As filed with the Securities and Exchange Commission on January 31, 2013
Registration No. 333-172846
AMENDMENT NO. 2
REEF 2012 - 2013 DRILLING FUND, L.P.
1901 N. Central Expressway, Suite 300
Approximate date of commencement of proposed sale of securities to the public:
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. ý
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.
The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we are not soliciting offers to buy these securities, in any state where the offer or sale is not permitted.
Subject to Completion. Preliminary Prospectus Dated January 31, 2012
Reef 2012 - 2013 Drilling Fund, L.P.
Reef 2012 - 2013 Drilling Fund, L.P. (the "Partnership") is a Texas limited partnership formed to drill and own interests in oil and natural gas properties located in the United States with a focus primarily on the Bakken area in North Dakota. The primary purpose of the Partnership will be to generate revenue from the production of oil and gas, distribute cash to the partners, and provide the tax benefits that are available to those that drill for and produce oil and natural gas. We are Reef Oil & Gas Partners, L.P., and we will be the managing general partner of the Partnership.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
These securities are speculative and involve a high degree of risk. Before buying units, you should consider carefully the risk factors beginning on page 10 in this prospectus, which include, but are not limited to the following:
Because we have not selected any prospects, you will not be able to evaluate the Partnership's prospects before making your investment decision Oil and natural gas investments are highly risky Our prior history demonstrates that partnership returns will be adversely affected in the event of dry holes and unproductive or marginal wells Cash distributions are not guaranteed Additional general partners have unlimited liability for Partnership obligations Your ability to resell your units is limited due to the lack of a public market and restrictions contained in the partnership agreement Our affiliates and we may have conflicts of interest with you and the Partnership Compensation payable to us will affect distributions The management of the general partner and of the Partnership is not subject to supervision or review by an independent board or officers The partnership agreement prohibits your participation in the Partnership's business decisions Lack of drilling rig availability may increase the Partnership's cost and may result in delays in drilling on Partnership prospects Partners will have limited ability to remove the managing general partner and may have difficulty in finding a successor managing general partner Drilling exploratory wells is riskier than drilling developmental wells Prices of oil and natural gas are volatile Tax treatment may change.
Reef Securities, Inc. is the dealer manager for this offering. The dealer manager and soliciting dealers are offering the units on a "best efforts minimum/maximum" basis. The dealer manager and soliciting dealers must sell the minimum number of units in the Partnership (10) in order for the Partnership to conduct an initial closing and break escrow. The dealer manager and soliciting dealers are required to use only their best efforts to sell the units offered in the Partnership.
Subscription proceeds for the Partnership will be held in an interest-bearing escrow account with Wilmington Trust, National Association, until $1 million has been received, without regard to units subscribed for by our affiliates or us. The offering period for the Partnership began on the date of this prospectus and will terminate on June 30, 2014. If the minimum subscription proceeds are not received by the Partnership's offering termination date, then your subscription will be promptly returned to you from the escrow account with interest and without deduction for any fees.
Investment in the Partnership involves a high degree of risk and is suitable only for investors of substantial financial means who have no need for liquidity in their investments. You should consider carefully the following factors, in addition to the other information in this prospectus, prior to making your investment decision.
Because we have not yet definitively identified or selected any prospects, you will not be able to evaluate the Partnership's prospects before making your investment decision.
The Partnership is a "blind pool" as we have not definitively selected any prospects for acquisition by the Partnership and may not select prospects for the Partnership until after the initial closing of the Partnership. You will not have an opportunity before purchasing units to evaluate geophysical, geological, economic or other information regarding the prospects to be selected. Delays are likely in the investment of proceeds from your subscription because the offering period for the Partnership can extend over a number of months, and no prospects will be acquired until after the initial closing of the Partnership. If we select a prospect for acquisition by the Partnership during the Partnership's offering period, we will file a prospectus supplement, and a post-effective amendment if necessary, describing the prospect and its proposed acquisition. If you subscribe for units prior to any such supplement you will not be permitted to withdraw your subscription as a result of the selection of any prospect. As the managing general partner, we will have broad discretion in allocating a substantial portion of the proceeds from the offering and selecting prospects. See "PROPOSED ACTIVITIESAcquisition and Drilling of Undeveloped Prospects."
Our prior history demonstrates that the Partnership's returns will be adversely affected in the event of dry holes and marginal or unproductive wells.
During the period from January 1996 through June 30, 2012, OREI, Inc. ("OREI") and Reef have sponsored 25 multiple-well drilling partnerships, of which 16 were private partnerships and nine were publicly-offered limited partnerships. With respect to the nine publicly-offered limited partnerships engaged in oil and natural gas operations, one was formed in 2002, one in 2003, three in 2004, two in 2005, one in 2006, and one in 2007.
As of June 30, 2012, the nine publicly-offered limited partnerships have not produced revenues in excess of the partners' capital contributions. These partnerships have experienced a significant number of dry holes or unproductive wells and are not expected to achieve payout. In addition, the independent registered public accounting firm's opinions on the 2011 financial statements for Reef Global Energy IV, L.P., Reef Global Energy VII, L.P., and Reef Global Energy VIII, L.P. include an explanatory paragraph indicating substantial doubt about each respective partnership's ability to continue as a going concern. Pursuant to a majority vote of each partnership's respective partners, due to the small operating revenues of each partnership, the financial statements of each of Reef Global Energy I, L.P., Reef Global Energy II, L.P., Reef Global Energy III, L.P., and Reef Global Energy IX, L.P. are no longer audited. However, we believe that if they had been audited, the opinion of independent registered public accounting firm conducting the audit related to each such partnership would have also included disclosures indicating substantial doubt about each such partnership's ability to continue as a going concern. See "PRIOR ACTIVITIES" beginning on page 62 of this prospectus.
As of June 30, 2012, of the 16 private oil and natural gas multiple-well drilling partnerships, (i) two have made distributions to participants in excess of capital originally contributed by the participants and continue to make distributions, (ii) one has made distributions to participants in excess of capital originally contributed by the participants, its wells have reached the end of their economic lives and been plugged, and is being liquidated and dissolved, (iii) one recently commenced drilling
operations focused in the Bakken area in North Dakota, (iv) one is producing oil and gas and making distributions to participants, but we are unable to predict with accuracy whether distributions ultimately will exceed capital originally contributed by the participants, (v) four are producing oil and gas but are not expected to achieve payout, (vi) five had wells that, while producing some revenue, were ultimately plugged and abandoned at a substantial loss of the participants' capital contributions, (vii) one drilled three unsuccessful wells, and (viii) one recently commenced drilling operations. See "PRIOR ACTIVITIESTable One" on page 65 of this prospectus.
The Partnership's ability to diversify risks depends upon the number of units issued, the development costs of each well, the size of the Partnership's interest in each well and the availability of suitable prospects.
We intend to spread the risk of oil and natural gas drilling and ownership of interests in oil and natural gas properties by purchasing working interests in multiple wells and prospects, possibly participating as a minority working interest owner with major and independent oil and natural gas companies as partners. If the Partnership is subscribed at the minimum level, it will be required to purchase smaller interests in prospects and be able to participate in fewer prospects, which would increase the risk to the partners. As the Partnership size increases, the diversification of the Partnership may increase because the Partnership can obtain interests in and drill on a greater number of wells and prospects. In addition, as the Partnership size increases, the Partnership may have a greater ability to acquire larger interests in oil and gas properties, including majority interests. The numbers of wells developed by the Partnership will depend upon the amount raised by the Partnership, the size of the Partnership's interest in each well, the value of interests in producing wells that may be acquired and the development costs of each well to be drilled.
Additional general partners have unlimited liability for Partnership obligations.
Under Texas law, the state in which the Partnership has been formed, general partners of the Partnership have unlimited liability for obligations and liabilities of the Partnership. If you purchase units as an additional general partner you will be liable for all obligations and liabilities arising from the Partnership's operations if these liabilities exceed both the assets and insurance of the Partnership, and our assets and insurance. Even if you convert your general partner interest into a limited partner interest, you will continue to be liable as a general partner for matters that occurred while you owned a general partner interest. Your liability as an additional general partner may exceed the amount of your subscription. Under the partnership agreement, additional general partners are only liable for their proportionate share of the Partnership's obligations and liabilities. This agreement will not eliminate your liabilities to third parties in the event you invest as an additional general partner and other additional general partners do not pay their proportionate share of the Partnership's obligations and liabilities.
The Partnership will almost always own less than 100% of the working interest in a prospect.
If a court holds you and the other third-party working interest owners of the prospect liable for the development and operation of the prospect and some of the third-party working interest owners do not pay their proportionate share of the costs and liabilities associated with the prospect, then the Partnership and you and the other additional general partners also may be liable for those costs and liabilities.
As an additional general partner you may become subject to the following:
cannot insure because coverage is not available or against which we may elect not to insure because of high premium costs or other reasons; and
If the Partnership's insurance proceeds and assets, our indemnification of you and the other additional general partners, and the liability coverage provided by major subcontractors are not sufficient to satisfy a liability, then we will call for additional funds from you and the other additional general partners to satisfy the liability. See "PROPOSED ACTIVITIESInsurance." Our ability to indemnify you is dependent upon our financial condition.
You may not receive a return of your investment or any specific rate of return on your investment in the Partnership.
You may not recover all or any of your investment in the Partnership, or if you do recover your investment in the Partnership, you may not receive a rate of return on your investment that is competitive with other types of investments. You will be able to recover your investment only through the Partnership's distributions of the sales proceeds from the production and sale of oil and natural gas from productive wells. The quantity of oil and natural gas in a well, which is referred to as its reserves, decreases over time as the oil and natural gas is produced until the well is no longer economical to operate. The Partnership's distributions may not be enough for you to recover all your investment in the Partnership or to receive a rate of return on your investment that is competitive with other types of investment if you do recover your investment in the Partnership.
Decisions about developmental operations on properties may be made by third parties that you will have no input in selecting. We will manage and control the Partnership's business.
We will exclusively manage and control all aspects of the business of the Partnership and will make all decisions concerning the business of the Partnership. You will not be permitted to take part in the management or in the decision making of the Partnership. Third parties may act as the operator of Partnership prospects, and in many cases, the Partnership may acquire a less than 50% working interest in various oil and natural gas properties. Accordingly, third parties may manage and control the drilling, completion and production operations on the properties. When it acquires a minority interest in a well, the Partnership will not control the selection of the operator or be able to direct operations under the terms of the applicable operating agreement. The success and timing of exploration and development activities operated by third parties will depend on a number of factors that will be largely outside of our control, including:
As a result, our limited ability to exercise control over the operations of wells in which the Partnership acquires a minority interest may cause a material adverse effect on the Partnership's results of operations and financial condition.
The Partnership may not have enough cash to make distributions to its partners.
The Partnership's oil and gas operations may not generate sufficient revenues to the Partnership to enable the Partnership to make cash distributions to its partners. The ability to make cash distributions will depend on the Partnership's future operating performance. See "PARTICIPATION IN DISTRIBUTIONS, PROFITS, LOSSES, COSTS AND REVENUESCash Distribution Policy." We will review the accounts of the Partnership at least quarterly to determine the cash available for distribution. Distributions will depend primarily on the Partnership's cash flow from operations, which will be affected, among other things, by the following:
Partnership income will be taxable to the additional general and limited partners in the year earned, even if cash is not distributed. See "Risks of Oil and Natural Gas Investments," "PARTICIPATION IN DISTRIBUTIONS, PROFITS, LOSSES, COSTS AND REVENUESCash Distribution Policy" and "OUR COMPENSATION."
Our affiliates and we have sponsored ventures in the past that have produced dry holes and abandoned wells.
We and our affiliates have sponsored 74 partnerships and joint ventures since 1996, which include: (i) three 3-D seismic partnerships, (ii) 14 income or income and development funds, (iii) 25 multiple-well drilling partnerships, (iv) 31 single well drilling partnerships, and (v) one salt water disposal well partnership. For a description of partnerships we have previously sponsored, please see "PRIOR ACTIVITIES" beginning on page 62 of this prospectus.
The 56 drilling partnerships sponsored since 1996 have participated in the drilling of 170 unique wells that have completed drilling, and are currently participating in 80 wells that are currently being drilled or completed. The ventures and partnerships described in this paragraph acquired interests in or conducted operations on exploitation and exploratory wells, in addition to developmental wells. Of these 170 wells drilled by our partnerships since 1996, 57 were exploratory wells, 5 were exploitation wells and 108 were developmental. An "exploitation well" is a well drilled within or as an extension of a proven oil and natural gas reservoir to a depth of a stratigraphic horizon known to be productive. Fifty-five of these wells were dry holes, and two wells were completed but were non-commercial. Of the 114 wells that were commercial, 68 are still owned by our drilling partnerships and producing, 27 have been plugged and abandoned, 13 were sold essentially for salvage value, three were sold for value, one is shut in, and two are currently used as salt water disposal wells. Using this data, approximately 66% of the gross wells in which the drilling partnerships participated in drilling since 1996 were completed
as commercially producing and 34% were dry holes (including the two wells that were completed but failed to become commercially productive). Approximately 24% of the wells in which these partnerships participated in drilling were completed successfully but subsequently abandoned or sold essentially for salvage value prior to abandonment. Twelve of the successful wells were drilled in conjunction with the income and development funds. The Partnership may produce dry holes and abandoned wells, reducing the amount of Partnership funds available for distribution to partners. Please see the "PRIOR ACTIVITIES" beginning on page 62 of this prospectus.
The Partnership will have limited external sources of funds, which could result in a shortage of working capital.
The Partnership intends to utilize substantially all available capital from this offering for the acquisition of drilling prospects and the drilling and completion of wells on those prospects. The Partnership will have only nominal funds available for Partnership purposes until there are revenues from Partnership operations. Any future requirement for additional funding will have to come, if at all, from the Partnership's revenues, the sale of Partnership properties or interests therein, or from borrowings.
Occasions may arise in which the Partnership will need to raise additional funds in order to finance costs of:
Additional operations requiring funding may include the acquisition of additional oil and natural gas leases, acquisition of interests in producing oil or gas wells, and the drilling, completing and equipping of additional wells to further develop Partnership prospects or to purchase additional prospects. The Partnership agreement provides that outstanding Partnership borrowings may not at any time exceed 25% of the Partnership's aggregate capital contributions without the consent of the investor partners. Furthermore, the Partnership may borrow funds only if the lender agrees that it will have no recourse against individual investor partners. If the above-described methods of financing should prove insufficient to maintain the desired level of Partnership operations, such operations could be continued through farmout arrangements with third parties, including us and/or our affiliates. These farmouts could result in the Partnership giving up a substantial interest in oil and natural gas properties it has developed. The Partnership's operations may not be sufficient to provide the Partnership with necessary additional funding, and the Partnership may not be able to borrow funds from third parties on commercially reasonable terms or at all. If the Partnership expends all of its capital on the acquisition and development of drilling prospects and such operations fail to generate sufficient revenues, then there may be doubt as to the Partnership's ability to continue as a going concern.
Your ability to resell your units is limited due to the lack of a public market and restrictions contained in the partnership agreement. You may not be able to sell your partnership interests.
No public market for the units exists or is likely to develop. Your ability to resell your units also is restricted by the partnership agreement for the Partnership. The Partnership itself may continue in existence for thirty years from its formation, unless earlier terminated. As a result, you should plan on owning your units for an indefinite period. See "TRANSFERABILITY OF UNITS."
The management of the general partner and of the Partnership is not subject to supervision or review by an independent board, independent officers, audit committee or compensation committee.
The principal executive officer of the managing general partner is Mike Mauceli, and Mr. Mauceli also owns and controls the securities of the managing general partner. Also, the officers of the
managing general partner and its affiliates are comprised entirely of employees of entities controlled by Mr. Mauceli. As a result, the activities of the managing general partner are not subject to the review and scrutiny of an independent board of directors. In addition, the managing general partner does not have an audit committee or compensation committee. Thus, there is no independent supervision of the management representing the interests of the partners.
Our affiliates and we may have conflicts of interest with you and the Partnership.
The continued active participation by our affiliates and us in oil and natural gas activities individually, and on behalf of other partnerships organized or to be organized by us, and the manner in which partnership revenues are allocated, could create conflicts of interest with the Partnership. See "CONFLICTS OF INTEREST." Our affiliates and we have interests that inherently conflict with those of the unaffiliated partners, including the following:
We will attempt, in good faith and in accordance with the terms of the partnership agreement, to resolve all conflicts of interest. Any transaction with us may not be on terms as favorable as could have been negotiated with unaffiliated third parties.
Should a legal dispute arise between us, the Partnership, and/or RSI, additional outside counsel may have to be retained in the event of a dispute.
Baker & McKenzie LLP serves as legal counsel to us, our affiliate OREI, our affiliate Reef Exploration, L.P. ("RELP"), and RSI. Because our affiliates have the same legal counsel as we have, there may be conflicts of interest inherent in our legal representation. The Partnership has not engaged its own independent counsel. As a result, in the event of a legal dispute between us, the Partnership, and/or RSI, additional outside counsel may have to be retained. Such outside counsel may not be as
familiar with us as Baker & McKenzie LLP, and its costs cannot be estimated and could be in excess of those that would be charged by Baker & McKenzie LLP.
RSI has been the subject of disciplinary proceedings.
If it is subject to future proceedings, its ability to sell units could be limited, which may create a diversification risk. RSI has been the subject of three proceedings brought by state securities agencies (Texas in 1995, Illinois in 1996 and Wisconsin in 2004), alleging that certain general partnerships sold by it, which RSI maintains were not securities under either federal or state law, were securities requiring registration under such states' laws. In two of these cases (Texas and Illinois), RSI settled the cases, without admitting or denying the factual allegations of the relevant state securities administrators, and consented to settlements (in Texas a $15,000 payment and a 180-day probation, and in Illinois, a $10,000 payment and withdrawal of broker dealer registration, which has subsequently been reinstated). With respect to the Wisconsin matter, Wisconsin dismissed the proceeding and vacated the order issued by it. Also in 2004, RSI was fined $3,750 by New Hampshire for failure to timely file documentation regarding a corporate name change effected by RSI in 2003.
