Which pieces of compression, cooling, and refrigeration equipment in a Texas LNG export facility qualify for the sales tax manufacturing exemption?

Plain-English summary

The Texas Comptroller worked through six specific pieces of compression, cooling, and refrigeration equipment in a new liquefied natural gas (LNG) export facility and ruled on which ones qualify for Texas's sales tax manufacturing exemption under § 151.318. This is a follow-up to a February 2016 ruling (STAR 201602740L) to the same taxpayer — the company came back with more detailed equipment-by-equipment questions.

Texas's manufacturing exemption has two tracks that worked together throughout this ruling: equipment that directly causes a chemical or physical change to the product is exempt under § 151.318(a)(2) (here, that's the Acid Gas Removal Unit, the NGL Recovery Unit, the Deethanizer/NGL Absorber, and the core cryogenic refrigeration system that liquefies the gas). Equipment that merely powers, supplies, supports, or controls that already-exempt processing equipment is separately exempt under § 151.318(a)(4) — even though it doesn't itself change the product.

Applying that "supply chain" test, the Comptroller found the Booster Compressors, Regeneration Gas Compressors, Expander/Compressors, Deethanizer Overhead Compressor, and Residue Gas Compressors (plus their associated coolers) all qualify under (a)(4) because each pressurizes or temperature-adjusts the gas stream to the exact specifications the next piece of exempt processing equipment requires. The entire propane/mixed-refrigerant cryogenic cooling system that actually liquefies the gas qualifies directly under (a)(2). But the Comptroller drew one clear line: the Regeneration Gas Heater, Cooler, and Scrubber — equipment used only to regenerate the Dehydration Unit's saturated filter beds, rather than to process the live gas stream — do NOT qualify, because that regeneration function is "one step removed from the processing operation."

What this means for you

LNG and natural gas processing facility operators

Equipment that conditions (pressurizes, cools, heats) a gas or product stream specifically so it can enter the NEXT piece of exempt processing equipment is itself exempt as "supplying" that equipment — you don't need the conditioning equipment to directly cause a chemical/physical change itself. But watch for the regeneration/maintenance carve-out: equipment that only services or regenerates a piece of processing equipment (rather than conditioning the actual product stream) is one step too far removed to qualify, even if it's part of the same processing train.

Manufacturers with multi-stage chemical or physical processing

This ruling is a useful template for the "supplying" theory of the manufacturing exemption generally, not just for LNG: identify which of your equipment directly changes the product (the (a)(2) core), then trace backward to see which upstream compressors, pumps, heaters, or coolers exist solely to get the product stream to the right pressure/temperature for that equipment (the (a)(4) supply chain) — as opposed to equipment that services or maintains the processing equipment itself.

Accountants and tax professionals

The ruling leans heavily on Comptroller's Decision No. 103,679 (2012), which established that pumps increasing product-stream pressure so it can enter processing equipment are "supplying" that equipment under (a)(4). The regeneration-equipment denial is the ruling's one narrowing move — worth flagging to clients who assume every piece of equipment in a continuous processing train is automatically exempt.

Common questions

Q: Does compression/cooling equipment need to directly change the product to be exempt?
A: No. Equipment that merely conditions the product stream to the specifications required by a separate, already-exempt piece of processing equipment is independently exempt under § 151.318(a)(4) as equipment that "supplies" that processing equipment.

Q: Why did the Regeneration Gas Heater, Cooler, and Scrubber fail to qualify?
A: Because they're used only to regenerate (clean/reactivate) the Dehydration Unit's molecular sieve beds — a maintenance-type function "one step removed from the processing operation" — rather than to condition the live gas stream itself.

Q: Does the core refrigeration system (propane vaporizers, cryogenic heat exchanger, mixed-refrigerant compressors) qualify?
A: Yes, directly under § 151.318(a)(2), because it makes the physical change (vapor to liquid) that defines the LNG manufacturing process itself.

