Do You Sincerely Want To Be Rich? (47 page)

was sufficient to account for the Fund of Funds, through its Natural Resources Account, becoming the biggest customer of the King Resources Company. And there was another congruity of interest to develop. In 1968, IOS was anxious to send its salesmen back into those underdeveloped countries from which they had been so unceremoniously expelled. So a new 'concept' was born: IOS and King together would create systems of natural resources investments in such countries.

    One of the first countries to be selected for the privilege of being 'bootstrapped' was Israel, whose government had regarded IOS with a cool and sceptical eye almost from the first.
¹
And the result was John King's Midbar venture, which ended with a small international incident, the intervention of the State Department and the loss of many millions of dollars.

    In the summer of 1968, King formed a little company named Midbar Ltd, after the Hebrew for 'wilderness'. It was registered in London, and was not much publicized. Midbar's audacious purpose, which had the approval of the Israeli Government, was

    
¹
See Chapter 7, The Jungle Jangle Jingle.

    to search for oil and gas in the territories and neighbouring waters captured from the Arabs during the Six Days' War. The IOS parent company - not the funds - lent Midbar a million dollars, and it went to work on seismic studies of the area, which proved encouraging.

    King then sent a maritime drilling rig, the Star I, out to the Mediterranean, and a land drilling team to the Sinai Peninsula. The land well was a 'dry hole' - but the Star struck oil. Unfortunately, though, she was drilling in a very exposed position in international waters: thirty miles off the onetime Egyptian port of El Arish, which is west of the Gaza Strip. (The safer waters off Israel had been taken by another American company.)

    The Star's well had to be 'capped' and kept quiet, because the Israelis could not guarantee protection for the rig. The problem was that the Israeli Navy had been relying upon the delivery of five new gunboats from France, and de Gaulle had blocked the sale. Before the Israeli Navy managed to commandeer the boats in their celebrated raid of Christmas 1969, the political heat had turned on the Midbar project. The heat was generated by the adventures of a second rig that King sent to go round the south of Africa and drill in the Gulf of Suez itself.

    The rig, drawn by a Dutch tug, berthed en route at Abidjan on the Ivory Coast, where a group of Arab saboteurs arrived one night and hung some sticks of dynamite around it. They were not very efficient saboteurs, and the three explosions did little damage - although some members of the rig crew had to spring naked into the water. But by the time the rig had been repaired and was under way again, the incident had focused the attention of the established oil companies upon the implications of Midbar's enterprise.

    The oil companies were naturally frightened that the Arabs might take reprisals against US oil investments in Libya and other places, if American companies went on helping Israel search for oil in disputed territory. The State Department was called in, and that was the end of Midbar.

    King Resources had to write off nearly $7 million on its Middle East operation, and private investors, who had bought participations for $8 milhon or so, also lost.

    IOS Ltd was not a loser: it got $1.3 million back on its $1 million, and was left with a free 25 % interest in Midbar. But that was IOS's own money. The same good fortune did not apply to most of the IOS customers' money that went into other King ventures.

    The Natural Resources Account of the Fund of Funds was started on March 4, 1968 and it was rather different to those subdivisions of the Fund which Meid or Alger ran. Until March 1970, IOS never announced who was running the account. As a result the relationship with King was not widely known about even within IOS. Secondly, there was no formal management agreement, and no charge was contracted. The manager of the account was IOS Ltd itself, and it was handled personally by Ed Cowett. Thirdly, none of the reports of FOF Proprietary ever gave a breakdown of what the Natural Resources Account was invested in.

    Although no fee was fixed formally, IOS proposed to reward itself for running the Natural Resources Account by taking 10% of any appreciation in the value of the account's investment, whether that appreciation was realized in a sale, or simply entered in the books. And 10 % of the income from investments, less an expenses allocation, would also accrue to IOS.

    The great point about natural resources investments, however, was that unlike stocks and shares, there was no widely quoted and established market to put a value on 'unrealized appreciation'. It was up to IOS itself, with the aid of King Resources, to assess increases in the value of any oil drilling leases or gold prospects, purchased through John King companies. The higher the values estimated, the more profits IOS would make.

    In May 1968, the Fund of Funds prospectus quoted one of the celebrated maxims of the Due de la Rochefoucauld: 'The greatest of all gifts is the power to estimate things at their true worth.'

