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QRE > SEC Filings for QRE > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for QR ENERGY, LP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis in conjunction with Management's Discussion and Analysis in Part II-Item 7 of our 2011 Annual Report and the consolidated financial statements and related notes therein. Our Annual Report contains a discussion of other matters not included herein, such as disclosures regarding critical accounting policies and estimates and contractual obligations. You should also read the following discussion and analysis together with the risk factors set forth in the 2011 Annual Report and in Part I-Item 1A "Risk Factors" of this report and the "Cautionary Statement Regarding Forward-Looking Information" in this report and in our Annual Report.

Overview

QR Energy, LP ("we," "us," "our," or the "Partnership") is a Delaware limited partnership formed on September 20, 2010, to receive certain assets of the affiliated entity, QA Holdings, LP (the "Predecessor") and own other assets. 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 being a co-issuer of our debt securities.

Our financial results depend upon many factors, but are largely driven by the volume of our oil and natural gas production and the price that we receive for that production. Our production volumes will decline as reserves are depleted unless we expend capital in successful development and exploitation activities or acquire properties with existing production. The amount we realize for our production depends predominately upon commodity prices and our related commodity price hedging activities, which are affected by changes in market demand and supply, as impacted by overall economic activity, weather, pipeline capacity constraints, inventory storage levels, basis differential and other factors. These risk factors are mitigated by our hedging program which generally hedges approximately 65% to 85% of our current and anticipated production over the next three-to-five year period. Oil and natural gas prices have been extremely volatile, and we expect this volatility to continue. Oil and natural gas prices have experienced a general decline since 2011. The unweighted arithmetic average first day of-the-month prices for the prior 12 months decreased to $94.97/Bbl for oil and $2.83/MMbtu for natural gas as of September 30, 2012 from $96.19/Bbl for oil and $4.12/MMbtu for natural gas as of December 31, 2011. Further declines in future oil and natural gas market prices could have a negative impact on our reserve value and could result in an impairment of our oil and gas properties. For example, a hypothetical $10/Bbl decrease in the 12 month average of oil prices would decrease our reserves by $208.1 million, and a hypothetical $1/Mcf decrease in the 12 month average of natural gas prices would decrease our reserves by $104.9 million. Accordingly, finding and developing oil and natural gas reserves at economical costs is critical to our long-term success.

Results of Operations

Because affiliates of the Fund own 100% of our general partner and an aggregate 38.8% limited partner interest in us including all of our preferred and subordinated units as of September 30, 2012, each acquisition of assets from the Predecessor is considered a transfer of net assets between entities under common control. As a result, we are required to revise our financial statements to include the activities of all assets acquired from the Predecessor for all periods presented by the Partnership, similar to a pooling of interests, to include the financial position, results of operations, and cash flows of the assets acquired and liabilities assumed. The table set forth below includes the recast historical financial information for the three and nine months ended September 30, 2011 as if the oil and gas properties acquired from the Predecessor in October 2011 were owned by us for all periods presented for the Partnership. These results are presented for illustrative purposes only and have been prepared from the Predecessor's historical cost-basis accounts and may not necessarily be indicative of the actual results of operations that would have occurred if the Partnership had owned the assets during the periods reported.


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                       Results of Operations - Continued