In addition, RSI was censured in 1995 by FINRA (then known as the NASD) and fined $2,500 for failure to maintain certain minimal net capital. In 2000, FINRA fined RSI $5,000 for failure to maintain a specific written policy regarding FINRA's continuing education policy, and in 2004 for failure to maintain specific written policies regarding FINRA's anti-money laundering policy (required even though RSI did not handle any investor money) and continuing education policy, for which RSI paid a fine of $17,500 without admitting or denying any of FINRA's factual allegations.
If RSI were to become involved in future disciplinary proceedings, its ability to sell the units could be limited. This could result in the Partnership being formed with less offering proceeds than if the dealer manager's sales activities were not limited by such proceedings. The Partnership subscribed at the minimum level would be able to participate in fewer prospects, which would increase the risk to the partners. As Partnership size increases, the diversification of the Partnership will increase because the Partnership can drill or obtain interests in multiple prospects.
We may rely upon a small number of marketers to purchase a majority of oil and gas from the Partnership, which could pose a credit risk in the event one or more of them fails to pay in a timely manner or at all.
We sell oil and natural gas on credit terms to refiners, pipelines, marketers, and other users of petroleum commodities. Revenues are received directly from these parties or, in certain circumstances, are paid to the operator of the property who disburses to us our percentage share of the revenues. During the year ended December 31, 2011, two marketers accounted for approximately 81% of our oil and natural gas revenues for our public drilling partnerships. The two marketers, PetroQuest Energy, LLC and Cokinos Energy Corporation, account for approximately 68% and 13% of our oil and natural gas revenues for our public drilling partnerships, respectively. Despite the competitive nature of the market for oil and natural gas, the loss of any particular purchaser could have a material adverse impact on the Partnership or us by affecting prices, delaying sales of production or increasing costs. In total, our public drilling partnerships received revenues from 15 different marketers. Our reliance upon one marketer to purchase approximately 68% percent of the oil and natural gas from our public drilling partnerships, as well as our reliance on another marketer to purchase approximately 13% of the oil and natural gas from our public drilling partnerships, poses a credit risk in the event one or more of such marketers should fail to pay in a timely manner or at all. In such event, the amount of distributions available to the investor partners could be substantially diminished, even if the Partnership's properties are successfully producing.
Compensation payable to us will affect distributions.
We will receive compensation from the Partnership throughout the life of the Partnership. The managing general partner and its affiliates will profit from their services in drilling, completing, and operating the Partnership's wells, and will receive the other fees and reimbursement of direct costs described in "OUR COMPENSATION," regardless of the success of the Partnership's wells. These fees and direct costs will reduce the amount of cash distributions to you and the other investors. The amount of the fees is subject to the complete discretion of the managing general partner, other than the fees must not exceed competitive prices and terms as determined by reference to charges of unaffiliated companies providing similar services, supplies, and equipment. See "OUR COMPENSATION." With respect to direct costs, the managing general partner has sole discretion on behalf of the Partnership to select the provider of the services or goods and the provider's compensation as discussed in "OUR COMPENSATION."
A lengthy offering period may result in delays in the investment of your subscription and any cash distributions from the Partnership to you.
Because the offering period for the Partnership can extend for many months, it is likely that there will be a delay in the investment of your subscription proceeds. This may create a delay in the Partnership's cash distributions to you, which will be paid only if there is sufficient cash available. See "TERMS OF THE OFFERING" for a discussion of the procedures involved in the offering of the units and the formation of the Partnership.
Your subscription for units is irrevocable.
Your execution of the subscription agreement is a binding offer to buy units in the Partnership. Once you subscribe for units, you will not be able to revoke your subscription.
Drilling prospects in one area may increase the Partnership's risk.
To the extent that prospects are drilled in one area at the same time, this may increase the Partnership's risk of loss. For example, if multiple wells in one area are drilled at approximately the same time, then there is a greater risk of loss if the wells are marginal or nonproductive since we will not be using the drilling results of one or more of those wells to decide whether or not to continue drilling prospects in that area or to substitute other prospects in other areas. This is compared with the situation in which we drill one well and assess the drilling results before we decide to drill a second well in the same area or to substitute a different prospect in another area.
Lack of drilling rig availability or hydraulic fracture equipment may increase the Partnership's costs and may result in delays in drilling on Partnership prospects, and therefore, delay the investor partners' ability to deduct intangible drilling costs in the year of their investment.
Due to increases in oil and natural gas prices in the United States, the amount of drilling activity within the United States and in U.S. waters has increased substantially. As a result of this increase in drilling activities, there may be shortages of drilling rigs and personnel available to drill on prospects we acquire. Such shortages could result in delays in the drilling of wells on such prospects and, therefore, delay the investor partners' ability to deduct intangible drilling costs in the year of their investment. Such shortages could also result in increased costs to the Partnership for drilling rigs and personnel used in Partnership operations, and, as a result, decrease the amount of cash, if any, available for distribution to the partners in the Partnership.
The Partnership may become liable for joint activities of other working interest owners, which could jeopardize full development of the prospects.
The Partnership may often acquire less than the full working interest in prospects and, as a result, may engage in joint activities with other working interest owners. Additionally, it is possible that the Partnership may purchase less than a 50% working interest in some or all of prospects acquired for the Partnership, with the result that someone other than the Partnership or us may control such prospects. The Partnership could be held liable for the joint activity obligations of the other working interest owners, such as nonpayment of costs and liabilities arising from the actions of the working interest owners. Full development of the prospects may be jeopardized in the event other working interest owners cannot pay their shares of drilling and completion costs.
Other partnerships we sponsor will compete with the Partnership for prospects, equipment, contractors, and personnel.
We plan to offer interests in other partnerships to be formed for substantially the same purposes as those of the Partnership. Therefore, multiple partnerships with unexpended capital funds, including partnerships formed before and after the Partnership, may exist at the same time. Due to competition among the partnerships for suitable prospects and availability of equipment, contractors, and our personnel, the fact that partnerships previously organized by our affiliates and us may still be purchasing prospects when the Partnership is attempting to purchase prospects may make the completion of prospect acquisition activities by the Partnership more difficult. In addition, multiple partnerships sponsored by us may invest in the same oil and gas property, creating a potential conflict of interest between the Partnership and us, if, among other scenarios, the Partnership is unable to fulfill its financial obligations relating to the property. Furthermore, as we continue to sponsor more partnerships, we will need to increase our personnel in order to meet the staffing needs associated with our additional administrative responsibilities as managing partner of these partnerships. If we are unable to find suitable personnel to meet such needs, our ability to effectively manage the Partnership could be impacted.
Because investors bear the Partnership's acquisition, drilling and development costs, they bear most of the risk of non-productive operations.
Under the cost and revenue sharing provisions of the Partnership agreement, we will share costs with you differently than the way we will share revenues with you. Because investor partners will bear a substantial amount of the costs of acquiring, drilling and developing the Partnership's prospects, investor partners will bear a substantial amount of the costs and risks of drilling dry holes and marginally productive wells.
The partnership agreement will prohibit the participation of all partners, including general partners and converted limited partners, in the Partnership's business decisions.
You may not participate in the management of the Partnership business. The partnership agreement will forbid you from acting in a manner harmful to the business of the Partnership. If you violate the terms of the partnership agreement, you may have to pay the Partnership or other partners for all damages resulting from your breach of the partnership agreement.
The partnership agreement will limit our liability to you and the Partnership and will require the Partnership to indemnify us against certain losses.
We will have no liability to the Partnership or to any partner for any loss suffered by the Partnership, and will be indemnified by the Partnership against loss sustained by us in connection with the Partnership if:
The indemnification provisions of the partnership agreement do not waive or diminish your rights under state and federal securities laws.
Because we will act as general partner of several partnerships, other commitments may adversely affect our financial condition.
As a result of our commitments as general partner of several partnerships and because of the unlimited liability of a general partner to third parties, our net worth is at risk of reduction. Because we are primarily responsible for the conduct of the Partnership's affairs, a significant adverse financial reversal for us could have an adverse effect on the Partnership and the value of its units, and could impair our ability to fulfill our obligation to indemnify the additional general partners for certain losses.
You should not rely on the financial status of other additional general partners as a limitation on your liability.
No financial information will be provided to you concerning any investor who has elected to invest in the Partnership as an additional general partner. In no event should you rely on the financial wherewithal of additional general partners, including in the event we should become bankrupt or are otherwise unable to meet our financial commitments.
Lack of an independent underwriter may reduce the due diligence investigation conducted on the Partnership and us.
There has not been an extensive in-depth "due diligence" investigation of the existing and proposed business activities of the Partnership and us that would be provided by independent underwriters. Our dealer manager, RSI, has an ongoing relationship with our affiliates and us. Furthermore, Michael J. Mauceli, our limited partner, the manager of our general partner, and the Chief Executive Officer of RELP, is the brother of Paul Mauceli, the sole shareholder, director and Chief Executive Officer of RSI. RSI's due diligence examination concerning the Partnership cannot be considered to be independent or as comprehensive as an investigation that would be conducted by a broker-dealer that is involved in selling offerings of unaffiliated companies. See "CONFLICTS OF INTEREST."
We expect to incur costs in connection with Exchange Act compliance and we may become subject to liability for any failure to comply, which will reduce our cash available for distribution.
As a result of our obligation to register our securities with the Securities and Exchange Commission ("SEC") under the Securities Act of 1933 ("the Securities Act"), we will be subject to the rules and related reporting requirements of the Securities Exchange Act of 1934 ("the Exchange Act"). This compliance with the reporting requirements of the Exchange Act will require timely filing of quarterly reports on Form 10-Q, annual reports on Form 10-K and current reports on Form 8-K, among other actions. Further, recently enacted and proposed laws, regulations and standards relating to corporate governance and disclosure requirements applicable to public companies, including the
Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and new SEC regulations, have increased the costs of corporate governance, reporting and disclosure practices which are now required of us. In addition, these laws, rules and regulations create new legal grounds for administrative enforcement and civil and criminal proceedings against us in case of non-compliance, which increases our risks of liability and potential sanctions. All of the additional compliance costs described above, whether from meeting the compliance requirements or as a result of liabilities related to a failure of such compliance, will decrease the amount of cash available to us to distribute to the partners.
Partners have a limited ability to remove the managing general partner and may encounter difficulty in finding a successor managing general partner.
We may be removed from our position as the managing general partner only by the affirmative vote of investors holding a majority of the then outstanding units of the Partnership. The general and limited partners in certain circumstances must, in order to continue the Partnership, elect a successor to the removed managing general partner if the removal of the managing general partner causes a dissolution of the Partnership. There is a risk that the general and limited partners could not find a new managing general partner or program manager if we were to be removed from such positions.
We may delegate or subcontract our duties under the partnership agreement to others, including our affiliates.
The partnership agreement authorizes us to delegate and subcontract our duties under the partnership agreement to others, including entities related to us. We anticipate that the staff of RELP will assist us in performing our duties under the partnership agreement. Our principal executive officer, Mr. Michael J. Mauceli, also the principal executive officer of RELP, enables us to monitor RELP to ensure, among other things, that it is performing the delegated duties consistent with our fiduciary duties to the Partnership. In addition, Mr. Mauceli will be in a position to monitor the financial condition of RELP. In the event it is determined by us that RELP's ability to perform the delegated or subcontracted duties is impaired as a result of its adverse financial condition, then we will assume the performance of those duties to the extent they are delegated.
Unauthorized acts of general partners could be binding against the Partnership, and such unauthorized acts could be contrary to the best interests of the Partnership.
Under Texas law, the act of a general partner of the Partnership apparently carrying on the business of the Partnership binds the Partnership, unless the general partner in fact has no authority to act for the Partnership and the person with whom the partner is dealing has knowledge in good faith of the fact that such general partner has no such authority. There is a risk that a general partner might bind the Partnership by his acts. Under the partnership agreement for the Partnership, the managing general partner will have such exclusive control over the conduct of the business of the Partnership that it is unlikely that a third party, in the absence of bad faith, would deal with a general partner in connection with the Partnership's business. The participation by a general partner in the management and control of the Partnership's business is expressly prohibited by the partnership agreement, and a violation of such prohibition would give rise to a cause of action by the Partnership against such general partner. Nevertheless, there is always the possibility that a general partner could attempt to take unauthorized actions on behalf of the Partnership, and if a court were to hold that such actions were binding against the Partnership, such unauthorized actions could be contrary to the best interests of the Partnership and could adversely impact the Partnership.
Oil and natural gas investments are highly risky, and there is a possibility you will lose all of your investment in the Partnership.
The selection of prospects for oil and natural gas drilling, the drilling, ownership and operation of oil and natural gas wells, and the ownership of non-operating interests in oil and natural gas properties are highly speculative. There is a possibility you will lose all or substantially all of your investment in the Partnership. We cannot predict whether any prospect will produce oil or natural gas or commercial quantities of oil or natural gas, nor can we predict the amount of time it will take to recover any oil or natural gas we do produce. Drilling activities may be unprofitable, not only from non-productive wells, but from wells that do not produce oil or natural gas in sufficient quantities or quality to return a profit. Delays and added expenses may also be caused by poor weather conditions affecting, among other things, the ability to lay pipelines. In addition, ground water, various clays, lack of porosity and permeability may hinder, restrict or even make production impractical or impossible.
Drilling exploratory wells is riskier than drilling developmental wells.
The proceeds from the offering that are spent on drilling activities will be used primarily for developmental wells, but the Partnership will also acquire interests in exploratory wells. Drilling exploratory wells involves greater risks of dry holes and loss of the partners' investment than the drilling of developmental wells. Drilling developmental wells generally involves less risk of dry holes. As a result, sometimes developmental acreage is more expensive and subject to greater royalties and other burdens on production. This investment is suitable for you only if you are financially able to withstand a loss of all or substantially all of your investment.
The Partnership may be required to pay delay rentals to hold drilling prospects, which may deplete partnership capital.
Oil and natural gas leases generally must be drilled upon by a certain date or additional funds known as delay rentals must be paid to keep the lease in effect. Delay rentals typically must be paid after the first year of entering into a lease if no production or drilling activity has commenced. If delay rentals become due on any property the Partnership acquires, the Partnership will have to pay its share of such delay rentals or lose its lease on the property. These delay rentals could equal or exceed the cost of the property. Further, payment of these delay rentals could seriously deplete the Partnership's capital available to fund drilling activities when they do commence.
Prices of oil and natural gas are volatile, and a decline in such prices would adversely affect the Partnership.
Global economic conditions, political conditions, and energy conservation have created volatile prices for oil and natural gas. Oil and natural gas prices may fluctuate significantly in response to minor changes in supply, demand, market uncertainty, political conditions in oil-producing countries, activities of oil-producing countries to limit production, global economic conditions, weather conditions and other factors that are beyond our control. The prices for domestic oil and natural gas production have varied substantially over time and may in the future decline, which would adversely affect the Partnership and the investor partners. Prices for oil and natural gas have been and are likely to remain extremely volatile.
Increases in drilling costs could impact the profitability of the Partnership's wells and the number of wells the Partnership may drill.
There has been an increase in recent years in the costs associated with the drilling of oil and natural gas wells, though the increase in costs has slowed with the recent volatility in the U.S. and global economy. Specifically, the costs of drilling rigs, steel for pipelines, mud and fuel have risen in
recent years and may rise again in the future. Such increases could result in limiting the number of wells the Partnership may drill as well as the profitability of each well once completed.
Competition, market conditions and government regulation may adversely affect the Partnership.
A large number of companies and individuals engage in drilling for oil and natural gas. As a result, there is intense competition for the most desirable prospects. The sale of any oil or natural gas found and produced by the Partnership will be affected by fluctuating market conditions and regulations, including environmental standards, set by state and federal agencies. Governmental regulations may fix rates of production from Partnership wells, and the prices for oil and natural gas produced from the wells may be limited. From time-to-time, a surplus of oil and natural gas occurs in areas of the United States. The effect of a surplus may be to reduce the price the Partnership may receive for its oil or natural gas production, or to reduce the amount of oil or natural gas that the Partnership may produce and sell.
Environmental hazards and liabilities may adversely affect the Partnership and result in liability for the additional general partners.
There are numerous natural hazards involved in the drilling of oil and natural gas wells, including unexpected or unusual formations, pressures, blowouts involving possible damages to property and third parties, surface damages, bodily injuries, damage to and loss of equipment, reservoir damage and loss of reserves. There are also hazards involved in the transportation of oil and natural gas from our wells to market. Such hazards include pipeline leakage and risks associated with the spilling of oil transported via barge instead of pipeline, both of which could result in liabilities associated with environmental cleanup. Uninsured liabilities would reduce the funds available to the Partnership, may result in the loss of partnership properties and may create liability for you if you are an additional general partner. The Partnership will maintain insurance coverage in amounts we deem appropriate. It is possible that insurance coverage may be insufficient. In that event, partnership assets would be utilized to pay personal injury and property damage claims and the costs of controlling blowouts or replacing destroyed equipment rather than for additional drilling activities.
New legislation and regulatory initiatives relating to hydraulic fracturing may adversely affect the Partnership.
Members of the U.S. Congress and the U.S. Environmental Protection Agency ('EPA') are reviewing more stringent regulation of hydraulic fracturing, a technology which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. Both the U.S. Congress and the EPA are studying whether there is any link between hydraulic fracturing and soil or ground water contamination or any impact on public health. Legislation has been introduced before the U.S. Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the fracturing process. In addition, some states have and others are considering adopting regulations that could restrict hydraulic fracturing in certain circumstances. Any new laws, regulation or permitting requirements regarding hydraulic fracturing could have a material adverse effect the Partnership's business, financial condition and results of operation through increased costs of compliance and doing business or by delaying the development of unconventional gas resources from shale formations, including the Bakken area in North Dakota, which are not commercial without the use of hydraulic fracturing
The Partnership may incur liability for liens against its subcontractors and incur excess costs as a result.
We will try to determine the financial condition of nonaffiliated subcontractors. If subcontractors fail to timely pay for materials and services, the properties of the Partnership could be subject to materialmen's and workmen's liens. In that event, the Partnership could incur excess costs in discharging the liens.
Shut-in wells and delays in production may adversely affect Partnership operations.
Production from wells drilled in areas remote from marketing facilities may be delayed until sufficient reserves are established to justify construction of necessary pipelines and production facilities. In addition, production from wells may be reduced or delayed due to seasonal marketing demands. Wells drilled for the Partnership may have access to only one potential market. Local conditions, including closing businesses, conservation, shifting population, pipeline maximum operating pressure constraints, and development of local oversupply or deliverability problems could halt sales from Partnership wells.
