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
  1934For
      the Quarterly Period Ended September 30,
2010




or


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




Texas
              (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 oNo 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 x





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


Yes oNox





As of
November 15, 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 INFORMATIONITEM
      1.
              Financial
      Statements (Unaudited)
              
              1Condensed
      Balance Sheets
              
              1Condensed
      Statements of Operations
              
              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 INFORMATIONITEM
      1.
              Legal
      Proceedings
              
              16ITEM
      1A.
              Risk
      Factors
              
              16ITEM
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              16ITEM
      3.
              Default
      Upon Senior Securities
              
              16ITEM
      4.
              (Removed
      and Reserved)
              
              16ITEM
      5.
              Other
      Information
              
              16ITEM
      6.
              Exhibits
              
              17Signatures
              
              18
  i


PART
I - FINANCIAL INFORMATION





Item
1. Financial Statements





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


Condensed
Balance Sheets





September
      30,
              2010
            
            
            December
      31,
              2009Assets
            
            (unaudited)Current
      assets:Cash
      and cash equivalents
            
            $
            404,499
            
            
            $
            18,243,848Accounts
      receivable
            
            
            959,873
            
            
            
            736,161Accounts
      receivable from affiliates
            
            
            628,738
            
            
            
            1,500,000Prepaid
      expenses and other current assets
            
            
            527
            
            
            
            —Total
      current assets
            
            
            1,993,637
            
            
            
            20,480,009Oil
      and gas properties, full cost method of accounting:Proved
      properties, net of accumulated depletion of $6,442,730 and
      $1,207,373
            
            
            16,013,474
            
            
            
            2,364,672Unproved
      properties
            
            
            55,391,974
            
            
            
            52,010,728Net
      oil and gas properties
            
            
            71,405,448
            
            
            
            54,375,400Total
      assets
            
            $
            73,399,085
            
            
            $
            74,855,409Liabilities
      and partnership equityCurrent
      liabilities:Accounts
      payable
            
            $
            20,909
            
            
            $
            571,154Accounts
      payable to affiliates
            
            
            —
            
            
            
            223,515Accrued
      liabilities
            
            
            13,521
            
            
            
            245,090Total
      current liabilities
            
            
            34,430
            
            
            
            1,039,759Long-term
      liabilities:Note
      payable (Note 4)
            
            
            5,000,000
            
            
            
            —Asset
      retirement obligation
            
            
            1,045,884
            
            
            
            248,912Total
      long-term liabilities
            
            
            6,045,884
            
            
            
            248,912Partnership
      equityGeneral
      partners
            
            
            37,236,252
            
            
            
            40,609,693Limited
      partners
            
            
            29,526,107
            
            
            
            32,253,928Managing
      general partner
            
            
            556,412
            
            
            
            703,117Partnership
      equity
            
            
            67,318,771
            
            
            
            73,566,738Total
      liabilities and partnership equity
            
            $
            73,399,085
            
            
            $
            74,855,409




See
accompanying notes to condensed financial statements (unaudited).




1





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


Condensed
Statements of Operations


(Unaudited)





For
      the three months
              ended
              September
      30,
            
            
            For
      the nine months
              ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Revenues
            
            $
            1,591,310
            
            
            $
            484,301
            
            
            $
            4,294,616
            
            
            $
            1,254,349Costs
      and expenses:Lease
      operating expenses
            
            
            767,167
            
            
            
            304,295
            
            
            
            1,995,665
            
            
            
            903,219Production
      taxes
            
            
            104,031
            
            
            
            22,926
            
            
            
            270,016
            
            
            
            59,460Depreciation,
      depletion and amortization
            
            
            560,987
            
            
            
            75,020
            
            
            
            1,710,675
            
            
            
            255,933Accretion
      of asset retirement obligation
            
            
            17,043
            
            
            
            4,610
            
            
            
            49,834
            
            
            
            13,830Property
      impairment
            
            
            —
            
            
            
            —
            
            
            
            3,524,682
            
            
            
            441,542General
      and administrative
            
            
            444,414
            
            
            
            235,021
            
            
            
            2,236,437
            
            
            
            535,663Total
      costs and expenses
            
            
            1,893,642
            
            
            
