Petrolog Automation Consulting ProjectBy: Caitlin Hempstead, Hannah Schuyler, Ryan Thompson, Denis Kraft

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Table of Contents

Overview……………………………………………………………………………………………………………..…………….........3

Readiness Assessment……………………………………………………………………………………………………….........4

Marketing Plan………………………………………………………...……………………………………………………………....6

Supply Chain………………………………………………………...………………………………………………………….….……8

Financial Analysis………………………………………………………...………………………………………………………….10

Implementation………………………………………………………...…………………………………………………….……..13

Lean Experimentation………………………………………………………...…………………………………………………..15

Resources………………………………………………………...……………………………………………………………………..16

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Overview

Petrolog Automation Inc., headquartered in Odessa, Texas, produces and distributes a patented Pump Off Controller (POC) designed to increase barrel count and optimize oil well efficiency, by automating the control of the well, which is traditionally done by a timer. The company also specializes in Remote Monitoring of the product and its effects on production, which can be monitored through a web-based interface. Petrolog Automation’s solutions allow for increased production and significant reduction in operational costs.

Though the pump off controllers work on oil wells of all sizes, Petrolog specifically targets stripper wells (wells approaching the end of production capability) because they “do not qualify” for traditional pump off controllers, which can be a costly investment for low-producing wells. The devices are produced in Mexico by DTE Global S.A., Petrolog Automation’s sister company.

At a recent trade show, ELKAM, a Russian oil production equipment and maintenance provider, expressed interest in distributing Petrolog’s pump off controller in the Russian marketplace. In this report, we will:

Analyze the market for Petrolog’s product viability Examine the profitability of a distribution partnership with ELKAM Provide recommendations to Petrolog going forward

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Readiness Assessment

Prospective Market Attractiveness Summary

Industry-agnostic Analysiso Relatively average competitiveness

Global Competitiveness ranking: 43/138 (World Economic Forum)o Extremely poor road infrastructure

Roads ranking: 123/138o Extremely poor intellectual property protection, but improving

IP Protection ranking: 117/138 Patent application ranking: 43/138

o Economic growth has slowed since oil prices plummeted in 2014o High government control over strategic industries

All strategic sectors (including oil) dominated by large enterprises in which the state owns a majority share

o FDI skyrocketed between 2010-2014, but has plummeted Signals low investor confidence in Russian economy

o Tariffs in Russia are relatively high, so imports are low

Industry Specific Analysiso High oil production - largest industry in Russia

Largest producer and reserve of natural gas Produces about 11 million barrels of oil per day (12% world total)

o Oil products constitute largest industry and dominant export 55% exports are oil products Russia imports very little

o Oil prices have been declining, so profitability is lowo VIOCs (Vertically Integrated OIl COmpanies) are responsible for 90-95% of oil

production These companies are controlled by Russian government Oil is seen as a matter of national security

Client Specific Analysiso Stripper wells are particularly sensitive to low oil prices

Low production volume restricts economies of scaleo Poor road quality and Russia’s large landmass would restrict partner’s ability to

distribute product to oil producerso High government control via VIOCs would require industry expertise and

networking in order to sell deviceso Low IP protection would require extensive measures to prevent competitors from

imitating device design

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The Russian oil industry offers great potential for Petrolog’s product. However, the characteristics listed above would make market penetration extremely complicated for Petrolog to perform independently, costing the company time and resources that would be better allocated in expanding domestically.

Luckily, a partnership with ELKAM would allow Petrolog to leverage their market expertise and current customer base in order to reduce most of the risk, as this company specializes in oil well equipment sales and is very familiar with the Russian market.

Overall, we feel as though this is an attractive opportunity for Petrolog to introduce their product internationally so long as they take extreme caution in legally protecting their intellectual property through the Russian government. Below, we discuss the specifics of a partnership with ELKAM.

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Marketing Plan

Mentioned earlier, a partnership with ELKAM would offer many benefits for Petrolog. Our main goal is to reduce costs, improve efficiency, and increase customer satisfaction in the Russian market. Although a partnership with ELKAM gives the company full control over marketing to end-users, we are offering some insightful suggestions.

