Western Midstream Partners LP

NYSE:WES

Earnings Call Analysis

Robust Capital Management and Growth Outlook

The company successfully issued $600 million in debt, used part to acquire Meritage assets, with high market demand; Senior notes had a 6.35% coupon. Half of a $1.25 billion share buyback program has been executed, totaling over $622 million. In Q3, a 2% increased distribution of $57.50 per unit was declared. Natural gas throughput growth is projected in mid-single digits, while growth for crude oil, NGLs, and produced water are expected in the low single and upper teens digits for 2023, respectively. Upbeat on 2023 EBITDA guidance, hitting the high end of $1.95 to $2.05 billion, the company eyes a free cash flow of $900 million to $1 billion, including additional growth capital for ongoing projects like Mentone Train III and North Loving Plant targeted for 2024 and 2025. With a raised base distribution to $2.21 per unit, the company emphasizes its strategy of balanced capital returns, eyeing a return to pre-acquisition leverage by the end of 2024.

Steady Throughput Growth and Capital Allocation

The company has reported a productive quarter, with cash flow from operations reaching $395 million, which in turn generated $200 million in free cash flow. Free cash flow after the recent distribution payment in August saw a use of cash of $21 million. Capital markets activities have also been notable, with a successful issuance of $600 million in five-year senior notes at a 6.35% coupon, which was well-received and oversubscribed in the market. As part of its capital allocation strategy, the company has repurchased 50% of its unit buyback program, amounting to over $622 million, including 5.1 million common units from Occidental. Management remains dedicated to a balanced approach, including retiring debt, unit buybacks, and incrementally increasing base distribution, which has risen by just over 2% for this quarter. Adjusted EBITDA and free cash flow are set to benefit from efficient capital allocation aimed at value creation for unitholders.

Guidance and Financial Position

The company is poised to hit the higher end of its adjusted EBITDA guidance of $1.95 billion to $2.05 billion, based on solid quarterly performance and the anticipated contribution from the Meritage acquisition in the fourth quarter. Looking ahead to 2023, they maintain guidance for total capital expenditures ($700 million to $800 million), free cash flow ($900 million to $1 billion), and they anticipate slight growth in yearly oil throughput. Growth in base distribution is reflected by a rise to approximately $2.21 per unit for 2023, which exceeds prior guidance. The company also holds firm on returning excess free cash flow to unitholders when possible and aims to manage net leverage under 3.2 times for 2023, prioritizing a balanced and responsible approach to capital return and growth.

M&A Strategy and Investment Outlook

The company's strategy embraces opportunistic M&A ventures, as exemplified by the Meritage acquisition. This acquisition serves as either a footprint expansion or an alternative to exiting the area, thus representing a commitment to seizing growth opportunities that align with corporate efficiency goals. The company expects to see more growth in 2024, especially with the development of the Mentone Train III and the North Loving plant. These projects, supported by solid commitments, are expected to fully utilize capacity upon completion, enhancing the company's processing capabilities and potentially increasing adjusted EBITDA.

Operational Efficiency and Upcoming Projects

Operationally, the company has excess capacity in the DJ Basin, which suggests minimal capital expenditure in 2023. Meritage, however, will require more growth capital in 2024, primarily for well connect compression and similar undertakings. With the online launch of Mentone III, the company foresees a marginal increase in margin as it reduces offload fees and welcomes the volumes onto its system, boosting overall performance and operational capacity without unnecessary volume offloadings.

Earnings Call Transcript 2023-Q3

[Operator]

Thank you for standing by. My name is Kayla Baker, and I will be your conference operator today. At this time, I would like to welcome everyone to the Western Midstream Partners Third Quarter 2023 Earnings Call.

[Operator Instructions]

I would now like to turn the call over to Director of Investor Relations, Daniel Jenkins. You may begin.