            641,872
            
            
            
            9,787,309
            
            
            
            2,209,647Loss
      from operations
            
            
            (302,332
            )
            
            
            (157,571
            )
            
            
            (5,492,693
            )
            
            
            (955,298
            )Other
      income (expense):Miscellaneous
      expense
            
            
            (16,573
            )
            
            
            —
            
            
            
            (7,559
            )
            
            
            —Interest
      income
            
            
            269
            
            
            
            12,944
            
            
            
            3,439
            
            
            
            131,716Interest
      expense
            
            
            (64,583
            )
            
            
            —
            
            
            
            (64,583
            )
            
            
            —Total
      other income (expense)
            
            
            (80,887
            )
            
            
            12,944
            
            
            
            (68,703
            )
            
            
            131,716Net
      loss
            
            $
            (383,219
            )
            
            $
            (144,627
            )
            
            $
            (5,561,396
            )
            
            $
            (823,582
            )Net
      loss per general partner unit
            
            $
            (449.17
            )
            
            $
            (153.92
            )
            
            $
            (6,169.10
            )
            
            $
            (905.54
            )Net
      loss per limited partner unit
            
            $
            (449.17
            )
            
            $
            (153.92
            )
            
            $
            (6,169.10
            )
            
            $
            (905.54
            )Net
      income (loss) per managing general partner unit
            
            $
            1,744.65
            
            
            $
            (885.87
            )
            
            $
            (9,279.51
            )
            
            $
            (2,169.92
            )




See
accompanying notes to condensed financial statements (unaudited).




2




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


Condensed
Statements of Cash Flows


(Unaudited)




For
      the nine months ended
              September
      30,2010
            
            
            2009Operating
      ActivitiesNet
      loss
            
            $
            (5,561,396
            )
            
            $
            (823,582
            )Adjustments
      to reconcile net loss to net cashused
      in operating activities:Adjustments
      for non-cash transactions:Depreciation,
      depletion and amortization
            
            
            1,710,675
            
            
            
            255,933Property
      impairment
            
            
            3,524,682
            
            
            
            441,542Accretion
      of asset retirement obligation
            
            
            49,834
            
            
            
            13,830Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (659,102
            )
            
            
            20,175Accounts
      receivable from affiliates
            
            
            871,262
            
            
            
            509,300Prepaid
      expenses
            
            
            (527
            )
            
            
            507,640Accounts
      payable
            
            
            (550,245
            )
            
            
            (1,181,805
            )Accounts
      payable to affiliates
            
            
            (236,121
            )
            
            
            147,585Accrued
      liabilities
            
            
            (231,569
            )
            
            
            (2,652,935
            )Net
      cash used in operating activities
            
            
            (1,082,507
            )
            
            
            (2,762,317
            )Investing
      ActivitiesPurchase
      of oil and gas properties
            
            
            (18,124,415
            )
            
            
            (80,758
            )Property
      development
            
            
            (2,945,856
            )
            
            
            (11,373,771
            )Net
      cash used in investing activities
            
            
            (21,070,271
            )
            
            
            (11,454,529
            )Financing
      ActivitiesProceeds
      from note payable
            
            
            5,000,000
            
            
            
            —Partner
      distributions
            
            
            (686,571
            )
            
            
            (344,788
            )Net
      cash provided by (used) in financing activities
            
            
            4,313,429
            
            
            
            (344,788
            )Net
      decrease in cash and cash equivalents
            
            
            (17,839,349
            )
            
            
            (14,561,634
            )Cash
      and cash equivalents at beginning of period
            
            
            18,243,848
            
            
            
            34,549,487Cash
      and cash equivalents at end of period
            
            $
            404,499
            
            
            $
            19,987,853Supplemental
      cash flow disclosure:Cash
      paid for interest expense on note payable
            
            $
            43,750
            
            
            $
            —Supplemental
      disclosure of non-cash investing transactions:Property
      additions included in accounts payable
            
            $
            —
            
            
            $
            (612,436
            )Property
      additions included in accounts payable to affiliates
            
            $
            (12,606
            )
            
            $
            (137,055
            )Property
      additions included in accrued liabilities
            
            $
            —
            
            
            $
            (168,360
            )Additions
      to property and asset retirement obligation
            
            $
            747,138
            
            
            $
            —Property
      additions related to Davric default
            
            $
            435,390
            
            
            $
            —




See
accompanying notes to condensed financial statements (unaudited).




