UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549










FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the Quarterly Period Ended June 30, 2010





or





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the Transition Period from ________ to ________





Commission
File Number: 000-53795










REEF
OIL & GAS INCOME AND DEVELOPMENT FUND III, L.P.


(Exact
name of registrant as specified in its charter)




Nevada
              (State
      or other jurisdiction of
              incorporation
      or organization)
            
            26-0805120
              (I.R.S.
      employer
              identification
      no.)1901
      N. Central Expressway, Suite 300
              Richardson,
      Texas
              (Address
      of principal executive offices)
            
            75080-3610
              (Zip
      code)(972)-437-6792(Registrant’s
      telephone number, including area
code)





Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes oNox





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes o  No 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.





Large
accelerated filer oAccelerated fileroNon-accelerated fileroSmaller reporting company o





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes oNo x





As of
August 16, 2010, the registrant had 490.9827 units of general partner interest
outstanding, 8.9697 units of general partner interest held by the managing
general partner, and 397.0172 units of limited partner interest
outstanding.





Reef
Oil & Gas Income and Development Fund III, L.P.


Form
10-Q Index


PART
      I — FINANCIAL
      INFORMATION
              
              1ITEM
      1.
              Financial
      Statements (Unaudited)
              
              1Condensed
      Balance Sheets
              
              1Condensed
      StatementsofOperations
              
              2Condensed
      Statements of Cash Flows
              
              3Notes
      to Condensed Financial Statements
              
              4ITEM
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              
              10ITEM
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              
              16ITEM
      4T.
              Controls
      and Procedures
              
              16PART
      II — OTHER
      INFORMATION
              
              16ITEM1.
              Legal
      Proceedings
              
              16ITEM
      1A.
              Risk
      Factors
              
              16ITEM
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              17ITEM
      3.
              Default
      Upon Senior Securities
              
              17ITEM
      4.
              (Removed
      and Reserved)
              
              17ITEM5.
              Other
      Information
              
              17ITEM6.
              Exhibits
              
              17Signatures
              
              19




i




PART
I - FINANCIAL INFORMATION





Item
1. Financial Statements





Reef
Oil & Gas Income and Development Fund III, L.P.


Condensed
Balance Sheets





June
      30,
              2010
            
            
            December
      31,
              2009(unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
            
            $
            626,941
            
            
            $
            18,243,848Accounts
      receivable
            
            
            928,152
            
            
            
            736,161Accounts
      receivable from affiliates
            
            
            1,084,402
            
            
            
            1,500,000Total
      current assets
            
            
            2,639,495
            
            
            
            20,480,009Oil
      and gas properties, full cost method of accounting:Proved
      properties, net of accumulated depletion of $5,881,743 and
      $1,207,373
            
            
            16,422,903
            
            
            
            2,364,672Unproved
      properties
            
            
            55,104,130
            
            
            
            52,010,728Net
      oil and gas properties
            
            
            71,527,033
            
            
            
            54,375,400Total
      assets
            
            $
            74,166,528
            
            
            $
            74,855,409Liabilities
      and partnership equityCurrent
      liabilities:Accounts
      payable
            
            $
            61
            
            
            $
            571,154Accounts
      payable to affiliates
            
            
            106,337
            
            
            
            223,515Accrued
      liabilities
            
            
            94,878
            
            
            
            245,090Total
      current liabilities
            
            
            201,276
            
            
            
            1,039,759Long-term
      liabilities:Note
      payable (Note 4)
            
            
            5,000,000
            
            
            
            —Asset
      retirement obligation
            
            
            1,028,841
            
            
            
            248,912Total
      long-term liabilities
            
            
            6,028,841
            
            
            
            248,912Partnership
      equityGeneral
      partners
            
            
            37,572,145
            
            
            
            40,609,693Limited
      partners
            
            
            29,797,715
            
            
            
            32,253,928Managing
      general partner
            
            
            566,551
            
            
            
            703,117Partnership
      equity
            
            
            67,936,411
            
            
            
            73,566,738Total
      liabilities and partnership equity
            
            $
            74,166,528
            
            
            $
            74,855,409




See
accompanying notes to condensed financial statements.




1





Reef
Oil & Gas Income and Development Fund III, L.P.


Condensed
Statements of Operations


(Unaudited)





For
      the three months ended
              June
      30,
            
            
            For
      the six months ended
              June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Revenues
            
            $
            1,446,082
            
            
            $
            441,928
            
            
            $
            2,703,306
            
            
            $
            770,048Costs
      and expenses:Lease
      operating expenses
            
            
            806,862
            
            
            
            324,426
            
            
            
            1,228,498
            
            
            
            598,924Production
      taxes
            
            
            90,003
            
            
            
            20,912
            
            
            
            165,985
            
            
            
            36,534Depreciation,
      depletion and amortization
            
            
            555,832
            
            
            
            77,540
            
            
            
            1,149,688
            
            
            
            180,913Accretion
      of asset retirement obligation
            
            
            16,778
            
            
            
            4,610
            
            
            
            32,791
            
            
            
            9,220Property
      impairment
            
            
            2,072,207
            
            
            
            —
            
            
            
            3,524,682
            
            
            
            441,542General
      and administrative
            
            
            655,725
            
            
            
            206,707
            
            
            
            1,792,023
            
            
            
            300,642Total
      costs and expenses
            
            
            4,197,407
            
            
            
            634,195
            
            
            
            7,893,667
            
            
            
            1,567,775Loss
      from operations
            
            
            (2,751,325
            )
            
            
            (192,267
            )
            
            
            (5,190,361
            )
            
            
            (797,727
            )Other
      income:Miscellaneous
      income
            
            
            9,005
            
            
            
            —
            
            
            
            9,014
            
            
            
            —Interest
      income
            
            
            1,790
            
            
            
            34,197
            
            
            
            3,170
            
            
            
            118,772Total
      other income
            
            
            10,795
            
            
            
            34,197
            
            
            
            12,184
            
            
            
            118,772Net
      loss
            
            $
            (2,740,530
            )
            
            $
            (158,070
            )
            
            $
            (5,178,177
            )
            
            $
            (678,955
            )Net
      loss per general partner unit
            
            $
            (3,044.54
            )
            
            $
            (167.68
            )
            
            $
            (5,719.93
            )
            
            $
            (751.62
            )Net
      loss per limited partner unit
            
            $
            (3,044.54
            )
            
            $
            (167.68
            )
            
            $
            (5,719.93
            )
            
            $
            (751.62
            )Net
      loss per managing general partner unit
            
            $
            (4,122.39
            )
            
            $
            (1,022.63
            )
            
            $
            (11,024.16
            )
            
            $
            (1,284.05
            )




See
accompanying notes to condensed financial statements.




2





Reef
Oil & Gas Income and Development Fund III, L.P.


Condensed
Statements of Cash Flows


(Unaudited)





For
      the six months ended
              June
      30,2010
            
            
            2009Operating
      ActivitiesNet
      loss
            
            $
            (5,178,177
            )
            
            $
            (678,955
            )Adjustments
      to reconcile net loss to net cashused
      in operating activities:Adjustments
      for non-cash transactions:Depreciation,
      depletion and amortization
            
            
            1,149,688
            
            
            
            180,913Property
      impairment
            
            
            3,524,682
            
            
            
            441,542Accretion
      of asset retirement obligation
            
            
            32,791
            
            
            
            9,220Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (627,381
            )
            
            
            (534,078
            )Accounts
      receivable from affiliates
            
            
            415,598
            
            
            
            (1,137,709
            )Prepaid
      expenses
            
            
            —
            
            
            
            507,640Accounts
      payable
            
            
            (571,093
            )
            
            
            (922,220
            )Accounts
      payable to affiliates
            
            
            (117,178
            )
            
            
            767,034Accrued
      liabilities
            
            
            (150,212
            )
            
            
            (2,684,261
            )Net
      cash used in operating activities
            
            
            (1,521,282
            )
            
            
            (4,050,874
            )Investing
      ActivitiesPurchase
      of oil and gas properties
            
