the last 10 years. The market is clearly very loose at this level and our mod-elling suggests that the stock level will likely not return to within the 10-year range until the fourth quarter of this year.


July 2009

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2,200

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Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

OEC

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ion

barr

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10yr spread 2008 2009a

Figure 4: OECD total product and crude inventories – monthly 1998 to 2009Source: IEA Oil Market Report (June 11, 2009)

2. Oil market – outlook

Supply and demand recent past plus 2009 forecastsThe table below illustrates the difference between world oil demand growth and non-OPEC supply growth over the last 9 years together with the IEA forecasts for 2009. Since the start of the year we have included an additional column in the table which shows our own estimates for global oil sup-ply and demand in 2009. However, the latest adjustments made by the IEA have now brought their estimates in line with our thinking, and so below we only comment on their forecasts.

(million barrels per day) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009e

World Demand 76.7 77.4 77.7 79.3 82.5 84.0 85.1 86.0 85.8 83.3

Non-OPEC supply (includes Angola and Ecuador for periods when each country was outside OPEC1)

46.2 47.2 48.1 49.1 50.3 50.4 51.2 50.1 49.6 50.5

Angola supply adjustment1 -0.8 -0.7 -0.9 -0.9 -1.0 -1.2 -1.4 0.0 0.0 0.0

Ecuador supply adjustment1 -0.4 -0.4 -0.4 -0.4 -0.5 -0.5 -0.5 -0.5 0.0 0.0

Indonesia supply adjustment2 1.2 1.2 1.1 1.0 1.0 0.9 0.9 1.0 1.0 0.0

Non-OPEC supply (ex. Angola/Ecuador and inc. Indonesia for all periods)

46.2 47.3 47.9 48.8 49.8 49.6 50.2 50.6 50.6 50.5

OPEC NGLs 3.1 3.4 3.7 3.9 4.2 4.3 4.4 4.5 4.7 5.2

Non-OPEC supply plus OPEC NGLs(ex. Angola/Ecuador and inc. Indonesia for all periods)

49.3 50.7 51.6 52.7 54.0 53.9 54.6 55.1 55.3 55.7

Call on OPEC-123 27.4 26.7 26.1 26.6 28.5 30.1 30.5 30.9 30.5 27.6

Iraq supply adjustment4 -2.6 -2.4 -2.0 -1.3 -2.0 -1.8 -1.9 -2.1 -2.5 -2.4

Call on OPEC-115 24.8 24.3 24.1 25.3 26.5 28.3 28.6 28.8 28.0 25.2 1Angola joined OPEC at the start of 2007, Ecuador rejoined OPEC at the end of 2007 (having previously been a member in the 1980s)2Indonesia left OPEC as of the start of 20093Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi, U.A.E. Venezuela4Iraq has no offical quota5Algeria, Angola, Ecuador, Iran, Kuwait, Libya, Nigeria, Qatar, Saudi, U.A.E. Venezuela

Source: 2000 - 2008 IEA oil market reports; (A) June 2009 Oil market Report

Figure 5: Estimated annual world oil supply & demand growth 2000 – 2009Source: 2000-2008 IEA oil market reports; June 2009 Oil market Report


July 2009

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OPECAt its extraordinary meeting on December 17, 2008, OPEC announced a 4.2m b/day cut from the ac-tual OPEC-11 September 2008 production level of 29.2m b/day, giving a new quota target of 25.0m b/day with effect from January 1, 2009. The previous quota was 27.3m b/day, implying an effective quota cut from this meeting of 2.3m b/day – the largest single cut in OPEC history.

OPEC production for June 2009 was reported as 25.9m b/day, an increase of 80,000 barrels per day on May. If this proves to be accurate, OPEC compliance will have fallen from around 90% to 75-80%, with Iran, Venezuela and Angola the principal over-producers. Interestingly, Angola is petitioning to have its current output target suspended on the grounds that the country is still suffering from the impact of its 30-year civil war – lower oil production will intensify an already grave financial crisis. Angolan oil officials point out that their situation is directly comparable with that of Iraq, which has no formal production targets. This will need to be carefully watched because without strict targets Angola could easily produce significantly more than is required: IEA estimates suggest current pro-duction capacity is 2 million barrels per day, almost 500,000 barrels per day above the target level.

OPEC met at the end of May and while keeping production quotas unchanged issued the following statement:

“Although some recent positive economic indicators point towards the possibility of the recession bottoming-out before year-end, the world is nevertheless still faced with weak industrial production, shrinking world trade and high unemployment: for this reason, the Conference decided to maintain current production levels unchanged for the time being. In taking this decision, Member Countries reiterated their firm commitment to the individually agreed production allocations, as well as their readiness to respond swiftly to any developments which might place oil market stability and their interests in jeopardy. The Secretariat will continue to closely monitor the market, keeping Member Countries abreast of developments as these occur, and the situation will be reviewed at the next Ordinary Meeting of the Conference, scheduled to take place at OPEC Headquarters in Vienna, on September 9, 2009.”