The production and producing life of Partnership wells is uncertain. Production will decline.
It is not possible to predict the life and production of any well. The actual lives could differ significantly from those anticipated. Sufficient oil or natural gas may not be produced for you to receive a profit or even to recover your initial investment. In addition, production from the Partnership's oil and natural gas wells, if any, will decline over time, and does not indicate any consistent level of future production. This production decline may be rapid and irregular when compared to a well's initial production.
Delays in the transfer of title to the Partnership could place the Partnership at risk.
Under certain circumstances, title to Partnership properties will be held by us on the Partnership's behalf. In other instances, title may not be transferred to us or the Partnership until after a well has been completed. When this is the case, the Partnership runs the risk that the transfer of title could be set aside in the event of the bankruptcy of the party holding title. In this event, title to the leases and the wells would revert to the creditors or trustee, and the Partnership would either recover nothing or only the amount paid for the leases and the cost of drilling the wells. Assigning the leases to the Partnership after the wells are drilled and completed will not affect the availability of the tax deductions for intangible drilling costs since the Partnership will have an economic interest in the wells under the drilling and operating agreement before the wells are drilled. See "PROPOSED ACTIVITIESTitle to Properties."
Extreme weather conditions may adversely affect drilling and production operations and distributions.
The Partnership may conduct drilling and production operations in the extreme northern part of the United States, such as North Dakota, where extreme cold weather occurs. The occurrence of this or other extreme weather may harm or delay the Partnership's operations and distribution of revenues, if any.
Our dependence on third parties for the processing and transportation of oil and gas may adversely affect the Partnership's revenues and distributions.
We will rely on third parties to process and transport oil and natural gas produced by wells in which the Partnership will participate. In the event a third party upon which we rely is unable to provide transportation or processing services, and another third party is unavailable to provide such services, then the Partnership will be unable to transport or process the oil and natural gas produced by the affected wells. In such an event, revenues to the Partnership and distributions to the partners may be delayed.
There are material tax risks of becoming a partner in the Partnership.
There are material risks associated with the U.S. federal income tax consequences of becoming a partner in the Partnership. The following paragraphs summarize some of these risks. Because the tax
consequences of becoming a partner are complex and certain tax consequences may differ depending on individual tax circumstances, each investor is urged to consult with and rely on its own tax advisor regarding the tax consequences of becoming a partner. No representation or warranty of any kind is made with respect to the acceptance by the IRS or any court of law regarding the treatment of any item of income, deduction, gain, loss or credit by an investor on its own tax return. Except where specifically mentioned, this prospectus does not discuss the U.S. federal estate and gift, foreign, state or local tax consequences or risks related to an investment in the Partnership or the risks specifically applicable to potential investors that are subject to special federal income tax treatment such as corporations, tax exempt organizations, insurance companies, financial institutions, broker-dealers, and non-U.S. taxpayers.
The current tax treatment of exploring for and producing oil and gas may change, and such changes may reduce or eliminate the tax benefits described in this prospectus.
The tax treatment currently available with respect to oil and natural gas exploration and production may be modified or eliminated without prior notice on a retroactive or prospective basis by future legislative, judicial, or administrative actions. Recently there have been specific legislative proposals concerning the tax treatment of exploring for and producing oil and gas, and some of those proposals reduce or eliminate some of the tax benefits described in this prospectus. For example, as part of its budget proposal for the 2013 fiscal year, the current administration has proposed to repeal a number of the tax benefits currently available for the exploration for and production of oil and gas. The changes proposed by the administration include the elimination of the current deduction of intangible drilling costs, percentage depletion for independent producers, and the working interest exception to the passive activity loss rules. The administration's budget proposal also includes proposals to increase the amortization period for geological and geophysical costs from two years to seven years for all taxpayers (currently only major integrated oil companies are required to amortize geological and geophysical costs over seven years); exclude gross receipts from the sale of oil and natural gas from the calculation of the domestic production deduction; and eliminate certain tax credits that are potentially available in connection with the production of oil and natural gas. The changes are proposed to take effect in 2013 and, if enacted, could have an adverse impact on the U.S. oil and gas industry. To date, these changes have not been enacted. The same changes were proposed by the current administration as part of its budget proposals for the 2010, 2011 and 2012 fiscal years. Those proposals were not enacted by Congress. At this time it is not possible to predict whether any legislative proposals, including the administration's budget proposals, will become law. Therefore, you are urged to consult with your own tax advisor regarding the impact that a change in the U.S. federal tax law could have on your decision to invest in the Partnership.
The tax treatment described in this prospectus depends upon partnership classification.
The tax treatment discussed in this prospectus applies only if the Partnership is classified as a "partnership" for federal income tax purposes and not as "an association taxable as a corporation." Under current law a limited partnership like the Partnership should be treated as a "partnership" for federal income tax purposes, and not as an association taxable as a corporation, so long as an election is not made to treat the partnership as a corporation for U.S. federal income tax purposes. We do not intend to make such an election. If we did elect for the Partnership to be treated as an association taxable as a corporation for federal income tax purposes or if the IRS were to successfully assert that such treatment is proper: (i) income, gains, losses, deductions and credits of the Partnership would not flow through to you; (ii) the taxable income of the Partnership would be subject to the federal income tax imposed on corporations at the Partnership level; and (iii) distributions would be treated as corporate distributions to the partners and could be taxable as dividends or capital gain.
Your tax liability from the Partnership may exceed the cash distributions that you receive from the Partnership.
As a partner in the Partnership, for U.S. income tax purposes you will be required to include in your own tax return your share of the items of the Partnership's income, gain, loss, deduction, and credit for the year, whether or not cash proceeds are actually distributed to you. As a result, you could owe U.S. federal income taxes based on your allocable share of Partnership taxable income, even though the Partnership did not distribute cash or property to you. The Partnership may not be able to make cash distributions to you to permit you to pay your tax liability. As a partner, you will not have the right to demand distributions of Partnership income. If your tax liability exceeds the cash you receive from the Partnership, you will have to use cash from other sources to pay your tax liability.
The Partnership may not meet the requirements to allow you to currently deduct intangible drilling costs.
Federal tax law places substantial limits on taxpayers' ability to currently deduct intangible drilling costs. Generally, only an "operator" is permitted to elect to currently deduct, or capitalize and deduct ratably over a 60-month period, costs that are properly characterized as intangible drilling costs that the operator incurs in connection with the drilling and development of oil and natural gas wells. For purposes of deducting intangible drilling costs, the term "operator" is generally defined by the IRS as one that owns a working or an operating interest in an oil or gas well. The Partnership intends to acquire working interests in oil and gas properties located in the United States. The Partnership's determination that it is an "operator" with respect to its oil and gas properties for tax purposes at the time that intangible drilling costs are incurred is not binding on the IRS. The IRS may assert that the Partnership is not an "operator" with respect to one or more of its oil or gas wells at the time that intangible drilling costs are incurred for the wells. If the IRS were successful in such a challenge, the Partnership and, therefore, the investor partners, would not be entitled to currently deduct the intangible drilling costs incurred in connection with such wells.
The IRS may challenge the Partnership's characterization of its costs as intangible drilling costs.
Intangible drilling costs are costs that are incident to and necessary for the drilling of wells and the preparation of wells for production that have no salvage value. We will make the initial determination of which costs incurred by the Partnership constitute intangible drilling costs. The IRS may not agree with our classification of certain costs and may assert that an item classified by us as an intangible drilling cost must be recharacterized as a cost that must be capitalized or that is not currently deductible. If the IRS is successful, you could owe additional taxes, penalties and interest for the tax years that are affected by the recharacterization. To the extent not deductible, the reclassified amounts should be included in the Partnership's basis in its mineral property and in your basis in your interest in the Partnership.
The Partnership's intangible drilling costs may not be deductible in any certain year.
Intangible drilling costs are generally deductible during the tax year when the well to which the costs relate is drilled. In certain limited circumstances, intangible drilling costs that are paid in one year for a well that is drilled during the following year can be deducted in the tax year during which the costs are paid rather than the subsequent year when the well is drilled. In order for prepaid intangible drilling costs to be deducted in the year during which they are paid, among other things, the wells to which the prepaid intangible drilling costs relate must be spudded no later than 90 days after the end of the year during which the costs are paid or it must be reasonable to conclude at the time the costs are paid that drilling will be complete on the well within 31/2 months after the prepayment. If the Partnership prepays some or all of its intangible drilling costs, such prepayments may not meet the requirements to be deducted during the year in which the prepayments are made. In addition, it is possible that the Partnership will not expend or contract to expend any of its capital contributions in
the year in which it is formed. As a result, the Partnership's subscriptions and, therefore, your investment in the Partnership, may not result in intangible drilling costs that are deductible in the year in which the Partnership is formed or in any certain later year.
Your own tax circumstances may limit your ability to take depletion deductions.
If one or more of the Partnership's wells is productive, you should be able to take cost or, if you qualify, percentage depletion deductions with respect to the production from the wells. You may claim a percentage depletion deduction only if you qualify as a so-called "independent producer" under U.S. federal tax law. Even if you qualify, only a limited amount of the Partnership's oil and gas production each year will qualify for percentage depletion. You must individually determine whether you qualify as an "independent producer." You will also be responsible for calculating your own depletion deductions, if any. The Partnership's wells may not be productive and, therefore, you may not be eligible to take depletion deductions in connection with your investment in the Partnership. If the Partnership has one or more productive wells, you may not qualify for any particular method of computing depletion, including percentage depletion.
Current deductions for intangible drilling costs, depletion and depreciation may only defer your tax liability to a later year.
Deductions for intangible drilling costs, depletion and depreciation must be recaptured as ordinary income if the Partnership disposes of its oil and gas properties at a gain for tax purposes, or if you dispose of your interest in the Partnership at a gain for tax purposes. Therefore, some or all of the gain on the sale of your interest in the Partnership or on the Partnership's sale of an oil and gas property may be taxable at ordinary income rates. If so, then deductions in one year for intangible drilling costs, depletion and depreciation may only defer your tax liability until a later year.
The tax treatment of an investment in the Partnership will differ for additional general partners and limited partners.
If you invest as a limited partner, your allocable share of the Partnership's taxable income, loss and credit should be subject to the passive activity loss rules. As a result, you will only be able to use your allocable share of Partnership losses to offset your taxable income from the Partnership and from other passive business activities, if any, that you own an interest in. If you invest directly in the Partnership as an additional general partner and not through an entity that limits your liability with respect to your additional general partnership interest, your allocable share of the Partnership's taxable income, loss and credit attributable to the Partnership's working interests should not be treated as a passive activity. As a result, you should be able to use your allocable share of Partnership working interest losses while you are an additional general partner to offset your taxable income from the Partnership and from other so-called "active" sources such as salary and from so-called "portfolio" income, which includes interest, dividends and royalties that are not derived from the active conduct of a trade or business. Special rules will apply once your additional general partnership interest is converted to a limited partnership interest. Because the tax treatment will differ for additional general partners and limited partners, each prospective investor is urged to consult with its own tax advisor before deciding to invest as an additional general partner or a limited partner.
A material portion of your subscription will be allocated to costs that are not currently deductible.
A material portion of your subscription will be used for costs and expenses that are not currently deductible. In addition, the IRS may not agree with the Partnership's categorization of its costs and expenses between currently deductible and non-deductible expenses. If the IRS were to successfully assert that certain costs and expenses that are initially deducted by the partners are non-deductible capital expenditures, you could owe additional taxes and be liable for penalties and interest.
Partnership borrowing may reduce the cash the Partnership has available to distribute to you to allow you to pay your tax liability from the Partnership.
We are authorized to cause the Partnership to obtain loans from banks or other financial sources, or from us or our affiliates, if necessary to fund Partnership activities. Your allocable share of the Partnership's net income that is applied to repay such loans will nonetheless be included in your taxable income. As a result, your income tax liability from the Partnership may exceed the cash the Partnership has available to distribute to you. If this occurs, you will have to use cash from other sources to pay your tax liability. In the event the Partnership borrows funds for any reason, the lender must agree that it will have no recourse against the individual investor partners. Any borrowings may, in our discretion, be secured by the Partnership's assets or income and may, in our discretion, be made with or without recourse to us as managing general partner.
The IRS may not respect the Partnership's allocation of tax items.
We intend for the Partnership to allocate items of income, gain, loss, deduction and credit among the partners in accordance with the terms of the partnership agreement. The IRS may not respect such allocations and may assert that the Partnership's income, gain, loss, deduction and credit should be allocated in some other manner. If the IRS successfully asserts that the Partnership's federal income tax items should be allocated in a different manner, you could owe additional taxes, penalties and interest.
The Partnership may generate taxable events for you, even if you are generally exempt from taxation.
Certain entities that are otherwise exempt from federal income tax, such as individual retirement accounts and annuities ("IRAs"), qualified plans, and charitable organizations are nonetheless taxed on "unrelated business taxable income" of $1,000 or more that they earn in any taxable year. Substantially all of the income from the Partnership's operations, if any, will constitute unrelated business taxable income and may result in a tax liability for you, even if you are otherwise tax exempt. If you invest with money from your IRA, it is possible that the earnings from the Partnership could be subject to tax twice: once when amounts are earned by the Partnership and then again when funds are distributed from the IRA to you. In addition, tax exempt charitable remainder trusts and charitable remainder unitrusts will be subject to a 100% excise tax on any unrelated business taxable income that they receive. Therefore, if you are a tax exempt prospective investor, we urge you to consult your own tax advisor regarding an investment in the Partnership before you invest.
Audits of the Partnership's tax returns could result in increased taxes due by the partners or audits of partners' individual tax returns.
It is possible that the IRS will audit the Partnership's tax returns. If an audit occurs, tax adjustments might be made that would increase the amount of taxes that you owe or increase the risk of audit of your individual tax returns. If additional tax is owed, you may also owe penalties and interest in addition to the tax. The costs and expenses incurred to respond to an audit of the Partnership's returns and to contest any audit adjustments will reduce the funds the Partnership otherwise has available to distribute to its partners. You may also incur costs and expenses in connection with an audit of your own tax returns and/or in connection with making changes to your own tax return as a result of adjustments that are made to the Partnership's tax return. You will be solely responsible for all costs of responding to audits of, contesting any adjustments and making any changes to your own tax returns.
State and local tax laws may result in additional tax liabilities and filing obligations for you.
You may be subject to state and local taxes on your share of Partnership income in the jurisdictions in which you reside and/or where the Partnership owns an interest in an oil or gas well. As a result, you may have additional filing obligations with those states or localities. In addition, the discussion of the material tax consequences in this prospectus is limited to U.S. federal tax issues, and it does not address state and local tax treatment, which may differ from the federal treatment. As a result, we urge you to consult your own tax advisor regarding the state and local tax risks and consequences of becoming a partner in the Partnership before you invest.
State and local taxes may reduce the Partnership's distributable cash.
The Partnership may be subject to various state or local taxes associated with its intended ownership of working interests and production of oil and gas such as franchise, sales, use, severance and/or property taxes, which are payable by the Partnership rather than the investor partners. These taxes will reduce the funds the Partnership has available to distribute to you. As a result, your income tax liability from the Partnership may exceed the cash the Partnership has available to distribute to you. If this occurs, you will have to use cash from other sources to pay your tax liability.
This prospectus contains forward-looking statements that involve risks and uncertainties. You should exercise extreme caution with respect to all forward-looking statements made in this prospectus. Specifically, the following statements are forward-looking:
We believe that it is important to communicate our future expectations to our investors. Forward-looking statements reflect the current view of management with respect to future events and are subject to numerous risks, uncertainties and assumptions, including, without limitation, the factors listed above in the section captioned "RISK FACTORS." Should any one or more of these or other risks or uncertainties materialize or should any underlying assumptions prove incorrect, actual results are likely to vary materially from those described herein. All forward-looking statements, expressed or implied, included in this prospectus are expressly qualified in their entirety by this cautionary statement. We do not intend to update our forward-looking statements, except as otherwise required by applicable law. All subsequent written and oral forward-looking statements attributable to persons acting on our behalf or us are expressly qualified in their entirety by the applicable cautionary statements.
We are sponsoring Reef 2012 - 2013 Drilling Fund, L.P., which we refer to in this prospectus as the "Partnership" or the "Fund." The maximum offering amount in the Partnership is $225 million. 85% of the units offered will be additional general partner units and 15% will be limited partner units. Units
are being offered at an offering price of $100,000 per unit. The minimum required subscription per investor is one-tenth of a unit ($10,000). Additional purchases above such minimum may be made in increments of $1,000. There is no market or market price for the Units. Reef established the offering price of the Units arbitrarily, without any arms-length negotiations or appraisal. Furthermore, the offering price does not necessarily bear any relationship to the Partnership's assets (tangible or intangible), book value, net worth or expected earnings. The offering price is based on the maximum offering amount divided by the number of units to be issued.
As long as at least a total of 10 units are sold in the Partnership, without regard to units bought by our affiliates and us, and at least one of such units is a unit of limited partner interest, including units we buy, there is no minimum number of additional general partner or limited partner units that must be sold. We will buy at least 1% of the issued units of the Partnership. These units may be either additional general partner interests or limited partner interests. Our affiliates and we may, in our respective discretion, subscribe for additional units.
The price to be paid by us for our minimum subscription, and the price to be paid by our affiliates and us for additional units that any of us may subscribe for, if any, is the same price per unit to be paid by investors, net, however, of organization and offering costs (including commissions). This means we will pay a minimum of 85% of the offering price for each unit we purchase, or $85,000 per unit. In addition, we will be charged with 100% of the organization and offering costs, excluding sales commissions, for the Partnership if and to the extent that such costs exceed 15% of the investor partners' subscriptions. We and/or our affiliates will be entitled to the same ratable interest per unit purchased in the Partnership as other unit holders. All units purchased by our affiliates and/or us will be made for investment purposes only and not with a view toward redistribution or resale.
The offering period for the Partnership began on the date of this prospectus and may be terminated at any time after the minimum number of units (10) has been subscribed for in the Partnership, without regard to units purchased by our affiliates and us. As of the date of this prospectus, the Partnership has not commenced operations and has no assets or liabilities.
Unless we elect to terminate the Partnership's offering period before the maximum number of units in the Partnership has been subscribed for, the offering period for the Partnership will terminate on June 30, 2014.