            
            (17,985,464
            )
            
            
            (80,758
            )Property
      development
            
            
            (2,658,011
            )
            
            
            (8,261,716
            )Net
      cash used in investing activities
            
            
            (20,643,475
            )
            
            
            (8,342,474
            )Financing
      ActivitiesProceeds
      from note payable
            
            
            5,000,000
            
            
            
            —Partner
      distributions
            
            
            (452,150
            )
            
            
            (197,005
            )Net
      cash provided by (used) in financing activities
            
            
            4,547,850
            
            
            
            (197,005
            )Net
      decrease in cash and cash equivalents
            
            
            (17,616,907
            )
            
            
            (12,590,353
            )Cash
      and cash equivalents at beginning of period
            
            
            18,243,848
            
            
            
            34,549,487Cash
      and cash equivalents at end of period
            
            $
            626,941
            
            
            $
            21,959,133Supplemental
      disclosure of non-cash investing transactions:Property
      additions included in accounts payable
            
            $
            —
            
            
            $
            (1,040,504
            )Property
      additions included in accounts payable to affiliates
            
            $
            (509
            )
            
            $
            (26,451
            )Property
      additions included in accrued liabilities
            
            $
            —
            
            
            $
            (676,610
            )Additions
      to property and asset retirement obligation
            
            $
            747,138
            
            
            $
            —Property
      additions related to Davric default
            
            $
            435,390
            
            
            $
            —Supplemental
      disclosure of non-cash financing transactions:Distributions
      included in accrued liabilities
            
            $
            —
            
            
            $
            37,188




See
accompanying notes to condensed financial statements.




3





Reef
Oil & Gas Income and Development Fund III, L.P.


Notes
to Condensed Financial Statements (unaudited)





1.
Organization and Basis of Presentation





The
financial statements of Reef Oil & Gas Income and Development Fund III, L.P.
(the “Partnership”) have been prepared pursuant to the rules and regulations of
the Securities and Exchange Commission (the “SEC”). Certain information and
footnote disclosure normally included in annual financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to those rules and regulations. We have
recorded all transactions and adjustments necessary to fairly present the
financial statements included in this Quarterly Report on Form 10-Q (this
“Quarterly Report”). The adjustments are normal and recurring. The following
notes describe only the material changes in accounting policies, account
details, or financial statement notes during the first six months of 2010.
Therefore, please read these condensed financial statements and notes to
condensed financial statements together with the audited financial statements
and notes to financial statements contained in the Partnership’s Annual Report
on Form 10-K for the period ended December 31, 2009 (the “Annual
Report”).





2.
Acquisitions





On
January 19, 2010, RCWI, L.P. (“RCWI”), an affiliate of the Partnership,
completed the acquisition of certain working interests in oil and gas properties
from Azalea Properties Ltd. (“Azalea Properties”) for a purchase price of
$21,610,116 pursuant to a Purchase and Sale Agreement between RCWI and Azalea
Properties dated December 18, 2009 (the “Azalea Purchase
Agreement”).  The Azalea Purchase Agreement is subject to three side
letter agreements regarding the post-closing acquisition of proven undeveloped
properties, the post-closing resolution of properties with title defects, and
the post-closing resolution of third-party consents for certain properties
(collectively, the “Side Letter Agreements”).





Subsequently,
RCWI entered into a Purchase and Sale Agreement with the Partnership (the “RCWI
Agreement”), dated January 19, 2010, to sell portions of the working interests
acquired from Azalea Properties to the Partnership.  The Partnership
acquired 61% of the working interests initially acquired by RCWI from Azalea
Properties for a purchase price of $13,182,171 in cash subject to post-closing
adjustments.  RCWI also assigned portions of the acquired working
interests to other affiliates of RCWI and the Partnership on the same terms. The
acquired working interests (“Azalea Acquired Properties”) cover more than 400
properties, including more than 1,400 wells, located in Texas, California, New
Mexico, Louisiana, Oklahoma, North Dakota, Mississippi, Alabama, Kansas,
Montana, Colorado, and Arkansas, and include undrilled infill and offset
acreage. Approximately $10.7 million of the purchase price is associated with
proved developed reserves.





The
transactions described above are effective as of December 1,
2009.  Revenues and expenses related to December 2009 are treated as a
purchase price adjustment.  Revenues and expenses subsequent to
December 2009 related to the Azalea Acquired Properties are included in the
unaudited condensed statements of operations for the three and six month periods
ended June 30, 2010.  Revenues related to the Azalea Acquired
Properties were $714,092 and $1,512,890 for the three and six month periods
ended June 30, 2010.  Net loss related to the Azalea Acquired
Properties was $84,154 and $2,149,673 for the three and six month periods ended
June 30, 2010.  The Partnership recorded impairment expense of $0 and
$1,452,475 related to the Azalea Acquired Properties during the three and six
month periods ended June 30, 2010.  The Partnership also recorded $0
and $730,063 of acquisition related costs during the three and six month periods
ended June 30, 2010, as general and administrative expenses on its condensed
statements of operations.





On June
15, 2010, Reef Oil & Gas Income and Development Fund IV (“Income Fund IV”)
paid $1,252,844 to Azalea Properties for the post closing settlement related to
the three side letter agreements which were a part of the original Azalea
Purchase Agreement. The Partnership reimbursed Income Fund IV $764,235 for its
61% of the post closing settlement amount. There was no additional payment for
undeveloped properties; the entire post closing settlement is associated with
proved developed reserves related to seventeen properties that were not included
in the January 19, 2010 closing as a result of title issues and preferential
purchase rights held by other parties that were unresolved at January 19,
2010.





4





On June
23, 2010, RCWI entered into a Purchase and Sale Agreement (the “Lett Purchase
Agreement”) with Lett Oil & Gas, L.P. (“Lett”) for certain oil and gas
property interests owned by Lett for a purchase price of
$6,000,000.  The properties (“Lett Acquired Properties”) are located
in the Thums Long Beach Unit and include approximately 870 producing wells and
485 injection wells.  The entire $6,000,000 purchase price is
associated with proved developed reserves. The Thums Long Beach Unit is a
long-lived waterflood project in the Wilmington Field, located underneath the
Long Beach Harbor in southern California.   The Lett Purchase
Agreement acknowledged two $500,000 deposits which were refundable to RCWI only
upon certain terms set forth in the agreement and which were credited towards
the purchase price at closing.  The Partnership advanced the two
$500,000 deposits as well as the remaining $5,000,000 of the purchase price
payable at closing by RCWI under the Lett Purchase Agreement.  The oil
and gas properties included in the purchase transaction were acquired by RCWI
for benefit of the Partnership and were assigned directly to the Partnership at
closing pursuant to an Assignment, Conveyance and Bill of Sale dated June 30,
2010, but effective June 1, 2010. Revenues and expenses related to June
2010 are treated as a purchase price adjustment.





The
following unaudited pro forma condensed consolidated statements of revenue
and earnings for the three and six month periods ended June 30, 2010 and
2009 are presented as if the acquisitions of the Azalea Acquired Properties
and the Lett Acquired Properties had occurred at the beginning of the periods
presented. The unaudited pro forma condensed consolidated financial information
is not indicative of our financial position or the results of our operations
that might have actually occurred if the acquisition of the Azalea Acquired
Properties and Lett Acquired Properties had occurred at the dates presented or
of our future financial position or results of operations. The information
presented for the three and six month periods ended June 30, 2010 includes pro
forma information for the Lett Acquired Properties only, as the Azalea Acquired
Properties are included in the condensed statements of operations of the
Partnership beginning January 2010.  In addition the results may vary
significantly from the results reflected in such statements due to normal oil
and gas production declines, reductions in prices paid for oil and gas, future
acquisitions and other factors.