July 2009

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OPEC-11* productionCall on OPEC-11

*OPEC-11: Algeria, Angola, Ecuador, Iran, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, U.A.E., Venezuela

IEA 2009 call estimate

Current OPEC quota

Figure 6: OPEC apparent production vs call on OPEC 2000 – 2009

Source: Bloomberg/IEA Oil Market Report (June 11, 2009)

The IEA are currently forecasting global oil demand for 2009 at 83.3 m b/day, comprising a decline of 2.3m b/day in the OECD and a decline of 0.2m b/day in non-OECD territories. This forecast for demand has been revised downwards several times in recent months, but as I mentioned earlier in the report was moved up by 0.1m b/day in the June Oil Market Report. When added to declines that have already occurred in the OECD in 2007 and 2008, (2.1m b/day), this gives a total decline in the OECD between 2007 and 2010 of 4 – 5m b/day, or 8%-10%. We consider this to be a good ballpark estimate if one tries to extrapolate from the past demand destruction periods of 1974 and 1980.

In this scenario we believe that the oil market will tend towards loose until the autumn. It is possible that OPEC will make at least one further cut to ensure that the market does indeed revert to bal-anced/tight, but we also think that OPEC would be satisfied with the current position as long as the oil price remains no less than $50 for the rest of the year. Although we continue to think that OPEC would ultimately like the oil price back at $70-$75, we think they would accept an average oil price of around $50 this year to play their part in any economic recovery that may take place. Of course if the oil price remains at say $60 or $65 for the remainder of the year the average price will be somewhat higher at $55 or $57.5.

Supply looking forwardNon-OPEC supply growth is still some way off, if possible at all. The truth is that the non-OPEC world is struggling to grow production. The growth was 2% per annum between1998-2003, 1% from 2003-2008 and is forecast 0.5% from 2008-2013 and we believe that has a good chance of not be-ing realised. Significantly, the IEA have now cut their forecast for non-OPEC supply growth in 2009 from 1.1m b/day (September 2008 estimate) to a decline of 100,000 b/day (June 2009 estimate). Around half of this cut came from the FSU, and predominantly from Azerbaijan: the FSU has long been the saviour of non-OPEC supply but is showing ominous signs of rolling over.


July 2009

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Demand looking forwardWe think that a comparison with the 1973-1975 and 1979-1983 recessionary periods is appropriate. Given the structural shift away from oil as a source of heating and power generation in OECD coun-tries and the recent rapid retreat in the oil price it is likely that the demand drop will not be as severe as the 17% OECD fall in 1979-83. It is likely, however, to be somewhat greater than the 7% OECD de-mand fall in 1973-75.

We project a drop of 8 - 10%.

This drop equates to around 5mb/day (vs IEA 4.9m b/day), of which by end of 2008 we had seen 2.3m b/day (OECD demand was 49.8m b/day in 2005 versus 47.5 m b/day in 2008). An inherent difference between the current outlook and the 1979-83 period is that back then the world was faced with a prolonged high oil price environment after the collapse of the Shah in Iran, as well as the at-tendant recession: this time the recession might be deeper, but the high oil price effect will be less. The other point of comparison - the 1973-5 recession - saw an oil price spike similar in scale to the recent one (although the price did not weaken as quickly as it has recently), and a recession of slightly smaller magnitude to the one we are entering. In non-OECD we expect growth to be flat from Asia, the Middle East and others - down from 1 – 1.5m b/day in 2008. In the May Oil Market Report the IEA revised down their growth forecast for non-OECD demand in 2009 from flat to – 0.2m b/day: our current assumption is that it will be flat.

Inventory levelsAs we discussed earlier in the report, OECD total crude and product inventories look very loose as shown by the fact the April 2009 inventory level is well above the top of the ten-year range.

Conclusions about oilFrom the low of $31.42 on December 22, 2008 we have seen the oil price (WTI) recover to above $70 before falling to the low-$60s as of the end of June. This is not particularly supported by the immedi-ate supply/demand and inventories balance which shows that though OPEC cuts match demand de-struction, inventories remain high. It follows that some combination of speculative demand, a dollar hedge and the animal spirits of traders have been at work. As of the end of June it appears possible that a new $50 – 75 trading range is being established. However, the oil price is always volatile and short-term spikes and troughs will continue to surprise us.

The table below illustrates our target oil price estimates and for comparison the rises in percentage terms that we have seen in the period from 2002 to 2008. We have nudged our 2009 estimate up from $50 to $55 given recent price strength. This assumes oil averages $60 for 2H 2009.


