The rise and progress of the Standard Oil Company

Front matter

HE RISE AND PROGRESS

STANDARD OIL COMPANY

U&U'AAI

Preface

The study of the Standard Oil Company — of which this book is the outcome — was undertaken by the author while Ricardo Scholar in Economics at Harvard University for the year 1 900-1 901. The results of this study were reported from time to time to the Seminary of the Department of Economics, and eventually were printed in the Quarterly Journal of Economics published for Harvard University. The period from 1865 till 1879 was treated in the Quarterly for February, 1902, in an article entitled "The Rise and Supremacy of the Standard Oil Company " ; and in the Quarterly for February, 1903, under the title of "The Later History of the Standard Oil Company," the narrative was continued to

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Preface

the present. By the courtesy of the editors and the publishers of the Quarterly Journal of Economics these two articles, which together compose this book, are reprinted unchanged.

The sources of this history are the reports of official investigating commissions and committees. Chief of these are the report of the "Hepburn" committee appointed in 1879 by the Legislature of New York to investigate railway abuses; the report submitted to Congress in 1888 by the committee appointed to investigate trusts, and the report of the Industrial Commission appointed by the President in 1898 and making its preliminary report on trusts in 1900.

The oil business, in its early phase, was the reflex of prevalent railway methods. To attempt to judge the situation without first ascertaining the standards set by the railway management of the time is not merely unfair, it is subversive of all historical accuracy. The South Improve-

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ment Company of 1872 is an instance in point. Its interrupted contracts with the railroads have since been generally execrated, and, as it is shown in these pages, probably rightly. But, while condemning these contracts, be it remembered that they followed in principle the best lights of the railway economy of the period ; that they were part of the generally accepted "evening system,' ' by which railways in perfect good faith protected themselves against disastrous competition. To appoint a group of the largest shippers "eveners," and in return for a special rebate require them to apportion traffic among the roads, seemed at that time a practice both inevitable and legitimate. This knowledge of contemporary railroad history may not change the current judgment upon the contracts of the South Improvement Company ; but it helps to a fairer distribution of the blame, if there be any, between the railroads and the company.

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The constant reference in the text to authorities in the foot-notes will not, it is hoped, detract from the narrative. In a matter so much discussed as the subject of this history there seems no longer room for unverified opinion. And if verification seems sometimes too insistent, the importance of authenticating facts which too often have been loosely disputed should be sufficient excuse.

Gilbert Holland Montague.

Cambridge, Massachusetts.

THE RISE AND PROGRESS OF THE

STANDARD OIL COMPANY

THE RISE AND PROGRESS

OF THE

STANDARD OIL COMPANY

The rise and progress of the Standard Oil Company, from its inception in 1865 till its control, in 1878, of ninety -five per cent, of the oil business of the United States, has presented itself to different critics in somewhat different characters; certain conservative writers think it was largely the result of discriminations in freight rates, extorted by more or less questionable practices from the easy virtue of the railroads. But just why the railroads found it expedient to grant such unusual favors, and why this particular group of men, above all others, proved best able to extort such favors, no one has satisfactorily explained. Corruption of the railway officials has been vaguely suggested; but it has not been shown whence this group of men had the means to suborn the railways, and no writer has been able to point to a piece of precise evidence, found by any court or investigating committee in the United States, which proved such subornation of railway officials, though it is not inconceivable that some evidence may exist. Congressional and legislative committees, on the other hand, and the more cautious writers on trusts, have been equally put to it to find in those acts of the railways which eventually made the Standard Oil Company supreme any self-interested motives. The fact of the discrimination in freight rates seems to account for the supremacy of the Standard Oil Company. But why those refiners identified with the Standard Oil Company, instead of some other group of refiners, should persistently have obtained the best rates, has been, to these investigators, a baffling mystery.