Unaudited
Pro Forma Condensed Consolidated Statements of Revenues and
Earnings





As
      of and For the Three Months Ended June 30,
            
            2010
            
            
            2009Revenues
            
            $
            1,660,183
            
            
            $
            1,223,976Net
      income (loss)
            
            $
            (2,566,118
            )
            
            $
            38,029Net
      loss per general partner unit
            
            $
            (2,867.26
            )
            
            $
            (14.32
            )Net
      loss per limited partner unit
            
            $
            (2,867.26
            )
            
            $
            (14.32
            )Net
      income (loss) per managing general partner unit
            
            $
            (2,228.82
            )
            
            $
            5,657.61




As
      of and For the Six Months Ended June 30,
            
            2010
            
            
            2009Revenues
            
            $
            3,123,498
            
            
            $
            2,166,013Net
      loss
            
            $
            (7,538,909
            )
            
            $
            (8,345,412
            )Net
      loss per general partner unit
            
            $
            (8,383.44
            )
            
            $
            (9,403.22
            )Net
      loss per limited partner unit
            
            $
            (8,383.44
            )
            
            $
            (9,403.22
            )Net
      income (loss) per managing general partner unit
            
            $
            (10,526.40
            )
            
            $
            518.02





3.
Summary of Accounting Policies





Oil
and Gas Properties





The
Partnership follows the full cost method of accounting for oil and gas
properties. Under this method, all direct costs and certain indirect costs
associated with acquisition of properties and successful as well as unsuccessful
exploration and development activities are capitalized. Depreciation, depletion,
and amortization of capitalized oil and gas properties and estimated future
development costs, excluding unproved properties, are based on the
unit-of-production method using estimated proved reserves, as determined by
independent petroleum engineers.  For these purposes, proved natural
gas reserves are converted to equivalent barrels of crude oil at a rate of 6 Mcf
to 1 Bbl.





5


In
applying the full cost method at June 30, 2010, the Partnership performs a
quarterly ceiling test on the capitalized costs of oil and gas properties,
whereby the capitalized costs of oil and gas properties are limited to
the  sum of the estimated future net revenues from proved reserves
using prices that are the 12-month un-weighted arithmetic average of the
first-day-of-the-month price for crude oil and natural gas held constant and
discounted at 10%, plus the lower of cost or estimated fair value of unproved
properties, if any. If capitalized costs exceed the ceiling, an impairment loss
is recognized for the amount by which the capitalized costs exceed the ceiling,
and is shown as a reduction of oil and gas properties and as property impairment
expense on the Partnership’s statements of operations. No gain or loss is
recognized upon sale or disposition of oil and gas properties, unless such a
sale would significantly alter the rate of depletion and amortization. During
the three and six month periods ended June 30, 2010, the Partnership recognized
property impairment expense of proved properties totaling $2,072,207 and
$3,524,682, respectively. During the three and six month periods ended June 30,
2009, the Partnership recognized property impairment expense of proved
properties totaling $0 and $441,542, respectively.





Unproved
properties consist of the capitalized costs associated with the development and
enhancement of waterflood operations in the Slaughter Dean project, and
undrilled infill and offset drilling locations associated with the Azalea
Acquired Properties.  Investments in unproved properties are not
depleted pending determination of the existence of proved reserves. The costs
associated with the development and waterflood enhancement project are
considered unproved pending an initial reservoir production
response.  Unproved properties are assessed for impairment quarterly
as of the balance sheet date by considering the data obtained from the
waterflood operations of the Slaughter Dean property, lease terms, drilling
activity in the area of the unproved properties, and other
information.  Any impairment resulting from this quarterly assessment
is reported as property impairment expense in the current period, as
appropriate. During the three and six month periods ended June 30, 2010 and
2009, the Partnership recognized no impairment of unproved
properties.





Estimates
of Proved Oil and Gas Reserves




Estimates
of the Partnership’s proved reserves at June 30, 2010 and December 31, 2009 have
been prepared and presented in accordance with new SEC rules and accounting
standards. These new rules are effective for fiscal years ending on or after
December 31, 2009, and require SEC reporting entities to prepare their reserve
estimates using revised reserve definitions and revised pricing based upon the
un-weighted arithmetic average of the first-day-of-the-month commodity prices
over the preceding 12-month period and current costs. Future prices and costs
may be materially higher or lower than these prices and costs, which would
impact the estimate of reserves and future cash flows.




Reserves
and their relation to estimated future net cash flows impact the Partnership’s
depletion and impairment calculations. As a result, adjustments to depletion and
impairment are made concurrently with changes to reserve estimates. If proved
reserve estimates decline, the rate at which depletion expense is recorded
increases, reducing net income. A decline in estimated proved reserves and
future cash flows also reduces the capitalized cost ceiling and may result in
increased impairment expense.





Restoration,
Removal, and Environmental Liabilities





The
Partnership is subject to extensive Federal, state and local environmental laws
and regulations. These laws regulate the discharge of materials into the
environment and may require the Partnership to remove or mitigate the
environmental effects of the disposal or release of petroleum substances at
various sites. Environmental expenditures are expensed or capitalized depending
on their future economic benefit. Expenditures that relate to an existing
condition caused by past operations and that have no future economic benefit are
expensed.





Liabilities
for expenditures of a non-capital nature are recorded when environmental
assessments and/or remediation is probable, and the costs can be reasonably
estimated. Such liabilities are generally undiscounted values unless the timing
of cash payments for the liability or component is fixed or reliably
determinable.





6


Asset
retirement costs and liabilities associated with future site restoration and
abandonment of long-lived assets are initially measured at fair value, which
approximates the cost a third party would incur in performing the tasks
necessary to retire such assets. The fair value is recognized in the financial
statements as the present value of expected future cash expenditures for site
restoration and abandonment. Subsequent to the initial measurement, the effect
of the passage of time on the liability for the net asset retirement obligation
(accretion expense) and the amortization of the asset retirement cost are
recognized in the results of operations.





The
following table summarizes the Partnership’s asset retirement obligation for the
six months ended June 30, 2010 and the year ended December 31,
2009.





Six
      months ended
              June
      30, 2010
            
            
            Year
      Ended
              December
      31,
              2009Beginning
      asset retirement obligation
            
            $
            248,912
            
            
            $
            230,472Additions
      related to acquisitions
            
            
            747,138
            
            
            
            —Accretion
      expense
            
            
            32,791
            
            
            
            18,440Ending
      asset retirement obligation
            
            $
            1,028,841
            
            
            $
            248,912




Fair
Value of Financial Instruments





The
estimated fair values for financial instruments have been determined at discrete
points in time based on relevant market information. These estimates involve
uncertainties and cannot be determined with precision. The estimated fair
value of cash, accounts receivable and accounts payable approximates their
carrying value due to their short-term nature.





Recently
Adopted Accounting Pronouncements





Modernization
of Oil and Gas Reporting





In
January 2009, the SEC adopted a new rule related to modernizing reserve
calculation and disclosure requirements for oil and gas companies, which became
effective prospectively for annual reporting periods ending on or after December
31, 2009. In addition to expanding the definition and disclosure requirements
for crude oil and natural gas reserves, the new rule changes the requirements
for determining quantities of crude oil and natural gas reserves. The new rule
requires disclosure of crude oil and natural gas proved reserves by geographical
area, using the unweighted arithmetic average of first-day-of-the-month
commodity prices over the preceding 12-month period, rather than end-of-period
prices, and allows the use of reliable technologies to estimate proved crude oil
and natural gas reserves, if those technologies have been demonstrated to result
in reliable conclusions about reserve volumes.  In addition, in
January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance
relating to crude oil and natural gas reserve estimation and disclosures to
provide consistency with the new SEC rules.  The Partnership adopted
the new standards effective December 31, 2009.  The new standards are
applied prospectively as a change in estimate. In April 2010, the FASB issued a
further accounting standards update regarding extractive oil and gas industries
to incorporate in accounting standards the revisions to Rule 4-10 of the SEC’s
Regulation S-X. The amendment primarily consists of the addition and deletion of
definitions of terms related to fossil fuel exploration and production arising
from technology changes over the past several decades. The accounting guidance
in Rule 4-10 did not change.





