Self-Government Succeeds in Oil: An Industry Proves That Corporate Business Can Be Profitably Operated as a Public Responsibility

I

As a product of nature, petroleum is as old as the eternal hills that hold it; as a product of man, it is so young that one individual’s effective lifetime has covered its entire span. In point of time the oil industry is strictly modern history; and in point of social history it is a large part of modern history — an outstanding example of the power of applied science and corporate methods to compass in a few years a progress and general usefulness which in earlier times required centuries.

The petroleum industry was horn in 1859 near Titusville, Pennsylvania. There, on a piece of flat bottom land beside Oil Creek, Colonel Edwin L. Drake struck oil by deliberately going after it, driving his well inside a casing to protect the hole. Hitherto oil from the earth had been a rarity recovered and refined in a small way, chiefly for medicinal purposes. Drake’s successful technique unlocked this hidden wealth to the beneficial use of mankind. Since his day $12,000,000,000 has been invested in the United States in the industry he fathered, which now employs more than a million men and represents two million stockholders.

At the start, few recognized the revolutionary nature of the earth-punching in northern Pennsylvania. The Civil War, then brewing, seemed vastly more important, and until the war was over the nation could become excited over nothing else. The oil boom began to make history where the war left off. What a boom it was! Oil was better stuff than gold, easier to find, easier to work, and infinitely more useful. All the oil in the world was right there in Pennsylvania, or so the footloose men of America said as they rushed toward the oil field. Cities rose as if by magic in the narrow valleys and on the sidehills of a countryside where, for several years, oil almost oozed from the shallow wells. Some of those cities and towns remain; others, like Petroleum Center and Pithole, third largest post office in Pennsylvania, have vanished almost without leaving a trace.

The pioneer producers wasted more oil than they sold, yet they sold enough to break the price of kerosene from two dollars a gallon to ten cents. One after another the rich fields were despoiled and abandoned — a melancholy example of the waste of irreplaceable natural resources under disorderly, untrammeled competition. Pennsylvania law held that oil was a fugitive and belonged to him who could catch it. The hunter had to get permission from the landowner to drill a well; but whatever oil came from a well belonged to its captor, even though drawn from a distance beyond his leasehold. Many a thrifty Pennsylvania farmer, expecting the oil under his small fields to be worth more later on, lost it all to neighboring drillers by waiting. Only recently has the country succeeded, in part at least, in overcoming the legal notion that oil is a ‘wild animal’ to be captured and sold at will by anyone with the right to drill.

Meanwhile the pioneers were finding that it was easier to draw oil from, than to move it over, the earth. Lack of transport brought small refineries to the oil fields, while larger refineries arose at convenient shipping points. From fields to refineries oil moved in barrels by wagon over miserable roads, by flatboat down streams often so shallow that they had to be dammed and cleared in a scries of mad ‘ freshet runs,’ and by hopelessly inadequate railroads.

Then came the first successful pipe line in 1865, inaugurating a trend whose influence it is impossible to overestimate in the march of petroleum. Oil is the only great industry to develop and, with consequent economy, to operate successfully its own transport system, which carries the major part of its raw and finished materials. With the coming of the pipe line the oil industry — then, as now, predominantly American — began to evolve discipline and order.

II

The guiding hand in this organization phase was Standard Oil, a small Ohio refining company established in 1870 by the then youthful John D. Rockefeller of Cleveland and his associates. These optimists saw that oil had an unlimited future if its four great branches — production, transport, refining, and marketing — could be integrated. In production, waste threatened to interrupt the steady flow of raw material; transportation was unduly expensive and undependable; refining was then an infant art without standards for the protection of the public and involving great risks for both refiners and their customers. A market grown suspicious of dangerous oil products, both at home and abroad, required to be shown how to use kerosene and furnished with dependable grades. Uses must be found for those by-products of crude oil refining which were both heavier and lighter than kerosene, the more volatile elements, now the components of gasoline, being generally poured into rivers or otherwise thrown away, while the gas was wasted into the air.

A vast, integrated business developed on the basis of separate functions as well as of different locations. One Standard Oil company had large primary production and small refineries; another the reverse. Pipe-line companies operated no oil wells, while producing companies owned no pipe lines or tank cars. In the marketing field, some companies made special products but lacked both raw materials and means of transport. So energetically did Standard Oil lead this fourfold advance that by 1900 the various companies in the group were refining and selling the major part of the oil products in the American market and were almost as influential abroad, export trade having been one of its early activities.

