U.S. Markets open in 7 hrs 4 mins

Will GE's Bold Oil and Gas Bet Finally Start Paying Off in 2018?

Matthew DiLallo, The Motley Fool

Last year was an unmitigated disaster for GE (NYSE: GE). Challenges in several of its businesses forced it to cut its dividend in half, and its stock plunged a jaw-dropping 44.6%. One of the problem areas was its oil and gas division, which floundered after making a bold bet to merge with oil services giant Baker Hughes to form Baker Hughes, a GE Company (NYSE: BHGE). GE closed that deal in July, right as oil prices were in a free fall. Baker Hughes' first full quarter as part of GE was awful, with financial results missing analysts' expectations, and management issuing pessimistic guidance due to the challenging market conditions.

Oil, however, has roared back since then, and has been in the mid-$60s this year, up from the low-$40s last summer. The higher price could entice oil companies to spend more money this year, which would be good for Baker Hughes' bottom line and might help GE's bet start paying off.

An offshore oil platform with the sun rising in the background.

Image source: Getty Images.

Hints that better days lie ahead

As oil prices were slumping in the middle of 2017, several producers made cuts to their spending plans. Anadarko Petroleum (NYSE: APC), for example, initially expected to spend $4.5 billion to $4.7 billion last year, but it announced in July that it would reduce its full-year spending by $300 million. Around the same time, Hess (NYSE: HES) also cut its budget, trimming it from $2.25 billion to $2.15 billion.

But with oil prices improving in 2018, many oil producers are increasing their spending and drilling activities. Anadarko, for example, expects to spend $4.2 billion to $4.6 billion this year; the midpoint of this guidance range puts it on pace to invest about $100 million more in 2018. And Hess has said it expects to increase its activities in the Bakken Shale by running six rigs there this year, up from four in 2018. In addition, it's teaming up with ExxonMobil (NYSE: XOM) to begin development of their world-class oil discoveries in Guyana, with the first phase costing the companies $3.2 billion. Hess expects to spend $250 million to fund its share of the project this year.

An oil field at sunset.

Image source: Getty Images.

More growth could be on tap if oil holds up

While many oil companies expect to spend more this year, none are opening the taps just yet. However, that could change if oil remains where it is: Several producers have based their budgets on $50 oil, which means they would generate excess cash if current prices hold up. Anadarko, for example, said its 2018 plan could produce more than $700 million in free cash flow for the year -- and that was when oil was lower than it is right now. The company has a range of options for that money, including buying back more stock or increasing its spending level.

Oil companies could choose to reinvest their windfall in exploration, as it's been among the first areas they've cut in recent years, and new oil discoveries have been at the lowest levels in decades as a result. Anadarko, for example, expects to spend only about 9% of its budget on "future upside" projects like exploration this year, compared to 15% last year. By increasing exploration spending instead of drilling more development wells, producers wouldn't immediately add more oil to a still-saturated market, which would help limit the near-term impact on prices. Exploration spending could directly benefit Baker Hughes since the company provides several exploration services.

The industry might also choose to sanction additional large-scale development projects, which also wouldn't immediately add more oil to the market, but would give Baker Hughes a shot in the arm as it provides the necessary services and equipment.

Reasons for optimism

While the new Baker Hughes got off to a rough start amid the oil-price dip last year, 2018 promises to be a much better year for the oil equipment and services company. Improving market conditions, plus the impact from merger-related cost savings, should enable the company to start making money again -- which could help turn around Baker Hughes' slumping stock.

More From The Motley Fool

Matthew DiLallo has the following options: short January 2018 $24 puts on General Electric. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.