Subsequent
Events




In May
2009, the FASB issued new guidance on accounting for subsequent
events.  This guidance established general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. This guidance is
effective for interim and annual reporting periods ending after June 15, 2009.
The Partnership adopted the provisions of this guidance for the period ended
June 30, 2009. In February 2010, the FASB issued an update to this guidance.
Among other provisions, this update provides that an entity that is a SEC filer
is not required to disclose the date through which subsequent events have been
evaluated. The Partnership adopted the provisions on its effective date of
February 24, 2010. There was no impact on the Partnership’s operating results,
financial position or cash flows.





7


Fair
Value Measurements





In
January 2010, the FASB issued new guidance related to improving disclosures
about fair value measurements. This guidance requires separate disclosures of
the amounts of transfers in and out of Level 1 and Level 2 fair value
measurements and a description of the reason for such transfers. In the
reconciliation for Level 3 fair value measurements using significant
unobservable inputs, information about purchases, sales, issuances and
settlements shall be presented separately. These disclosures are required for
interim and annual reporting periods effective January 1, 2010, except for
the disclosures related to the purchases, sales, issuances and settlements in
the roll forward activity of Level 3 fair value measurements, which are
effective on January 1, 2011. This guidance was adopted on January 1,
2010 for Level 1 and Level 2 fair value measurements and did not impact the
Partnership’s operating results, financial position or cash flows or disclosures
regarding the fair value of financial instruments.





4.
Long-Term Debt





On June
30, 2010, the Partnership and Texas Capital Bank, N.A. (“TCB”) entered into a
Credit Agreement (the “Credit Agreement”) which currently has a $5,000,000
borrowing base, and a related promissory note and security agreement for
purposes of funding the acquisition of oil and gas properties purchased from
Lett by RCWI and assigned to the Partnership under the Assignment, Conveyance
and Bill of Sale described in Note 2 above.  The per annum interest
rate is equal to the U.S. prime rate as published by the Wall Street Journal’s
“Monday Rates” plus 0.5%, with a minimum interest rate of 5%, payable
monthly.  The obligations of TCB to the Partnership under the Credit
Agreement expire on June 30, 2013, at which point the promissory note matures,
and any unpaid principal and interest becomes due and payable.  The
Credit Agreement is a reducing revolving credit facility, and is subject to
semi-annual redetermination of the borrowing basein accordance with the
TCB’s customary practices for oil and gas loans.  At June 30,
2010, the borrowing base was equal to $5,000,000.  The Partnership
borrowed $5,000,000 from TCB under the Credit Agreement which was paid directly
to Lett to satisfy the closing obligations of RCWI under the Lett Purchase
Agreement described in Note 2 above.  The principal and accrued
interest thereon may generally be prepaid by the Partnership in whole or in part
at any time and without premium or penalty.





Under the
terms of the Credit Agreement, on June 30, 2010 the Partnership paid TCB a
facility fee of $50,000 (one percent (1.00%) of the initial borrowing base) and
is obligated to further pay, upon each determination of an increase in the
borrowing base, a facility fee in the amount of one percent (1.00%) of the
amount by which the borrowing base is increased over that in effect on the date
of determination.  On June 30, 2010, the Partnership also paid TCB an
engineering fee in the amount of $5,000, and is obligated to further pay
additional engineering fees in the amount of $5,000 if TCB’s internal engineers
perform the engineering review of the collateral; or the actual fees and
expenses of any third-party engineers retained by TCB to prepare an engineering
report, payable at the time of a redetermination of the borrowing
base.





The
Credit Agreement is guaranteed by RCWI and RCWI GP LLC. Borrowings under the
Credit Agreement are secured by a first priority lien on no less than 90% of the
oil and gas properties utilized in determining the borrowing base, based on the
net present value of the crude oil and natural gas to be produced from the oil
and gas properties calculated using a discount rate of nine percent (9.00%) per
annum.




The
Credit Agreement contains various covenants, including among
others:




·
            
            restrictions
      on liens;




·
            
            restrictions
      on incurring other indebtedness without the lenders’
    consent;




·
            
            restrictions
      on distributions and other restricted
payments;




·
            
            maintenance
      of a current ratio as of the end of each fiscal quarter commencing
      September 30, 2010 of not less than 1.0 to 1.0, as adjusted;
      and




8




·
            
            maintenance
      of an interest coverage ratio of cash flow to fixed charges as of the end
      of each fiscal quarter commencing September 30, 2010, to be at least 3.0
      to 1.0.




All
outstanding amounts owed under the Credit Agreement become due and payable upon
the occurrence of certain usual and customary events of default, including among
others:




·
            
            failure
      to make payments under the Credit
Agreement;




·
            
            non-performance
      of covenants and obligations continuing beyond any applicable grace
      period; and




·
            
            the
      occurrence of a “Change in Control” (as defined in the Credit
      Agreement).




At June
30, 2010, the Partnership was in compliance with all financial covenants under
the Credit Agreement.





5.
Transactions with Affiliates





Reef
Exploration, L.P. (“RELP”), an affiliate of Reef Oil & Gas Partners, L.P.
(“Reef”), the managing general partner of the Partnership, currently serves as
the operator of the Slaughter Dean Project and receives drilling compensation in
an amount equal to 15% of the total well costs paid by the
Partnership.  Total well costs include all drilling and equipment
costs, including intangible development costs, surface facilities, and
costs of pipelines necessary to connect the well to the nearest delivery
point.  In addition, total well costs also include the costs of all
developmental activities on a well, such as reworking, working over, deepening,
sidetracking, fracturing a producing well, installing pipeline for a well or any
other activity incident to the operations of a well, excluding ordinary well
operating costs after completion.  Total well costs do not include
costs relating to lease acquisitions.  During the six months ended
June 30, 2010, RELP received $84,733 in drilling compensation. During the year
ended December 31, 2009, RELP received $1,544,858 in drilling
compensation.  Drilling compensation payments are included in oil and
gas properties in the financial statements.





Reef
receives an administrative fee to cover all general and administrative costs in
an amount equal to 1/12 th of 1%
of all capital raised payable monthly.  During the three and six month
periods ended June 30, 2010, Reef received $224,220 and $448,440, respectively,
in administrative fees. During the three and six month periods ended June 30,
2009, Reef received $224,220 and $448,440, respectively, in administrative
fees.  During the three and six month periods ended June 30, 2009,
$202,050 and $368,174 of administrative fees were capitalized and are included
in property costs in the financial statements, with the remainder included in
general and administrative expenses.  Administrative fees related to
2010 are included in general and administrative expense in the financial
statements. Reef’s general and administrative costs include all customary and
routine expenses, accounting, office rent, telephone, secretarial, salaries and
other incidental expenses incurred by Reef or its affiliates that are necessary
to the conduct of the Partnership’s business, whether generated by Reef, its
affiliates or by third parties, but excluding direct costs and operating
costs.





The
Partnership also reimburses Reef and its affiliates for their costs relating to
the acquisition of the oil and gas properties and for costs relating to the
development of Partnership wells.  During the three and six month
periods ended June 30, 2010, Reef and its affiliates have received $0 and
$535,111, respectively, in reimbursement for such costs. Reef and its affiliates
received no reimbursement for such costs during the comparative periods in 2009.
Development costs include the cost of drilling, testing, completing, equipping,
plugging, abandoning, deepening, plugging back, reworking, recompleting,
fracturing, implementing waterflood activities, and similar activities on
Partnership wells which are not defined as routine operating
costs.  Acquisition costs include all reasonable and necessary costs
and expenses incurred in connection with the acquisition of a property or
arising out of or relating to the acquisition of properties, including but not
limited to all reasonable and necessary costs and expenses incurred in
connection with searching for, screening and negotiating the possible
acquisition of properties for the Partnership, the conduct of reserve and other
technical studies of properties for purposes of acquisition of a property, and
the actual purchase price of a property and any other assets acquired with such
property.





