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Executives

Taylor Miele – IR Manager

Alan Smith – CEO

John Campbell – President and COO

Cedric Burgher – CFO

Analysts

Kevin Smith – Raymond James

John Ragozzino – RBC Capital Markets

Michael Peterson – MLV & Company

Ethan Bellamy – Baird

Elliot Miller – Private Investor

QR Energy, LP (QRE) Q2 2012 Earnings Call August 9, 2012 11:00 AM ET

Operator

Welcome to the QR Energy Second Quarter 2012 Results and Outlook Conference Call. My name is Christi and I will be your operator for the call. On the line, we have Chief Executive Officer, Alan Smith; President and Chief Operating Officer, John Campbell; Chief Financial Officer, Cedric Burgher; and Investor Relations Manager, Taylor Miele.

At this time, all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I will now turn the call over to Taylor Miele.

Taylor Miele

Thank you, Christi, and good morning, everyone. Welcome to QR Energy’s second quarter 2012 earnings call. We issued a press release this morning containing the results and guidance that will be discussed on the call today. I would like to remind all listeners that we will use forward-looking statements as defined by securities laws. 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 10-Q which we filed with the Securities and Exchange Commission this morning. It is available on our website at qrenergylp.com on the Investor Relations tab or on the Securities and Exchange Commission website at sec.gov.

Additionally, during the course of today’s discussion, management will refer to adjusted EBITDA, distributable cash flow and the distribution coverage ratio as important metrics for evaluating QR Energy’s performance. Please note these are non-GAAP financial measures. They are reconciled to their most directly comparable GAAP measures in this morning’s press release.

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

Alan Smith

Well, thanks, Taylor, and good morning, everyone. We appreciate you taking the time to join our call and look forward to updating you with our second quarter results.

Overall we really deliver strong operational and financial results in the second quarter. Even with the volatility that has been present in the marketplace with lower commodity prices and the third-party downturn, we really deliver a solid distribution coverage ratio of 1.3 times for the quarter.

We continue to remain focused on our core strategy of top-notch execution on our existing asset base while strategically sourcing and closing accretive acquisitions that provide growth for QRE.

Over the past nine months we have nearly tripled the size of the company which is also led to an 18% increase in our quarterly cash distributions. Our robust commodity hedge portfolio continues to give us confidence in the stability of our cash flows even in periods of commodity punctuation as we saw this quarter.

On the acquisition front, we closed the $225 million Prize Petroleum acquisition on April 20, as planned. The Prize assets added approximately 1,200 BOEs per day or 9% to our daily production and we welcome our new team members who are busy implementing new artificial lift projects and upgrading facilities to further increase our production.

As a result to this acquisition, we increased our quarterly cash distribution by 3% this quarter, therefore, tomorrow’s distribution will be $48.75 per unit. Last month we significantly increased our available liquidity by completing a $300 million bond offering, which we utilized to pay down our bank rollover. This gives us approximately $330 million of available liquidity with risk to peruse accretive acquisitions.

Our operations team continues to execute well on the field. We produced 14,505 BOEs per day in the second quarter which included only a partial quarter of the assets acquired from Prize. Production was within our guidance range and was a 7% increase from the first quarter even though we experienced some third-party down time from force majeure events during the quarter which impacted production by approximately 175 BOEs per day.

John will review the production details with you here in a moment.

Our lease operating expenses for the quarter were also within our guidance range and a bit higher than the first quarter due to a 20% increase in oil production. We spent approximately $26.2 million of CapEx in the second quarter and our capital was a bit higher than our guidance due to project timing as we have some additional projects with strong returns planned for this year. So, we have increased our annual guidance to $75 million to $85 million.

Adjusted EBITDA came in at $50 million and distributable cash flow was $27.7 million for the quarter. As I mentioned at the beginning, these results gave us additional coverage ratio 1.3 times.

Let’s take a look at our hedging program. Our oil and gas production was 88% hedged in the quarter and commodity hedges secured more than $68 million of revenue. In addition to the six years of oil hedges that we added this quarter in conjunction with the Prize acquisition, we also added natural gas hedges in 2016 and 2017 which resulted majority of our oil and gas production now hedged through 2017. Cedric will give you more details on our hedge portfolio and financial position here in a moment.

Moving onto our acquisition activity. We’ve discussed with you before that we have multiple ways to grow QRE. We are actively reviewing and evaluating deals in the market as well as considering our drop-down opportunities.

