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Executives

Taylor Miele – IR Manager

Alan Smith – CEO

Paul Geiger – SVP, Eastern Business Unit

Cedric Burgher – CFO

Analysts

Dan Guffey – Stifel Nicolaus

Kevin Smith – Raymond James

Michael Peterson – MLV & Company

Brett Reilly – Credit Suisse

QR Energy LP (QRE) Acquisition of $145 Million of Oil Properties in Florida Gulf Coast Area Conference Call January 3, 2013 11:00 AM ET

Operator

Welcome to QR Energy’s Acquisition Conference Call. My name is Shira, and I will be your operator for the call. On the line we have Chief Executive Officer, Alan Smith; and Investor Relations Manager, Taylor Miele. (Operator Instructions)

I will now turn the call over to Taylor Miele.

Taylor Miele

Thank you, Shira, and good morning, everyone. Welcome to QR Energy’s call to discuss our $145 million acquisition of oil properties in the Jay Field in Florida. We issued a press release yesterday after the close that contains details of the transaction, and we also published presentation slides, which are available on our website, qrenergylp.com, on the Investor Relations homepage.

I’d like to remind all listeners that we will use forward-looking statements as defined by securities laws on today’s call. These statements reflect our current views with regard to future events and are subject to various risks, uncertainties and assumptions. Our results may differ materially from those conveyed in our forward-looking statements. For a more complete list of these risk factors, please read QR Energy’s filings with the Securities and Exchange Commission, which are available on our website or on the SEC website at sec.gov.

In addition, certain remarks on the call will be made in reference to estimated oil and natural gas reserves. The estimates of proved reserves referenced on this call are prepared in accordance with our internal estimates as opposed to SEC reserve reporting requirements. Therefore, our internal proved reserve estimates may differ materially from the estimates of our proved reserves prepared by third parties.

Now, I will turn the call over to our Chief Executive Officer, Alan Smith.

Alan Smith

Well, thanks, Taylor, and thank you for joining us. Yesterday, we announced the $145 million acquisition of conventional oil properties in the Jay field located in the Florida Panhandle from our sponsor Quantum Resources Fund. As Taylor mentioned, we have posted slides on our website, so please follow along with us beginning on slide 3, which is the acquisition summary.

The Jay field is a mature legacy oil field that has all the attributes we look for – large original oil in place, material predictable production, a low decline rate, low risk development inventory, and a low maintenance capital requirement.

Let’s look at the production and reserves that come along with the Jay transaction. The net production is approximately 2,500 barrels of oil per day equivalent, with a base decline of 9%. The production is 100% liquids, which is 90% oil and 10% NGLs, and we operate 100% of the field. These are fields in close proximity to the Gulf of Mexico. The production receives Louisiana Light Sweet crude oil pricing that currently is receiving a $20 premium over the price of WTI.

The proved reserves are 11.3 million barrels of oil equivalent that are 100% proved developed and 76% proved developed producing. Reserves were also 100% liquids with an 87% oil and a 13% NGL split. The acquisition has a proved reserve life of 12.4 years and the expected maintenance capital is approximately $11 million per year to keep production flat for five years.

I’d also like to point out that there are more than 4 million barrels of high quality probable reserves. The probable reserves consist of low-risk incremental tertiary flood performance and enhancing the processing capabilities of the plant. The shallow decline and low maintenance capital requirements makes this deal immediately accretive to our EBITDA and distributable cash flow. We expect 2013 adjusted EBITDA for the acquisition to exceed $35 million.

We innovated all hedges from our sponsor on a significant percentage of production for Jay through 2017, which we expect will add stability to our future cash flows. This morning’s press release contains a table of our current oil and natural gas hedges post transaction.

We closed the deal last Friday, December 28, and financed it with cash on hand and our bank revolver. We expect to receive $170 million borrowing base increase as a result of this transaction in our recently closed East Texas acquisition, which is expected to result in pro forma borrowing base of $900 million, with a little over $400 million of availability.

Turning to slide 4, here we give you a more specific locator map of the Jay field. Most of the field’s 14,600 acres are in Santa Rosa and Escambia counties in Florida, with a small portion in Escambia County in Alabama. QRE now owns 93% working interest and 76% net revenue interest in the field.

Jay was discovered back in 1970 by ExxonMobil. The original oil in place is about 1 billion barrels of oil and the field has produced about 500 million barrels of oil to-date. It produces from the Smackover carbonate, and we are using tertiary recovery methods, which involves nitrogen and water injection into the reservoir. This field is another example of the benefit of owning large original oil-in-place reservoirs as a small incremental increase in recovery can lead to meaningful additional reserves and value creation for QRE.