                                      Three Months Ended           Nine Months Ended
                                                  September                   September
                                    September     30, 2011      September     30, 2011
                                    30, 2012         (1)        30, 2012         (1)
Revenues: (2)
Oil sales                         $   51,076    $   38,315    $  145,270    $  120,565
Natural gas sales                      8,623        17,453        27,604        50,474
NGLs sales                             4,860         8,521        18,848        22,930
Processing and other                     410           492         1,243         1,523
Total Revenue                         64,969        64,781       192,965       195,492
Operating Expenses:
Lease operating expenses              19,203        18,672        56,861        48,802
Production and other taxes             4,693         4,480        14,224        13,431
Processing and transportation            785         1,009         2,363         2,964
Total production expenses             24,681        24,161        73,448        65,197
Depreciation, depletion and
amortization                          21,298        19,965        61,428        58,295
Accretion of asset retirement
obligations                              915           719         2,645         2,033
General and administrative and
other                                  9,232         8,338        26,345        22,577
Acquisition and transaction
costs                                    278              -        1,286              -
Total operating expenses              56,404        53,183       165,152       148,102
Operating income                       8,565        11,598        27,813        47,390
Other income (expense):
Realized gains (losses) on
commodity derivative contracts        13,375       (39,072)       35,668       (79,924)
Unrealized gains (losses) on
commodity derivative contracts       (55,585)      153,378        12,328       160,233
Interest expense, net                (11,533)      (19,950)      (28,398)      (39,161)
Total other income (expense),
net                                  (53,743)       94,356        19,598        41,148
Income (loss) before income
taxes                                (45,178)      105,954        47,411        88,538
Income tax benefit (expense)             171          (789)         (528)         (934)
Net income (loss)                 $  (45,007)   $  105,165    $   46,883    $   87,604
Production data (3):
Oil (MBbls)                              576           439         1,575         1,314
Natural gas (MMcf)                     3,400         3,834        10,587        11,709
Natural gas liquids (MBbls)              202           200           559           576
Total (Mboe)                           1,345         1,278         3,899         3,842
Average Net Production (Boe/d)        14,620        13,891        14,230        14,073
Average sales price per unit
(4):
Oil (Per Bbl)                     $    88.67    $    87.28    $    92.23    $    91.75
Natural gas (per Mcf)             $     2.60    $     4.71    $     2.67    $     4.45
Natural gas liquids (Per Bbl)     $    29.10    $    54.27    $    41.42    $    51.07
Average unit cost per Boe:
Lease operating expense           $    14.28    $    14.61    $    14.58    $    12.70
Production and other taxes        $     3.49    $     3.51    $     3.65    $     3.50
Depreciation, depletion and
amortization                      $    15.83    $    15.62    $    15.75    $    15.17
General and administrative
expenses                          $     6.86    $     6.52    $     6.76    $     5.88

(1) These results of operations have been recast to include financial information for the assets acquired under common control. Refer to Note 2 - Significant Accounting Policies of Notes to Financial Statements (Unaudited) for basis of presentation.

(2) Certain natural gas liquid sales for the three and nine months ended September 30, 2011 have been reclassified from natural gas sales to conform to current presentation. This resulted in an increase in natural gas liquid sales and a decrease in natural gas sales of $5.6 million and $15.5 million and an increase in natural gas liquid volumes of 103 MBbls and 304 MBbls and a decrease in natural gas volumes of 615 MMcf and 1,819 MMcf.

(3) Includes certain volumes for natural gas (79 MMcf and 256 MMcf for the three and nine months ended September 30, 2012 and 130 MMcf and 366 MMcf for the three and nine months ended September 30, 2011) and natural gas liquids (35 MBbls and 104 Bbls for the three and nine months ended September 30, 2012 and 43 MBbls and 127 MBbls for the three and nine months ended September 30, 2011) for which revenues were reported on a net basis.

(4) Does not include the impact of derivative instruments.


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Results of Operations - Continued

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

We recorded net loss of $45.0 million for the three months ended September 30, 2012 compared to net income of $105.2 million for the three months ended September 30, 2011. This change was primarily driven by a net decrease in realized and unrealized gains on commodity derivative contracts of $156.5 million.

Oil and Gas Revenues:




                                               Three Months Ended September 30,
                                                                Increase      Percentage
                                        2012        2011       (Decrease)       Change
    Production:
    Oil (MBbls)                           576         439            137            31%
    Natural Gas (MMcf)                  3,400       3,834           (434)           -11%
    NGL (MBbl)                            202         200              2             1%
    Total (Mboe)                        1,345       1,278             67             5%

    Average sales prices per unit:
    Oil (per Bbl)                    $  88.67    $  87.28    $      1.39             2%
    Natural Gas (per Mcf)                2.60        4.71          (2.11)           -45%
    NGL (per Bbl)                       29.10       54.27         (25.17)           -46%
    Total (per Boe)                     48.00       50.30          (2.30)            -5%

    Revenues:
    Oil sales                        $ 51,076    $ 38,315    $    12,761            33%
    Natural Gas sales                   8,623      17,453         (8,830)           -51%
    NGL sales                           4,860       8,521         (3,661)           -43%
     Total oil and gas revenue       $ 64,559    $ 64,289    $       270             0%

Total oil and gas revenue increased by $0.3 million to $64.6 million for the three months ended September 30, 2012 due higher production volumes despite a decrease in the prices per Boe mainly attributable to lower natural gas and NGL prices. The increase in production volumes is mainly attributable to increased oil production related to the assets acquired in the Prize Acquisition, offset by a decrease in natural gas and natural gas liquids production volumes due to the effects of natural declines in the three months ended September 30, 2012 as compared to the three months ended September 30, 2011.

