The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supercompany

by Charles R. Morris

  Cleveland’s opportunity arose by courtesy of the Pennsylvania’s shortsighted policy of milking its Pittsburgh-to-Philadelphia traffic monopoly. (Andrew Carnegie railed against this practice for years. Despite his close relations with the Pennsylvania, he always took care to locate his steel plants so they couldn’t gouge him, and eventually built his own railroad.) Cleveland was a natural gateway for both Gould’s and Vanderbilt’s westward routes, and both of them decided to build up Cleveland refining to sop up excess freight capacity outside of the grain season. Since Cleveland refiners could also ship by Great Lake steamers during the seven ice-free months of the year, they found themselves with the bonus of three competing carriers. The Pennsylvania’s rates from Pittsburgh were high enough that Gould and Vanderbilt could easily match them at Cleveland; and as the two of them inevitably engaged in price-cutting duels, they steadily increased Cleveland’s advantage. With Rockefeller and his new partner, the charismatic and aggressive Henry Flagler,* leading the charge, Cleveland rapidly built refining capacity. By the time the Pennsylvania finally began to react about 1870, Cleveland had already zoomed past Pittsburgh as a refining center.

  The growth spurt in refining left the industry with a huge capacity overhang. In the early days, “oil-boiling,” as refining was called, was not much different from distilling whiskey, and early refiners used color, smell, and taste to decide which distillates were most suitable for kerosene, heating oil, or other products. Refining economics were even more spectacular than those in drilling. The cost of building a moderately sized refinery was about $13 per barrel for the first production run, which was close to the sale price for refined product; in other words, an investor could recover most of his cash investment with a single run. Hundreds of refineries, some of them handling no more than five barrels a day, sprang up throughout the oil region and at its transportation termini in Pittsburgh and Cleveland.

  By the late 1860s, however, the better refiners were starting to ratchet up the competitive barriers as they developed sound empirical understandings of heating cycles, process sequences and timing, still design, and the use of acids and other chemicals to improve product performance and physical characteristics. There was considerable innovation in continuous processing, the use of vacuum and superheated steam technology, and the mechanization of time-consuming tasks like removing sludge buildup from still bottoms. Still sizes increased by a factor of ten, and full-line refiners learned to tune operations to the full range of petroleum products, from heavy paraffins to very light solvents like benzene and naphtha. Standard Oil (as the Rockefeller refineries were rechristened in 1870) was not an innovator in any of these areas, but Rockefeller was an early adopter of proven technologies and constantly on the prowl for talent—buying up Charles Pratt’s cutting-edge refinery in 1874, for instance, and picking up the brilliant distillation specialist Henry Rogers with the deal.

  There is evidence that Rockefeller was running very scared in this period, for he doubtless divined that the industry was on the edge of a cataclysmic shakeout. He pressed on every front to reduce costs, cut waste, and sell more by-products. No opportunity to pick up a nickel of margin was overlooked—creating his own hauling operation, building his own barrel plant, purchasing his own piping supplies. Aside from his management talent, Flagler brought in wealthy in-laws, whose equity investments may have been critical in permitting major operational improvements in the company. Even the most anti-Rockefeller muckrakers conceded the high quality of operations at the Standard.

  Rockefeller also may have been unique among oil executives for his understanding of distribution. Kerosene—illuminating oil—was arguably the first global consumer product. (Grain markets were global, of course, but grain was usually processed locally into flour or bread before being sold to consumers.) Rockefeller pursued tightly integrated marketing and distribution operations from the earliest days, rapidly moving from contractual relationships to outright purchase and merger. His network acquisitions from the late 1860s through the first half of the 1870s included pipeline-based crude gathering facilities, tank storage farms, tank-car-loading facilities, domestic and overseas wholesale shipping and distribution operations, and coastal assemblage and ship-loading facilities (Rockefeller built his own and also took over both the Erie and the New York Central oil dock operations). The Standard was therefore the only company positioned to balance refinery output, transportation, and distribution, and squeeze margin increments at every stage. Since the Standard’s distribution services, like the New York oil dock operations, were used by other shippers, competing refineries also contributed to the burgeoning Standard cash coffers. The accumulation of minor efficiencies at so many points gradually amassed into a crushing profitability advantage.