Moving on to slide 5, we have a significant amount of expertise and history in owning and operating the Jay field. The field was purchased in 2006 by our sponsor, and since that time there have been successful efforts completed to simplify the operation in the field. The outcome of this work has resulted in historical run times over the past three years that exceed 95% – 97%. As mentioned earlier, there are several low-risk development projects that we either are implementing or plan to implement that are expected to increase the recovery factor for the field. Some of these projects are already underway.

We have cleaned out a number of injection wells over the past 12 months and increased our daily water injection by approximately 20% resulting in an increased oil production. We are installing equipment in the plant that is expected to increase natural gas liquid recoveries and enhance certain product volumes that allow us to increase the price we are receiving for the products. We are also evaluating the potential to lower Smackover horizontal drilling, but have no definitive plans at this time.

In summary, our investment rationale is on slide 6. We’re very excited about the accretion this deal provides to our distributable cash flow. The low decline rate, expected asset performance and robust hedges will add many years of stable cash flow. We also expect margins to remain strong since the oil at Jay currently benefits from the LLS pricing premium that exist in the market today. As you have heard us say before, these larger fields are an excellent fit with our investment criteria, and we like the fact that there are low-risk probable reserves that we expect to potentially recover over the next several years.

Due to our pre-existing ownership of a 7.4% overriding royalty interest on the oil at Jay, QRE was a natural buyer allowing the joining of these assets with the overriding royalty interest. And finally, the fact that this is a dropdown from our sponsor, elevates much of the transaction and integration risk, we have a proven track record of operating the asset and the operating team is exactly the same post transaction.

In closing, we believe this is a quality asset that will allow us to grow our distribution coverage ratio significantly going forward.

We appreciate your time and attention this morning. And Cedric Burgher, our CFO; Paul Geiger, our Senior Vice President of Eastern Business Unit and I will be glad to take any questions that you may have. With that, I’ll turn it back over to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Guffey, Dan Guffey with Stifel Nicolaus.

Dan Guffey – Stifel Nicolaus

Good morning, Alan.

Alan Smith

Good morning.

Dan Guffey – Stifel Nicolaus

It seems that your recent equity offering and the $400 million of current liquidity you have, you guys are well positioned for additional acquisitions. Can you kind of talk and give a little color on how your current acquisition pipeline looks and then also potential time of any upcoming transactions?

Alan Smith

Well, sure. Clearly, the fourth quarter of last year was rather busy. I think the tax laws had some – the risk of the tax changes had some people spooked, and so we did see quite a bit of activity in the fourth quarter. I think that a lot of people started that process a little bit later than they should have or needed to, so I think you will see some carryover of transactions into the first quarter of this year.

Our last look at the kind of conventional asset market for 2012 was it was north of $25 billion, so very robust. I think we’re going to continue to see that in 2013 and I think that the dynamics behind what’s driving that hasn’t changed. You’ve got a lot of the shale players continuing to spend to purchase their land positions and to hold their acreage and to draw up their inventory and outspend their cash flow, so we continue to expect a deal further come from there as well as just the natural realizations that come as certain assets go through portfolio management of some of the mid to large-sized independents.

We have a very active deal pipeline today. We are always looking at anywhere from probably two to five opportunities, some more pressing than others. But as we consistently have to do, we can’t give you any guidance on anything until it becomes something that is going to happen. So but I think it’s going to be a very, again, another robust year in 2013 on the acquisition side.

Dan Guffey – Stifel Nicolaus

Okay. Great. And then the 2,500 BOE a day of oil-weighted production that remains at the sponsor, is that going to be a 2013 dropdown or is that 2014 and beyond?

Alan Smith

Well, some of them will depend on the asset performance with regard to those assets. One of them is a restart of a waterflood, and so we’ll how that goes this year. And the other one is – asset is that when we recently bought in 2012, and so the development plans and the execution of what we want to try to accomplish there is still in the works. So probably unlikely that it’s in 2013, but we’ll keep you updated as those things progress.

Dan Guffey – Stifel Nicolaus

Okay. Thanks. And then last one from me. Can you give your current run rate for total and also your maintenance CapEx for 2013?

Alan Smith

We’re currently in the process of formulating all of our guidance for 2013, so we’ll hold off to our fourth quarter results, come out here in the next month or so.

Dan Guffey – Stifel Nicolaus

Okay. Thanks and congrats.

Alan Smith

I appreciate it.

Operator

Your next question comes from the line of Kevin Smith with Raymond James.

