Page images

utilization for the industry as a whole. Notably, the analysis of the cited observers does not distinguish between the two situations. Through vertical integration the pipeline is assured the loyalty of a faithful customer while the petroleum company enjoys the security of a captive pipeline. This security is of little comfort to nonowner shippers who must deal with a pipeline whose primary purpose is to accommodate the needs of its parent oil company. Similarly, wedded to its own pipeline, a vertically integrated oil company has no incentive to promote the development of new lower cost pipelines. Thus the greater security of the integrated company comes at the expense of competing shippers and alternative independent pipelines.


Oil pipelines have become the linchpin of the oil industry, not only holding the production, refining, and marketing segments together, but also providing a critical element of control over the industry. In the ensuing sections it will be shown in more detail how the original Standard Oil companies used oil pipelines to control the early oil industry and provided a model of industry structure and behavior which, despite a variety of attempts to deal with the problem, has continued to this day.

A. Standard Oil Companies as the Industry Prototype The Standard Oil Companies, prior to their dismemberment in 1911, provide a unique prototype of the development of vertical integration and the use of pipelines to secure control over other segments of the industry where the relative position of Standard was weaker compared with other companies operating in competition with Standard. Divorcement brought an end to Standard's empire, but the divorced companies and new entrants followed the model set by Standard-vertical integration through all four segments of the petroleum industry with heavy reliance on pipeline ownership and control as a vehicle for securing and maintaining dominance at all levels of the industry.

John D. Rockefeller started as an oil commission merchant in Cleveland, Ohio in 1863. By the late 1870's his companies leased or controlled 90 percent of the domestic refining industry and were on their way to securing control over the remainder of the industry.- Rockefeller capitalized on the principal characteristic of the early industry: consuming markets were located on population centers far from the producing fields. Refineries, as a consequence, were located in these centers—Cleveland, New York, Philadelphia, Baltimore--and transportation from the collecting points for the various producing fields to the refineries became the key to industry strategy. The transportation conduit, first railroads and then pipelines, brought the consuming market to the oil fields and established the conditions by which refineries obtained their crude.?

Rockefeller first used the railroads to gain control over the industry, Rockefeller's Standard Oil of Ohio was able to gain favorable railroad rates for crude transportation by guaranteeing full train shipments as well as by granting rebates to railroads to gain transportation advantages over competitors. Standard Oil of Ohio expanded its control of the refineries in and around Cleveland as a further stranglehold on the industry. Railroads were kept in line by playing one against another and by the development of an expanded gathering pipeline system that brought the oil to the railheads.*

[blocks in formation]



Pipelines soon entered the fray. Standard Oil's practice of obtaining discriminatory freight rates from railroads made it necessary for competitors to devise new and cheaper means of transportation. The pipeline was the natural result and the first trunkline was built by Standard Oil competitors in an effort to compete with the advantageous freight rates given by railroads to Standard Oil through secret rebates and agreements. Initially, Standard Oil tried to discourage the building of pipelines by competitors. But with their demonstrated success, Standard Oil turned toward their control. “By using these lines for carrying crude oil and by retaining the railroad's favor through the continued rail shipment of products, Standard Oil was able to enjoy the economies of pipelines to prevent producers and refiners from gaining access to the same forms of transportation at comparable costs. By 1883, Standard Oil was able to acquire a one third interest in the first trunkline pipeline and Standard's major competitor-Tide Water Pipe Lineand forced it to agree to carry only 1112 percent of the available trade. Prior to Standard Oil's control of Tide Water, railroads were forced to lower their rates in order to compete effectively with Tide Water.' But following the acquisition, "it has been shown that the surrender of the Tide Water Oil Company to the Standard Oil Company was almost instantly followed by a sharp advance in railroad rates on crude oil to the seaboard. There can be little doubt that these rates were advanced and were long maintained at the instance of the Standard Oil Company, with a view to keeping its competitors from establishing refineries at tidewater." 10

By 1880, Standard Oil had integrated to support its strategy without a strong commitment to production. It relied primarily on refining and transportation. Production ownership came later in the 1880's. u

The Standard Oil trust formed in 1882 proved vulnerable to legal action and reorganized into a holding company in 1899 under the name of Standard Oil Company (New Jersey). «* By 1899, Standard Oil's dominance of production from the Appalachian field was 88 percent; its share of refining had "slipped” to 82 percent with its share of kerosene production down to 85 percent. “

As other fields came into production, particularly the LimaIndiana field, Standard Oil was able to extend its control to these fields through a combination of production ownership and pipeline ownership.15 Standard Oil's domination of both the Appalachian fields and the Lima-Indiana fields extended through at least 1905.16 Standard Oil was not important in the Spindletop field in Texas (discovered in 1901), but was an important factor in the Mid-Continent fields of Oklahoma and Kansas through its ownership of the Prairie Oil and



5 Oil & Oil Pipelines at 236. & Id. at 236-237. 7 Johnson at 5. 8 Beard, William, Regulation of Pipelines 28 Common Carriers, Columbia Univ. Press, New York, 1941 at 13 (Hereinafter cited as "Beard") ; Oil & Oil Pipelines at 237.

