[Editors note: This is part 3 of 4 in Alex Epstein’s exploration of innovation and creative destruction of the early oil market. Read Part 2 here. References are at the bottom. This post was originally published in The Objective Standard.]
George Bissell was the last person anyone would have bet on to change the course of industrial history. Yet this young lawyer and modest entrepreneur began to do just that in 1854 when he traveled to his alma mater, Dartmouth College, in search of investors for a venture in pavement and railway materials. 26 While visiting a friend, he noticed a bottle of Seneca Oil—petroleum—which at that time was sold as medicine. People had known of petroleum for thousands of years, but thought it existed only in small quantities. This particular bottle came from an oil spring on the land of physician Dr. Francis Beattie Brewer in Titusville, Pennsylvania, which was lumber country.
At some point during or soon after the encounter, Bissell became obsessed with petroleum, and thought that he could make a great business selling it as an illuminant if, first, it could be refined to produce a high quality illuminant, and, second, it existed in substantial quantities. Few had considered the first possibility, and most would have thought the second out of the question. The small oil springs or seeps men had observed throughout history were thought to be the mere “drippings” of coal, necessarily tiny in quantity relative to their source.
But Bissell needed no one’s approval or agreement—except that of the handful of initial investors he would need to persuade to finance his idea. The most important of these was Brewer, who sold him one hundred acres of property in exchange for $5,000 in stock in Bissell’s newly formed Pennsylvania Rock Oil Company of New York.
To raise sufficient funds to complete the project, Bissell knew that he would have to demonstrate at minimum that petroleum could be refined into a good illuminant. He solicited Benjamin Silliman Jr., a renowned Yale chemist, who worked with the petroleum, refined it, and tested its properties for various functions, including illumination. After collecting a $500 commission (which the crash-strapped firm could barely put together), Silliman delivered his glowing report: 50 percent of crude petroleum could be refined into a fine illuminant and 90 percent of the crude could be useful in some form or another.
Proof of concept in hand, Bissell raised just enough money to enact the second part of his plan: to see if oil could be found in ample quantities. According to the general consensus, his plan—to drill for oil—was unlikely to uncover anything. (One of Bissell’s investors, banker James Townsend, recalled his friends saying, “Oh, Townsend, oil coming out of the ground, pumping oil out of the earth as you pump water? Nonsense! You’re crazy.”) But Bissell’s organization had reason to suspect that the consensus was wrong—mostly because saltwater driller Samuel Kier had inadvertently found modest quantities of oil apart from known coal deposits, which contradicted the coal-drippings theory. And so Bissell proceeded, albeit with great uncertainty and very little money.
He sent Edwin Drake, a former railroad conductor and jack-of-many-trades, to Titusville to find oil. Drake and his hired hands spent two years and all the funds the company could muster, but after drilling to 69.5 feet with his self-made, steam-powered rig, he found nothing. Fortunately, just as the investors told Drake to wrap up the project, his crew noticed oil seeping out of the rig. Ecstatic, they attempted to pump the oil out of the well—and succeeded. With that, a new industry was born.
That is, a new potential industry was born. In hindsight we know that oil existed in quantities and had physical qualities that would enable it to supplant every other illuminant available at the time. But this was discovered only later by entrepreneurs with the foresight to invest time and money in the petroleum industry.
Bissell and other oilmen faced a difficult battle. They had to extract, refine, transport, and market at a profit this new, little-understood material, whose ultimate quantities were completely unknown—while vying for market share with well-established competitors. Fortunately, they were up to the task, and many others would follow their lead.
When word got out about Drake’s discovery, a “black gold” rush began, a rush to buy land and drill the earth for as much of this oil as possible. For example, upon seeing Drake’s discovery, Jonathan Watson, a lumber worker on Brewer’s land, bought what would become millions of dollars worth of oil land. George Bissell did the same. Participants included men in the lumber industry, salt borers turned oil borers, and others eager to take advantage of this new opportunity. 27
Progress in this new industry was messy and chaotic—and staggering. In 1859, a few thousand barrels were produced; in 1860, more than 200,000; and in 1861, more than 2 million. 28 Capital poured in from investors seeking to tap into the profits. In the industry’s first five years, private capitalists invested $580 million—$7 billion in today’s dollars. 29
Even in the middle of the 19th century, when wealth was relatively scarce, the supposed problem of attracting capital to fund the development of a promising energy source did not exist so long as the energy source was truly promising.