Q: Can another LNG or gas-processing company rely on this ruling?
A: No. It binds the Comptroller only as to the taxpayer and facts in this specific request and cannot be relied on by any other taxpayer, though the "supplying exempt equipment" framework it applies is a reusable analytical tool.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318(a)(2) (direct chemical/physical change exemption)
• Tex. Tax Code § 151.318(a)(4) (equipment supplying/supporting/powering/controlling exempt equipment)
• 34 Tex. Admin. Code Rule 3.10(d)(2)
• Comptroller's Decision No. 103,679 (2012)
• STAR Accession No. 201602740L (prior ruling to same taxpayer)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201902009L

Original ruling text

February 21, 2019

RE: Private Letter Ruling #140900961

** and **

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters.[1] We are responding to your request regarding the taxability of equipment used in the natural gas liquefaction process. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.[2]

Facts Presented

You initially contacted us to request guidance on March 18, 2014, and you supplemented your request on Aug. 12, 2014. We responded to your inquiry by issuing a private letter ruling on Feb. 22, 2016. [Editor's Note: See STAR 201602740L.] You subsequently requested additional, specific guidance based on the facts described below.

** and ** (collectively, Taxpayer) are building new liquefied natural gas facilities in Texas. At the facilities, Taxpayer will convert customers’ pipeline quality natural gas in vapor form to liquefied natural gas (LNG) – natural gas in a liquid state – that is suitable for export.

The liquefied natural gas facilities consists of pretreatment facilities (PF), which change the chemical composition of the gas to meet the specifications required for liquefaction, and the liquefaction facilities (LQF), which convert the gas to a liquid state.

The steps in the liquefaction process are:

natural gas is received at the inlet to the PF, the gas stream flows through separators and coalescers to remove certain impurities and contaminants;

the gas stream flows through a bank of guard beds and filters to remove any mercury in the gas stream;

the gas stream is fed through the Acid Gas Removal Units (AGRU) to remove carbon dioxide and sulfur compounds from the gas stream;

water is removed from the gas stream through a two-stage dehydration process;

natural gas liquids, such as propane, butane, and ethane, are removed from the gas stream; and

the gas is then moved from the PF into the LQF and cooled in a multi-stage process leading to liquefaction.

Taxpayer uses compression equipment to adjust the pressure and temperature of the gas stream to specifications required to enter equipment that removes carbon dioxide and sulfur compounds, water, and liquid hydrocarbons.

Requested Rulings, Responses, and Analysis

Our restatement of the facts presented and your questions are shown below, followed by our responses and analysis.

Question 1: Is Taxpayer’s purchase of the Booster Compressor and the Booster Compressor Discharge Coolers exempt pursuant to Section 151.318 (Property Used in Manufacturing)?

Ruling: Taxpayer’s purchase of the Booster Compressors and the Booster Compressor Discharge Coolers is exempt under Section 151.318(a)(4).

Facts Presented:

The Booster Compressor (60K-11 A/B/C) and the Booster Compressor Discharge Coolers (60K- 11 A-C-El) raise the pressure and reduce the temperature of the gas stream to the specifications required for the gas stream to enter the AGRU for further processing. The equipment in the AGRU causes a chemical change in the natural gas by removing carbon dioxide (CO2), hydrogen sulfide (H2S), and organic sulfur compounds from the gas stream. The AGRU qualifies for exemption under 151.318(a)(2).

Analysis:

The Booster Compressor and Booster Compressor Discharge Coolers are supplying a gas stream pressurized and temperature-adjusted to the specifications required for entry into the AGRU for further processing. The Booster Compressor and Booster Compressor Discharge Coolers qualify for exemption under Section 151.318(a)(4). See Comptroller’s Decision No. 103,679 (2012) (holding that pumps designed to increase the pressure of the product stream so that it could enter processing equipment were supplying the processing equipment and were exempt under Section 151.318(a)(4)).

Question 2: Is Taxpayer’s purchase of the Regeneration Gas Compressors exempt pursuant to Section 151.318?