In the acquisition market based upon our reconnaissance, it appears that there are going to be a number of opportunities come to the market in the upcoming third and fourth quarters. We believe that this increased deal flow is being driven by couple of factors. First, those companies are selling assets to fund their Shale programs and second those companies that fear the capital gains tax laws could change in 2013. As always, we will utilize our liquidity to target those opportunities that that are investment criteria and meet our geographical preferences.

As the potential drop-downs from our sponsor, they have approximately 5,000 Boe per day of oil-weighted production that likely fits our investment criteria. And we said before, our sponsor enhances these assets, allows into season and once they are ready a drop-down processes initiated that we are not in a position where we can commit to the timing of any future drop-downs, we expect that potentially have of the current production remaining and our sponsor may be sufficiently develop the drop-down by early 2013.

In conclusion, I believe we have established a solid foundation of assets and operating performance and we are looking forward to finding accretive acquisition opportunities where we can utilize our increased liquidity to further grow QRE.

Now, I will turn the call over to our President and COO John Campbell.

John Campbell

Thank you, Alan. Our average production in the second quarter was 14,505 Boe per day was within our guidance range and a 7% increase from the first quarter. It was 55% liquids which is consistent with the majority of our capital being directive towards our liquid projects.

Production was negatively affected by approximately a 175 Boe per day this quarter due to third-party downtime, force majeure events in the Permian Basin and our Ark-La-Tex region and a non-operative in the Gulf Coast. By the end of the second quarter, all except one of these issues were resolved and production was restored to previous levels.

LOE and workover expenses for the second quarter were 20.2 million or $15.30 per Boe in the middle of our guidance range. Excluding the four mentioned downstream interruptions LOE per Boe would have been closer to $15.

Turning to Prize, our NGL impact was limited by the fact that our NGLs were only 14% of our production and 10% of the revenue this quarter. We saw like 22% price erosion in our NGL quarter-over-quarter and they averaged $42.68 per barrel. We priced 95% of our NGLs at (inaudible) that is our NGL production from Permian and the Ark-La-Tex areas and only 5% at convey from the Mid-Continent area. Therefore, we didn’t experience as much of the dramatic price decline that our peer saw this quarter. Our 5% of NGLs at price convey made up less than 1% of our revenue.

Our average oil price including hedges for the period was $95.23 per barrel and our average natural gas price including hedges was $5.01 per Mcf. Total capital spending for the second quarter was $26.2 million of which $13 million or 26% of EBITDA was our quarterly maintenance capital. By the end of the second quarter, we had drilled and completed 29 out of 35 or 83% of the wells planned in 2012.

Today, we have TD 33 wells or 94% of the wells planned for the year all of which are in the Permian Basin. Comparing [ph] with our volume adding workover to recompletions and artificial lift projects, our capital program has delivered approximately 1300 Boe per day of uplift this year. We have identified additional recomplitions and workvoers in the Ark-la-Tex and Permian area and further optimization of the newly acquired Prize properties that make sense to accelerate. Therefore we have increased our capital budget by $5 million to allow for the completion of these projects.

In addition to our successful capital program, we have completed and integrated our acquisition from the Prize Petroleum in the second quarter. These assets contributed less than a full quarter of production but by the end of the quarter we had full operational control of these assets and have begun executing on our development program.

Turning to our forward guidance, we expect third quarter production to be in the range of 14,400 BOEs to 14,800 BOEs per day as our capital program continues to offset production decline and we have the benefit of a full quarter with the Prize assets. Note that we widened our production guidance ranges slightly to be consistent with the rest of the market. We will spend another $10 million to $15 million of capital in the third quarter on the projects as described (inaudible).

We expect the maintenance portion of that capital to be approximately $13 million. Our LOE will likely be in the $14 to $16 per BOE range for the quarter. For the full year we expect production to be in the range of 14,200 BOEs to 14,600 BOEs per day which reflects stable production for the rest of the year. Full year LOE is likely to be in the $14 to $16 per BOE range.

Now I will turn it to over to Cedric to review our financial results.

Cedric Burgher

Okay. Thanks, John. We achieved several important financial milestones in the second quarter. First, our S3, for future equity offerings was deemed effective by the SEC in mid-June, while we have no immediate plans to issue equity we are now in a position to facilitate our growth through overnight offerings rather than filing an S1 weeks in advance.

