June 18 (Bloomberg) -- A Mongolian company has tapped one of the world’s most closed markets by taking a stake in a North Korean oil refinery, to help Asia’s fastest growing economy ease its energy reliance on Russia and China.
HBOil JSC, an oil trading and refining company based in Ulaanbaatar, Mongolia, said it acquired 20 percent of the state-run entity operating North Korea’s Sungri refinery, according to an e-mailed statement yesterday. It intends to supply crude to Sungri, which won’t be fully operational for up to a year, and export the refined products to Mongolia.
“Mongolia has had diplomatic relations with North Korea for many years,” Ulziisaikhan Khudree, HBOil’s chief executive officer, said in a June 12 interview in Ulaanbaatar. “There are certain risks, but other countries do business with North Korea so I am quite optimistic the project will be successful.”
The investment comes as ex-communist Mongolia seeks to power its mining-led boom while offering sanctions-hit North Korea a bridge to economic reforms. Since Swiss-educated Kim Jong Un took over the leadership of the totalitarian regime in December 2011, Mongolia has pledged to help its Soviet-era ally implement an economic transition similar to its own of the 1990s.
In March, Mongolia offered to play peacemaker after North Korea said it’s in a “state of war” with its neighbor to the south.
Mongolia, a landlocked country squeezed between Russia and China, adopted democracy and free elections in 1990, opening up to foreign investment that has focused mainly on its commodity riches. Rio Tinto Group Plc has invested about $6.2 billion in the country’s Oyu Tolgoi copper and gold mine that’s due to start exporting this month.
Although Mongolia has become one of China’s main suppliers of coking coal, used to make steel, the nation of 2.9 million has limited reserves of crude oil and relies on its two neighbors for fuel, which can periodically lead to shortages.
Mongolia has in the last year encouraged what it saw as signs of economic change in North Korea. After a meeting with Kim Young Nam, the North Korean president of the Presidium of the Supreme People’s Assembly, in September, Mongolian President Tsakhia Elbegdorj said he saw the isolated nation taking steps towards economic reform.
Outside of Mongolia, North Korea’s Kim Jong Un has so far failed to improve international relations since succeeding his father. A rocket launch last year broke a food-aid deal agreed with the U.S. in February 2012. North Korea’s proposal for peace talks with the U.S. on June 16 was met with skepticism.
The HBOil deal looks like a “one-off” at this point as rhetoric for economic change in North Korea has not translated into real investment -- a sign that “real reform” has yet to come, said Daniel Pinkston, a Seoul-based analyst with the International Crisis Group.
Still, like Mongolia, North Korea needs to diversify its sources of supply, technology and investment away from China, and business offers that try to improve its own energy security problems will be seen as favorable by the Kim regime, Pinkston said. “I can see all the incentives for North Korea to desire this kind of arrangement,” he said.
Under the transaction, worth as much as $10 million, the Mongolian Stock Exchange-listed HBOil would swap shares for full ownership of Ninox Hydrocarbons (L) Berhad, a private Malaysian company that owns 20 percent of KOEC International Inc., and issue convertible notes to fund investment at Sungri.
The rest of KOEC International is held by North Korea’s national oil company, Korea Oil Exploration Corp., which also has oil production and exploration rights in North Korea.
“This is a chance to take an equity holding in a foreign entity, and will allow us to import petroleum products, which could be lower than the current price,” said HBOil’s Khudree.
HBOil jumped by the daily limit of 15 percent to close at 253 tugrik (18 cents) on the Mongolian stock exchange today.
The deal will be the first purchase by a Mongolian-listed company of a foreign asset, according to Joseph Naemi, chief executive officer of the Ninox parent, Ninox Energy Ltd. The company is in compliance with international sanctions levied against North Korea, he said.
“If the sanctions change, and if they target the oil and gas industry, that would put us out of business, and we will have to comply,” Naemi said. “That is a risk one takes.”
Naemi said he had briefed his North Korean partners on the transaction and that “they are supportive.” No one was available to speak about the deal at North Korea’s embassy in Ulaanbaatar, which is in the middle of a renovation.
North Korean entities are currently under orders “from the top” to boost international deals, attract foreign trade and earn more, according to Pinkston.
North Korea has three onshore oil basins with “proven working petroleum systems” and the country is conducting exploration for new fields, BDSec brokerage, Mongolia’s largest and the underwriter of the bonds HBOil plans to offer, said in a note to investors yesterday.
The Sungri refinery, located in the Special Economic Zone of Rason City in North Korea’s northeast, has a refining capacity of 2 million tons a year and is connected to the Russian railways system, HBOil said in its release.
Oil production in Mongolia rose 42 percent to 3.64 million barrels in 2012 compared with a year earlier, and it exported almost all of that, according to government data. The country, which has no major oil refineries, consumed about 22,000 barrels a day of refined petroleum products in 2011, according to CIA’s World Factbook. That is equivalent to about 1.1 million tons a year.
HBOil has an alternative proposal for delivering petroleum products to Mongolia. The company will offer to sell the North Korean refined oil to the far east of Russia, where there are no local refineries, Naemi said. In exchange, Russian oil companies, most of which own refineries, could send their petroleum products to Mongolia, a shorter route than delivering cargo to the country’s far east, Naemi said.
“We can deliver what they need on the east coast of Russia, and they can deliver the same like product into Mongolia,” Naemi said. “From a Russian perspective it makes sense, so the swap strategy would be the ideal scenario, but sometimes that does not happen.”
HBOil, which recycles fuel used by mining companies in Mongolia, is also “studying the potential to expand its oil product processing and manufacturing business into” North Korea, the company said in the statement.
HBOil is part-owned by New York-based private equity firm Firebird Management LLC, according to CEO Khudree. Firebird also owns stakes in Mongolian companies including coal miner Sharyn Gol.
Additionally, HBOil has signed an option to buy 51 percent of Blacktip Energy Inc., another Ninox Energy Ltd. subsidiary and owner of Korex Ltd., which is an offshore explorer focused on the sea east of North Korea, it said.
Mongolia’s economy grew 12.3 percent last year, compared with 17.5 percent in 2011, according to its central bank.
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