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 nine 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 nine month
periods ended September 30, 2010.  Revenues related to the Azalea
Acquired Properties were $704,370 and $2,217,260 for the three and nine month
periods ended September 30, 2010.  The Partnership recorded net income
related to the Azalea Acquired Properties of $53,556 for the three month period
ended September 30, 2010 and net loss of $2,018,143 for the nine month period
ended September 30, 2010.  The Partnership recorded impairment expense
of $0 and $1,452,475 related to the Azalea Acquired Properties during the three
and nine month periods ended September 30, 2010.  The Partnership also
recorded $0 and $730,063 of acquisition related costs during the three and nine
month periods ended September 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 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.  Revenues and expenses subsequent to June 2010 related to
the Lett Acquired Properties are included in the unaudited condensed statements
of operations for the three and nine month periods ended September 30,
2010.  Revenues related to the Lett Acquired Properties were $296,401
for the three and nine month periods ended September 30, 2010.  Net
loss related to the Lett Acquired Properties was $18,764 and $2,183,097 for the
three and nine month periods ended September 30, 2010.  The
Partnership recorded impairment expense of $0 and $2,072,204 related to the Lett
Acquired Properties during the three and nine month periods ended September 30,
2010.  The Partnership also recorded $61,037 of acquisition related
costs during the three and nine month periods ended September 30, 2010, as
general and administrative expenses on its condensed statements of
operations.





The
following unaudited pro forma condensed consolidated statements of revenue
and earnings for the three and nine month periods ended September 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 nine month period ended September 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





For
      the Three Months Ended September 30,
            
            2010
            
            
            2009Revenues
            
            $
            1,591,310
            
            
            $
            1,358,021Net
      income (loss)
            
            $
            (383,219
            )
            
            $
            90,163Net
      income (loss) per general partner unit
            
            $
            (449.17
            )
            
            $
            42.50Net
      income (loss) per limited partner unit
            
            $
            (449.17
            )
            
            $
            42.50Net
      income per managing general partner unit
            
            $
            1,744.65
            
            
            $
            5,844.09For
      the Nine Months Ended September 30,
            
            2010
            
            
            2009Revenues
            
            $
            4,714,808
            
            
            $
            3,524,034Net
      loss
            
            $
            (1,514,325
            )
            
            $
            (5,622,123
            )Net
      loss per general partner unit
            
            $
            (1,674.70
            )
            
            $
            (6,455.65
            )Net
      loss per limited partner unit
            
            $
            (1,674.70
            )
            
            $
            (6,455.65
            )Net
      income (loss) per managing general partner unit
            
            $
            (3,031.51
            )
            
            $
            7,859.51




5




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.





In
applying the full cost method at September 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 nine month periods ended September 30, 2010, the Partnership
recognized property impairment expense of proved properties totaling $0 and
$3,524,682, respectively. During the three and nine month periods ended
September 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 nine month periods ended September 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 September 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.




6





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.





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
nine months ended September 30, 2010 and the year ended December 31,
2009.





Nine
      months
              ended
              September
      30,
              2010
            
            
            Year
      ended
              December
      31,
              2009Beginning
      asset retirement obligation
            
            $
            248,912
            
            
            $
            230,472Additions
      related to acquisitions
            
            
            747,138
            
            
            
            —Accretion
      expense
            
            
            49,834
            
            
            
            18,440Ending
      asset retirement obligation
            
            $
            1,045,884
            
            
            $
            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.





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.




7





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





•
            
            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.




8




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
September 30, 2010, the Partnership was not in compliance with certain
non-financial covenants under the Credit Agreement, for which it obtained a
waiver from the lender.





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.  RELP also receives drilling compensation in an amount
equal to 5% of the total well costs paid by the Partnership for non-operated
wells included in the Azalea Acquired Properties and the Lett Acquired
Properties. All of the wells included in these two purchases are non-operated.
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 nine months ended September 30, 2010, RELP
received $216,991 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.