Kevin Smith – Raymond James

Good morning and Happy New Year.

Alan Smith

Good morning, Kevin.

Kevin Smith – Raymond James

Looks like you guys were busy over the holidays. Congrats.

Alan Smith

Thanks.

Kevin Smith – Raymond James

Having a hard time hitting your $35 million in EBITDA number. It kind of looks pretty conservative to me, so if maybe you can kind of walk me through some of the assumptions. Last I heard Jay field’s LOE were running around $30 per barrel. Are we still in that ballpark?

Alan Smith

No, we’ve never really been below $35, Kevin, at Jay. When you look at just this asset that we’re dropping down, it’s going to be closer to $42 a barrel, but when you blend it with the override that we already own, it’s going to be in the $35 to $37 range. So I think that’s – that’s kind of what we’re looking at and operating the field going forward is in that range.

Kevin Smith – Raymond James

Okay. Fair enough. And then, are you also in your forecast, are you including the 9% decline rate? I mean should we think about that being not keeping production flat over the year?

Alan Smith

Look, this field is – it’s a function of the water that you’re putting in the ground and the nitrogen that you’re putting in the ground. In tertiary terms, it’s called lag and so we’re very – what we’ve been doing there over the last three years is continuing to enhance the ability to put more water in the ground and to put more nitrogen in the ground. The reservoir so far has responded very well to that and so that 9% decline is something we’re very comfortable with but there’s possibility that we will outperform that.

Kevin Smith – Raymond James

Okay. And then I’m a little bit surprised at how high your maintenance CapEx is. You’re running essentially 30% EBITDA. How do you – can you maybe walk me through how you’re getting to that level based off a 9% decline?

Alan Smith

Sure. I’ll cover a little bit of it and then Paul Geiger may want to opine a little bit on that. So this field, it does have some ongoing – we have a plant turnaround that we have to do every year and we’re going to be, it’s almost every year. We’re going to be very diligent about doing that. It’s the right thing to do for the equipment and for the run times that we’ve experienced. You also have some things you have to do out here with regard to well work and things along those lines. And so when you add all that up, it adds up into that range. Paul, would you like to add anything to the maintenance capital.

Paul Geiger

Sure. Within that maintenance capital number, you’ve got a base amount that’s for facility maintenance, you’ve got a base amount that’s for mechanical integrity on wells and then the remainder and these are about thirds, the remainder is well worked to offset base decline.

Kevin Smith – Raymond James

Got you. And is there – do you think there will be a significant difference between growth CapEx versus maintenance CapEx on this property next year or you expect your maintenance CapEx really to be your CapEx for the Jay field?

Alan Smith

We really don’t anticipate a lot of growth CapEx out here in this field. There are some things we can do that potentially either shallow the decline or enhance the production. We’re continuing to evaluate those, but I don’t think it’s going to be – it’s going to be much north of half side $15 million, total capital for the field.

Kevin Smith – Raymond James

Got you. Okay. I’ll jump back in queue. Nice transaction.

Alan Smith

Okay, thanks a lot. Appreciate it.

Operator

Your next question comes from line of Michael Peterson with MLV & Co.

Michael Peterson – MLV & Company

Hi. Good morning, everyone. I have a couple of detailed questions for Paul. Paul, could you talk a little bit about nitrogen sourcing and also address taking the 24% proven developed not producing what some of the costs and operational necessities would be to return that to producing?

Paul Geiger

Sure. As far as the nitrogen sourcing, Jay is a setup with its own nitrogen source. It was originally built for a retail supply to Exxon when they put that in place. But the Quantum has operated, it purchase that nitrogen supply sources right across the state line in Alabama that you’ll hear referred to as ASU, a air separation unit. And it just takes raw air in and separates out a nitrogen stream that it delivers to the plant for injection. So that’s a very secure source long term. It’s expandable. So we’ve got that in-house and under control. From the – go ahead.

Michael Peterson – MLV & Company

No, no, please. That’s great. Thank you.

Paul Geiger

From the standpoint of the PDMP there’s a – we see the PDMP really in two ways. One is we’ve got the opportunity for additional injection work to increase throughput there in existing wells, and then the biggest component of it that we’ve got is additional refinement of refrigeration process at the production plant to extract additional NGL volumes out of the produce stream. That’s why you see the slight shift in your percentage oil and NGL from the production side to the reserve side. You see that you got a little – you are a little heavier on the NGL side from the reserve standpoint and that’s why, we’ve got some very low risk, refrigeration type projects in queue for this next year to further increase our NGL extraction.

Michael Peterson – MLV & Company

Okay. So, as you increase the not producing component, we will see the NGL piece of production increase into the wedge more comparable to reserves?