9


Reef and
its affiliates may enter into other transactions with the Partnership for
services, supplies and equipment, and will be entitled to compensation at
competitive prices and terms as determined by reference to charges of
unaffiliated companies providing similar services, supplies and
equipment.





6.
Commitments and Contingencies





The
Partnership is not currently involved in any legal proceedings.





7.  Partnership
Equity





Information
regarding the number of units outstanding and the net loss per type of
Partnership unit for the three and six month periods ended June 30, 2010 is
detailed below:





For the
three months ended June 30, 2010





Type of Unit
            
            Number
      of
              Units
            
            
            Net
      loss
            
            
            Net
      loss
              per
      unitManaging
      general partner
            
            
            8.9697
            
            
            $
            (36,976
            )
            
            $
            (4,122.39
            )General
      partner
            
            
            490.9827
            
            
            
            (1,494,818
            )
            
            $
            (3,044.54
            )Limited
      partner
            
            
            397.0172
            
            
            
            (1,208,736
            )
            
            $
            (3,044.54
            )Total
            
            
            896.9696
            
            
            $
            (2,740,530
            )





For the
six months ended June 30, 2010





Type of Unit
            
            Number
      of
              Units
            
            
            Net
      loss
            
            
            Net
      loss
              per
      unitManaging
      general partner
            
            
            8.9697
            
            
            $
            (98,883
            )
            
            $
            (11,024.16
            )General
      partner
            
            
            490.9827
            
            
            
            (2,808,385
            )
            
            $
            (5,719.93
            )Limited
      partner
            
            
            397.0172
            
            
            
            (2,270,909
            )
            
            $
            (5,719.93
            )Total
            
            
            896.9696
            
            
            $
            (5,178,177
            )




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





The
following is a discussion of the Partnership’s financial condition, results of
operations, liquidity and capital resources. This discussion should be read in
conjunction with our financial statements and the related notes thereto,
included in the Annual Report.





This
Quarterly Report contains forward-looking statements that involve risks and
uncertainties.  You should exercise extreme caution with respect to all
forward-looking statements made in this Quarterly Report.  Specifically,
the following statements are forward-looking:





·
            statements
      regarding the state of the oil and gas industry and the opportunity to
      profit within the oil and gas industry, competition, pricing, level of
      production, or the regulations that may affect the
      Partnership;




·
            statements
      regarding the plans and objectives of Reef for future operations,
      including, without limitation, the uses of Partnership funds and the size
      and nature of the costs the Partnership expects to incur and people and
      services the Partnership may
employ;




·
            any
      statements using the words “anticipate,” “believe,” “estimate,” “expect”
      and similar such phrases or words;
and





·
            any
      statements of other than historical
fact.




10




Reef
believes that it is important to communicate its future expectations to the
partners.  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 risk factors
listed in the section captioned “RISK FACTORS” contained in the
Partnership’s Annual Report. Although Reef believes that the expectations
reflected in such forward-looking statements are reasonable, Reef can give no
assurance that such expectations will prove to have been correct.  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.  There can be no assurance that the
projected results will occur, that these judgments or assumptions will prove
correct or that unforeseen developments will not occur.




Reef does
not intend to update its forward-looking statements.  All subsequent
written and oral forward-looking statements attributable to Reef or persons
acting on its behalf are expressly qualified in their entirety by the applicable
cautionary statements.





Overview





Reef Oil
& Gas Income and Development Fund III, L.P. is a Texas limited partnership.
The primary objectives of the Partnership are to purchase working interests in
oil and gas properties with the purposes of (i) growing the value of properties
through the development of proved undeveloped reserves, (ii) generating revenue
from the production of crude oil and natural gas, (iii) distributing cash to the
partners of the Partnership, and (iv) selling the properties no later than 2015,
in order to maximize return to the partners of the Partnership.  Reef
is the managing general partner of the Partnership.





On
properties purchased by the Partnership, the Partnership plans to produce
existing proved reserves and develop any proved undeveloped reserves, but does
not expect to engage in exploratory drilling for unproved reserves, should
acreage purchased by the Partnership be deemed to contain unproved drilling
locations.  Drilling locations for unproved reserves, if any, may be
farmed out or sold to third parties or other partnerships formed by
Reef.





The
Partnership purchased an initial 41% working interest in a producing oil
property located in the Slaughter Field in Cochran County, Texas, approximately
50 miles southwest of Lubbock, Texas (the “Slaughter Dean Project”), in January
2008 from Sierra-Dean Production Company, L.P. (“Sierra Dean”).  
Under the terms of the acquisition agreement, each month thereafter additional
working interests are purchased based on the amount the Partnership spends
developing the project through January 2013.  Under the acquisition
agreement the Partnership generally pays 82% of all drilling, development and
repair costs (including amounts allocable to the working interest initially
retained by Sierra Dean), and Sierra Dean conveys additional working interests
to the Partnership each month in payment of its share of such costs. In a
separate transaction in May 2008, the Partnership purchased 11% of the 18%
working interest in the Slaughter Dean Project owned by Davric Corporation
(“Davric”). Davric retained a 7% working interest in the Slaughter Dean
Project





The
management of the operations and other business of the Partnership is the
responsibility of Reef.  Reef Exploration, L.P. (“RELP”), an affiliate
of Reef, serves as the operator of the Slaughter Dean Project. This relationship
with the Partnership is governed by two operating agreements.  One
operating agreement (the “Sierra-Dean Operating Agreement” is between the
Partnership, RELP and Sierra Dean.  The other operating agreement is
between the Partnership, RELP, and Davric (the “Davric Operating
Agreement”).





The
Partnership has been advised that Davric, who is unrelated to Reef and owns a 7%
working interest in the Dean Unit and the Dean “B” unit, was unable to pay
$538,443 of its share of costs incurred subsequent to February 28,
2009.  Pursuant to the Davric Operating Agreement, the Partnership
assumed the 7% working interest of Davric and Davric is now a non-consenting
working interest owner. The unpaid costs have been recorded as property
additions and operating costs on the books of the Partnership, and the
Partnership will retain the Davric 7% working interest until the net revenues
related to this interest exceed the unpaid costs, plus penalties ranging from
300% to 450% of the amount in default.





11


On
January 19, 2010, RCWI, L.P. (“RCWI”), an affiliate of the Partnership,
completed the acquisition of certain working interests in oil and gas properties
from Azalea Properties Ltd. (“Azalea Properties”) for a purchase price of
$21,610,116 pursuant to a Purchase and Sale Agreement between RCWI and Azalea
Properties dated December 18, 2009 (the “Azalea Purchase
Agreement”).  The Azalea Purchase Agreement is subject to three side
letter agreements regarding the post-closing acquisition of proven undeveloped
properties, the post-closing resolution of properties with title defects, and
the post-closing resolution of third-party consents for certain properties
(collectively, the “Side Letter Agreements”).





Subsequently,
RCWI entered into a Purchase and Sale Agreement with the Partnership (the “RCWI
Agreement”), dated January 19, 2010, to sell portions of the working interests
acquired from Azalea Properties to the Partnership.  The Partnership
acquired  61% of the working interests initially acquired by RCWI from
Azalea Properties for a purchase price of  $13,182,171 in cash subject
to post-closing adjustments.  RCWI also assigned portions of the
acquired working interests to other affiliates of RCWI and the Partnership on
the same terms. The acquired working interests (“Azalea Acquired Properties’)
cover more than 400 properties, including more than 1,400 wells, located in
Texas, California, New Mexico, Louisiana, Oklahoma, North Dakota, Mississippi,
Alabama, Kansas, Montana, Colorado, and Arkansas, and include undrilled infill
and offset locations.  The acquired working interests represent
minority non-operated interests.  The properties are operated by more
than 100 different operators, none of which are affiliates of the Partnership or
Reef. Approximately $10.7 million of the purchase price is associated with
proved developed reserves.