We also eliminated the last two material weaknesses in our financial reporting this quarter which is a testament to how far our accounting organization is come in the past year and a half since our IPO.

In July, we executed our first debt offering of $300 million of senior notes with a coupon of 9.25%. As with all first time issuers there was a premium which should not be required with future deals. We more than doubled our liquidity to approximately $330 million of available bank debt, with which we will pursue accretive acquisitions. So this transition was strategic for us as it helps us – help to position us for continued growth.

Our revenue for the second quarter was $62.2 million of which 70% came from oil sales. The 5% decrease in revenue from the first quarter was a result of lower realized prices for all commodities excluding hedges.

Total production expenses which include LOE production and other taxes and processing and transportation were $25.7% a 12% increase from the first quarter which is commensurate with the increase in oil production.

Production and other taxes were approximately 7.7% of revenue and DD&A was $15.56 per BOE.

Our GAAP G&A for the second quarter which includes non-cash allocations from Quantum Resources Management was $8.8 million. Our cash G&A which is 3.5% of the previous quarter’s adjusted EBITDA was $1.8 million. In 2013 we will assume the forecast of our portion of share G&A from Quantum Resources Management, the entity that houses all of the employees for QRE and/or sponsor QRS.

We have not yet determined on which methodology the G&A allocation will be made but we are analyzing several methods to determine the most equitable solution and we will announce the methodology before the end of the year. Regardless of the methodology, it’s safe to say that our G&A will increase to a more normalized level next year.

Our net income of $99.1 million or $2.15 per common unit in the second quarter was once again significantly impacted by the non-cash mark-to-market on our commodity derivative contracts. We had a net commodity derivative gain of $103.9 million comprised of a $14.2 million realized gain and an $89.7 million unrealized gain on commodity derivatives.

Our interest expense for the period was approximately $9.4 million, a 26% increase from the first quarter, due to a net swing of $3.1 million of non-cash mark-to-market on our interest rate derivatives.

Going forward, our effective interest rate on outstanding bank debt will be approximately 3.3%, therefore out all-in effective interest rate on total debt including the senior notes will be approximately 6.2%.

Adjusted EBITDA was $50 million for the second quarter, a 2% increase from the first quarter. After subtracting cash interest expense of $6.6 million estimated maintenance capital expenditures of $13 million our distribution to convertible preferred units at a 4% yield which was$3.5 million and making the management incentive fee adjustment of $772,000, our distributable cash flow was $27.7 million.

Tomorrow, we will pay a cash distribution attributable to the second quarter of $48.75 per unit to all common and subordinated units. As a result, our second quarter distribution coverage ratio was 1.3 times. Our long-term target is in the 1.2 times coverage ratio area but like our peers, our coverage ratio will fluctuate from quarter to quarter.

Looking at our commodity derivative contracts for the second half of the year, we have hedged 5,872 barrels per day of oil and more than 30 million cubic feet per day of natural gas. If we achieve the midpoint of our guidance, our oil and natural gas production will be approximately 92% hedged in the second half of the year. And we will continue to be opportunistic relaying on commodity hedges as we did this year, this quarter for 2016 and 2017.

Our press release and 10-Q have comprehensive commodity derivative tables as of June 30 and you will see that we now have a majority of our production hedged for the next five and half years.

In summary, we are very pleased with our increased liquidity position and the progress that our team has made over the past several months as we have tripled the size of the company and increased the distribution 18% since our IPO. We will continue to actively look for opportunities to grow our production and cash flow through accretive acquisitions, drop-downs from our sponsor and further development of our existing assets.

Thank you for your attention. We are now ready to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first audio question comes from the line of Kevin Smith for Raymond James.

Kevin Smith – Raymond James

Hi, good morning.

Unidentified Company Representative

Good morning.

Kevin Smith – Raymond James

Would you I guess help me understand what’s going on with the maintenance incentive fee and guess a change from quarter to quarter?

Cedric Burgher

Yeah, Kevin, that’s a good question. This has caused some confusion. It’s a small amount but first I just make sure one knows that the general partner is entitled to a management incentive fee based on the value of assets under management once the target distribution is met. As detailed in our IPO perspectives and materials, the management incentive fee is paid out of adjusted operating surplus. So due to the timing of cash flows in the second quarter, the adjusted operating surplus was a limiting factor in determining the management incentive fee. Also in the quarter, we made a cumulative true up to the adjusted operating surplus for the previous three quarters and that resulted in a net credit for the second quarter.

