In seeking election in 1904, Theodore Roosevelt was happy to fan the flames of concern over the apparent power of the largest companies in America. This was juxtaposed with equal enthusiasm for receiving campaign funds from the self-same sources. Nearly three quarters of Roosevelt’s campaign funds came from big business, including amounts ranging from $50,000 to $150,000 from luminaries such as J. P. Morgan, C. S. Mellon and $100,000 solicited by the Republican campaign treasurer from Standard Oil. The source of these funds led the newspapers to allege hypocrisy and speculate whether Roosevelt had any incentive to act against the trusts he publicly decried. Roosevelt responded by suggesting the return of the funds from Standard Oil. It is questionable whether the suggestion was not somewhat disingenuous, at least if the later account of William Taft is to be believed:
“[Attorney General] Knox said he came into the office of Roosevelt one day in October 1904, and heard him dictating a letter directing the return of the $100,000 to the Standard Oil Company. He said to him ‘Why, Mr. President, the money has been spent. They cannot pay it back – they haven’t got it.’ ‘Well,’ said the President, ‘the letter will look well on the record anyhow,’ and so he let it go.”⁴⁸
Not only therefore was the contribution kept, but the party treasurer later sought a further $150,000 from Standard Oil – which, perhaps unsurprisingly, was this time refused.
5.4 – Big oil and politics: political dexterity not a new phenomenon
The cases covered the whole range of Standard’s operations, not just transportation and storage of product but also the sale of subsidiary products such as lubricating oils. One such case was an investigation into the purchasing practices of railroads in regard of lubricating oils. This did not appear a particularly threatening case, as it was a relatively insignificant market, but it quickly threw the relationship between Standard Oil and the railroads into clear relief. Garfield’s investigation found that outside Pennsylvania (where the competition was most intense) Standard Oil used the threat of its relationship in the carriage of freight to ensure that contracts flowed to its subsidiary, the Galena-Signal Oil Company. Officials argued that they were not aware that Galena was a Standard Oil subsidiary, that its oils were superior, or some combination of both. In November 1906, following publication of the report, the federal government filed a bill in equity against Standard Oil of New Jersey and seven of its directors asking that the entity be found a monopoly and in conspiracy of restraint of trade under the definition of the Sherman Antitrust Act. The prepared remedy was that Jersey Standard should be stripped of its stock holdings in its operating subsidiaries. The subsidiaries were to be given complete independence.
5.5 – Standard Oil hearings: apparently small items become of great importance
Source: Wall Street Journal, 8 June 1908.
Other than the institution of the federal case, the last big development was a decision in August 1907 against Standard Oil of Ohio by Judge Landis and the award of aggregate damages against the company of over $29m ($1.7bn). Shortly after this decision, the ‘Prices and Profits’ section of the Bureau of Corporations report was released. This report was again a damning indictment of Standard Oil, including special reference to Galena Oil, and further inflamed public opinion. Standard Oil’s efforts to counter the poor publicity were too little too late. The groundswell of adverse public opinion encouraged the political decision to pursue the company even more vigorously in the courts. President Roosevelt, who had previously shown little interest in the trusts, led the charge against Standard Oil, though the case was to last beyond his presidency. In 1909 the federal court found against Standard Oil and ordered its dissolution. Not surprisingly the company appealed against the decision and sought to continue the fight at both the legal and public relations level. Despite Standard Oil’s efforts to counter the arguments on pricing and unreasonable returns, the Supreme Court upheld the earlier decision and ordered the dissolution of the trust. Standard Oil was given six months from 21 June 1911 to complete the dissolution process.
5.6 – Standard Oil breakup met with consternation
Source: Wall Street Journal, 26 July 1911.
The company was subdivided, largely according to its geographic operating units. The original holding company became Standard Oil of New Jersey (Exxon) and was by some distance the largest single entity, accounting for over 40% of the assets of the trust. The next largest operation was Standard Oil of New York (Mobil), with approximately 10%. Other companies included: Standard Oil of California (Chevron), Standard Oil of Ohio (Sohio, which later became a division of BP, subsequently BP Amoco), Standard Oil of Indiana (Amoco), Continental Oil (Conoco) and Atlantic Oil (ARCO). The stock market listing of these companies, though, was not to take place until after World War I.
5.7 – Back to concerns over monopoly
Source: Wall Street Journal, 19 May 1914.
At the time, opinion was split as to the value of the different subsidiaries. Many believed the value of the combined operation was diminished by its breakup. In general the response to the dissolution fell into two camps, both critical. The first group argued that small shareholders would be disadvantaged by the number of different shares they would be receiving and the relative lack of knowledge they had about the 35 individual operating entities. The second response was concerned with the impact on the structure of the industry. There were fears that the increased number of competitors would lead to greater instability in pricing and threaten the independent producers. The view was also expressed that the dissolution would automatically lead to higher costs for the new operating companies, which would then increase prices to consumers. Ironically, then, the same press which had some years before castigated Standard Oil for monopoly practices and restraint of trade was how bemoaning its breakup as heralding instability and higher prices. However, the concern over the economic benefits of the breakup neglected the changing demand characteristics associated with the automobile and oil-powered shipping, particularly on the military side. As a consequence, before long the press was recanting, shifting back towards the anti-monopolistic view.
