This article is from TOS Vol. 3, No. 2. The full contents of the issue are listed here.

Vindicating Capitalism: The Real History of the Standard Oil Company

The Standard Story of Standard Oil

In 1881, The Atlantic magazine published Henry Demarest Lloyd’s essay “The Story of a Great Monopoly”—the first in-depth account of one of the most infamous stories in the history of capitalism: the “monopolization” of the oil refining market by the Standard Oil Company and its leader, John D. Rockefeller. “Very few of the forty millions of people in the United States who burn kerosene,” Lloyd wrote,

know that its production, manufacture, and export, its price at home and abroad, have been controlled for years by a single corporation—the Standard Oil Company. . . . The Standard produces only one fiftieth or sixtieth of our petroleum, but dictates the price of all, and refines nine tenths. This corporation has driven into bankruptcy, or out of business, or into union with itself, all the petroleum refineries of the country except five in New York, and a few of little consequence in Western Pennsylvania. . . . the means by which they achieved monopoly was by conspiracy with the railroads. . . . [Rockefeller] effected secret arrangements with the Pennsylvania, the New York Central, the Erie, and the Atlantic and Great Western. . . . After the Standard had used the rebate to crush out the other refiners, who were its competitors in the purchase of petroleum at the wells, it became the only buyer, and dictated the price. It began by paying more than cost for crude oil, and selling refined oil for less than cost. It has ended by making us pay what it pleases for kerosene. . . .2

Many similar accounts followed Lloyd’s—the most definitive being Ida Tarbell’s 1904 History of the Standard Oil Company, ranked by a survey of leading journalists as one of the five greatest works of journalism in the 20th century.3 Lloyd’s, Tarbell’s, and other works differ widely in their depth and details, but all tell the same essential story—one that remains with us to this day.

Prior to Rockefeller’s rise to dominance in the early 1870s, the story goes, the oil refining market was highly competitive, with numerous small, enterprising “independent refiners” competing harmoniously with each other so that their customers got kerosene at reasonable prices while they made a nice living. Ida Tarbell presents an inspiring depiction of the early refiners.

Life ran swift and ruddy and joyous in these men. They were still young, most of them under forty, and they looked forward with all the eagerness of the young who have just learned their powers, to years of struggle and development. . . . They would meet their own needs. They would bring the oil refining to the region where it belonged. They would make their towns the most beautiful in the world. There was nothing too good for them, nothing they did not hope and dare.4

“But suddenly,” Tarbell laments, “at the very heyday of this confidence, a big hand [Rockefeller’s] reached out from nobody knew where, to steal their conquest and throttle their future. The suddenness and the blackness of the assault on their business stirred to the bottom their manhood and their sense of fair play. . . .”5

Driven by insatiable greed and pursuing his firm’s self-interest above all else, the story goes, Rockefeller conspired to obtain an unfair advantage over his competitors through secret, preferential rebate contracts (discounts) with the railroads that shipped oil. By dramatically and unfairly lowering his costs, he slashed prices to the point that he could make a profit while his competitors had to take losses to compete. Sometimes he went even further, engaging in “predatory pricing”: lowering prices so much that Standard took a small, temporary loss (which it could survive given its pile of cash) while his competitors took a bankrupting loss.

These “anticompetitive” practices of rebates and “predatory pricing,” the story continues, forced competitors to sell their operations to Rockefeller—their only alternative to going out of business. It was as if he was holding a gun to their heads—and the “crime” only grew as Rockefeller acquired more and more companies, enabling him, in turn, to extract ever steeper rebates from the railroads, which further enabled him to prey on new competitors with unmatchable prices. This continued until Rockefeller acquired an unchallengeable monopoly in the industry, one with the “power” to banish future competition at will and to dictate prices to suppliers (such as crude oil producers) and consumers, who had no alternative refiner to turn to.