Product

First, Petrolog will need to make changes to their product to ensure suitability in the Russian market. Specifically, both the instruction and installation manuals must be translated from English to Russian. Because Petrolog’s proprietary technology is cloud-based, the translation effort is both minimal and centralized, making the changes to the Petrolog’s product very simple. Although this process is not very time consuming, money must be allocated for the costs of time and price of labor devoted to this product change. Lastly, Petrolog’s domestic business model includes installation and maintenance services in addition to device sales. This service has proven to work domestically, but we suggest ELKAM strays away from this element of Petrolog’s business model due to the fact that oil wells in Russia are in remote, hard to reach locations.

Because Petrolog’s POCs universally fit all oil wells, no physical modifications are necessary. We would recommend that ELKAM distribute satisfaction surveys to customers in order to maintain consistency and ensure quality of the imported devices.

Price

We suggest that Petrolog sells devices to ELKAM at 85% of the domestic sale price. This distributor profit margin is fairly standard (Gray, 2016), though Petrolog will need to evaluate a modified cost structure under the new exporting model, which will include the cost of modifications (discussed above) as well as transportation costs and tariffs.

As with any export, it is important for Petrolog to be aware of the price changes that occur when entering the Russian market and adapt accordingly. Because the Russian economy has been declining, we suggest that Petrolog examine the exchange rate at least every three months and adjust Russian pricing. This practice will stabilize the price of the product in the Russian market in the short term, as well as ensure profitability in the long term.

Promotion

We are suggesting ELKAM implements a “push” strategy to ensure success for the distributor. Because it is an unknown market, it is important ELKAM focuses on this push strategy in an attempt to inform clients of this niche product, rather than using a “pull” strategy, which focuses on traditional advertising. By establishing a presence at Russian tradeshows, ELKAM will have the ability to build a powerful platform and to reach out to potential customers. Also, ELKAM has been a well-established brand for over 20 years and has developed trust and

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credibility, allowing the distributor to highlight Petrolog’s niche product. Trade shows allow ELKAM to quickly educate a wide base of customers about the benefits of Petrolog’s product.In addition, we suggest that Petrolog provide an in-depth training program with ELKAM sales representatives. It is important that the ELKAM staff is knowledgeable about Petrolog’s product and the installation process. This training program will diminish the chance of implementation mistakes. It would also allow ELKAM to effectively promote Petrolog’s POCs and inform potential clients about the specific benefits Petrolog’s devices offer.

Another suggestion for ELKAM is to offer a product demo program to familiarize potential customers with their products. This tactic is a promotional effort that Petrolog currently is implementing domestically. Specifically, this entails installing a small number of POCs at no cost, for up to three months. During the demo period, ELKAM should track any increases in production to demonstrate the attractive ROI of the devices to clients.

As the final clients will be large companies that own large quantities of wells, we suggest that the demo time would only be for a couple of wells. Our main goal with the demo trial period is to show how the product works and the benefits it offers.

In order to maximize ELKAM’s confidence in a mutually beneficial relationship with Petrolog, the partnership contract should encourage loyalty by including a non-compete clause that would span a specified period of time.

Place (Channel Strategy)

As mentioned above, it is important to us that our partnership with ELKAM allows us to foster a relationship that benefits both parties. We want to ensure success for our distributor and believe these suggestions will ultimately drive the company to prosperity.

Our product will only be available for sale through ELKAM, allowing for us to monitor performance and reduce complexity. Furthermore, ELKAM will have exclusive distribution rights to Petrolog’s product.

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Supply Chain

Ideally, Petrolog should be able to establish Free On-Board (FOB) Mexico terms in a contract with distributor ELKAM. In this scenario, liability of the product shipment would be transferred from sister company DTE (manufacturer in Mexico) to ELKAM upon departing the shipping dock in Mexico. These terms would leave Petrolog with very minimal supply chain logistics to handle and consequently very little risk. However, FOB terms are difficult to negotiate, and Petrolog should be prepared for the possibility of managing transportation from Mexico to Russia.

In order to successfully export a product to Russia, there are a number of logistical issues to be considered. For example, our product must be in compliance with the Customs Union Technical Regulations for the Eurasian Economic Union, which Russia belongs to. In addition, Petrolog would need to prepare trade documents such as a bill of lading, commercial invoice and country of origin.