You may elect to purchase units as a limited partner and/or as an additional general partner, by purchasing units of limited partner interest or units of general partner interest. 85% of the units offered will be additional general partner units and 15% will be limited partner units. As long as at least a total of 10 units are sold in the Partnership, and at least one of such units is a unit of limited partner interest, including units we buy, there is no minimum number of additional general partner or limited partner units that must be sold.
Subscriptions for units are payable in cash upon subscription. Checks for units should be made payable to "Wilmington Trust, National Association as escrow agent for Reef 2012 - 2013 Drilling Fund, L.P.," or such other bank or escrow agent as we may choose and should be given to your broker for submission to the dealer manager and escrow agent.
Your execution of the subscription agreement, or the execution of the subscription agreement by your authorized representative in the case of fiduciary accounts, constitutes a binding offer to buy units
in the Partnership and an agreement to hold the offer open until the subscription is accepted or rejected by us. Once you subscribe for units, you will not have any revocation rights, unless otherwise provided by state law. We will not complete the sale of units until at least five business days after you have received a copy of the final prospectus for the offering. Upon completion of the sale of your units, we will send you a written confirmation of your purchase.
We may refuse to accept any subscription without liability to the subscriber. Subscriptions will be accepted or rejected by us within 30 days of their receipt. If a subscription for the Partnership is accepted, the subscriber will be admitted as a partner no later than 15 days after the release from the escrow account of the capital contributions to the Partnership, and thereafter a subscriber for the Partnership will be admitted into the Partnership not later than the last day of the calendar month in which their subscription was accepted by the Partnership. We may reject a subscription if, for example, the prospective investor does not satisfy the suitability standards described below or if the subscription is received after the offering period has terminated. If a subscription is rejected, then all of the rejected subscriber's funds will be returned to the subscriber immediately, with interest earned and without deduction for any fees. The execution of the subscription agreement and its acceptance by us also constitute the execution of the partnership agreement and an agreement to be bound by its terms as a partner, including the granting of a special power of attorney to us appointing us as the partner's lawful representative to make, execute, sign, swear to, and file a certificate of formation, governmental reports, certifications, contracts, and other matters.
Subscription proceeds of the Partnership will be held in a separate interest-bearing escrow account with Wilmington Trust, National Association, as escrow agent, until at least 10 units in the Partnership have been subscribed for, without regard to units subscribed for by our affiliates and us, in compliance with Rule 15c2-4 promulgated by the SEC. If the minimum number of units in the Partnership is not subscribed for prior to the termination of the Partnership's offering period, the escrow agent will promptly return all subscription proceeds to subscribers in full, with any interest earned on the subscriptions, in compliance with Rule 10b-9 promulgated by the SEC. In no event will an investor's funds be held in escrow for more than one year. If at least 10 units have been subscribed for during the Partnership's offering period, without regard to units our affiliates and we buy, then we may direct the escrow agent to disburse the funds in the escrow account, in whole or in part, at any time during the remainder of the Partnership's offering period, and to pay to us all funds in the escrow account upon termination of the Partnership's offering period. After at least the minimum subscription proceeds are transferred to the Partnership's account, the Partnership may begin its activities, including acquiring oil and gas properties and drilling to the extent the prospects have been identified in a supplement to this prospectus.
Subscriptions will not be commingled with our funds or the funds of our affiliates, nor will subscriptions be subject to the claims of our creditors or those of our affiliates. Subscription proceeds will be deposited in interest-bearing accounts or invested during the offering period only in short-term highly-liquid securities where there is appropriate safety of principal, which are deemed permissible under Rule 15c2-4 promulgated by the SEC. Interest accrued on subscription funds prior to closing of the offering and funding of the Partnership will be allocated pro rata to the respective subscriber.
The Partnership was formed pursuant to the Texas Business Organizations Code (the "Act"). The escrow agent will partially fund the Partnership by releasing the funds held in escrow on our request after the minimum subscription level has been reached, without regard to units our affiliates and we buy, and will continue to partially fund the Partnership by releasing subsequent subscription funds to the Partnership on a regular basis. Additionally, during the offering period of the Partnership, in the event the Partnership acquires a property (or it becomes reasonably probable that the Partnership will acquire a property) that has not been described herein, we will file with the SEC a prospectus
supplement describing such property. Once every three months, we will consolidate these supplements into a post-effective amendment that we will file with the SEC and distribute to each of the investor partners.
Upon funding of the Partnership, we will deposit the subscription funds into interest-bearing accounts or invest such funds in the Partnership's name in income producing short-term, highly-liquid investments where there is appropriate safety of principal such as a money market fund, until the funds are required for Partnership purposes. Any such income shall be allocated pro rata to the investor partners. Interest earned on amounts so deposited or invested will be credited to the accounts of the Partnership.
We anticipate that within 24 months following the termination of the Partnership's offering period all subscriptions will have been expended or committed for Partnership operations. Unless we determine that it is prudent for the Partnership to set aside funds for working capital, contingencies, or any other matter, any unexpended and/or uncommitted subscriptions at the end of such 24-month period will be returned pro rata to the investor partners and we will reimburse such partners for organization and offering costs allocable to the return of capital.
We also will take all other actions necessary to qualify the Partnership to do business as a limited partnership or cause the limited partnership status of the Partnership to be recognized in any other jurisdiction where the Partnership conducts business.
You May Choose to Be a Limited Partner and/or an Additional General Partner. You may purchase units as a limited partner and/or as an additional general partner. The income, gains, losses, deductions, and cash distributions allocable to the investor partners are generally shared pro rata between the unit holders based upon the ratio of the number of units that each investor partner owns to the total number of outstanding units. There are, however, material differences in the federal income tax consequences and the liability associated with these different types of units. See "Material Federal Income Tax ConsequencesPassive Loss Limitations."
Each investor must indicate the number of units of limited partner interests or additional general partner interests subscribed for and fill in the appropriate line on the investor signature page of the subscription agreement. If you fail to indicate on the subscription agreement a choice between investing as a limited partner or as an additional general partner, we will not accept the subscription and will promptly return the subscription agreement and the tendered subscription funds to you.
Limited Partners. The liability of a limited partner of the Partnership for the Partnership's debts and obligations will be limited to that partner's capital contributions, his share of partnership assets, and the return of any part of his capital contribution. Under Texas law and the partnership agreement of the Partnership, a limited partner is liable for all or part of a returned capital contribution or partnership distribution if the limited partner received the Partnership distribution in violation of the partnership agreement of the Partnership or the Texas Business Organizations Code and such limited partner knew at the time of the distribution that the distribution violated the terms of the partnership agreement or the Texas Business Organizations Code.
General Partners. The general partners of the Partnership will consist of Reef as managing general partner and each investor purchasing units of general partner interest referred to in this prospectus as "additional general partner interests." Each additional general partner will be fully liable for the debts, obligations and liabilities of the Partnership individually and as a group with all other general partners as provided by the Act to the extent liabilities are not satisfied from the proceeds of insurance, from indemnification by us, or from the sale of partnership assets. See "RISK FACTORS." While the activities of the Partnership will be covered by substantial insurance policies and indemnification by us (see
"PROPOSED ACTIVITIESInsurance" and "SUMMARY OF PARTNERSHIP AGREEMENTIndemnification"), the additional general partners may incur personal liability as a result of the activities of the Partnership that are not covered by insurance, partnership assets, or indemnification.
Conversion of Units by Additional General Partners and Us. We will convert all units of additional general partner interest of the Partnership into units of limited partner interest on a one-to-one basis as soon as practicable after the end of the year in which drilling by the Partnership has been substantially completed. We anticipate that such conversion will occur during the second or third year after the completion of the offering; however, it is possible that drilling activities will continue in subsequent years, resulting in additional general partners retaining unlimited liability during such periods. Additional general partners may, however, upon written notice to us, except as provided below and in the partnership agreement, convert their interests into limited partner interests of the Partnership at any time within the 30-day period prior to any material change in the amount of the Partnership's insurance coverage.
Upon conversion, an additional general partner of the Partnership will become a limited partner of the Partnership. Conversion will not be permitted if it will cause a technical termination of the Partnership for federal income tax purposes. We do not expect for a conversion to cause a technical termination of the Partnership.
Conversion of additional general partner interests to limited partner interests in the Partnership will not be effective until we file an amendment to the Partnership's certificate of formation. We are obligated to file an amendment to the Partnership's certificate at any time during the full calendar month after receiving the required notice of the additional general partner requesting conversion, as long as the conversion will not result in a termination of the Partnership for tax purposes. A conversion made in response to a material change in the Partnership's insurance coverage will be made effective prior to the effective date of the change in insurance coverage. After the conversion of his general partner interest to that of a limited partner, each converting additional general partner will continue to have unlimited liability for Partnership liabilities arising prior to the effective date of such conversion, and will have limited liability to the same extent as limited partners for liabilities arising after conversion to limited partner status is effected.
Except with respect to units we buy in the Partnership for cash, we are not entitled to convert our interests into limited partner interests. Limited partners do not have any right to convert their units into units of additional general partnership interest.
We reserve the right, in our sole discretion, to abandon or terminate the offering at any time during the offering period, to reject all or part of any subscription from any potential investor for any reason and, in the event that the offering is oversubscribed, to allot a lesser number of units than are subscribed by any method that we deem appropriate. We are not obligated to accept subscriptions in the order in which they are received. We also reserve the right to waive any individual subscription requirement other than investor suitability standards. If the offering is terminated without closing for any reason or if a subscriber's subscription is not accepted, we will cause all funds to be refunded promptly to the affected subscribers, with interest and without deduction of fees, within 30 days of the termination or reception of the subscription.
We and each person selling units will make every reasonable effort to determine that the purchase of units is a suitable and appropriate investment for each prospective investor, based on the investor's investment objectives, investment experience, age, investment portfolio and financial situation, and the
investor's income or net worth. Furthermore, the dealer manager or we, before accepting a subscription, will make reasonable efforts to see that the prospective investor:
General Suitability Requirement. Units of limited partner interests, including fractional units, will be sold only to an investor who has either:
Units of additional general partner interests, including fractional units, will be sold only to an investor who has either:
Unless otherwise specified, net worth shall be determined exclusive of home, home furnishings and automobiles. In addition, units will be sold only to an investor who makes a written representation that it is the sole and true party in interest and that it is not purchasing for the benefit of any other person, or, in the alternative, that it is purchasing for another person who meets all of the conditions set forth above.
Additional Requirements for Purchasers in Certain States. Additional suitability requirements are applicable to residents of certain states where the offer and sale of units are being made as set forth below.
Alabama investors are not permitted to invest in the units if the dollar amount of the investment in this fund and other similar funds is equal to or more than 10% of their liquid net worth, such net worth being defined as the portion of the purchaser's total net worth that is comprised of cash, cash equivalents, or readily marketable securities.
California residents generally may not transfer units without the consent of the California Commissioner of Corporations. Any subsequent transfer by a California resident shall be limited to no less than a minimum unit equivalent to an initial subscription, which is 0.4 Unit.
Arizona, California, Kentucky, Michigan, Missouri, Nebraska, Ohio, Oregon, and Pennsylvania investors are not permitted to invest in the units if the dollar amount of the investment is equal to or more than 10% of their net worth, exclusive of home, home furnishings and automobiles.
Iowa and Kansas investors are advised to limit their investment in the units and similar oil and natural gas partnerships to no more than 10% of their liquid net worth, such net worth being defined as "that portion of the purchaser's total net worth that is comprised of cash, cash equivalents, or readily marketable securities."
Oklahoma investors are not permitted to invest in the units if the dollar amount of the investment in this Partnership is equal to or more than ten percent (10%) of their liquid net worth, exclusive of home, home furnishings and automobiles.
A resident of Tennessee who subscribes for units of limited partnership interests or additional general partnership interests must have a minimum annual gross income of $100,000 and a minimum net worth of $100,000; or a minimum net worth of $500,000. Tennessee residents' investment must not exceed ten percent (10%) of their liquid net worth.
Massachusetts and Vermont investors are not permitted to invest in the units if the dollar amount of the investment is equal to or more than 5% of their liquid net worth, such net worth being defined as "that portion of the purchaser's total net worth that is comprised of cash, cash equivalents, or readily marketable securities."
A resident of Vermont who subscribes for units must have a minimum net worth of $1,000,000, exclusive of home, home furnishings and automobiles.
Purchasers of Units. A resident of California who subscribes for units of limited partnership interests must meet one of the following requirements:
A resident of California who subscribes for units of additional general partnership interests must meet one of the following requirements:
Miscellaneous. It is anticipated that the Partnership will acquire interests in federal oil and natural gas leases. Subscriptions therefore will not be accepted from a person who is not an eligible citizen. In general, an eligible citizen is a citizen of the United States or someone who is otherwise eligible to be qualified to hold an interest in oil and natural gas leases on federal lands under federal laws and regulations in effect from time to time. Each subscriber must represent in writing that he or she is an eligible citizen.
Transferees of units seeking to become substituted partners must also meet the suitability requirements discussed above, as well as the requirements for transfer of units and admission as a substituted partner imposed by the partnership agreement. These requirements apply to all transfers of units, including transfers of units by a partner to a dependent or to a trust for the benefit of a dependent or transfers by will, gift or by the laws of descent and distribution.
Where any units are purchased by an investor in a fiduciary capacity for any other person, or for an entity in which such investor is deemed to be a "purchaser" of the subject units, all of the suitability standards set forth above will be applicable to such other person or entity.
You are required to execute your own subscription agreement. We will not accept your subscription agreement if it has been executed by someone other than you. In the case of fiduciary accounts, we will not accept any subscription from someone who does not have a legal power of attorney to sign on your behalf.
For details regarding how to subscribe, see "INSTRUCTIONS TO SUBSCRIBERS" attached as Appendix C.
You are not required to make any capital contributions to the Partnership other than the payment of the offering price for your units. At times, however, the actual costs of the Partnership's proposed drilling activities may exceed total Partnership capital contributions due to unforeseen events or opportunities. In such instances, additional funds may be required to uphold the Partnership's obligations. Because the partnership agreement does not provide for assessments of the investor partners, we must obtain any necessary additional financing through either the use of Partnership revenues, which will result in less overall distributions to the partners, the sale of Partnership properties or production interests in partnership properties, or borrowings made by the Partnership. In no event will the Partnership's borrowings exceed 25% of the Partnership's capital contributions without the consent of the partners. The proceeds of the Partnership's borrowings will not be used to pay fees or expenses to us or our affiliates, other than to reimburse us or our affiliates for fees or expenses we have paid to third parties in the normal course of business on behalf of the Partnership. In the event the Partnership borrows funds for any reason, the lender must agree that it will have no recourse against the individual investor partners. The Partnership may borrow money on a non-recourse basis from us or any of our affiliates, provided that on any loans made available by us or any of our affiliates to the Partnership, we or such affiliate shall not receive interest in excess of the amount which would be charged to the Partnership (without reference to our financial abilities or guaranties) by independent third parties for the same purpose. Any borrowings may, in our discretion, be secured by the Partnership's assets or income and may, in our discretion, be made with or without recourse to us as managing general partner.
We cannot guarantee that such additional financing will be available at the time needed, if at all, and if we are unable to procure a source of additional financing we may have to forego further drilling activities, development, completion or operations of oil and natural gas wells on partnership properties. Our inability to make required payments could also result in the loss of our interest in Partnership properties, or in the sale of Partnership assets or production interests in producing properties held by the Partnership to third parties or our affiliates. In such instances, the Partnership may not realize the full value of its holdings. In addition, to the extent the Partnership incurs indebtedness, its repayment of such borrowings will decrease the Partnership's cash available for distributions to the partners.
We may from time to time elect to sell a production interest in the Partnership's properties to another fund sponsored by one of our affiliates or us. Should we elect to do so, the revenues generated by the sale of such production interest would be a source of additional financing for the Partnership's initial or subsequent operations. The proceeds from such sale might also be utilized to purchase
additional Partnership properties, which would result in a more diverse portfolio of Partnership properties and enable the Partnership to participate in drilling activities requiring more capital than the amount initially raised by the Partnership. The sale of a portion of the Partnership's interest in producing properties would, however, result in the revenues from such properties being spilt between the Partnership and the persons or entities purchasing an interest in the production from the Partnership's wells and could result in decreased distributions to the partners.
We will make all decisions as to how to raise any necessary additional financing and at times we may, in our discretion, loan funds to the Partnership. In the event we or one of our affiliates makes a loan to the Partnership, neither we nor our affiliate may receive interest in excess of our interest costs, nor may our affiliate or we receive interest in excess of the amounts which would be charged the Partnership (without reference to our financial abilities or guaranties) by unrelated banks on comparable loans for the same purpose, and our affiliate or we shall not receive points or other financing charges or fees, regardless of the amount.
Upon completion of the offering of units in the Partnership, the sole funds available to the Partnership will be the capital contributions of the partners, which will range from a minimum of $1,000,000 if the minimum subscription of 10 units is sold, without regard to purchases by our affiliates and us, to a maximum of $225,000,000 (2,250 units). The maximum aggregate capital contribution includes the purchase of units by our affiliates and us. We will purchase at least 1% of the units issued in the Partnership at the offering price of $100,000 per unit, net of organization and offering costs (including commissions). There is no limit on the number of units our affiliates and we may elect to purchase in the Partnership.
The determination of the maximum amount of the offering for the Partnership is based on a variety of factors, including the amount of capital the managing general partner believes may be utilized effectively on oil and gas acquisitions and operations within 12 months of the termination of an offering, the price of oil and gas, and general market conditions.
In order to fund the Partnership, a minimum of 10 units ($1,000,000) must be sold, without regard to purchases by our affiliates and us. The following table presents information regarding the financing of the Partnership based upon the sale of 10 units ($1,000,000) and the sale of 2,250 units ($225,000,000), the minimum and maximum number of units, respectively, that can be sold for the Partnership. We will receive a fee in an amount equal to the excess, if any, of 15% of the subscriptions
by investor partners to the Partnership over the sum of all organization and offering costs and all commissions payable to the dealer manager.
As the managing general partner, we will have broad discretion in allocating a substantial portion of the proceeds from the Partnership offering and selecting properties for the Partnership.