As the result of litigation extending over six years, the parent company — Standard Oil (New Jersey) having succeeded the Standard Oil Trust of earlier days — was dissolved in 1911 through the distribution to its stockholders of shares in thirty-three constituent companies.

For a time the separated companies bought and sold goods and services equitably in an effort to maintain their position, but gradually, under separating ownership and diverging group ambitions, they became more highly competitive, until to-day all community of interest has disappeared. As for the independents, they had a sure foothold even before the dissolution and grew rapidly afterwards.

Standard Oil Company (N. J.), owning large refineries on the Jersey side of New York Harbor, faced the actuality of inadequate production and a too limited domestic market. Its great refineries in Jersey had been built chiefly to supply oil and gasoline for the rich and populous New York and New England market. Although large in extent, the New Jersey company’s own trading area south along the seaboard to the Carolinas could not absorb the output of Bayonne and Bayway, where were refined the oils pushed across the continent in the country’s greatest pipeline system.

Obviously, the legal dissolution of 1911 accomplished its objective. The thirty-three surviving units set out to perpetuate themselves and to prosper, each as best it could. Whether the social gain of this change outweighs the economic loss involved is still debated. But, whatever the financial loss incurred through legal surgery, it was soon made up by the lift given to the oil industry by the swift rise to popular use of the gasoline motor car.

To understand what the motor car has meant to the oil industry, one must recall that until well after the turn of the century gasoline was a bothersome and unprofitable by-product of kerosene, the old, reliable, slow-burning fuel for lamps and stoves. There are automobile users to-day who have never smelled kerosene or seen an oil lamp. They may be interested in learning that thirty-five years ago Standard Oil, still trying to find a market for gasoline, organized a drive to convert the nation to gasoline stoves. The motor car changed this, until in 1915 gasoline sales surpassed those of kerosene. A waste product which the pioneers dumped in rivers or burned became the chief product, kerosene the by-product. As old Standard Oil sent salesmen forth to teach Americans to burn gasoline in the kitchen, so representatives of its successors now travel far and hard to teach the yellow, black, and brown races to light their darkness with kerosene, and at home to develop furnace oil sales through introducing improved burners for domestic heating.

The tremendous shift in demand from one fuel to another, with steady increase in volume sales, so expanded the market that there was leeway in the oil industry both for independents to grow and for disassociated Standard Oil companies to round out their facilities. But the free play of economic forces, continuing in spite of courts and judges, made for integration. Both the successor Standard companies and the independents, confronted with an unknown crude amount, were moved imperatively to seek new sources of supply, to ensure delivery of crude through pipe lines, and to deliver finished products through tank cars, tank wagons, and gasoline stations. Necessities of the situation drove dozens of oil companies to reproduce the plan worked out by John D. Rockefeller to bring conservatism and order into a business subject to flood or famine.

The hidden, fugacious nature of oil resources makes discovery an expensive and hazardous undertaking, yet the dependence of the world on oil renders that search imperative. Exploration and wildcatting must be encouraged sometimes, retarded at other times, but never entirely discontinued even though dry wells swallow fortunes or flush pools make oil almost worthless. We have seen how Pennsylvania once thought it held all the oil in North America. Then other states entered production — notably California in 1879, Ohio in 1880, Wyoming in 1885, Kansas in 1890, Texas in 1895, Louisiana and Arkansas in 1902, and New Mexico in 1909. Now the MidContinent, Gulf, and California fields are the quantity-production stand-bys. Gloomy prophecies of early exhaustion of oil resources have been confounded by the discovery of new fields, by improvements in the art of drilling through which levels two miles underground arc tapped, and by progressive developments in refining through which a given volume of crude oil is made to yield larger proportions of those derivatives in greatest demand, at present gasoline and motor-cylinder oil. The ‘cracking’ process and hydrogenation are cases in point.

As a result of these three forces — daring exploration, better recovery, and improved refining — America’s domestic oil resources have been kept at least ten to twelve years ahead of threatened exhaustion. An extractive industry could accomplish that expansion only by vigor, faith, and intelligent integration. Conditions inseparable from the business of locating, recovering, moving, refining, and selling petroleum in an ever-growing market lead both the present Standard Oil companies and their thousands of competitors along a definite course toward efficient integration, with the result that Standard Oil (N. J.) is now much larger than the parent company was when dissolved in 1911.