July 2009

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2002 2003 2004 2005 2006 2007 2008 2009e 2010e 2011eAverage WTI ($) 26.1 31.2 41.7 56.6 66.1 72.2 99.9 55 60 70

Change y-o-y ($) - 5.1 10.5 14.9 9.5 6.1 27.7 -44.9 +5.0 +10.0Change y-o-y (%) - +20% +34% +36% +17% +9% +38% -45% +10% +17%

e = estimateSource: Bloomberg, Guinness Asset Management estimates (June 2009)

3. Natural gas market – June 2009 in review

The US spot natural gas price (Henry Hub, Louisiana) opened the month at $3.92 per Mcf (1000 cubic feet). The price rose briefly over $4 then declined to a low for the month on June 11 of $3.51, before rallying over the next week to a high of $4.18 on June 18. The price drifted off again over the final days of the month to close at $3.70. The gas price has fallen 72% from its high almost exactly a year ago, on July 2, 2008, of $13.31. The 12-month gas strip price (a simple average of settlement prices for the next 12 months’ futures prices) closed the month 2% higher at $5.26.

Figure 7: Henry Hub Gas price ($/Mcf) 18 months – December 31, 2007 to June 30, 2009Source: Bloomberg

Factors which supported the gas price in June included:

• Hot weather in the US. Unusually warm weather in the final week of June, particularly in the south of the country, contributed to a higher-than-average draw of natural gas from storage. Warmer weather in the summer tends to boost demand for air-conditioning, which in turn increases natural gas con-sumption.

• Falling rig count. The US natural gas rig count, which gives the number of land rigs actively drill-ing in the US, continued to fall in June, albeit at a slower rate than in previous months. The rig count


July 2009

briefEnergy

ended the month 16 rigs lower at 687, which is 57% down from a high of 1,606 in September 2008.

Factors which weakened the gas price in June included:

• US production strength. Although the natural gas rig count has fallen by 57% since September 2008, production continues to be strong. The April data published at the beginning of July showed gross onshore production up by 1.9 Bcf/day year-on-year, at 56.6 Bcf/day. That said, month-on-month onshore production was down 0.2 Bcf/day.

• Weak demand. Total US demand in April was down 4% year-on-year, led by a 9% fall in industrial demand (about one third of total demand) as the US economy slowed.

• LNG imports into the US. Daily volumes of Liquefied Natural Gas (LNG) into the US in June were 1.2 Bcf/day, up by 0.3 Bcf/day year-on-year. Although the increase from 2008 levels is only 0.3 Bcf/day, it comes at a time when the US already has a glut of domestic natural gas.

Natural gas storageSwings in the supply/demand balance for US natural gas should, in theory, show up in movements in gas storage data. The following graph shows the 12 month gas strip price (in blue) against the amount of gas in storage expressed as the deviation from the 5 year storage average (in green). Swings in storage have frequently been a leading indicator to movements in the gas strip price.

US natural gas price (Henry Hub 12 month strip $/Mcf) vs deviation from 5yr gas storage norm

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Deviation from 5yr norm (Bcf) Gas price ($/Mcf)

Figure 8: Deviation from 5yr gas storage norm vs gas price 12 month strip

Source: Bloomberg, EIA (July 2009)


July 2009

briefEnergy

The surplus of gas in the second half of 2008 can be seen in gas storage data, with the inflection point in storage occurring in July 2008 and the storage line moving from negative (i.e. deficit) to positive (i.e. surplus) territory at the end of the year. This coincided with the gas strip price falling from a peak of over $13 in July to around $6 by the end of the year. The surplus has continued to build in the first 4 months of 2009, helping to push the gas strip price below $5 for the first time since 2003. Over the past 12 weeks, the growth in storage above the 5-year average indicates that the US gas market is around 2 Bcf/day oversupplied. We expect the market to remain oversupplied and that the storage deviation to continue to move significantly into excess territory through the summer. The moment when the storage line turns will likely be a coincident indicator for the start of a sustained gas price recovery.

4. Natural gas market - Outlook

Supply & demand recent pastThe sharp contraction in the gas price since July 2008 reflects both the move down in the oil price and the fact that supply/demand fundamentals have changed materially.

The supply side fundamentals for natural gas in the US are driven by 5 main moving parts: onshore and offshore domestic production, net imports of gas from Canada, exports of gas to Mexico and imports of liquefied natural gas (LNG). In the last 2 years onshore production has been growing at an accelerating pace as gas shales have been developed using advances in horizontal drilling and “fraccing” techniques; by contrast offshore production and imports from Canada and of LNG (until recently) have been declining.

On the demand side, industrial gas demand and electricity gas demand, each about a third of total US gas demand, are key. Commercial and residential demand, which make up the final third, have been fairly constant on average over the last decade - although yearly fluctuations due to the cold-ness of winter weather can be marked. Growth in gas’ market share of the residential and commercial heating market has been balanced by efficiency gains.

Industrial demand tends to trend up and down depending on the strength of the economy; the level of the US dollar; and the differential between US and international gas prices. Until mid-2008 a weaker dollar, high international gas prices and a strong economy saw industrial demand recovering after declining in the first half of this decade. Not surprisingly, just recently demand has turned down (April 2009 industrial demand was 19.8 Bcf/day vs 21.9 Bcf/day for April 2008).