RELP
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 nine
month periods ended September 30, 2010, RELP received $224,220 and $672,660,
respectively, in administrative fees. During the three and nine month periods
ended September 30, 2009, RELP received $224,220 and $672,660, respectively, in
administrative fees.  During the three and nine month periods ended
September 30, 2009, $215,268 and $583,442 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. RELP’s general and
administrative costs include all customary and routine expenses, accounting,
office rent, telephone, secretarial, salaries and other incidental expenses
incurred by RELP or its affiliates that are necessary to the conduct of the
Partnership's business, whether generated by RELP, its affiliates or by third
parties, but excluding direct costs and operating costs.





Beginning
on January 1, 2010, RELP began processing joint interest billings and revenues
on behalf of the Partnership. At September 30, 2010, RELP owed the Partnership
$148,737 for net revenues processed in excess of joint interest and technical
and administrative services charges. The cash associated with net revenues
processed by RELP is normally received by RELP from oil and gas purchasers 30-60
days after the end of the month to which the revenues pertain.  Prior
to 2010, the Partnership processed its own joint interest billings and
revenues.





6.
Commitments and Contingencies





The
Partnership is not currently involved in any legal proceedings.




9





7.  Partnership
Equity





Information
regarding the number of units outstanding and the net income (loss) per type of
Partnership unit for the three and nine month periods ended September 30, 2010
is detailed below:





For the three months ended September
30, 2010





Type of Unit
            
            Number
      of Units
            
            
            Net
      income (loss)
            
            
            Net
      income (loss) per unitManaging
      general partner
            
            
            8.9697
            
            
            $
            15,648
            
            
            $
            1,744.65General
      partner
            
            
            490.9827
            
            
            
            (220,537
            )
            
            $
            (449.17
            )Limited
      partner
            
            
            397.0172
            
            
            
            (178,330
            )
            
            $
            (449.17
            )Total
            
            
            896.9696
            
            
            $
            (383,219
            )





For the nine months ended September 30,
2010





Type of Unit
            
            Number
      of Units
            
            
            Net
      loss
            
            
            Net
      loss per unitManaging
      general partner
            
            
            8.9697
            
            
            $
            (83,235
            )
            
            $
            (9,279.51
            )General
      partner
            
            
            490.9827
            
            
            
            (3,028,922
            )
            
            $
            (6,169.10
            )Limited
      partner
            
            
            397.0172
            
            
            
            (2,449,239
            )
            
            $
            (6,169.10
            )Total
            
            
            896.9696
            
            
            $
            (5,561,396
            )




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.




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.




10





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”).





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.





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.




11





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  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.





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





Leasehold
      Costs
            
            
            Drilling
      and Facilities Costs
            
            
            Workovers
            
            
            Total
      CostsPurchase
      Existing Wells
            
            $
            35,964,401
            
            
            $
            
            
            
            $
            
            
            
            $
            35,964,401New
      WellsProducing
      Wells
            
            
            12,023
            
            
            
            27,176,562
            
            
            
            
            
            
            
            27,188,585Waterflood
      Injector Wells
            
            
            
            
            
            
            5,149,620
            
            
            
            
            
            
            
            5,149,620Facilities
            
            
            
            
            
            
            1,801,009
            
            
            
            
            
            
            
            1,801,009Existing
      Wells
            
            
            
            
            
            
            
            
            
            
            6,784,059
            
            
            
            6,784,059Total
            
            $
            35,976,424
            
            
            $
            34,127,191
            
            
            $
            6,784,059
            
            
            $
            76,887,674




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.  Non-Reef partners purchased
490.9827 general partner units and 397.0172 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 $56,258,401 on property acquisitions and development
costs related to the Slaughter Dean Project, $14,586,513 on property
acquisitions and development related to the Azalea Properties, and $6,042,760
related to the Lett Acquired Properties.