As indicated above, it is anticipated that substantially all of the Partnership's initial capital will be committed or expended following the offering of units in the Partnership. Any future requirements for additional capital may have to be satisfied from partnership production or from borrowings to fund subsequent operations. See "ADDITIONAL FINANCING" and "RISK FACTORSSpecial Risks of the PartnershipThe Partnership has limited external sources of funds, which could result in a shortage of working capital." Alternatively, the Partnership could farmout or sell partnership properties.
Profit and Losses from Operations. To the extent that the Partnership has a profit or loss for a given year from its oil and natural gas production and from the sale or other disposition of productive wells, leases and equipment without regard to the items of income and costs that are specially allocated as discussed below, (i) the profit will be allocated to the holders of units and to us in accordance with our respective rights to cash distributions from the Partnership, and (ii) the loss will be allocated first to the extent of, and in the same manner as, any prior allocations of undistributed profits, and then to the holders of units and us in accordance with our respective capital contributions to the Partnership (excluding the portion of capital contributions, if any, that are used to pay organization and offering costs). No partner will be required to restore a deficit balance in its capital account, if any.
Interest Income. Any interest earned on the deposit of subscription funds prior to the closing of the offering for the Partnership and prior to use in the Partnership's operations will be credited 100% to the investor partners. Interest earned on the deposit of operating revenues and revenues from any other sources will be allocated and credited in the same percentages that oil and natural gas revenues are then being allocated to the investor partners and to us.
Organization and Offering Costs. The units issued by the Partnership will be allocated 100% of the tax attributes of the organization and offerings costs to the extent such costs do not exceed 15% of the investor partners' subscriptions. Any excess organization and offering costs will be paid by, and allocated to, us. Organization costs include expenses for printing, engraving, mailing, salaries of employees while engaged in sales activity, charges of transfer agents, registrars, trustees, escrow holders, depositaries, engineers and other experts, expenses of qualification of the sale of the securities under federal and state law, including taxes and fees and accountants' and attorneys' fees but excluding sales commission, reimbursement of due diligence and wholesaling fees.
Management Fee. The management fee is the amount by which the sum of (i) 15% of the subscriptions by investor partners to the Partnership exceeds (ii) the sum of all commissions payable to the dealer manager. The management fee, if any, will be allocated 100% to the investor partners.
Based on our experience in sponsoring oil and natural gas funds prior to this fund, we estimate that direct costs and administrative costs allocable to the investor partners for the initial 12 months of the Partnership's operations will be approximately $125,000 if minimum subscriptions ($1,000,000) are received (representing 12.5% of aggregate partnership capital); and approximately $4,500,000 if maximum subscriptions ($225,000,000) are received (representing 2.0% of aggregate partnership capital). These costs exclude all offering and organization costs. As the managing general partner, we will bear a percentage of the direct costs and administrative costs equal to our percentage of revenue participation in the Partnership, except with regard to direct costs related to drilling or acquisition activities, which are allocated 1% to us. Administrative costs will be allocated to the Partnership on the basis of assets, revenues, time records or other methods (including expenses) conforming with generally accepted accounting principles. The following table describes the components of these estimated charges to the investor partners during the first year after the Partnership is formed, assuming the minimum or the maximum subscriptions are obtained. The costs below do not include third party costs paid for land, engineering, geological and geophysical services provided to the Partnership in connection with the review and acquisition of potential prospects. The costs relating to the review and acquisition of potential prospects include fees paid to third party vendors and are allocable to the
Partnership and one or more other ventures sponsored by us. The fees allocable to the Partnership cannot be determined until the conclusion of the Fund. See "PROPOSED ACTIVITIES."
We will make distributions of distributable cash to the partners. For distributions made during the offering period and for 90 days thereafter, "distributable cash" means an amount not to exceed the net income of the Partnership under generally accepted accounting principles that has been actually collected, not just earned and accrued, by the Partnership, that is determined monthly and allocated to the units that were issued prior to the beginning of such month. After the expiration of 90 days after the closing of the offering, "distributable cash" means cash remaining after the payment of all partnership obligations and the establishment of contingency reserves for anticipated future costs, as determined by us. There is no assurance that any cash distributions will be made. As the managing general partner of the Partnership, we will determine if and when there is any distributable cash to the investor partners. In the event that we determine there is distributable cash in the Partnership from operations, it will be distributed 89% to the holders of partnership units (including units that we purchase) and 11% to us as managing general partner until each investor partner has been distributed, in the aggregate, an amount at least equal to its capital contributions. After the investor partners have been distributed amounts equal to their capital contributions, cash distributions will be distributed 79% to the investor partners and 21% to us. We will also receive the distributable cash allocable to units that we purchase in the Partnership. Therefore, if we purchase 1% of the remaining 89% partnership interest represented by units issued by the Partnership, we will receive 11.89% of the Partnership's distributable cash, and the investor partners will receive the remaining 88.11% until the investor partners have been distributed amounts equal to their capital contributions, and we will receive 21.89% of the Partnership's distributable cash, and the investor partners will receive the remaining 78.11% thereafter.
As the managing general partner of the Partnership, we will determine if and when to make cash distributions to the investor partners. We expect that cash distributions, if any, to the partners in the
Partnership will begin during the offering period approximately 3 months after the (i) first acquisition of a producing well, or (ii) completion of the drilling of the first successful well, and will be made monthly thereafter. We may, at our discretion, make distributions less frequently. We will review the accounts of the Partnership monthly for the purpose of determining the distributable cash available for distribution. The timing and amount of distributions will depend primarily on the Partnership's net cash receipts from its oil and natural gas operations, and will be affected, among other things, by the price of oil and natural gas and the level of production of the Partnership's wells. Generally, we estimate that the expenditure of the Partnership's capital for the acquisition, drilling and completion of oil and gas wells will take between one to one and one-half years, depending on the drilling schedule followed by the operators and conditions that may arise during operations. After drilling is completed, it is expected to take between three to four months for an investor partner to receive distributions, if any, based on any production from the completed well, including the time required to hook up the well up to existing infrastructure and engage in related marketing activities. No assurance can be given that any level of cash distributions to the investor partners will be attained, that cash distributions will equal or approximate cash distributions made to investors in prior drilling funds sponsored by us or our affiliates, or that any level of cash distributions can be maintained. See "RISK FACTORS" and "PRIOR ACTIVITIES."
In general, the volume of production from producing properties declines with the passage of time, and the rate of decline varies significantly. The cash flow generated by the Partnership's prospects and the amounts available for distribution to the Partnership's respective partners from such prospects will, therefore, decline in the absence of significant increases in the prices that the Partnership receives for its respective oil and natural gas production, or significant increases in the production of oil and natural gas from prospects resulting from the successful additional development of such prospects. See "RISK FACTORSRisks of Oil and Natural Gas Investments."
Upon termination and final liquidation of the Partnership, the assets of the Partnership, if any, that remain after the payment of all partnership costs and liabilities and the establishment of reasonable reserves to fund future Partnership liabilities, shall be distributed as follows:
We are authorized to amend the partnership agreement for the Partnership if, in our sole discretion based on advice from our legal counsel or accountants, an amendment to revise the cost and/or revenue allocations is required for the allocations to be recognized for federal income tax purposes either because of the promulgation of Treasury Regulations or other developments in the tax law. We will use our best efforts to make any required amended allocation provisions conform as nearly as possible to the original allocations described above.
The following table summarizes the items of compensation to be received by us from the Partnership. Some of the compensation cannot be quantified until the Partnership is conducting business.*
Our "partnership interest," as described in the table above, refers only to our interest as managing general partner and does not include the interest we will have as a result of our purchase of at least 1% of the units that are issued by the Partnership and our contribution of an amount equal to 1% of the net capital contributions to the Partnership after payment of all organization and offering costs, which amount will be used to pay lease costs, intangible drilling and development costs, and well completion costs. Direct costs cannot be quantified until the Partnership is conducting business.
We will contribute 1% of the net capital of the Partnership after payment of all organization and offering costs and will receive an interest of 11% in the Partnership. This 11% interest is not represented by partnership units that may otherwise be sold to investors. This Partnership interest does not include any additional interest we may hold as a result of our purchase of units. We will purchase at least 1% of the units issued by the Partnership. Therefore, initially, we will have a total partnership interest in the Partnership of at least 11.89% (the 11% interest plus at least 1% of the 89% of the Partnership owned by the units). In the event the investor partners receive distributions from the Partnership in amounts equal to their capital contributions, then we will receive an additional 10% general partnership interest in the Partnership and the interest owned by the unit holders will be reduced to 79% of the Partnership. We will be charged with 100% of the organization and offering costs, excluding sales commissions, for the Partnership if and to the extent that such costs exceed 15% of the investor partners' subscriptions. The following table shows our cash contributions and interests in
the Partnership, including our initial 11% interest and our interest as a result of buying at least 1% of the units in the Partnership.
We will receive a management fee in an amount equal to the excess of 15% of the subscriptions by investor partners to the Partnership over the sum of all commissions payable to the dealer manager and all organization and offering costs. This management fee is in consideration for services to be rendered by the managing general partner in managing the business of the Partnership. The actual amount of the management fee, if any, cannot be determined until total organization and offering costs for the offering are determined.
We will be reimbursed for direct costs and all documented out-of-pocket expenses incurred on behalf of the Partnership, including administrative costs. Administrative costs and other charges for goods and services must be fully supportable as to the necessity thereof and the reasonableness of the amount charged. Direct costs shall be billed directly to and paid by the Partnership to the extent practicable. Administrative costs must be reasonably allocated to the Partnership on the basis of assets, revenues, time records or other methods (including expenses) conforming with generally accepted accounting principles. No portion of salaries, benefits, compensation or remuneration of controlling persons shall be reimbursed as administrative costs.
Operators fees will be payable only if one of our affiliates serves as operator of the partnership prospect. See "PROPOSED ACTIVITIESDrilling and Completion Phase." Under such circumstances, our affiliate will receive fees, not exceeding the competitive rate in the area, during the production phase of operations. Often these are charged as a monthly fee per well for operations, field supervision, accounting, engineering, management and general and administrative expenses.
One of our affiliates or we may provide oil field or other services, equipment or supplies to the Partnership. If one of our affiliates or we provide such services, equipment or supplies as a part of ordinary business, then the compensation, price or rental for such services, equipment and supplies provided to the Partnership will be at prices competitive with those charged by others in the geographical area of operations that reasonably could be available to the Partnership. If one of our affiliates is not, or we are not, engaged in the business as set forth above, then the compensation, price or rental will be the cost of the services, equipment or supplies to such entity, or the competitive rate that could be obtained in the area, whichever is less. Any such services for which one of our affiliates is or we are to receive compensation will be embodied in a written contract that precisely describes the services to be rendered and all compensation to be paid.
The Partnership was formed to acquire, drill, complete and/or own oil and natural gas properties. We have a geological and engineering staff that reviews prospects from a diverse number of geographical regions in the continental United States with a focus primarily on the Bakken area in North Dakota. Regardless of the area, the properties we select for the Partnership must meet our acquisition criteria. We will evaluate all prospective acquisitions on the basis of their oil and natural gas producing potential, the predictability of their drilling and completion costs and their access to readily available pipeline hookups, among other criteria.
The actual number, identity and percentage of interests in the oil and gas undeveloped properties to be acquired by the Partnership will depend upon, among other things, the total amount of capital contributions to the Partnership, the latest geological and geophysical data, potential title or spacing problems, availability and price of drilling services, tubular goods and services, approvals by federal and state departments or agencies, agreements with other working interest owners in properties, and continuing review of other properties that may be available. In addition, the nature and extent of development operations on an acquired property will be dependent upon the anticipated costs of such development, actual conditions encountered in the field and type and depth of well being drilled. It is impossible to estimate the number of properties or wells in which the Partnership will acquire working interests.
The attainment of the Partnership's business objectives, including the generation of revenue from partnership operations, the distribution of cash to the partners and the provision of tax benefits, will depend upon many factors, including:
Accordingly, there can be no assurance that the Partnership will achieve its business objectives.
Many of the activities and policies of the Partnership discussed throughout this section and elsewhere in the prospectus are defined in and governed by the Partnership agreement, including:
Other policies and restrictions upon our activities and the activities of the Partnership are not contained in the Partnership agreement, but instead reflect our current intention and are subject to change at our discretion. For these activities, in making a change, we will utilize our reasonable business judgment as manager of the Partnership and will exercise judgment consistent with our obligations as a fiduciary to the investor partners.
We have not pre-selected any prospects. In the event we select a property or prospect for acquisition by the Partnership during the offering period, we intend to file a prospectus supplement describing the property or prospect and its proposed acquisition. Once every three months, such supplements shall be consolidated into a post-effective amendment that will be filed with the SEC and distributed to the investor partners. A "prospect" is generally defined as a contiguous oil and gas leasehold estate, or lesser interest in a leasehold estate, upon which drilling operations may be conducted. Depending on its attributes, a prospect may be characterized as an "exploratory" or "developmental" site. Generally speaking, exploratory drilling involves the conduct of either drilling operations in search of a new and yet undiscovered pool of oil and/or natural gas or, alternatively, drilling within a discovered pool with the hope of greatly extending the limits of the pool. In contrast, developmental drilling involves drilling to a known producing formation in a previously discovered field. These characterizations are based upon the SEC's definitions of exploratory drilling and developmental drilling.
The Partnership may enter into agreements with major and independent oil and natural gas companies to drill and own interests in oil and natural gas properties. The Partnership also may drill and own interests without such strategic partners.
It is anticipated that all prospects will be evaluated utilizing data provided to us by RELP, including well logs, production records from RELP's and others' wells, seismic, geological and geophysical information, and such other information as may be available and useful. RELP is an affiliate of ours. See "MANAGEMENT." In addition, prospects will be evaluated by petroleum engineers, geophysicists, and other technical consultants retained by us.
Regardless of drilling location, we will evaluate all prospective acquisitions primarily on the basis of their oil and natural gas producing potential. We will target properties that we believe have predictable costs, and quick pipeline hookups. We seek properties that are within or offsetting proven producing oil and natural gas fields and that have the potential, if successful, to generate cash distributions to our investors equal to at least 100% of the development costs for wells on such properties within five years after the end of the Partnership's offering period.
Reef develops and purses drilling and production opportunities which exceed certain proprietary internally developed standards which include but are not limited to industry proven lower risked pay objectives, opportunities that have a consistent industry record of repeatability, opportunities which have a consistent industry record of exceptional return on investment, opportunities which have a consistent industry proven record of exceptional rates of return and relatively short payout periods.
In addition, Reef drilling and production opportunities all meet or exceed a stringent set of proprietary geological and reservoir engineering criteria, including but not limited to the opportunity must be located within or be an extension of a well-defined producing fairway, the opportunity must be a product of superior joint geological and reservoir engineer evaluation, and the opportunity must pass or exceed a stringent set of risk-reward criteria and offer multiple well offset potential.
Prospects will be acquired pursuant to an arrangement in which the Partnership will acquire part of the working interest. For purposes of this prospectus, a working interest includes any interest that is subject to some portion of the costs of development, operation or maintenance. This working interest will be subject to landowners' royalty interests and other royalty interests payable to unaffiliated third parties in varying amounts. The partnership agreement forbids us or any of our affiliates from acquiring or retaining any overriding royalty interest in the Partnership's interest in the prospects, that is, any royalty interest which would be paid out of the Partnership's working interest, unless we acquire that interest from an unrelated third party. The Partnership will generally acquire less than 100% of the working interest in each prospect in which they participate. In order to comply with certain conditions for the treatment of additional general partners' interests in the Partnership as not passive activities,
and not subject the additional general partners to limitation on the deduction of partnership losses attributable to such additional general partners to income from passive activities, we have represented that the Partnership primarily will acquire and hold operating mineral interests. The Partnership may acquire non-working interests as part of a larger transaction primarily intended to acquire working interests. We, for our sole benefit, may sell or otherwise dispose of prospect interests not acquired by the Partnership or may retain a working interest in the prospects and participate in the drilling and development of the prospect on the same basis as the Partnership.
In acquiring interests in leases, the Partnership may pay such consideration and make such contractual commitments and agreements as we deem fair, reasonable and appropriate. For purposes of this prospectus, the term "lease" means any full or partial interest in:
In most instances we will acquire the leases and interests in the leases to be developed by the Partnership on behalf of the Partnership. All leases that we transfer to the Partnership will be transferred at our cost, unless we have reason to believe that such cost is materially more than the fair market value of such property, in which case the price will not exceed the fair market value of the property. We will obtain an appraisal from a qualified independent expert with respect to sales of our properties and those of our affiliates to the Partnership that were not originally acquired by us on behalf of the Partnership.
The actual number, identity and percentage of working interests or other interests in prospects to be acquired by the Partnership will depend upon, among other things, the total amount of capital contributions to the Partnership, the latest geological and geophysical data, potential title or spacing problems, availability and price of drilling services, tubular goods and services, approvals by federal and state departments or agencies, agreements with other working interest owners in the prospects, farm-ins, and continuing review of other prospects that may be available.
The Partnership's geographic focus will be primarily on the Bakken area in North Dakota. The Bakken area of North Dakota became a major oil producing area only after 2005, although the Bakken formation was discovered in the 1950s.
Although the Partnership will focus primarily on the Bakken area in North Dakota, the Partnership may acquire drilling or production opportunities in other areas if we believe such opportunities are superior to the opportunities that we have in the Bakken area. The areas outside of the Bakken in which the Partnership may acquire opportunities include the Permian Basin, the Mid-Continent Region and the Granite Wash.
The current boom that is underway in these areas is unique in certain respects. Historically, boom periods in the oil industry have generally been tied directly to the price of oilwhen oil prices soar, producers can pull oil from the areas that may not be economically viable in times of depressed prices. Today's boom, while partly a product of pricing, is also being driven by technology: specifically, developments in drilling techniques and advances in hydraulic fracturing methods in recent years are enabling producers to extract oil and gas from fields that were previously considered largely exhausted using conventional drilling methods and techniques.
New advances in horizontal drilling enable oil companies to be more exact in aiming at and drilling into key oil sections which had been previously missed. Advanced hydraulic fracturing technologies help oil producers penetrate rocks and pay sections more easily and remove oil from those areas more quickly than previously. Vertical drilling technologies have improved as well and producers are also making use of multistate fracturing technologies, further accelerating the progress in these areas. Drilling technologies are allowing rigs to target deeper producing formations, and to operate in closer proximity to other rigs than previously. These drilling and completion technologies and techniques have led to an increase in the number of companies who are either buying large tracts of acreage in major producing areas, or who are returning to develop sites which they had previously ceased developing. However, these drilling technologies have come under regulatory scrutiny and are not without risk. See "RISK FACTORSRisks of Oil and Natural Gas InvestmentsNew legislation and regulatory initiatives relating to hydraulic fracturing may adversely affect the Partnership."