As producers demonstrated that enormous quantities of oil existed, they created a huge profit opportunity for others to build businesses performing various functions necessary to bring oil to market. At first, would-be transporters were hardly eager to build rail lines to Titusville, and would-be refiners were hardly eager to risk money on distillation machines (“stills”) that might not see use. As such, the oil industry was not functioning efficiently, and much of the oil produced in the first three years went to waste. The oil that did not go to waste was expensive to bring to market, requiring wagon-driving teamsters to haul it 20–40 miles to the nearest railroad station in costly 360-pound barrels. 30
But once production reached high levels, driving crude oil prices down, the transportation, refining, and distribution of oil attracted much investment and talent. An early, price-slashing solution to transportation problems was “pond fresheting.” Entrepreneurial boatmen on Oil Creek and the Alleghany River, which led to Pittsburgh, determined that they could offer cheaper transportation by strapping barrels of oils on rafts and floating them down the river. But this only worked half the year; the rest of the time, water levels were too low. The ingenious workaround they devised was to pay local dam owners to release water (“freshet”) at certain points in the year in order to raise water levels, thereby enabling them to float their rafts downstream. The method worked, and Pittsburgh quickly became the petroleum refining capital of America. 31
Railroads entered the picture as well, building lines to new cities, which allowed them to become refining cities. In 1863, the Lake Shore Railroad built a line to Cleveland, inspiring many entrepreneurs to establish refineries there—including a 23-year-old named John Rockefeller. 32 Another innovation in oil transport was “gathering lines”—small several-mile-long pipelines that connected drilling sites to local storage facilities or railroads. At first, gathering lines were halted by the Pennsylvania government’s lax enforcement of property rights; the politically-influential teamsters would tear down new pipelines, and the government would look the other way. But once rights were protected, gathering lines could be constructed quickly for any promising drilling site, enabling sites to pump oil directly to storage facilities or transportation centers without the loss, danger, and expense of using barrels and teamsters. Still another innovation was the tank car. These special railroad cars could carry far more oil than could normal boxcars loaded with barrels, and, once certain problems were solved (wood cars were replaced by iron cars and measures were taken to prevent explosion), they became the most efficient means of transportation. 33
In the area of refining, innovation was tremendous. Certain industry leaders, such as Joshua Merrill of the Samuel Downer Company and Samuel Andrews of Clark, Rockefeller, and Andrews (later to be named Standard Oil), continuously experimented to solve difficulties associated with the refining process. 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, and gasoline for fuel. The process employs a still 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 boil off and bottle kerosene was hugely problematic: Impure kerosene could be highly noxious and highly explosive. Additionally, early stills did not last very long, yielded small amounts of kerosene per unit, took hours upon hours to cool between batches, and raised numerous other challenges.
Throughout the 1860s, the leading refiners experimented with all aspects of the refining process: Should stills be shaped horizontally or vertically? How should heat be applied for evenness of temperature? How can the life of the still be maximized? How can the tar residue at the bottom be cleaned quickly and with as little damage to the still as possible? What procedures should one employ to purify the kerosene once distillation has been performed? When the process involves a chemical treatment, how much of that treatment should be used? Is it profitable to “crack” the oil, heating it at high temperature to create more kerosene molecules, which creates more kerosene per barrel but takes longer and requires expensive purification procedures?
The leading refiners progressively asked and answered these questions, and profited immensely from the knowledge they gained. By the end of the 1860s, the basics of refining technology had been laid down, 34 though it would not be until the 1870s—the Rockefeller era—that they would be employed industry-wide.
On the marketing and distribution end, kerosene became a widely available good. Refining firms made arrangements with end sellers, most notably wholesale grocers and wholesale druggists, to sell their product. Rockefeller’s firm was a pioneer in international sales, setting up a New York office to sell kerosene all around the world—where it was in high demand thanks to its quality and cheapness, and to the lack of alternatives. 35
The pace of growth of the oil industry was truly phenomenal. Within five years of its inception, with no modern communication or construction technology, the industry had made light accessible to even some of the poorest Americans. In 1864, a chemist wrote:
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. 36
Within five years, an unknown technology and an unimagined industry had become a source of staggering wealth creation. Had the early days of this industry been somehow filmed, one would see oilmen in every aspect of the business building up an enormous industry, moving as if the film were being fast-forwarded. Almost nothing in history rivals this pace of development, and it is inconceivable today that any construction-heavy industry could progress as quickly. It now takes more than five years just to get a permit to start building an oil derrick, let alone to complete the derrick, much less thousands of them.
But in the mid-1800s, no drilling permits or other government permissions were required to engage in productive activity. This did not mean that oilmen could pollute at will—property rights laws prohibited polluting others’ property (though some governments, unfortunately, were lax in their enforcement of such laws). It did mean that, for the most part, they were treated as innocent until proven guilty; and they knew that so long as they followed clearly defined laws, their projects would be safe. 37
Anyone with an idea could implement it as quickly as his abilities permitted. If he thought a forest contained a valuable mineral, he could buy it. If he thought drilling was the best means of extracting the mineral, he could set up a drilling operation. If he thought a railroad or a pipeline was economical, he could acquire the relevant rights-of-way, clear the land, and build one. If he thought he could do something better than others, he could try—and let the market be the judge. And he could do all of these things by right, without delay—in effect, developing energy at the speed of thought.