Pick a modern history or economics textbook at random and you are likely to see some variant of the Lloyd/Tarbell narrative being taken for granted. Howard Zinn provides a particularly succinct illustration in his immensely popular textbook A People’s History of the United States. Here is his summary of Rockefeller’s success in the oil industry: “He bought his first oil refinery in 1862, and by 1870 set up Standard Oil Company of Ohio, made secret agreements with railroads to ship his oil with them if they gave him rebates—discounts—on their prices, and thus drove competitors out of business.”6

Exhibiting the same “everyone knows about the evil Standard Oil monopoly” attitude, popular economist Paul Krugman writes of Standard Oil and other large companies of the late 19th century:

The original “trusts”—monopolies created by merger, such as the Standard Oil trust, or its emulators in the sugar, whiskey, lead, and linseed oil industries, to name a few—were frankly designed to eliminate competition, so that prices could be increased to whatever the traffic would bear. It didn’t take a rocket scientist to figure out that this was bad for consumers and the economy as a whole.7

The standard story of Standard Oil has a standard lesson drawn from it: Rockefeller should never have been permitted to take the destructive, “anticompetitive” actions (rebates, “predatory pricing,” endless combinations) that made it possible for him to acquire and maintain his stranglehold on the market. The near-laissez-faire system of the 19th century accorded him too much economic freedom—the freedom to contract, to combine with other firms, to price, and to associate as he judged in his interest. Unchecked, economic freedom led to Standard’s large aggregation of economic power—the power flowing from advantageous contractual arrangements and vast economic resources that enabled it to destroy the economic freedom of its competitors and consumers. This power, we are told, was no different in essence than the political power of government to wield physical force in order to compel individuals against their will. In the free market, through unrestrained voluntary contracts and combinations, Standard had allegedly become the equivalent of a king or dictator with the unchallenged power to forbid competition and legislate prices at whim. “Standard Oil,” writes Ron Chernow, author of the popular Rockefeller biography Titan, “had taught the American public an important but paradoxical lesson: Free markets, if left completely to their own devices can wind up terribly unfree.”8

This lesson was and is the logic behind antitrust law, in which government uses its political power to forcibly stop what it regards as “anticompetitive” uses of economic power. John Sherman, the author of America’s first federal antitrust law, the Sherman Antitrust Act of 1890, likely had Rockefeller in mind when he said:

If we will not endure a king as a political power we should not endure a king over the production, transportation, and sale of any of the necessaries of life. If we would not submit to an emperor, we should not submit to an autocrat of trade, with power to prevent competition, and to fix the price of any commodity.9

But Rockefeller was no autocrat. The standard lesson of Rockefeller’s rise is wrong—as is the traditional story of how it happened. Rockefeller did not achieve his success through the destructive, “anticompetitive” tactics attributed to him—nor could he have under economic freedom. Rockefeller had no coercive power to banish competition or to dictate consumer prices. His sole power was his earned economic power—which was no more and no less than his ability to refine crude oil to produce kerosene and other products better, cheaper, and in greater quantity than anyone thought possible.

It has been more than one hundred years since Ida Tarbell published her History of the Standard Oil Company. It is time for Americans to know the real history of that company and to learn its attendant and valuable lessons about capitalism.

The “Pure and Perfect” Early Refining Market

Any objective analysis of the nature of Rockefeller’s rise to dominance—Standard Oil had an approximately 90 percent market share in oil refining from 1879 to 189910—must take into account the context in which he rose. This means taking a thorough look at the market he came to dominate, before he entered it.

Traditional accounts of Rockefeller’s ascent, which began in 1863, portray the pre-Rockefeller market as a competitive paradise of myriad “independent refiners”—a paradise that Rockefeller destroyed when he drove his competitors out of business and wrested full “control” of the oil refining business for himself.

This idealized view of the early oil refining market appeals to most readers, who have been taught that a good, “competitive” market is one with as many viable competitors as possible, and that it is “anti-competitive” to have a market with a few dominant participants (“oligopoly”), let alone one dominant participant (“monopoly”). This view of markets was formalized in the 20th century as the doctrine of “pure and perfect” or “perfect” competition, which holds that the ideal market consists of as many distinct producers as possible, each selling equally desirable, interchangeable products. Under “perfect competition,” no one competitor has any independent influence on price, and the profits of each are minimized as much as possible (on some variants of “perfect competition,” prices equal costs and profits are nonexistent). Although advocates of this view acknowledge (or lament) that it cannot exist in reality, they view it as a model market toward which we should at least strive.

