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 March 31, 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 x    No o





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 o
Accelerated filer o
Non-accelerated filer o
Smaller 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  o    No x


As of May 24, 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 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
9ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
13ITEM 4T.
Controls and Procedures
13PART II -- OTHER INFORMATION
14ITEM 1.
Legal Proceedings
14ITEM 1A.
Risk Factors
14ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
14ITEM 3.
Default Upon Senior Securities
14ITEM 4.
(Removed and Reserved)
14ITEM 5.
Other Information
14ITEM 6.
Exhibits
14Signatures

15





i


PART I - FINANCIAL INFORMATION





Item 1. Financial Statements





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


Condensed Balance Sheets





March 31,

2010


December 31,

2009(unaudited)AssetsCurrent assets:Cash and cash equivalents

$
3,147,349


$
18,243,848Accounts receivable


1,464,680



736,161Accounts receivable from affiliates


1,299,421



1,500,000Total current assets


5,911,450



20,480,009Oil and gas properties, full cost method of accounting:Proved properties, net of accumulated depletion of $3,253,704 and $1,207,373


11,752,386



2,364,672Unproved properties


54,853,482



52,010,728Net oil and gas properties


66,605,868



54,375,400Total assets

$
72,517,318


$
74,855,409Liabilities and partnership equityCurrent liabilities:Accounts payable

$
74,398


$
571,154Accounts payable to affiliates


437,221



223,515Accrued liabilities


2,498



245,090Total current liabilities


514,117



1,039,759Long-term liabilities:Asset retirement obligation


993,470



248,912Total long-term liabilities


993,470



248,912Partnership equityGeneral partners


39,233,638



40,609,693Limited partners


31,141,227



32,253,928Managing general partner


634,866



703,117Partnership equity


71,009,731



73,566,738Total liabilities and partnership equity

$
72,517,318


$
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

March 31 ,2010


2009Revenues

$
1,257,224


$
328,120Costs and expenses:Lease operating expenses


421,636



274,498Production taxes


75,982



15,622Depreciation, depletion and amortization


593,856



103,373Accretion of asset retirement obligation


16,013



4,610Property impairment


1,452,475



441,542General and administrative


1,136,298



93,935Total costs and expenses


3,696,260



933,580Loss from operations


(2,439,036
)


(605,460
)Other income:Interest income


1,389



84,575Total other income


1,389



84,575Net loss

$
(2,437,647
)

$
(520,885
)Net loss per general partner unit

$
(2,675.38
)

$
(583.94
)Net loss per limited partner unit

$
(2,675.38
)

$
(583.94
)Net loss per managing general partner unit

$
(6,901.77
)

$
(261.42
)





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 three months ended

March 31,2010


2009Operating ActivitiesNet loss

$
(2,437,647
)

$
(520,885
)Adjustments to reconcile net loss to net cash

used in operating activities:Adjustments for non-cash transactions:Depreciation, depletion and amortization


593,856



103,373Property impairment


1,452,475



441,542Accretion of asset retirement obligation


16,013



4,610Changes in operating assets and liabilities:Accounts receivable


(728,519
)


(543,001
)Accounts receivable from affiliates


200,579



(1,137,709
)Prepaid expenses


--



507,640Accounts payable


(496,756
)


(470,326
)Accounts payable to affiliates


183,749



2,038,506Accrued liabilities


(242,592
)


(1,918,215
)Net cash used in operating activities


(1,458,842
)


(1,494,465
)Investing ActivitiesPurchase of oil and gas properties


(10,705,500
)


(80,758
)Property development


(2,812,797
)


(7,578,714
)Net cash used in investing activities


(13,518,297
)


(7,659,472
)Financing ActivitiesPartner distributions


(119,360
)


(120,519
)Net cash used in financing activities


(119,360
)


(120,519
)Net decrease in cash and cash equivalents


(15,096,499
)


(9,274,456
)Cash and cash equivalents at beginning of period


18,243,848



34,549,487Cash and cash equivalents at end of period

$
3,147,349


$
25,275,031Supplemental disclosure of non-cash investing transactions:Property additions included in accounts payable to affiliates

$
(29,957
)

$
(139,733
)Additions to property and asset retirement obligation

$
728,545


$
--





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 three 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 approximately 61% of the working interests initially acquired by RCWI from Azalea Properties for a purchase price of approximately $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 (“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 Acquired Properties are included in the unaudited condensed statement of operations for the three months ended March 31, 2010.  Revenues related to the Acquired Properties were $798,798, and net loss related to the Acquired Properties was $2,065,540 for the three months ended March 31, 2010.  The Partnership recorded impairment expense of $1,452,475 related to the Acquired Properties during the three months ended March 31, 2010.  The Partnership recorded $730,063 of acquisition related costs during the three months ended March 31, 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 months ended March 31, 2010 and 2009 are presented as if the acquisition 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 Acquired Properties had occurred at the dates presented or of our future financial position or results of operations. 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.


