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Standard Oil

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Standard Oil was an American company principally concerned with oil refining to produce kerosene and petroleum byproducts (such as paraffin wax, lubricating oils, and naphtha) from its foundation in 1870 to its breakup by the Supreme Court in the 1911 antitrust case of Standard Oil Co. of New Jersey v. United States. It was founded by John D. Rockefeller and associates, and it controlled almost all oil production, processing, marketing, and transportation in the United States.[1]


Mainstream Portrayal[edit]

Standard Oil has been presented in mainstream history as one of the big ways in which capitalism failed in the Gilded Age and has been presented as proof for the necessity of regulating the free market. It was supposedly a company which used the free market to become too big and used the power to hurt the consumer. Some of the accusations against Standard Oil are as follows:

Destruction of competition[edit]

Standard Oil was supposed to have used three methods of curtailing competition:

1) Buying up competitors: Standard Oil would buy up its competitors to destroy competition. Many small refiners were allegedly bought up aggressively.

2) Predatory pricing: Standard Oil would cut its prices below those of competitors to destroy their sales and force them to accept buyout proposals.

3) Preferential rail rates: Standard oil would strike deals with railroads to secure lower rail rates for its products over their competitors' products.

Monopoly pricing[edit]

After Standard Oil destroyed its competitors and had monopoly power, it would raise its prices above the market level and extort high rates from consumers

Controlling the price of oil[edit]

Through its size, Standard Oil could control the prices of crude oil.

Hidden companies[edit]

Standard Oil sometimes bought companies and did not publicly announce that they were its holdings.

Libertarian Response[edit]

Standard Oil has been much misunderstood, both in its status as capitalist baddie and as a company which used the free market to gain advantage.

A general overview first:

Standard Oil emerged out of a period of cutthroat competition in the 1860s [2]. It was a time when many young entrepreneurs tried their hands at the refining business [3]. Supply was unstable and prices fluctuated wildly [4]. Surface oil stores were tapped quickly for easy profit and then businessmen moved on [5]. Standard Oil introduced order to a hectic market. They were able to stabilize prices and supply in an insecure market.

A response to mainstream accusations:

Destruction of competition[edit]

Standard Oil did indeed outcompete many of its competitors

1) Buying up competitors: The majority of Standard Oil buyouts were not aggressive and benefited both parties. As Hidy notes, "Rockefeller and his associates ... won the confidence of competitors through comprehensive voluntary association." [6]. Many of the former executives of the firms which were bought up were offered high-ranking position in the new company and a guarantee of equality in management [7] and were integrated into the management due to their experience in refining and their knowledge of local markets. The Standard Oil trust was not comprised of one company which had bought out all others. Instead, the Trust was very much a cooperation of different companies[citation needed] which sought to improve their competitive advantage and which still maintained competition even in-between the member companies [8].

Furthermore, it is important to note, as Hidy does, that numerous oilmen successfully resisted pressure to be bought and to be out-competed [9]

2) Predatory Pricing: This claim does not stand strongly against either history, sound economic thought, or logic:

- History: There is no evidence for large-scale predatory pricing on the part of Standard Oil[citation needed]. There have been recorded cases of such "price cutting wars," yet most have been initiated by competitors of Standard Oil, not Standard Oil itself[citation needed].

Furthermore, price cutting has been previously shown to be ineffective (and indeed counter-productive), as seen in the case of Herbert Dow[10]. Dow was selling cheap Bromine in Germany, angering the competing Bromkonvention which decided to retaliate by flooding the US market with below-cost bromine. Dow simply ordered his agents to buy up the cheap bromine and resell it in Germany below Bromkonvention's prices yet still at a profit (relative to the below-cost price), effectively destroying the attempt at predatory pricing.

Sometimes rebates that Standard Oil offered are pointed to as a way to obtain extra customers, yet 1) this is a fair market practice, and 2) competitors were using rebates as well [11]

- Sound Economic thought: The idea of predatory pricing begs the question "what qualifies as predatory pricing?" Price cutting by itself is not a negative thing in the market and is indeed how competition works[citation needed]. When companies employ more efficient methods of production, they may lower their prices, thus gaining an advantage on the market. Furthermore, price cutting is an effective and recognized tactic to enter a new market which may already have an existing market power.

