Southwest Royalties v Hagar, Supreme Court of Texas, June 17, 2016, 2016 Tex. LEXIS 508

Casing, tubing and other well equipment used in production operations do not constitute property used in “processing” that would exempt it from sales taxes.

Southwest argued that hydrocarbons in a reservoir must be separated – liquids from gas – and that its equipment was used in processing such separation. The statute provides that equipment “necessary or essential to the manufacturing, processing or fabrication operation and directly makes or causes a physical change” to the product is exempt from sales taxes. The trial court recognized that when hydrocarbons in the reservoir under pressure flow to the lower pressure well bore which is held open by casing and which flows through the narrower tubing, the liquids separate from the gas. However, the trial court held, and the Supreme Court agreed, that such changes were not caused by the casing and tubing but occurred naturally due to the reduction in pressure and temperature, thus such equipment was not subject to sales tax exemption.