American Legal History

History of Standard Oil: The Cleveland Massacre

The Cleveland Massacre refers to a three month period in 1872 when Standard Oil Company acquired virtually all its competing oil refineries in Cleveland, Ohio. During a six week span in February and March of 1872 Standard Oil acquired 22 of 26 rival refineries at highly discounted rates. At the time, Cleveland was overcrowded with oil refineries resulting in excess capacity and severely diminished prices. Spearheaded by its leader John D. Rockefeller, Standard Oil bought out the competition and in order to stabilize production back to profitable levels.

Standard had been the largest refiner in Cleveland and had large cash reserves prior to its acquisitions. However it is widely argued that Rockefeller’s ability to convince virtually all his competition to sell out within weeks was mainly the result of a secret agreement with the railroads called the South Improvement Company. Standard had agreed to divide its oil shipments amongst the railroads in agreed upon proportions, in exchange for the railroads charging enormous rates to all of Standard’s competitors. Although the South Improvement Company was dissolved before it went into force, many believe the specter of the agreement caused a panic amongst non-participating Cleveland refineries and motivated them sell before their operations completely lost value.

The Cleveland Massacre

In the late nineteenth century Cleveland became a major player in the oil refining industry. At the time, oil was chiefly refined into kerosene and used as lamp fuel. The bulk of United States refined kerosene was exported to Europe which had a much larger and wealthier marketplace. Thus with kerosene originating from crude oil fields in western Pennsylvania and shipping to Europe from the east coast, Cleveland seemed an unlikely refining center located over 200 miles inland. However, Cleveland’s abundant access to transportation made it viable as its shipping costs were cheaper than its east coast counterparts. In the warmer months, the Erie Canal was a cheap and effective method of transport to the east coast. More importantly, Cleveland connected to three major railroads - the Erie, the Pennsylvania, and the New York Central - all of whom competed for Cleveland refiners’ business by engaging in bitter price wars. (Granitz & Klein, p. 6).

With little initial capital or expertise required for start-up, refineries quickly sprang up all over Cleveland. As Rockefeller would later recall, “All sorts of people went into it: the butcher, the baker, and the candlestickmaker began to refine oil.” (Chernow, p. 130). Within a decade of opening its first refinery, Cleveland was overrun with a surplus of capacity. In 1870, refining capacity outweighed demand by a factor of three to one and the retail price of kerosene plummeted by more than half. (Yergin, p. 40). By 1871 only 26 refineries remained, down from as many as 50 in 1866, and 90% of the survivors were losing money. (Chernow, p. 130).

The future of Cleveland refining was in a critically dangerous position, and the way Rockefeller saw it, any solution began by eliminating the “ruinous competition” within the industry. He began to envision his version of a successful enterprise which replaced competition with cooperation in order to control production output and stabilize prices. The first step was to eliminate his rivals in Cleveland. Too impatient to wait for the refining downturn to slowly bankrupt the other refineries, Rockefeller instead decided to simply acquire and add them to his operation. (Chernow, p. 130 -131)

In order to accomplish his goal of combination, Rockefeller needed to amass enough capital to buy out his rivals. Rockefeller had already raised considerable funds in 1870 by incorporating the partnership Rockefeller, Andrews and Flagler into Standard Oil, a move that raised $1M. Upon incorporation, Standard Oil was massive operation that included a fleet of tank cars, a barrel making facility, and east coast warehouses and boats. Its Cleveland refining operation accounted for 10% of the entire U.S. capacity (Chernow, p. 132). In January of 1872, additional stock was issued to a select group of shareholders, increasing Standard’s capital to 2.5M (Tarbell, p. 63). Thus in 1872, Standard, as the largest refiner in Cleveland and a massive reserve of capital, was poised to take control of the area.

Rockefeller’s first target was Standard’s biggest competitor, Clark, Payne and Company (Chernow, p. 143). The refinery was sold for $400,000 and one of the partners, Colonel Oliver H. Payne, was kept on as an executive at Standard. This would be Rockefeller’s pattern throughout the acquisitions. He would suggest the acquisition was a partnership, offering Standard stock as compensation and often retain the services of key executives. Later on, executives would describe his pitch as follows:

“You see, this scheme is bound to work. It means an absolute control by us of the oil business. There is no chance for anyone outside. But we are going to give everybody a chance to come in. You are to turn over your refinery to my appraisers, and I will give you Standard Oil Company stock or cash, as you prefer, for the value we put upon it. I advise you to take the stock. It will be for your good. (Chernow, p. 144).

