Terrence Edwards in Ulaanbaatar -

A small yet bold Mongolian firm is preparing to launch a new oil enterprise in North Korea. It's an unlikely pairing, but the firm is betting it has the key ingredients to make such an unlikely gamble pay.

As Mongolia sputters away from frontier-economy status into the territory of middle-developed, Mongolian Stock Exchange-listed HBOil has hopes to tap into one of the world's last remaining true frontier markets. The company is counting on Mongolia's close relations with the neighbouring hermit kingdom to help serve as a base to launch the country's first home-grown multi-national.

"It's a big opportunity, especially having ownership in a foreign company," said Ulziisaikhan Khudree, HBOil's chief executive. Valued at just $2m, HBOil is chiefly involved in oil-waste recycling, but it has thus far found its digs at home less than fulfilling; Mongolia sports just one producing oil well and no refineries.

North Korea may mirror the potential Mongolia has in natural resources - with 24 times the reserves of South Korea and 360 varieties, according to the Korea Energy Economics Institute. A 2012 report by the Asia-Pacific-focused think tank Nautilus Institute suggests the best indicator of potential onshore production is reports from 2006 of up to 300,000 tons of crude oil a year, while Pyongyang is said to be eyeing the West Sea (the Korean name for the Yellow Sea), which is said to hold 12bn barrels of oil.

The deal will open onshore exploration, development, and production rights for HBOil via the full acquisition of Malaysian company Ninox Hydrocarbons (L) Berhad. Ninox will offer HBOil 20% in KOEC International - a joint venture with the state-owned Korea Oil Exploration Corp - as well as the option to acquire 51% of an entity with oil exploration and production rights in the Korean East Sea (internationally known as the Sea of Japan). The value of the deal has not been released, but a capital raising of $5-15m will cover the costs and also determine the acquisition of the offshore interest, according to Ninox.

Breaking the chains of energy dependence

Dependence on foreign fuel has built a strong desire in Mongolia to develop the country's own production capabilities. Petrol and diesel shortages are the norm during the summer months, when Russia typically cuts its supply, while in January 2012 Mongolia was pushed to the verge of crisis when oil prices spiked 16% overnight. Lacking in its own industries, Mongolia relies on imports to meet demand for numerous goods, including most groceries. Hikes in fuel prices therefore directly impact prices as transport costs are hit.

A key point in the deal for HBOil then is the interest it offers in the Sungri Oil Refinery at the Rason Special Economic Zone on the northeast tip of North Korea. Although the facility is under refurbishment currently, HBOil hopes it will eventually win the right to deliver all of Sungri's output to Mongolia. "From our perspective the refinery is a strategic value proposition... from HBOil's perspective, they were looking at expanding their domestic recycling business by taking it overseas and potentially looking at refineries," says Joseph Naemi, CEO of Singapore-based seller Ninox Energy.

With rail already linking Rason and Mongolia, the deal also hints at future access to North Korean ports, which would offer Mongolia's growing minerals output reach to new international markets. Currently China consumes more than 90% of the country's mineral exports, but with the giant's growth slowing, access to Japan, South Korea and India would hedge Mongolia's risks.

Such a move was advised in a report published by Japan's Economic Research Institute for Northeast Asia (ERINA) last January. "Mongolia's securing of sea access to the Pacific via DPRK ports is highly strategic and could reduce its dependence on Chinese and Russian transit ports," it forecast.

Fool's errand or final frontier?

North Korea is absent from the lists of most investors due to perceptions of a regime gone rogue, the veil of mystery surrounding the governing structure, and its concerning nuclear agenda. The Eurasia Group counted North Korea as one of its top risks for 2013 for these reasons, but HBOil and Ninox say they have seen enough change to validate the move. "There's lots of foreign investment in the DPRK," says Naemi, adding industries such as tourism and telecoms to mining, where foreign investors had already made their mark.

Despite high possibilities for disruptions stemming from broken agreements and political instability, with the potential that expanded international sanctions could make it impossible to operate, neither Khudree nor Naemi appear fazed. Naemi says the companies were already in compliance with present sanctions, which he said were mostly targeted at activities related to the military and nuclear capability of North Korea.

"DPRK is neither unstable nor isolated; instead it is engaged in a complex geopolitical tension, which has become more complicated over time," Khudree insists. "HBOil takes comfort in the excellent and longstanding relationship between Mongolia and DPRK, and is confident that its planned investments are less risky than [some] that are currently being made by multinationals in certain other parts of the world."