The Standard Oil Company: 1870-1882

On January 10, 1870, the Standard Oil Company of Ohio was created by John D. Rockefeller (30%), William Rockefeller (13.34%), Henry Flagler (16.67%), Samuel Andrews (16.67%), Stephen Harkness (13.34%), and O. B. Jennings (brother-in-law of William Rockefeller, 10%). It held about 10% of the oil business at the time of its formation.

In Rockefeller's eyes, the state of the oil business was chaotic. Because entry costs were so low in both oil drilling and oil refining, the market was glutted with crude oil with an accompanying high level of waste. In his view, the theory of free competition did not work well when there was a mix of very large, efficient firms and many medium and small firms. His view was that the weak firms, in their attempts to survive, drove prices down below production costs, hurting even the well-managed firms such as his own.

Although his economics may be suspect in modern eyes, his solution -- a market with a few (maybe one!) large, vertically integrated firms -- in effect an oligopolistic market -- was what other industrial sectors eventually evolved into. What makes oil stand out is that it happened by design -- as the result of a plan formulated by a single person -- John D. Rockefeller.

During 1871, Rockefeller formulated his plan for consolidating all oil refining firms into one great organization with the aim of eliminating excess capacity and price-cutting. Although no written records exist, both Rockefeller and Flagler 30 years later claimed this was when they worked out the master plan, which they later implemented. The claim that the plan was formulated in 1871 is evidenced by the fact that all the major Cleveland banks joined the Standard Oil organization in 1871 and later backed Rockefeller and Flagler to the hilt in their rapid expansion.

The South Improvement Scheme

What interrupted Rockefeller and Flagler's careful planning was the emergence of the South Improvement scheme of 1871. Tom Scott of the Pennsylvania Railroad came up with the idea. The scheme was inspired by the Anthracite Railroad combination of 1868-71 in which five railroads and two coal companies bought up all the coal pits along the five railroads in order to control output and prices.

The South Improvement Company had been created by the Pennsylvania Legislature in 1870 and its charter allowed the Company to hold the stocks of other companies outside the state. This was an unusual power at the time and made it ideal for Scott's scheme. Scott arranged for the purchase of the charter by a group of Philadelphia and Pittsburgh refiners with Scott in the background.

The scheme was essentially a plan to unite the oil-carrying railroads in a pool; to unite the refiners in an association, the South Improvement Company; and to tie the two elements together by agreements which would stop "destructive" price-cutting and restore railroad freight charges to a profitable level.

To enforce the cooperation of refiners, a set of rebates was agreed to for participating refiners. This alone would have undoubtedly forced all the refiners into the combine, but the scheme did not stop there. In what turned out to be a public relations disaster, the participants decided to add a drawback on every barrel shipped by a non-participant equal to the ordinary rebate. In effect, this would be a tax on non-participants, the proceeds of which would be transferred to the participating oil refiners.

What the planners forgot, however, was to include the producers in the scheme as well. Despite efforts to reassure the drillers in the Oil Regions that the scheme would benefit them as well by keeping prices up, the Oil Regions Men revolted and organized an effective boycott of all the refiners and railroads they suspected of being part of the scheme. Consequently, the scheme collapsed in 1872 before it was ever implemented.

Subsequent historians repeated the view of many at the time that Rockefeller had been one of the originators of the South Improvement Scheme. In fact he had not been, but he and Flagler did agree to participate, and worked hard to set up the scheme. Rockefeller's most important error of his career was to not go public at the time with his side of the story. This was the first time that a broad public became aware of Rockefeller and the episode was to forever tarnish his reputation. He said of it later, "Our silence encouraged the wildest romancers to spread wild tales about us;" and on another occasion, "I shall never cease to regret that at that time we never called in the reporters."

In December 1871, during the dust-up over the South Improvement Scheme, Rockefeller and Flagler set in motion their plan to consolidate the industry. They began by buying up all their competitors in Cleveland. The strategy and tactics were Rockefeller’s and he handled the negotiations with the rival refiners personally. He began with the strongest refineries first. He believed that if he had bought up the weak refineries first then he would be faced with higher prices later and stiffer resistance. Consequently, he approached the strongest first and bought them out.

His technique was always the same. The merger would be effected by an increase in the capitalization of The Standard Oil. The rival refinery would be appraised and the owners would be given Standard Oil stock in proportion to the value of their property and good will and they would be made partners in Standard Oil. The more talented owners would also be brought into the Standard Oil management. If they insisted upon cash they received it.

Later some owners who had been bought out complained to the press that they had been treated unfairly. The evidence is overwhelming that the Standard’s rivals were paid fair -- even generous -- prices for their property, and if they had the wisdom to take Standard Oil stock, they ended up very rich indeed.