As one prominent journalist wrote:
It is certain . . . the development [of the petroleum industry] could never have gone on at anything like the speed that it did except under the American system of free opportunity. Men did not wait to ask if they might go into the Oil Region: they went. They did not ask how to put down a well: they quickly took the processes which other men had developed for other purposes and adapted them to their purpose. . . . Taken as a whole, a truer exhibit of what must be expected of men working without other regulation than that they voluntarily give themselves is not to be found in our industrial history. 38
Imagine if George Bissell and Edwin Drake were to pursue the idea of drilling for oil in today’s political context. At minimum, they would have to go through a multiyear approval process in which they would be required to do environmental impact studies documenting the expected impact on every form of local plant and animal life. Then, of course, they would have to contend with zoning laws, massive taxes, and government subsidies handed to their competitors. More likely, the EPA would simply ax the project, declaring Titusville “protected” government land (the fate of one-third of the land in the United States today). More likely still, Bissell would not even seriously consider such a venture, knowing that the government apparatus would wreck it with unbearable costs and delays, or a bureaucratic veto.
The speed of progress depends on two things: the speed at which men can conceive of profitable means of creating new value—and the speed at which they can implement their ideas. Since future discoveries depend on the knowledge and skills gained from past discoveries, delays in market activity retard both the application and the discovery of new knowledge.
In 1865, members of the oil industry experienced a tiny fraction of the government interference with which the modern industry regularly contends: the Civil War’s Revenue Act of 1865. This was a $1 per barrel tax on crude inventory—approximately 13 percent of the price. This Act “slowed drilling to a virtual standstill” and “put hundreds of marginal producers out of business” by eating into businesses’ investment and working capital. 39 Remarkably, the damage done by the Act scared the government away from taxing crude and oil products for decades, an effective apologyforits previous violation of property rights. Such was the general economic climate of the time.
After the brief but crushing bout of confiscatory taxation, the economic freedom that made possible the rise of the oil industry resumed, as did the industry’s explosive growth. In 1865, kerosene cost 58 cents a gallon, much less expensive than any prior product had been—and half the price of coal oil. 40 But entrepreneurs did not have time to revel in the successes of the past. They were too busy planning superior ventures for the future—knowing that with creativity they could always come up with something better, and that customers would always reward better, cheaper products.
The paragon of this relentless drive to improve was Rockefeller, who developed a new business structure that would bring the efficiency of oil refining—and ultimately, the whole process of producing and selling oil—to new heights. Rockefeller was obsessed with efficiency and with careful accounting of profit and loss. In seeking to maximize his efficiency, he had one central realization that steered the fate of his company: Tremendous efficiency could be achieved through scale. From his first investment in a refinery in 1863, when he built the largest refinery in Cleveland, to his continual borrowing to expand the size of his operations, Rockefeller realized that the more oil he refined, the more he could invest in expensive but efficient devices and practices whose often-high costs could be spread over a large number of units. He created barrel-making facilities that cut his barrel costs from $3 to $1 each. He built large-scale refineries that required less labor per barrel. He purchased a fleet of tank cars, and created an arrangement with a railroad that lowered his costs from $900,000 to $300,000 a trip. (Such savings are the real basis of Rockefeller’s much-maligned rebates from railroads.)
[editor’s note: for parts 2-4, citations are colored and referenced at the bottom]
Alex Epstein is a fellow at the Ayn Rand Center for Individual Rights, focusing on energy issues. He is the author of numerous articles on oil and energy, which have appeared in such publications as the Wall Street Journal, Forbes, Investor’s Business Daily, and FOX News. Epstein is a frequent speaker at universities around the country, a frequent guest on nationally syndicated radio programs, and a guest panelist on the popular “Front Page” show on PJTV.com
26 This discussion is based on Williamson and Daum, The American Petroleum Industry, pp. 63–81.
27 Ibid., pp. 86–89.
28 Ibid., p. 103.
29 Robert L. Bradley, Oil, Gas, and Government: The U.S. Experience, vol. 1 (London: Rowman & Littlefield, 1996), p. 18.
30 Williamson and Daum, The American Petroleum Industry,pp. 85, 106.
31 Ibid., pp. 165–69.
32 Burton W. Fulsom, The Myth of the Robber Barons (Herndon, VA: Young America’s Foundation, 1996), p. 85.
33 Williamson and Daum, The American Petroleum Industry, pp. 183–89.
34 Ibid., pp. 202–31.
35 Alex Epstein, “Vindicating Capitalism: The Real History of the Standard Oil Company,” The Objective Standard, Summer 2008, pp. 29–35.
36 Williamson and Daum, The American Petroleum Industry, p. 320.
37 For a comprehensive account of the existence and decline of economic freedom in the oil industry, see Bradley, Oil, Gas, and Government.
38 Paul Henry Gidden, The Birth of the Oil Industry (New York: The Macmillan Company, 1938), p. xxxix.
39 Bradley, Oil, Gas, and Government.
40 Discussion based on Alex Epstein, “Vindicating Capitalism.”