HBOil Takes North Korean Gamble

BMI View: HBOil 's move into North Korea's oil and gas industry could be a game-changer for the pariah state. It promises to open North Korea's upstream segment and revitalise its downstream segment, offering the country a lifeline from the economic sanctions placed against it. At the very least , HBOil 's investment in the Sungri refinery promises to increase fuel supplies in the region and bring down fuel prices in Mongolia, which would help to support its economic growth. HBOil does risk W estern sanctions for its venture , which runs counter to the West's strategy of squeezing North Korea, though it could also serve as a bellwether of the political viability of exploring opportunities in the isolated country.

Mongolia-based coal and oil trader HBOil has taken a brave step to extend its operations into North Korea. It has acquired Malaysian company Ninox Hydrocarbons , which holds a 20% stake in KOEC International alongside North Korea's national oil company (NOC) Korea Oil Exploration Corporation (KOEC). This would give HBOil a stake in both upstream and downstream assets in North Korea:

  • Upstream : Onshore blocks in the North Korea, spanning an area of 120,540 square kilometres (sq km). HBOil 's official press release is optimistic about the country's upstream potential, highlight ing positive 2D seismic data that is supported by some oil finds in early exploration efforts. HBOil could also acquire offshore acreage, if it exercises an option to take a 51% share in British Virgin Islands-incorporated Blacktip Energy . Blacktip is the owner of Korex , which has product ion rights covering the entire North Korean sector of the Korean East Sea. HBOil specifically cites its proximity to the producing offshore Sakhalin fields in Russia to highlight the prospectivity of this acreage.

  • Downstream : Sungri refinery, located in the Rason City Special Economic Zone (SEZ) in the north east of the hermit country. HBOil will supply the 40,000 barrels per day (b/d) refinery with crude oil, and export refined products to Mongolia.

A Victory Boost

HBOil 's upstream participation will take time to make its impact felt, but its downstream involvement could produce early results. Sungri refinery - also known as Victory - is one of two refineries in North K orea , both of which are majority-owned by the state . It was completed in 1973 and had been dependent on Russian crude feedstock for its operations. Russia had ended supplies to Sungri as part of the six-party talks to end North Korea's nuclear programme. In March 2007, Russian media reported that Russia could resume crude oil exports to North Korea . Gazprom Neft , oil subsidiary of Russian state-owned gas giant Gazprom , had also reportedly shown 'preliminary interest' in helping North Korea rebuild the Sungri refinery.

However, Russia did not appear to have followed through with these plans. During his October 2011 visit to the SEZ in October 2011, b oard director of Choson Exchange John Kim reported that the refinery was currently idle. Kim stated that Sungri was 'very basic' and 'backward' compared to more modern refineries elsewhere in the world, and would need 'over US$500mn' in investment to become competitive. Therefore, HBOil 's participation and the investment it would bring could help bring Sungri online again. In fact, the firm is optimistic that it can make Sungri operational 'within six to 12 months', 'subject to certain repairs and refurbishment'.

Weakening The Western Oil Weapon

If HBOil manages to start-up production at Sungri in the stated timeframe, it would be a boost to North Korea. Crude oil has been one of the key items which the West has imposed trade embargo on in the latter's bid to end North Korea's nuclear programme. These products make up some of the largest commodities by value that China provides for North Korea as part of the former's aid programme, but even supplies from China are unreliable. China had twice suspended crude oil exports to North Korea in 2006 and 2007 in a bid to pressure the latter into softening its stance on its nuclear practices.

Trade embargo es , exacerbated by a lack of crude feedstock for its refineries, have seen North Korea's oil consumption fall precipitously from about 73,211b/d in 1990 to 14,973b/d in 2012. Raising domestic fuel production capacity could ease the country's shortages and support the North Korean regime. It was reportedly in negotiations with Iran for crude oil supplies in March 2013, though the country's election of moderate Has s an Rowhani as president in June 2013 could see it less reluctant to engage North Korea in an effort to make peace with the West . In this hostile international climate, HBOil 's offer of investment and crude oi l in return for fuel products offers a lifeline for North Korea .

Sanctions Hit Consumption
North Korea's Oil Consumption, '000b/d

Mongolian Diplomacy

HBOil's investment in North Korea could bring about a boost to Mongolia's fuel security. Economic growth is fuelling an increase in oil demand, but the country lacks refining capacity to meet its domestic fuel needs. Its crude oil production is mainly exported to China and meets the majority of its fuel requirement through imports from the following countries: Russia (90%), China (4%) and Kazakhstan (4%).

Consumption Hike Brings Need Demands
Mongolia's Oil Production & Consumption, '000b/d

A planned refinery project by Japan's Toyo Engineering Corporation could bring Mongolia's first refinery online by 2015, making 40,000b/d of fuels available for the domestic market ( see 'Moving Toward Domestic Refining', January 18). Importing fuel products from North Korea will help the country further diversify its sources of fuels, reducing its fuel import dependence on Russia. Until North Korea's upstream potential is proven, Mongolia's surplus of crude production can also be exported to the Sungri refinery instead of China, opening up another market for Mongolian crude. This will allow Mongolia to reduce its energy dependence on Russia and China, thereby weakening the two countries' political grip on it.

Alternatively, fuel products from North Korea could be directed to the Russian Far East as part of a fuel swap that would see fuels originally intended for the Russian Far East transported to Mongolia instead. Nonetheless, even in this scenario, the increase in fuel output in the region will help lower prices in the region. This will be to the benefit of Mongolia's growing mining and agricultural sectors.

More Than Just A Frontier Risk

HBOil's decision to enter the North Korean market is a risky one. Although the country is in dire need for foreign capital for development, expropriation risks remain in an economy that is tightly controlled by the state. However, the bigger risk for HBOil could lie in Western sanctions against the firm, as its investment runs counter to the West's strategy of squeezing Pyongyang into giving up its nuclear programme.

Despite acknowledgement of these potential risks, HBOil chief executive Ulziisaikhan Khudree remains optimistic that 'the project will be successful'. This confidence could rest in the unique position played by Mongolia in regional politics. It has diplomatic relations with both the US and North Korea, and has drummed up its credentials as a peacemaker in the region - particularly in March 2013, when it initiated peace talks after Pyongyang declared a state of war against South Korea. Mongolia has also presented itself as a positive influence on North Korea, pushing economic liberalisation in the hermit state through growing economic ties between the two countries.

For the moment, the market has reacted very positively to HBOil's entry into North Korea. At the time of writing, its share price in the Mongolia Stock Exchange had risen 15% since the announcement was made on June 18 to approach levels last hit in January 2009.

Bullish Risk Sentiment On HBOil's Venture
HBOil's Share Price Movement, MNT

It could take longer for this optimism to play out. Given the key role that oil sanctions play in the West's strategy of isolating North Korea, HBOil's latest venture could be poorly viewed. However, the West's reaction would also serve as a bellwether for other firms of the political viability of investing in North Korea's underdeveloped oil and gas industry.

This article is tagged to:
Sector: Oil & Gas
Geography: Mongolia, North Korea

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