[Kristen Shults, executive]

Thank you. I'm glad you could join us today for Western Midstream's Third Quarter 2023 Conference Call. I'd like to remind you that today's call, the accompanying slide deck and last night's earnings release contain important disclosures regarding forward-looking statements and non-GAAP reconciliations, please reference to Western Midstream's most recent Form 10-Q and other public filings for a description of risk factors that could cause actual results to differ materially from what we discuss today. Relevant reference materials are posted on our website. With me today are Michael Ure, our Chief Executive Officer; and Kristen Shults, our Chief Financial Officer. I'll now turn the call over to Michael.

[Michael Ure, executive]

Thank you, Daniel, and good afternoon, everyone. During the third quarter, increased throughput from all operated assets and across all products led to improved adjusted gross margin and adjusted EBITDA on a sequential quarter basis. Specifically, in the Delaware Basin, our throughput increased across all 3 products, mostly due to new production coming online and continued high-facility operability. .

In the DJ Basin, both natural gas and crude oil and NGLs throughput increased quarter-over-quarter, a trend we expect to continue into the fourth quarter, and throughput also increased from our other assets, specifically in South Texas as additional volumes from new customers came online. Focusing on the Delaware Basin, we achieved record natural gas, crude oil and NGLs and produced water throughput during the third quarter. For the first time in West's history, we averaged more than 1 Bcf per day of natural gas Gadom third parties for the months of August and September, demonstrating our focus on growing the entirety of our business. This throughput record is a testament to our team's ability to successfully compete for new business by reducing costs and providing superior customer service. Since 2021, West has grown its third-party volumes in the Delaware Basin by approximately 65%, which is more than twice the rate of natural gas volume growth from the entire Delaware Basin.

I would also like to highlight a new contract extension that West recently executed with one of our largest producing customers in the Delaware Basin, bringing total dedicated acreage from that producer to roughly 40,000 acres and extending the duration of our agreement by 10 years to 2035.

[Audio Gap]

Customer demand with the expansion of Mentone and the construction of our greenfield plant at North Loving. In the DJ Basin, which generates roughly 50% of our free cash flow, we reached the trough of the throughput decline, and we expect to see producers gradually grow volumes over the coming quarters. The Powder River Basin has favorable producer activity levels with competitive economics. And when paired with our existing core basins, we'll support West's long-term growth strategy for years to come.

With that, I will turn the call over to Kris to discuss our operational and financial performance.

[Kristen Shults, executive]

Thank you, Michael, and good afternoon, everyone. Our third quarter natural gas throughput increased by 5% on a sequential quarter basis, primarily due to increased throughput in the Delaware Basin from new production coming online from our other assets, specifically in South Texas and from our equity investments. Additionally, we achieved increased throughput in the DJ Basin due to increased completion activity from both affiliated and third-party producers. Our crude oil NGL throughput increased by 7% on a sequential quarter basis, primarily due to increased throughput from our equity investments in Delaware Basin oil system. Of note, we saw our first sequential quarter increase in crude oil and NGL throughput from the DJ Basin since the fourth quarter of 2021. We produced water throughput increased by 14% on a sequential quarter basis due to increased completion activity and high facility operability in the Delaware Basin. Our per MCF adjusted gross margin for our natural gas assets was flat compared to the prior quarter. Higher throughput from our South Texas assets, which have a lower than average per Mcf margin as compared to our other natural gas assets and lower distributions from our natural gas equity investments had a dilutive impact on our per McF adjusted gross margin, which was offset by increased throughput from both the Delaware Basin and DJ Basin. .

Excluding any potential impact from cost of service, we expect our fourth quarter natural gas per Mcf adjusted gross margin to increase slightly, primarily due to the addition of volumes from the Meritage acquisition. Our per barrel adjusted gross margin for our crude oil and NGL assets decreased by $0.31 compared to the prior quarter, primarily due to a decrease in distributions coupled with an increase in throughput from our equity investments. which have lower than average per barrel margin as compared to our other crude oil and NGL assets. Excluding any potential impact from cost of service, we expect our per barrel adjusted gross margin in the fourth quarter to increase slightly, primarily due to a lower throughput expectation from our equity investments. Our per barrel adjusted gross margin for our produced water assets increased by $0.01 compared to the prior quarter, mostly due to contract mix. We expect our per barrel adjusted gross margin in the fourth quarter to be in line with our third quarter results.

