A district court judge in Texas has reversed his earlier ruling that oil and natural gas equipment used “below ground” should be exempt from state sales taxes on extraction equipment.

In a judgment signed April 30, Travis County District Court Judge John Dietz said Southwest Royalties Inc. had not proven that oil and gas production equipment qualifies for the state’s tax exemption on manufacturing equipment, Texas Tax Code Section 151.318(a)(2).

“It is undisputed that a physical change occurs when petroleum is brought to the surface of the ground,” Dietz said. “Proof that a physical change has occurred, however, is insufficient to establish that the exemption applies because what must be shown is that the equipment at issue directly causes the physical change to the petroleum.”

Texas Comptroller Susan Combs, one of the defendants in the case, said the state could have lost up to $4.4 billion in revenue from oil and gas sales taxes if Southwest, a subsidiary of Clayton Williams Energy Inc., was successful in their legal challenge. Dietz was originally in favor of Southwest’s argument, and issued a bench ruling to that effect on April 12 (see Shale Daily, April 23; April 18).

“We are pleased with Judge Dietz’s ruling after hearing legal arguments in the case,” R.J. DeSilva, spokesman for Combs’ office, told NGI’s Shale Daily on Monday. “The judge’s ruling continues tax policy that has existed for 50 years in Texas.”

The Texas Oil & Gas Association (TXOGA) did not release a statement after Dietz’s latest ruling, other than to reiterate that they were not involved in the case — also known as Southwest Royalties Inc. v. Combs et al. (Cause No. D-1-GN-09-004284) — and had indeed made the decision to not get involved from the onset.

“We have not yet decided if we’re going to appeal,” Ray Langenberg, an attorney with the Austin-based law firm Scott, Douglass & McConnico LLP who is representing Southwest, told NGI’s Shale Daily on Monday. He declined to comment further.

TXOGA Executive Vice President Debbie Hastings said the oil and gas industry in Texas paid $7.8 billion in state and local taxes, plus $1.5 billion in royalties, during fiscal year 2011. She added that the “vast majority” of state and local revenue were not affected by the case.