Investment in the Partnership involves a high degree of risk and is suitable only for persons of substantial financial means who have no need of liquidity in their investments. In addition to the other information set forth elsewhere in this Memorandum, the following factors relating to the Partnership should be carefully considered:

Oil and gas prices and OPEC

The oil and gas business is subject to changes in oil and gas prices, which are influenced by a multitude of regional, national and world factors. Agreements among members of the Organization of the Petroleum Exporting Countries (OPEC), including agreements to limit the amount of production, may also affect prices and the financial and operational performance for investors in the oil and gas business. Such fluctuations in oil and gas prices could have an adverse effect on the Partnership's future results of operations and financial condition.

Speculative Nature of Investment

The success of the Partnership will be dependent upon the ability of the General Partner to discover commercial quantities of oil and gas. There can be no assurance that the General Partner will be successful in discovering oil or gas reserves in commercial quantities, even with the aid of the latest technology and geology, which could have an adverse effect on the Partnership's future results of operations and financial condition. If the General Partner is successful in discovering commercial quantities of oil and gas, the success of the Partnership and the availability of cash to distribute to the Limited Partners will depend upon the Partnership's ability to operate and develop those properties. There can be no assurance that such operations and development activities will be successful. Production and Development Risks
Various factors over which the Partnership will have no control may affect the production of oil and gas, as well as the value of such production, from any property acquired by the Partnership. These factors include the forces of nature, price controls, federal and state laws and regulations, including income tax laws, international oil prices and development of other energy sources.

Development Risks

The wells included in the Partnership are not operated by the General Partner. Thus, the General Partner has little control over decision-making with respect to development, such as the timing of development of the wells and to what extent development of such wells will proceed. The General Partner's limited control over such decisions could have an adverse effect on the Partnership's investments. For example, if a dry hole is encountered in any phase of the development of a well, the planned projects for that area could change or even be terminated. Although the General Partner will have some input, it will not have the final decision-making authority with respect to development of the wells.

Drilling Risks

Drilling risks include, but are not limited to, the risk that no commercially productive oil or natural gas reservoirs will be encountered. The cost of drilling, completing and operating wells is often uncertain, and drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including unexpected drilling conditions, pressure or irregularities in formations, equipment failures or accidents, adverse weather conditions, other events of force majeure and shortages or delays in the delivery of equipment. In addition, the production from a particular well may be in such limited quantities that it is not considered an economical well and must be plugged. The Partnership's future drilling activities may not be successful and, if unsuccessful, such failure will have an adverse effect on the Partnership's future results of operations and financial condition.

Title to Properties

As with any real property, the title to a piece of property in which the Partnership holds an interest is subject to an extensive title search. However, title to such property still could be challenged in court for a number of reasons. Such challenges could include forgery, fraud, an heir being left out of a will or a document not being properly signed or properly prepared to cover all aspects of a sale or assignment. The Partnership's interest in property, including its interest in a producing well, could be subject to such challenges and therefore adversely affected.

Non-operated Properties

The Initial Investment Wells being offered in this Partnership are non-operated wells. "Non-operated wells" are those wells where the General Partner (i) does not have control over day-to-day decision making involved with such wells, (ii) is limited in what actions can be taken with respect to such wells, and (iii) does not have the final authority with respect to such wells. Furthermore, wells associated with the Development Prospects also may be non-operated wells. Although the General Partner strives to ensure that it invests in wells operated by prudent and resourceful operators, there can be no guaranty that the operators associated with the Partnership's wells will be such.

Oil and Gas on the Properties

Although producing wells already exist on the acreage surrounding the Initial Investment Wells, there can be no assurance that the Initial Investment Wells, the properties associated with the Development Prospects or any other interests that the General Partner may acquire will produce oil or gas in the quantities anticipated by the General Partner.


Although much of the initial risk of investment has already been borne by the General Partner in the drilling and completion of the Initial Investment Wells, the Partnership may operate in a highly competitive environment, particularly with respect to the Development Prospects. The Partnership could encounter competition from other oil and gas companies in all areas of its operations. Many of such competitors could be large, well-established companies with substantially larger operating staffs and greater capital resources than the Partnership's and could have been engaged in the energy business for a much longer time than the Partnership. The Partnership's success with the Development Prospects could be dependent upon its ability to consummate transactions in a highly competitive environment.

