May 5 (Bloomberg) -- General Electric Co.’s Oil & Gas unit, which invested $4.1 billion in acquisitions since October, is increasing research spending on new products including equipment to extract fossil fuels from the ocean floor and shale rock.
Oil & Gas is spending a record 4 percent of sales a year in research and development, excluding acquisitions, said Claudi Santiago, the unit’s head. The company introduced products this week including a black-box system, similar to that used in commercial jets, that can withstand deep-sea pressure in underwater drilling and remote-monitoring software that crunches time-use data.
Revenue from service contracts tied to such products “will continue to grow strong double digits because there are massive opportunities to upgrade our installed base of equipment all around the world,” Santiago said in a telephone interview this week.
Opportunities lie in areas such as Brazil, Australia, West Africa and to a lesser extent, Canada, while extraction of oil and natural gas from shale rock is rising in North America.
The unit’s focus tracks the strategy at the parent company, where Chief Executive Officer Jeffrey Immelt has boosted industrial research and development spending to about $6 billion this year, the highest ever.
GE Oil & Gas predicts about $11 billion in total sales this year, up from more than $1 billion a decade ago, making it one of the fastest-growing businesses at the Fairfield, Connecticut-based company.
Positioning the Business
Acquisitions since October have included John Wood Group Plc’s well-support division and Wellstream Holdings Plc, an oil services provider focused on Brazil, for a combined $4.1 billion, and parts of the $3 billion Dresser Inc. takeover.
The division’s record of integrating previous purchases such as the 2007 acquisition of Vetco Gray Inc., along with booming demand for new sources of fossil fuels in both developed and emerging markets, drove the recent expansion, he said.
“We have positioned the business extremely well for the next decade,” Santiago said. “When the dust settles, and we put on the board numbers I know they are going to deliver, our shareholders will be very pleased.”
Sales in the first quarter, which included only one month of Wellstream results, rose 12 percent to $1.79 billion, with profit rising 4 percent to $199 million.
Because GE Oil & Gas now does business in more than 100 countries, it can act as an entry conduit in those places for the parent company’s other businesses, Santiago said.
Service Contract Sales
In the first quarter, the oil and gas unit reported an equipment backlog of $7.5 billion, with a service agreement backlog of $4.1 billion. Investing now will lay the foundation to increase sales of service contracts, which have higher, steadier margins than equipment alone, during the next decade, Santiago said.
Services revenue of less than $200 million 10 years ago “now is $2.5 billion,” he said.
In the first quarter, the Oil & Gas profit margin of 11 percent fell below some analyst estimates, as Santiago invested in developing products, some of which use technology from the parent company’s other divisions. Those include the world’s biggest makers of aircraft engines and medical-imaging equipment and related software. That spending will weigh on margins for the next two to three quarters, he said.
“Obviously in the short term, as we are spending all that money to create and accelerate, it’s going to put a little bit of pressure in the margins,” Santiago said. The investment will contribute to growth “over the next decade,” he said.
The ability to increase oil extracted from wells by 2 or 3 percentage points versus competitors gives GE an advantage, Santiago said.
Liquefied Natural Gas
Producers are boosting exploration for oil and natural-gas liquids in the U.S. because of higher crude prices, which have climbed 37 percent in the past year. The number of land rigs active in the U.S. over the past 12 months has climbed 25 percent to 1,769, according to Baker Hughes Inc.
Annual production of gas from shale in the U.S. climbed 57 percent last year to 4.87 trillion cubic feet, according to the Energy Department. Shale formations include dense rock that can be fractured to release oil and gas.
“With what happened in Japan in the nuclear industry, we see gas becoming a key source of energy in the power-generation industry” and liquefied natural gas demand continuing to grow, he said. “We believe gas will become the de-facto cleanest source of energy.”