By this standard, the early oil refining market was “perfect” in many ways. Many small, “independent,” practically indistinguishable refiners were in business. No one threatened to drive the others out of business, and the market was extremely easy to enter; those with no experience in refining could buy the necessary equipment for three hundred dollars and start making profits almost immediately.11 Some refiners recovered their start-up costs after one batch of kerosene.12

But the traditional perspective ignores the crucial aspect of markets relevant to their impact on human life: their productivity—how much it produces, the value of that which is produced, and the efficiency with which it is produced. By this standard, the oil refining market was anything but perfect—refiners were at an early, primitive stage of productivity, which happily ended.

This is not a moral criticism of the early oil refining industry. The first five years of that industry, along with the crude production industry, from 1859 to 1864, were full of great achievements. It is almost impossible to overstate the dramatic and near-immediate positive effect of a group of scientists and businessmen discovering that “rock oil,” previously thought to be useless, could be refined to produce kerosene—the greatest, cheapest source of light known to man. In 1858, a year before the first oil well was drilled, only well-to-do families such as that of 11-year-old Henry Demarest Lloyd could afford sperm whale oil at three dollars per gallon to light their homes at night.13 For most, the day lasted only as long as did the daylight. But by 1864, just five years into the industry, a New York chemist observed:

Kerosene has, in one sense, increased the length of life among the agricultural population. Those who, on account of the dearness or inefficiency of whale oil, were accustomed to go to bed soon after the sunset and spend almost half their time in sleep, now occupy a portion of the night in reading and other amusements; and this is more particularly true of the winter seasons.14

Still, the market’s primitive methods of production and distribution at this early stage made it impossible for it to have anywhere near the worldwide impact it would have by the time Lloyd’s famous essay damning Rockefeller was published.

A particularly problematic area was transportation, which was convoluted and extremely expensive. Oil was transported in 42-gallon wood barrels of spotty quality, costing $2.50 each. Each one had to be filled and sealed separately and piled onto a railroad platform (where barrels were prone to leak or fall off) or occasionally onto a barge (where barrels were prone to fall off and start fires).15 The myriad small refiners each could ship only a handful of barrels at a time; this required the railroads to make many separate stops at different destinations for different refiners, which resulted in a lengthy and expensive journey for both railroads and refiners. And for some time, this was the best aspect of the process. In the early days, to get barrels of crude oil from assorted oil spots in northwest Pennsylvania onto railways headed for the refineries, oil was transported by horse and wagon by teamsters, often through roadless territory and waist-high mud, with barrels perpetually bouncing and frequently breaking or falling out. (Because of government intervention, the teamsters had a huge influence in politics and for years prevented the construction of local pipelines—an incomparably superior form of oil transportation.)16

The refining process, the core of the industry, was also at a primitive stage. To refine crude oil is to extract from it one or more of its valuable “fractions,” such as kerosene for illumination, paraffin wax for candles, or gasoline for fuel. The heart of the refining process uses a “still”—a distillation apparatus—to heat crude oil at multiple, increasing temperatures to boil off and separate the different fractions, each of which has a different boiling point. Distillation is simple in concept and basic execution, but to produce quality kerosene and other by-products requires precise temperature controls and various additional purification procedures. Impure kerosene could be highly explosive; death by kerosene was a common phenomenon in the 1860s and even the 1870s, claiming thousands of lives annually. In fact, the spotty quality of much American kerosene is what inspired John Rockefeller to call his company Standard Oil.17

Some refineries in the early 1860s, such as those of famed refiners Joshua Merrill and Charles Pratt, produced safe, high-quality kerosene, but most did not. Tarbell’s exalted “independent refiners” from the Oil Regions of Pennsylvania, incidentally, produced the worst quality kerosene.

“Deluded by petroleum enthusiasts as to the simplicity of refining,” write Williamson and Daum in their comprehensive history of the early petroleum industry, “individuals inexperienced in any form of distillation flocked into the new business. . . .” But, they note,

successful petroleum refining . . . called for the utmost vigilance. . . . Real separation of the various components of crude oil was no objective at all; their major purpose was simply to distill off the gases, gasoline and naphtha fractions as fast as heat and condensation could permit. All condensed liquid that conceivably could be fobbed off as burning oil . . . was recovered and the tar residue was thrown away. . . . Only in the provincial isolation of the Oil Region and nearby locations did such outfits receive serious designations as petroleum refineries.18

In a mature market, such operations, with their inferior, hazardous products, would never succeed. But in the early stages of the market, anyone could succeed, because the overall refining capacity was insufficient to meet the enormous demand for kerosene.Even lower-quality kerosene was spectacularly valuable compared to any other illuminant Americans could buy.