Alan Smith

That’s correct.

Michael Peterson – MLV & Company

Okay, terrific. I appreciate that. Alan, if I could ask one broader question. The nature of recovery for this asset adds a bit of complexity. Can you discuss your thoughts on execution and the technical demands of these assets for what are very compelling returns? I just wanted to know how you thought about risk to reconcile those two.

Alan Smith

Yes, Mike. I mean I think it was very well thought out as to when this asset belonged in QRE. We’ve now been operating the asset for three years. Paul and his team have done an amazing job of simplifying the processes out here, we – there was a downtime source that we eliminated and we felt like that the operational performance of the field running 97% run times. The field personnel, we have excellent retention there with leadership in the field as well as the employees out there and we’ve had very good, I think continuity with the Houston side of things of how we run that asset.

So it actually is a – it’s – anytime you have a tertiary recovery project, there is some complexity to it, but I think the fact that we have three years under our belt here of operating it in this more simplified format. And the excellent run times we have and the upside that we have been able to, I think, document with the processing that Paul alluded to and the success we’ve had with the wellbores out here and being able to increase the water injection and the nitrogen injection has been really, really quite exceptional. So I think that where we are today we feel like this is one of our better performing assets that we oversee. Its run times have been excellent and it’s not going to take a lot of additional time here in Houston to manage the field.

Michael Peterson – MLV & Company

Very helpful. Thank you, Alan. And that’s all I have for questions.

Alan Smith

Great. Thanks.

Operator

Your final question comes from the line of Brett Reilly with Credit Suisse.

Brett Reilly – Credit Suisse

Good morning. Just a quick follow-up. Can you talk a little bit about your assumptions on the pricing for your LLS here? Is it going to be in line with some of the hedges you acquired here or are you guys looking more at where LLS is trading today?

Cedric Burgher

Yes. Hi, Brett. This is Cedric. We – in the press release you’ll see the hedges, which is a total company portfolio hedges. We innovated a number of hedges that were on this asset with the sponsor, innovated all of them actually, but what you see is combined with what we already had existing hedges. You will notice we have LLS hedged for two years. If you look into the hedging market for LSS, it’s very shallow, virtually non-existing after two years.

So we will continue to roll those hedges. That’s the strategy is to roll LLS hedges since that is the better marker. The differentials have been wide around $20 today but that’s – that’s been that way for some time now. Whether it continues or not we don’t know, you would think over a time that gap would narrow but there is a lot built into that, you’d know better than me in terms of the WTI discount. But – so we’ll continue to – we hedged WTI in the outer year just because that’s what’s available.

Brett Reilly – Credit Suisse

Got you. So to get that $35 million number for next year, you guys are looking more towards, call it $110 for LLS where it is today or closer to 100?

Cedric Burgher

Well, we’ve hedged it so we’ve locked it in. As LLS moves we will have hedges offsetting and then – if for example if it goes up we’ll benefit at the well head with the fiscal sale and it’ll be offset to a degree by the hedges.

Brett Reilly – Credit Suisse

Okay. Got you. And then on the composition of the NGL barrel, you guys are extracting- fully exacting your ethane stream down there and can you talk a little bit about some of the pricing that you might get for some of those products in the market?

Paul Geiger

Sure. Brett, this is Paul. We extract with a propane filtration process, so it’s not cryogenic. We don’t get down to ethane, we just take off the heavy of that. We are able to sell two streams. We run it through an oil stabilizer. We are able to sell that that is able to stabilized as crude and then the remainder we’re setting up and that’s one of our PDMP projects is to capture the remainder of the lights and sell those as a – not just a Y grade product but a fractionated spec product through propane, butane et cetera.

Brett Reilly – Credit Suisse

Okay. And then transportation on those, is that, guessing it’s probably by some other mode other than pipe?

Paul Geiger

No, sir. The stabilized crude goes out as pipe, goes down to the refinery at Mobil and then NGL goes out into the market in any one of several – to anyone of several processing plants.

Brett Reilly – Credit Suisse

Okay. Got it. That’s all from me. Thank you.

Paul Geiger

Thank you.

Operator

I will now turn the conference over to Mr. Smith for closing remarks.

Alan Smith

Okay. Well, we certainly appreciate everyone taking the time first off the New Year to spend some time with us this morning and we’ll – Taylor, we’d be glad to take any of your questions that you may have going forward or feel free call to Cedric or I also. So we appreciate your time.

Operator

Thank you for your participation in today’s QR Energy’s acquisition conference call. You may now disconnect.

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