- Logic: Predatory pricing fails on the logical front as a tool which simply cannot work to systematically drive out competitors [12]. To quote DiLorenzo extensively -

"In the first place, such practices are very costly for the large firm, which is always assumed to be the predator. If price is set below average cost, the largest firm will incur the largest losses by virtue of having the largest volume of sales. Losing a dollar on each of 1,000 widgets sold per month is more costly than losing a dollar on each of 100 widgets.
Second, there is great uncertainty about how long a price war would last. The prospect of incurring losses indefinitely in the hope of someday being able to charge monopolistic prices will give any business person pause. A price war is an extremely risky venture. Standard Oil was not the only trust accused of predatory pricing; antitrust folklore has it that virtually all of the late-19th-century trusts were guilty of the practice. However, the industries accused of becoming monopolies during the congressional debates on the 1890 Sherman Antitrust Act all dropped their prices more rapidly than the general price level fell during the 10 years before the Sherman Act. It would certainly have been irrational for those businesses to have engaged in predatory pricing for an entire decade in the dim hope of someday being able to charge prices slightly above the competitive market rate.
Third, there is nothing stopping the competition (or "prey") from temporarily shutting down and waiting for the price to return to profitable levels. If that strategy is employed, price competition will render the predatory pricing strategy unprofitable--all loss and no compensatory benefit. Alternatively, even if the preyed-upon firms went bankrupt, other firms could purchase their facilities and compete with the alleged predator. Such competition is virtually guaranteed if the predator is charging monopolistic prices and earning above-normal profits.
Fourth, there is the danger that the price war will spread to surrounding markets and cause the alleged predator to incur losses in those markets as well.
Fifth, the theory of predatory pricing assumes the prior existence of a "war chest of monopoly profits" that the predator can use to subsidize its practice of pricing below average cost. But how does that war chest come into being if the firm has not yet become a monopoly? That part of the theory is simply a non sequitur." [12]

Furthermore, the idea of predatory pricing only considers the supply side of the equation without taking into account the demand side. Assuming that a company manages by some magical means to use predatory pricing to destroy a few competitors and then institute "monopoly prices" (see below), consumers in other parts of the nation who hear of such behavior must really be of a low mental caliber to buy up the cheaper products of Standard Oil when it comes in the future to their market knowing that this would help Standard Oil destroy competition and institute new high prices.

3) Preferential rail rates: Standard Oil did indeed make deals with railroads for cheaper product transport, as did many of its competitors, hardly making it an unfair market practice. In fact, almost all of the refiners in the country enjoyed some of the advantages of favorable railroad rates at one time or another [13]. Irwin, one of Standard's competitors, notes that everyone got rebates. [14]Railroads were quietly seeking the business of Standard Oil's competitors [15]. Hidy note that "In fact, bargaining with railroads was a delicate task and the results were not always satisfactory. ... Once bulk stations had been built on a particular line, Standard Oil marketers could not easily transfer their business to another line and their bargaining capacity was curtailed. ... Standard Oil enjoyed advantages in rates, but the favors were neither so easily come by nor so certain as critics implied." [16] Furthermore, if Standard Oil could secure for the railroads a stable inflow of traffic, then this is a legitimate market practice by any standard, as production is streamlined and stabilized. It is also important, as Hidy note, that "Rebates to Standard Oil on crude oil shipments had been virtually eliminated without recourse to legislative enactment." [17]

The argument breaks down even more considering that Standard Oil increasingly transported oil through pipelines and not on rails [18].

Monopoly pricing[edit]

The argument that Standard Oil extorted high prices from the public is simply unsupported by evidence. Indeed, the opposite appears to be true: Refined oil prices "fell from over 30 cents per gallon in 1869, to 10 cents in 1874, to 8 cents in 1885, and to 5.9 cents in 1897." [19] Being a large market power, but a market power nonetheless, Standard Oil could not create monopoly prices for fear of competitors springing up to win over dissatisfied customers.

The argument of monopoly pricing further fails when considering substitute goods - alternative goods that customers may buy to achieve the same ends with different means. For example,

"Coal continued to be a cheaper generator of heat and energy than petroleum. Vegetable and animal oils were used as illuminants and lubricants by the very large segments of the world's population living in relatively unindustrialized countries. ... Tallow and stearine candles constituted strong rivals to those made form paraffin was in some markets. In Europe, especially, artificial gas and later electricity gained on kerosene as a source of light ..." [20]

Thus, monopoly prices in kerosene and other products made by Standard Oil would have simply been replaced with substitute goods which Standard Oil did not control.