The Bakken area is a rock unit on the subsurface of the Williston Basin, underlying parts of Montana, North Dakota and Saskatchewan, encompassing approximately 125,000 square miles (approximately 80,000,000 acres). It is estimated that two-thirds of the acreage is in western North Dakota. The basin produces oil and gas from numerous horizons including, but not limited to, the Bakken and Three Forks-Sanish, which are currently our primary objectives.
The Bakken formation is an interbedded sequence of black shale, siltstone and sandstone and was deposited within the Williston Basin during the Late Devonian and Early Mississippian age. It consists of a lower shale member, middle sandstone member and an upper shale member. These formations are organic-rich and are of marine origin, which make them rich source rocks for oil and natural gas deposits. The middle Bakken's geological properties and local development of matrix porosity enhances oil production in both continuous and conventional Bakken reservoirs. All three members of the Bakken formation have produced oil and/or natural gas.
In April 2008, the USGS estimated the recoverable reserves within the United States portion of the Bakken formation to be up to 4.3 billion barrels of oil, 1.85 trillion cubic feet of natural gas and 148 million barrels of natural gas liquids. This represents a 25-fold increase over the USGS 1995 estimate of 151 million barrels of recoverable oil. The increase in the estimated recoverable oil reserves from the Bakken shale is primarily due to advanced technologies that have recently been applied to the Bakken formation, and advances in horizontal drilling and multi-stage completion technologies. Over time, oil companies have learned to increase the number of hydraulic fracturing stages when completing wells. In a typical 9,000 to 10,000-foot lateral extension of a well, operators may fracture the formations in more than 30 stages.
The Three Forks-Sanish formation, an unconventional carbonate play believed to be a completely separate reservoir from the Bakken formation, lies just below the lower Bakken oil shale formation. Similar to the middle Bakken, the upper Three Forks-Sanish is primarily exploited using advanced drilling and completion techniques, which include multi-stage fracture stimulations. Drilling in the upper Three Forks-Sanish began in mid-2008 and is estimated to contain recoverable oil reserves in excess of 2.58 billion barrels. The Bakken and Three Forks-Sanish formations continue to be the target of more than 95% of wells being drilled in North Dakota.
The Greater Permian Basin consists of five separate tectonic sub-features including the Northwest shelf, the Delaware basin, the Central Basin platform, the Midland Basin and the Eastern Shelf. In the Greater Permian Basin area operators are aggressively pursuing oil and liquid rich plays with both vertical and horizontal wellbores on the Northwest shelf, including the Yeso and Lower Abo; and in the Delaware Basin, including the Delaware, Avalon Shale, Bone Spring, Wolfcamp and Penn Shale. On the Central Basin platform, oil plays include the Grayburg, San Andres and Clearfork. In the Midland Basin the oil plays include the Wolfberry, Cline, Wolfcamp, Wolffork and Mississippian.
Mid-Continent Region area operators are pursuing oil and liquid rich plays with both vertical and horizontal wellbores, including the Granite and Hogshooter Washes which are thick, tight, fractured and liquid rich and the Cherokee carbonates and the Cleveland and Marmaton sandstone. In addition, the Cana-Woodford section is being developed and is a large liquids-rich play in Oklahoma which is moving into the development mode. The Cana-Woodford producing trend is more than 81 miles in length and appears to have clear oil-condensate-dry gas producing windows.
The Partnership may acquire drilling or production opportunities in any of the areas discussed above.
We will assign leasehold interests in a lease to the Partnership. However, under certain circumstances, title to partnership properties will be held by us on the Partnership's behalf. In other instances, record title may not be transferred to us or the Partnership until after a well has been completed. See "RISK FACTORSRisks of Oil and Natural Gas InvestmentsDelays in the transfer of title to the Partnership could place the Partnership at risk." Leases acquired by the Partnership will initially and temporarily be held in our name to facilitate joint-owner operations and the acquisition of properties. The existence of the unrecorded assignments from the record owner will indicate that the leases are being held for the benefit of the Partnership and that the leases are not subject to debts, obligations or liabilities of the record owner; however, such unrecorded assignments may not fully protect the Partnership from the claims of our creditors.
Investor partners must rely on us to use our best judgment of the best interests of the Partnership to obtain appropriate title to leases. Provisions of the partnership agreement relieve us from any mistakes of judgment with respect to the waiver of title defects. We will take such steps as we deem necessary to assure that title to leases is acceptable for purposes of the Partnership. We are free, however, to use our judgment in waiving title requirements if it is in the best interests of the Partnership and will not be liable for any failure of title to leases transferred to the Partnership, unless such mistakes were made in a manner not in accordance with general industry standards in the geographic area and such mistakes were the result of our negligence. Further, neither our affiliates nor we will make any warranties as to the validity or merchantability of titles to any leases to be acquired by the Partnership.
The Partnership will enter into an operating agreement with an operator engaged to conduct and direct and have full control of all operations on the Partnership's prospects. If RELP, our affiliate, serves as operator of the Partnership's prospects, RELP will receive fees from the Partnership for serving as operator, not exceeding the competitive rate in the area, during the drilling and production phases of operations.
The operator's duties include testing formations during drilling, and completing the wells by installing such surface and well equipment, gathering pipelines, heaters, separators, etc., as are necessary and normal in the area in which the prospect is located. We will pay the drilling and completion costs of the operator as incurred, except that we are permitted to make advance payments to the operator where necessary to secure drilling rigs, drilling equipment and for other similar purposes in connection with the Partnership's drilling operations. If the operator determines that the well is not likely to produce oil and/or natural gas in commercial quantities, the operator will plug and abandon the well in accordance with applicable regulations.
After drilling, the operator will complete each well deemed by it to be capable of production of oil or natural gas in commercial quantities. The depths and formations to be encountered in each of the Partnership's wells are unknown. With respect to those prospects as to which the Partnership owns less than a 50% working interest, it is probable that the majority owner of such prospects will select the
operator for the wells drilled on such prospects. We will monitor the performance and activities of the operator, participate as the Partnership's representative in decision-making with regard to the Partnership's activities, and otherwise represent the Partnership with regard to the activities of the Partnership.
General. Once the Partnership's wells are "completed" such that all surface equipment necessary to control the flow of, or to shut down, a well has been installed, including the gathering pipeline, production operations will commence. We will be responsible for selling the Partnership's oil and natural gas production. We will attempt to sell the oil and natural gas produced from the Partnership's prospects on a competitive basis at the best available terms and prices. Domestic sales of oil will be at fair market prices. We will not make any commitment of future production that does not primarily benefit the Partnership. The Partnership will sell natural gas discovered by it at spot market or negotiated prices domestically, based upon a number of factors, such as the quality of the natural gas, well pressure, estimated reserves, prevailing supply conditions and any applicable price regulations promulgated by the Federal Energy Regulatory Commission ("FERC"). See "COMPETITION, MARKETS AND REGULATION."
We may sell oil and/or natural gas production from Partnership wells to marketers, refineries, foreign governmental agencies, entities controlled by foreign governments, industrial users, interstate pipelines or local utilities. Revenues from the Partnership's production will be received directly from these parties or paid to the operator of a prospect who will disburse to the Partnership its percentage share of the revenues.
Oil and natural gas production in South Texas and in Louisiana, areas in which we may conduct drilling activities, is a mature industry with numerous pipeline companies and potential purchasers of oil and natural gas. Because of competition among these purchasers for output from oil and natural gas producers, we generally will not enter into long term contracts for the purchase of the Partnership's production.
As a result of effects of weather on costs, the Partnership's results may be affected by seasonal factors. In addition, both sales volumes and prices tend to be affected by demand factors with a significant seasonal component.
Expenditure of Production Revenues. The Partnership's share of production revenue from a given well will be burdened by and/or subject to royalties and overriding royalties, monthly operating charges, and other operating costs. These items of expenditure involve amounts payable solely out of, or expenses incurred solely by reason of, production operations. We intend to deduct operating expenses from the production revenue for the corresponding period.
We will carry blowout, pollution, public liability and workmen's compensation insurance. For drilling operations where we are not the operator, we may elect to be covered under the insurance coverage of the operator. However, any such insurance may not be sufficient to cover all liabilities. Each unit held by the additional general partners represents an open-ended security for unforeseen events such as blowouts, lost circulation, stuck drillpipe, etc. that may result in unanticipated additional liability materially in excess of the per unit subscription amount.
We will obtain various insurance policies, as described below, and intend to maintain such policies subject to our analysis of their premium costs, coverage and other factors. In the exercise of our fiduciary duty as managing general partner, we will obtain insurance on behalf of the Partnership to provide the Partnership with coverage we believe is sufficient to protect the investor partners against the foreseeable risks of drilling and production. We will review the Partnership's insurance coverage
prior to commencing drilling operations and periodically evaluate the sufficiency of insurance. We will obtain and maintain insurance coverage for the Partnership equal to the lesser of $50,000,000 or twice the capitalization of the Partnership, and in no event will the Partnership maintain public liability insurance of less than $10,000,000. Subject to the foregoing, we may, in our sole discretion, increase or decrease the policy limits and types of insurance from time to time as we deem appropriate under the circumstances, which may vary materially. We are the beneficiary under each policy and pay the premiums for each policy. The following types and amounts of insurance are expected to be maintained:
We will notify all additional general partners of the Partnership at least 30 days prior to any material change in the amount of the Partnership's insurance coverage. Within this 30-day period and otherwise after the expiration of one year following the closing of the offering with respect to the Partnership, additional general partners have the right to convert their units into units of limited partnership interest by giving us written notice. Additional general partners will have limited liability as a limited partner for any partnership operations conducted after their conversion date, effective upon the filing of an amendment to the certificate of formation of the Partnership. At any time during this 30-day period, upon receipt of the required written notice from the additional general partner of his intent to convert, we will amend the partnership agreement and will file the amendment with the State of Texas prior to the effective date of the change in insurance coverage. This amendment to the partnership agreement will effectuate the conversion of the interest of the former additional general partner to that of a limited partner. Effecting conversion is subject to the express requirement that the conversion will not cause a termination of the Partnership for federal income tax purposes. However, even after an election of conversion, an additional general partner will continue to have unlimited liability regarding partnership activities while he was an additional general partner. See "TERMS OF THE OFFERING."
There are a large number of oil and natural gas companies in the United States. Competition is strong among persons and companies involved in the exploration for and production of oil and natural gas. We expect the Partnership to encounter strong competition at every phase of business. The Partnership will compete with entities having financial resources and staffs substantially larger than those available to the Partnership.
The national supply of natural gas is widely diversified, with no one entity controlling over 5%. As a result of deregulation of the natural gas industry by Congress and FERC, competitive forces generally
determine natural gas prices. Prices of crude oil, condensate and natural gas liquids are not currently regulated and are generally determined by competitive forces.
There will be competition among operators for drilling equipment, goods, and drilling crews. Such competition may affect the ability of the Partnership to acquire leases suitable for development and to expeditiously develop such leases once they are acquired.
The marketing of any oil and natural gas produced by the Partnership will be affected by a number of factors that are beyond the Partnership's control and whose exact effect cannot be accurately predicted. These factors include:
The supply and demand balance of crude oil and natural gas in world markets has caused significant variations in the prices of these products over recent years. The North American Free Trade Agreement eliminated trade and investment barriers between the United States, Canada, and Mexico, resulting in increased foreign competition for domestic natural gas production. New pipeline projects recently approved by, or presently pending before, FERC as well as nondiscriminatory access requirements could further substantially increase the availability of natural gas imports to certain U.S. markets. Such imports could have an adverse effect on both the price and volume of natural gas sales from partnership wells.
Members of the Organization of Petroleum Exporting Countries establish prices and production quotas for petroleum products from time to time with the intent of affecting the current global supply of crude oil and maintaining, lowering or increasing certain price levels. We are unable to predict what effect, if any, such actions will have on both the price and volume of crude oil sales from the Partnership's wells.
In several initiatives, FERC has required pipeline transportation companies to develop electronic communication and to provide standardized access via the Internet to information concerning capacity and prices on a nationwide basis, so as to create a national market. Parallel developments toward an electronic marketplace for electric power, mandated by FERC, are serving to create multi-national markets for energy products generally. These systems will allow rapid consummation of natural gas transactions. Although this system may initially lower prices due to increased competition, it is anticipated to expand natural gas markets and to improve their reliability.
The Partnership's operations will be affected from time to time in varying degrees by domestic and foreign political developments, federal and state laws and regulations and the laws of other countries where some of the prospects may be located.
Production. In most areas of operations within the United States the production of oil and natural gas is regulated by state agencies that set allowable rates of production and otherwise control the conduct of oil and natural gas operations. Among the ways that states control production is through regulations that establish the spacing of wells or in some instances may limit the number of days in a given month during which a well can produce.
Environmental. The Partnership's drilling and production operations will also be subject to environmental protection regulations established by federal, state, and local agencies that in turn may necessitate significant capital outlays that would materially affect the financial position and business operations of the Partnership. These regulations, enacted to protect against waste, conserve natural resources and prevent pollution, could necessitate spending funds on environmental protection measures, rather than on drilling operations. If any penalties or prohibitions were imposed on the Partnership for violating such regulations, the Partnership's operations could be adversely affected.
Natural Gas Transportation and Pricing. FERC regulates the rates for interstate transportation of natural gas as well as the terms for access to natural gas pipeline capacity. Pursuant to the Wellhead Decontrol Act of 1989, however, FERC may not regulate the price of natural gas. Such deregulated natural gas production may be sold at market prices determined by supply and demand, Btu content, pressure, location of wells, and other factors. We anticipate that all of the natural gas produced by Partnership wells will be considered price decontrolled natural gas and that the Partnership's natural gas will be sold at fair market value.
Proposed Regulation. Various legislative proposals are being considered in Congress and in the legislatures of various states, which, if enacted, may significantly and adversely affect the petroleum and natural gas industries. Such proposals involve, among other things, the imposition of price controls on all categories of natural gas production, the imposition of land use controls, such as prohibiting drilling activities on certain federal and state lands in protected areas, as well as other measures. At the present time, it is impossible to predict what proposals, if any, will actually be enacted by Congress or the various state legislatures and what effect, if any, such proposals will have on the Partnership's operations. On December 19, 2007, President Bush signed into law the Energy Independence and Security Act ("EISA"), a law targeted at reducing national demand for oil and increasing the supply of alternative fuel sources. While EISA does not appear to directly impact the Partnership's operations or cost of doing business, its impact on the oil and gas industry in general is uncertain. No prediction can be made as to what additional legislation may be proposed, if any, affecting the competitive status of an oil and gas producer, restricting the prices at which a producer may sell its oil and/or gas, or the market demand for oil and/or gas, nor can it be predicted which proposals, including those presently under consideration, if any, might be enacted, nor when any such proposals, if enacted, might become effective.
The Kyoto Protocol to the United Nations Framework Convention on Climate Change became effective in February 2005 (the "Protocol"). Under the Protocol, participating nations are required to implement programs to reduce emissions of certain gases, generally referred to as greenhouse gases that are suspected of contributing to global warming. The United States is not currently a participant in the Protocol. However, the U.S. Congress is considering proposed legislation directed at reducing greenhouse gas emissions. In addition, there has been support in various regions of the country for legislation that requires reductions in greenhouse gas emissions, and some states have already adopted legislation addressing greenhouse gas emissions from various sources, primarily power plants. The natural gas and oil industry is a direct source of certain greenhouse gas emissions, namely carbon dioxide and methane, and future restrictions on such emissions could impact the operations on wells by the Partnership. At this time, it is not possible to accurately estimate how potential future laws or regulations addressing greenhouse gas emissions would impact the Partnership's business.
We are Reef Oil & Gas Partners, L.P. (formerly Reef Oil & Gas Partners, LLC), a privately-owned Nevada limited partnership that was originally formed as a limited liability company in February 1999 by the holders of all of the outstanding common stock of OREI, Inc., and we will serve as managing general partner of the Partnership. OREI, Inc. (a Texas corporation formerly known as Reef Exploration, Inc.) ("OREI") was organized in 1987 for the principal purpose of reviewing drilling prospects upon which partnerships and joint ventures formed by OREI might engage in energy, development, exploitation and production activities, and to serve as operator of most of such prospects. Since 1987 and until 2005, OREI has been engaged continuously in the business of developing, exploiting and producing oil and natural gas both within and outside the continental United States, through partnerships and joint ventures it has formed. An affiliate of ours, Reef Exploration, L.P. ("RELP"), was formed in 2005 and may serve as operator of some or all of the properties developed by the Partnership. Michael J. Mauceli, the manager of our general partner, is also the manager of the general partner and Chief Executive Officer of RELP and is the Chief Executive Officer of OREI. During 2005 and 2006, RELP assumed all of OREI's operating responsibilities.
We will actively manage and conduct the business and oversee the day-to-day operations of the Partnership. We will be responsible for maintaining the Partnership's bank accounts, collecting partnership revenues, making distributions to the partners, delivering reports to the partners, and supervising the drilling, completion, and operation of the Partnership's oil and natural gas wells. Certain of our officers are also directors, officers and employees of RELP. Subject to limitations set forth in the partnership agreement, such individuals, RELP and we intend to continue to engage in the oil and natural gas business for our own account and for the account of others. We and such directors, officers and employees will devote as much of their time and talents to the management of the Partnership as necessary for the proper conduct of the Partnership's business.
Michael J. Mauceli, the manager of our general partner and the Chief Executive Officer and manager of the general partner of RELP, oversees all aspects of prospect and project generation and review. Working closely with Mr. Mauceli are Daniel C. Sibley and Ralph Moore. Mr. Moore is employed by RELP as its Exploration Manager. RELP employs Mr. Sibley as its General Counsel and Chief Financial Officer to oversee all legal and financial matters for the operation of RELP, Reef, and the partnerships formed by Reef. RELP employs one drilling engineer, two production operations engineers, one geologist and three technical staff members and also retains a number of subcontractors and consulting companies. These include, but are not limited to, geologists, geophysicists, petrophysicists, paleontologists, drilling engineers, completion engineers, reservoir engineers, drilling rig supervisors, landmen, surveyors and other specialists with expertise in the search, development, exploitation and day to day operations associated with petroleum exploration and production.
