When the ad valorem tax authorities impose taxes on produced oil or gas (not the severance taxes imposed when the oil or gas is produced and not the ad valorem tax imposed on the value of hydrocarbons in the ground), they tax (i) the land where the production is stored; (ii) the equipment used to store or transfer the production; and (iii), the “cushion” or “pad” gas, in the case of natural gas, used to maintain pressure in the natural gas storage reservoir. In general, if the oil or gas itself is stored in connection with the operation of an interstate pipeline, it is exempt from ad valorem taxes under the Commerce Clause of the U.S. Constitution. This exemption is recognized under the Texas Constitution and the Texas Tax Code.

Generally, oil stored in a tank farm that is an integral part of an interstate, common carrier pipeline system will not be subject to ad valorem taxation (although the tanks, pumps, and pipes themselves will be taxed) under a case called Midland Central Appraisal District v. BP America Production Co., 282 S.W.3d 215 (Tex. App.—Eastland 2009, pet. denied).

Natural gas stored in a depleted reservoir used in connection with an interstate common carrier pipeline system is also not subject to ad valorem taxation under Peoples Gas, Light & Coke Co. v. Harrison Cent. Appraisal Dist., 270 S.W.3d 208 (Tex. App.—Texarkana 2008, pet. denied) … until now.

In ETC Marketing v. Harris County Appraisal District, No. 01-12-00264-CV (Tex. App.—Houston [1st Dist.] Oct. 2, 2014, and by a 2-1 decision, the First District Court of Appeals affirmed the imposition of ad valorem tax on natural gas stored in a depleted reservoir used in connection with an interstate common carrier pipeline system.

ETC Marketing, Ltd. (ETC), buys and sells gas in interstate commerce. When ETC buys gas it entrusts it to its affiliate, Houston Pipeline Company, LP (HPL), who stores some of the natural gas in its underground storage facility in the Bammel reservoir located in Harris County, Texas.

As of the appraisal date (normally January 1 of the tax year or September 1 of the preceding year, at the taxpayer’s election) HPL had stored 33 Bcf of ETC’s natural gas at Bammel. HPL had already been assessed ad valorem tax on the land of the Bammel reservoir, the equipment used to inject and retrieve the gas, and on the “cushion” or “pad” gas it owned in the reservoir. In addition, the Harris County Appraisal District (HCAD) sought to tax ETC’s natural gas stored at Bammel. The resultant additional tax was approximately 4¢/Mcf.

Under the Texas Tax Code, personal property is taxable if it is located in the taxing unit “for longer than a temporary period” or is exempt from such taxation by federal law. Texas Tax Code §§ 11.01 and 11.12. ETC, relying on the precedents in Midland Central and Peoples Gas, argued that its storage of the gas in the Bammel reservoir constituted interstate commerce activity exempt from state ad valorem taxation. For the purposes of the appeal, the Court accepted, without analysis, ETC’s position that the gas was in interstate commerce.

The majority then applied a four part test from Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), to conclude that (i) the stored gas had a substantial nexus to the taxing state, (ii) that the apportionment was fair (i.e., it was not taxed in multiple states and was externally consistent), (iii) the tax did not discriminate against interstate commerce, and (iv) the tax was fairly related to the services provided by the State. The majority held that the ad valorem tax imposed by the Harris County Appraisal District satisfied all four parts of the Complete Auto test, allowing the gas to be taxed despite its presence in interstate commerce.

Notably, the two person majority (Justices Higley and Massengale) focused on the fact that since ETC used the stored natural gas “for its own business purposes of timing the market and selling the gas at higher prices out of state during cold months,” ETC’s activity was distinguisable from theMidland case, because in Midland the oil “was not held in the tank farm for storage purposes or for any business purpose of the owner other than its transmission through the pipeline.” This distinction, rejected by the dissent (Justice Keyes), apparently led the majority to conclude that the stored gas had a substantial nexus to the taxing state.

In contrast, the dissent stated that the first inquiry should be to determine if the natural gas temporarily stored at the Bammel reservoir is actually in interstate commerce and then decide whether the tax meets the test of Complete Auto. In determining the natural gas was in interstate commerce, the dissent found the current case to be indistinguishable from Midland and Peoples Gas, concluding that the natural gas was in interstate commerce and that the activity of gas storage did not have a substantial Texas nexus.

The dissent also found that the ad valorem tax discriminated against interstate commerce because it imposed a burden excessive in relation to local benefits and created a financial barrier around the state that impeded the free movement of commerce. A 4¢/Mcf additional cost will do that. The dissent also concluded that the services provided by the State were related to the HPL facility, which already pays substantial taxes, and not to the activity of storing gas during its transmission through the interstate pipeline system.