Union Oil versus Standard Oil of California
Although Union Oil had competed against Standard Oil in California for some considerable time, it was only with the dissolution of the Standard Oil Trust that annual reports specific to the Californian company became available. The comparison between the two companies therefore runs for the ten-year period after dissolution. In 1911 the two companies both had net income of approximately $3.5m ($190m). The return on assets was also broadly comparable between the two companies, as Unocal earned the return on $59m of assets and Standard Oil on $49m. In terms of return on equity, the figures looked better for Unocal because, where Standard Oil’s balance sheet had virtually no debt, Unocal ran a moderate level of financial gearing. One would have expected Standard Oil to show a higher return, if only because it applied a much higher rate of depreciation to its assets. Put otherwise, a comparison of the book value of assets would understate the position of Standard Oil relative to Unocal.
From 1911 onwards the picture begins to change dramatically. Unlike Unocal, Standard Oil was able consistently to lift its production and shipment of refined product. When this was combined with the depreciated assets position, returns grew substantially. The return on assets rose even during the tough pricing environment of 1912–1914 and sharply thereafter when price movements began to come through. Unocal’s net income remained stagnant, only rising with pricing. As a consequence, in a weak pricing environment, the company was unable to hold its dividend and had to divert cash to maintain its debt position at reasonable levels. For the investor, the progress made by Unocal over the ten-year period to 1920 would have been reasonable. It remained a well-positioned company in a growing market. However, the difference in performance between Standard Oil’s California business as a Standard Oil subsidiary and as a standalone company was striking. Net income for Standard Oil of California was ten times higher
in 1920 than it was in 1911 and even if this figure was abnormally high, the growth rate was certainly not much less than 30% comparable per annum. Unocal’s stock note by contrast has roughly half that level. What is more, the growth in net income of Standard Oil had not been achieved at the expense of a weakened balance sheet or shareholder dilution. The Standard Oil shareholder had been rewarded with a consistently high cash dividend and frequent stock distributions. At the end of the period, therefore, the net assets of Standard Oil were more than two and a half times those of Unocal. It might have been a growing history, but there were very different returns to be earned by different companies. Those who doubted the ability of Standard Oil subsidiaries when out from under the umbrella of the trust were proved definitively wrong.
5.8 – After the post: Unocal vs Socal
Source: Union Oil of California annual reports. Standard Oil of California annual reports. CRSP, Center for Research in Security Prices, Graduate School of Business, University of Chicago, 2000. (Used with permission. All rights reserved. www.crsp.uchicago.edu.) New York Times. Commercial and Financial Chronicle.
The operating environment for the new companies was very different from that which prevailed at the beginning of the century. Until that earlier point, the principal product refined from crude oil was kerosene. The volatile, lighter end product, gasoline – which represented under 20% of a barrel – was mostly disposed of as waste. Refining needs changed dramatically in the early 1900s, however, as kerosene gave way to electric lighting and production of the automobile began its exponential growth. Lubricants and kerosene now took second place to gasoline. Instead of a single area dominating world production, there were multiple producing regions and nations. Finally, instead of a single company effectively controlling the entire global industry, new powerful competitors were emerging.
General opinion at the time – including that of the operators themselves – had not yet realised the potential of the new automobile industry. Before World War I, the consumable on which the companies focused remained kerosene. Transportation was recognised as a growth area, but few saw automobiles as the daily force. Rather, the focus was on the use of heavier oils for powering large engines and supplanting coal as a fuel. In this regard the target consumers were locomotives and the shipping industry, particularly navies. Union Oil of California made mention of the growing prospects for oil as a locomotive and maritime fuel in its 1911 annual report, but it was not until after the end of World War I that any mention was made of demand for gasoline. Nevertheless, the profitable condition of oil companies can be seen by a comparison of the two major operators in the Californian market.
Conclusions
Oil was not a ‘new technology’ in the sense of the incandescent lamp or the locomotive engine, although there were many similarities. The uses of kerosene were widely known and the refining process itself was not new. Knowledge of the chemistry of rock oil was new, however, and it led to the creation of an entire new industry. This industry operated in a largely unregulated environment and for an extended period was characterised by price volatility and excess supply. The volatility was removed with a temporary period of monopoly control, but in general the response to pricing changes in the oil industry changed little in the century that followed. Although capital costs have risen sharply, exploration and production budgets still tend to rise when prices rise, which leads to periods of excess supply followed by falling prices.