Generally speaking, the majority of incremental electricity demand over the last few years has been met by gas rather than coal, nuclear or hydro power. While electricity demand has grown 1-2% per an-num (pa), gas demand for electricity generation has grown by on average 5% pa (1 Bcf/day per year).

Supply Outlook

Fall in Rig CountThe most important immediate short term supply driver is a sharply dropping onshore rig count. The rig count has dropped from a peak of 1,606 gas land rigs to 687 as of end of June 2009. This should


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halt supply growth this spring and according to our forecasts bring supply down by 3–3.5 Bcf/day by September 2009 and by 5–6 Bcf/day by year end. The most recent data point from the US Depart-ment of Energy (DOE) shows total gross production (including offshore) declining slightly in April but is still up 0.5 Bcf/day since the start of the year. At 63.4 Bcf/day production is the same as it was in November when the rig count was around 1,500.

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Figure 9: US natural gas production 2005 – 2009 (Lower 48 States)Source: EIA (June 2009)

Liquid natural gas (LNG) arbitrageThe UK national balancing point (NBP) gas price – which serves as a proxy to the European gas price – was flat in dollar terms at $4.00. The differential to Henry Hub is now very small and may encour-age LNG cargoes to the US that were previously being diverted to Europe. In October 2008 this NBP gas price stood at the equivalent of $14.90 ($1.49/therm).

Canadian imports into the USThese were down approximately 5% for full year 2008 vs. 2007, though 10% for the second half of the year. So far in 2009 to end April they are down approximately 9% (around 1 Bcf/day). Falling rig counts, a less attractive royalty regime enacted in 2007, and increased demand from Canadian oil sands development are all factors at work here.

Demand OutlookThe likely effect of this current recession on US natural gas demand is more difficult to ascertain. Gas demand splits roughly a third each between residential/commercial for heating; electricity genera-tion and industrial. Residential/commercial and most of electricity demand are principally weather rather than economy sensitive. Industrial demand is economy sensitive. Between 1972-5, industrial demand for natural gas fell 18%, and the 1979-83 period saw a fall of 21%. However the mix of indus-trial use today appears to be less business cycle sensitive so the effect this time may be less marked. We are assuming we may see a 20% decline in industrial demand and 7% in electricity giving a total


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decline of 5-6 Bcf/day. So far in 2009 industrial demand is down by only 11% year-on-year and elec-tricity demand flat (total decline of 3 Bcf/day), so our forecasts may prove to be overly pessimistic, depending on the shape and duration of the recession.

Other Relationship between gas price and other energy commodity prices in the USThe oil/gas price ratio ($ per bbl WTI/$ per mcf Henry Hub) of 18.9x at the end of June was the high-est it has been since September 2006 and is still well outside the more normal ratio of 6-9x. If oil averages, say, around $60 in 2010 and the relationship between the oil and gas price returns to its longer-term average of 6-9x, this implies the gas price increasing back to around $8 once the gas market has returned to balance.

The following chart of the front month US natural gas price against heating oil (No2), residual fuel oil (No5) and coal (Sandy Barge adjusted for transport and environmental costs) seeks to illustrate how coal and residual fuel oil switching provide a floor and heating oil a ceiling to the natural gas price. The gas price is now sitting just above the coal price support level, both having declined steeply over the past 12 months, whereas the residual and heating oil prices are well above gas and coal.

Figure 10: Natural gas price (black) vs residual fuel oil (light blue) and heating oil (dark blue) and Sandy Barge (adjusted) (green) 2000 – 2009Source: Bloomberg LP

Conclusions about US natural gas

We expect weakness in the US natural gas price to continue until a reduced US land rig count is seen to be working its time honoured function of reducing supply to bring it back into balance with demand reduced by the current recession by 5-6 Bcf/day (our pessimistic scenario) or 3-4 Bcf/day (actual so far). We judge the earliest this could occur is Q3 2009 but is more likely nearer the end of the year.


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5. Guinness Atkinson Global Energy Fund performance review

The main index of oil and gas equities, the MSCI World Energy Index , was down 5.22% over the month of June. The S&P 500 was up 0.20% in June. The Fund was down 6.63% over the month un-derperforming the MSCI World Energy Index by 1.41% (all in US dollar terms).

Within the Fund, June’s stronger performers were Addax Petroleum, Dragon Oil, Singapore Petro-leum, Swift Energy and Repsol YPF. Poorer performers were Whiting, Hess, Unit, Apache and Suncor.

Performance as of June 30th, 2009

Inceptio ndate June

30, 2004

Q2 2009 Q1 2009 Full Year 2007

Full Year 2008

One Year (annu-alised)

Last 2 years

(annu-alised)

Last 5 years

Since In-ception

Global En-ergy Fund*

32.52% -1.15% 37.25% -48.56% -42.89% -12.17% 15.22% 15.22%

MSCI Energy Index

15.95% -7.99% 30.86% -37.88% -39.50% -14.26% 9.30% 9.30%

S&P 500 Index

15.93% -11.01% 5.49% -37.00% -26.21% 19.89% -2.24% -2.24%

*Expense ratio 1.31%

Buys/Sells

There were no buys or sells in the month of June.