Kevin Smith – Raymond James

Okay. So if I understand that correctly that just means that your – the management incentive fee was somewhat overstated in the previous quarters and now you kind of balancing out?

Cedric Burgher

Well, there was a true up to this surplus account. It’s something that needs to be preserved in effect as a cushion. The cash flows did cause to be lower. So some of that true up was discretionary and some of it was required. But it’s an incentive fee, obviously, that aligns our interest with our partner in certainly incentives, it gives us greater incentive for drop-downs as well.

Kevin Smith – Raymond James

Okay. Any sort of guidance from what we expect or should expect that to be from the next two quarters?

Cedric Burgher

Well, it’s hard to predict. Cash flow volatility which can happen in this business particularly when it’s something like an acquisition occurs or an equity offering occurs. Those two have been happened which really affected the timing. But kind of business as usual, I expect to go back to more normal rate like it was in the first quarter.

Kevin Smith – Raymond James

Okay. And this doesn’t have any sort of impact on resetting of proved reserves or PV-10 or anything that nature right. This is going to forward-looking for the second half of the year. This is backward looking.

Cedric Burgher

That’s right.

Kevin Smith – Raymond James

Okay. And then your incentive fee will be reset based of those mid-year reserves, right?

Cedric Burgher

Yes.

Kevin Smith – Raymond James

Okay. And then moving on to another question, CapEx was higher than I was expecting this quarter. I think your – original guidance like $15 million to $20 million. Do you have new projects or, I guess, what moved the needle on that?

John Campbell

We had some projects that we accelerated into the third quarter. It was really projects we had identified that we just moved up due to timing.

Kevin Smith – Raymond James

Okay. Fair enough. And I think last quarter you were talking about maybe picking up another rig in the Permian. Have you made decisions on that?

John Campbell

Yeah, we’ve got some wells we’re going to drill here later in the year. So we do have that on our schedule to pick up a rig to drill a couple of wells between now and the end of the year.

Kevin Smith – Raymond James

Okay. All right. That does it for me. Thank you.

Cedric Burgher

Thanks, Kevin.

Operator

Your next audio question comes from John Ragozzino with RBC Capital Markets.

John Ragozzino – RBC Capital Markets

Good morning everybody.

Kevin Smith – Raymond James

Good morning.

John Ragozzino – RBC Capital Markets

Cedric, you mentioned a couple of things previously just about the different options you had in terms of assessing the administrative services fee going forward. Can you give us a little more detail in terms of what those options are? I’m not asking for anything specific, but just a better feel for what the availability is.

Cedric Burgher

Well, to make sure I understand the question, I think I understand it, it’s really a two-gate process where you have to meet the test in terms of the targeted distribution. We’ve done that. Expect to continue to do that

John Ragozzino – RBC Capital Markets

Incentive fee?

Cedric Burgher

The G&A.

John Ragozzino – RBC Capital Markets

I’m sorry, did I say incentive fee? I meant the administrative services fee. I apologize.

Cedric Burgher

On the G&A. Thank you. So yes, the G&A we’ve got – methodology. The current GAAP methodology is based on production. And so, if we allocate it based on production, the number you see on our income statement would be indicative of where that would come out next year, all things being equal.

We are looking at a number of other methods. Some of our peers use other methods, and so we’re just evaluating that. So certainly by the end of the year – we’d like to come out even earlier, but certainly by the end of the year we’ll have that information out to you as to what methodology we’ll use.

John Ragozzino – RBC Capital Markets

Okay, thanks. Can you talk...

Cedric Burgher

The other thing I’d point out is this is an allocation between QRE and QRF Fund I. To the extent there are other funds in the future, that would be a sharing arrangement. So there’s a lot of synergy amongst the cost. It’s one of the benefits of setting it up this way is that we get more team for the money than we would by sharing those costs between the various funds. And so, as those funds develop and grow over time, we’d expect the fee-sharing arrangement to improve, from our perspective.

John Ragozzino – RBC Capital Markets

Okay. Great. Can you comment a bit about the composition of your NGL barrels by production? Pricing at Belvieu is still pretty ugly relative to – it wasn’t as bad as Conway, but do you have a higher component of the heavier ends of the mixed barrel, or what’s the story there?

Cedric Burgher

The makeup of the NGLs, is that the question here?

