High-Cost Natural Gas Tax Exemption

High-Cost Natural Gas Tax Exemption

by Albert Jou – 2L


The Railroad Commission (“RRC”) has, in the past, provided for tax breaks on produced high-cost natural gas.  For well operators interested in tight sands, this tax exemption can provide much-desired economic relief.  However, in a recent RRC release, the RRC presented its interpretation of the relevant Statewide Rule 101 (“SWR 101”).   The RRC asserts that an oil and gas producer must first receive a tight formation area designation from the RRC before the RRC will approve an individual well for the tax exemption.  This may present an economic problem for oil and gas producers.  The date on an application for an individual well designation locks in the oil and gas producer’s date, thereby, allowing the operator to claim a tax exemption on its activities starting from that date.  Under the recent interpretation of SWR 101, an application for an individual well designation is not considered submitted until the tight formation has been designated.  But the Texas Tax Code and the express language of SWR 101 is silent on how tight gas wells are certified for high-cost gas tax purposes.  Is the RRC’s stance correct and what procedure does an applicant now need to follow when applying for high-cost gas tax exemptions?


Texas’s high-cost tax statute provides that an applicant must include a high-cost well certification from the RRC. 1   The high-cost natural gas exemption was adopted for the purposes of encouraging producers to recover gas ultimately resulting in greater economic benefit to the state. 2   When an applicant receives the RRC high-cost well certification, then the applicant does not have to provide additional information.  3  But the Texas Tax Code does not specifically define the procedures for a tight gas well certification. [4.: See Tex. Tax Code Ann. § 201.057]     The specific information required for administering high-cost gas certifications is likely left to the RRC’s discretion. 4     The RRC has listed procedures for specific high-cost gas well applications – including, tight gas well applications – that applicants must follow. 5


For tight gas wells, SWR 101 explicitly requires applicants for tight gas well certifications to include specific information showing that the well is within a designated tight formation area. 6  SWR 101 further states that unless the well is completed in a formation interval “previously certified as a designated tight formation by the Federal Energy Regulatory Commission . . . or by the [RRC], an operator [has a duty to] first apply for a tight formation area designation.” 7  Otherwise, the applicant has a duty to first apply for a tight formation area designation. 8


Moreover, there is one significant distinction between tight formation area designations and tight gas well certification processes.  Applications for tight formation area designations require a large number of technical reports and maps identifying the tight gas formation; whereas, applications for individual tight gas well certifications require information merely to spatially locate the well. 9   This difference suggests that RRC staff will not be able to correctly classify an individual well as tight gas, unless certain information is submitted.    Notably absent from tight gas well certifications is a requirement for engineering and geological exhibits that establish in situ permeability of the proposed formation.  Permeability rates are required by the RRC to determine whether the proposed formation can be classified as “tight gas.”  Presumably the RRC requires an operator to submit certain documents before it can made a reasonably supported decision on whether a designation should be granted.


While the RRC does not explain the reasons for having different requirements for area designations and well certifications, the absence of explanation does not necessarily permit an applicant to file a tight gas well application before receiving a tight formation area designation.  Furthermore, the legislature provides much deference for administrative decisions.  10  Thus, it is more likely that RRC staff cannot feasibly nor accurately certify an individual tight gas well without the information required for tight formation area designation.  Even if a court interprets the statute to permit an applicant to file for a well certification before receiving an area designation, improper well certifications will likely result because RRC staff is missing necessary information.  Improper well certifications would provide an unwarranted tax break which is incongruous with the purpose of the statute.


Thus, an attorney should advise an operator, one interested in receiving a tax exemption for drilling in tight-formations, to first file for and receive approval on a tight formation area designation.  Accordingly, the operator may want to consider lower levels of financial investment until the RRC has approved the tight-formation because, only then, will the operator’s application be considered submitted for tax exemption purposes. 11


  1. Tex. Tax Code Ann. §201.057(e)
  2. See Tex. B. Analysis, H.B. 2615, (1999)
  3. Id.
  4. See Id.; Tex. Gov’t Code Ann. § 311.016(1) (stating that the word “may” creates discretionary authority or grants permission or a power).
  5. Tex. Admin. Code § 3.101(e)(1)-(6).
  6. Tex. Admin. Code § 3.101(e)(5) (requiring a specific commission docket number assigned to a designated tight formation area certification and a map outlining the designated tight formation area approved by commission).
  7. See Tex. Admin. Code at § 3.101(f)(1); Tex. Gov’t Code Ann. § 311.016(2) (providing that the word “shall” imposes a duty).
  8. See Tex. Admin. Code § 3.101(e)(5); 3.101(f)(1) (stating that an operator shall first apply for a tight formation area designation); Tex. Gov’t Code § 311.016(2) (explaining that “shall” imposes a duty).
  9. Compare Tex. Admin. Code § 3.101(f)(3) (requiring (1) a map with an outline of the geographical limits of the formation in and around the requested area, (2) a list of the counties involved, abstract numbers, survey names, geologic formation markers, and other descriptive information that will aid in identifying the subject formation, (3) a structure map and a cross-section to depict upper and lower limits of the proposed formation, (4) engineering and geological exhibits that establish in situ permeability of the proposed formation, (5) engineering and geological exhibits that establish the production rates, as determined by geometric mean or median analysis are within certain limits, and (6) the requested designated area does not extend beyond a two and a one-half mile radius from any data point well, with Tex. Admin. Code § 3.101(e)(5) (requiring (1) completed applicable commission form, (2) copies of tests and logs filed on subject well, (3) specific reference to the commission docket number assigned to the applicable designated tight area certification, and (4) a copy of the map with the subject well location within a designated tight area formation approved by the commission).
  10. See Tex. Gov’t Code Ann. § 311.023(5)-(6) (explaining that a court may consider the consequences of a particular construction and the administrative construction of the statute).
  11. Given the current natural gas prices and the expensive nature of pursuing an operation in tight-sands, it appears unlikely that many operators will undertake drilling.