RELP may serve as operator of the wells developed by the Partnership. On occasion, we may choose third-party operators of certain prospects that may be located in areas in which RELP chooses not to serve as operator. In such cases, we will choose third-party operators who are experienced in the operation of oil and natural gas properties. RELP was formed in 2005 and employs personnel formerly employed by OREI. RELP has assumed operation of the wells formerly operated by OREI as well as new acquisitions. Since the inception of OREI in 1987, OREI and RELP have served as operator of approximately 286 wells. RELP is currently the operator of approximately 160 wells.
Our managers, officers and key personnel, their ages, current positions with RELP and/or us, and certain additional information are set forth below:
Michael J. Mauceli is the Manager and a member of Reef Oil & Gas Partners GP, LLC, which is the general partner of Reef, as well as the Chief Executive Officer of RELP. Mr. Mauceli has been the principal executive officer of Reef since its formation in February 1999. He has served in this position with RELP since January 2006 and has served in this position with its predecessor entity, OREI, since 1987. Mr. Mauceli attended the University of Mississippi where he majored in business management and marketing as well as the University of Houston where he received his Commercial Real Estate License. He entered the oil and natural gas business in 1976 when he joined Tenneco Oil & Gas Company. Mr. Mauceli moved to Dallas in 1979, where he was independently employed by several exploration and development firms in planning exploration and marketing feasibility of privately sponsored drilling funds.
Daniel C. Sibley became General Counsel of RELP in January 2009 and resumed his position as Chief Financial Officer of RELP in March 2010. He also served as Chief Financial Officer for RELP from January 2006 until his appointment to General Counsel of RELP, and had served in this same position with RELP's predecessor entity, OREI, since 1998. Mr. Sibley was employed as a Certified Public Accountant with Grant Thornton from 1977 to 1980, although he no longer maintains a CPA license. From 1980 to 1994, he was involved in the private practice of law. He received a B.B.A. in accounting from the University of North Texas in 1973, a law degree (J.D.) from the University of Texas in 1977, and a Master of Laws-Taxation degree (L.L.M.) from Southern Methodist University in 1984.
David Tierney, the Treasurer and Chief Financial Reporting Officer of RELP has been employed by RELP since January 2006 and was previously with its predecessor entity, OREI, Inc., since March 2001. Mr. Tierney became Chief Financial Reporting OfficerPublic Partnerships in February 2010. Mr. Tierney became Treasurer of RELP in May 2009, and prior to that, Mr. Tierney served as Chief Accounting OfficerPublic Partnerships of RELP starting in July 2008. From 2001 to 2008, Mr. Tierney was the Controller of the Reef Global Energy Ventures and Reef Global Energy Ventures II partnerships. Mr. Tierney received a Bachelor's degree from Davidson College in 1974, a Masters of Business Administration from Tulane University in 1976, and is a Texas Certified Public Accountant. Mr. Tierney has worked in public accounting, and has worked in the oil and gas industry since 1979. From 1992 through 2000 he served as controller/treasurer of an independent oil and gas exploration company.
Ralph Moore joined RELP in 2011 as a Senior Geologist and now is its Exploration Manager. Ralph has over 35 years of experience in the Permian Basin, Mid-Continent Region, Rocky Mountain Region and Appalachian Basin generating prospects. He has developed successful prospects and prospect generating programs for companies such as Mewbourne Oil Company, XOG Operating, and Pacific Enterprise Oil Company. In addition, he is a holds a BS (Geology) from Stephen F. Austin State University.
Mark Gragert, 57, has served as the Senior Geologist at RELP since joining the company in 2008. Mr. Gragert has over 30 years of experience as an exploration and development geologist, including 13 years as an independent consultant working in domestic and international locations. His geological experience includes working assignments throughout North America, Africa, South America and the Middle East. Prior to joining RELP, he served as a geologist for Energy Partners, Ltd. starting in 2003. He previously worked as a geologist for a subsidiary of Vintage Petroleum in Yemen and Argentina from 2000 to 2003, CMS Nomeco in Congo and Tunisia from 1997 to 1999, and Genesis Development from 1990 to 2004. Mr. Gragert holds a bachelor's degree in geology from Phillips University and is registered as a Certified Petroleum Geologist through the American Association of Petroleum Geologists.
Ronald M. Sentz, 70, has served as the Production Manager for RELP since joining the company in 2007. Prior to joining RELP, he served as an oil and gas operations engineer for Petrohawk Operating Company from 2005 to 2007, Stokes and Spiehler from 2004 to 2005, Wopsen Energy from 1984 to 2004, South Union Exploration Co. from 1978 to 1984, Atso, Inc. from 1977 to 1978, and Halliburton Services from 1975 to 1977. Mr. Sentz holds a Bachelor of Science in Mechanical Engineering degree with a minor in Applied Math and Aerospace Engineering from the University of Colorado. He is a member of the American Association of Drilling Engineers and the Society of Petroleum Engineers.
George Ricks, 56, has served as a Production Engineer for RELP since joining the company in 2007. Prior to joining RELP, he served as an oil and gas operations engineer for multiple companies from 1992 to 2007 as a result of successive mergers of his employers, including Andarko Petroleum Corporation from 2006 to 2007, Kerr McGee from 2004 to 2006, Westport Resources from 2002 to 2004, Belco Energy from 1997 to 2002, Coda Energy from 1993 to 1997, and MJM Oil & Gas from 1992 to 1993. Mr. Ricks holds a Bachelor of Science in Chemical Engineering from the University of Oklahoma and a Master of Business Administration from the University of Texas at Dallas. He is a member in the Society of Petroleum Engineers.
Jerald L. Sluder, 60, joined RELP during 2012 as a senior addition to our evaluation engineering department. Prior to joining RELP, Mr. Sluder practiced law for three years, environmental engineering for 15 years, and petroleum engineering for 20 years, with ConocoPhillips, Anadarko, Tulane University, Quicksilver Resources and others. Mr. Sluder holds a Bachelor of Science in Petroleum Engineering from Oklahoma University, a Doctor of Jurisprudence from Loyola School of Law, and a Ph.D. in Environmental Engineering from Tulane University.
Bucky Pauling, 32, joined RELP in July 2006 to provide mathematical and engineering software support to our geological and engineering departments. Today, Mr. Pauling plays a major role in our evaluation engineering department, is in charge of our quarterly and annual internal evaluations of all oil and gas properties for our financial reporting staff, and deals extensively with our two engineering consulting firms, Cawley, Gillespie and Associates and Forrest Garb and Associates, as well as our independent financial auditors. Mr. Pauling holds a Bachelor of Science in Agricultural Economics and a Masters of Agribusiness, both from Texas A&M University, and is currently pursuing a Master of Science in Mechanical Engineering from The University of Texas at Dallas.
J. Lee Cummings, 34, joined RELP in January 2012 as an evaluation engineer. Prior to joining RELP, Mr. Cummings had seven years of experience assisting petroleum engineers with Cawley, Gillespie and Associates and Energy Spectrum, and one year as a Product Engineer/Specialist with Siemens Energy and Automation. Mr. Cummings evaluates potential acquisitions for RELP, a direct progression from the services he rendered the past seven years working under highly experienced and respected petroleum engineers. Mr. Cummings holds a Bachelor of Science in Mechanical Engineering from The University of Texas at Arlington, and is working toward completing graduate work in
industrial and petroleum engineering at The University of Texas at Arlington and Texas A&M University.
The following diagram depicts the ownership of Reef, OREI, RELP and certain of their affiliates. It does not include the drilling and income fund ventures of which Reef and its affiliates serve as managing partner. Investor partners will not have any interest in any company in the following diagram. Investor partners will own an interest only in Reef 2012 - 2013 Drilling Fund, L.P. Except as otherwise noted, each entity is wholly-owned and controlled by Michael J. Mauceli. The address of each entity is 1901 N. Central Expressway, Suite 300, Richardson, Texas 75080.
The following table sets forth information with respect to the membership interests of Reef owned by each person who owns beneficially 5% or more of the outstanding membership interests, by all managers of Reef individually, and by all managers and executive officers of Reef as a group. The interest held by Michael J. Mauceli includes a 99% interest held of record by Mr. Mauceli and a 1% interest held of record by Reef Oil & Gas Partners, GP, LLC, a limited liability company controlled by Mr. Mauceli.
No officer, manager, director or employee of Reef, RELP or OREI will receive any direct remuneration or other compensation from the Partnership.
On August 26, 2010, Frank Stevenson ("Stevenson") filed a lawsuit, styled Stevenson v. Wayne Kirk, Michael J. Mauceli, Reef Global Energy Ventures II, et al., Cause No. 10-10647, in the 191st Judicial District Court, Dallas County, Texas. The suit also names as defendants Reef Global Energy VI, L.P. and multiple other Reef-sponsored ventures and limited partnerships, as well as Reef Securities, Inc., among others (collectively, "Defendants"). On September 22, 2010, via Plaintiffs' First Amended Original Petition, James and Carol Estle (the "Estles") and Nancy Dykes Thurmond Antolic ("Antolic") joined the suit as additional plaintiffs. On January 27, 2011, Donna Stevenson (Frank Stevenson's spouse) and Jaime Davis ("Davis") joined the suit as additional plaintiffs (Stevenson, Estles, Antolic, and Davis are collectively referred to as "Plaintiffs") via Plaintiffs' Second Amended Original Petition. On September 19, 2012, Robert C. Phalen ("Phalen") filed an Original Petition in Intervention in the case, alleging the same claims as the other Plaintiffs. With respect to Davis's and Phalen's claims, specifically, Reef Securities, Inc. did not offer or sell the interests in the Reef programs that either of them purchased. Rather, they each purchased their interests through an unaffiliated broker/dealer. On January 24, 2012, Plaintiffs filed their Sixth Amended Petition, by which Plaintiffs allege that, collectively, they are seeking in excess of $2.5 million in compensatory damages as well as exemplary damages, attorneys' fees, pre- and post-judgment interest, and costs. Plaintiffs assert claims of misrepresentations and omissions under the Texas Securities Act ("TSA"), fraud, control person liability under the Texas Securities Act, breach of fiduciary duty, breach of contract, civil theft, negligent misrepresentation, and fraudulent concealment. Plaintiff Davis asserts against defendant Reef Oil & Gas Income and Development Fund, L.P. a claim for tortious interference with an existing contract. Defendants believe Plaintiffs' claims are meritless because, among other things, in connection with each Reef program in which Plaintiffs participated, each Plaintiff received offering documents that thoroughly disclosed all material facts and risks associated with participation in such programs, particularly the fact that no guarantees or promises could be made or relied upon. Plaintiffs also claim that Defendants misallocated costs, expenses and deductions among unidentified Reef-sponsored ventures and limited partnerships. Plaintiffs seek approximately $2.5 million as actual damages, $620,000 as exemplary damages, as well as attorneys' fees, pre- and post-judgment interest, and costs. Defendants (including Reef Global Energy VI, L.P.) intend to vigorously defend the lawsuit and may seek damages from plaintiffs. Defendants filed Motions for Partial Summary Judgment seeking the dismissal of certain of Plaintiffs Stevenson, Estles, and Antolic's claims. Following Defendants' filing of their Motions for Summary Judgment, by filing their Sixth Amended Petition, Plaintiffs dismissed their claims for rescission under the TSA for failure of Defendants to register under the TSA, control person liability under the TSA in connection with such registration claims, and a majority of Plaintiffs' fraud claims under the TSA. On December 18, 2012, the Court heard Defendants' Joint Motion to Sever and Stay Claims of Plaintiff Jaimie Davis and to Sever Claims of Plaintiff Robert Phalen, and on that same date, the Court granted the Motion. Accordingly, Jaimie Davis's claims have been severed and stayed, and are now pending under Cause of Action No. DC-13-00527 in the Dallas County District Court. Additionally, Robert Phalen's claims have been severed and are now pending under Cause of Action No. DC-13-00528. As to the remaining Plaintiffs in the Stevenson matter, discovery is ongoing, and trial has been set for April 29, 2013. The Defendants intend to vigorously defend against these claims.
On July 21, 2011, Justin Abernathy, Jason Abernathy and Lorna Abernathy ("the Plaintiffs") filed a lawsuit, styled Abernathy v. Reef Oil & Gas Partners GP, LLC, et al., Cause No. 11-08969, in the 162nd Judicial District Court, Dallas County, Texas against Reef Oil & Gas Partners, GP, LLC, Reef Oil & Gas Partners, L.P., and other Reef-sponsored joint ventures and partnerships, among others
(collectively referred to in this paragraph as the "Defendants"). On November 17, 2011, Plaintiffs filed their First Amended Petition in which Reef Securities, Inc., Reef Exploration, L.P. and Wayne Kirk were added as Defendants). In their most recent Petition, Plaintiffs assert claims of fraud, fraud by nondisclosure, rescission under the Texas Securities Act ("TSA"), liability for control persons and aiders under the TSA, violations of the TSA and conspiracy to violate the TSA, breach of fiduciary duty, breach of contract, fraudulent misrepresentation and negligent misrepresentation, theft, and unjust enrichment. Plaintiffs also assert application of the discovery rule to toll limitations for all causes of action asserted. Although Plaintiffs allege that they collectively invested in excess of $3.5 million in the specified Reef Oil & Gas Partners, L.P. ("ROGP")-sponsored programs, Plaintiffs seek an unspecified amount in compensatory damages, as well as exemplary damages, attorneys' fees, pre- and post-judgment interest, and costs. Defendants have filed counterclaims and are seeking damages from Plaintiffs for attorneys' fees and costs based upon breaches of representations and warranties made by Plaintiffs, as well as the indemnification provisions of the documents executed by each of them. Discovery has been conducted and is ongoing, including the exchange of requests and responses to disclosures, the production of thousands of documents and the exchange of Interrogatories, and answers thereto. On March 19, 2012, the court conducted a hearing on Defendants' Motion for Partial Summary Judgment, at which time the court granted the motion with respect to the Plaintiffs' registration claims under the TSA (and derivative control person and aider claims pertaining to registration under the TSA), denied the motion with respect to the unjust enrichment claim, and continued the motion to a yet-to-be-determined date in the future with respect to the remaining claims under the TSA and certain breach of contract claims. Trial is set for November 4, 2013. The Defendants intend to vigorously defend against these claims.
Our interests and the interests of our affiliates differ in certain respects from those of the Partnership and the investor partners. You should recognize that relationships and transactions of the kinds described below involve inherent conflicts between our interests, our affiliates' interests and the interests of the Partnership, and that the risk exists that such conflicts will not always be resolved in a manner that favors the Partnership.
Our Prior and Future Programs. We expect to organize and manage oil and natural gas drilling funds or partnerships in the future that will have substantially the same investment objectives as the Partnership. Our affiliates and we currently manage other drilling funds for investors and operate oil and natural gas properties for investors in such other drilling funds. We will decide whether a prospect will be retained or acquired for the account of the Partnership or for other drilling funds that our affiliates or we may presently manage or manage in the future. As a result, the Partnership will compete with such other funds for suitable prospects, equipment, contractors and personnel.
To resolve conflicts, we will initially examine the funds available to the Partnership and the time limitations on the investment of such funds to determine whether the Partnership or another fund should acquire a potential prospect. We will then determine which partnership shall obtain the properties based upon: (i) the suitability of the properties for such partnership under its existing circumstances, (ii) the capital available in such partnership, (iii) how the timing of development of the property fits within the Partnership's situation, and (iv) the type of property under consideration (whether an exploratory or developmental property). We believe that the possibility of conflicts of interest between the partnerships and prior funds is minimized by the fact that substantially all the funds available to prior drilling funds in which we or an affiliate of ours serves as general partner have been committed to specific drilling projects. We do not have a written policy relating to the resolution of conflicts of interests between the partnerships. However, the terms of the Partnership agreement, as described below, are intended to govern situations involving potential conflicts of interests.
Our Fiduciary Responsibility. We are a fiduciary and have a duty to exercise good faith and to deal fairly with the investor partners in handling the Partnership's affairs. We will owe such a duty to other partnerships we may manage in the future. Because we must deal fairly with the investors in all of our drilling funds, if conflicts between the interest of the Partnership and such other drilling funds do arise, they may not in every instance be resolved to the maximum advantage of the Partnership, and our actions could fall short of the full exercise of our fiduciary duty to the Partnership. In the event we breach our fiduciary duty, you would be entitled to an accounting and to recover any economic losses caused by such breach only after either proving a breach in court or reaching a settlement with us.
Property TransactionsAcquisitions from Our Affiliates and Us. The partnership agreement permits sales of prospects to the partnerships by our affiliates or us. These sales may be from existing inventory we hold at the time the Partnership is acquiring prospects. In order to minimize conflicts of interest, however, the partnership agreement places certain restrictions on the pricing and terms of these transactions. Our (or our affiliates') cost will be the purchase price in any purchase of an interest in a prospect (or of any other property) from our affiliates or us. Further, if the seller has reasonable grounds to believe that the fair market value of any property is less than the seller's cost, the sale must be made at a price of not more than its fair market value.
Neither our affiliates nor we may sell an interest in a prospect to the Partnership unless the Partnership acquires an equal proportionate interest in all leases comprising the prospect owned by our affiliates or us.
The partnership agreement prohibits the sale to the Partnership of less than all of our or our affiliates' interest in any prospect unless:
Neither our affiliates nor we are permitted to create and retain any overriding royalty interests or other burdens on lease interests conveyed to the Partnership.
If we determine that less than all of our or our affiliates' interest in a prospect should be acquired by the Partnership, our affiliate or we may either retain a proportionate interest in the prospect or transfer such interest to third parties. Since the Partnership will not have expended any funds with respect to the interest transferred by our affiliate or us, any profit realized from the transfers will be solely for our affiliate's or our account.
Property TransactionsFarmouts. We expect that the Partnership will develop substantially all of its leases and will farmout few, if any. However, the decision to make farmouts and the terms of making farmouts involve conflicts of interest. A farmout may permit us to achieve cost savings and to reduce our risk. Further, in the event of a farmout to an affiliate, either our affiliates or we will represent both related entities.