The supply-and-demand equation of kerosene even made it possible for refiners with low efficiency to profit handsomely. In 1865, kerosene cost fifty-eight cents a gallon; at one-fifth the cost of whale oil this was a great deal for consumers—and it was a price at which anyone with a still could make money. Even if the still was very small, requiring much more manpower and other expenses per gallon of output than a larger still; even if the still refined only kerosene and failed to make use of the other 40 percent of crude; even if the still was low-quality and needed frequent repair or replacement—the owner could turn a healthy profit.19

This stage of the industry was necessarily temporary. As more and more people entered the refining industry, attracted by the premium profits, prices inevitably went down—as did profits for those who could not increase their efficiency accordingly.

Such a process, which began in the mid-1860s, was more dramatic than almost anyone expected. Between 1865 and 1870, refining capacity exploded relative to oil production, and prices plummeted correspondingly. In 1865, kerosene cost fifty-eight cents a gallon; by 1870, twenty-six cents.20 Refining capacity was increasing relative to the supply of oil; by 1871 the ratio of capacity to crude production was 2.5:1.21 At this point, those who expected to make a livelihood with three-hundred-dollar stills found the market very inhospitable. A shakeout of the efficient men from the inefficient boys was inevitable. In the mid-1860s, no one imagined that the best of the men, by orders of magnitude, would turn out to be a 24-year-old boy named John Davison Rockefeller.

The Phenomenon.

In 1863, the first railroad line was built connecting the city of Cleveland to the Oil Regions in Pennsylvania, where virtually all American oil came from. Clevelanders quickly took the opportunity to refine oil—as had the residents of the Oil Regions, Pittsburgh, New York, and Baltimore. Cleveland had the disadvantage of being one hundred miles22 from the oil fields but the advantage of having far cheaper prices for materials and land (Oil Regions real estate had become extremely expensive), plus proximity to the Erie Canal for shipping.23

In 1863, Rockefeller was running a successful merchant business with his partner, Maurice Clark, when a local man named Samuel Andrews approached the two. A talented amateur chemist, Andrews sought their investment in a refinery. After investigating the industry, Rockefeller convinced Clark that they should invest four thousand dollars.24 Rockefeller was attracted to the substantial—and then stable—profits of the refining industry, in contrast to the production industry, which alternated between incredible booms and busts. (When producers struck a “gusher,” whole towns were built up to the height of 1860s luxury; when they dried up, those towns faded into abject poverty.) He was not, however, impressed with the efficiency with which refiners ran their operations. He believed he could do better.

And he did—immediately. Instead of setting up a shanty refinery, Rockefeller invested enough to create the largest refinery in Cleveland: Excelsior Works. From the beginning, he encouraged Andrews to expand and improve the refinery, which soon produced 505 barrels a day,25 as compared to some refineries in the Oil Regions that produced as few as five barrels a day.26 Additionally, in a highly profitable act of foresight, Rockefeller carefully bought the land for his refinery in a place from which it would be easy to ship by railroad and by water, thus putting shippers in competition for his business; his competitors simply placed their refineries near the new Cleveland rail line and took for granted that it would be their means of transportation.27

Rockefeller’s business background made him well-suited to run a highly efficient firm. His first interest in business had been accounting—the art of measuring profit and loss (i.e., economic efficiency). Rockefeller’s first job had been as an assistant bookkeeper, and for his entire career he revered the practice of careful financial record-keeping. “For Rockefeller,” writes Ron Chernow, “ledgers were sacred books that guided decisions and saved one from fallible emotion. They gauged performance, exposed fraud, and ferreted out hidden inefficiencies.”28

Rockefeller was hardly the only man in the refining industry with a background in accounting or a concern with efficiency. But he was distinguished in this regard by his degree of focus on applying good accounting practices to his new business. Rockefeller, from a young age, exhibited an obsessive, laser-like concentration on whatever he chose as his purpose. At age sixteen he landed an accounting job after six weeks of repeated visits to top firms, shrugging off rejections until he finally convinced one of them, Hewitt and Tuttle, to hire him.29 Applied to the task of minimizing costs and maximizing revenues in his refining operation, Rockefeller’s focus brought Standard Oil phenomenal success.