    By the end of 1969, $60 million from the Fund of Funds had flowed into John King's companies. This was by far the most important destination for new fund investment. Yet no list was published showing the disposition of this cash until March 1970, and even then it did not go out to the investors, but appeared as a footnote to an article by John King in the Bulletin, aimed mainly at salesmen. 'Geologists tell us,' wrote King, 'that there is an infinite amount of natural resources -the earth itself, the treasures found within it, upon and in the skies above it.' King Resources, which he called 'a merchant banker of natural resources', was burrowing away in search of these treasures, with especial emphasis upon the underdeveloped world, where 'the old exploitation approach' was being avoided.

    The subsequent brief note on the FOF money in his care showed that little had gone to the poorer parts of the world, except for $3 million spent on oil and gas exploration in Gabon and Liberia. More than 45 % of the money had gone into King's companies operating in the US, chiefly to acquire oil and gas prospects. Another 39% had gone to Canada, $11 million having been spent on oil exploration rights in the Arctic.

    In South Africa and its colony, South-West Africa, 11% was divided between a titanium prospect and a diamond prospect. (After the 'Apocalypse' an IOS executive said he found the Fund of Funds' stake in the diamond business especially hard to assess. ‘I have looked at this,' he said, 'and I have looked at it for some time. The result is that I have no way of knowing whether it is a highly valuable investment, or whether it is the biggest heap of bullshit I have ever seen.')

    But the real action, the source of hope, was in the Arctic. When the Atlantic Richfield company struck oil at Prudhoe Bay on the North Slope of Alaska in January 1968, a great glamour spread over the whole 550,000 square miles of the North American Sedimentary Basin, stretching between Greenland and Alaska. That glamour was much intensified when rights to exploit the new Alaskan oilfields were auctioned off for an average of more than $2,000 per acre. It obscured in many minds the fact that the North Slope is only a small part of the whole area - which consists mainly of the Canadian Arctic islands and their seas between. People naturally assumed that here was a bonanza, in which the shrewd or fortunate might buy frosty territory cheap, and sell it dear upon the discovery of gushers. But the financial realities of oil exploration are rather more complicated than that.

    As long ago as 1931, an explorer named Parry noted that rocks in the Canadian Archipelago smelt of gasoline when broken. A geological survey in 1947 disclosed that the rock formations in the area strongly resembled those of major oilfields, but at the time oil companies were put off by natural hazards. The special nastiness of the Archipelago is that it is warmer than the mainland, because its winds come from the Greenland Sea. The snow cover is never thick, and in the 24 hour summer days, when the temperature can reach 65°f, it melts - turning the land surface into a sloppy layer of mud on top of 1,500 feet of permafrost, while most of the sea remains frozen. The difficulties of searching for oil there, and of extracting it if found, kept most people's attention fixed on easier exploration prospects.

    A few wells were drilled in the early Sixties, after the US nuclear submarine Nautilus sailed under the polar icecap and gave rise to the notion that the problem of extracting oil from the Arctic might be solved by giant submarine tankers. But no oil was found, and the Archipelago might have been abandoned to the caribou had it not been for a dedicated geologist named Sproule. After much campaigning, the Canadian Government anno

amount of money is spent on exploration over the term of the permit. This 'work obligation' may be discharged by drilling, by making seismic surveys, or even by researching improved means of Arctic transport. The requirement is expressed as a cost per acre, and the sum depends on the location of the permit area. As an earnest of his intention to spend the money the permit holder must either make deposits with the Canadian Government or find an acceptable financial institution to put up a bond on his behalf. This money can be reclaimed by submitting bills to the Government as exploration costs are incurred. The idea is to stop people taking up permits and sitting on them: to keep the permits 'in force' exploration work must be undertaken.

    There is nothing to stop a permit holder from selling his permits, or an interest in them, to third parties, and if the territory looks promising, people may be willing to pay a cash price for the privilege of participating in possible eventual profits, in addition to taking on their share of the work obligation. Alternatively, the permit holder may decide that a certain area is worth particularly close exploration and may draw up a drilling programme whose cost may well exceed the minimum Government work requirements for the area. The permit holder may then decide to 'farm out' the work to a third party to whom he will give in exchange an interest in the permit. The planned cost of this programme can then also be expressed as a cost per acre, although no cash changes hands. Again, however, in order to 'earn' his interest the third party must complete the contracted work which may take some years - although he may pass on to yet another person a share of the work. In the Arctic, you don't own a thing until you earn it.