The secret of this strange success with the railways is not, however, completely insoluble. If the episodes in the progress of the Standard Oil Company from 1865 till 1877 be carefully studied, the motives of every act, both of the company and of the railways, will certainly be revealed. The materials for this study are not lacking. A vast amount of evidence showing the ability of the Standard Oil Company to turn these possibilities to advantage has been gathered by various commissions and investigating committees. With such sources of information as these available, an intelligible narrative may readily be put together. Not only may each act of the company and of the railways be authenticated, but also, at each step in the progress, the increasing efficiency and importance of the company may be estimated, and the momentary opportunities of railway and industrial conditions may be gauged. And so in what seems at first sight an unaccountable and suspiciously rapid growth may be discerned signs of inevitable development— the operation of motives which are, at any rate, explicable.

1865-70

In 1865, when Mr. John D. Rockefeller began in a small way to refine petroleum at Cleveland, Ohio, the oil industry was in a singularly inchoate state. With the success of Drake's oil-well at Titus ville, Pennsylvania, in 1859, refiners had been released from the necessity of distilling coal into petroleum before refining petroleum into kerosene; and at the same time the sources of petroleum were shown to be enormously greater than they had ever before been guessed. This discovery stimulated consumers to increased use of lubricants and burning oils, and in this way rapidly increased the demand in the arts for the refined product. In even greater measure it encouraged the production of crude petroleum. Within a year after Drake's success wells had been sunk all around Oil City and along the Alleghany River. In 1864 had occurred the Cherry "run," followed by the Benninghoff and the Pioneer "runs" and the sensational exploitation of Pithole Creek. While Mr. Rockefeller was erecting his little refinery, Pithole City — now a field sown with wheat — had a post-office nearly as large as that of Philadelphia. From Manitoulin Island to Alabama, and from Missouri to Central New York, wells had been bored for oil. So rapid had been the increased demand for the products of petroleum, and so unexpected had been the increase of supply, that in 1865 existing refineries proved quite inadequate to the business suddenly thrust upon them.

The difficulties besetting refiners in 1865 were chiefly such as could be cured by an increase of capital. In 1861 the best wells had been thirty miles from the railroads. Because of the lack of barrels and the difficulty of transportation, petroleum had fallen from $20 a barrel to almost nothing. By 1863 boats had begun transporting petroleum down Oil Creek, and small pipe-lines and branch railway lines had been built. In 1866 a more efficient cylinder refining-still was invented, casing and torpedoes were coming to be used in drilling, the tank-car began to replace the clumsy flat - car with its wooden tubs, and pipe-lines regularly transported petroleum from the wells to the railroads. To secure these economies in refining, small concerns must either increase their capital to about $500,000 or else combine into this larger and more efficient unit of production. Mr. Rockefeller was among the first to see the exigency; and in 1867 he united into the firm of Rockefeller, Andrews & Flagler the refineries of William Rockefeller &

Co., Rockefeller & Andrews, Rockefeller & Co., S. V. Harkness, and H. M. Flagler. The reasons for this union, as he afterwards stated them, must even then have been evident: "The cause leading to the combination was the desire to unite our skill and capital, in order to carry on a business of some magnitude and importance in place of the small business that each had separately heretofore carried on." *

With the reorganization of the firm of Rockefeller, Andrews & Flagler, in 1870, into the Standard Oil Company of Ohio, with capital stock of $1,000,000, the first period of the oil industry may be said to close. No company had sought, or, indeed, has since sought, to control the oil-fields. So far as may be known, no refiner had yet organized the pipe-lines to his exclusive advantage or exacted of the railroads better freight rates than were grant-

1 Report of the Industrial Commission, 1900, p. 799.

ed to his competitor. The transportation of oil by rail and by pipe-line was left to independent companies, and it was only by the competition and by the improvements of such companies that the cost of the transportation had been reduced. Till 1870 the competition of refiners was solely concerned with efficiency of production; and, since this was to be gained only by refineries of $500,000 capitalization or more, there was concentration among the stronger concerns and extermination of the weaker. By its process of concentration, and solely on account of its superior efficiency, the Standard Oil Company of Ohio became in 1870 larger than most of its competitors, and produced four per cent, of all the oil refined.1 After 1870 the progress of the

1 Evidence as to the capacity of the Standard Oil Company of Ohio in 1870. — B. B. Campbell (a prominent opponent of the Standard Oil Company) (Investigation of Trusts, Congress, 1888, p. 116):

"Question. How large at that time [1870] was the oil industry, generally, and the precedence of the Standard Oil Company, in particular, was to lie in the direction of cheaper transportation exacted of the transportation companies by the refiners.

interest of those who now represent the Standard Oil Trust?