Production Expenses. Our production expense for the three months ended September 30, 2012 increased to $24.7 million from $24.2 million for the three months ended September 30, 2011, consisting mainly of an increase in lease operating expenses to $19.2 million, or $14.28 per Boe, for the three months ended September 30, 2012 from $18.7 million, or $14.61 per Boe for the three months ended September 30, 2011, and an increase in production and other taxes to $4.7 million, or $3.49 per Boe, from $4.5 million, or $3.51 per Boe for the three months ended September 30, 2011. The increase in production expenses is primarily attributable to the Prize Acquisition offset by a decrease in workover expenses in the three months ended September 30, 2012 as compared to the three months ended September 30, 2011.

Depreciation, Depletion and Amortization Expenses. For the three months ended September 30, 2012, our depreciation, depletion and amortization ("DD&A") expenses were $21.3 million, or $15.83 per Boe, as compared to $20.0 million, or $15.62 per Boe, for the three months ended September 30, 2011. The increase in DD&A expense is mainly attributable to the Prize Acquisition for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011.

General and Administrative and Other Expenses. For the three months ended September 30, 2012 our general and administrative and other expenses increased to $9.2 million, or $6.86 per Boe, as compared to $8.3 million, or $6.52 per Boe, for the three months ended September 30, 2011. The increase is mainly attributable to the higher personnel costs associated with increasing our staffing levels to meet our current organizational needs in the three months ended September 30, 2012 as compared to the three months ended September 30, 2011.


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Effects of Commodity Derivative Contracts. For the three months ended September 30, 2012, our realized gains on commodity derivative contracts increased to $13.4 million from a realized loss of $39.1 million for the three months ended September 30, 2011. Unrealized gains (losses) on commodity derivative contracts decreased to a $55.6 million loss for the three months September 30, 2012 from a $153.4 million gain for the three months ended September 30, 2011. Unrealized gains and losses result from changes in the future commodity prices as compared to the fixed price of our open commodity derivative contracts. Realized gains and losses result from the settlement of derivative contracts at the market price as compared to the fixed contract price.

The change in realized and unrealized gains (losses) is mainly attributable to increasing oil and gas prices as compared to our fixed price derivative contracts in the three months ended September 30, 2012 as compared to decreasing oil and gas prices in the three months ended September 30, 2011, as well as the modification of certain oil derivative contracts during the third quarter of 2011.

Interest Expense, net. Net interest expense decreased to $11.5 million for the three months ended September 30, 2012 as compared to $20.0 million for the three months ended September 30, 2011. The net decrease in realized and unrealized losses on derivative contracts is related to lower interest rates in September 30, 2012 versus September 30, 2011 offset by an increase in interest expense of $4.1 million related to the Senior Notes issued during the three months ended September 30, 2012.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

We recorded net income of $46.9 million for the nine months ended September 30, 2012 compared to net income of $87.6 million for the nine months ended September 30, 2011. This change was primarily driven by a net decrease in realized and unrealized gains on commodity derivative contracts of $32.3 million and an increase in lease operating expenses of $8.1 million.

Oil and Gas Revenues:




                                                Nine Months Ended September 30,
                                                                 Increase      Percentage
                                        2012         2011       (Decrease)       Change
   Production:
   Oil (MBbls)                          1,575        1,314            261            20%
   Natural Gas (MMcf)                  10,587       11,709         (1,122)           -10%
   NGL (MBbl)                             559          576            (17)            -3%
   Total (Mboe)                         3,899        3,842             57             1%

   Average sales prices per unit:
   Oil (per Bbl)                    $   92.23    $   91.75    $      0.48             1%
   Natural Gas (per Mcf)                 2.67         4.45          (1.78)           -40%
   NGL (per Bbl)                        41.42        51.07          (9.65)           -19%
   Total (per Boe)                      49.17        50.49          (1.32)            -3%