During the third quarter, we generated net income attributable to limited partners of $271 million, adjusted EBITDA in the third quarter totaled $511 million, a quarter-over-quarter increase of 5%. Relative to the second quarter, our adjusted gross margin increased by $35 million. This was mostly due to increased throughput across all 3 products in the Delaware Basin, paired with increased natural gas throughput in the DJ Basin. As expected, we experienced a sequential increase in our operations and maintenance expense primarily due to increased utilities and asset maintenance and repair expenses. The sequential increase in utility cost was driven by higher electricity prices as well as higher utility usage, which is typical during the hotter summer months of the third quarter.

Keep in mind that approximately 25% of our overall utility expense impacts our adjusted EBITDA as the remainder is reimbursed either cash reimbursement of electricity costs or contribution of fuel gas for reimbursement of electricity equivalent costs. We expect our operation and maintenance expense in the fourth quarter to be in line with our third quarter results as lower utility costs are partially offset by the inclusion of 2.5 months of contribution from Meritage. Our property and other tax expense decreased on a sequential quarter basis from a reduction in the ad valorem property tax accrual related to the finalization of rates in West Texas and lower property values in Colorado.

Turning to cash flow. Our third quarter cash flow from operations totaled $395 million, generating free cash flow of $200 million. Free cash flow after our quarter distribution payment in August was a use of cash of $21 million. From a capital markets perspective at the end of the third quarter, we accessed the debt capital markets for the second time this year, issuing $600 million of 5-year senior notes with a 6.35% coupon, the proceeds of which were used on a portion of the Meritage acquisition. We were pleased with how well the issuance was received by the market. an order book more than 4x oversubscribed and a deal that ultimately priced at 170 basis points above the 5-year treasury rate.

Since we expanded our unit buyback program to $1.25 billion in November of 2022, we have repurchased approximately 50% of the total aggregate consideration allocated towards our unit buyback program or just over $622 million. This includes 5.1 million common units purchased from Occidental in the third quarter for a total aggregate consideration of $128 million and for an average price of $25 per unit. Focusing on the base distribution. In October, we declared a distribution of $0.5750 per unit, an increase of just over 2% compared to the prior quarter's distribution, payable on November 13 to unitholders as of November 1.

We remain committed to our capital allocation framework, and we will continue to maintain a balanced approach of retiring debt buying back units opportunistically and increasing our base distribution over time. We will continue to be good stewards of our unitholders' investment by efficiently allocating growth capital that will create the greatest value for our unitholders with the ultimate goal of prudently growing just EBITDA and free cash flow.

Moving to annual throughput growth rates. With 2.5 months of contribution from the Meritage assets, we now expect average year-over-year natural gas throughput growth to be in the mid-single-digit range for 2023. We continue to anticipate low single-digit growth for crude oil and NGL throughput and upper teens throughput growth for produced water. Keep in mind that our crude oil and NGLs growth expectations for 2023 excludes the impact of Cactus II from our 2022 throughput actuals.

Focusing on basin-specific activity, we still expect the Delaware Basin to be the main driver of throughput growth, and we continue to expect average year-over-year throughput growth all 3 products in the basin as we exit this year. Although we believe the throughput declines in the DJ Basin have subsided, we still expect to average year-over-year throughput to decrease for both natural gas and crude oil and NGLs relative to 2022. Steady online activity and increased producer activity levels that resulted in additional wells coming online contributed to the end of this decline and should provide continued modest growth for both products during the fourth quarter. These projected changes in natural gas and crude oil and NGLs throughput in the DJ Basin are expected to have a minimal impact on our adjusted EBITDA in the near term due to the current structure of demand and deficiency fee revenues.

