Tuesday, January 10, 2017

January 10, 1870 – John D. Rockefeller incorporates Standard Oil in Cleveland, Ohio.

Rockefeller was born in July 1839 in Richford, New York -- the southeast area of the Finger Lakes country. His father was a snake-oil salesman who would abandon the family for a year at a time. His sainted mother, Eliza, instilled in her children an almost fanatical devotion to hard work and saving. The family moved frequently, but in 1853 the Rockefellers moved to Strongsville, Ohio. John enrolled at Cleveland Central High School, then the only free public school around. After graduation, he took a 10-week course in bookkeeping.

Rockefeller's first job was as an accountant for a local grocery company. He became adept at figuring out ways to save money on transportation, and in 1859 formed his own produce-importing business with William Clark after convincing local investors to loan him $4,000 ($106,000 in 2016 inflation-adjusted dollars). It is a testimony to Rockefeller's rock-solid character and business sense that practically everyone in town believed he would succeed -- at the age of 20.

By 1863, the price of whale oil had skyrocketed due to the demands for lubricating oil brought about by the Civil War and the complete collapse of the whale fisheries. Petroleum had only begun to be refined in 1848, and in 1859 the first oil well was drilled in western Pennsylvania. The oil business was booming: One could simply dig a hole in the ground, and oil would pool in it. Chemist Samuel Andrews approached Rockefeller and Clark with a proposition to form a new oil refining company using Clark's methods. The two agreed, and with additional money from Clark's two brothers a new company was formed -- Andrews, Clark & Company.

The Rockefeller refinery was built on Kingsbury Run (now filled in) on the Flats in Ohio. Frugal as always, Rockefeller found uses for the wide range of "waste products" -- things like gasoline, petroleum jelly, paraffin, and tar. Rather than contract out the construction of barrels and plumbing services, he created this in-house, saving huge sums of money. (It's not just that he paid his workers less. These employees worked on a piece-rate basis for every firm. Rockefeller promised them steady work [unlike other firms], but only if they cut their prices. It was a win-win for both parties.)

In February 1865, Rockefeller bought out the Clark brothers for $72,500 (equivalent to $1 million in 2016 inflation-adjusted dollars). He then changed the name of the firm to Rockefeller & Andrews. Rockefeller convinced his less-than-ambitious brother, William, to get into the oil business too, and soon William (with a loan from John) had constructed an oil refinery in Cleveland.

On March 4, 1867, John and William Rockefeller, Andrews, and businessman Henry Flagler formed the oil refining firm of Rockefeller, Andrews & Flagler. (Flagler's step-brother, the liquor magnate Stephen V. Harkness, was a silent partner.) Transportation costs were the key to making oil cheaply available to consumers, and cheap oil meant more market share (and more profit). For Rockefeller, Andrews & Flagler, the question was how to get its refined oil to East Coast cities.

At the time, the railroads were engaged in cutthroat competition for refined oil. Rate-cutting was common (with railways often losing money on shipments). Each railroad also attempted to win more oil freight business by rapidly building up its supply of tank cars, but this left the railroads with an oversupply of cars, which lost them even more money.

In 1868, Rockefeller formed a consortium of Cleveland-area refining companies. The consortium agreed to pool their shipments to the East Coast if lower freight rates could be procured. On behalf of the consortium, Henry Flagler reached an agreement with Amasa Stone, the Cleveland railroad baron who ran the Lake Shore & Michigan Southern Railroad: The consortium would guarantee at least 60 tank cars of refined oil every day, in return for which the LS&MS would cut shipping rates by 30 percent (e.g., offer a "rebate"). The consortium agreed not to ship oil with any other railway unless the LS&MS could not take the oil, and the LS&MS agreed not to offer a rebate to any other refiners unless they could provide at least 60 tank cars of oil a day (which none of them could). Stone quickly agreed to the plan, which greatly enhanced Rockefeller, Andrews & Flagler's market share.

Rockefeller had long believed that overcapacity in the oil refining business would cause a crash in the price of refined oil. Anticipating the crash, on January 10, 1870, Rockefeller incorporated Standard Oil. John D. Rockefeller received 2,667 shares; Harkness received 1,334 shares; William Rockefeller, Flagler, and Andrews received 1,333 shares each; and the firm of Rockefeller, Andrews & Flagler received 1,000 shares as a reserve. New to the group was Oliver Burr Jennings, William Rockefeller's brother-in-law, who also received 1,000 shares.