"Answer. Not much larger interest, I should judge, than some of their competitors."

Charles T. Morehouse ("Hepburn" Report, New York, 1879, p. 2624):

"Q. Now tell us what was their [the Standard Oil Company's] capacity then [1870] as compared with other works at Cleveland and other points ?

"A. Not as large as some of the other works, . . . but comparing very favorably with such works as Charles Pratt & Co. and three or four in the oil regions."

Lewis Emery (at present the most prominent opponent of the Standard Oil Company) (Report of the Industrial Commission, 1900, p. 646):

"Mr. H. M. Flagler swore they had a capacity of six hundred barrels per day of crude oil in their refinery, the production at that time [1870] being about sixteen thousand barrels a day. That would give them four per cent, of the refining business at that time. At that time there existed in the oil country, spread from Louisville, Kentucky, to Portland, Maine, more than two hundred and fifty refineries."

1870-74

Though the progress of the oil industry from 1865 till 1870 be said to have determined the most efficient unit of production, and though the advance of the next seven years be said to consist in cheapening the transportation of oil, yet it must not be forgotten that a considerable advance in refining took place in this later period. Large refineries soon began manufacturing for their own use barrels, tin cans, boxes for enclosing cans, paint, glue, and sulphuric acid. By experiment the process of distillation was made applicable to qualities of petroleum which previously had been almost useless. By improvement in the details of refining, more durable machinery, tanks, and pumps were constructed, and a better illuminant was produced at less cost. In 1875 a method had been devised of utilizing the residuum of crude petroleum left after the manufacture of illuminating oil ; and, after the example of the shale works of Scotland, the process of refining lubricants and paraffine wax from the waste that previously was used as fuel had been adopted in the larger refineries. These improvements, however, were by no means so considerable in the period from 1870 till 1877 as the advantage from the control of transportation; and, though they rendered unprofitable those refineries which could not buy better machinery or utilize their residuum, they were quite too generally adopted by large refiners to account for the growing pre-eminence of the Standard Oil Company.

From 1870 till 1877, then, the struggle of the refiners was chiefly for transportation facilities. Until the issuance of the socalled "Rutter Circular/' in 1874, the advantage they sought lay chiefly in discriminating freight rates. From 1874 till 1877 the large refiners sought both to obtain special rates from the railroads and to organize into systems for their own advantage the bewildering net-work of pipe-lines that had been building since 1869. By surpassing skill in both regions of activity the Standard Oil Company grew in seven years from a concern controlling four per cent, of the refined oil output into one controlling ninety-five per cent. Organization of the pipe-lines came late, because of the excessive amount of capital it demanded. Opportunities for discriminating freight rates, however, presented themselves early. How the Standard Oil Company availed itself of the unique railway conditions and of the practices common in the freight traffic of that time is one of the most sensational episodes in the history of American railroads.

By 1 87 1 the New York Central, the Erie, and the Pennsylvania railroads had completed connections that afforded them entrance to Chicago, and the great struggle for the traffic of the West had set in. The roads were so poor, and the necessity for revenue so great, that rate wars had begun as early as 1869, when the New York Central and the Pennsylvania roads had secured connection with Chicago. With the entrance of the Erie road and, in 1874, of the Baltimore and Ohio into Chicago, the competition for traffic throughout the region of the trunk lines became more embittered. During the years from 1869 till 1873 the agents of the roads met annually at New York to agree upon freight rates; and afterwards, in order to get traffic, they regularly broke their agreement. Every year during this period fourth-class rates from Chicago to New York fell from about 80 cents per one hundred pounds in December to about 25 cents in August and September. This reckless competition for traffic was extended to the oil regions. The Pennsylvania Railroad, which had the earliest and closest connection with the centre of petroleum production at Oil City, hauled oil to Pittsburg, a distance of eighty miles, and to Philadelphia, a distance of four hundred miles.