Ruling: Taxpayer’s purchase of the Regeneration Gas Compressors is exempt under Section 151.318(a)(4).

Facts Presented:

The Dehydration Unit removes water from the gas coming out of the AGRU. Dehydration of the gas in the Dehydration Unit occurs in two stages. First, heat exchangers cool the gas, and the water that condenses as the gas cools is removed from the gas stream. Second, the gas passes through molecular sieve beds which absorb the remaining water vapor.

After the molecular sieve beds in the Dehydration Unit become saturated with water, Taxpayer will regenerate the molecular sieve beds one bed at a time using a side stream of the dehydrated treated gas. The side stream of gas, called regeneration gas, is heated to 540° F by the Regeneration Gas Heater (61E-30). The heated regeneration gas will then be used to heat up the molecular sieve beds and to drive off adsorbed moisture one bed at a time. The regeneration gas moves from the molecular sieve beds to a Regeneration Gas Cooler (61E-3 l) where the water in the gas is condensed. The gas then passes through a Regeneration Gas Scrubber (61V-32), which removes the condensed water from the cooled gas stream. After the cooler and scrubber remove water from the regeneration gas, it moves to the Regeneration Gas Compressors (61K-30 A/B). The Regeneration Gas Compressors compress the gas to the pressure required for entry into the AGRU.

Analysis:

The regeneration of the molecular sieve beds is one-step removed from the processing operation. As a result, the Regeneration Gas Heater (61E-30), Regeneration Gas Cooler (61E-3 l), Regeneration Gas Scrubber (61V-32), and the fuel used to power these items do not qualify for exemption. The Regeneration Gas Compressors are supplying the AGRU with a gas stream pressurized and temperature-adjusted to the specifications required for entry into the AGRU. The AGRU further processes the regeneration gas. As stated above, the AGRU qualifies for exemption under 151.318(a)(2) because it makes chemical changes to the gas stream. The Regeneration Gas Compressor qualifies for exemption under Section 151.318(a)(4) because the compressor is supplying the AGRU. See Comptroller’s Decision No. 103,679.

Question 3: Is Taxpayer’s purchase of the Expander/Compressors exempt pursuant to Section 151.318?

Ruling: Taxpayer’s purchase of the Expander/Compressors is exempt under Section 151.318(a)(4).

Facts Presented:

Taxpayer uses the Expander/Compressors (61XK-42) in two processes. First, the Expander/Compressors are used in conjunction with the Booster Compressor and Compressor Discharge Coolers, addressed in Ruling 1, to increase the pressure of the natural gas stream to 903 PSIG, the pressure required for the gas stream to enter the AGRU.

Second, Taxpayer uses Expander/Compressor in the removal of naturally occurring natural gas liquids (NGLs), such as propane, butane, and ethane, from the dry gas stream. (The term “dry gas” refers to gas that the Dehydration Unit has successfully dehydrated.) Taxpayer must remove NGLs from the dry gas prior to liquefaction. Otherwise, these heavier hydrocarbon components would freeze in the cryogenic equipment and cause plugging. The Expander/Compressor reduces the temperature and pressure of dry natural gas coming from the Dehydration Unit to the specifications required for processing to occur in the NGL Recovery Unit. The NGL Recovery Unit causes chemical changes in the natural gas stream by removing heavier hydrocarbon components. The NGL Recovery Unit qualifies for exemption under 151.318(a)(2).

Analysis:

Taxpayer uses the Expander/Compressor to compress the gas stream to the pressure required for entry into the AGRU, which is exempt processing equipment. In addition, Taxpayer uses the Expander/Compressor to reduce the pressure and temperature of the gas stream to the pressure and temperature necessary for entry into the NGL Recovery Unit. Like the AGRU, the NGL Recovery Unit is exempt processing equipment.

In both processes, the Expander/Compressor is supplying equipment that is exempt from tax under Section 151.318(a)(2). Taxpayer’s purchase of the equipment qualifies for exemption under Section 151.318(a)(4).