On June
15, 2010, Reef Oil & Gas Income and Development Fund IV (“Income Fund IV”)
paid $1,252,844 to Azalea Properties  for the post closing settlement
related to the three side letter agreements which were a part of the original
Azalea Purchase Agreement. The Partnership reimbursed Income Fund IV $764,235
for its 61% of the post closing settlement amount. There was no additional
payment for undeveloped properties, the entire post closing settlement is
associated with proved developed reserves related to seventeen properties that
were not included in the January 19, 2010 closing as a result of title issues
and preferential purchase rights held by other parties that were unresolved at
January 19, 2010.





On June
23, 2010, RCWI entered into a Purchase and Sale Agreement (the “Lett Purchase
Agreement”) with Lett Oil & Gas, L.P. (“Lett”) for certain oil and gas
property interests owned by Lett for a purchase price of
$6,000,000.  The properties (“Lett Acquired Properties”) are located
in the Thums Long Beach Unit and include approximately 870 producing wells and
485 injection wells.  The entire $6,000,000 purchase price is
associated with proved developed reserves. The Thums Long Beach Unit is a
long-lived waterflood project in the Wilmington Field, located underneath the
Long Beach Harbor in southern California.   The Lett Purchase
Agreement acknowledged two $500,000 deposits which were refundable to RCWI only
upon certain terms set forth in the agreement and which were credited towards
the purchase price at closing.  The Partnership advanced the two
$500,000 deposits as well as the remaining $5,000,000 of the purchase price
payable at closing by RCWI under the Lett Purchase Agreement.  The oil
and gas properties included in the purchase transaction were acquired by RCWI
for benefit of the Partnership and were assigned directly to the Partnership at
closing pursuant to an Assignment, Conveyance and Bill of Sale dated June 30,
2010, but effective June 1, 2010. Revenues and expenses related to June
2010 are treated as a purchase price adjustment.





12


The
table below summarizes Partnership expenditures for property purchases,
development, and waterflood enhancement by type and classification of well as of
June 30, 2010.




Leasehold
              Costs
            
            
            Drilling
      and Facilities Costs
            
            
            Workovers
            
            
            Total
              CostsPurchase
      Existing Wells
            
            $
            35,899,311
            
            
            $
            
            
            
            $
            
            
            
            $
            35,899,311New
      WellsProducing
      Wells
            
            
            8,713
            
            
            
            27,127,027
            
            
            
            
            
            
            
            27,135,740Waterflood
      Injector Wells
            
            
            
            
            
            
            5,149,620
            
            
            
            
            
            
            
            5,149,620Facilities
            
            
            
            
            
            
            1,771,406
            
            
            
            
            
            
            
            1,771,406Existing
      Wells
            
            
            
            
            
            
            
            
            
            
            6,492,196
            
            
            
            6,492,196Total
            
            $
            35,908,024
            
            
            $
            34,048,053
            
            
            $
            6,492,196
            
            
            $
            76,448,273




With the
acquisition of the Lett Acquired Properties, the Partnership has expended all of
its available capital, and no additional property purchases are
anticipated.





Critical
Accounting Policies





There
have been no changes from the Critical Accounting Policies described in the
Annual Report.





Liquidity
and Capital Resources





The
Partnership was funded with initial capital contributions totaling $89,410,519
from both non-Reef partners and Reef, net of adjustments for sales to brokers
for their own accounts, who were permitted to buy Units at a price net of the
commission that they would normally earn on sales of Units.  Non-Reef
partners purchased 490.9827 general partner units and 397.0173 limited partner
units for $88,648,094, net of adjustments for sales to brokers for their own
accounts, who were permitted to buy Units at a price net of the commission that
they would normally earn on sales of Units. Reef contributed $762,425 for the
purchase of 8.9697 general partner units at a price of $85,000 per unit, which
is net of all offering costs. Organization and offering costs totaled
$13,168,094, leaving capital contributions of $76,242,425 available for
Partnership activities. The Partnership has expended $55,970,557 on property
acquisitions and development costs related to the Slaughter Dean Project,
$14,477,716 on property acquisitions and development related to the Azalea
Properties, and $6,000,000 related to the Lett Acquired Properties.





The
Partnership has working capital of $2,438,219 at June 30, 2010. The Partnership
has expended $76,448,273 on the property acquisitions and development costs
detailed above. Expenditures in excess of available capital have been financed
through debt or recovered from cash flows by reducing Partnership distributions.
Subsequent to expending the initial available Partnership capital contributions
on property acquisitions and development, the Partnership working capital
consists primarily of cash flows from productive properties utilized to pay cash
distributions to investors.





Results
of Operations





The
following is a comparative discussion of the results of operations for the
periods indicated. It should be read in conjunction with the condensed financial
statements and the related notes to the condensed financial statements included
in this Quarterly Report.





The
following table provides information about sales volumes and crude oil and
natural gas prices for the periods indicated. Equivalent barrels of oil (“EBO”)
are computed by converting 6 Mcf of natural gas to 1 barrel of crude
oil.




For
      the three months
              ended
      June 30,
            
            
            For
      the six months
              ended
      June 30,2010
            
            
            2009
            
            
            2010
            
            
            2009Sales
      volumes:Oil
      (Barrels)
            
            
            18,687
            
            
            
            9,047
            
            
            
            32,204
            
            
            
            19,021Natural
      gas (Mcf)
            
            
            51,482
            
            
            
            2,735
            
            
            
            95,576
            
            
            
            4,222Average
      sales prices received:Oil
      (Barrels)
            
            $
            62.54
            
            
            $
            48.47
            
            
            $
            68.16
            
            
            $
            40.18Natural
      gas (Mcf)
            
            $
            5.39
            
            
            $
            1.27
            
            
            $
            5.32
            
            
            $
            1.38




13




Overall,
sales volumes increased during the second quarter of 2010 compared to the second
quarter of 2009, due primarily to the Partnership’s purchase in January 2010 of
the Azalea Acquired Properties.  The Azalea Acquired Properties
accounted for oil volumes of 6,895 Bbl and gas volumes of 50,217 Mcf during the
second quarter of 2010.  Oil volumes from the Slaughter Dean Field
also increased over the 2009 levels, as volumes produced from newer wells
drilled during the development phase were higher than volumes from the over
twenty previously productive older wells converted to water injection wells
during 2009. In addition, average crude oil and natural gas sales prices rose
significantly during the comparable periods.  Average oil prices
increased by 29.0% and average gas prices increased by 324.4% during the three
months ended June 30, 2010 compared to the three months ended June 30,
2009.  The large increase in gas prices is primarily due to the fact
that because of lower quality, Slaughter Dean gas is sold at a heavily
discounted price while gas from the newly acquired Azalea properties is sold at
a higher price. The Lett Acquired Properties will lead to increased volumes
during the third quarter of 2010.





In
January 2009, the SEC adopted a new rule related to modernizing reserve
calculation and disclosure requirements for oil and gas companies, which became
effective prospectively for annual reporting periods ending on or after December
31, 2009.  In addition to expanding the definition and disclosure
requirements for crude oil and natural gas reserves, the new rule changes the
requirements for determining quantities of crude oil and natural gas reserves.
The new rule requires disclosure of crude oil and natural gas proved reserves by
significant geographic area, using the un-weighted arithmetic average of
first-day-of-the-month commodity prices over the preceding 12-month period,
rather than end-of-period prices, and allows the use of reliable technologies to
estimate proved crude oil and natural gas reserves, if those technologies have
been demonstrated to result in reliable conclusions about reserves volumes.
Reserve and related information for June 30, 2010 is presented consistent with
the requirements of the new rule. The new rule does not allow prior-year reserve
information to be restated, so all information related to June 30, 2009 is
presented consistent with prior SEC rules for the estimation of proved reserves.
The effect of applying the new definition of reliable technology and other
non-price related aspects of the updated rules did not significantly impact 2010
net proved reserve volumes.  All of the Partnership’s reserves are
located in the United States.