The Erie Railroad, which had no direct communication with the oil country, effected an entrance by a connection with the Atlantic and Great Western road, and hauled oil from Oil City to New York, a distance of five hundred and fifty miles. The New York Central Railroad entered Oil City by connections at Cleveland, and hauled oil to New York, a distance of seven hundred and forty miles. Just as agents of the roads had annually agreed upon a rate from Chicago to the seaboard, making the charge 80 cents by each road with a differential of 5 cents in favor of Baltimore and Philadelphia, so in the case of the oil traffic the same rate was charged by each road on oil moving from Oil City to the seaboard. The effect of this " group rate" was naturally displeasing to refiners at Pittsburg : it deprived them of all geographical advantage, and enabled their competitors at Cleveland — among others, the Standard Oil Company — to ship oil seven hundred and forty miles by the New

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York Central Railroad at precisely the rate they were charged for a haulage of four hundred miles.

Clearly this was a coincidence in rates not based upon any corresponding coincidence of cost, and as such constituted a case of discrimination. The competition of the railroads, however, was so fierce as to make no other adjustment practicable. In the practice and theory of railway rates, moreover, ample economic justification is to be found.

Because of the futility of basing rates on cost of service, a system of freight rates has arisen which favors certain classes of goods, certain localities, and certain individuals. By lowering rates on cheap goods, by lowering rates at competitive points, and by lowering rates to benefit growing concerns, the revenue of the railways is greatly increased with very slight increase in its expenses. By lowering rates in those three ways, then, and charging "what the traffic will bear," the railways may do business most cheaply, give lowest rates, and make the most profit. In pursuance of this principle, discriminations of the first sort have been practised from the earliest times. "'Group rates" — a form of the second sort of discrimination— have been freely made since 1869, when the railways first made the rates uniform on all the routes between the competitive points of New York and Chicago. Similar "group rates" have since been established in the coal traffic from the anthracite regions to the seaboard, and in the fruit traffic of California and Florida. The prominence of such "group rates" in the pooling agreements of the trunk lines in 1873, 1875, and 1877, and in the " Southwestern pooling agreements" of 1879, show how general was their acceptance. So fundamental, indeed, have they become in American railway tariffs that the Interstate Commerce Commission has repeatedly sanctioned them.1 Discriminations of the third sort were common throughout the period from 1870 till 1874, and by 1875 the " evening system" — a form of the third class of discriminations which the South Improvement Company closely anticipated — had become especially prominent in the cattle business between New York and Chicago.2 These

1 In the milk cases {Report of the Interstate Commerce Commission, ii., p. 273; vii., p. 97) the principle of the " group rates " is interestingly discussed from the most conservative stand-point.

2 The principle of the "cattle eveners' agreement " has been stated as follows : ' ' The trunk lines leading to New York agreed upon a per cent, of the business which each road should receive, and appointed three cattle eveners, whose duty it was to see that the shipments were made over all the roads in the agreed proportions; and for that service they were to receive $15 a car ... on every car-load of cattle shipped from the West to New York, no matter by whom shipped. . . . The commission was later reduced to $10. Now every man is made his own evener — i.e., if he ships his cattle by the road he is requested to he gets a certain price ; if he ships contrary to directions his price is made $10 higher; and this is said to work very well, the rates via all routes of course being the same." — Report of the "Hepburn" Committee, New York, 1879, pp. 69, 70.

2 17 various sorts of discrimination, then — special tariffs, " group rates," and " evening systems" — must all be regarded as practices inevitable in the railway management of the period — as essential consequences of railway economy in its development.