(Exporting markets - Russia).

International Freight Forwarder

Because Petrolog has limited resources and knowledge of the Russian market, our first recommendation is for them to find an international freight forwarding company that will transport their devices by sea freight from the manufacturing plant in Mexico. Benefits of partnering with a freight forwarder (FF) include:

FF will assume liability for products during transportation (contract would ideally specify FOB Mexico)

FF will manage tariffs upon arrival at port in Russia FF can also assist with letters of credit for payments from ELKAM if necessary

Kuehne + Nagel

Should Petrolog decide to enlist the help of an international freight forwarder, we would recommend that they consider Kuehne + Nagel, a Fortune 500 company and leader in logistical solutions. The following factors were considered in selecting this freight forwarder for Petrolog:

Less than Container Load (LCL) option. This service would afford Petrolog the flexibility of sending small batches of devices to Russia without the expense of shipping a full container. LCL may prove to be strategic should Petrolog send a preliminary batch of devices as complimentary samples to ELKAM, which we outline in the Marketing Plan segment of this report. Currently, Petrolog’s largest customer owns only 90 POCs, while 83% of their customers own 20 POCs or less (Petrolog Business Plan). Ideally, ELKAM would eventually establish sizeable customers in the Russian market to allow for large, full-container sized orders from DTE in Mexico.

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KN Login. This web-based data management tool offers clients the ability to track and monitor their shipments between ports.

Excellent reputation. With over 120 years in operation, Kuehne + Nagel is one of the leaders in sea freight shipping worldwide. As Petrolog attempts to penetrate the Russian market, it will be important to have the utmost credibility across all aspects of the supply chain.

Cargo Insuranceo Cargo insurance and risk management services are available to Kuehne + Nagel

clients through Nacora, an affiliated Insurance Broker. Though Petrolog devices are of relatively low value, insurance would protect the small company from potentially detrimental losses.

(KN LC)

Our group reached out to Kuehne + Nagel with a request for a quote, but did not hear back from a representative. We do understand that in some situations, industry leaders with excellent reputations like that of Kuehne + Nagel may not offer the most competitive prices.

Lynden International

In the case that Kuehne + Nagel’s services are out of price range for Petrolog, we investigated an alternative company for freight forwarding services, Lynden International. We believe that the following factors would enable Lynden to provide the services needed by Petrolog:

Operates “company-owned service centers in Moscow and Yuzhno-Sakhalinsk” Offers extensive knowledge of “Russia’s business practices and government

regulations”. Twenty years of experience doing business in Russia. Offer Delivered Duty Paid (DDP) services “to any point in Russia” from the U.S. and

Mexico. Freight is consolidated in Houston which serves as a convenient point of contact for

Petrolog, which is headquartered in Texas.

(DDP Russia Service)

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Financial Analysis

ROI Model

There are several variables to take into account when performing the financial analysis of the market entry in Russia. In this analysis, we will focus on the key variables that would shift the viability of Petrolog’s entry into Russia and examine the effects that exporting will have on Petrolog’s financial model. First of all, there are additional costs related to the exportation of the Petrolog device to Russia, such as:

Transportation costs. The devices would have to be produced in Mexico by DTE and shipped overseas to Russia, so transportation costs would increase significantly. Furthermore, using an IFF as intermediary induces additional costs as well.

Margin edits. Distributors typically charge a 10-15% margin on products sold by them, and this will reduce Petrolog’s margin.

VAT Tax. Additionally, VAT tax in Russia is 18%, compared to the Texas Sales Tax of 8.25%. This increases the cost of the product by 9.75% initially.

Tariffs. Finally, foreign products imported to Russia are subject to a customs tariff. The average tariff for Russian imports is 8.1%, but the exact amount depends on the nature of the product. The IFF can help Petrolog in finding the exact tariff for their products.

On the other hand, Petrolog’s installation and maintenance costs will be drastically reduced when exporting in Russia, as those services will be provided by ELKAM.Secondly, it is important to note that the Russian Ruble has experienced a severe downfall in the last three years (see figure below).