12





The
Partnership has working capital of $1,959,207 at September 30, 2010. The
Partnership has expended $76,887,674 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
              September
      30,
            
            
            For
      the nine months
              ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Sales
      volumes:Oil
      (Barrels)
            
            
            18,730
            
            
            
            8,339
            
            
            
            50,934
            
            
            
            27,360Natural
      gas (Mcf)
            
            
            79,556
            
            
            
            2,421
            
            
            
            175,132
            
            
            
            6,643Average
      sales prices received:Oil
      (Barrels)
            
            $
            67.81
            
            
            $
            57.64
            
            
            $
            68.03
            
            
            $
            45.50Natural
      gas (Mcf)
            
            $
            4.04
            
            
            $
            1.51
            
            
            $
            4.74
            
            
            $
            1.43





Overall,
sales volumes increased during the third quarter of 2010 compared to the third
quarter of 2009, due primarily to the Partnership’s purchase in January 2010 of
the Azalea Acquired Properties and the Partnership’s purchase in June 2010 of
the Lett Acquired Properties.  The Azalea Acquired Properties and the
Lett Acquired Properties accounted for oil volumes of 10,314 Bbl and gas volumes
of 77,732 Mcf during the third quarter of 2010.    Volumes
from the Slaughter Dean Field declined slightly from 2009 levels due to the
conversion of over twenty previously productive wells to water injection wells
during 2009. Average crude oil and natural gas sales prices rose significantly
during the comparable periods.  Average oil prices increased by 17.6%
and average gas prices increased by 167.5% during the three months ended
September 30, 2010 compared to the three months ended September 30,
2009.  The large increase in gas prices is primarily due to the fact
that because of its lower quality, Slaughter Dean gas is sold at a heavily
discounted price, while gas from the newly acquired Azalea and Lett properties
is sold at a higher price.





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 September 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 September 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.




13





The
estimated net proved crude oil and natural gas reserves as of September 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)September
      30, 2010
            
            
            707,161
            
            
            
            1,527,998September
      30, 2009
            
            
            282,884
            
            
            
            211,666





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





The
Partnership had a net loss of $383,219 for the three months ended September 30,
2010, compared to a net loss of $144,627 for the three months ended September
30, 2009.





Partnership
revenues totaled $1,591,310 for the three months ended September 30, 2010
compared to $484,301 for the comparable period in 2009.  Volumes
increased due primarily to the Partnership’s purchase in January 2010 of the
Azalea Acquired Properties and the Partnership’s purchase in June 2010 of the
Lett Acquired Properties.  The Azalea Acquired Properties and the Lett
Acquired Properties accounted for oil volumes of 10,314 Bbl and gas volumes of
77,732 Mcf during the third quarter of 2010.   In addition,
average crude oil and natural gas sales prices rose significantly during the
comparable periods.  Average oil prices increased by 17.6% and average
gas prices increased by 167.5% during the three months ended September 30, 2010
compared to the three months ended September 30, 2009.  The large
increase in gas prices is primarily due to the fact that because of its lower
quality, Slaughter Dean gas is sold at a heavily discounted price, while gas
from the newly acquired Azalea and Lett properties is sold at a higher
price.





Lease
operating expenses increased from $304,295 for the three months ended September
30, 2009 to $767,167 for the three months ended September 30, 2010,
and production taxes increased from $22,926 for the three months ended
September 30, 2009 to $104,031 for the three months ended September 30, 2010.
These increases are primarily due to the Partnership’s purchases of the Azalea
Properties in January 2010 and the Lett Properties in June 2010, as well as the
Partnership’s assumption of Davric’s 7% working interest in Slaughter
Dean.





Depreciation,
depletion and amortization increased from $75,020 for the three months ended
September 30, 2009 to $560,987 for the three months ended September 30, 2010.
The Azalea and Lett purchases have resulted in increased production levels and a
higher depletion rate, as well as a higher property depletable
basis.





General
and administrative costs incurred during the three month periods ended September
30, 2010 and 2009 increased from $235,021 in 2009 to $444,414 in 2010. Overhead
charges from RELP charged to general and administrative expense increased by
approximately $215,000.  During the third quarter of 2009, a portion
of RELP overhead charges were capitalized due to the capital expenditures
program in the Slaughter Dean Field.  In addition, acquisition costs
related to the Lett Properties increased 2010 expenses by approximately
$61,000.  These increases were partially offset by decreases in legal
fees related to financial reporting and direct costs charged to the
Partnership.