The stock was set at a $100 per share par value ($1,894 in 2017 inflation-adjusted dollars), and Standard Oil paid a 105 percent dividend in 1870 and 1871. The overcapacity crash hit in 1871, and many refiners neared bankruptcy. In the fall of 1871, Rockefeller learned of a conspiracy being promoted by Thomas A. Scott (First Vice President of the Pennsylvania Railroad) and Peter H. Watson (then a director of the LS&MS). On November 30, 1871, Rockefeller met with Scott and Watson at the St. Nicholas Hotel in New York City, where Scott outlined his plan: Using a vaguely-worded corporate charter he had obtained from the Pennsylvania General Assembly, the Pennsylvania Railroad, the New York Central Railroad, the Erie Railroad, Standard Oil, and a few small oil refining companies would create and invest in a new firm -- the South Improvement Company (SIC).

The SIC's participating railroads would give the SIC's investor-refiners a 50 percent rebate on oil shipments, helping them to drive competing refiners out of business. Additionally, any time the SIC carried the oil of a non-participating refiner, the SIC would give a 40-cents-per-barrel payment ($8 in 2017 dollars) to the investor-refiners. The SIC would also provide the investor-refiners with information on the shipments of their competitors, giving them a critical advantage in pricing and sales.

Rockefeller saw the SIC as the ideal mechanism for achieving another goal: A monopoly on oil refining in Cleveland -- then about the only place in the country which had refineries. Once the SIC had severely weakened his competitors, Standard Oil would buy out the city's 26 major oil refining companies at fire-sale prices. The monopoly would allow Standard Oil to dominate the national refining market, garner significantly higher profits, and drive competitors out of business. With higher profits, Standard Oil could then rapidly expand, becoming even more dominant.

To make the purchases, Standard Oil needed cash. To secure the cash, Rockefeller allowed Amasa Stone, Stillman Witt, Benjamin Brewster, and Truman P. Handy — all of whom were officers in Cleveland banks — to buy shares in Standard Oil at par in December 1871. Stone and the other bankers used their influence at their own and other banks to give Rockefeller the financial backing he needed.

The SIC conspiracy collapsed in March 1872, but between February 17, 1872, and March 28, 1872, Rockefeller was able to buy out 22 of the 26 major refiners in Cleveland, an event which historians call "the Cleveland Massacre".

Events moved so quickly that additional capital was needed, and Rockefeller felt that the Cleveland banks could not be counted on to keep his loan requests confidential. On January 2, 1872, Standard Oil issued 4,000 new shares of stock in the form of a dividend (stock was issued on a pro rata basis to all the existing shareholders). Later that same day, another issue of stock was made. This constituted 11,000 shares, of which 3,000 were given to John D. Rockefeller, 1,400 to Henry Flagler, 4,000 to the owners of Clark, Payne and Company (one of the largest oil refineries in Cleveland), 700 to refiner Jabez A. Bostwick, 200 to refiner Joseph Stanley, and 500 to Peter Watson (who by now was the president of the SIC). Another 1,200 shares were given to John D. Rockefeller to retain as a reserve. On January 2, 1872, a third new issue of 10,000 shares occurred, and was given to Rockefeller to hold in reserve.

By trading shares in Standard Oil for ownership of the Clark/Payne, Bostwick, and Stanley refineries, Standard Oil completed its conquest of the Cleveland refinery business.

Standard Oil would grow even larger as it sought to control oil fields and oil transportation, and as it developed the "trust" form of corporate governance which allowed it to evade state and federal law and secretly undermine other oil drilling, refining, and transportation companies.

But it is Standard Oil's monopoly on the oil refining business of Cleveland that created the monster.

Standard Oil would last only until 1911. But in that time, John D. Rockefeller would become the wealthiest American of all time (even richer than Bill Gates, Warren Buffet, Andrew Carnegie, Cornelius Vanderbilt, John Jacob Astor, Richard B. Mellon, Frederick Weyerhauser, Marshall Field, Sam Walton, Henry Ford, or J.P. Morgan) and the richest person in modern history.

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