Government Regulation and Environmental Matters

The oil and gas business is regulated by certain local, state and federal laws and regulations relating to the exploration for, and the development, production, marketing, pricing, transportation and storage of, oil and natural gas. The Partnership's business is also subject to extensive and changing environmental and safety laws and regulations governing plugging and abandonment, the discharge of materials into the environment or otherwise relating to environmental protection. For example, some of the Initial Investment Wells are located in the city limits of Houston , Texas . Therefore, regulatory and environmental matters such as local Houston ordinances or the need to obtain special use and other city permits and the costs related to those matters could prevent the drilling of a particular well.

In addition, the Partnership is subject to changing and extensive tax laws, and the effect of newly enacted tax laws cannot be predicted. The implementation of new, or the modification of existing, laws or regulations could have a material adverse effect on the Partnership.

Tax Laws

No assurances can be given that current tax laws, rulings and regulations will not change during the life of the Partnership. Prospective Limited Partners should consult their tax advisors for further information about the tax consequences of purchasing an interest in the Partnership.

Project timing

A significant portion of the Partnership's future earnings is based on the start-up of a number of drilling projects in 2004 and 2005. If some of these projects are delayed or fail to mature, there could be a material adverse effect on the earnings figure, rate of return and return on investment. In addition, it could take longer for the Partners to reach Payout than as currently anticipated.

Distributions Are Not Guaranteed

The actual amount of monthly cash distributed to Partners may fluctuate depending on the sales price received for production, lease operating costs and amount of production. Operating expenses may be greater in some months than the actual amount of product sold, which would result in no cash distributions to the Partners.

Control by the General Partner

The General Partner will exercise control over the activities of the Partnership except as otherwise provided in the Partnership Agreement. Therefore, the Limited Partners have little opportunity for input in the activities of the Partnership and must rely on the judgment of the General Partner, who will perform duties on behalf of the Partnership, such as negotiating with mineral owners and oil and gas operators.

Financial Condition of the Operator

It is the intention of the Partnership to develop oil and gas properties that will not be operated by the General Partner. If any operator of the Partnership's oil and gas properties should experience financial difficulties or fail to pay for materials or services in a timely manner, such wells operated by any such operator could be subject to materialmen's and workmen's liens. In such event, the Partnership could incur costs in discharging such liens.

Indemnification of General Partner

Under the Partnership Agreement, the General Partner and its officers, directors, employees and affiliates are indemnified by the Partnership to the fullest extent permitted by law against any losses, costs, liabilities, damages and expenses any of them may incur in connection with the management of the Partnership, except that indemnification shall not apply to actions constituting willful misconduct or a breach of a provision of the Partnership Agreement, losses, costs, liabilities, damages and expenses any of them may incur in connection with the management of the fund.

Limited Transferability of Partnership Interest

Each Limited Partner will be required to represent that they are acquiring the interests in the Partnership for investment and not with a view to distribution or resale; that they understand that the Partnership interests are not readily transferable and in any event that they must bear the economic risk of investment for an indefinite time because the Partnership interests have not been registered under the Securities Act of 1933 nor applicable state securities laws and that the interests in the Partnership cannot be sold unless registered, or an exemption from registration is available. There will be no ready market for the interests in the Partnership, and a Limited Partner cannot expect to liquidate their investment in the Partnership on acceptable terms, if at all, in the event their circumstances would require liquidation. The Partnership Agreement prohibits a Limited Partner from transferring their interests in the Partnership to any person, except members of their immediate family, without the written consent of the General Partner. In addition, a transfer of interests may be substituted as a new Limited Partner only with the consent of the General Partner.

Potential Conflicts of Interest

Paragon Energy, Inc., the Management Team for the Partnership, and the General Partner, Paragon Energy GP, LLC, are Affiliates. Eric Kim , Manager of the General Partner, is also President of Paragon Energy, Inc. Paragon Energy, Inc. will share mineral interests with the Partnership in the Initial Investment Wells and perhaps in the Development Prospects. The Manager of the General Partner, Paragon Energy, Inc. and other Affiliates of the Partnership may engage in drilling and production activities for their own account or in conjunction with others whether or not they are competitive with the operations of the Partnership. They will not be under any obligation to offer or share any particular acquisition opportunities with the Partnership.

