This Energy Stock Secures a Win-Win Deal to Further Support its 8.8%-Yielding Dividend

Western Midstream (NYSE: WES) operates crucial energy midstream assets to support the operations of its top shareholder, Occidental Petroleum (NYSE: OXY), and other oil and gas companies. Those assets generate stable cash flow to support the master limited partnership's (MLP) 8.8%-yielding cash distribution.

The energy companies recently renegotiated some of their natural gas gathering and processing contracts. These new mutually beneficial agreements, along with a new one with oil giant ConocoPhillips (NYSE: COP), will support the production growth of those upstream oil and gas companies while enhancing the sustainability of the MLP's big-time payout.

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Mutually beneficial agreements

Western Midstream has renegotiated natural gas gathering and processing contracts with Occidental Petroleum in the Delaware Basin. They are replacing the legacy cost-of-service structure of the gathering contract with a simplified fixed-fee structure. The deal will reduce Occidental's near-term costs, enhancing its ability to grow production in the region. In exchange, Occidental will transfer 15.3 million of Western Midstream's common units that it currently owns to the MLP (valued at $610 million). This transfer will make the restructured agreement value-neutral for Western Midstream. As a result, Occidental's interest in the MLP will fall from 42% to 40%.

Additionally, Western Midstream has entered into a new gas-gathering and processing agreement with ConocoPhillips for a portion of its Delaware Basin production. The fixed-fee contract has a term through the early 2030s and will support ConocoPhillips' production growth in the region. This deal will further diversify the MLP's revenue by reducing its related party revenue (Occidental) by more than 10%.

Enhancing the sustainability of the big-time payout

The restructured Occidental Petroleum contracts won't have any impact on Western Midstream's free cash flow. The company expects to offset the reduced near-term cash flows with distribution savings from the common units it received from Occidental and from cost-savings initiatives launched last year.

Additionally, the MLP expects to maintain a net leverage ratio at or near 3.0 times this year, even after accounting for the recently closed acquisition of Aris Water Solutions and the $1.1 billion in growth-oriented capital spending it anticipates in 2026. That's a very conservative leverage ratio for the energy midstream sector.

As a result, Western Midstream's big-time distribution remains on rock-solid ground following the transactions. The company's growth capital spending plan, which includes building the North Loving II gas processing plant and Pathfinder Pipeline, should fuel cash flow growth in the coming years. That will help support the MLP's plan to deliver low-to-mid single-digit annual distribution growth.

An enticing passive income investment

Western Midstream offers a big-time yield backed by the predictable cash flows underpinned by long-term contracts with energy companies like Occidental and ConocoPhillips. Add in its rock-solid balance sheet and visible growth profile, and the MLP is an enticing option for those seeking passive income (and are comfortable receiving a Schedule K-1 Federal tax form each year).

Matt DiLallo has positions in ConocoPhillips. The Motley Fool recommends ConocoPhillips and Occidental Petroleum. The Motley Fool has a disclosure policy.