III

To Standard Oil (N. J.) were left two unimportant producing companies, Standard of Louisiana and Carter Oil Company; a number of smaller companies in which natural gas had succeeded petroleum as the chief output; certain pipe-line companies; refinery capacity beyond its remaining market needs and a domestic trading area large in extent but small in population and demand. In the foreign field its holdings were less constricted. Also the Standard tankers— the largest merchant fleet under one house flag — remained largely with the New Jersey company. Standard Oil (N. J.) stood forth as first in overseas trade — in exports of American petroleum products, in producing and refining oil from foreign fields.

On the home continent, however, Standard Oil (N. J.) needed to balance its operations before it could move forward. New outlets were required for the products of its refineries and increased field production to fill its pipe lines, tanks, and stills. In the first direction new domestic markets were developed; in the second, new crude supplies were added by the acquisition of a majority interest in Humble Oil and Refining, in 1919. With large proved acreage, Humble lacked capital for development, pipe lines, refineries, ships, and markets, all of which Standard Oil (N. J.) could supply. The New Jersey company is to-day insured as far as possible against lack of either supplies or customers, and transacts a larger proportion of the nation’s oil business than any single competitor. The Jersey group, which had 2,733,000 barrels net production in the year following the dissolution, had 47,973,000 barrels net in 1934.

Standard Oil (N. J.) is solely a holding company, a setup rendered necessary by the geographical scope and functional complexity of the operations carried on by its subsidiaries. Through these subsidiaries and affiliates Standard Oil (N. J.) is active almost the world over under different flags and sovereignties, each of which has its own corporation law and tax system. In the United States, also, there arc state and local regulations which make for diversity of corporate structure. Then there is diversity on the basis of functions. Oftentimes an innovation may be tried out through a separate corporation more easily than by establishing another department in an already vast structure. Thus has grown with complete naturalness a group of some four hundred companies in each of which Standard Oil (N. J.) owns all or a majority of the capital stock.

Close supervision of these companies in all their operations would be impossible for the ten directors who sit in New York, in spite of the fact that every man of them has grown up in the oil business and most of them have been with Standard Oil from youth. Unlike many large corporations, Standard Oil (N. J.) has never expanded its board by taking in as directors leaders in other lines of business. The ten directors are working oil men, available for meetings every day; but, from President Walter C. Teagle and Chairman William S. Farish down, they know that the only way this vast business can be run satisfactorily is by selecting able executives to head each of the far-flung operations, trusting these lieutenants implicitly, judging them by results, and then correlating those results for the benefit of the entire group.

Peculiar aspects of the oil business make large-scale operations by some companies inevitable. Without them, the small units could not survive. From crude oil in the earth to gasoline in the automobile tank, large-scale production reduces costs, narrows margins of profit, and lowers prices on finished products. A pipe line must be kept full, and if the flow from one field becomes inadequate, another must be drawn upon. Refining is economical as a continuous process, but expensive when interrupted. A tanker can be efficiently used only if its cargo is loaded and discharged quickly on arrival in port; and the oil-burning ships now plying the seas require refueling from ports of call. The tank cars and tank wagons supplying the stations where motorists call for gasoline and oil must be kept moving. To anticipate and fill the demand for the oil products which make the wheels of the modern world go round is primarily a business for large and amply capitalized companies, and can never be anything else.

IV

Consider the problems in discovering and developing oil fields. American oil consumption is so high, owing to our ownership of more than 70 per cent of the world’s automobiles, that foreign oil reserves under American control are recognized as valuable insurance for the nation’s future. Since 1859 America has been the chief source of the world’s oil. At one time we produced 90 per cent; of late years the American percentage of world output has been declining and now stands at 59 per cent. Obviously American oil cannot continue to flow at this rate forever, even with the best of management. Other extensive oil fields may be discovered in the continental United States, science and effective coöperation may improve recovery and prevent waste, closer refining may give buyers greater fuel efficiency: nevertheless each gallon of crude oil taken out leaves that much less for future needs. Consequently, the United States Government at various times has urged its oil companies to seek reserves abroad, and through diplomatic channels has backed the claims of American oil companies for rights to participate in developments under other flags. Both justice and common sense dictate this course. Prodigally the United States has provided the world with a natural resource stimulating to civilization and vital to both social life and the national defense. Wise policy looks toward ensuring the return of like resources from abroad as they become necessary.