Controlling the price of oil[edit]

Standard Oil did not control the oil extraction business [21]. At the end of its years as a trust it attempted to enter the market but was never a large force on the extraction market. Indeed, it bought its raw material from thousands of producers of crude oil [22]. The prices of crude oil were determined on the stock exchange [23] and Standard Oil did not speculate on the exchanges [24]

Hidden companies[edit]

As Hidy notes, "How hidden the companies actualy were is not known, but the implication of critics was that Standard Oil was putting something over on the public. Standard Oil men certainly disliked the use of the practice by competitors." [25]

The unsung benefits of Standard Oil[edit]

Environmental friendliness/Curtailing of waste[edit]

Standard Oil came at a time when many of its competitors extracted only one product from oil and moved on without creating byproducts. Standard Oil instead squeezed the most it could out of oil and created numerous products from the products left after the creation of kerosene such as paraffin wax and lubricating oils, which allowed it to decrease its kerosene prices [26]. Acid sludge was sold to fertilizer companies instead of being dumped into the Atlantic Ocean and coke byproducts were either used internally or sold to outside companies [27].

Quality of products/Self-regulation[edit]

Standard Oil worked to bring both a higher and more uniform standard of products to the market.[28] Indeed, it also built better infrastructure than competitors: when constructing its pipelines, it sunk the pipe beneath the earth at least eighteen inches deep, except over solid rock, while some competitors only sank their line when it crossed tilled land. This resulted in whipsawing of the pipes of competitors when cold weather came [29].

Standard Oil also provides an example of market regulations at work. Standard Oil engaged outside experts to investigate complaints and to recommend methods for improvement whenever necessary [30]. When there were leaks in its barrels it immediately sealed them and sought out the cause (resulting in environmentally-friendly policies due to a desire to not lose profit). Furthermore, when there were allegations that the company was using inaccurate and fraudulent measurements on its tanks, Standard Oil invited all of the oil exchanges to send delegates to check their measurements. No errors were found, and honesty of Standard Oil's field storage units were never again seriously questioned [31].

Building of pipelines[edit]

Standard Oil followed a policy geared to win the good-will of landowners along their right of way and was generous in the prices it paid to private individuals and in adjustments for damages [32].

Increased standard of living[edit]

Through its superior quality goods and uniform standards, Standard Oil helped to increase the standard of living in millions of homes using kerosene. Furthermore, in efforts to create new markets, Standard Oil distributed heat stoves, lamps, and other utensils to consumers for little or no profit[33].

Government influence on Standard Oil[edit]

Standard Oil's methods were fair, free-market methods, as covered above. However, it is important to note in what ways Standard Oil was in fact made larger than it would have been due to active government intervention in the free market (unlike the mainstream view that the Gilded Age was largely laissez-faire):

Patents[edit]

Government granting of patent monopolies shielded Standard Oil from competition. Hidy note that Standard Oil "relied heavily on patent rights to attain an advantage over competitors in cost and quality of products. ... Patents for the mechanical fabrication of cans were practically monopolized by Standard Oil companies." [34] Furthermore, "the Standard Oil combination received and fully utilized patents granted by the federal government. That patent monopoly constituted the foundation for the large earnings of several Standard Oil units for more than fifteen years." [35] In this manner, government in fact granted Standard Oil monopolies in small regions (look up "Intellectual Property" for an explanation on why patent monopolies are not free-market tools but instead government intervention in the free market which curtails competition).

Tariffs[edit]

Tariffs are another government intervention in the free market which contributed the the size of Standard Oil. There was a consistent tariff on kerosene in the US. In 1865 the kerosene tariff was increased to 40 cents per gallon [36]. In 1884, kerosene was placed on the free list, yet with a catch: if another country had a tariff on the goods of the US, then the kerosene tariff on that country was 40 percent. As D.T. Armentano explains, tariffs restrict foreign competition, which is a vital section of the free market (after all, foreign competition is simply business which is outside of the arbitrarily-drawn line of a given country) [37][38]. The hindering of possibly more efficient foreign competitors shielded Standard Oil from pressure to lower its prices even further. Indeed, abroad Standard Oil was forced to lower its prices to compete with Russian oil [39], yet the protective tariffs prevented the same from occurring in the US. This is another example of government intervention during the Gilded Age distorting market forces and creating inefficient, less competitive scenarios.