Alan Smith

The mix, ethane versus...

Cedric Burgher

It’s about like you’d expect, like 60% of ethane is the norm there, if that answers your question.

Alan Smith

So we do have some heavies.

Cedric Burgher

Yes, we do have some heavies, yes.

John Ragozzino – RBC Capital Markets

Okay, I’ve just seen there’s areas where it swings rather dramatically in some way. I’m just wondering if that was what was...

Cedric Burgher

No.

John Ragozzino – RBC Capital Markets

Leading some of the better pricing you saw. And then, just bigger picture, if you look out to 2013 and beyond, and if you bake in the impact of the recent debt offering, it seems like coverage may come under a little bit of pressure next year.

And then in 2014, you have – assuming that the preferred units are going to convert. How do you think about distribution growth going forward and how do you combat that trend if, all else equal, prices stay where they are?

Alan Smith

So John, this is Alan. We are very aware of what’s in front of us with the G&A and with the – whenever the convertible units actually step up. I think that the thing, again, that we have going for us here is that, as we’ve told you guys before, we have multiple paths to growth.

And I think that it is – we feel like it is advantageous to us to have drop-downs that we can actually work toward, and I tried to give you some guidance there to the extent possible. And then, we’re very active in the acquisition market. I mean, that’s one of the reasons why we did this bond deal. That really gives us some more fire power, so we will be looking at those types of opportunities.

We continue to work our assets hard to uncover additional opportunities within the existing asset base. So, I think when you combine all of that together, us being able to continue to generate some organic – I think growth, albeit not huge from the organic side, but we will be working very hard on the third-party acquisitions and continuing to get some assets ready for a drop down. So, I think that when you look at the impact that those have then that begins to, I think, improve things down the road.

John Ragozzino – RBC Capital Markets

Okay and then just one more quick one on the acquisition market. Can you give us a feel for what things looking like in terms of given the slight uptick in gas prices, oil packages versus gas prices kind of what are price looking like or how is the deal pipeline looking just bigger picture thoughts on the M&A acquisition market.

Cedric Burgher

Sure. So I am giving sort of global comment that that I think that it’s been a relatively active year very similar to what we saw back in 2011 and we expect to see that going forward. And as I mentioned, there are at least one additional – there is one additional catalog there that we are seeing from our reconnaissance that is driving additional acquisition opportunities. And that is – there is several private companies we’ve talked throughout there that are just nervous about the capital gains tax status. And so they are pushing their sales up a little bit and trying to get those executed before the end of the year. So that’s going to drive I would say above average drill flow in the third and fourth quarters.

As you aware, these – the Shale players whether they are roll or liquid rich gas they are very dizzy still and they are – most of those guys out spending their capital, their cash flow. And so that continues to bring opportunities to us because that they certainly access the equity markets from time to time or the debt markets that they ultimately sell these conventional assets that are embedded in their portfolios which meets our investment criteria very well. So we are continuing to see that.

I think as you think about oil versus gas, we are seeing I think more oil-weighted opportunities keep in mind that oil-weighted transactions usually get classified as anything north of 51%. So there is some gas in those opportunities too. We are seeing more of those type liquids rich packages on the market. We think that while there has been some rebound in natural gas that that we will continue to see the banks be cautious on that which will I think lead to some bond-based redeterminations early to mid-next year which will create any immediate pain for those companies that have to go through that because their hedging changes dramatically in 2013.

And so as that those hedges roll often, they don’t have – the – our look is that the mid to large caps only have some often 15% to 25% hedge in 2013. So that’s going to trade that bond-based pressure in ‘13 which will change our liquidity picture. And again while it may not be immediately painful, it could trigger them to be the catalyst to see some more gas-weighted deals come to the market next year. Currently, we are not seeing a lot of gas-weighted deals in the marketplace.

John Ragozzino – RBC Capital Markets

Thanks very much. I appreciate it.

Operator

Your next audio question comes from the line of Michael Peterson with MLV & Company.

Michael Peterson – MLV & Company

Good morning everyone. \

Cedric Burgher

Hi, Michael.

Michael Peterson – MLV & Company

Given the revenue security that you have with your hedge book in the present liquidity position that you have that it seems you are well positioned to expand the portfolio. I appreciate the color you provided with regard to the M&A market in the previous questions. Can you give us an idea in terms of the size of the package that you are targeting relative to the current portfolio? Do you see more opportunity in maybe a number of smaller pieces or is this something that could very well be somewhat transformative to the current operation?