A case of this kind arose in developing the Irak oil field in Upper Mesopotamia. The State Department encouraged a number of American companies to enter the project. Before Mosul oil could be utilized, millions had to be spent in development and a pipe line 1150 miles long built across desert wastes to the Mediterranean coast. One by one other American companies, discouraged by the delays incidental to international control and mounting construction costs, sold their interests to Standard Oil (N. J.) and Socony-Vacuum. These two now share with British, French, and Dutch interests the 85,000 barrels of oil which the Mosul pipe line brings daily under the desert to tidewater. The American investment in the Mosul oil fields runs to $20,000,000, which indicates the size of the chips you have to buy to sit in on the international oil game.

Closer home are other examples of huge gains and losses: Venezuela, Peru, Mexico, Bolivia, Colombia — each with a different history. That of Colombia is perhaps the most colorful. The original French concessionaires were helpless to recover the wealth which, by all the evidence of geology, underlay their extensive acreage. The oil might be there, but could it be recovered and delivered where it had value? The site was an almost impenetrable jungle, lacking labor, houses, roads, food supplies, and even potable water. Merely proving the presence of oil exhausted the resources of the owners. They sold to a small American company, which in turn grew discouraged and sold to a Standard Oil (N. J.) subsidiary. The latter put $50,000,000 into the field and pipe line before it got a barrel of oil to tidewater. Standard engineers built roads, houses, towns, schools, pipe lines, and railroads. They sanitated streams to provide pure water supplies, instituted mosquito control against malaria and yellow fever, and built modern hospitals. Native labor, settled under superior living conditions, was trained by the North American staff. After years of costly pioneering Colombian oil began to flow toward refineries by pipe line and tankers. The task which had proved impossible for two small companies was conquered by a large company because it had almost unlimited resources.

Such developments make Standard Oil (N. J.) outstanding in international trade. Its foreign business includes 70 per cent of its production of crude oil, 50 per cent of its refining, and 55 per cent of its markets.

V

Immediate need for large capital also arises when a new oil field is discovered in the United States. With the shooting of the discovery well, newcomers flock in from all quarters. Houses, hotels, and highways are overtaxed. The rush for black gold and quick returns reproduces in a new environment the hectic scenes of vanished Pithole and Petroleum Center. Meantime oil may be gushing forth and running to waste for lack of storage or transportation. Humble it may be, or one of the other producing subsidiaries of Standard Oil (N. J.), which acquires leases in the new field. Immediately that company starts in train a decisive series of actions designed to bring order out of disorder, profit out of waste, settled production out of flush production. It shifts skilled men from other operations to the new fields, routes drilling and storage materials thence from warehouses and factories; and, if conditions warrant, begins at top speed to lay a pipe line from the nearest point on its great network, meantime endeavoring to bring the various producing interests into agreement on a programme to protect the entire field against rash exploitation.

With oil going begging at ten cents a barrel, producers have been offered much higher prices to win support for a prorated production programme. Under an arrangement of this kind, producers agree to regulate production and to share equally in sales, and, by fixing upon a given acreage for each well, to abstain from trying to draw oil from under each other’s land. One well to twenty acres is the approved figure in many successfully prorated fields. Then, subject to varying conditions, production is restricted to the volume of oil which can be carried by the pipe me and absorbed by the market. By order of the Federal Oil Administrator in 1933, the price of crude at central pipe-line stations was fixed at one dollar a barrel of forty-two gallons. Comparison of costs and prices in various fields indicates that in wide-open, non-prorated fields many producers lose money. Drilling costs are high because far more wells are drilled than are necessary; and production costs are high because the wells are of short life and may soon require pumping. In the Oklahoma City field, where everyone went after oil on the principle of the devil take the hindmost, crude oil cost 90 cents to $1.00 a barrel, while in the Conroe (Texas) field, prorated from the start, comparative costs were only 15 to 22 cents a barrel.

From 1859 to 1934, Americans drilled more than 825,000 wells, 191,000 of which were dry, and from them recovered something less than 17 billion barrels of oil worth a little more than one dollar a barrel at the well. Accurate cost figures of the earlier period are not available, but those for 1900-1934 show an average production of oil worth $42,000 per well against an average cost of $25,000 for each well drilled, exclusive of prospecting, leasing, pumping, taxes, and overhead. These items equal the cost of drilling in most cases, so that it can be said that throughout the entire oil age America has been buying crude at less than its true cost. The operators may get back their investment and a profit in the remaining life of the wells.