   Revenues:
   Oil sales                        $ 145,270    $ 120,565    $    24,705            20%
   Natural Gas sales                   27,604       50,474        (22,870)           -45%
   NGL sales                           18,848       22,930         (4,082)           -18%
   Total oil and gas revenue        $ 191,722    $ 193,969    $    (2,247)            -1%

Total oil and gas revenue decreased by $2.2 million to $191.7 million for the nine months ended September 30, 2012 due to lower sales prices per Boe mainly attributed to decreased prices for natural gas and natural gas liquids, partially offset by a slight increase in the total production volumes of 57 Mboe. The increase in production volumes is mainly attributable to increased oil production related to the assets acquired in the Prize Acquisition, offset by a decrease in natural gas and natural gas liquids production volumes due to the effects of natural declines in the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011.

Production Expenses. Our production expense for the nine months ended September 30, 2012 increased to $73.4 million from $65.2 million for nine months ended September 30, 2011, consisting mainly of an increase in lease operating expenses to $56.9 million, or $14.58 per Boe, for the nine months ended September 30, 2012 from $48.8 million, or $12.70 per Boe for the nine months ended September 30, 2011, and an increase in production and


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other taxes to $14.2 million, or $3.65 per Boe, from $13.4 million, or $3.50 per Boe for the nine months ended September 30, 2011. The increase in production expenses is attributable to the Prize Acquisition, an increase in workover expenses, and an increase in other lease operating expenses in the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011.

Depreciation, Depletion and Amortization Expenses. For the nine months ended September 30, 2012 our DD&A expenses were $61.4 million, or $15.75 per Boe as compared to $58.3 million, or $15.17 per Boe for the nine months ended September 30, 2011. The increase in DD&A expense is due mainly attributable to the Prize Acquisition during the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011.

General and Administrative and Other Expenses. For the nine months ended September 30, 2012 our general and administrative and other expenses increased to $26.3 million, or $6.76 per Boe, as compared to $22.6 million, or $5.88 per Boe for the nine months ended September 30, 2011. The increase is mainly attributable to the higher personnel costs associated with increasing our staffing levels to meet our current organizational needs in the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011.

Effects of Commodity Derivative Contracts. For the nine months ended September 30, 2012, our realized gains increased to a $35.7 million gain from a realized loss of $79.9 million in the nine months ended September 30, 2011. Unrealized gains on commodity derivative contracts decreased to $12.3 million for the nine months September 30, 2012 from $160.2 million for the nine months ended September 30, 2011. Unrealized gains and losses result from changes in the future commodity prices as compared to the fixed price of our open commodity derivative contracts. Realized gains and losses result from the settlement of derivative contracts at the market price as compared to the fixed contract price.

The change in realized and unrealized gains (losses) is mainly attributable to increasing oil and gas prices as compared to our fixed price derivative contracts in the three months ended September 30, 2012 as compared to decreasing oil and gas prices in the three months ended September 30, 2011, as well as the modification of certain oil derivative contracts during the third quarter of 2011.

Interest Expense, net. Net interest expense decreased to $28.4 million for the nine months ended September 30, 2012 as compared to $39.2 million for the nine months ended September 30, 2012. The net decrease in realized and unrealized losses on derivative contracts is related to lower interest rates at September 30, 2012 as compared to September 30, 2011 partially offset by a commitment fee of $1.6 million related to the Bridge Loan and an increase in interest expense of $4.6 million related to the Senior Notes in the nine months ended September 30, 2012.

Liquidity and Capital Resources

Our cash flow from operating activities for the nine months ended September 30, 2012 was $110.4 million.

Our primary sources of liquidity and capital resources are cash flows generated by operating activities, borrowings under our credit facility, and debt and equity offerings. The capital markets continue to experience volatility. Many financial institutions have had liquidity concerns, prompting government intervention to mitigate pressure on the credit markets. Our exposure to current credit conditions includes our credit facility, debt securities, cash investments and counterparty performance risks. Continued volatility in the debt markets may increase costs associated with issuing debt instruments due to increased spreads over relevant interest rate benchmarks and affect our ability to access those markets.