While other refiners took any given business cost for granted—including the cost of barrels and the cost of crude—Rockefeller put himself and those who worked for him to the task of discovering ways to lower every cost while continuously seeking additional sources of revenue.

Consider the cost of transporting oil in barrels. Barrels were a major expense for everyone in the industry, and barrel makers were notoriously unreliable when it came to delivering barrels on time. Rockefeller at once slashed his costs and solved this reliability problem by having his firm manufacture its own barrels. He purchased forest land, had laborers cut wood, and—in a crucial innovation—had the wood dried in a kiln before using it to transport kerosene. (Others used green wood barrels, which were far heavier and thus more expensive to transport.) With these and other innovations, Rockefeller’s barrel costs dropped from $2.50 a barrel to less than $1 a barrel—and he always had barrels when he needed them.30

Rockefeller further lowered his costs by eliminating the use of barrels altogether in receiving crude oil (barrels would remain in use for shipping refined oil to customers for some time). He did so by investing in “tank cars”—railroad cars fitted with giant tanks—shortly after they came on the market in 1865. By 1869, he owned seventy-eight of them, yielding huge cost savings over his competitors.31

Or consider the cost of buying crude, which most people took as entirely dependent upon current market prices. One way in which he cut this cost was by employing his own purchasing agents, which eliminated the need for paying “jobbers” (purchasing middlemen). A shrewd negotiator, Rockefeller trained his purchasing agents to obtain the best possible prices. Further saving money and improving his negotiating position, Rockefeller built large storage facilities to keep crude in reserve, so that he would not have to pay exorbitant prices in the event of a spike in its price. Accordingly, his purchasing agents developed comprehensive, constantly updated knowledge of the industry so that they could determine the most opportune times to purchase crude.

These improvements, along with many others, reflected a practice that characterized Rockefeller’s firm for his thirty-five years at the helm: vertical integration—incorporating into a company functions that it had previously paid others to do. Time after time, Rockefeller found that, given his and his subordinates’ talent and innovative spirit, many facets of the business could be done more cheaply if his firm undertook them itself.

Rockefeller also lowered costs in the refining process itself. One particularly innovative form of cost-cutting in which he engaged was self-insurance against fires. In the early refining industry, the danger of fire was omnipresent. Even in the 1870s, when safety improved significantly, premiums “varied from 25 per cent down to 5 per cent of valuation. . . .”32 Rockefeller determined that he could save money by self-insuring. He regularly set aside income to handle fire damage, while implementing every safety precaution he and his men could think of. The practice saved the company thousands and, eventually, millions of dollars; over time, its insurance funds grew to the point where they could be used to pay large dividends to shareholders. (In later years, Rockefeller contained the risk of fire even more by multiplying refineries across the country, so that one disaster could do only so much damage.)33

Another refining cost that Rockefeller minimized was the chemical treatment of kerosene. Samuel Andrews was skilled at determining the right quantity of sulfuric acid needed to completely purify distilled kerosene. This was important because sulfuric acid was expensive. Rockefeller saved money by getting ideal results with 2 percent whereas competitors often used up to 10 percent.34

And in building his refineries, Rockefeller used the highest quality materials to get maximum longevity from equipment—thus avoiding the reliability issues of early stills—and he built large facilities so as to lower his labor costs per gallon refined.

Rockefeller also worked to maximize the amount of revenue he could bring in, both by selling by-products of crude besides kerosene and by establishing marketing operations in major consumer states and overseas. Appalled at the idea of wasting the 40 percent of his crude that was not kerosene, Rockefeller extracted and sold the fraction naphtha, and he sold much of the remaining portion of the crude to other refiners who specialized in other non-kerosene fractions, such as paraffin wax and gasoline. (He also used fuel oil from crude to help power his plants, thereby saving money on coal.) Later, Rockefeller’s firm refined and sold all these fractions—becoming what is called a “complete” refinery—but even before that development, he let no cost-cutting or value-creating opportunity go to waste.