Sector BreakdownThe following table shows the asset allocation of the Fund at 30 June 2009.


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(%) Dec. 31, 2006 Dec. 31, 2007 Dec. 31, 2008 June 30, 2009 Change in 2009

Oil & Gas 95.4 103.5 96.4 99.1 2.7Integrated 45.2 66.2 53.7 48.7 -5.0

Exploration & Production

30.3 25.8 28.7 32.0 3.3

Drilling 9.9 8.1 5.2 8.4 3.2Equipment and

services3.4 3.4 6.4 6.3 -0.1

Refining and marketing

6.6 0.0 2.4 3.7 1.3

Coal and con-sumables

3.3 2.5 2.3 0.0 -2.3

Construcito nand engineer-

ing

0.0 0.0 0.4 0.5 0.1

Cash 1.3 -6.0 0.9 0.4 -0.5Total 100 100 100 100 -

Source: Guinness Asset ManagementBasis: Global Industry Classification Standard (GICS)

Equity valuationWhile it is hard to be precise, the current price of energy equities reflects a medium to long-term oil price of $40/barrel. You can make a rough calculation that takes the 2007 PER of the Fund (7.4x) which reflected earnings when the oil price was $72 and work out what oil price would reduce earn-ings by enough to put the Fund on the same P/E ratio as the broad market is currently – 18.6x (S&P 500 operating earnings which exclude write-downs). Today that implied oil price is $40. The sum is very crude and makes heroic assumptions (for instance, that F&D and lifting costs are $20/barrel) but is in my view a perfectly respectable approach to give an indication of oil price implicit in current energy equity valuations.6. Guinness Atkinson Global Energy Fund portfolio

The fund at June 30, 2009 was on a PER (2008) of 4.7 x (7.3x 2007) with a median PER (2008) of stocks held of 6.7x. By comparison the S&P 500 Index at 919.3 was on a PER of 18.6x (2008) (Based on S&P 500 ‘operating’ earnings per share estimates of 49.51 for 2008). This is shown in the follow-ing table:


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At 30 June 2009 2007 2008 2009Fund PER 7.3 4.7 15.2

S&P 500 PER 11.1 18.6 16.5Premium (+)/Discount

(-)-34.2% -74.7% -7.9%

Fund 2007 vs. S&P 500 2008

-60.8% Fund 2008 vs. S&P 500 2009

-71.5%

Average oil price (WTI) $ $72.2/bbl $99.9/bbl $51.51/bbl (YTD)Source: Standard and Poor’s; Guinness Asset Management Ltd (S&P500 ‘operating’ EPS consensus 2009 : 42.3)

Portfolio HoldingsOur Integrated and similar stock exposure (c.48%) is comprised of a mix of mid-cap and large-cap stocks. Mid-caps are ConocoPhillips, Marathon, Statoil, Occidental, OMV, Hess, Petro-Canada, Rep-sol and ENI. Our three large caps are Royal Dutch Shell, BP and Total. At the end of June the median PER of this group was 5.8x 2008 earnings (and 12.0X 2009).

Our Exploration & production exposure (c.32%) gives us exposure most directly to any recovery in the oil price. The stocks with oil sands exposure are Imperial Oil, Encana, OPTI Canada, Suncor and Nexen. The pure E&P stocks are all now largely in the US (Anadarko, Newfield, Pioneer Natural Re-sources, Swift and Whiting), although Apache and Noble have significant international production as well. The metrics behind four of the E&P stocks held are low enterprise value /proven reserves (Noble, Swift, Pioneer and Whiting). All of them also give us exposure to North American natural gas (they are each maximum 50% oil) and they include one of the industry leaders (Apache) and one of the more leveraged companies (Anadarko). We also have smaller positions in two non-US E&P stocks, Dragon Oil and Addax Petroleum, both of which were previously held in our ‘research’ portfolio. Dragon Oil has producing oil assets in the Caspian Sea and trades on 7.4x 2008 earnings (13.5x 2009 earnings) and has recently been the subject of a takeover rumours. Addax is mainly an oil producer in offshore Nigeria and also trades on attractive metrics. The company has recently been the subject of a take-over approach from Sinopec and we are monitoring the bid closely.

We have exposure to two Emerging Markets stocks (Petrobras and CNOOC). They are both main-ly E&P focused and have significant growth potential and advantages as national champions. For Petrobras, the recent Tupi, Jupiter and Carioca discoveries and the surrounding acreage in the off-shore Brazilian subsalt could yield substantial value.

We have useful exposure to North American Oil Service stocks. On estimated 2008 earnings they are all trading with PERs of between 4.0x and 7.3x - Helix (4.0x), Transocean (5.3x), Patterson UTI (5.7x), Unit (4.0x) and Halliburton (7.3x).

Our independent Refining exposure is currently in the Far East in Singapore Petroleum. The com-pany has recently been the subject of a take-over approach from Petrochina and we are monitoring the bid closely.