By March or April 1872, Rockefeller had bought up and/or merged with almost all the refineries in Cleveland. The inefficient and poorly constructed refineries were dismantled, while the better-quality ones were upgraded to Rockefeller and Flagler’s standards.

After the conquest of Cleveland, the Standard inexorably expanded. All the transactions were kept as secret as possible. The leaders of the Standard were so successful in this secrecy at times that many rival independent refiners were totally unaware of what was going on.

In 1872, Jabez A. Bostwick was brought into the Standard along with his important oil facilities on Long Island and on New York Harbor. In 1873, Standard acquired Devoe Manufacturing Company (Long Island) and Chess, Carley and its important distribution system in the Kentucky region (Louisville, KY). In 1874, Standard began building its own pipeline system using Bostwick & Co.

The teamsters, men who drove commercial wagons drawn by horse-teams, fought pipelines tooth and nail, but were destined to lose because it was so much cheaper and easier for the producers to send their crude through pipes as opposed to wagons. It was a short logical step to extend those pipelines directly to refineries. Rockefeller made a deal with the Erie Railroad and gained control of important terminal facilities in New York harbor in exchange for shipping half of Standard’s oil on the Erie.

The Standard expanded into the Pennsylvania Oil Regions, gaining control of the Imperial Refinery near Oil City and bringing J.J. Vandergrift into the Standard management. Two large refineries in Titusville joined the Standard and John Archbold (later the President of Standard Oil) was brought into the management. The Standard expanded into Pittsburgh by merging Warden, Frew & Co. and Lockhart, Frew & Co., thereby acquiring half the refining capacity of Pittsburgh. The Standard expanded into Philadelphia by buying the largest refinery.

In 1875, the Standard bought more pipelines and firms in the oil buying business and merged them all into the United Pipe Lines in 1877. Flagler and Rockefeller negotiated an agreement with the railroads: the Pennsylvania Railroad would carry 51% of Standard Oil shipments; the Erie 20%; the NY Central 20%; and the Baltimore & Ohio 9%; and obtained rebates from all the railroads for being an "evener" (that is, the Standard was charged with making certain that the railroads all got their "fair" share).

In 1875-76, Johnson N. Camden (later a senator from West Virginia) came into the Standard secretly and moved to buy up all the West Virginia oil supply to squeeze the Pittsburgh independents. By 1876 Camden gained control of most of the West Virginia refineries.

In 1877, Standard bought the Columbia Conduit Co. of PA and gained control of its pipelines and refineries. Columbia had tried to bypass the Pennsylvania Railroad by building a pipeline from the Oil Regions down to the new B&O railroad line near Pittsburgh. The Pennsylvania Railroad used armed guards to prevent them from laying a pipeline under its right-of-way north of Pittsburgh. The Standard gained control of most of the property of the Empire Transportation Company -- a subsidiary of the Pennsylvania Railroad that had its own fleet of tank cars, pipelines, lake steamers, and terminals in New York harbor. The Empire had briefly threatened the Standard, but Rockefeller built 600 new tank cars, cut prices, and cancelled all his shipments over the Pennsylvania Railroad. The railroad capitulated and sold Rockefeller the Empire's assets.

In 1877-78, the Standard and the trunk lines agreed on a new split: Pennsylvania Railroad 47%; NY Central 21%; Erie 21%; B&O 11%. New York City was to get 63% of the total traffic and Baltimore and Philadelphia 37%. On refined oil, non-Standard companies shipping from Cleveland, Pittsburgh, and Titusville paid $1.44.5 per barrel while the Standard paid $.80!

In 1878, the Standard forced the railroads to pay a drawback of 20-35 cents a barrel of crude oil shipped by any other party. In effect, this was a tax levied by the Standard upon its competitors. This combination of rebates and "taxes" (some authors dub this a "drawback" -- but that term is also used to refer to a specific type of rebate) is what forced the remaining independent refiners to capitulate to the Standard. Production increased in the Pennsylvania Oil Regions because of a large discovery in the Bradford area. Standard was forced to frantically build as many large holding tanks as possible to hold the market glut of oil.

By 1879, the Standard Oil Company did about 90 percent of the refining in the United States, with almost 70 percent being exported overseas. The business had become so large and so complex that Rockefeller only dealt with the major problems and the larger outlines of his affairs. Rockefeller was only 40 years old.

The Standard’s only serious competitor -- the Tidewater Pipe-Line Company (later the Tidewater Oil Company) -- emerged in 1879-83. It took Rockefeller by surprise and succeeded in building a pipeline from the Oil Regions east across northern Pennsylvania to Williamsport, where the oil was transferred to the Reading Railroad. The Reading then took the oil down to a refinery at Chester, Pennsylvania on the Delaware Bay. Rockefeller tried to gain control of Tidewater but failed, and his rival had about 10% of the market in 1888.