Pivoting to financial guidance, we now expect to be at the high end of our previously revised adjusted EBITDA guidance range of $1.95 billion to $2.05 billion. This is based on our third quarter financial performance and the expected adjusted EBITDA contribution from Meritage in the fourth quarter. With that said, we are maintaining the following 2023 guidance ranges from the prior quarter. Total capital expenditures of $700 million to $800 million, includes additional growth capital for Meritage as well as capital for both Mentone Train III and our North Loving plant. While we expect some Mentone and North Loving plant capital to push out of 2023 and into 2024 based on construction time lines. We still expect the plants to be operational by the end of the first quarter of 2024 and the first quarter of 2025, respectively.

Free cash flow of $9 million to $1 billion, which includes the incorporation of the Meritage capital expenditure plan for the remainder of 2023. Based on our most recent increase to the base distribution in conjunction with the closing of the Meritage acquisition, we've grown the base distribution to approximately $2.21 per unit for 2023. We slightly exceeding our base distribution guidance range of at least $2.185 per unit. We will continue to evaluate the base distribution on a quarterly basis and will consider recommending an increase in the base distribution to our Board as the underlying fundamentals of our business support additional adjustments.

We also remain committed to our enhanced distribution framework with a net leverage threshold of 3.2x for year-end 2023. With that said, we remain committed to the concept of returning excess free cash flow to unitholders if we can't find a better use for that capital during the year. And as Michael said earlier, we see a path to pre-Meritage leverage levels by year-end 2024. Finally, focusing on 2024. Even though we have not yet provided official guidance, we expect our average year-over-year throughput for our operated assets to increase relative to 2023. In the Delaware basin, producer activity levels remain strong, and we expect more wells to come to market year-over-year. In the DJ Basin, we reached the trough of the decline in the third quarter.

Going forward, we expect modest increases in total volumes over the coming quarters and more noticeable growth in the back half of 2024, especially for natural gas volumes, but crude oil and NGL volumes would be at a slower, more moderate pace. Increased throughput in the DJ Basin in 2024 will have a minimal impact on our adjusted EBITDA due to demand and deficiency fee revenue we collect associated with minimum volume commitments. We also expect healthy natural gas throughput growth in the Powder River Basin associated with the addition of Meritage assets.

Turning to capital expenditures. We are seeing septal needs pushed into 2024 due to updated plant construction time lines, capital expansion projects moving into next year and flex producers pushing well connects into early 2024. As such, we expect some of the capital cost for Mentone and almost all of the cost for North Loving plant to come in 2024 and as we look to bring those facilities online in early 2024 and early 2025, respectively. Additionally, now that the transaction is closed, we continue to evaluate the capital needs for the new Meritage assets. We expect 2024 to be a slightly heavier capital year for these assets in order to complete certain expansion projects needed for increasing throughput in both '24 and 2025.

With that, I will now turn the call over to Michael.

[Michael Ure, executive]

Thank you, Kristen. Before we open it up for Q&A, I would like to highlight a few key points and reiterate why West is in a strong position as we exit this year and transition into 2024. West is very well positioned for throughput and adjusted EBITDA growth in 2024 relative to 2023. We expect to benefit from capital-efficient organic projects such as Mentone Train III by the end of the first quarter of 2024, and we are to complete the North Loving plant by the end of first quarter 2025. Keep in mind, these capital expansion projects are supported by significant minimum volume commitments, and we continue to expect that the plants will be full once they come online. These plant expansions will put us in a strong position to capture more value for our partnership to increase natural gas processing capacity. The Meritage acquisition was consummated at an extremely attractive valuation, which should result in approximately $155 million to $175 million of incremental adjusted EBITDA based on the 5 to 6x pre-synergy multiple we highlighted when we announced the transaction. .

Additionally, we continue to be focused on returning capital to stakeholders, which is demonstrated in our leading total capital return yield amongst midstream companies. Our view is that M&A opportunities, like Meritage enhance capital return opportunities over time with expanded adjusted EBITDA and increased free cash flow generation, we remain committed to a balanced approach to capital return as seen with the additional increase of base distribution upon closing of the Meritage transaction and our opportunistic unit buyback from Occidental in September. Finally, West continues to screen favorably relative to midstream companies and members of the Russell 3000 Index. When comparing the midstream sector relative to the Russell 3000 Index, West is now the leading midstream investment opportunity with an instrument grade credit rating and a trailing 12-month distribution yield of nearly $0.09.

