Good morning, and welcome to Western Midstream's Fireside Chat. My name is Rhianna Disch, Manager of Investor Relations, and with me today are our Chief Executive Officer and President, Oscar Brown, and our Chief Financial Officer and Senior Vice President, Kristen Shults. Oscar, this morning, WES announced new amendments that involved the renegotiation of our contracts in the Delaware Basin with Occidental and ConocoPhillips. Can you give us an overview of these contracts and amendments?
Sure thing, Rhianna. This morning, we announced that we renegotiated natural gas gathering and processing contracts in the Delaware Basin with a subsidiary of Occidental Petroleum and entered into a new natural gas gathering and processing arrangement with ConocoPhillips, related to a portion of its Delaware Basin natural gas volumes on WES's system. These agreements reset Delaware Basin natural gas fees in exchange for WES common units from OXY, thereby encouraging the development of acreage supported by WES's natural gas, crude oil, and produced water systems. The transaction also realigns our equity capital structure to better accommodate changes that we believe will provide long-term strategic benefits to WES. These changes represent a significant step in WES's continuing evolution after becoming a standalone midstream enterprise, simplifying our contract portfolio, diversifying our customer base, and reinforcing our ability to deliver enduring value for our stakeholders.
There's a lot there. Can we focus first on the changes to the OXY contract? Are there still volumetric protections related to OXY's Delaware Basin natural gas volumes after these amendments?
The amendment to the OXY natural gas gathering contract effectuates an earlier transition from the legacy cost-of-service structure to a simplified fixed-fee structure than what was previously provided for under that agreement. This transition further positions WES as a standalone midstream enterprise and allows the acreage serviced by WES to better compete for capital within OXY's portfolio. Additionally, the amended Delaware Basin natural gas gathering contract with Occidental provides volumetric protection via substantial minimum volume commitments through the original cost-of-service term. From that point forward, the existing acreage dedication and fixed-fee structure continues through the duration of the contract. Future throughput risk is mitigated further by the fact that volumes under the OXY gathering contract will remain subject to our natural gas processing contract with OXY, which is also subject to minimum volume commitments through 2035.
Is the new contract with ConocoPhillips for new volumes that will be coming into the WES system?
No, these aren't new volumes. The agreement with ConocoPhillips is for natural gas gathering and processing related to a portion of ConocoPhillips' Delaware Basin wells that are already on our system. However, by entering into an agreement directly with ConocoPhillips, we have further diversified our revenues by reducing related-party revenue by more than 10%. We already have a strong relationship with ConocoPhillips, and we look forward to further supporting their development efforts in the Delaware Basin in both Texas and New Mexico.
You also mentioned that these agreements reset Delaware Basin natural gas fees in exchange for WES common units from OXY. Can you provide more details on this aspect of the transaction?
In consideration for these transactions, OXY will transfer to WES approximately 15.3 million WES common units, representing approximately $610 million of limited partnership interests in a transaction that was approved by WES's Special Committee of Independent Directors and by the full board. The transfer was structured on terms intended to represent value neutrality for both WES and OXY for the economic impact of these agreements and the corresponding decrease in WES's operating cash flow over time. As a result of this redemption and cancellation of these common units, OXY's total ownership interest in WES will decrease from approximately 42% to approximately 40%, which we expect will also provide substantial annual distribution savings of over $56 million per year and growing beginning in 2026.
Kristen, can you give us an overview of the adjusted EBITDA impact of the contract changes?
Sure, Rhianna. The value of the common units transferred, approximately $610 million, will be added to the contract liability associated with the Occidental-Delaware Basin natural gas agreement, which was approximately $560 million before these agreements. The total balance of approximately $1.2 billion will be recognized to revenue beginning in 2026 through 2032. As such, for the next seven years, approximately $165 million a year on average will be recognized to revenue as the contract liability decreases by the corresponding amount. Of the $165 million, approximately $90 million relates to the reset of the Delaware Basin natural gas gathering fees executed in exchange for the common units, the transaction Oscar just discussed. The remaining $75 million relates to the contract liability already recorded on the books.
As such, based upon our most recent forecast and including recognition of revenue associated with the contract liability, the conversion to a fixed-fee structure is not expected to reduce adjusted EBITDA through 2027, and after 2027 and until 2032, we expect that conversion will have a minimal impact to adjusted EBITDA.
You mentioned revenue recognition and the contract liabilities a few times now. Can you further explain these components?
Since inception, the OXY Delaware Basin natural gas gathering contract has been subject to revenue deferral due to the contract possessing a variable rate or the cost-of-service aspect of it and a fixed rate within the original primary term of the contract. Under GAAP revenue recognition accounting, revenue is smoothed over the contract's life, even though cash received varies with rate changes. Historically, higher variable fees led to more cash inflow than reported revenue, resulting in a deferral of revenue and the recording of a contract liability on the balance sheet, as disclosed in Footnote 2 of the financials. As of the third quarter of 2025, contract liability is amounted to $704 million, of which approximately $540 million related to this contract. The remainder primarily related to aid in construction payments received from customers that are recognized over the expected period of the customer benefit, which is normally 20+ years.