RUB/USD exchange rate (XE.com)

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To arrive at the same amount of US dollars, a Russian consumer would have to spend almost twice as many Rubles today than in January 2014. Naturally, this is harmful for any company wanting to export products to Russia and should be monitored closely. Going forward, Petrolog should examine the price of the device every couple of months, depending on the evolution of exchange rates (see Marketing Plan).

Similarly, crude oil barrel prices have fallen by about 50% in the past three years (NASDAQ: see below), which has lowered oil companies’ margin. This is especially harmful for stripper well operators, as their smaller production quantities limit economies of scale and leaves a slimmer profit margin. Stripper well owners can’t compensate by selling at higher prices due to the commodity nature of oil. Some experts argue that 50% of the American stripper wells would be forced to shut down if oil prices would fall below $40 per barrel (Cunningham). We weren’t able to find specific information about the situation of Russian wells, but it is likely that their profitability margins are similar.

Crude Oil Price in USD (source: nasdaq.com)

While all of the elements presented above seem to be working against Petrolog’s market entry in Russia, there are some factors that encourage Petrolog’s market entry in Russia, which we will examine below.

Size, Growth and Structure of the market. The size and the future growth opportunities in the Russian oil market make it quite attractive (see Market Readiness part) . Furthermore, stripper wells are responsible for a significant proportion of the Russian oil production. We were unable to find specific data, but a Russian website states that 50% of the wells owned by Bashneft (one of the VIOC’s) are stripper wells (Great Encyclopedia of Oil & Gas). Overall, the large size of the players in this market (i.e., the VIOC’s) makes it possible for a company like Petrolog to achieve high sales in Russia by having a couple of large customers.

Adjustments. The ability to reach at least one of these large customers through the distributor is key. We lack specific information about Petrolog’s internal costs and

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margins, and the fee required by the selected International Freight Forwarder. However, it is highly recommended that Petrolog calculate the specific number of devices that need to be sold to justify this international venture. Petrolog should consider the recommended pricing adjustments and other financial factors mentioned above in calculation of their break-even point for this venture.

Diversification. Furthermore, being active in multiple parts of the world is a good way to diversify risk associated with one specific region.

Therefore, Petrolog’s financial success in this market will have some dependence on external variables such as the evolution of oil prices and RUB/USD exchange rates. But the possibility of their success depends mainly on two internal factors - the quality of the relationship with their partner ELKAM and their ability to reach a sufficient number of Russian stripper wells.

This partner has working relationships with large Russian oil companies, so they will serve as an intermediary to enable Petrolog devices to be sold and installed on Russian wells. Using ELKAM as an international intermediary is also a great way to limit the required investment for Petrolog, as this partner will be bearing most of the risk associated with the market entry. Petrolog’s investment in exporting to Russia will mostly take two forms:

Human and financial resources required for: the research and preparation finding a freight forwarder, adaptation of the product for the Russian market, the production and shipment of initial no-cost samples, and the training and education of ELKAM team.

Liquidity required for the new working capital model, explained in the next section.

Working Capital Model

Using ELKAM as a distribution partner for the Russian partner changes Petrolog’s cash-to-cash cycle significantly. Instead of warehousing devices and installing them quickly once an order is placed (like Petrolog currently does in Texas), the company will only start producing the devices in large numbers as soon as an order is put in by the Russian distributor. Once the production stage is over, the equipment will be shipped to Russia in order to be installed by ELKAM. Full payment will likely be received once all the devices have arrived to the distributor.

This whole process requires much more working capital, as there will be a longer delay between the moment when an order is placed and the moment when it is entirely paid for. This increased need for working capital will have to be financed accordingly, either through Petrolog’s own resources or thanks to financing intermediaries, such as:

The International Freight Forwarding Company, that is likely to be able to help with letters of credit between Petrolog and ELKAM;

The Export-Import (EXIM) bank of the United States, that can provides a Working Capital Loan for overseas exports (EXIM).

It may also be possible to lower this required working capital by requesting payment terms that include an initial deposit by ELKAM.

