A state court ruling could cost the state $4.4 billion in oil and gas tax revenues over the next five years, a loss would sting in the time of budget shortfalls.

At the heart of the case is whether oil and gas drilling counts as “manufacturing” and is thus subject to a tax exemption. Currently, oil and gas drilling is classified in Texas as “mining” and subject to tax.

Last week, Travis County District Judge John Dietz indicated in a hearing that he would side with Southwest Royalties Inc. in the company’s lawsuit against the comptroller.

“Southwest, which filed the suit in 2009, argued that bringing oil and gas out of the ground fundamentally changes it and so should be considered a manufacturing process, according to court filings, and thus subject to an existing sales-tax exemption for manufacturing equipment,” Tom Fowler wrote in the Wall Street Journal.

Southwest is asking for $605,000 in tax rebates from the state, but the decision would mean the comptroller’s office would have to return $2 billion of taxes collected in the last four years and would lose $2.4 billion in future revenue. 

Comb’s office told Fowler that the case threatens to change “50 years of tax policy.” John Opperman, budget director in Lieutenant Governor David Dewhurst’s office, told the Texas Energy Report‘s Polly Ross Hughes, that in his view, the legislature never intended for this exemption to apply to drilling.

Dietz has yet to issue an written decision in the case. State Comptroller Susan Combs’ office has indicated that it plans on continuing to collect taxes as the case winds its way to the appeals process.

An energy lobbyist who spoke to Hughes on the condition of anonymity said the optics on a tax break could be bad for the industry.

One industry lobbyist speculated that the sales tax hit, if it sticks, could create a backlash with both hard-pressed lawmakers and the public.

“In this environment, when oil is selling for $120 a barrel, you don’t want to be out asking for any tax breaks,” the unnamed lobbyist said. “I think it’s going to create so much ill will among policy makers and the public, too. I’m hoping companies will be very prudent in whether or not they go file for any big refunds. It’s just so unexpected. It’s not anything that was on anybody’s radars.”