I would like to close the call by thanking the entire West workforce for all of their hard work and dedication to our organization. I would also like to extend additional things to all of our employees that have been part of the Meritage acquisition. Your effort enabled us to close the transaction quickly and begin moving forward with integration whether it's working on strategic acquisitions or enhancing our daily operations, our employees' contributions continue to yield substantial results that are creating value for our stakeholders. I look forward to finishing the year on a strong footing and updating you on additional progress as we transition to 2024 on our fourth quarter call in February. With that, we'll open the line for questions.

[Operator]

[Operator Instructions]

Your first question comes from the line of Spiro Dounis with Citi.

[Spiro Dounis, analyst]

Maybe starting with Meritage, if we could. Michael, as you said in your prepared remarks, a really hasn't been part of the strategy historically. So this is kind of new. So just curious, is this a shift in strategy or just seeing a more conducive M&A environment? And if you can maybe just provide a little more context on how Meritage came together?

[Michael Ure, executive]

Yes. Thanks, Spiro. Definitely not a shift in strategy. Our strategy has always been that we would be opportunistically looking for M&A opportunities. This is an acquisition opportunity as we looked at footprint out there. From our perspective, it was either needed to potentially exit the area or get larger. As we looked at this particular opportunity and at the area as a whole, we got really excited about what this might be to become for us and for the company overall. And so it's a company and an opportunity that we've actually been following for quite some time. And then the timing just made a lot of sense post our transformation for us to be able to feel confident that we could tuck in these assets and be able to achieve greater synergies and potential opportunities for growth on the heels of the work that we've been doing in order to get more efficient across the board in our operations. So definitely not a shift in strategy, just executing opportunistically as we had indicated, and that opportunity really found a home as we executed that transaction in the third quarter.

[Spiro Dounis, analyst]

Got it. Got it. Helpful. And switching gears to CapEx. First, it sounds like in your remarks there, a few factors coming together that maybe keep CapEx a little bit elevated next year. Sounds like Delaware, obviously, there's 2 processing kind of your biggest spend, which makes sense. But in looking at the DJ and Meritage, once again, kind of a 2-part question here. DJ is growing again, should we expect more capital to be allocated there as a result? Or do you kind of have a long run rate of sort of available capacity? And with Meritage, you also mentioned higher capital needs next year? Just maybe a sense of what is the nature of that spending? Is that well connect CapEx or something more substantial?

[Kristen Shults, executive]

Yes. So on the DJ, you're right, Spiro, we've got extra capacity in the DJ right now. So I'd say any capital that we're spending there will be relatively minimal kind of what you've seen in 2023, just as we're connecting new pads and so forth and so on. For Meritage, yes, there's a little bit more growth capital next year for Meritage. And so well connects compression and things of that nature that I would expect to hit the 2024 budget.

[Operator]

And your next question comes from the line of Brian Reynolds with UBS.

[Brian Reynolds, analyst]

Maybe to follow up on Spiro's CapEx question, Kristen, I think you mentioned that you expect the processing plants to effectively open full. So how should we be thinking about the next processing plant just given that it seems like WEST is gaining more and more acreage dedications in the Delaware?

[Michael Ure, executive]

Yes, Brian, that's a great question. Yes, the way they manage that we've offloaded volumes in order to bridge the timing between when it is that we receive the commitments from our customers as to when those commitments kicked in to take sort of the interruptible volumes. We've offloaded in order to bridge that timing to when that plant comes online. And so that's a plants come online that they're ultimately full. As we sit here today, first, we expanded the North Loving area in a new greenfield area with the opportunity for us to expand more of that footprint should the need arise. But as we sit here today, we don't currently see the need in order to offer up additional expansions on North Loving.