In one way or another every advantage obtained in rates by the large refiners at Cleveland, in the period from 1870 till 1874, may be classified under one of these three sorts of discrimination. As soon as oil became a prominent export they benefited, with all other refiners, in the special rates on oil in barrels and in tanks. Under the " group rates" on oil from Oil City to the seaboard they enjoyed local discrimination— a discrimination doubtless annoying to refiners on the shorter routes, but not essentially different from that of the ' ' group rate" from Chicago to New York, or those later enforced by pools and authorized by the Interstate Commerce Commission. And in 1872 they obtained from the railroads, under the abortive contract of the South Improvement Company, an * ' evening arrangement ' ' that, whether wrongly or not, has since become a hissing and a by-word with every opponent of the Standard Oil Company.

Early in 187 1 the advantage of Cleveland over Pittsburg, as a refining centre, had become evident. Cleveland not only enjoyed the same railroad rates that Pittsburg had, but also had water communication to the East by way of the great lakes and the Erie Canal. Pittsburg depended almost entirely for transportation upon the railroads. Cleveland, however, could at any time avail herself of the competition of rail and water transportation by taking to lake vessels whenever the charges of the New York Central Railroad were unsatisfactory.

Cleveland, as a competitive point, had the oil traffic of the New York Central at her mercy. Unless the refiners at Cleveland were allowed low freight rates, the New York Central must see its traffic directed to lake vessels. As the danger of such loss became more imminent, the New York Central was obliged to grant greater and greater favors to the refiners. And when, in 1 871, an unexpected shift in the centre of oil production threatened the entire refining business at Cleveland, the railroads dependent on this business were stirred to unusual action. ,

Beginning in 1871, at the Clarion River, remarkable discoveries of petroleum had been made throughout Butler and Clarion counties, in the region extending five miles beyond Antwerp, and southwestward a distance of fifteen miles to Millerstown and Greece City. "The development southward," says the editor of the Oil City Derrick,1 "brought about conditions through which some of the most im-

1 P. C. Boyle, Report of the Industrial Commission, 1900, p. 421.

portant railroads of the country might be deprived of a share of the oil -carrying trade. The Pennsylvania Railroad, however, was not affected by the transfer of activities from the Venango region to that of Butler and Clarion counties. The northern railway lines — namely, the Erie and New York Central — were naturally affected by the transfer of operations to distant fields, which they could not reach with their existing connections. The firstnamed road was materially aided by the gathering lines of the Pennsylvania Transportation Company, operated by Henry Harley ; but the New York Central and its connections were left without petroleumfeeders of any description." As usual in new developments of territory, the increase in production due to the large capacity of the wells, the over-capacity of the pipe-lines in the older oil-fields, and the over-production of refining plants which had taken place in the last two years — all these had conspired to make the transportation and refining of oil unremunerative throughout the petroleum country, and especially unprofitable at Cleveland.

To remedy this situation, a combination of the railroads and certain refiners was planned. " It had its inception/ ' to quote again the editor of the Oil City Derrick1 "with certain Philadelphia and Pittsburg refiners, with an agreement for co-operation with certain Cleveland refiners. But philosophical minds, viewing the subject from this distance, are agreed that it had its origin, as a matter of fact, with the railroad interests rather than with the oil interests.' 9 The form which this combination took was a contract between the railroads and certain refiners of Pittsburg, Philadelphia, and Cleveland organ-

1 Boyle, Report of the Industrial Commission, 1900, p. 42 1 . Mr. Boyle's impartiality has been questioned by opponents of the Standard Oil Company (see Report of the Industrial Commission , 1900, p. 398), but has never been disproved.

ized into the South Improvement Company.

By an act of the Pennsylvania Legislature on May i, 1871, the South Improvement Company had been created and vested with all the powers conferred by the act of April 7, 1870, upon the Pennsylvania Company. The powers of the company included authority "to construct and operate any work or works, public or private, designed to include, increase, facilitate, or develop trade, travel, or the transportation of freight, live-stock, passengers, or any traffic by land or water, from or to any part of the United States." * Of the two thousand shares of this company, nine hundred were owned by Messrs. H. M. Flagler, O. H. Payne, William Rockefeller, H. Bostwick, and J. D. Rockefeller, who later were to become prominent in the Standard Oil Company.2

