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 acquire oil and gas assets from our affiliated entity, QA Holdings, LP (the “Predecessor”) and other third party entities in order to enhance and exploit oil and gas properties. We currently have oil and gas related properties in Alabama, Arkansas, Florida, Kansas, Louisiana, Michigan, New Mexico, Oklahoma and Texas. Certain of the Predecessor’s subsidiaries (collectively known as the “Fund”) include 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. Quantum Resources Management, LLC (“QRM”) provides management and operational services for us and the Fund. Our general partner is QRE GP, LLC (or “QRE GP”). We conduct our operations through our wholly owned subsidiary QRE Operating, LLC (“OLLC”). Our wholly owned subsidiary, QRE Finance Corporation (“QRE FC”), has no material assets and was formed for the sole purpose of serving as a co-issuer of our debt securities.

We completed our initial public offering (“IPO”) of 15,000,000 common units representing limited partner interests in the Partnership on December 22, 2010 (the “IPO Closing Date”). Net proceeds from the IPO were approximately $280 million. On the IPO Closing Date, a Contribution, Conveyance and Assumption Agreement (the “Contribution Agreement”) was executed by and among the Fund, the Partnership and QRE GP, see Note 15 – Related Party Transactions for details, with net assets contributed by the Fund to the Partnership (“IPO Assets”) using historical book value of the Fund as the transaction is a transfer of assets between entities under common control. In exchange for the net assets, the Fund received 11,297,737 common and 7,145,866 subordinated limited partner units. QRE GP made a capital contribution to the Partnership in exchange for 35,729 general partner units. The underwriters exercised their option in full for 2,250,000 common units issued by the Partnership. Net proceeds from the sale of these common units, after deducting offering costs, were approximately $42 million.

On October 3, 2011, the Fund sold certain oil and gas properties to the Partnership (the “October 2011 Transferred Properties”) pursuant to a purchase and sale agreement (the “October 2011 Purchase Agreement”) by and among the Fund, the Partnership and OLLC in exchange for 16,666,667 Class C Convertible Preferred Units (“Preferred Units”) and the assumption of $227 million in debt (the “October 2011 Transaction”). The fair value of the Preferred Units on October 1, 2011 was $21.27 per unit or $354.5 million with net assets of $252.0 million contributed to the Partnership by the Fund. The October 2011Transaction was accounted for as a transaction between entities under common control whereby the October 2011 Transferred Properties were recorded at historical book value. As such, the value of the Preferred Units in excess of the net assets contributed by the Fund was deemed 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 historical book value of the Predecessor as prescribed by our accounting policy for transactions between entities under common control in Note 2 – Summary of Significant Accounting Policies and a $2.7 million purchase price adjustment for natural gas imbalances in accordance with the purchase and sale agreement.

On April 20, 2012, we closed the acquisition of primarily oil properties from Prize Petroleum, LLC and Prize Petroleum Pipeline, LLC (collectively “Prize”) for $225.1 million in cash after customary purchase price adjustments (the “Prize Acquisition”). Refer to Note 4 – Acquisitions for further details.

On December 4, 2012, we closed the acquisition of mature, legacy predominantly oil properties (“the East Texas Oil Field Properties”) from an undisclosed private seller located in East Texas for $214.3 million in cash subject to customary purchase price adjustments (the “East Texas Oil Field Acquisition”). Refer to Note 4 – Acquisitions for further details.

On December 28, 2012, the Fund sold certain oil and gas properties to the Partnership (the “December 2012 Transferred Properties”) pursuant to a purchase and sale agreement (the “December 2012 Purchase Agreement”) by and among the Fund, the Partnership and OLLC in exchange for $28.6 million in cash, after customary purchase price adjustments, and the assumption of $115 million in debt (the “December 2012 Transaction”). The December 2012 Transaction was accounted for as a transaction between entities under common control whereby the December 2012 Transferred Properties were recorded at historical book value. As such, the cash paid in excess of the net assets contributed by the Fund was deemed a $68.9 million distribution to the Predecessor 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
Evaluated	$	141,315
Accumulated depreciation, depletion, and amortization		(45,416)
Other assets ⁽¹⁾		10,732
Derivative instruments, net		(2,948)
Long-term debt		(115,000)
Asset retirement obligation		(34,261)
Book value of net assets		(45,578)
Purchase price adjustment		5,270
Net assets contributed by the Predecessor ⁽²⁾	$	(40,308)

⁽¹⁾	Represents a reclamation deposit in escrow as security for abandonment and redemption obligations.

⁽²⁾

The net assets contributed to us include the historical book value of the Predecessor as prescribed by our accounting policy for transactions between entities under common control in Note 2 – Summary of Significant Accounting Policies and a $5.3 million purchase price adjustment related to novated derivatives unwound by the Partnership.

As of December 31, 2012, our ownership structure comprised a 0.1% general partner interest held by QRE GP, a 31.7% limited partner interest held by the Fund, represented by all of our preferred units and 7,145,866 common units, and a 68.2% limited partner interest held by the public unitholders. As of December 31, 2011, our ownership structure comprised a 0.1% general partnership interest held by QRE GP, a 67% limited interest held by the Fund which included all of our preferred units and subordinated units, and a 32.9% limited partner interest held by the public unitholders.