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Implementation

To implement our export strategy in Russia, our client should follow an indirect method of exporting, utilizing an intermediary already located in Russia to distribute our product to the final customer. Our client has been in contact with ELKAM, a large manufacturer and supplier of oil well equipment throughout Russia and CIS countries. Since the Russian oil & gas industry is highly concentrated on a small number of government firms, the success of Petrolog in Russia is highly dependent on obtaining one of these firms as a customer. ELKAM already sells their products to these customers, and would be able to add Petrolog’s controller to their product line of oil well equipment. This would be a mutually beneficial experience, as this would allow Petrolog to bypass the typically long sales process that comes with becoming a supplier to a large government-controlled firm.

To ensure our product shipments securely arrive at ELKAM’s specified location with all documentation correctly completed, we recommend the use of an International Freight Forwarder. We examined two specific companies to utilize as a freight forwarder in the Supply Chain section above. Petrolog should request a quote from both companies, and examine which option is financially viable for them, keeping in mind the importance of this decision with regard to Petrolog’s international future.

To improve their chances of success when exporting to Russia, Petrolog should take extreme care when negotiating the terms of the partnership with prospective partner ELKAM. Petrolog should strongly consider specific terms and our recommendations of how to approach them, such as:

Margin Stack. Petrolog should ensure that the profits are split fairly, and should expect for ELKAM to require about a 15% profit margin of the final sales price for their services. While this may seem drastic, the vast increase in units sold and customer base will generate a significant return. The selling price will have to be slightly raised (compared to US price) to account for the factors mentioned above.

Marketing Rights. Petrolog should understand that there is little reason that paid advertising should be necessary for their product. However, the company should be willing to hand over marketing rights to ELKAM in order to best localize their sales strategy to the Russian market.

Product Adaptations. Petrolog should handle all adaptations to its user interface and instruction manual in-house. They should allow ELKAM to produce localized marketing materials and suggest adaptations that would make the product more suitable for Russia. They should not allow ELKAM to tamper with the underlying software or technology.

After-Sales Service. Petrolog should make ELKAM aware of its current after-sales service, being as transparent as possible in all aspects. However, Petrolog should not commit to any obligations to fulfill an after-sales service with its existing resources. The vast land mass, and relatively poor infrastructure will make the after-sales service model that Petrolog currently has in place much more difficult and expensive to maintain. Petrolog should provide available information on their current after-sales operations,

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and allow ELKAM to perform its proper research and make an independent decision to if it should continue the service or not.

Returns and Exiting the Partnership. Petrolog should negotiate terms that allow for no returns of product unless they are defective. Ensure there are measures included that allow for Petrolog to exit the partnership in the case of an unfortunate event.

Payment terms. If ELKAM is unwilling to provide cash in advance, Petrolog should require a deposit on any large order. Cash in advance is a risky payment agreement on the part of the buyer. Because there will be transportation risk involved, it is unlikely that ELKAM would be willing to pay for the devices entirely upfront. Our recommendation to Petrolog is to establish payment terms that include an initial deposit and full payment upon delivery. If Petrolog should require additional financing to fulfil an order, the company should inquire its chosen International Freight Forwarder or the United States’ Export-Import Bank, which can assist with temporary financing.

Incoterms. Petrolog should try to negotiate FOB terms. If ELKAM, is unwilling to provide FOB terms, Petrolog should request CIF terms. This is most likely the INCOTERM that will be established between Petrolog and ELKAM, as FOB terms are unfavorable and risky for the buyer. Under these conditions, Petrolog would be responsible for the cost of freight and insurance to transport the goods to the named port of destination. Once the product has arrive to ELKAM, the liability will transfer to ELKAM.

Given the consolidated nature of the industry, we recommend that Petrolog provides 50-100 units initially, to give 5-10 samples to each prospective client, in order to test the market demand. If the market experimentation is successful, Petrolog should provide further inventory at the discretion of ELKAM, but preferably on a per-order basis. Since Petrolog’s product is a capital expenditure, the large companies will likely take a considerable amount of time before placing their order. ELKAM should stay in contact with Petrolog on prospective clients and estimated timelines in order for Petrolog to have the inventory on hand in a timely manner.