The removal of volatile industry conditions was associated with a new company that came into existence and forced order on the industry. The purpose of the Standard Oil ‘trust’ was to create and sustain the benefits of monopoly pricing. The power of the trust came not from control of production but from the strength of its negotiating position with the providers of distribution, most notably the railroads. The railroads had a high fixed capital base and required throughput to maintain profitability. Since they were in fierce competition with each other, and there was excess supply, an opportunity presented itself to whoever could become the dominant customer. With a strong balance sheet and a willingness to take the risk of guaranteeing freight, Standard Oil was able to turn its position in the volatile refining business into one of impregnable strength.
5.9 – Kerosene price: market power revealed?
US wholesale price of kerosene, Pennsylvania
Source: NBER Macro History Database. US Bureau of Labor Statistics. Oil, Paint and Drug Reporter.
As the success of Standard Oil became apparent, international competitors also began to gain strength with increasing support from their respective governments, particularly when the use of oil as a fuel with military uses became apparent. Standard Oil remained the dominant player, but was no longer the overwhelming monopoly. Interestingly, the search for oil was stimulated by demand for kerosene rather than motor fuel. Demand for motor fuel started with large-scale power generation, mainly in the naval sector, but took off when the automobile proved itself a viable means of transportation, some 30 years after oil production began in earnest. By the time demand from this quarter was a factor in the market, the Standard Oil Trust was well on the way to its ultimate dissolution in the face of antitrust laws and hostile public opinion.
So far as the operations of Standard Oil were concerned, the impact the trust had on the market is relatively clear from the stability in the pricing pattern of the main product. The chart in figure 5.9 details the price of kerosene from 1890 to 1917. The pattern is clear. Every time prices moved upward it established a new pricing level. Demand was rising through the period, but such a clear pattern of pricing behaviour is unlikely without some degree of collusion or market control. Combine this with the returns earned by Standard Oil, and it gives a clear picture of the benefits of the position the company had established. The irony was that the antitrust case itself turned less on the evidence of monopoly on a macro level, and more on the ability of the prosecution to paint a picture of individual instances of abuse which in isolation might appear trivial.
There were clear lessons in the case for future organisations which were to find themselves in similar positions. The most obvious are that reliance on macro level arguments will prove insufficient if enough cases of alleged abuse of power can be demonstrated. Successive cases against companies which have reached dominant positions have followed a similar path, although not all those under investigation have necessarily learned the lessons of the past. Microsoft’s behaviour during antitrust investigations in the late 1990s and early 2000s, for example, suggested a lack of familiarity with the history of the consequences of adopting a confrontational attitude to government. The extended survival of AT&T as a single entity, by contrast, rested upon the company’s awareness that its future was dependent upon arriving at an accommodation with the authorities.
5.10 – Standard Oil’s profitability creates a financial institution
Source: Wall Street Journal, 11 May 1910.
The dissolution of Standard Oil still left some very large operating businesses. The industry was on a growth path which was to completely overshadow that of kerosene, the original staple product. It took a long time, though, for the industry to recognise the potential of the derived demand from automobiles. In the early years, oil companies were as cautious about prospects as the world at large. Not only did Standard Oil became a giant company in the oil industry, the recycling of its profits made it one of the largest financial concerns in the world and at the same time propelled its bank, which ultimately became Citibank, into the upper leagues of financial institutions.
* * *
42 web.archive.org/web/20020202062122/www.umr.edu/~eepe/jon.html
43 P. G. Hubert, Men of Achievement – Inventors, New York: Charles Scribner’s Sons, 1893, p.275.
44 D. Yergin, The Prize: The Epic Quest for Oil, Money, and Power, New York: Simon & Schuster, 1991, p.40.
45 R. Chernow, Titan: The Life of John D. Rockefeller, Sr., New York: Random House, 1998, p.243.
4
6 Ibid., p.249.
47 Yergin (1991), p.86.
48 B. Bringhurst, Antitrust and the oil monopoly, Westport, Conn.: Greenwood Press, 1979, p.130.
chapter 6
Driving Forward
The history of the automobile
“The ordinary ‘horseless carriage’ is at present a luxury for the wealthy; and although its price will probably fall in the future, it will never, of course, come into as common use as the bicycle.”
The Literary Digest, 14 October 1899
“The horse is here to stay, but the automobile is only a novelty – a fad.”⁴⁹
Advice to Henry Ford’s lawyer regarding a potential investment in Ford Motor Company
The search for a horseless carriage
The automobile transformed the transport business in the 20th century as profoundly and as dramatically as the railways had transformed economics and society in the 19th century. The story of the development of the automobile is a story of two great issues. The first concerned which of three rival technologies would emerge as the source of power for self-propelled vehicles. Although the petrol-powered internal combustion engine would ultimately emerge as the winner in this race, seeing off the challenge of steam and electric power in the process, the issue took several years to be resolved. The second issue was which of the hundreds of companies that set out to make and sell cars would succeed in establishing long-term viable businesses. A third, more tangential, issue was whether leadership in the automobile industry would be seized by the United States or by Europe. Investors at the time had to weigh up all three of these issues.
Engines That Move Markets (2nd Ed) Page 23