Cedric Burgher

Well, Michael, certainly a good question. That’s been our experience that you might have heard me says before we are not really good at predicting exactly what will come our way and what we think is ends up being actionable at the end of the day. We do typically prefer deals north of couple of hundred million dollars for a couple of reasons. We do like the fact that they typically have a little bit more inventory with them – lot of times you will get little bit more quality with them. So we typically do look at deals like that. That being said and we have – we’ve got very nice broad diverse asset base at this time and so we will look at both arms significantly smaller than that that we can that we believe accretive to our financial side and to our operational side. So we actually look at both – I think with the bond offering did do force and I think if you look at our available liquidity, we certainly have to keep a surplus available just prudent to do so.

So we think that something – we thought we have somewhere in the neighborhood of $400 million to $450 million of draught powder and we will look at all different opportunities and just know where to predict how it will ultimately end up.

Michael Peterson – MLV & Company

Those details are very helpful. Thank you.

Operator

Your next audio question comes from the line of Ethan Bellamy with Baird.

Ethan Bellamy – Baird

Cedric, just a follow-up on Kevin’s question about the incentive fee calculation. I looked in the Q and I couldn’t see the math behind that. Can you walk us through that or that are done offline. I am pretty sure I am not the only one that need handful on that.

Cedric Burgher

Well, it’s difficult to math. I will tell it’s difficult if you saw the models internally that are used to calculate the operating surplus. The math on the – the incentive fee itself or in terms of what your GPs entitled to is much smaller so I will describe that first and then I will describe the surplus which is the two prompt thing. So the incentive fee itself is based on assets under management. It’s 1% a year assets under management. It’s the same fee that the private fund is getting today on the assets and that is why the incentives drop-down to come here versus haven’t to go third party.

Certainly the sponsor consider the third party and that the price and they will but incentive fee staying with the asset in the same way it currently exists is real strength of that arrangement. So it’s the PV-10 basically plus the mark to market hedges as you generally going to get you to times 1% a year or 25 basis points a quarter. We will get you to that normal fee amount which is what happened in the first quarter.

There is also an operating surplus test which is based on cash flow and when you do a large acquisition like Prize or you do an equity offering like we did in April and both of those happened in April, then you will have sometimes a cash – it’s a cash flow test quarterly and you will have cash swings or lags, oil and gas sale lags that are just normal and that happened with the drop-down to for the fourth quarter of last year. So there is a little bit of a cumulative adjustment there. Some of that was discretionary. Some of that was necessary. It was immaterial in terms of the amounts related to the fourth quarter of last year.

But so that’s really what was going on. The operating surplus if you can read about it in the S-1 that we do with the IPO or the partnership agreement that was also filed as an Exhibit. But it’s a long list of line items that add up that’s where we have to model. But in summary and short, I would just tell you it’s a cash flow test. And so the lag that we experienced in part due to Prize acquisition and in part due to the equity offering timing, those are probably the biggest factors impacting the second quarter operating surplus calculation.

Alan Smith

Just to be clear there is, we shouldn’t expect let’s say the variance between what the number was at this quarter versus what it would have been had there not been that constraint from operating surplus perspective. That’s not going to be true up next quarter where the –

Cedric Burgher

I don’t think…

Alan Smith

Reduction in fee there.

Cedric Burgher

I don’t think so Ethan because we are watching that and trying to build up more cushions. And good news for everyone is that it forces us to have kind of a cash cushion before you can pay that fee out. So the fee was greatly reduced this quarter and so there is this cash cushion we are trying to build it up, we are watching it and so I would think not but if we do a large enough deal or if there is unexpected cash flow swings, then it could be a limiting factor in the future as well.

Ethan Bellamy – Baird

Okay.

Cedric Burgher

One another thing I would like to just to sort of clear up with that I think it’s important there is a lot thought into that that management incentive fee and how it structured and really the adjusted operating surplus was put in place to give the investor comfortable that we weren’t going to bond-based to pay the management fee. So we have to have an available cash to be able to pay that management fee and sort of describe to you it’s a couple of unique things happened there in the second quarter. Then that ended up in packing it and then as we – so we needed to do a trip of those three quarters to get around the same page and when we did that you got the result that you have this quarter.