[Brian Reynolds, analyst]

Great. Appreciate that. And then looking ahead to '24, it sounds like there will be some growth. Clearly, the Delaware is growing and the processing plants are running full. But is there any way to sensitize how many volumes are currently being offloaded and potentially the impact that will have on margin that comes back onto your system? And then as it relates to DJ, some tailwinds there with the first quarter of growth when should we expect to be above those MVCs at this point? Is it second half of '24 or early '25 at this juncture?

[Kristen Shults, executive]

Yes. So on the growth side of things, as Michael was saying, we're offloading volumes today. And so as we're bringing Mentone III online, the capacity of that train rate, you would expect that to get on our system and decrease those offloads. So quite a bit that's being offload today. Obviously, when we're saying that we expect Mentone II to be full on day 1. And then -- sorry, Sue, can you repeat your last question that you answered -- you asked?

[Brian Reynolds, analyst]

Just as it relates to margin, I mean, could see some margin benefits just given that you're no longer offloading integrated?

[Kristen Shults, executive]

We definitely will. We expect to see a little bit of margin benefit incremental every month from that. So higher OpEx on our side as we're obviously running that plant, and we've got people that are on that plant, maintenance as well not. But yes, I would expect to see some adjusted gross margin benefit as the offload fees are reduced.

[Michael Ure, executive]

And then Brian, to answer your question on the DJ, we would -- we currently would still expect that there would be minimum volume commitments received primarily on the oil side throughout 2024 as it sits here today.

[Operator]

And your next question comes from the line of Jeremy Tonet with JPMorgan.

[Jeremy Tonet, analyst]

Jeremy. Just wanted to take a step back and think about the -- your portfolio as it stands right now, your base business. And if we think about just the organic growth that's possible, how do you think about that right now in general as far as it low single digit, mid-single digit otherwise? Just wondering how you think about organic growth. Obviously, you're not giving '24 guide, but just trying to get a sense for how you think about the business at this point?

[Michael Ure, executive]

Yes. So I would I'd attention to Slide 9 in the deck where we talk about our estimated growth rates for 2023. And as we look into 2024 expectation that we'll actually grow on top of 2023. And so we're seeing positive tailwinds, frankly, throughout our operated portfolio, which are contributing overall to an expected growth in 2024 over 2023.

[Jeremy Tonet, analyst]

Got it. And from EBITDA perspective, any color that you could share there?

[Michael Ure, executive]

No close just yet. We haven't actually put out guidance, but definitely look forward on the next quarter call to walk through our expectations for 2024. We're still in the process of receiving full information from a lot of our producers in terms of what their drilling plans and expectations are for the back half of this year and into the first part of next year that will be the primary drivers for what our expectations might be on volumetric growth for 2024. So as we gather that information and then are able to share that with the market on our call in the first quarter of next year, then we'll definitely be able to walk through what our expectations might be on EBITDA growth.

[Jeremy Tonet, analyst]

Got it. That's helpful there. And I just wanted to shift to the DJ for a minute, if I could, and see that Williams kind of got a bit bigger in the basin. I think they're now the #3 process there. Just wondering if this changes the competitive dynamics in any way or any other thoughts that you could share with us on the DJ at this point?

[Michael Ure, executive]

Yes, it's a great question. Definitely don't foresee that having a meaningful impact on us in terms of the competitive dynamics. Williams is a great company. And so the fact that they're investing as much as they are in the DJ. Obviously, it's a very positive sign from our perspective. corroborates our view of the basin as a whole and the highly prolific nature of that basin. But I certainly wouldn't expect that it would have a meaningful impact on us.

[Jeremy Tonet, analyst]

Got it. And if I could just sneak 1 last 1 in for the Meritage acquisition. Just wondering, on a per unit basis, is it accretive or dilutive to per Mcf or per barrel fee? And just how do you see the trajectory from this business over time?

[Kristen Shults, executive]

So it would be accretive on a per Mcf basis. I actually expect in Q4 to see our gross margin per Mcf increase just a little bit as we add those Meritage volumes into our throughput numbers.