The oil-producing states all recognize the validity of group agreements to conserve oil. Five leading oil-producing states — Texas, Oklahoma, Kansas, California, and New Mexico — have entered into an interstate compact to conserve their oil resources by rationing production.

VI

From the consumer’s standpoint there seems no warrant for disturbing the present balance of economic forces in the oil world. In 1920 the average price of gasoline in fifty representative cities was 29.7 cents. In 1934 it was 13.6 cents, a drop of 54.2 per cent. The intervening period saw gasoline sales taxes rise to an average of six cents per gallon; nevertheless the public buys its gasoline for ten cents per gallon less in 1935 than it did in 1920. This has been accomplished chiefly by improved refining and more economical drilling. A barrel of crude petroleum now yields about twice as many gallons of gasoline as it did fifteen years ago, and improved quality registers in better performance. Exclusive of tax, the average cost of owning and operating a motor car mile for mile is less than half what it was in 1920, a benefit accruing to the public partly through improvements in automobile design and manufacture on declining price levels and partly through improved motor fuels and lubricants. In addition, gaso line and other supplies of high quality are available wherever motorists require them. These social dividends have accrued to the public through the cooperative efforts of two great industries operating under the free play of economic conditions with stern competition among their corporative units.

VII

In this most intricate of mining operations, exploration is spurred by possibilities of rich rewards. Each new pool is the result of persistent individual initiative. Theoretically, wild-catting increases when the price of oil rises, and declines as the price of oil drops. But the oil prospector is such a determined individualist that price fixation on any basis fails to discourage the gamble of drilling. What keeps prospectors feverishly on the move is the possibility that their luck may coincide with a period of high crude prices. These price bulges come only occasionally, but they are the lure which keeps exploration going at top speed.

Experience also reveals the difficulty of fixing a price for crude oil entirely fair to all interests handling petroleum on its long march from buried oil sand to consumer. Under the dollar-perbarrel price, many refineries have operated at a loss, competition keeping the price of gasoline, not subject to regulation, below the price at which it can be profitably recovered from dollar crude. To this extent price fixation upset the normal relationship of crude and refined prices. This is not serious, perhaps, to a well-rounded company active in all branches of the oil business; but it is a vital matter for companies limited to refining. The situation emphasizes the difficulty of attaining complete fair play by government regulation, however well intended. There is only one price regulator which is utterly fair in an unmonopolized industry full of unusual hazards, and that is supply and demand.

However, in this industry which has invested so many millions in the recovery of hidden wealth, the law of supply and demand does not now operate with the reckless speed that it did in the slapdash, early days. Then all hands sought quick profits without regard for the future. To adventurers with small resources, cash in the bank meant more than oil in the ground. At present, conservation of oil resources is being financed by large companies which can afford to wait while their oil and that of others in prorated fields are being produced and marketed in an orderly manner at prices fair both to producers and to consumers. No monopoly exists in the oil business; small enterprises are at this moment growing into large; and valiant, fortunate men emerge into leadership with every new pool development and every improvement in refining and marketing. But as the small companies become large, they inevitably progress toward integration and self-sufficiency, and tend to become conservative influences lending their weight in support of orderly and economical practices. Nevertheless, oil being what it is, a hidden and flighty substance which must first be caught, the persistent search of private initiative remains tremendously important, for without fresh supplies the industry must perish eventually. This essential balance is now the goal of the industry and to a considerable degree already has been attained.

The effort is frustrated somewhat by illegal production of ‘hot oil’ and by the extreme size and productivity of the East Texas field, so large and easily worked that the controls applied to smaller fields have never been altogether effective there. But in the main the oil industry has of late years accomplished a tremendous work both in conserving oil resources and in providing the public with oil products at declining prices, even when general prices were advancing. If ever an industry has made a gallant and successful effort to govern itself, the oil industry has. From this point on, increased government control is likely to harm the industry without bringing corresponding benefit to the public.

Copyright 1935, by The Atlantic Monthly Company, Boston, Mass. All rights reserved.

  1. Seventh in a series of advertisements on Industrial America: Its Way of Work and Thought.