Question 4: Is Taxpayer’s purchase of the Deethanizer Overhead Compressor and the Deethanizer Overhead Compressor Recycle Cooler exempt pursuant to Section 151.318?

Ruling: Taxpayer’s purchase of the Deethanizer Overhead Compressor and the Deethanizer Overhead Compressor Recycle Cooler qualifies for exemption under Section 151.318(a)(4).

Facts Presented:

As described in Ruling 3, dry gas coming from the Dehydration Unit is cooled, depressurized in the expander section of the Expander/Compressor, and then fed into the NGL Recovery Unit, where the NGL Absorber removes heavier hydrocarbon components from the natural gas feed. Natural gas leaves the NGL Absorber in two streams. The gas from the NGL Absorber overhead system, called residue gas, has been treated and moves to the next stage of liquefaction. The stream from the bottom of the NGL Absorber flows to the Deethanizer, where butane and lighter components are separated from pentanes and heavier components. A stream of NGL-enriched gas leaves the Deethanizer.

The residue gas is mixed with a precise amount and type of NGL-enriched gas to achieve the specified BTU-rated gas stream that will be liquefied. The NGL-enriched gas must be at a certain temperature in order to mix with the residue gas. The Deethanizer Overhead Compressor (61K- 43A/B) is used to compress the NGL-enriched gas to 608 PSIG. The Deethanizer Overhead Compressor Recycle Cooler (61K-43-E1) then cools the compressed NGL-enriched gas to 109°F.

The mixing of the residue gas from the NGL Absorber overhead system and the NGL-enriched gas from the Deethanizer occurs in the piping that is downstream of the Deethanizer and the NGL Absorber. The mixing would not occur without the compression of the NGL-enriched gas to 608 PSIG. The mixture of the two gas streams is fed directly to the Residue Gas Compressors.

The Deethanizer Overhead Compressor Recycle Cooler cools the NGL-enriched gas after compression in the Deethanizer Overhead Compressor to minimize the increase in temperature of the mixture of the two gas streams that is directly fed to the Residue Gas Compressors.

Analysis:

Based on the information provided, Taxpayer uses the Deethanizer Overhead Compressor and the Deethanizer Overhead Compressor Recycle Cooler to compress and cool the NGL-enriched gas so that it will mix with residue gas.

The Deethanizer Overhead Compressor and Deethanizer Overhead Compressor Recycle Cooler supplies, equipment that qualifies for exemption under Section 151.318(a)(2). The Deethanizer Overhead Compressor and the Deethanizer Overhead Compressor Recycle Cooler support the NGL Absorber and Deethanizer. The NGL Absorber and Deethanizer work in tandem to remove natural gas liquids from the gas stream. The Deethanizer Overhead Compressor and the Deethanizer Overhead Compressor Recycle Cooler support the NGL Absorber and Deethanizer in producing a residue gas stream that has the correct composition for liquefaction.

Question 5: Is Taxpayer’s purchase of the Residue Gas Compressors and the Residue Gas Compressor Discharge Coolers exempt pursuant to Section 151.318?

Ruling: Taxpayer’s purchase of the Residue Gas Compressors and the Residue Gas Compressor Discharge Coolers are exempt under Section 151.318(a)(4).

Facts Presented:

The processed gas stream passes through the Residue Gas Compressors (60K-40 A-C) to raise the gas pressure from 608 psig to 1,142 psig. The gas stream is then cooled by the Residue Gas Compressor Discharge Coolers (60K-40-E1A-C) to 109°F. Both of these processes are required for the gas to move from the pretreatment stage to the liquefaction stage.

Analysis:

The Residue Compressor and the Residue Compressor Cooler compresses and cools the processed gas stream to the temperature and pressure required to enter LQF liquefaction processing equipment.

Question 6: Is Taxpayer’s purchase of the items listed below, which are used to cool the processed gas stream to liquid, exempt under Section 151.318?