  The last piece in the mosaic was superior discounts from railroads and other shippers, almost always via month-end rebates from posted freight tariffs. Rebates were typically volume-based, but often involved other considerations, like the free use of Standard storage tank or loading facilities, freight smoothing agreements, and the Standard’s absorption of fire risk (very important to the roads in the early days of oil). At one point Rockefeller purchased a fleet of wide-gauge tank cars for the cash-strapped Erie and its allies; naturally, the Standard got first dibs on the cars, paid a lower freight rate for their use, and collected rent when the railroads used them for other refiners.

  Two early contracts are illustrative. Both were negotiated primarily by Flagler, who had lead responsibility for shipping and freight management. The first, executed in 1868 and subsequently renewed, comprised a sequence of agreements between a consortium of Cleveland refiners led by the Standard, Jay Gould’s Erie and one of its allied railroads, and a crude-oil-gathering pipeline (it piped oil field production to tank-car-loading points) also under the control of the Erie. The companies made exclusive traffic commitments and major rate concessions, while the refineries got some stock in the pipeline. The clear intent of the agreements was to tie the companies into an integrated network and to ensure a steady product flow. While the arrangement made excellent economic sense, it was treated almost as evidence of criminality when it came to light many years later.

  The second contract was executed in 1870 between the Standard and the Lake Shore, a Vanderbilt road. Flagler extracted a discount of about 30 percent from posted rates by guaranteeing no fewer than sixty tank car loads a day. According to a Lake Shore executive, J. H. Devereaux, the arrangement effected tremendous savings for the railroad, since it could schedule daily nonstop oil train runs to the coast. The time required for tank car round-trips was reduced to a third of what it was when tank cars were intermixed with other freight, with commensurate savings in rolling stock and capital costs. Tongue tucked firmly in cheek, Devereaux made the offer to any other refiner, provided that it guaranteed the same volumes.

  Crisis and Consolidation

  By 1871, the crisis Rockefeller had feared was at hand. Refining capacity had ballooned to some twelve million barrels a year, much of it spread around hundreds of mom-and-pop oil-boilers, while crude production was just over five million barrels. For a brief period the producers basked in high prices as refineries bid for their product—wellhead crude went to $5 per barrel in 1871—but big new discoveries soon created a glut of crude as well. The railroads also were under strain. The Erie Wars had triggered vicious price wars, but desperate refiners continued to clamor for ever-deeper discounts and rebates. At the same time, Tom Scott was rapidly expanding the Pennsylvania into New York and New Jersey, and bruiting plans for a powerful east coast refining sector to take on Cleveland and Pittsburgh. Clearly, a cataclysmic restructuring was overdue.

  Besides shoring up his own operations, Rockefeller had positioned himself for a shakeout by reorganizing his businesses as the Standard Oil Co., a joint-stock corporation, in 1870. Joint-stock corporations were still uncommon outside of railroads, but their ability to use stock as takeover currency made them an ideal acquisition vehicle. The Standard
was capitalized at $1 million (10,000 $100 par shares), including $200,000 of new equity investment, $100,000 of which was paid in at the time of incorporation by O. B. Jennings, brother-in-law to John’s younger brother and partner, William, with the rest taken in over the next two years from officers of important Cleveland banks. The remaining shares were distributed among the partners in the same ratio as their old partnership equity.

  The crisis came to a head in a remarkable five-month period from December 1871 through April 1872. On November 30, 1871, while he was in New York, Rockefeller first heard of a plan being floated by Tom Scott and Peter Watson, then an executive in the Vanderbilt system, to organize a refiner-railroad petroleum cartel. A new corporation, the South Improvement Company (SIC), jointly owned by the railroads and the refiners, would establish uniform freight rates and freight allocations among the three major trunk lines and allocate production and shipping quotas among the participating refineries. In contrast to most contemporary pooling arrangements, this one had teeth. Oil shipping freight rates would be set very high, at least double the current averages, with almost all of the increases rebated back to the participating refiners. To top it off, the extra charges levied on nonparticipating shippers would also be rebated back to the participants. Not to join, in short, was to die. Although Rockefeller and Flagler always claimed that they were extremely skeptical of the SIC idea, Rockefeller took the lead role in selling it to his industry.