As of December, the contract liability associated with this contract is now $560 million. With the recent amendment, WES receives upfront consideration: the $610 million of units in exchange for an earlier conversion to a fixed-rate structure and the effective rate reset over the next seven years. That amount will increase the contract liability that we have on the books today and will be recognized ratably to revenue beginning in 2026 and through 2032, which is the original term of the contract.
Understood. So while revenues and adjusted EBITDA include the recognition of revenue associated with the contract liability through 2032, operating cash flow will not. Is that correct?
Yes. Beginning in 2026, operating cash flows will reflect only the new fixed-fee rates, while revenues and adjusted EBITDA will also include the recognition of revenue associated with the contract liability. At the end of 2032, the contract liability should be zero, and at the beginning of 2033, both adjusted EBITDA and operating cash flow associated with the natural gas gathering contracts will be determined by only the fixed-fee rates.
Does this decrease in cash flow associated with these recent transactions change your capital allocation strategy going forward?
No. These transactions have provided us with an opportunistic redemption of units, as we received units in exchange for the amendment to reset the fees. The unit redemption amounted to $610 million of present value in exchange for the concession on OXY's fees, while eliminating the associated cash distributions, which would have been approximately $56 million per year at today's distribution rate. In fact, over the next 10 years, which is now the remaining term of the amended OXY Delaware Basin gas gathering agreement, we expect that the cumulative reduction in operating cash flow from these transactions will largely offset by the cumulative distribution savings in financing cash flows as the result of the common unit redemption.
The other uses of capital we continue to evaluate include organic growth funding and building coverage for future distribution growth, all while maintaining leverage at or near 3x, which enables us to pursue other acquisitions and growth. We're not planning any changes to these objectives as we continue to expect leverage to remain at or near 3x throughout 2026, even taking into account our recent acquisition of Aris Water Solutions and the already announced 2026 growth-oriented capital expenditure program of approximately $1.1 billion.
WES has also been successful at reducing costs over the past few quarters. Do you think WES will continue to be successful reducing costs, and can this offset the reduction in cash flow?
Yes. In 2025, we launched a cost reduction initiative at WES to ensure that every dollar spent supports our strategic objectives. Across the whole organization, employees have been applying zero-based processes and design reviews and eliminating activities that are not aligned with our differentiating capabilities. The results of this hard work began to materialize in our financial results, partially during the second quarter and even more so during the third quarter. In fact, operations and maintenance costs decreased 8% in the third quarter of 2025 compared to the third quarter of 2024. These are permanent cost reductions, and as we continue to implement changes and identify incremental opportunities, we expect our operating and G&A costs to further decrease.
As such, if we take into account the ongoing distribution savings from the common unit redemption, which is approximately $56 million a year at today's distribution rate, together with the cost reduction initiatives, which are only partially reflected in our 2025 results, we expect to fully offset the reduction in free cash flow after distributions resulting from these transactions and the transition to a fixed fee structure.
There's been a lot of conversations over the years about WES's cost-of-service contracts with OXY, concerns around recontracting risk, and rates being lowered as those contracts expire. Any thoughts after this amendment or additional clarity you would like to provide to investors?
The new amendment with OXY creates better alignment between both parties, and going forward should materially reduce investor concerns and the overhang associated with perceived recontracting risk. These contract amendments materially reduce the percentage of remaining WES revenue generated by cost-of-service rates going forward since the Delaware Basin natural gas gathering contract was previously the most significant cost-of-service agreement between WES and OXY. After this amendment, approximately 9% of WES's total revenue will remain subject to cost-of-service rates, with only 1% of total revenue subject to cost-of-service rates expiring in the late 2020s.
The remaining cost-of-service rate provisions extend into the mid to late 2030s and include provisions to convert to fixed fee structures at that time. Additionally, all significant fixed fee contracts with OXY, including the contracts being amended, are effective through the mid to late 2030s. Given these recent contract amendments and the clarity regarding the remaining cost-of-service rates and other significant contracts with OXY, we believe this provides incremental transparency to our unit holders regarding our contract portfolio.
Terrific. Thank you both for your time. Any closing thoughts, Oscar?
The last year has been a busy year here at WES. From the sanctioning of the Pathfinder Pipeline and North Loving II to the acquisition of Aris, we have successfully set WES up to capitalize on future Delaware Basin growth. We are extremely gratified that we have already begun to see the results of our prudent growth strategy by doing two things that are very hard to do at the same time, and that is improve our overall cost structure and process efficiency while executing on growth opportunities. In fact, the former truly enables success in the latter, and we now have great momentum towards improving our competitiveness in the midstream market.
Oscar, Kristen, thank you both for joining us today. For our listeners, if you have any additional questions, please feel free to reach out to us. Our contact information is located in the investor relations section of our corporate website at westernmidstream.com.