Monopolization by “Raising Rivals’ Costs”: The Standard Oil Case

Authors: E. Granitz & B. Klein

Presented by Liu Pucheng

Motivation

• During the 1870s, J. D. Rockefeller established a petroleum refining monopoly in the United States, Standard Oil. How to accomplish this?

• And controlled more than 90 percent of U.S. refining capacity by 1879. Also, how to?

• For the following 20 years, Standard maintained a dominant share of refining. Why can?

Framework of The Paper

• First of all, motivation and a brief literature review.John McGee(1958): monopoly through “voluntary” M&AThe authors of this paper not agree with him and give else explanations.

• Then, unfolding the authors points in seven parts:. Railroad competition in the early oil industryⅠ. The South Improvement Company conspiracy: Rockefeller's Ⅱ

acquisition of Cleveland refineries (1871-72). Rockefeller's consolidation of refinery ownership (1872-79) Ⅲ. Monopolization by "raising rivals' costs" Ⅳ

. Stability of the cartel Ⅴ. Efficiency explanations for Rockefeller's success Ⅵ. ConclusionⅦ

Ⅰ. Railroad competition in the early oil industry

• 1859, oil was first discovered in northwestern Pennsylvania, that became known as the Oil Regions.

• 1863, Rockefeller built his first refinery in Cleveland.• 1864, the Philadelphia& Erie railroad was completed.• 1865, a direct link from the Oil Regions to New York was

established.• Some transportation price information in 1867:

From Pittsburgh to Philadelphia, 355 miles, $1.70 per barrel; From Cleveland to New York, 629 miles, $1.53 per barrel.

• 1870, the three rail systems negotiated substantially lower rates for year-round contracts with Cleveland refiners (Rockefeller).

• More information about the percentage of crude shipped to major refining centers in 1865-71 would be seen in the next page table 1.

TABLE 1

• the percentage of crude shipped to major refining centers in 1867-71

The scene in 1871

Ⅱ. The SIC conspiracy: Rockefeller's acquisition of Cleveland refineries (1871-72)

• The three railroads decided in 1871 to enlist the cooperation of several refiners to police a collusive rate agreement.

• The railroads established a corporation called the South Improvement Company (SIC).

• And then it selected the largest refiners in each of the refining centers of Pittsburgh, Philadelphia, Cleveland,

and New York as joint owners of the company.

SIC’s events list

• Feb. 25th, 1872, an officer of the Lake Shore Railroad announced that the rate on crude shipments to New York had been increased from $0.87 to $2.14;

• Two days later, 3,000 men in the Oil Regions gathered and formed an organization Petroleum Producers' Union to impose an embargo on crude shipments to SIC, known at the time as the Oil War ;

• Mar. 25th, the railroads cancelled their contracts with SIC;

• Apr. 2nd, the Pennsylvania legislature revoked SIC.

Ⅲ. Rockefeller's consolidation of refinery ownership (1872-79)

• Until 1874, Standard had negotiated preferential lower rates from both the New York Central and the Erie Railroad.

• Later, Rockefeller secretly merged with its original partners in SIC, and then became the largest refiners in Pittsburgh and Philadelphia.

• Standard could now pressure the Pennsylvania with the threat of moving its crude shipments away from its newly acquired refineries in Pittsburgh and Philadelphia to its

Cleveland refineries.

Standard’s forcefully acquisition

• The total effect was to give Standard a substantial transportation cost advantage over its refining rivals. For example, while the open rate in 1878 for crude shipments to New York was $1.70 per barrel, Standard paid only $1.06 per barrel.52 Standard's $1.06 transportation rate implied a marginal refinery profit of plus $.49 per barrel, while the independents' $1.70 transportation rate implied a marginal refinery profit of minus $.15 per barrel, or 9 percent of the gross rate.

• For example, in1873 there were 22 independent refineries in Pittsburgh; by the end of 1877 Standard and its affiliates had acquired all of them.

• A summary of Standard's records shows that :24 were bought or leased in 1876, 35 in 1877, 40 in 1878 and 9 in 1879.

Ⅳ. Monopolization by "raising rivals' costs"

• How was the petroleum industry monopolized?

• How was the monopoly- monopsony profit created by the monopolization of the petroleum industry shared between Standard and the railroads?

• Which stage of the petroleum industry, transportation or refining, actually was monopolized?

Ⅴ. Stability of the cartel

• A. The Empire Rate War

• B. Entrants into Petroleum Transportation

• C. Standard's construction of a pipeline network

• D. Discovery of new fields

Ⅵ. Efficiency explanations for Rockefeller's success

• Lester Telser presents an transportation efficiency explanation for Standard's success based natural monopoly conditions present in the railroad industry.

• The explanation of this paper:1.Controlling railroad through acquisition and large share of the whole refining market;2.Controlling petroleum supply by railroad monopoly;3. monopoly in railroad and Oil Regions consolidating the dominant status in the refining market.

Ⅶ. Conclusion

• A vertical relationship can facilitate the creation of monopoly power.

• Any questions?