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Porfolio at June 30, 2009GAGEX - Global Energy Fund 30 June 2009

Wtd. Av. 2007 2008 2009 2010 30.06.09

Stock SEDOL curr Country % of NAV Mkt. Cap.B'berg mean

PERB'berg mean

PERB'berg mean

PERB'berg mean

PERMkt. Cap.

($bn)

Integrated Oil & GasRoyal Dutch Shell PLC 'B09CBL4 EUR NL 3.4 5.25 5.0 5.2 10.1 7.9 156.5BP PLC '0798059 GBP GB 3.4 5.07 9.1 5.1 12.0 8.8 147.5Total SA 'B15C557 EUR FR 3.4 4.35 6.7 6.3 10.3 8.2 128.2ENI SpA '7145056 EUR IT 3.6 3.38 6.3 6.0 10.6 8.3 94.8StatoilHydro ASA '7133608 NOK NO 3.4 2.16 9.3 8.0 12.5 9.2 62.8ConocoPhillips '2685717 USD US 3.3 2.06 4.2 4.0 12.8 7.0 62.3Occidental Petroleum Corp '2655408 USD US 3.5 1.87 10.8 7.5 21.8 13.4 53.3Marathon Oil Corp '2910970 USD US 3.4 0.73 5.3 5.1 13.0 8.1 21.3Hess Corp '2023748 USD US 2.9 0.51 8.9 6.8 84.3 18.8 17.6

30.30Integrated Oil & Gas - CanadaImperial Oil Ltd '2454241 CAD CA 3.4 1.11 13.6 11.3 21.8 15.4 32.9Suncor Energy Inc '2861142 CAD CA 1.5 0.43 11.3 11.1 28.0 12.8 28.5Petro-Canada '2684316 CAD CA 3.1 0.58 7.8 5.5 19.5 11.2 18.8

8.0Integrated Oil & Gas - Emerging marketPetroleo Brasileiro SA '2683410 USD BR 3.4 5.64 9.4 7.6 14.2 11.1 165.7Repsol YPF SA '5669354 EUR ES 3.6 0.97 6.2 6.7 10.5 8.2 27.3OMV AG '4651459 EUR AT 3.5 0.39 5.2 4.4 9.2 6.8 11.2

10.43Oil & Gas Exploration & ProducApache Corp '2043962 USD US 2.0 0.49 8.5 6.0 17.2 9.4 24.2Anadarko Petroleum Corp '2032380 USD US 2.2 0.51 5.6 8.9 nm 55.9 22.7Noble Energy Inc '2640761 USD US 3.6 0.37 11.0 8.6 23.3 21.0 10.2Newfield Exploration Co '2635079 USD US 2.2 0.09 24.8 9.5 8.7 9.4 4.3Pioneer Natural Resources Co '2690830 USD US 2.2 0.06 12.6 7.6 nm 25.4 2.9Whiting Petroleum Corp '2168003 USD US 2.7 0.05 10.8 5.9 nm 24.8 1.8Swift Energy Co '2867430 USD US 2.3 0.01 3.4 2.4 nm 12.0 0.5

17.3Oil & Gas Exploration & Production - CanadaEnCana Corp '2793193 CAD CA 2.2 0.81 11.1 7.7 13.5 17.5 37.3Nexen Inc '2172219 CAD CA 3.2 0.36 12.2 6.4 18.4 10.1 11.3OPTI Canada Inc 'B00R3Q7 CAD CA 0.5 0.00 nm nm nm 65.0 0.3Grey Wolf Exploration Inc 'B06CMR0 CAD CA 0.0 0.00 nm 37.5 nm nm 0.0

5.8Oil & Gas Exploration & Production - Emerging marketsCNOOC Ltd 'B00G0S5 HKD HK 3.1 1.74 13.5 8.3 14.5 10.6 55.4Addax Petroleum Corp 'B0YBYH3 CAD CA 2.3 0.16 16.0 9.5 30.1 14.7 6.7Dragon Oil Plc '0059079 GBP GB 2.0 0.06 11.9 7.3 13.3 8.1 3.1Afren PLC 'B067275 GBP GB 0.2 0.00 nm nm 5.4 2.0 0.6Coastal Energy Co ' CAD CA 0.6 0.00 nm nm 5.5 2.2 0.2Falkland Oil & Gas Ltd 'B030JM1 CAD GB 0.4 0.00 nm nm nm nm 0.2WesternZagros Resources Ltd 'B28C175 CAD CA 0.2 0.00 nm nm nm nm 0.2

8.9DrillingTransocean Ltd 'B3KFWW1 USD US 3.3 0.79 5.2 5.2 5.8 6.0 23.8Patterson-UTI Energy Inc '2672537 USD US 2.1 0.04 4.6 5.6 nm nm 2.0Unit Corp '2925833 USD US 3.0 0.04 4.8 4.0 14.4 12.4 1.3