We entered into a Second Amendment to the Credit Agreement on March 16, 2012 to provide for additional derivative contracts to cover production to proved reserves to be acquired.

In April 2012, we entered into the Third Amendment to the Credit Agreement whereby increasing our credit facility from $750 million to $1.5 billion, increasing our borrowing base from $630 million to $730 million, and the maturity date was extended from December 22, 2015 to April 20, 2017.

On June 1, 2012, we filed a registration statement on Form S-3 with the SEC to register the issuance and sale of, among other securities, our debt securities, which may be co-issued by QRE FC. The registration statement also registered guarantees of debt securities by OLLC. Refer to Part I, Item 1. Consolidated Financial Statements (Unaudited) - Note 16 - Subsidiary Guarantors for further details.


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On July 30, 2012, we, and our wholly-owned subsidiary QRE FC, issued $300 million of 9.25% Senior Notes due 2020. Under the Credit Agreement we are required to reduce our borrowing base by an amount equal to 0.25 multiplied by the stated principal amount of any issuances of senior notes. As a result of the issuance of the Senior Notes on July 30, 2012, our borrowing base was reduced by $75 million to $655 million from $730 million. On the same date, we made a payment on our outstanding borrowings under our revolving credit facility of $291.5 million using the cash proceeds from the Senior Notes issuance and cash on hand. On October 30, 2012, we were notified of an increase in our borrowing base, as part of our semi-annual borrowing base redetermination, from $655 million to the borrowing base prior to the issuance of the Senior Notes of $730 million. Refer to Part I, Item 1. Consolidated Financial Statements (Unaudited)
- Note 9 - Long-Term Debt for further details.

As of September 30, 2012, our liquidity of $355.0 million consisted of $25.1 million of available cash and $329.9 million of availability under our credit facility after giving consideration to $0.1 million of outstanding letters of credit. As of September 30, 2012, we had $325 million of borrowings outstanding. As of November 8, 2012 we had $325 million of borrowings outstanding with borrowing availability of $404.9 million ($730 million of borrowing base less $325 million of outstanding borrowing and $0.1 million of outstanding letters of credit) under our credit facility. The borrowing base is redetermined as of May 1 and November 1 of each year. The administrative agent of our Credit Agreement accepted the Third Amendment to the Credit Agreement as our May 1 redetermination and our November redetermination was completed on October 30, 2012 as discussed above. In addition, we may request additional capacity for acquisitions of a minimum of the lesser of $50 million or ten percent of the then-existing borrowing base. We will continue to monitor our liquidity and the credit markets. Additionally, we continue to monitor events and circumstances surrounding each of the lenders in our credit facility.

A portion of our capital resources may be utilized in the form of letters of credit to satisfy counterparty collateral demands. As of September 30, 2012, we had letters of credit in the amount of $0.1 million outstanding for utilities.

On April 17, 2012, we issued 6,202,263 common units representing limited partnership interests in us, and the Fund sold 11,297,737 common units it held in us, to the public pursuant to a registration statement filed with the SEC. In conjunction with the Equity Offering, the Partnership granted the underwriters an over-allotment option for 30 days to purchase up to an additional 2,625,000 common units from the Partnership, which they exercised in full. The common units, including the units issued pursuant to the underwriters' full exercise of their option, were issued by us or sold by the Fund at $19.18 per unit. Proceeds from the Equity Offering, net of transaction costs of $0.5 million and underwriter's discount of $6.8 million, were approximately $162 million.

On September 28, 2012, we announced that our general partner declared a cash distribution to our common and subordinated unitholders and our general partner at the third quarter rate of $0.4875 per unit. Our Partnership Agreement obligates us to make cash distributions to our preferred unitholders at a rate of $0.21 per unit per quarter. Due to our cash distribution policy, we expect that we will distribute to our unitholders most of the cash generated by our operations. As a result, we expect that we will rely upon external financing sources.

Working Capital. Working capital is the amount by which current assets exceed current liabilities. Our working capital requirements are primarily driven by changes in accounts receivable and accounts payable. These changes are impacted by changes in the prices of commodities that we buy and sell. In general, our working capital requirements increase in periods of rising commodity prices and decrease in periods of declining commodity prices. However, our working capital . . .

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