1 Report of the Industrial Commission, 1900, p. 607. 1 Lewis Emery, Report of the Industrial Commission , 1900, p. 619.

On January 18, 1872, the South Improvement Company effected the desired combination by completing contracts with the Pennsylvania, the New York Central, and the Erie railroads. According to the contracts1 the South Improvement Company agreed to ship forty-five per cent, of all the oil transported by it over the Pennsylvania Railroad, and to divide the remainder equally between the Erie and the New York Central railroads, to furnish suitable tankage facilities for shipping petroleum and receiving it at its destination, and to keep records of the amount of petroleum and its products shipped over the railroads both by itself and by other parties. The railroads in return agreed to allow the South Improvement Company rebates on all petroleum and its products carried by them, to charge all other parties not less than the full rates specified in the

1 These contracts are printed in full in "Hepburn" Report, Exhibits, New York, 1879, pp. 418- contract,1 to furnish to the South Improvement Company way-bills of all petroleum or its product transported over their lines by any parties whatsoever, and, finally, "at all times to co-operate, as far as it legally may, with the party hereto of the first part, to maintain the business of the party hereto of the first part against loss or injury by competition, to the end that the party hereto of the first part may keep

1 Rates and rebates according to contract: "On Crude Petroleum

Gross Rate (a). Rebate (a).

"From any common point to

Pittsburg .80 .40

"On Refined Oil, etc.

" From Pittsburg to New York $2.00 $0.50 "From Cleveland to New York 2.00 .50"

"This contract provided that the railways should increase the freight to about double what they had been charging on all oil shipped." — M. L. Lockwood, Report of the Industrial Commission, 1900, P- 385-

(a) For each barrel of forty-five gallons. "Hepburn" Report, Exhibits, New York, 1879, p. 422.

up a remunerative, and so a full and regular business, and to that end shall lower or raise the gross rates of transportation over its railroads and connections, as far as it legally may, for such times and to such extent as may be necessary to overcome such competition/ ' The aim of the railroads, as avowed in the preamble, was plainly an increase in traffic : " whereas the magnitude and extent of the business and operations to be carried on by the party hereto of the first part will greatly promote the interest of the party hereto of the second part, and make it desirable for it by fixing certain rates of freight, drawbacks, and rebates, and by the other provisions of this agreement to encourage the outlay proposed by the party hereto of the first part, and to facilitate and increase the transportation to be received from it, . . . the party hereto of the second part covenants and agrees/ ' And for the attainment of that end, the railroads reserved the right to grant similar rebates and advantages to any other party who should furnish an amount of transportation equal to that furnished by the South Improvement Company, and equal facilities for promoting the petroleum trade.

In general outline the contract was very like those subsequently made with the grain-elevator owners in the Northwest, and with the cattle-shippers of Chicago. Throughout this period it was the policy of the railroads to bind to themselves growing businesses, in which, as in the elevator and refining industries, considerable capital and much enterprise were necessary in order to succeed, and by granting to these concerns special rates to build up trade for the industries and traffic for themselves. By this form of personal discrimination the railroads entering New York had built up traffic for themselves and business for A. T. Stewart, who was competing for the market in the Central West with Field, Leiter & Co., of Chicago. Where the competition for traffic was keen, the railroads usually contracted with the strongest shipper or group of shippers to carry freight at a special rate, or else — as in the case of the large cattle-shippers at Chicago and the South Improvement Company in the oil regions — appointed the group " evener," and in return for a special rebate required it to apportion traffic among the roads according to a fixed ratio.1

Such are the economic grounds on which to judge this contract. Popular judgment, however, was much less deliberate. On January 18th the contract was signed; and on February 27th, the day after the contract went into effect, an excited massmeeting was held at Titusville and an organization to oppose the new company hastily effected. At once a complete embargo was placed on the sale of oil to

1 As to the frequency of such discriminations, see the "Hepburn" Report, New York, 1879, pp. 43-71. The plan of the cattle-eveners' contract is contained in the " Hepburn" Report, New York, 1879, p. 70; of A.T. Stewart's contract, " Hepburn" Report, -pp. 452, 808, 1597.