Tax Risks

The following is a brief summary of certain federal income tax consequences of an investment in the Partnership. It is based upon the Internal Revenue Code of 1986, as the same may be amended from time to time (the "Code"), the Income Tax Regulations promulgated under the Code (the "Regulations") and rulings and procedures of the Internal Revenue Service (the "IRS" or the "Service") and other authorities. There can be no assurance that any of such authorities will not be changed in the future. This summary is primarily directed at investors who are individuals and United States citizens. The summary is qualified by the more detailed discussion under "Federal Income Tax Consequences." Counsel has not opined on the federal income tax matters discussed herein.

Limited Tax Benefits

The Partnership will be formed for the purpose of generating income through the acquisition, exploration and development of Working Interests in oil and gas properties. It is expected that the Partnership will recognize deductions for intangible drilling and development costs and depletion and depreciation deductions that may be viewed by some persons as federal income tax benefits. However, the Partnership will also have to capitalize a number of expenditures, including organization and syndication costs. Potential investors should recognize that the Partnership is not organized to provide investors with tax benefits but rather to engage in the business of exploring for and developing oil and gas.

Limitation on Losses, Including Passive Activities

A Partner will be subject to a number of limitations on deducting losses from the Partnership. First, the Partner may not deduct any losses that are in excess of the Partner's tax basis. Second, the Partner may not deduct any amounts that are not considered to be "at risk." See "Federal Income Tax Consequences-General Features of Partnership Taxation-Limitations on Deduction of Losses-At-Risk Limitation." Finally, any losses are limited by the passive activity rules.

Audit of Partnerships

The IRS may audit the federal income tax returns filed by the Partnership. If such an audit occurs, the General Partner, as the tax matters partner, will be primarily responsible for the decisions regarding the audit and potential administrative and judicial proceedings resulting therefrom. An audit of the Partnership's returns may result in audits of the individual returns of the Partners, which could lead to adjustments to items that are unrelated to the Partnership.

Allocations of Profit and Loss

Income and loss of the Partnership's deductions generally shall be allocated among the Partners in accordance with their Sharing Ratios, which means 99% as to the Limited Partners and 1% as to the General Partner. No assurance can be given that the IRS will not challenge the allocations of Partnership income and loss. See "Federal Income Tax Consequences-General Features of Partnership Taxation-Tax Allocations."

Relationship between Income and Distributions

A Partner will be required to take into account their allocable share of the Partnership's income even if they receive no cash distributions from the Partnership. Therefore, a Partner may be required to recognize taxable income in excess of their share of cash distributions.

Recognition of Gain

A Partner may be required to recognize gain, under certain circumstances, if the Partner receives a distribution from the Partnership in excess of his tax basis. See "Federal Income Tax Consequences-General Features of Partnership Taxation-Taxation of Partners." A Partner may also be required to recognize gain if he transfers or sells his Units. See "Federal Income Tax Consequences-Sale of Units-Recognition of Gain or Loss."

Alternative Minimum Tax

Individuals subject to the alternative minimum tax may have significant tax preference due to the expense of Intangible Drilling Costs, which is defined below under "Tax Risk." This may affect the after-tax economic benefit of the Units. See "Federal Income Tax Consequences-Other Tax Consequences-Alternative Minimum Tax."

State and Local Taxes

A Limited Partner may incur tax liabilities and be required to file income tax returns under state and/or local income tax laws of certain jurisdictions in which the Partnership will operate, as well as in the jurisdiction of the Limited Partner's domicile. Such laws vary from one locale to another, and like the federal income tax laws, are both complex and subject to change. Each investor is urged to consult their own tax advisor concerning state and local tax matters.

Tax Shelter Registration

Although an investment in the Partnership may generate certain tax benefits, the Partnership should not be considered a "tax shelter" as that term is commonly understood. Nevertheless, because the Partnership meets the definition of "tax shelter" for federal tax law purposes, the General Partner will be required to register the Partnership as a tax shelter by obtaining a registration number for the Partnership. ISSUANCE OF A REGISTRATION NUMBER DOES NOT INDICATE THAT THIS INVESTMENT OR THE CLAIMED TAX BENEFITS HAVE BEEN REVIEWED, EXAMINED OR APPROVED BY THE INTERNAL REVENUE SERVICE. The registration number will be furnished to each investor, who must include the number on his or her individual federal income tax return and must furnish the number and certain other information to any transferee of his or her Partnership interest. The General Partner also must maintain and make available to the Service, on request, a list of investors in the Partnership. See "Federal Income Tax Consequences - Administrative Matters - Tax Shelter Registration."