  Rockefeller returned to Cleveland on December 15 and promptly proposed a Standard buyout to Oliver H. Payne, the primary partner in Clark, Payne, Cleveland’s second biggest refiner. Payne was one of Cleveland’s wealthiest and best-connected businessmen; the Clarks were Rockefeller’s former partners in his first refinery venture. Rockefeller stipulated that he wished to retain Payne as an executive, but there would be no role for the Clarks. The deal was closed in just a few days. Payne, who had been souring on the refinery business, was first invited to examine the Standard’s books and was “thunderstruck” at its profitability. He agreed to an all-stock deal valued at $400,000, representing a goodwill premium of $150,000 over the appraised value of the Clark, Payne assets.

  In two successive filings on January 1 and 2, 1872, Standard Oil increased its capitalization, first to $2,500,000, then to $3,500,000, by issuing an additional 25,000 $100 par shares. Of the new shares, 4,000 were issued pro rata to existing shareholders, presumably as a stock dividend; 4,400 were purchased by Rockefeller and Flagler; 4,000 were issued to cover the Clark, Payne acquisition; and 900 went for two further acquisitions—a small Cleveland refinery and an internationally focused refining and distribution business owned on the New York waterfront by Jabez Bostwick. Finally, 500 shares were issued, significantly enough, to Watson, while the remaining 11,200 shares were retained against further acquisitions. (See the chapter Notes for the Standard stock tables.) Rockefeller was moving very fast.

  On January 2, the SIC was incorporated, with Watson as president. Of the 2,000 authorized shares, Watson held 100 and was the only railroad representative. The Standard held 900 shares, including 360 in the names of Payne and Bostwick. Two refineries with interlocking ownership in Philadelphia and Pittsburgh received almost all the remainder, totaling 80 more than the Standard group. With some haggling, the Erie and Vanderbilt roads agreed to come in, and quickly settled their respective traffic allocations with the Pennsylvania.

  Rockefeller was a whirlwind. He and Watson were the key drivers of the SIC, holding meetings up and down the east coast and throughout the oil regions. At the same time, his Cleveland acquisition program went into hyperdrive. By the end of January, he had made buyout propositions to all twenty-six Cleveland refineries. By the end of March, he had closed on twenty-one.

  The SIC crashed and burned just as the last Cleveland acquisitions were closing. Despite Scott’s protestations, the refiner-incorporators of the SIC did not want to include the producers, and only reluctantly invited in the oil region’s bigger refiners, who refused to join. Then in February, through a clerical error, the proposed freight rates under the SIC plan were posted as if they were already in effect. The oil region exploded in shock and anger. There were torchlit parades, fiery speeches, and attacks against the facilities of SIC participants. When Rockefeller and Watson attempted conciliation, they were shouted out of meeting rooms. Most dramatically, for the only time in the region’s history, the producers actually enforced an embargo against the SIC’s member refineries. Night-riding embargo vigilantes kept waverers in line. By early March, the Standard was effectively out of business, and up to 5,000 Cleveland refinery workers were laid off.

  With Scott leading the way, the railroads capitulated in mid-March. Cornelius Vanderbilt said it was all a mistake, bravely blaming his son. George McClellan, the bumbling Civil War general who was now president of the Atlantic & Great Western, denied he had signed on in the first place. Jay Gould at the Erie, ever the pretense-puncturer, promptly sent producers a telegram with the details of McClellan’s signup. The railroad’s peace offering was a new uniform rate schedule—no rebates or discounts allowed—announced on March 25, basically tracking the rebated schedules in the SIC plan. (The railroads stuck with their no-discount promise for about two weeks.) Jumping on the bandwagon, the Pennsylvania legislature righteously revoked the SIC’s charter on April 2. A week later, the triumphant producers announced the end of their embargo.