4





Unaudited Pro Form Condensed Consolidated Statements of Revenues and Earnings





As of and For the Three Months Ended March 31,

2010


2009Revenues

$
1,257,224


$
823,200Net loss

$
(2,437,647
)

$
(3,992,734
)Net loss per general partner unit

$
(2,675.38
)

$
(4,489.93
)Net loss per limited partner unit

$
(2,675.38
)

$
(4,489.93
)Net income (loss) per managing general partner unit

$
(6,901.77
)

$
(633.33
)





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 March 31, 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 month periods ended March 31, 2010 and 2009, the Partnership recognized property impairment expense of proved properties totaling $1,452,475 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 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 month periods ended March 31, 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 March 31, 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.





5


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.





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 three months ended March 31, 2010 and the year ended December 31, 2009.








Three months ended

March 31, 2010


Year Ended

December 31, 2009Beginning asset retirement obligation

$
248,912


$
230,472Additions related to acquisition


728,545



--Accretion expense


16,013



18,440Ending asset retirement obligation

$
993,470


$
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 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 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.





6


Accounting Standards Codification





In June 2009, the FASB issued guidance on the accounting standards codification and the hierarchy of generally accepted accounting principles. The accounting standards codification is intended to be the source of authoritative US GAAP and reporting standards as issued by the FASB. Its primary purpose is to improve clarity and use of existing standards by grouping authoritative literature under common topics. The accounting standards codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Partnership now describes the authoritative guidance used within the footnotes but no longer uses numerical references. The accounting standards codification does not change or alter existing US GAAP, and there has been no expected impact on the Partnership’s financial position, results of operations or cash flows.





Fair Value Measurement of Liabilities





In August 2009, the FASB issued new guidance for the accounting for the fair value measurement of liabilities.  The new guidance provides clarification that in certain circumstances in which a quoted price in an active market for the identical liability is not available, a company is required to measure fair value using one or more of the following valuation techniques: the quoted price of the identical liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, and/or another valuation technique that is consistent with the principles of fair value measurements.  The new guidance is effective for interim and annual periods beginning after August 27, 2009.  The provisions of the new guidance did not have a material effect on the Partnership’s results of operations, financial position or liquidity.





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.





4. 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 appropriate or 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 three months ended March 31, 2010, RELP received $66,275 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.





7


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 months ended March 31, 2010 and 2009, Reef received $224,220 and $22,171, respectively, in administrative fees. Administrative fees 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 month periods ended March 31, 2010 and 2009, Reef and its affiliates have received $535,111 and $0, respectively, in reimbursement for such costs. 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.





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.





5. Commitments and Contingencies





The Partnership is not currently involved in any legal proceedings.





6.  Partnership Equity





Information regarding the number of units outstanding and the net income (loss) per type of Partnership unit for the three month periods ended March 31, 2010 and 2009 is detailed below:





For the three months ended March 31, 2010





Type of Unit

Number of

Units


Netloss


Net loss

per unitManaging general partner


8.9697


$
(61,907
)

$
(6,901.77
)General partner


490.9827



(1,313,567
)

$
(2,675.38
)Limited partner


397.0172



(1,062,173
)

$
(2,675.38
)Total


896.9696


$
(2,437,647
)





For the three months ended March 31, 2009





Type of Unit

Number of

Units


Net loss


Net loss

per unitManaging general partner


8.9697


$
(2,345
)

$
(261.42
)General partner


490.9827



(286,705
)

$
(583.94
)Limited partner


397.0172



(231,835
)

$
(583.94
)Total


896.9696


$
(520,885
)





8





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.





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 the 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 an 11% working interest in the Slaughter Dean Project from Davric Corporation.





9


The management of the operations and other business of the Partnership are the responsibility of Reef.  Reef Exploration, L.P. (“RELP”), an affiliate of Reef, serves as the operator of the Partnership’s interests in 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 Corporation (the “Davric Operating Agreement”).





On January 19, 2010, RCWI, L.P. (“RCWI”), an affiliate of Reef, 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 approximately 61% of the working interests initially acquired by RCWI from Azalea Properties for a purchase price of approximately $13,182,171 in cash subject to post-closing adjustments.  RCWI is also assigning portions of the acquired working interests to other Reef affiliates on the same terms.





The working interests in oil and gas properties acquired under the RCWI Agreement represented by leases 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.