[Operator]

[Operator Instructions]

Our next question comes from the line of Neel Mitra with Bank of America.

[Indraneel Mitra, analyst]

I just wanted to understand maybe the rationale going forward, underpinning distribution increases. Now that Meritage is in the mix and debt is a little bit higher. I wanted to understand the priorities with capital allocation? And when you look at distribution increases, do you have a formula where you look at payout ratios or percentage of CFO? Just wanted to understand the background behind that and how you're looking at that going forward?

[Michael Ure, executive]

Yes, it's a great question, Neel. So our primary driver is that we want to be able to set the base distribution at a level that we believe is stable over time. And so the reason for actually now the multiple increases in the base distribution that we've had this year were primarily for the first one, the fact that we had received Bcf of incremental commitments overall since we had established that primary base distribution level and the fact that we're spending as much growth capital as we are, which would indicate stronger sustainability from a free cash flow perspective as we go over time.

With the most increase in the distribution. It was the fact that we're bringing on incremental through the Meritage acquisition, and so therefore, our expectation of a sustainable level increase in light of that new free cash flow is coming online with that transaction. And so when we look at it on a holy basis, we're looking at what do we believe is actually a sustainable base distribution level going forward. We haven't actually made any changes at all in terms of our prioritization of return of capital for the remaining free cash flow that we have on an annual basis, we're always looking at opportunistic ways that we can that capital.

So for example, if in a particular period, we think it's of great benefit to pay down debt, then we'll pay down debt if there's great opportunities on the unit repurchase side, then we'll do that. And obviously, this year, we've actually seen pretty much both of those things through debt repurchases, unit repurchases as well as the addition of Meritage into the company. And so that's going to continue to be our levers that we pull. And as we have potentially continued progress in terms of our expectations, sustainability of that base distribution going forward then, we'll look at it on a quarterly basis with the board and determine whether or not we think it warrants an increase overall. If we have superior year performance relative to expectations and that puts us in a place to be able to pay and enhanced distribution as we meet those criteria that we've highlighted in our slides. And then that's where the base distribution comes in to pay out that incremental value relative to our expectations for that period. So I hope, Neel, that answers your question. .

[Indraneel Mitra, analyst]

Yes. That's very helpful. I appreciate it. And just as a follow-up, I know you can't answer the numbers shake out, but maybe you could just kind of outline the factors that go into cost of service for the calculation next year? I know the wells were turned in line later than expected similar commodity prices. But as I understand it, it's backward-looking and forward-looking and there are some other components. So are there any general themes that we should look at going into next year?

[Michael Ure, executive]

Yes, it's a great question, Neel. So the way that, that calculation works is that it takes the previous period. So in this instance, it would be 2023 relative to of free cash flow under those contracts for 2023 and combines that with the expectations of the free cash flow out through the end of the period of those contracts, and then determines in accordance with what the predetermined rate would be, what the fees would ultimately need in order to generate that rate of return. So in a scenario where there's underperformance on the volumes, if all expectations were held flat, the same as they were before into future periods, you would expect that those rates would have to go up in order to generate the same expected rate of return that was expected as of the previous year when that rate was determined. .

So does that hopefully give you a little bit of context of how that works. As we sit here today, we don't know quite yet what those long-term forecast would be in order to generate that rate and then what the cost would be in order to bring those volumes onto the system to generate that return. That will occur throughout the end of this year into the first part of next wherein we'll be able to give a little bit more information on our expectations for 2024 EBITDA and capital.

[Operator]

And the next question comes from the line of Gabe Moreen with Mizuho.

[Gabriel Moreen, analyst]

Maybe I can just start with a quick clarification on the CapEx spend next year what Kristian talked about it being a heavier year. Is that just heavier compared to 2023? I just wanted to clarify that.

[Kristen Shults, executive]

Yes, that's right, Gabe. So heavier compared to why Meritage was spending in 2023. I think when we looked at doing the due diligence on that. And historically, you're looking around $50 million of kind of a run rate CapEx spend for an asset like that. And so heavier relative to that just slightly.