Further acquisitions followed at an astonishing rate. Between February and March of 1872, 21 of 26 Cleveland refineries were purchased, 6 of which within one 48-hour period in March. Cleveland giants such as Fawcett and Critchley; Bishop and Heisel ; and Alexander, Scofield & Company were all purchased (Chernow, p. 145). In the aftermath, bitterness existed amongst the vanquished refiners, mostly because Rockefeller was buying at a fraction of the refiners’ construction costs (Chernow, p. 145). Furthermore Rockefeller refused to account for intangible value such as reputation or client lists. For his part, Rockefeller believed intangible assets of failing companies have no value and rather felt he was overpaying for his acquisitions saying he wasn’t “so short-sighted as to antagonize these very men whom they were eager to have come into a close and profitable relationship with them.” (Chernow, p. 146).

By the middle of 1972, Rockefeller has taken complete control of the Cleveland refining industry. By 1879, he owned 90% of refining capacity in the entire United States (Granitz & Klein, p. 2). And his empire would continue to amass into the early twentieth century until it was one of the first corporations to be broken up under the Sherman Antitrust Act.

The Role of the South Improvement Company

It is widely believed that in addition to its dominant market position and capital reserves, Standard accomplished its Cleveland acquisitions though illegal collusion with the major railroads. Testimonial evidence suggests that in a common practice at the time, railroads gave the larger refiners discounted rates in order to secure their large volume shipments. However the railroads were and remain subject to many legal constraints brought on by their classification as common carriers. Relevant to oil refining is that common carriers are forbidden to discriminate amongst customers and must charge equal rates across the board. Thus in order to ensure that the larger refiners would use their rail for their volumnimous shipments, railroads needed to provide under the table incentives in the form of rebates. The refiners would pay the public market rate but at the end of the month, if their monthly shipments were large enough, the railroads would issue a rebate on a per barrel basis. According to industry sources at the time, this was a common practice and the larger the shipment, the larger the rebates. (Tarbell, p. 46).

Standard Oil, being the largest refiner in Cleveland, had long been suspected of extracting rebates from the railroads. The most egregious example being an agreement known as the South Improvement Company. In an effort to put an end to constant price wars, the three major railroads – the Erie, the Pennsylvania, and the New York Central – entered into a secret agreement with a select group of the largest U.S. refineries. The refineries would divide their shipments amongst the three railroads at an agreed upon percentage in exchange for highly discounted rates. These discounted rates were funded by a highly inflated price to non-participating refineries. In an unprecedented design, the participating refiners would receive rebates from their own shipments and also receive a percentage of the higher prices paid by the non-participating refiners in the form of “drawbacks”. Thus while their competitors were bearing highly inflated transport costs, the South Improvement refiners not only avoid the price hikes but also profited from them. However word of the deal leaked before the scheme ever launched causing massive protests and enmity among outsiders. Soon thereafter the railroads, abandoned the plan and the South Improvement Company was dissolved. (Granitz & Klein, 9-10).

Although never in force, it is widely believed that the specter of the South Improvement Company was enough to scare the Cleveland refiners into selling out to Rockefeller. The three month span in 1872 where Standard purchase all the major refiners in Cleveland occurred after the South Improvement Company agreement was finalized but before it was abandoned. Furthermore there is substantial testimonial evidence that knowledge of the agreement was the capitulating refiners’ main motivation for agreeing to sell. Therefore it seems likely that the remarkably short span in which all Cleveland refiners decided to sell can be explained by the sudden discovery of an event that was going to drive them out of business and they all rushed to cash out as much value as possible. (Granitz & Klein, p. 14-15).

Chernow, Ron. Titan: The Life of John D. Rockefeller, Sr. London: Warner Books, 1998.

Elizabeth Granitz & Benjamin Klein, Monopolization by “Raising Rivals’ Costs”: The Standard Oil Case, 39 J.L. & ECON. 1 (1996).

Tarbell, Ida M. The History of the Standard Oil Company, 1904.

Yergin, Daniel. The Prize: The Epic Quest for Oil, Money, and Power. New York: Simon & Schuster, 1991.

-- TylerConway - 03 Feb 2013



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r1 - 03 Feb 2013 - 22:01:57 - TylerConway
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