Ethan Bellamy – Baird

All right. Well, I know I tell you probably have a clear schedule for the rest of the day. Back to question on the NGL barrel, so 60% ethane, what’s the balance of that composite barrel of oil traded – relation better than what I did this quarter?

Cedric Burgher

Well, I have to give back to you on that to get you this specific breakout. But we are going to – I mean, we are going to do it by area and I mean it’s pretty tailwind. We didn’t get back – get something on that.

Ethan Bellamy – Baird

All right. Thanks very much.

Operator

Your next audio question comes from the line of (inaudible) with Wells Fargo.

Unidentified Analyst

Hey, good morning. Just quick questions from me. First, you made a comment that half of the remaining production at QRF could be drill up in early 2013. I am just wondering if you could provide a rough timeline for when the remaining production could be ready for sale. Is that a 2014 event?

Cedric Burgher

Well, we already said that since the IPO that that and of course the response we are did close an additional acquisition in the second quarter. That was around 1,000 barrels a day. So there has been a little bit added to the toll when that 5,000 does include that because sponsor did sell some (inaudible)that our investment criteria in the Gulf Coast. But that being said, I think that we have – we told before that it’s very likely that over the next 18 to 24 months that that most of that production we believe would be in a position. Those assets are being developed where they would hit the investment criteria for QRE.

Unidentified Analyst

Okay. And just one more question, could you just talk about the return you expect to realize on your CapEx budget for the balance of the year. Has the decline in NGL prices impacted returns at all?

Cedric Burgher

Actually just a little bit. I mean, when you look at our projects that are – most of our projects in the Permian Basin are focused on all – the recompletions and artificial lifts that we have over in the East Texas area, a little bit of NGLs there but not a whole lot. So it really hasn’t affected us much at all in NGLs is less than around 10% of our total revenue. So that really hadn’t affected the economics of our projects. Some of the Cotton Valley drilling that we deferred this year is affected by the NGLs but really not the recompletions and stuff with there right now.

Unidentified Analyst

Okay. Thank you.

Operator

(Operator Instructions). Your next audio question comes from the line of Elliot Miller, Private Investor.

Elliot Miller – Private Investor

Yes, good morning. I am curious as to whether there any coal features in the bonds that you wish because the interest rate is quite substantial. And I was wondering if you can call them, you have to call them at a premium, you can call them at par, what is the availability essentially refinancing that debt?

Cedric Burgher

Yes, it’s Cedric, good question. There are coal features after four years. We can call them early with a – what’s called a may call provision basically mark to market based on the treasury yield, comparable treasury yields. But at four years, there is a call provision; it is at a premium that declines over several years. The other thing as I mentioned in my part of the call earlier that these bonds – it was our first time to issue and so there is a normal premium that comes with that that should not be expected to happen in the future. And so this was strategic for us to as we have more acquisition opportunities. It’s one more source of capital beyond equity and bond-based debt. It gives us kind of a third leg if you will in terms of primary capital sourcing pools. It’s a different market. It’s an institutional debt market versus the bank market versus the equity market.

So we think it strategic to help us and there are times when it’s going to be attractive. It also allows us to term out some debt and a little bit longer term than we can get into the bank market and so there are a lot of reasons why we are not alone. Lot of our peers have access this market to and so. The bonds are trading well. I understand. You can see those, they are trading well above par so you can – we would expect again that we would come back to the market on a subsequent issue at a lower rate.

Elliot Miller – Private Investor

I appreciate that I would just wondering as about the likely of the refinancing this debt out because there is a premium you first time go around the premium and I understand that. I also understand the reasons for tapping that institutional bond market and they are all valid. I am just concerned about the weighted average cost of your debt.

Cedric Burgher

That’s around – like I said around 6.2% – (inaudible) based which will bring that percentage down. But so I guess the answer to the question, yes, we have call provisions and that’s something that we would evaluate over time.

Elliot Miller – Private Investor

How much is the premium as to four years?

Cedric Burgher

That’s little over 4%.

Elliot Miller – Private Investor

Okay. And that declines..

Cedric Burgher

That declines – it declines to 2% and then no premium two years into it.

Elliot Miller – Private Investor

So after six years you can refinance the debt.

Cedric Burgher

Hmm

Elliot Miller – Private Investor

Thanks very much.

Operator

At this time, there are no further questions.

Cedric Burgher

Okay. Well, we want to thank you for joining us on the call and we look forward to following up with you throughout the quarter.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect at this time.

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