Propane Vaporizers (11E-30, 11E-31, 11E-32, 11E-33) and the Main Cryogenic Heat Exchanger (IE-40);

Propane Compressor (11K-30), Propane Compressor Motor Driver (11KM-30), Propane Desuperheater/Condenser (11K-30-E1), Propane Accumulator (11K-30-V5), Propane Subcooler (11K-30-E2), Propane Suction Drums (11K-30-V1, 11K-30-V2, 11K-30-V3, 11K-30-V4), Residue Gas Compressors (60K-40 A-C), Residue Gas Compressor Discharge Coolers (60K-40-E1A-C); and

Mixed Refrigerant Compressors (11K-31, 11K-32, 11K-33), Mixed Refrigerant Compressor Motor Drivers (11KM-31, 11KM-32), Mixed Refrigerant Compressor Aftercoolers (11K-31-E1, 11K-32-E1, 11K-33-E1), Mixed Refrigerant Propane Vaporizers (11E-34, 11E-35, 11E-37), Mixed Refrigerant Separator (11V-32), Mixed Refrigerant Liquid Turbine (11XP-32), and Mixed Refrigerant Suction Drum (11K-31- V1).

Ruling: Taxpayer’s purchase of the items identified above is exempt under Section 151.318(a)(2).

Facts Presented: Once Taxpayer has removed contaminants from the gas stream, as described above, the gas stream is ready for conversion to LNG. Taxpayer changes the gas stream from its natural vapor state to a liquid state in a multistep temperature-reduction process.

Converting the vapor stream to a liquid state is a two-stage process. In the first stage, the gas stream is pre-cooled to approximately -30° F in a series of Propane Vaporizers (11E-30, 11E-31, 11E-32, 11E-33), which are heat exchangers where the gas is cooled through a heat transfer using propane as the refrigerant media that absorbs heat from the gas stream. In the second stage, the temperature of the gas stream is reduced to approximately -260° F in the Main Cryogenic Heat Exchanger (IE- 40), another heat exchanger where the gas is cooled through a heat transfer using a mixed refrigerant comprised of ethylene and other light hydrocarbons as the refrigerant media that absorbs the remaining heat from the gas stream.

The Propane Vaporizers and the Main Cryogenic Heat Exchanger are components of large refrigeration units. They cannot and do not work without a number of other components of those systems that support and supply the heat exchangers. This process is similar to other vapor- compression refrigeration systems in that the refrigerant must be compressed, condensed, and expanded to ready it as a refrigerant media that produces the required heat exchanges in the Propane Vaporizers and the Main Cryogenic Heat Exchanger. This cooling process is analogous to the workings of a household refrigerator or air conditioning unit.

Analysis:

The refrigeration operations described directly makes or causes a physical change to the gas stream by converting the gas stream from a vapor state to a liquid state. The facts provided establish that the refrigeration system is directly used during the processing of natural gas, is necessary or essential to the processing, and directly makes or causes a chemical or physical change to the product. The Propane Vaporizers, Main Cryogenic Heat Exchangers, and listed integral components of the refrigeration units are exempt under Section 151.318(a)(2).

Additional sales tax information, including links to statutes, rules, forms, and publications, is available at comptroller.texas.gov/taxinfo/sales/.

The State Tax Automated Research (STAR) System is a searchable database of Comptroller letters, decisions, hearings, and other documents. STAR documents may be accessed online at cpastar2.cpa.state.tx.us/. The “Help” tab located in the yellow banner near the top of the page provides instructions on using the STAR System.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/taxhelp/ and reference Private Letter Ruling No. 140900961.

Sincerely,

Tax Policy Division – Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTES:

[1] Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.

[2] We issue this private letter ruling based on the facts presented, without any independent verification of those facts. If there has been a misstatement or omission of material facts in your request, or if the facts subsequently developed are materially different from the facts in your request, this decision will not bind the Comptroller. Rule 3.10(d)(2).