Glimmers of hope seen in North Korean basins, markets

Alex Stewart
North Asia Research Associates
London

Korean contractor's aging Romanian rig drills well No. 401 for SOCO International plc in North Korea. Photo courtesy of SOCO.

North Korea and East Asian Basins [164,830 bytes]
West Korean Basin Stratigraphy [144,649 bytes]
West Korean Basin Cross-Section [77,144 bytes]
The view which used to be held in oil circles was that there was not much, if any, commercial oil to be found off North Korea.

There were good grounds for thinking so, when local oil companies had searched fruitlessly for many years off South Korea, and when the quality of Soviet-era data available on potential deposits gave little cause for optimism, bearing in mind how Soviet data had overstated actual deposits in Viet Nam.

This view however is coming up for re-evaluation in the wake of new seismic shot by two western oil companies with exploration licenses off North Korea. Both companies are now at the stage of looking for partners to help finance exploration wells.

In the last year a third company has taken the last major concession area, and furthermore started drilling onshore. The two others expect to begin drilling within a year as well. What they find will determine whether North Korean estimates of 6-8 billion bbl of oil are the fantasy of a dream-prone regime or herald the opening of an exciting new oil frontier.

If it is the latter it will be more than usually exciting as the "frontier" will be next door to the world's largest concentration of demand for imported oil.

Offshore geology

Geology in West Korea Bay off North Korea is similar to that in Bohai Bay off China.

The basement is thick carbonate rock (5,000 m) of the Late Proterozoic and Early Paleozoic overlain by Mesozoic (6,000-10,000 m) and Cenozoic (4,000-5,000 m) sediments.

Source rocks are Jurassic black shale (3,000 m or more), Cretaceous black shale (1,000-2,000 m), and pre-Mesozoic carbonates (several thousand meters).

Reservoir rocks are Mesozoic-Cenozoic sandstone with high porosity and pre-Mesozoic fractured carbonate rocks. Petroleum traps are of the anticline, fault sealed, buried hill, and stratigraphic types.

Offshore on the East Korean Sea side, source rock is constituted of Tertiary thick marine shales (1,500-3,500 m); reservoir rocks are Tertiary sandstone with good reservoir physical properties and fractured carbonate rocks at the base; trap structures are of the anticline, fault sealed, buried hill, facies sealed, stratigraphic type. There is the possibility of some Mesozoic and a good chance of Early Paleozoic carbonates.

Offshore operations

Seven wells have been drilled in the West Bay area. All had hydrocarbon shows, and several recovered oil and gas.

Prior to the arrival of western exploration companies seismic had been shot with a grid of 10 by 20 km throughout the basin. Since then seismic with a 2 by 4 km grid has been shot over some parts. On the East Sea side, two wells had been drilled, each uncovering oil and gas shows.

Seismic surveys have been carried out with a grid of 10 by 20 km throughout the basin with a grid of 2 by 2 km over the area principally known as the Hungnam Depression near the port of Wonsan.

North Korea has let two concessions on the west side and one concession on the east side facing the Sea of Japan.

Each side has different operating conditions. The East Korean Sea has been considered more gas prone (although the company holding the concession actually considers it oil prone), and in the northern part of the sea the continental shelf falls steeply to depths of 2,000-3,000 m; water depths in the lower sector are between 150-200 m, which is similar to West Korea Bay. The west side has a more complex tidal pattern, wide mud flats, and freezes in winter, making it logistically more complex.

Exploration history

Exploration activity dates to 1965, when Chinese petroleum engineers began making initial surveys. In 1967, North Korea conducted a joint geological study with the former Soviet Union in the Tuman estuary area. Thereafter North Korean geologists maintained survey activity assisted by Soviet engineers.

In 1980, the Norwegian subsidiary of Geco Geophysical Ltd., part of Schlumberger, surveyed several blocks, and in 1987 Leeward Petroleum (Great Britain) Ltd. was contracted to undertake more survey work. During the 1980s the North drilled around 15 wells on both sides of the peninsula on and offshore. The land drilling was often to look for coal.

Claremont/Beach concessions

The first western company to obtain an exploration license was Meridian Oil NL of Australia in 1990. Meridian was formerly part of the Independent Resources Ltd. (IRL) group, which acquired control of Beach Petroleum NL, Adelaide, and its then parent company, Claremont Petroleum NL.