[Gabriel Moreen, analyst]

Got it. Okay. And then maybe if I can ask it. It's been a couple of quarters here when you talk about staff Texas volumes being up. I know you talk about that very much considering the other basins that you've got. But can you just talk a little bit about what's going on there, less competitive position? Are you spending any capital out there that would be helpful?

[Michael Ure, executive]

Yes. So actually, that's frankly a reflection of the incredible job the team is doing down there and establishing new relationships and with those new relationships, garnering increased confidence counterparties actually bringing more volumes onto our system. So actually, not a meaningful amount of capital. It's really more of a reflection of the team's excellent job and gaining confidence from new customers coming into the area. So we believe we're definitely competitively positioned there. But as much as anything, speaks to the strong customer service element of the way that we think about the business and the high-touch nature with our customers that is resulting in increased volumes coming on in our system.

[Gabriel Moreen, analyst]

Maybe if I can just stay in that third-party customer vein. Earlier you mentioned the milestone that you've had across and third-party volumes overall. But as it pertains to getting more third-party volumes, particularly in the Delaware Basin. Can you just talk about West's positioning in terms of being a little bit less integrated than peers in terms of your downstream assets? Are you viewing that as a hindrance that you don't have that integration that you might need it? Or really the shoe on the other foot because everyone is looking to add downstream capacity to your third-party producer customers can kind of pick and chose between different options?

[Michael Ure, executive]

Yes, it's a great question. Actually, the way that we look at it is, obviously, we can provide an integrated solution for our customers by combining all of the marketing needs and then creating flow assurance through the marketing process that we do at no cost to us, it's all passed back. But we actually -- but is a positive that we can then differentiate ourselves through the high-touch nature of our service operations and through our ability to be so concentrated on making sure that volumes that are coming from their customers are cared for properly and that we are focusing exclusively on making sure that optimizing their throughput coming through the system overall as opposed to providing some arbitrage through the system down to the water. And so for us, inherent in making sure that we provide a superior customer service product, making sure that our operability, which incidentally has increased every quarter this year that our operability is high and sustained such that our customer base knows that we're going to be strong stewards of the relationship that we have overall with them. So frankly, we view it as a great opportunity for us to differentiate ourselves. And what you're seeing by virtue of that third-party growth as well as those increased commitments from our customers is it's rained in terms of our new customer acquisition and retention.

[Operator]

And your next question comes from the line of Ned Baramov with Wells Fargo.

[Ned Baramov, analyst]

You've had the Meritage asset for several weeks now. Could you maybe talk about the integration progress and any early findings on the magnitude of potential synergies?

[Michael Ure, executive]

Yes. So thanks for the question. Actually, what we found is a great overall between the 2 companies. as far as an integration perspective, it's literally like hand in glove at the field level. The teams are working very well together overall. The team is very excited about being a part of a franchise like for Midstream. And we're obviously very excited to have them into our organization. So it's still a little early to be able to determine what might be from a synergies perspective because we're trying to make sure that we're diligent in finding all opportunities that we can potentially drive greater EBITDA growth out there. But I would say overall that the integration is going very positively and the teams are really excited to work well together.

[Ned Baramov, analyst]

And then on the new customer contract, are the economics of the extended agreement comparable to what you had in place with this customer before the amendment?

[Michael Ure, executive]

So it is an extension from this existing customer that we would say are done at very competitive rates overall. So it's an addition of incremental acreage into the system and an extension of an existing agreement at competitive rates. So it's a customer that we have had a long-standing relationship with an incredible report. We have the highest amount of respect for them and obviously, it appears as if they do the same for us. So we're really excited about being able to continue that relationship long into the future.

[Operator]

And I will now turn the call back over to Michael Ure.

[Michael Ure, executive]

Thank you, everyone, for joining for the third quarter call. I would like to wish everyone an early, happy holidays and look forward to speaking again in the first quarter of next year.

[Operator]

And this concludes today's conference call. You may now disconnect.