The most important factor for Petrolog is the quality of the relationship with its distribution partner ELKAM. Petrolog should exercise extreme caution when interacting, and ensure that ELKAM is being transparent and fair throughout the business relationship and negotiations. Petrolog should ensure that ELKAM is willing to make a commitment to ensure the success of Petrolog’s product in Russia, and be open and responsive to the intermediary’s needs and requests. Overall, Petrolog should defer to the market knowledge of ELKAM, as Petrolog has little international experience and none in the Russian market thus far.

Another key factor is the US Government’s relations with Russia. Petrolog should keep close watch over the events and potential policy changes that could affect their business, arising from the relationship between the two countries. For example, there is a very strong possibility that tariffs could rise.

There are a number of key expenses to take into consideration, including shipping costs, the tariff, tax differences, translation resources, negotiation time, among others. These are all mentioned in further detail throughout the report.

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Lean Experimentation

Since the Russian economy, and specifically the oil industry in Russia are in a down time, the companies will be less willing to spend money on capital expenditure (such as Petrolog’s product). While our product does provide a relatively quick ROI, it should be noted that given the state of the industry, target clients likely won’t have much room in their budget for a product such as Petrolog’s.

Therefore, given the inherent risks and in order to avoid a large share of the risk that accompanies entering an international market, Petrolog should follow the “lean” methodology of testing a hypothesis within the market before devoting significant resources to the project.. These are significant factors that went into Our hypothesis is: the Russian oil & gas industry is viable market for Petrolog’s POC-G2 controller.

The main experiment we recommend are samples, or surveys. We believe that providing a small number of samples of the product to target customers, then following up and presenting the results of how our product has helped some months later, would be the best way to enter the market. However, we were not provided sufficient data to calculate how long or how many units would be needed to provide significant return, and if our client has the resources to be able to provide such products at no cost.

Therefore, we suggest that ELKAM contact each target customer, and present the benefits of Petrolog’s product, and which wells it would benefit most, in a fitting manner. It should provide data relevant to each key decision maker within the company, and perhaps even provide an interactive calculator. The calculator would ask for the number of wells applied, have preset options of 5, 10, 20 years and then display the revenue saved or earned due to Petrolog’s product. The content should be followed with a short survey.

o The survey should ask: If they would be interested in receiving samples of the product How many wells they think their company could apply this product to Contact information

ELKAM should then follow up with the respondents, providing a presentation in-person with a more customized approach to how their company could benefit. ELKAM should ask the client to gauge their purchase timeline and size of order and relay that information to Petrolog in a timely manner, before any order is made. Petrolog should then evaluate the opportunity and any suggestions made by ELKAM, and if interest is great enough, proceed to follow the necessary steps to fulfill the order.

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Resources

"KN LCL." Kuehne + Nagel. N.p., n.d. Web. 02 Dec. 2016.

"DDP Russia Service, Door-to-Door Shipping to Russia | Lynden International." Lynden International. N.p., n.d. Web. 02 Dec. 2016.

Petrolog Business Plan

Cunningham, Nick. "Production From Stripper Wells at Risk in Current Price Environment." The Fuse. The Fuse, 06 Jan. 2016. Web. 04 Dec. 2016.

"Commodities: Latest Crude Oil Price & Chart." NASDAQ.com. N.p., n.d. Web. 30 Nov. 2016.

"Большая Энциклопедия Нефти и Газа." (Translated as “Great Encyclopedia of Oil and Gas.”) Малодебитные скважины составляют значительную часть фонда насосных скважин. (Translated as Marginal wells account for a significant part of the fund of pumping wells.) N.p., n.d. Web. 01 Dec. 2016

"XE Currency Charts: RUB to USD." XE. N.p., n.d. Web. 30 Nov. 2016.

“Types of Exporting” Powerpoint - Alex Gabbi

"Export Markets - Russia." Doing Business - Tariffs and Regulations – Russia – For Australian Exporters - Austrade. Australian Trade and Investment Commission, n.d. Web. 04 Dec. 2016.

Gray, Thomas H. "Reasonable Markup to Distributors." Thomas H. Gray, Profit Spotter. N.p., 2016. Web. 04 Dec. 2016.

"What We Do - Get Financing." Export-Import Bank of the United States. N.p., n.d. Web. 04 Dec. 2016.

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