IRL lost control of Beach and Claremont in 1991. Subsequently the new directors of Beach and Claremont launched an action against former directors and against other IRL companies, alleging fraud. The new directors were successful in this action, and in the subsequent restructuring Beach took control of Claremont in 1994-95.

Claremont still owned part of the interests in the West Korea Bay held by Meridian. In 1994 the new management of Beach visited North Korea to review these interests and took up an offer to acquire permits to explore the two other concessions. These were above the old Meridian blocks, now let to Taurus Petroleum AB, Stockholm, and the whole East Sea side.

Beach decided to take the option on the east side, covering approximately 29,000 sq km (after relinquishment required in the PSC, this is now approximately 24,500 sq km). It cut its interest off two thirds of the way up the coast where the continental shelf falls sharply away.

Beach signed a 25 year production sharing agreement with Zosonsulbi, a state trading firm that acts on behalf of the Ministry of Energy. The contract was comprised notionally of a 5 year exploration period and a 20 year production period.

The production sharing agreement was substantially the same as Meridian had signed with the North, with the share determined on a sliding scale based on total output from the concession. To sweeten the contract no taxes or signature bonuses are payable, with the exception of a production payment bonus that becomes payable if a certain level of production is reached.

Beach in 1997 farmed out a 25% interest to a Malaysian company, Puspita Emas Sdn. Bhd., in return for funding the costs of shooting 1,000 km of additional seismic in July 1997. The company also reprocessed 7,000 line km of seismic shot in the Soviet period and evaluated data from the two wells drilled, both of which confirmed the presence of oil shows.

Beach Petroleum has identified eight prospects and nine leads. These include buried hill structures, with the potential, according to Beach, to hold oil deposits of 500 million to 1 billion bbl. Beach's studies indicate the onset of oil generation is likely to occur in the Lower and Middle Miocene sediments at subsurface depths of below 2,100 m.

Taurus joins the search

During this period Meridian had sent seismic data which the North Koreans had shot to a processing center in London. It failed to pay for the processing, and the center kept the data to offer other companies.

North Korea began re-advertising the concession through its overseas network, and Taurus took up the permits in 1992, unaware at the time of Meridian's earlier activity. Taurus was already active in Cuba and not therefore shy of operating in an area shunned by many other oil companies.

Taurus signed a production sharing contract with Zosonsulbi in February 1993. The contract provides for a 5 year exploration period, extendable by a further 3 years on payment of $1 million.

The exploration phase is divided into four periods. The first period (2 years extendable to December 1998) requires reprocessing and interpretation of the earlier seismic shot by Geco, together with acquisition and processing of new seismic, which it carried out last year.

The contract provides for North Korea to obtain a rising share of production in proportion to the level of output, starting at 55% of production. The same no-tax incentives apply, and Taurus has 100% ownership rights.

Under the terms of Taurus's production sharing contract it must drill one well in the second period of the exploration phase at an approximate cost of $7 million and then one more well in each of the two succeeding years. The company is looking for partners to help finance the second and following periods.

SOCO International

The third major concession was acquired in May 1998 by SOCO International plc, a London exploration and production company spun off from Snyder Oil Corp. of Fort Worth, Texas, in 1997. The production sharing agreement covers an exploration area of 7,000 sq km, two thirds offshore and one third onshore in the Anju and Onchon basins.

The terms of the PSC commit SOCO to spend $350,000 a year for 5 years, which the company describes as a "cheap look" to see whether further investigation is warranted. SOCO is already active in Mongolia and Viet Nam and hence no stranger to the region. It is attracted to the similarities with Bohai Bay and of oil finds in the buried hills. However it is not holding its breath, conceding that the opportunity in North Korea has as much to do with attracting interest from potential longer term partners in South Korea, China, and Japan.

Like the other concessions, the area had already had some drilling and seismic shot. SOCO plans to shoot additional seismic at the end of 1999.

SOCO has begun drilling onshore. The local Korean contractor is responsible for the drilling, using a Romanian made rig that SOCO confesses has seen better days. By the end of the summer it had drilled through 3,000 m with the eventual goal to reach 4,300 m. SOCO pays for the purchase of drilling equipment, which it imports mostly from China by train. It is offering an outside investor 50% of its entitlement.