In the mid-1860s, Rockefeller set up an office in New York City to focus on overseas sales. The overseas market for kerosene was larger than the American market and presented a great opportunity to Rockefeller since nearly all the world’s known oil at the time was American. Recognizing the importance of having a steady stream of foreign demand, Rockefeller had his brother head the New York operation to keep tabs on the various markets and maximize sales.

These improvements in efficiency and marketing resulted in a company that was staggeringly more productive than most of its rivals, and well on its way to revolutionizing the oil refining industry.

Rockefeller’s obsession with cutting costs has been called “penny-pinching”35—a term that aptly describes his desire and ability to cut costs to the smallest detail. But insofar as it conjures an image of a miserly businessman, the term does not apply. Rockefeller, by disposition and in action, was anything but averse to spending money; he recognized that spending in the form of investing was vital to the dramatic increases in efficiency he sought and achieved.

Many of Rockefeller’s penny-pinching methods required investments, often large ones. He knew that although these would cut into his cash in the short run, they would prove profitable in the long run—if the company simultaneously invested in its growth. The greater the firm’s output, the more it could leverage economies of scale, achieving greater efficiency by dispersing productivity-increasing costs over a greater number of units. By virtue of its size and output, Rockefeller’s firm was able, for example, to purchase, maintain, and replant forests in order to more efficiently produce barrels—a strategy that would be utterly unprofitable for a small refiner producing, say, fifty barrels a day.

The bigger the company, the more it can invest in efficiency-increasing measures—from tank cars to forests to purchasing agents to self-insurance—when it makes financial sense. Recognizing this, Rockefeller reinvested profits in the business at every opportunity. Whereas other oilmen in the booming 1860s spent almost all of their profits on the premise that current market conditions would endure and therefore future revenue would easily cover their future costs, Rockefeller reinvested as much of the firm’s profit as possible in its growth, efficiency, and durability.

Rockefeller also solicited large amounts of capital from outside the company. Early on, he borrowed money frequently, which he could do easily given his lifelong track record of perfect credit. Rockefeller’s penchant for borrowing turned out to be his path to assuming full leadership of the company. His business partner, Maurice Clark, routinely complained during the refinery’s first two years about Rockefeller’s borrowing, and in 1865 threatened to dissolve the firm. Rockefeller called his bluff, announced the dissolution in the paper, and agreed to bid with him for the refinery business. The 26-year-old Rockefeller won, for a price of $72,500 (the equivalent today of about $820,000).36 Clark thought he had gotten a bargain—but given what Rockefeller was to accomplish in the next five years, Clark would undoubtedly come to think twice.

In 1867, Rockefeller accepted an outside investment of several hundred thousand dollars from Henry Flagler and John Harkness.37 The investment turned out better than anyone could have hoped; Rockefeller gained not only vital capital, but also Flagler, who would be his beloved right-hand man for decades to come.

By 1870, the firm of Rockefeller, Andrews, and Flagler was, thanks to Rockefeller’s vision, a super-efficient refining machine, generating more than fifteen hundred barrels a day38—more than most refineries could produce in a week—at lower cost than anyone else. And in that year, the firm became the Standard Oil Company of Ohio—a joint-stock company, of the type used by railroads, that enabled Rockefeller to more easily acquire other refiners in the coming years.

Reflecting Rockefeller’s profitable investments in efficiency, the Company declared assets including “ . . . sixty acres in Cleveland, two great refineries, a huge barrel making plant, lake facilities, a fleet of tank cars, sidings and warehouses in the Oil Regions, timberlands for staves, warehouses in the New York area, and [barges] in New York Harbor.”39

But Standard’s most important asset was Rockefeller, followed by his close associates. Rockefeller’s ambition for the expansion of the business was only growing, and he talked with Henry Flagler morning, noon, and night about possibilities and plans. Reflecting on the company nearly fifty years later, Rockefeller recalled: “We had vision. We saw the vast possibilities of the oil industry, stood at the center of it, and brought our knowledge and imagination and business experience to bear in a dozen, in twenty, in thirty directions.”40

The days of indistinguishably inefficient refiners were over. And Rockefeller, barely thirty, was just scratching the surface of his productive potential.

Having explored this much of Rockefeller’s hard-earned success, let us turn to his most controversial form of cost savings and efficiency: railroad rebates.