Other important points of note[edit]

Competition[edit]

While Standard Oil owned 88% of refining business at its height (by no means a monopoly), its market share had already decreased to 64% by 1911 (before the anti-trust case) [40]. Indeed, many competitors were present and ready to pick up any time that Standard Oil did not meet expectations [41]. Furthermore, whenever Standard Oil hesitated in taking an action into a new field, competitors sprang up in the new area, as was the case with discovery of the inferior grade Lima oil which would require new processing techniques [42]. This suggests that competition was hardly stifled and that Standard Oil retained the top spot thanks to its efficiency and quality (and its size was likely increased by the government help, including patents and tariffs, mentioned above).

Trust cohesion[edit]

It is important to remember that Standard Oil was not a single monolithic company which was run strictly top-down. Indeed, minority interest in different companies had to be considered and Hidy note that "instances are not lacking of objections to recommendations by committees and outright refusal to cooperate on the part of companies, even when 100 percent of their stock was held by the Trust."[43] This adds further evidence that Standard Oil survived because of its bending to satisfy many different desires and was always at a risk of member managers breaking off to form new refineries.

See also[edit]

Links[edit]

References[edit]

  • Hidy, Ralph; Hidy, Muriel (1955), Pioneering in Big Business, 1882-1911, (History of Standard Oil Company New Jersey), New York, NY: Harper and Brothers 

Notes[edit]

  1. ↑ EncyclopΓ¦dia Britannica Inc., "Standard Oil Company and Trust", 05 Apr. 2013. Referenced 2013-04-05.
  2. ↑ Hidy, 9
  3. ↑ ibid, 4
  4. ↑ ibid, 9
  5. ↑ ibid
  6. ↑ ibid, 33
  7. ↑ ibid, 34
  8. ↑ ibid, 71
  9. ↑ ibid, 34
  10. ↑ Burton W. Folsom. "Herbert Dow, the Monopoly Breaker", Mackinac Center for Public Policy, May 1, 1997. Referenced 2011-11-19.
  11. ↑ ibid, 118
  12. ↑ 12.0 12.1 DiLorenzo, Thomas (1992). "The Myth of Predatory Pricing". Cato Institute Policy Analysis (Cato Institute) (169). http://www.cato.org/pub_display.php?pub_id=1029. Retrieved 2011-11-09. 
  13. ↑ Hidy, 202
  14. ↑ McGee, http://www-personal.umich.edu/~twod/oil-ns/articles/research-oil/research-oil/john_mcgee_predatory_pricing_standard_oil1958.pdf, page 147
  15. ↑ ibid, 198
  16. ↑ ibid, 119
  17. ↑ ibid, 89
  18. ↑ ibid, 215
  19. ↑ Galles, Gary (2011-05-13). "100 Years of Myths about Standard Oil". Ludwig von Mises Institute. Retrieved 2011-11-09. 
  20. ↑ Hidy, 129
  21. ↑ ibid, 88
  22. ↑ ibid, 208
  23. ↑ ibid, 89
  24. ↑ ibid, 88
  25. ↑ ibid, 118
  26. ↑ ibid, 193
  27. ↑ ibid, 192-193
  28. ↑ ibid, 210-211
  29. ↑ ibid, 81
  30. ↑ ibid, 140
  31. ↑ ibid, 84
  32. ↑ ibid, 81
  33. ↑ ibid, 116
  34. ↑ ibid, 93
  35. ↑ ibid, 168
  36. ↑ ibid, 6
  37. ↑ Armentano, D.T. Monopoly. Freedom Daily. 1992
  38. ↑ "100,000,000 Barrels Surplus Oil Stored", The New York Times, 1909-08-05, http://query.nytimes.com/mem/archive-free/pdf?res=F2071EFA385F12738DDDAC0894D0405B898CF1D3, retrieved 2011-11-09 
  39. ↑ Hidy, 139
  40. ↑ DiLorenzo, Thomas (2005). How Capitalism Saved America. New York, NY: Random House. http://mises.org/daily/2317#3. 
  41. ↑ Hidy, 88, 120
  42. ↑ ibid, 156
  43. ↑ ibid, 64

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