  And a week after that, the trade press first revealed that the Standard, for all practical purposes, had consolidated the entire Cleveland refinery industry. Until the SIC fiasco, most people in the industry had never heard John Rockefeller’s name; now he controlled more than a fourth of the country’s refining capacity. As the shock waves reverberated through the oil regions—one paper spoke of the South Improvement Company “alias the Standard Oil Company”—Rockefeller and Flagler made a conciliatory visit, floating a so-called “Pittsburgh Plan” whereby refiners would sign on to a minimum wellhead crude price—provided the oil fields would limit production to agreed levels. They may not have been entirely serious; galvanizing angry producers into a one-month embargo was one thing, but sustained production agreements were quite beyond the region’s organizational capacity. The excursion was still useful to Rockefeller, for he established friendly relations with the two biggest region refiners, John Archbold and J. J. Vandergrift, who had been among his fiercest critics during the SIC fiasco.

  Rockefeller and his partners were otherwise not much in the news for the next eighteen months, as they concentrated on a root-and-branch reworking of their Cleveland refining base. Most of their newly acquired businesses were sold for scrap, as a total of twenty-four refineries were consolidated into six large, state-of-the-art installations, designed from the outset for efficient production of the full range of oil by-products. From that point, the Standard was a money-spinning machine. Between 1870 and 1873, the price of kerosene in New York dropped by about 25 percent. Most of the hit was absorbed by the producers, as wellhead crude fell from more than $4 a barrel to less than $2. Per-barrel railroad freight recoveries were squeezed by an additional 15 percent, but refinery per-barrel revenues actually increased by 25 percent. For most of the industry, the revenue kick would have barely stemmed the flow of red ink; for the Standard, it locked in an already powerful profit advantage. Most executives might have considered the “Conquest of Cleveland” the work of a lifetime. But Rockefeller was only thirty-three, and was just getting started.

  The Muckrakers’ Case against Rockefeller

  Ida Tarbell’s History of Standard Oil, based on her famous nineteen-part series in McClure’s Magazine from 1901 to 1903, may be considered the urtext, the canonical statement, of the case against Rockefeller. It is a splendid polemic, and has dominated the perception of the man and his rise ever since. Tarbell was a child of the oil region. Her father built the first tank system to contain the runaway flows of some of the earliest oil strikes, and as a teenager during the region’s war against the SIC,
she proudly saw him gallop to battle as a vigilante enforcing the oil embargo. Her story is a morality play: the stalwart independent producers and refiners of the region fighting a hopeless struggle against a distant corporation personified by a soulless John D. Rockefeller. Its central argument is that the region’s producers and refiners had an inherent advantage over any other petroleum center, especially Cleveland. It was the only place with integrated production and refining, and was closer to major eastern markets and ports to boot. She concedes Rockefeller’s excellence as a businessman, but insists that he could not have overcome such advantages except by cheating. And she uncovers the cheating in the system of “unjust and illegal” railroad rebates that discriminated in favor of the large shipper.

  The great power of Tarbell’s prose, unfortunately, conceals the holes in her argument. To begin with, the region’s refiners did not enjoy an inherent advantage over the more distant centers; the reverse, in fact, was more likely the case. Wellhead to refinery to market distances were indeed the shortest, as Tarbell says, but the locational advantage came with built-in problems, like unreliable access to supplies and very high land prices—lessors preferred the windfalls from drilling. Much more important, transportation within the region was poor. This was rough, mountainous country; the railroad network was rather like many newer urban rapid transit systems—designed to move people between suburbs and city center, but of little help in getting around the city itself. The struggle was to keep up with the shifting locations of high-production fields as older wells ran down and new discoveries expanded the region’s boundaries. Region refineries, inevitably, tended to be tied to particular well centers and were typically small and underutilized. It was the smaller operators that Tarbell especially romanticized—men whose lives ran “swift and ruddy and joyous . . . until a big hand reached out from nobody knew where, to steal their conquest and throttle their future.” But the hard fact was that with two or three exceptions, the region’s refiners were among the least efficient of all. As production technology shifted to favor large-scale, full-line, continuous processing, the consolidated refining centers situated at major transportation hubs acquired an unassailable advantage.