    Even then it is not that simple. Normally you would not turn a permit into a lease until you have found oil in commercial quantities. At that point it becomes advantageous to convert a 6-year permit into a 21-year lease so that you can continue to benefit from the production of that well. Nevertheless at that point also you run into fresh regulatory complications. In the first place the Canadian Government reserves the right to keep for itself half your permit acreage. Secondly only Canadian citizens or companies half of whose capital at least is owned by Canadians may own leases. King Resources would therefore have had to float off a separate Canadian company to own leases, while the FOF itself would have been, in the words of a Canadian Government official who investigated the position, 'very hard pressed to hold a lease in its own name.'

    King's invasion of the Arctic is even now hard to chart with any precision, although its broad outlines are clear enough. King Resources' first move was made in the autumn of 1968 when the company took out a number of permits in its own name. These covered about 4.5 million acres and were recorded in the prospectus which IOS helped King draw up for the Eurodollar issue at the end of that year.
¹
The acres, it said, were 'scattered in and around the Sverdrup Basin in the Queen Elizabeth Islands' and were described as having 'only speculative value'. Neil MacKenzie, boss of King's Canadian operation, said: 'We're going to have to be lucky. The mineral resources industry is a calculated gamble, but if you go into it on a big enough scale, the odds are in your favour.'

    King's next big deal came in March 1969 when he took a 50% interest in permits covering roughly 20 million acres. These permits had been taken out by two companies called Transalta and Siebens who had pooled their Arctic interests. The great bulk of this acreage was offshore, some of it outside the Sverdrup Basin in the Arctic ocean. Such permits carry only a small Government work requirement, for at this stage of the game permits covering big slices of frozen sea are not much desired. It is not drillable in the present state of the art.

    King took on an obligation to spend only 20 cents an acre in the first four years of these permits: according to Transalta,

    
¹
See Chapter 17 The Master Financiers.

    

    King did not earn his interest on them until February 1970, when the necessary money was deposited with the Canadian authorities.

    King's third main Arctic stake - and by far his most important one - was a series of complicated farm-out agreements made with Panarctic, the company backed by the Canadian Government. They covered some 4.5 million of the more promising onshore acres in the islands. King stood to earn varying interests by undertaking a drilling programme of five wells to be started at various dates before September 1971.

    King was manoeuvring in the Arctic action throughout the summer and autumn of 1969. By late August he had interests, or the right to earn them, in 29,700,000 acres. But in addition to these three main moves, he acquired a number of other interests in return for undertaking to do seismic work or to drill wells. King Resources also took out more permits in its own name, including some covering remote sections of Ellesmere Island, the furthest north of all the islands, which he filed in September. By December 22, the acreage in which King had interests had climbed to 35,710,000: the interests varied between 100% and 30% and the average was 63%, so that King's 'net' acreage in the Arctic was 22,380,000. It was a half share in that 22 million which was Bernie Cornfeld's 'most spectacular investment'. It was hardly prime oil territory; four fifths of it being undrillable frozen ocean. In Arctic slang it was mostly 'whale pasture and caribou turd'.

    Supposedly, the Fund of Funds went into the Natural Resources Account on a fifty-fifty basis with King and his companies. Cowett later tried to tell the IOS board that King Resources were in effect money managers for the Natural Resources Account - but the relationship was not like that at all in practice. At least, money managers are not usually allowed to sell properties of their own to the funds they manage, which was what King Resources was doing. The fifty-fifty Natural Resources Account was built up by the simple device of King companies selling to the FOF half-interests in properties already owned, or about to be owned. And King decided that this was a sales situation in which the philosophy of caveat emptor should apply: his companies took mark-ups on sales to the FOF, and it was up to the FOF to object if the prices were too high.

    Cowett claims to have been 'naive' about these arrangements, and as dismayed IOS investigators found later, they resulted in some spectacular mark-ups for King companies. In some cases, King's private company, the Colorado Corporation, bought American oil and gas properties and re-sold to the FOF within days at mark-ups of a thousand per cent and more. And that was mild compared to what happened in the Arctic.

    The Fund of Funds paid King Resources Company a total of $11 million cash for the privilege of participating in his Arctic interests. And King Resources paid virtually no cash price when taking up the interests - the costs being computed in terms of work obligations assumed, totalling some $20 million. Half of that burden of work obligations was transferred to the FOF at once.