The partnership agreement limits farmouts by providing that the Partnership will acquire only those leases reasonably expected to meet the stated purposes of the Partnership. The Partnership will not acquire any lease for the purpose of a subsequent sale or farmout unless the acquisition is made after a well has been drilled to a depth sufficient to indicate that such an acquisition would be in the Partnership's best interest. Further, the Partnership may not farmout, sell or otherwise dispose of leases unless we, exercising the standard of a prudent operator, determine that:
Any farmout to one of our affiliates must be on terms no less favorable to the Partnership than those obtainable in the geographic area of operations. Under no circumstances will we farmout a lease for the primary purpose of avoiding our costs relating to the lease.
Property TransactionsTransfers to Affiliated Partnerships and Us. The partnership agreement permits our affiliates and us, including other partnerships sponsored by our affiliates or us, to purchase or acquire property from the Partnership. In order to minimize conflicts of interest, however, the partnership agreement places restrictions on the pricing and terms of these transactions. In all cases, these transactions must be fair and reasonable to the investor partners in the Partnership. In addition:
Property TransactionsProperties Within Prospect Limits. From time to time, we may cause partnership prospects to be enlarged on the basis of geological data that defines the productive limits of any pool discovered. If an affiliate of ours or we own a separate property interest in the enlarged area and the activities of the Partnership were material to establishing the existence of undeveloped reserves on such property, the interest shall be sold to the Partnership. The Partnership is not required, however, to expend additional funds for the acquisition of property unless such acquisition can be made from capital contributions. In the event such property is not acquired by the Partnership, the Partnership may lose a promising prospect. Such prospect might be acquired by our affiliate or us or other drilling funds conducted by our affiliate or us.
In addition, our exercise of our discretion in deciding which prospects to transfer to the Partnership could result in another drilling fund sponsored by us acquiring property adjacent to partnership property. Such other fund could gain an advantage over the Partnership by reason of the knowledge gained through the Partnership's prior experience in the area. Neither our affiliates nor we will retain undeveloped acreage adjoining the Partnership prospect in order to use partnership funds to "prove up" the acreage owned for our own account.
If an affiliate of ours or we (other than an affiliated limited partnership in which our interest or the interest of our affiliates is identical or less than our or their interest in the Partnership), proposes to acquire an interest in a prospect in which the Partnership already owns an interest or in a prospect abandoned by the Partnership within one year preceding such proposed acquisition, such affiliate or we will offer an equivalent interest in such prospect to the Partnership. If cash or financing is not available to the Partnership to enable it to consummate a purchase of an equivalent interest in such property, neither our affiliates nor we will acquire such interest. The term "abandon" means the termination, either voluntarily or by operation of the lease or otherwise, of all of the Partnership's interest in a prospect. These limitations will not apply after the lapse of five years from the date of formation of the Partnership.
Transactions between the Partnership and Operator. RELP, or another affiliate of ours will act as an operator on certain prospects for the Partnership. As a result, we may be confronted with a continuing conflict of interest with respect to the exercise and enforcement of the rights of the Partnership under operating agreements. We believe the fees our affiliates will charge the Partnership for operator services will be competitive with those charged by unaffiliated persons for such services.
Other Arrangements. The partnership agreement provides that:
In addition, the partnership agreement will prohibit advance payments by the Partnership to us, except where necessary to secure drilling rigs, drilling equipment and for other similar purposes in connection with the Partnership's drilling operations. These payments, if any, shall not include non-refundable payments for completion costs prior to the time that a decision is made that the well or wells warrant a completion attempt. Furthermore, no rebates or give-ups may be received by us or any of our affiliates, nor may we or any affiliate participate in any reciprocal business arrangements that would circumvent this restriction. In addition, the partnership agreement prohibits us from taking any action, or permitting any other person to take any action, with respect to the assets or property of the Partnership that does not benefit the Partnership, including, among other things, utilization of funds of the Partnership as compensating balances for our own benefit or the commitment of future production.
The Partnership agreement will further limit our affiliates and us in the compensation we may receive from providing any oil field, equipage or other services to the Partnership or for selling or leasing any equipment or related supplies to the Partnership. Unless such person is engaged, independently of the Partnership and as an ordinary and ongoing business, in the business of rendering such services or selling or leasing such equipment and supplies to unaffiliated persons in the oil and natural gas industry, then the compensation, price or rental will be the lesser of the cost of such services, equipment or supplies to such person or the competitive rate that could be obtained in the
area. The partnership agreement further provides that neither our affiliates nor we may profit under any circumstances by drilling in contravention of fiduciary obligations to the investor partners. Any services not otherwise described in this prospectus for which any of our affiliates or we are to be compensated will be embodied in a written contract that precisely describes the services to be rendered and the compensation to be paid. No turnkey drilling contracts shall be made between the Partnership and us or our affiliates.
Our Interest. Although we believe that our interests in the Partnership's profits, losses, and cash distributions is equitable (see "PARTICIPATION IN DISTRIBUTIONS, PROFITS, LOSSES, COSTS AND REVENUES"), such interest was not determined by arm's-length negotiation.
Receipt of Compensation Regardless of Profitability. We are entitled to receive the management fee, and reimbursement for certain costs from the Partnership, regardless of whether the Partnership operates at a profit or loss. See "OUR COMPENSATION." These fees and reimbursements will decrease the unit holders' share of any cash flow generated by operations of the Partnership or increase losses if operations should prove unprofitable.
Time and Services of Common Management. Our officers and manager are also officers, directors or employees of our affiliates. As a result, they do not intend to devote their entire time to the Partnership. Management is required to devote to the business and affairs of the Partnership so much time as is, in their judgment, necessary to conduct such business and affairs in the best interest of the Partnership. We serve as the managing general partner for approximately 35 partnerships. The time our officers and managers spend on the Partnership fluctuates and varies depending on the operational phase of the Partnership. In the early stages of the Partnership, the management's time devoted to the Partnership is greater as developmental and acquisition operations are undertaken. Once the Partnership's drilling, completion and acquisition activities are completed, the amount of time required by our officers and managers decreases. Once the Partnership is nearing its termination, the management's devotion of time necessarily increases for the necessary dissolution activities.
Legal Representation. Counsel to RSI, the dealer manager of this offering, and to us in connection with this offering are the same. RSI has not engaged independent counsel to represent it in this offering. Such dual representation will continue in the future. The Partnership has not engaged independent legal counsel.
Due Diligence Review. RSI, the dealer manager of the offering, has an ongoing relationship with our affiliates and us, and our due diligence examination concerning this offering cannot be considered to be independent. Michael J. Mauceli, the manager of our general partner and the Chief Executive Officer and manager of the general partner of RELP, is the brother of Paul Mauceli, the sole shareholder and Chief Executive Officer of RSI.
Other Relationships. Both our affiliates and we will have relationships on an ongoing basis with companies and other entities engaged in the oil and natural gas industry, including operators, petroleum engineers, consultants and financial institutions. Such relationships could influence us to take actions, or forbear from taking actions, which we might not take or forbear from taking in the absence of these relationships.
Independent Activities. Except as limited by our fiduciary duty to the partners as described below and by the partnership agreement, we and our affiliates may pursue business opportunities that are consistent with the Partnership' investment objectives for their own account only after they have reasonably determined that such opportunity either cannot be pursued by the Partnership because of insufficient funds or because it is not appropriate for the Partnership under the existing circumstances.
Policy Regarding Roll-Ups. It is possible at some indeterminate time in the future that the Partnership may become involved in a roll-up. In general, a roll-up means a transaction involving the
acquisition, merger, conversion, or consolidation of the Partnership with or into another partnership, corporation or other entity, and the issuance of securities by the roll-up entity to you and the other investors. A roll-up will also include any change in the rights, preferences, and privileges of you and the other investors in the Partnership. These changes could include the following:
If a roll-up should occur in the future, the partnership agreement provides various policies which include the following:
Fiduciary Duty. We are accountable to the Partnership as a fiduciary and consequently must exercise utmost good faith and integrity in handling Partnership affairs. In this regard, we are required to supervise and direct the activities of the Partnership prudently and with that degree of care, including acting on an informed basis, which an ordinarily prudent person in a like position would use under similar circumstances. Moreover, we have a responsibility for the safekeeping and use of all funds and assets of the Partnership, whether or not in our control, and we may not employ or permit another to employ such funds or assets in any manner except for the exclusive benefit of the Partnership.
Generally, courts have held that a limited partner may institute legal action on behalf of himself and all other similarly situated limited partners to recover damages for a breach by a general partner of his fiduciary duty, or on behalf of the Partnership to recover damages from third parties. In addition, limited partners may have the right, subject to procedural and jurisdictional requirements, to bring partnership class actions in federal courts to enforce their rights under the federal securities laws. Further, limited partners who have suffered losses in connection with the purchase or sale of their interests in the Partnership may be able to recover such losses from a general partner where the losses result from a violation by the general partner of the antifraud provisions of the federal securities laws. The burden of proving such a breach, and all or a portion of the expense of such lawsuit, would have to be borne by the limited partner bringing such action. In the event of a lawsuit for a breach of our fiduciary duty to the Partnership and/or the investor partners, we may, depending upon the particular circumstances involved, be able to raise various affirmative defenses to the lawsuit. For example, we may be able to claim:
If you have questions concerning our responsibilities, you should consult your own counsel.
Indemnification. The partnership agreement provides for indemnification of us against liability for losses arising from our action or inaction if:
We will not, however, be indemnified for liabilities arising under federal and state securities laws unless:
A successful claim for indemnification would deplete partnership assets by the amount paid. As a result of such indemnification provisions, you may have a more limited right of legal action than you would have if such provision were not included in the partnership agreement. To the extent that the indemnification provisions purport to include indemnification for liabilities arising under the Securities Act, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable.
The partnership agreement also provides that the Partnership shall not incur the cost of the portion of any insurance that insures any party against any liability as to which such party is prohibited from being indemnified.
You should not assume that you will experience returns similar to those experienced by investors in the other funds described below which were sponsored by OREI or us. There can be no assurance that prior performance will be indicative of future returns. The unaudited results described below were determined as of June 30, 2012 (except for Table Two, which shows income tax data through December 31, 2011) and should be viewed only as indicative of our experience and level of activity.
Since 1996, we and our affiliates have sponsored 74 partnerships: (i) 14 prior private income and income and development funds, (ii) 47 private drilling partnerships, (iii) 1 private salt water disposal partnership, (iv) 3 three-dimensional seismic partnerships, and (v) 9 public drilling partnerships. As of June 30, 2012, ventures sponsored by us and our affiliate have raised approximately $631.1 million from outside investors, comprised of approximately $190.8 million for income and income and development funds and approximately $440.3 million for drilling, three-dimensional seismic, and salt water disposal partnerships. Of the 47 private drilling ventures, 16 are privately held multiple-well drilling partnerships and 31 are single-well drilling ventures. The single-well drilling ventures do not have similar objectives to that of Reef 2012 - 2013 Drilling Fund, L.P., and the results from these ventures are aggregated into a single line item in the tables below. Reef 2012 - 2013 Drilling Fund, L.P. is the tenth public drilling partnership sponsored by us as managing general partner. Our first public drilling fund, Reef Global Energy Ventures, began offering units in limited partnerships in January 2002. Together, the five Reef Global Energy Ventures partnerships raised approximately $34.8 million from outside investors. Our second public drilling fund, Reef Global Energy Ventures II began offering units in limited partnerships in July 2005. Together, the four Reef Global Energy Ventures II partnerships raised approximately $85.1 million from outside investors. The nature of the drilling activity of the nine publicly-held limited partnerships is substantially different from the activities planned for Reef 2012 - 2013 Drilling Fund, L.P. Unlike those nine publicly-held limited partnerships, Reef 2012 - 2013 Drilling Fund, L.P. plans to acquire oil and natural gas properties that contain both income producing properties and the potential for the development of multiple oil and natural gas wells. It is anticipated that the Partnership will focus more on acquiring developmental wells rather than exploratory wells. Many of the nine publicly-held limited partnerships had substantial investments in exploratory wells as compared to developmental wells. Additionally, we anticipate that most of these oil and natural gas properties purchased by the Partnership will be located in the Bakken area of North Dakota, an area in which none of the nine publicly-held limited partnerships acquired any interest.
Upon request, we will provide you at no cost the most recent Form 10-K Annual Report, including any exhibits, filed with the SEC by any prior public partnership sponsored by us or our affiliates that has reported to the SEC within the last two years.
As of June 30, 2012, the nine publicly-held limited partnerships have not produced revenues in excess of the partners' capital contributions and have experienced a significant number of dry holes or unproductive wells and will not achieve payout. As a result, the investors in these partnerships will not receive a positive return on their investments. In addition, the independent registered public accounting firm's opinions for the 2011 financial statements of Reef Global Energy IV, L.P., Reef Global Energy VII, L.P., and Reef Global Energy VIII, L.P. include explanatory paragraphs indicating substantial doubt about the partnerships' ability to continue as going concerns. Pursuant to a majority vote of each partnership's respective partners, due to the small operating revenues of each partnership, the financial statements of each of Reef Global Energy I, L.P., Reef Global Energy II, L.P., Reef Global Energy III, L.P., and Reef Global Energy IX, L.P. are no longer audited. However, we believe that each such partnership has operating characteristics indicating substantial doubt about each such partnership's ability to continue as a going concern.
The nine public drilling partnerships are also multiple well drilling partnerships. Of the 16 private oil and natural gas multiple well drilling partnerships, (i) two(1) of them have made distributions to participants in excess of capital originally contributed by the participants and continue to make distributions, (ii) one(2) has made distributions to participants in excess of capital originally contributed by the participants, its wells have reached the end of their economic lives and been plugged, and is being liquidated and dissolved, (iii) one(3) recently commenced drilling operations focused in the Bakken area in North Dakota, (iv) one(4) is producing oil and gas and making distributions to participants, but we are unable to predict with accuracy whether distributions ultimately will exceed capital originally contributed by the participants, (v) four(5) are producing oil and gas but are not expected to achieve payout, (vi) five(6) had wells that, while producing some revenue, were ultimately plugged and abandoned at a substantial loss of the participants' capital contributions, (vii) one(7) drilled three unsuccessful wells, and (viii) one(8) recently commenced drilling operations.
Of the 14 income or income and development funds that we have sponsored, (i) nine were dedicated almost exclusively to the purchase of interests in already producing reserves, (ii) one was dedicated primarily to the purchase of interests in already producing reserves but has the ability to use up to 20% of capital raised for development purposes, (iii) two allowed for up to 50% of capital raised to be used for development of proven reserves, and (iv) two allowed for different percentages of capital raised to be used for development of proven reserves and for the acquisition of already producing reserves. We refer to the funds described in clause (i) in the preceding sentence as "income" funds and to the funds described in clauses (ii), (iii) and (iv) as "income and development" funds. Collectively, the income funds and the income and development funds have participated in the drilling of 128 wells, all of which were developmental wells and four of which were dry holes. Twelve of the successful wells were drilled in conjunction with the multiple well drilling partnerships. Four of these funds are producing revenues but are not making acquisitions or participating in any development activities, three funds are continuing to develop properties but not making additional acquisitions, five funds have been fully liquidated and two funds have been partially liquidated. As of June 30, 2012, these funds have acquired interests in approximately 3,500 producing wells (of which 376 have been subsequently sold) and participated in the drilling of 128 wells (of which 10 have been sold).
The following tables and narratives contain information about the partnerships sponsored by us and OREI since 1996. The results contained in these tables and narratives have not been audited. The units being offered pursuant to this offering are for partnerships more akin to the 25 multiple-well drilling partnerships. However, information regarding the income and income and development funds is still provided below, as it is relevant. The income and development funds use a majority of their funds for development purposes. This means that between 50% and 60% of their funds (depending on the terms of the income and development fund) are invested in non-producing, undeveloped wells. Therefore, the information pertaining to the income and development funds is relevant because they have similar investment objectives, and such information would be helpful in establishing the track record of Reef Oil & Gas Partners, L.P. for selecting and developing non-producing, undeveloped wells.
The income funds do not have a substantial portion of their funds allocated to development purposes, but their information is relevant. Although the income funds only purchase already producing wells, their information is also relevant as it shows the experience of Reef in selecting wells. The engineering and economic judgment used for determining the producing properties in which to invest is similar to that used for making those same investment decisions in properties that have not been developed.
Table One sets forth the capital contributions to and cumulative distributions from the partnerships since the date of such partnership's formation, as well as total distributions from the partnership during the quarter ended June 30, 2012. Income funds are ventures that are dedicated almost exclusively to the purchase of interests in already producing reserves. Income fund and development funds are ventures that have the ability to use up to 50% of capital raised for development of proven reserves. As a result, the income funds and the income and development funds are less likely to encounter dry holes, which allows for them to have higher cumulative distributions than the multiple-well drilling partnerships that have drilled dry holes.
Table One sets forth the capital contributions to and cumulative distributions from each partnership since the date of such partnership's formation, and the total distributions from each partnership during the year ended June 30, 2012. The following information has not been audited by independent accountants.
TABLE ONEPART ONE
TABLE ONEPART TWO
TABLE ONEPART THREE
Table Two sets forth certain information regarding taxable income and loss recognized by the investors in each named partnership, as well as the taxable income and loss recognized by OREI or Reef as managing general partner of each partnership during the same period.
TABLE TWOPART ONE
TABLE TWOPART TWO
TABLE TWOPART THREE
Table Three sets forth the acquisition and drilling results as of June 30, 2012 for each named partnership previously sponsored by us or OREI. For purposes of this Table Three, a "gross well" is a well in which a leasehold interest is owned, a "net well" equals the actual leasehold interest owned in one gross well divided by 100, and a "dry hole" refers to a well that is plugged and abandoned with or without a completion attempt because the operator has determined that it will not be productive in commercial quantities.
TABLE THREEPART ONE
information. These wells are included above in the information shown for the private drilling partnership revenues.
TABLE THREEPART TWO
See (1) in Table Three, Part Three: The net totals of wells drilled include duplicate wells in the drilling partnerships set forth in Part Two of Table Three. The total number of net wells drilled by the income funds, the income and development funds and the drilling partnerships is 286 wells.
TABLE THREEPART THREE
Table Four sets forth the total partnership revenue and expenditures made by each named partnership from its inception through June 30, 2012.
TABLE FOURPART ONE
TABLE FOURPART TWO