Total
other income and expense for the three month periods ended September 30, 2010
and 2009 decreased from income of $12,944 in 2009 to expense of $80,887 in
2010.  The decrease is primarily due to interest expense related to
the Partnership’s borrowings under the Credit Agreement described in Note 4 to
the financial statements.




14





Nine
months ended September 30, 2010 compared to the nine months ended September 30,
2009





The
Partnership had a net loss of $5,561,396 for the nine months ended September 30,
2010, compared to a net loss of $823,582 for the nine months ended September 30,
2009.





Partnership
revenues totaled $4,294,616 for the nine months ended September 30, 2010
compared to $1,254,349 for the comparable period in 2009.  Volumes
increased due primarily to the Partnership’s purchase in January 2010 of the
Azalea Acquired Properties and the Partnership’s purchase in June 2010 of the
Lett Acquired Properties.  These purchases resulted in oil volumes of
24,024 Bbl and gas volumes of 171,170 Mcf during the first nine months of
2010.  In addition, average crude oil and natural gas sales prices
rose significantly during the comparable periods.  Average oil prices
increased by 49.5% and average gas prices increased by 231.5% during the nine
months ended September 30, 2010 compared to the nine months ended September 30,
2009.  The large increase in gas prices is primarily due to the fact
that because of its lower quality, Slaughter Dean gas is sold at a heavily
discounted price, while gas from the newly acquired Azalea and Lett properties
is sold at a higher price.





Lease
operating expenses increased from $903,219 for the nine months ended September
30, 2009 to $1,995,665 for the nine months ended September 30, 2010, and
production taxes increased from $59,460 for the nine months ended September 30,
2009 to $270,016 for the nine months ended September 30, 2010.  These
increases are primarily due to the Partnership’s purchases of the Azalea
Acquired Properties in January 2010 and the Lett Acquired Properties in June
2010, as well as the Partnership’s assumption of Davric’s 7% working interest in
Slaughter Dean.





Depreciation,
depletion and amortization increased from $255,933 for the nine months ended
September 30, 2009 to $1,710,675 for the nine months ended September 30, 2010.
The Azalea and Lett purchases have resulted in increased production levels and a
higher depletion rate, as well as a higher property depletable
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. The total impairment of $3,534,682 during
2010 is primarily related to the Azalea Acquired Properties and Lett Acquired
Properties, for which the quarterly ceiling test is calculated using 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%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 nine month periods ended September
30, 2010 and 2009 increased from $535,663 in 2009 to $2,236,437 in 2010. This
increase is primarily due to acquisition costs related to the Azalea Acquired
Properties and the Lett Acquired Properties of approximately $791,000, as well
as increased overhead.  Overhead charges from RELP charged to general
and administrative expense increased by approximately
$595,000.  During the first nine months of 2009, a portion of RELP
overhead charges were capitalized due to the capital expenditures program in the
Slaughter Dean Field.  Remaining increases relate to the timing of
audit and accounting fees (approximately $79,000), direct costs charged to the
Partnership  (approximately $160,000), and financing charges incurred
in connection with the note payable  related to the financing of the
Lett Acquired Properties (approximately $92,000).





Total
other income and expense for the nine month periods ended September 30, 2010 and
2009 decreased from interest income of $131,716 in 2009 to interest expense of
$68,703 in 2010.  Interest income decreased from $131,716 to $3,439
due to the fact that the Partnership spent its remaining capital available
during 2010 to acquire the Azalea Acquired Properties and the Lett Acquired
Properties. In addition, the Partnership was charged interest expense of $64,583
during the third quarter of 2010 related to its borrowings under the Credit
Agreement for financing the acquisition of the Lett Acquired Properties, as
described in Note 4 to the financial statements.




15





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 September 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.





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.




16





Item
6.  Exhibits





Exhibits10.1
              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
  17




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 partnerDated: November
      15, 2010
            By:
            /s/
      Michael J. MauceliMichael
      J. Mauceli
              Manager
      and Member
              (Principal
      Executive Officer)Dated: November
      15, 2010
            By:
            /s/
      Daniel C. SibleyDaniel
      C. Sibley
              Chief
      Financial Officer and General Counsel of
              Reef
      Exploration, L.P.
              (Principal
      Financial and Accounting Officer)




18




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





19