NOTE 1 - ORGANIZATION AND OPERATIONS

QR Energy, LP (“we,” “us,” “our,” or the “Partnership”) is a Delaware limited partnership formed on September 20, 2010, to receive certain of the assets of QA Holdings, LP (the “Predecessor”). Our general partner is QRE GP, LLC (“QRE GP”). We operate the acquired assets through our wholly owned operating company QRE Operating, LLC (“OLLC”).

The Predecessor is a Delaware limited partnership, which commenced operations on April 1, 2006 for the primary purpose of acquiring, owning, enhancing and producing oil and gas properties through its subsidiaries. The Predecessor holds general partner interests in a collection of limited partnerships. Certain of the Predecessor's subsidiary limited partnerships, (collectively, or in any combination, known as the “Fund”) comprise Quantum Resources A1, LP, Quantum Resources B, LP, Quantum Resources C, LP, QAB Carried WI, LP, QAC Carried WI, LP and Black Diamond Resources, LLC. The Partnership and the Fund are managed by Quantum Resources Management, LLC (“QRM”), a full service management company originally formed to manage the oil and natural gas interests of the Predecessor. The general partner of the Predecessor and the individual entities included in the Fund is QA Global GP, LLC (“QA Global”).

On December 22, 2010 (the “Closing Date”), we completed our initial public offering (“IPO”) of 15,000,000 common units representing limited partner interests in the Partnership at $20.00 per common unit, or $18.70 per unit after payment of the underwriting discount. Net proceeds from the sale of the common units in the IPO were $279.8 million ($300 million less $19.5 million underwriters' discount and $0.7 million structuring fee). IPO costs totaling $5.1 million were borne entirely by the Fund and are included in offering costs in the Predecessor's consolidated statement of operations for the period January 1 to December 21, 2010.

On the Closing Date, a Contribution, Conveyance and Assumption Agreement (the “Contribution Agreement”) was executed by and among the Fund, the Partnership and QRE GP with net assets contributed by the Fund to the Partnership (“IPO Assets”) using carryover book value of the Fund as the transaction is a transfer of assets between entities under common control. The Contribution Agreement and other concurrent transactions included $223.7 million in net assets contributed by the Fund to the Partnership. In exchange for the net assets, the Fund received 11,297,737 common, 7,145,866 subordinated limited partner units and a $300 million cash distribution. QRE GP made a capital contribution of $0.7 million in exchange for 35,729 general partner units which was received in January 2011.

On January 3, 2011, the underwriters exercised their over-allotment option in full for 2,250,000 common units issued by the Partnership at $20.00 per unit. Net proceeds from the sale of these common units, after deducting offering costs, were approximately $42 million which, in accordance with the Contribution Agreement were distributed to the Fund as consideration for assets contributed on the Closing Date and reimbursements for pre-formation capital expenditures.

On September 12, 2011, a Purchase and Sale Agreement (“Purchase Agreement”) was executed by and among the Fund, the Partnership and OLLC with certain oil and gas properties and attributable liabilities contributed by the Fund to the Partnership (“Transferred Properties”) in exchange for 16,666,667 Class C Convertible Preferred Units (“Preferred Units”) and the assumption of $227 million in debt (the “Transaction”).

The Partnership completed the Transaction on October 3, 2011, effective on October 1, 2011 (“Effective Date”). The fair value of the Preferred Units on the Effective Date was $21.27 per unit or $354.5 million. On the Effective Date, net assets of $252.0 million were contributed by the Fund to the Partnership. The value of the Preferred Units in excess of the net assets contributed by the Fund is considered a $102.5 million distribution from the Partnership and allocated pro rata to the general partner and existing limited partners. Net assets contributed by the Fund comprised the following:

Oil and gas properties, net	$	441,207
Gas processing equipment, net		251
Derivative instrument asset, net		64,671
Deferred tax asset		205
Long-term debt		(227,000	)
Asset retirement obligation		(26,294	)
Natural gas imbalance		(3,709	)
Book value of net assets		249,331
Purchase price adjustments		2,715
Net assets contributed by the Predecessor (1)	$	252,046

(1)

The net assets contributed to us include the carryover book value of the Predecessor as prescribed by our accounting policy for transactions between entities under common control in Note 2 and a $2.7 million purchase price adjustment for natural gas imbalances in accordance with the Purchase Agreement.

The Preferred Units will receive a cumulative preferred quarterly distribution of $0.21 per unit equal to 4.0% annual coupon on the par value of $21.00 for the first three years following the date of issuance. The Preferred Units have a senior liquidation preference of $21.00 per unit plus any accrued but unpaid distributions. After three years, the quarterly cash distribution will be equal to the greater of (a) $0.475 per unit or (b) the cash distribution payable on each Common Unit for such quarter. The Preferred Units are convertible, subject to certain limitations, into common units representing limited partner interests in us on a one-to-one basis, subject to adjustment.

In connection with the issuance of the Preferred Units, on October 3, 2011, we executed Amendment No. 1 to the First Amended and Restated Agreement of Limited Partnership (the “Amendment”) to designate and create the Preferred Units and set forth the rights, preferences and privileges of such units, including the respective conversion rights held by the holders of the Preferred Units and us.

As of December 31, 2011, our ownership structure comprised a 31.8% preferred unitholder interest held by the Fund, 0.1% general partnership interest held by QRE GP, 35.2% in limited partner interests held by the Fund and 32.9% in limited partner interests held by the public unitholders.

Services Agreement

On the Closing Date, we entered into a Services Agreement (the “Services Agreement”) with QRM, QRE GP and OLLC, pursuant to which QRM will provide the administrative and acquisition advisory services necessary to allow QRE GP to manage, operate and grow our business. Under the Services Agreement, from the Closing Date through December 31, 2012, QRM will be entitled to a quarterly administrative services fee equal to 3.5% of the Adjusted EBITDA generated by us during the preceding quarter, calculated prior to the payment of the fee. After the term of the Services Agreement, in lieu of the quarterly administrative services fee, QRE GP will reimburse QRM, on a quarterly basis, for the allocable expenses QRM incurs in its performance under the Services Agreement, and we will reimburse QRE GP for such payments it makes to QRM.

Omnibus Agreement

On the Closing Date, we entered into an Omnibus Agreement (the “Omnibus Agreement”) by and among QRE GP, OLLC, the Fund, the Predecessor and QA Global. The Omnibus Agreement governs the following types of potential transactions:

The Fund agrees to provide us, for at least five years from the Closing Date, the first opportunity to purchase certain oil and gas assets it may offer for sale which consist of at least 70% proved developed producing reserves.

The Fund agrees to allow us the first option to participate in certain of its acquisition opportunities so long as 70% of the allocated value of the acquisition is attributable to proved developed producing reserves for a period of five years from the Closing Date.

Should QA Global or any of its affiliates close any new investment fund within two years from the Closing Date, the Omnibus Agreement shall be amended to include those entities as parties to the terms in the first two points above.

For additional discussion of the agreements listed above see Note 14.