The
estimated net proved crude oil and natural gas reserves as of June 30, 2010 and
2009 are summarized below. The quantities of proved crude oil and natural gas
reserves discussed in this section include only the amounts which the
Partnership reasonably expects to recover in the future from known oil and gas
reservoirs under the current economic and operating conditions. Proved reserves
include only quantities that the Partnership expects to recover commercially
using current prices, costs, existing regulatory practices, and technology.
Therefore, any changes in future prices, costs, regulations, technology or other
unforeseen factors could materially increase or decrease the proved reserve
estimates.





Net
      proved reserves
            
            Oil
      (Bbl)
            
            
            Gas
      (Mcf)June
      30, 2010
            
            
            694,403
            
            
            
            1,559,466June
      30, 2009
            
            
            290,923
            
            
            
            214,087





Three
months ended June 30, 2010 compared to the three months ended June 30,
2009





The
Partnership had a net loss of $2,740,530 for the three months ended June 30,
2010, compared to a net loss of $158,070 for the three months ended June 30,
2009.





14


Partnership
revenues totaled $1,446,082 for the three months ended June 30, 2010 compared to
$441,928 for the comparable period in 2009.  Volumes increased due
primarily to the Partnership’s purchase in January 2010 of the Azalea Acquired
Properties.  This purchase resulted in oil volumes of 6,895 Bbl and
gas volumes of 50,217 Mcf during the three months ended June
30, 2010.  In addition, average crude oil and natural gas sales
prices rose significantly during the comparable periods.  Average oil
prices increased by 29.0% and average gas prices increased by 324.4% during the
three months ended June 30, 2010 compared to the three months ended June 30,
2009.  The large increase in gas prices is primarily due to the fact
that because of lower quality, Slaughter Dean gas is sold at a heavily
discounted price, while gas from the newly acquired Azalea properties is sold at
a higher price.





Lease
operating expenses increased from $324,426 for the three months ended June 30,
2009 to $806,862 for the three months ended June 30, 2010.  This
increase is primarily due to the Partnership’s purchase in January 2010 of the
Azalea Properties and the Partnership’s assumption of Davric’s 7% working
interest in Slaughter Dean.





Depreciation,
depletion and amortization increased from $77,540 for the three months ended
June 30, 2009 to $555,832 for the three months ended June 30, 2010, primarily
due to increased production levels and higher property
basis.   During the three months ended June 30, 2010, the
Partnership recorded impairment expense of proved properties totaling
$2,072,207. This impairment expense represents the differential between the
capitalized costs of proved properties, and the ceiling test value at June 30,
2010, which is computed by applying the sum of the estimated future net revenues
from proved reserves using prices that are the 12-month un-weighted arithmetic
average of the first-day-of-the-month price for crude oil and natural gas held
constant and discounted at 10%. The impairment is primarily related to the Lett
Acquired Properties, for which the quarterly ceiling test is calculated using an
un-escalated price held constant and discounted at 10% for the entire life of
these very long-lived properties. This measure of discounted future net cash
flows does not purport to present the fair value of our crude oil and natural
gas reserves.





General
and administrative costs incurred during the three month periods ended June 30,
2010 and 2009 increased from $206,707 in 2009 to $655,725 in 2010. This increase
is due to the timing of audit and accounting fees of approximately $29,000
related to financial reporting.  In addition, direct costs charged to
the Partnership increased by approximately $102,000.  Financing
charges increased by approximately $92,000 related to the financing of the Lett
Acquired Properties.  Overhead charges from Reef charged to general
and administrative expense increased by approximately
$178,000.  During the second quarter of 2009, a portion of Reef
overhead charges were capitalized due to the capital expenditures program in the
Slaughter Dean Field.





Six
months ended June 30, 2010 compared to the six months ended June 30,
2009





The
Partnership had a net loss of $5,178,177 for the six months ended June 30, 2010,
compared to a net loss of $678,955 for the six months ended June 30,
2009.





Partnership
revenues totaled $2,703,306 for the six months ended June 30, 2010 compared to
$770,048 for the comparable period in 2009.  Volumes increased due
primarily to the Partnership’s purchase in January 2010 of the Azalea Acquired
Properties.  This purchase resulted in oil volumes of 14,246 Bbl and
gas volumes of 93,438 Mcf during the first six months of 2010.  In
addition, average crude oil and natural gas sales prices rose significantly
during the comparable periods.  Average oil prices increased by 69.6%
and average gas prices increased by 285.5% during the six months ended June 30,
2010 compared to the six months ended June 30, 2009.  The large
increase in gas prices is primarily due to the fact that because of lower
quality, Slaughter Dean gas is sold at a heavily discounted price, while gas
from the newly acquired Azalea properties is sold at a higher
price.





Lease
operating expenses increased from $598,924 for the six months ended June 30,
2009 to $1,228,498 for the six months ended June 30, 2010.  This
increase is primarily due to the Partnership’s purchase in January 2010 of the
Azalea Acquired Properties and the Partnership’s assumption of Davric’s 7%
working interest in Slaughter Dean.





Depreciation,
depletion and amortization increased from $180,913 for the six months ended June
30, 2009 to $1,149,688 for the six months ended June 30, 2010, primarily due to
increased production levels and higher property basis.  Crude oil
prices reached a low point for 2009 during the first quarter, and consequently
the Partnership incurred first quarter 2009 property impairment cost of
$441,542.  At March 31, 2010, the Partnership recorded impairment
expense of proved properties totaling $1,452,475, and at June 30, 2010, the
Partnership recorded impairment expense of proved properties totaling
$2,072,207. This impairment expense represents the differential between the
capitalized costs of proved properties, and the ceiling test value at June 30,
2010, which is computed by applying the sum of the estimated future net revenues
from proved reserves using prices that are the 12-month un-weighted arithmetic
average of the first-day-of-the-month price for crude oil and natural gas held
constant and discounted at 10%. The total impairment of $3,534,682 is
primarily related to the Azalea Acquired Properties and Lett Acquired
Properties, for which the quarterly ceiling test is calculated using an
un-escalated price held constant and discounted at 10% for the entire life of
these very long-lived properties. This measure of discounted future net cash
flows does not purport to present the fair value of our crude oil and natural
gas reserves.





15


General
and administrative costs incurred during the six month periods ended June 30,
2010 and 2009 increased from $300,642 in 2009 to $1,792,023 in 2010. This
increase is primarily due to acquisition costs related to the Azalea Properties
of $730,063.  Remaining increases relate partially to the timing of
audit and accounting fees of approximately $70,000 related to financial
reporting.  In addition, direct costs charged to the Partnership
increased by approximately $169,000. Financing charges increased by
approximately $92,000 related to the financing of the Lett Acquired
Properties.  Overhead charges from Reef charged to general and
administrative expense increased by approximately $380,000.  During
the first six months of 2009, a portion of Reef overhead charges were
capitalized due to the capital expenditures program in the Slaughter Dean
Field.





Item
3. Quantitative and Qualitative Disclosures About Market Risk





The
Partnership is a “smaller reporting company” as defined by Rule 12b-2
promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”), and as such, is not required to provide the information required under
this Item.





Item
4T. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures





As the
managing general partner of the Partnership, Reef maintains a system of controls
and procedures designed to provide reasonable assurance as to the reliability of
the financial statements and other disclosures included in this report, as well
as to safeguard assets from unauthorized use or disposition. The Partnership,
under the supervision and with participation of its management, including the
principal executive officer and principal financial officer, evaluated the
effectiveness of the design and operation of its “disclosure controls and
procedures” as such term is defined in Rule 13a-15(e) promulgated under the
Exchange Act, as of the end of the period covered by this Quarterly Report.
Based on that evaluation, the principal executive officer and principal
financial officer have concluded that the Partnership’s disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Partnership in reports that it files or submits under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in SEC rules and forms, and includes controls and procedures designed to ensure
that information required to be disclosed by us in such reports is accumulated
and communicated to our management, including the principal executive officer
and principal financial officer, as appropriate to allow timely decisions
regarding financial disclosure.





Changes
in Internal Controls





There
have not been any changes in the Partnership’s internal controls over financial
reporting during the fiscal quarter ended June 30, 2010 that have materially
affected, or are reasonably likely to materially affect, the Partnership’s
internal control over financial reporting.





