A Texas court ruling classifying drilling for oil and gas as a manufacturing process would cost the state up to $4.4 billion in revenue, its comptroller has warned.
In a hearing in Austin last week, the Travis County District Judge said he would side with Southwest Royalties Inc. in its dispute with the comptroller over whether metal pipes and other equipment used in creating oil and gas wells should be exempt from state sales tax. The judge hasn't yet issued a written decision.
Southwest, which filed the suit in 2009, argued that bringing oil and gas out of the ground fundamentally changes it and so should be considered a manufacturing process, according to court filings, and thus subject to an existing sales-tax exemption for manufacturing equipment.
The state argued that the pipes used for well casings don't change the oil or gas, and that Texas lawmakers didn't intend for energy producers to be classified as manufacturers.
Southwest is seeking $960 million in tax rebates, according to Tax Lawyers in Corpus Christi. The comptroller's office puts the eventual cost of the ruling much higher. Exempting the extraction equipment of all the oil and gas companies in the state from the sales tax would require the state to rebate $2 billion plus interest for the past four years and other time periods, and cost it $2.4 billion in future tax revenues through 2017, according to the analysis.
The decision would change 50 years of tax policy.
Southwest Royalties is a wholly owned subsidiary of Clayton Williams Energy Inc., of Midland, which is run by onetime Republican gubernatorial candidate Clayton Williams. A spokesman for Clayton Williams Energy declined to comment.
The executive vice president of the Texas Oil and Gas Association, said in a statement that many in the industry were surprised by the ruling, and stressed that the trade group didn't take part in the case.
There may be potential implications of this decision to the companies, the state of Texas and local taxing entities.
The trade group said the state's oil-and-gas industry paid $7.8 billion in state and local taxes in 2011.
When Texas lawmakers last met, in early 2011, the state faced a $27 billion deficit for the current two-year fiscal period, which it closed through deep cuts in services, including $4 billion in education spending, and some accounting adjustments. In the past year, the state's fiscal outlook has improved, along with the rest of the U.S. economy, but Texas is expected to face more budget cuts when the legislature meets again next year.
The final impact of the ruling may not be known for some time. The judge asked lawyers for Southwest to write up a draft ruling that he would circulate among the parties for review.
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