8.4Equipment & ServicesHalliburton Co '2405302 USD US 3.3 0.61 7.7 nm nm nm 18.6Helix Energy Solutions Group Inc'2037062 USD US 2.7 0.03 3.3 3.9 8.9 8.5 1.1Shandong Molong Petroleum Machinery Co Ltd'B00LNZ8 HKD HK 0.3 0.00 18.5 0.4 1.1 0.9 0.5

6.3Construction & EngineeringKentz Corp Ltd 'B28ZGP7 GBP GB 0.5 0.00 11.9 0.1 9.1 8.6 0.3

Oil & Gas Refining & MarketingSingapore Petroleum Co Ltd '6812340 SGD SG 3.7 0.08 6.3 13.0 16.8 14.1 2.2

Cash 142,450 0.4Total 100.00

Average PER of Fund 7.3 4.7 15.2 10.6Median PER stocks held 8.9 6.7 13.3 10.4

nm' = Not meaningfulResearch position

The Fund’s portfolio may change significantly over a short period of time; no recommendation is made for the purchase or sale of any particular stock.


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7. Manager’s concluding comments

Although June saw energy equities retreating, in the 3 month period from March 31, 2009 to June 30, 2009, the MSCI World Energy Index was up 15.90%, nearly exactly matching a rise of 15.91% in the S&P 500 Index. Notwithstanding this move up my view remains that they represent a good store of value and potential for above average returns as the oil price stabilises around the level sought by OPEC ($60 - $80) (I mention earlier we believe they discount an oil price well below this indeed possibly only $40 per barrel). Then, when a few years thereafter the oil price resumes its rise to the level that will balance dwindling supply and relentless demand from developing economies, further upside waits. We still find it easier to see how energy equities can rise 50% or perhaps even double from their current level than for the broad market to do the same. We believe recent weakness rep-resents an opportunity to buy on dips.

There are signs that oil demand is now recovering, especially in the non-OECD region: the data from China on oil imports and car/vehicle sales is encouraging. In the OECD signals are less clear. For example, in the US despite a recent strengthening in gasoline sales, demand for other oil products continues to drop. My judgement is that quite a sharp economic recovery is likely as vehicle sales and housing starts retrace from very depressed levels. However, as oil inventories remain very loose, I am lead to infer that the recent price strength has been caused by non-fundamental factors such as speculator and commodity index fund buying either as a hedge against a weak dollar or rising inflation or anticipating improving fundamentals. Last month I said: “So our enthusiasm for energy equities on a valuation and improving fundamentals basis is tempered by a natural caution as there is a possibility the oil price gives up some of its recent gains.” This turned out pretty accurate.

The US natural gas market remains weak but the continued rapid decline in the US rig count is bring-ing closer the day that this will also tighten. We expect a smart snap-back in the US natural gas price when this begins to occur. This again should be supportive of equity prices in 2010.

We recognise that there are also risks in respect of our medium term positive analysis of the funda-mentals. It may turn out that OPEC have not yet taken enough barrels off the market and that if com-pliance falters the market will loosen further. The US natural gas market may not rebalance as fast as we hope. But we keep coming back to one key proposition: oil and gas are running out and it does seem reasonable to believe that before they do run out they will trade at much higher prices than we have yet seen and shareholders in companies that are part of that world should be duly rewarded.

Overall, the Fund continues to seek to be well placed to benefit from the oil price environment de-scribed above and to enable investors to benefit from a recovery in energy markets when it comes.

Tim GuinnessChairman & Chief Investment Officer10 July 2009

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The Fund’s holdings, industry sector weightings and geographic weightings may change at any time due to ongoing portfolio management. References to specific investments and weightings should not be construed as a recommendation by the Fund or Guinness Atkinson Asset Management, Inc. to buy or sell the securities. Current and future portfolio holdings are subject to risk.

Mutual fund investing involves risk and loss of principal is possible. The Fund invests in for-eign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its as-sets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller compa-nies, which involve additional risks such as limited liquidity and greater volatility.

The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. The MSCI World Energy Index is an unmanaged in-dex composed of more than 1,400 stocks listed on exchanges in the U.S., Europe, Canada, Australia, New Zealand and the Far East. They assume reinvestment of dividends, capital gains and excludes management fees and expenses. They are not available for investment. The Goldman Sachs Com-modity Index is a global production weighted index composed of 24 commodity futures contracts. The index is managed by Goldman Sachs Group Inc. The DJ AIG Commodity Index is also an in-dex composed of commodity futures contracts. The index is managed by Dow Jones and Company. Bloomberg Active Indices for Funds (BAIF) are used to measure a fund’s performance against its peers. BAIF indices represent a composite of funds in the same peer group. This index (BBOEN-RUS) represents open-ended energy funds domiciled in the United States. They are not available for investment.

Price to earnings ratio reflects the multiple of earnings at which a stock sells.

Earnings per share is the portion of a company’s profit allocated to each outstanding share of com-mon stock. The amount is computed by dividing net earnings by the number of outstanding shares of common stock.