At March 31, 2010, the Partnership recorded non-cash impairment expense of proved properties totaling approximately $1.45 million. This impairment expense represents the differential between the capitalized costs of proved properties, and the ceiling test value at March 31, 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%. This measure of discounted future net cash flows does not purport to present the fair value of our crude oil and natural gas reserves.





10


The table below summarizes Partnership expenditures for property purchases, development, and waterflood enhancement by type and classification of well as of March 31, 2010.





Leasehold

Costs


Drilling and

Facilities

Costs


Workovers


Total CostsPurchase Existing Wells

$
29,037,057


$
--


$
--


$
29,037,057New WellsProducing Wells


4,126



26,889,237



--



26,893,363Waterflood Injector Wells


--



5,149,620



--



5,149,620Facilities


--



1,721,975



--



1,721,975Existing Wells


--



--



6,115,647



6,115,647Total

$
29,041,183


$
33,760,832


$
6,115,647


$
68,917,662





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 $55,719,910 on property acquisitions and development costs related to the Slaughter Dean Project, and $13,192,012 on property acquisitions related to the Azalea Properties.





The Partnership had cash and accounts receivable of $5,911,450 and $20,480,009 at March 31, 2010 and December 31, 2009, respectively, which includes interest income and net revenues available for distribution to partners.  At March 31, 2010, the Partnership also had $511,619 of accounts payable and $2,498 of other current payables.  At December 31, 2009, the Partnership also had $794,669 of accounts payable and $245,090 of other current payables.





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.





11


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 March 31,2010
2009Sales volumes:Oil (Barrels)
13,517
9,974Natural gas (MCF)
92,970
1,488Average sales prices received:Oil (Barrels)
$75.94
$32.66Natural gas (MCF)
$2.48
$1.59





Overall, sales volumes increased during the first quarter of 2010 compared to the first quarter of 2009, due primarily to the Partnership’s purchase in January 2010 of the Azalea Properties.  The Azalea Properties accounted for oil volumes of 7,351 BBL and gas volumes of 92,098 MCF during the first quarter of 2010.  Oil volumes from the Slaughter Dean Field declined due to the conversion of over twenty previously productive wells 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 132.5% and average gas prices increased by 56.0% during the three months ended March 31, 2010 compared to the three months ended March 31, 2009.





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 March 31, 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 March 31, 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 March 31, 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)March 31, 2010
426,644
1,528,942March 31, 2009
299,028
216,708





Three months ended March 31, 2010 compared to the three months ended March 31, 2009





The Partnership had a net loss of $2,437,647 for the three months ended March 31, 2010, compared to a net loss of $520,885 for the three months ended March 31, 2009


Partnership revenues totaled $1,257,224 for the three months ended March 31, 2010 compared to $328,120 for the comparable period in 2009.  Volumes increased due primarily to the Partnership’s purchase in January 2010 of the Azalea Properties.  This purchase resulted in oil volumes of 7,351 BBL and gas volumes of 92,098 MCF during the first quarter of 2010.  In addition, average crude oil and natural gas sales prices rose significantly during the comparable periods.  Average oil prices increased by 132.5% and average gas prices increased by 56.0% during the three months ended March 31, 2010 compared to the three months ended March 31, 2009.





12


Lease operating expenses increased from $274,498 for the three months ended March 31, 2009 to $421,636 for the three months ended March 31, 2010.  This increase is primarily due to the Partnership’s purchase in January 2010 of the Azalea Properties.





Depreciation, depletion and amortization increased from $103,373 for the three months ended March 31, 2009 to $593,856 for the three months ended March 31, 2010, primarily due to increased production levels.  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 non-cash impairment expense of proved properties totaling approximately $1.45 million. This impairment expense represents the differential between the capitalized costs of proved properties, and the ceiling test value at March 31, 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%. 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 March 31, 2010 and 2009 increased from $93,935 in 2009 to $1,136,298 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 $46,000 related to financial reporting.  In addition, direct costs charged to the Partnership increased by approximately $46,000 and overhead charges from Reef increased by approximately $200,000.


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 March 31, 2010 that have materially affected, or are reasonably likely to materially affect, the Partnership’s internal control over financial reporting.





13


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.





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).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





14


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:     May 24, 2010
By:   /s/ Michael J. MauceliMichael J. MauceliManager and Member of the general partner ofReef Oil & Gas Partners, L.P.(Principal Executive Officer)Dated:     May 24, 2010
By:   /s/ Daniel C. SibleyDaniel C. SibleyChief Financial Officer and General Counsel ofReef Exploration, L.P.(Principal Financial and Accounting Officer)















15




















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).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


16