PART
II – OTHER INFORMATION





Item
1.  Legal Proceedings





None.





Item
1A.  Risk Factors





There
were no material changes in the Risk Factors applicable to the Partnership as
set forth in the Annual Report.





16


Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds





None.





Item
3.  Default Upon Senior Securities





None.





Item
4.  (Removed and Reserved)





Item
5.  Other Information





None.





Item
6.  Exhibits





Exhibits





10.1
            Purchase
      and Sale Agreement, dated January 19, 2010, by and between Azalea
      Properties Ltd. and RCWI, L.P. (incorporated by reference to Exhibit 10.1
      to the Partnership’s Form 8-K, as filed with the SEC on January 22,
      2010).





10.2
            Purchase
      and Sale Agreement, dated January 19, 2010, by and between RCWI, L.P., and
      Reef Oil & Gas Income and Development Fund III, L.P. (incorporated by
      reference to Exhibit 10.2 to the Partnership’s Form 8-K, as filed with the
      SEC on January 22, 2010).





10.3
            Side
      Letter Agreement, dated January 19, 2010, between RCWI, L.P. and Azalea
      Properties Ltd. Regarding Post Closing PUDs (incorporated by reference to
      Exhibit 10.3 to the Partnership’s Form 8-K, as filed with the SEC on
      January 22, 2010).





10.4
            Side
      Letter Agreement, dated January 19, 2010, between RCWI, L.P. and Azalea
      Properties Ltd. Regarding Post Closing Properties/Title Defect Notice
      (incorporated by reference to Exhibit 10.4 to the Partnership’s Form 8-K,
      as filed with the SEC on January 22,
2010).





10.5
            Side
      Letter Agreement, dated January 19, 2010, between RCWI, L.P. and Azalea
      Properties Ltd. Regarding Third Party Consents (incorporated by reference
      to Exhibit 10.5 to the Partnership’s Form 8-K, as filed with the SEC on
      January 22, 2010).





10.6
            Purchase
      and Sale Agreement by and between Lett Oil & Gas, L.P., as seller and
      RCWI, L.P., as buyer dated as of June 23, 2010 (incorporated by reference
      to Exhibit 10.1 to the Partnership’s Form 8-K, as filed with the SEC on
      July 9, 2010).




10.7
              Assignment,
      Conveyance and Bill of Sale between Lett Oil & Gas, L.P. (“Assignor”)
      and Reef Oil & Gas Income and Development Fund III, L.P. (“Assignee”)
      executed June 30, 2010 and dated effective June 1, 2010 (incorporated by
      reference to Exhibit 10.2 to the Partnership’s Form 8-K, as filed with the
      SEC on July 9, 2010).
  10.8
                  $50,000,000
      Credit Agreement dated June 30, 2010 between Reef Oil & Gas Income and
      Development Fund III, L.P., as borrower and Texas Capital Bank, N.A., as
      lender (incorporated by reference to Exhibit 10.3 to the Partnership’s
      Form 8-K, as filed with the SEC on July 9,
    2010).
 17
  10.9
                      Form
      of Security Agreement (General) dated June 30, 2010 by Reef Oil & Gas
      Income and Development Fund III, L.P., in favor of Texas Capital Bank,
      N.A., as lender (incorporated by reference to Exhibit 10.4 to the
      Partnership’s Form 8-K, as filed with the SEC on July 9,
      2010).


10.10
                  Promissory
      Note in the principal amount of up to $50,000,000 dated June 30, 2010
      payable to Texas Capital Bank, N.A. (incorporated by reference to Exhibit
      10.5 to the Partnership’s Form 8-K, as filed with the SEC on July 9,
      2010).


31.1
            Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.*





31.2
            Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.*





32.1
            Certification
      of the Principal Executive Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*





32.2
            Certification
      of the Principal Financial Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*


*Filed
herewith





18




SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.




REEF
      OIL & GAS INCOME AND DEVELOPMENT FUND III, L.P.By:
              Reef
      Oil & Gas Partners, L.P.Managing
      General PartnerBy:
              Reef Oil & Gas Partners, GP,
      LLC,its
      general partner
  Dated: August
      16, 2010
                By:
                /s/
      Michael J. MauceliMichael J.
    MauceliManager
      and Member(Principal Executive
      Officer)




Dated: August
      16, 2010
                By:
                /s/
      Daniel C. SibleyDaniel C.
    SibleyChief
      Financial Officer and General Counsel ofReef
      Exploration, L.P.(Principal Financial and
      Accounting Officer)
  19




EXHIBIT
INDEX





Exhibits





10.1
            Purchase
      and Sale Agreement, dated January 19, 2010, by and between Azalea
      Properties Ltd. and RCWI, L.P. (incorporated by reference to Exhibit 10.1
      to the Partnership’s Form 8-K, as filed with the SEC on January 22,
      2010).





10.2
            Purchase
      and Sale Agreement, dated January 19, 2010, by and between RCWI, L.P., and
      Reef Oil & Gas Income and Development Fund III, L.P. (incorporated by
      reference to Exhibit 10.2 to the Partnership’s Form 8-K, as filed with the
      SEC on January 22, 2010).





10.3
            Side
      Letter Agreement, dated January 19, 2010, between RCWI, L.P. and Azalea
      Properties Ltd. Regarding Post Closing PUDs (incorporated by reference to
      Exhibit 10.3 to the Partnership’s Form 8-K, as filed with the SEC on
      January 22, 2010).





10.4
            Side
      Letter Agreement, dated January 19, 2010, between RCWI, L.P. and Azalea
      Properties Ltd. Regarding Post Closing Properties/Title Defect Notice
      (incorporated by reference to Exhibit 10.4 to the Partnership’s Form 8-K,
      as filed with the SEC on January 22,
2010).





10.5
            Side
      Letter Agreement, dated January 19, 2010, between RCWI, L.P. and Azalea
      Properties Ltd. Regarding Third Party Consents (incorporated by reference
      to Exhibit 10.5 to the Partnership’s Form 8-K, as filed with the SEC on
      January 22, 2010).





10.6
            Purchase
      and Sale Agreement by and between Lett Oil & Gas, L.P., as seller and
      RCWI, L.P., as buyer dated as of June 23, 2010 (incorporated by reference
      to Exhibit 10.1 to the Partnership’s Form 8-K, as filed with the SEC on
      July 9, 2010).




10.7
              Assignment,
      Conveyance and Bill of Sale between Lett Oil & Gas, L.P. (“Assignor”)
      and Reef Oil & Gas Income and Development Fund III, L.P. (“Assignee”)
      executed June 30, 2010 and dated effective June 1, 2010 (incorporated by
      reference to Exhibit 10.2 to the Partnership’s Form 8-K, as filed with the
      SEC on July 9, 2010).
 10.8
                $50,000,000
      Credit Agreement dated June 30, 2010 between Reef Oil & Gas Income and
      Development Fund III, L.P., as borrower and Texas Capital Bank, N.A., as
      lender (incorporated by reference to Exhibit 10.3 to the Partnership’s
      Form 8-K, as filed with the SEC on July 9,
  2010).
 10.9
                  Form
      of Security Agreement (General) dated June 30, 2010 by Reef Oil & Gas
      Income and Development Fund III, L.P., in favor of Texas Capital Bank,
      N.A., as lender (incorporated by reference to Exhibit 10.4 to the
      Partnership’s Form 8-K, as filed with the SEC on July 9,
      2010).
 10.10
                    Promissory
      Note in the principal amount of up to $50,000,000 dated June 30, 2010
      payable to Texas Capital Bank, N.A. (incorporated by reference to Exhibit
      10.5 to the Partnership’s Form 8-K, as filed with the SEC on July 9,
      2010).





31.1
            Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.*





31.2
            Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.*





32.1
            Certification
      of the Principal Executive Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*





32.2
            Certification
      of the Principal Financial Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*


*Filed
herewith





20