Regional oil potential

Geologists are naturally hopeful, based on the data already obtained, that the extension of the Bohai basin northward will reveal oil plays of similar attractiveness. One of the companies engaged in North Korea said production from buried hills can be typically 10,000 b/d.

In the case of Bohai Bay, oil companies have so far located 450 million bbl of recoverable reserves in eight fields, according to Edinburgh consultants Wood Mackenzie's Southeast Asia Upstream Survey, from which production as of mid-May 1998 was running at 68,500 b/d.

The largest field, Suizhong 36-1, produces 40,000 b/d, backed by recoverable reserves of 250 million bbl. No doubt western promoters of oil off North Korea would be happy to match that.

Industrial strategies

The location of these concessions will become their major attraction if oil is found, as they are within 50-100 km of the Korean armistice line and adjacent to markets in Japan and China.

Unsurprisingly, South Korea's industrial conglomerates are showing the strongest interest in this potential. For the last few months South Korean oil companies have been discussing options for participation with ethnic Korean middlemen. This activity became much more public after the visit by Hyundai's honorary chairman to the North at the end of October, when his visit was crowned by a meeting with supreme leader Kim Jong Il.

It is reported that they discussed billions of dollars worth of investment, including offshore oil, the construction of power stations, and the construction of a subsea pipeline to Hyundai's two refineries on the west coast. The economics of this are attractive, especially at a time of low oil prices, as the short transportation distance will reduce shipping costs by upwards of $1.50/bbl in comparison with oil shipped from the Middle East.

Oil refining, consumption

Higher than usual political risks are associated with an investment in North Korea. However the North's desperate need for energy (or hard currency to pay for it) is forcing it to open up its oil sector as fast as it can.

The lack of oil dates from the collapse of Comecon, when North Korea obtained cheap (and sometimes free) concessional oil from the Soviet Union. The economy mostly runs on indigenous coal, but the lack of oil has affected the operation of many parts of the economy including agriculture (feedstock for fertilizer; fuel to operate the hydraulic system for irrigation; diesel for tractors). It is this background which makes the meeting which took place in October 1998 between North Korea's Kim Jong Il and Hyundai more than usually significant.

North Korea will almost certainly take its share of production in crude oil rather than dollars and try and process the crude at its two refineries. These are located close to the Chinese and Russian borders, on the west and east coasts, respectively. Their combined design capacity is 60,000 b/d, which is approximately what North Korea consumed in 1995, according to U.S. Department of Energy statistics.

DOE reports that North Korea in 1995 imported around 20,000 b/d of refined products, suggesting that it processed the balance of 40,000 b/d itself. However it seems unlikely that in 1998 it processed nearly this amount owing to the steady deterioration of the refineries due to lack of maintenance. This is making North Korea more dependent on imports each year but without the hard currency to pay for them.

Subsistence economy

North Korea is therefore surviving on hand outs. China still supplies some refined oil on concessional terms. North Korea is also able to barter oil for weapons with Middle East countries like Iran and Syria.

The third source of undollarized oil is the Korean Peninsular Energy Development Organisation (KEDO), the U.S. led consortium which is supplying light water nuclear reactors to North Korea. Under this agreement, signed at the end of 1994, North Korea receives the equivalent of 10,000 b/d of heavy fuel oil, half of it for use at the power station in the Rajin-Sonbong free trade zone.

North Korea's wretched inability to pay for oil means that it has a per capita level of consumption which is about one twentieth the level of the South's. The prize for oil companies which can find a method of tying up crude and refining in North Korea is that one day there could be similar demand for refined product in the North.

The North's economy is at such a critical juncture that it is bound to offer attractive terms to foreign investors. Indeed, the fact that Kim Jong Il's meeting with Hyundai's founding chairman was his first with a foreign dignitary suggests that the North is now acutely business minded, despite the hall of mirrors in which negotiations about North Korea's nuclear intentions are pursued.

It is against this background, therefore, that those with an ear to the ground will have to decide if this is the opportune time to stake a place in North Korea's energy future.

The Author

Alex Stewart is the principal of North Asia Research Associates, an investment research and advisory company with offices in London and Osaka, Japan, that promotes investment in North Asia from Kazakstan across to the Sea of Japan. In North Korea it is offering advice to the sponsors of an investment fund which is proposing to invest in North Korean resource projects. E-mail: [email protected]