Cash flow is equal to cash receipts minus cash payments over a given period of time.This information is authorized for use when preceded or accompanied by a prospectus for the Guin-ness Atkinson Global Energy Fund. The prospectus contains more complete information, including investment objectives, risks, charges and expenses related to an ongoing investment in the Fund. Please read the prospectus carefully before investing.

Distributed by Quasar Distributors, LLC. (07/09)

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Appendix: oil and gas markets, historical context

Figure 11: Oil price (WTI $) last 20 years.Source: Bloomberg

For the oil market, the period since the Iraq Kuwait war (1990/91) can be divided into two distinct periods: the first 9-year period was broadly characterized by decline. The oil price steadily weakened 1991 - 1993, rallied between 1994 –1996, and then sold off sharply, to test 20 year lows in late 1998. This latter decline was partly induced by a sharp contraction in demand growth from Asia, associ-ated with the Asian crisis, partly by a rapid recovery in Iraq exports after the UN Oil for food deal, and partly by a perceived lack of discipline at OPEC in coping with these developments.

The last 9 years, by contrast, have seen a much stronger price and upward trend. There was a very strong rally between 1999 and 2000 as OPEC implemented 4 m b/day of production cuts. It was followed by a period of weakness caused by the rollback of these cuts, coinciding with the world eco-nomic slowdown, which reduced demand growth and a recovery in Russian exports from depressed levels in the mid 90’s that increased supply. OPEC responded rapidly to this during 2001 and reintro-duced production cuts that stabilized the market relatively quickly by the end of 2001.

Then, in late 2002 early 2003, war in Iraq and a general strike in Venezuela caused the price to spike upward. This was quickly followed by a sharp sell-off due to the swift capture of Iraq’s Southern oil fields by Allied Forces and expectation that they would win easily. Then higher prices were gener-ated when the anticipated recovery in Iraq production was slow to materialise. This was in mid to end 2003 followed by a much more normal phase with positive factors (China demand; Venezu-elan production difficulties; strong world economy) balanced against negative ones (Iraq back to 2.5 m b/day; 2Q seasonal demand weakness) with stock levels and speculative activity needing to be monitored closely. OPEC’s management skills appeared likely to be the critical determinant in this environment.

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By mid 2004 the market had become unsettled by the deteriorating security situation in Iraq and Saudi Arabia and increasingly impressed by the regular upgrades in IEA forecasts of near record world oil demand growth in 2004 caused by a triple demand shock from strong demand simultane-ously from China; the developed world (esp. USA) and Asia ex China. Higher production by OPEC has been one response and there was for a period some worry that this, if not curbed, together with demand and supply responses to higher prices, would cause an oil price sell off. Offsetting this has been an opposite worry that non OPEC production could be within a decade of peaking; a growing view that OPEC would defend $50 oil vigorously; upwards pressure on inventory levels from a move from JIT (just in time) to JIC (just in case); and pressure on futures markets from commodity fund investors.

Since 2005 we saw a further strong run-up in the oil price. Hurricanes Katrina and Rita which devas-tated New Orleans caused oil to spike up to $70 in August 2005, and it spiked up again in July 2006 to $78 after a three week conflict between Israel and Lebanon threatened supply from the Middle East. OPEC implemented cuts in late 2006 and early 2007 of 1.7 million barrels per day to defend $50 oil and with non-OPEC supply growth at best anaemic demonstrated that it could to act a price-setter in the market at least so far as putting a floor under it.

Continued expectations of a supply crunch by the end of the decade, coupled with increased specu-lative activity in oil markets, contributed to the oil price surging past $90 in the final months of 2007 and as high as $147 by the middle of 2008. This latest spike has now unwound and the oil price fell back early 2009 to bottom just above $30 from where it is now recovering.

Figure 12: North American gas price last 17 years (Henry Hub $/Mcf)Source: BloombergWith regard to the US natural gas market, the price traded between $1.50 and $3/Mcf for the period 1991 - 1999. This was followed by two significant spikes up to $8-10/Mcf, one in late 2000 and one early in 2003. The spikes were caused by very tight supply situations because there is an underlying problem with supply in the rapid depletion of North American gas reserves. On both occasions, the


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price spike induced a spurt of drilling which brought the price back down. More recently we have seen another period of very firm (over $5/Mcf) gas prices followed by a hurricane induced spike. Since the big spike in late 2005 the gas price has traded mainly in the $6-$8 range, with a significant move down precipitated by the collapse of Amaranth in 2006 and most recently a new but short-lived spike in 2008 above $10 and in 2009 a very weak period below $4.North American gas prices are important to many E&P companies. In the short-term, they do not necessarily move in line with the oil price, as the gas market is essentially a local one. (In theory 6 Mcf of gas is equivalent to 1 barrel of oil so $60 per barrel equals $10/Mcf gas). It is a regional market more than a global market because Liquid Natural Gas imports cannot rapidly respond to increased demand because of the high infrastructure spending needed to increase capacity but that is slowly becoming less true as LNG infrastructure is put in place.


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