Oil & Oil Pipe Lines at 237. 10 Bureau of Corporations report, 1906, in Oil & Oil Pipelines at 237. 11 Mitchell, ed. at 193. 19 State of Ohio v. Standard Oil Company, 49 Ohio 137 (1892). 13 Mitchell, ed. at 193. 14 Johnson at 7. 16 Id. at 12-14. 16 Id. at 11 ang 13.

1 17

Gas Company and the Prairie Pipe Line Company, which had extended its pipeline to interconnect with Standard's existing Buckeye and other pipeline systems in Illinois, Indiana and Ohio, providing a direct link between the Mid-Continent and the East Coast.

There was little doubt that the hallmark of Standard Oil's efficiency was its use of vertical integration, although the company was somewhat imbalanced due to its emphasis on refining and transportation. Its dominance was achieved predominantly because of its pipeline control. "

In the early years of the 1900's, public attention turned to the monopoly over oil that the Standard Oil Company had constructed and the anticompetitive practices that the trust was engaging in.” The Bureau of Corporations, organized in 1903, gathered the mounting evidence of Standard Oil's abuses and in 1906 wrote in its report on the Transportation of Petroleum:

The Standard Oil Company has all but a monopoly of the pipelines in the United States. Its control of them is one of the chief sources of its power. While in the older oil fields pipelines are by the State laws common carriers, there has been little attempt by the States to regulate their charges. The Federal Government has not as yet exercised any control over pipelines engaged in interstate commerce. The result is that the charges made by the Standard for transporting oil through its pipelines for outside concerns are altogether excessive, and in practice are largely prohibitive. Since the charges far exceed the cost of the service, the Standard has a great advantage over such of its competitors as are forced to

use its pipelines to secure their crude oil.20 In November 1906, the Department of Justice brought a civil action against the Standard Oil Company of New Jersey based upon the Sherman Antitrust Act, requesting dissolution of the associated companies. 21 The Government ultimately was successful in this effort and the Supreme Court on May 15, 1911 ordered the dismemberment of the Standard Oil

During the interim betwen the initial filing of the suit and the ultimate victory, other agencies contributed to the evidence against Standard Oil. Thus an ICC investigation submitted on January 28, 1907 stated,

At the basis of the monopoly of the Standard Oil Company in the production and distribution of petroluem products rests the pipeline. The possession of these pipe lines enables the Standard to absolutely control the price of crude petroleum and to deter

17 Id. at 17-18.
18 Johnson at 462-63.

According to the subsequent court record (of the 1911 suit against Standard Oil), Jersey Standard and its defendant companies between 1899 and 1906 produced more than 80 percent of crude produced in Pennsylvania, Ohio, and Indiana ; refined more than 75 percent of all crude oil; owned more than half of all the tank cars ; marketed and exported more than 80 percent of the kerosene and naptha, and distributed more than 90 percent of the lubricating oil purchased by American railroads. The Standard group was unquestionably dominant at three levels of the industry, and the government asked for its dissolution under the Sherman Antitrust Act of 1890. (Footnote

omitted.) (Mitchell, ed. at 194–95.) 19 See, e.g., Í. Tarbell, The History of the Standard Oil Company (1904).

0 Bureau of Corporations, “Transportation of Petroleum” 37 (1906), in PICA 98. n PIOA at 96.

Standard Oil Company v. United States, 221 U.S. 1 (1911).

mine, therefore, the price which its competitor in a given locality

shall pay. The ICC Report concludes,

... it will probably be found necessary to disassociate in the case of oil, as in that of other commodities, the function of trans

portation from that of production and distribution.23 In May 1907, the Bureau of Corporations in its Report on the Petroleum Industry, part 1, focused on the tactics used by the Standard Oil pipeline officials to prevent others from enjoying the transportation cost savings available to Standard Oil: harassing litigation; preemption of right of way; connivance with railroads in rate matters; and payment of discriminatory premiums to producers to lure them away from competitors.24 The report stated that Standard Oil's decisive advantage lay in its control of the long-distance trunk pipelines and its documented Standard's continuing practice of denying access to nonaffiliated companies. The report, however, opted for better pipeline regulation, rather than reiterating the ICC's divorcement approach.25

It is noteworthy that during the trial of Standard Oil, it advanced an argument that was to echo throughout the industry for decades to come. Standard Oil argued that pipelines were part of the organic whole, pipelines were built to serve its own refining operations. Its pipelines were not built to compete for common carrier business and never had so competed.26 While this plant facility argument did not avail Standard Oil in 1911, major integrated oil companies have not given up pressing this position.27

Arthur Johnson, in his treatise on pipeline policy, states with respect to Standard's strategy and tactics that Standard was the prototype which other companies emulated. Thus, Johnson concluded:

As vital links between oil fields and refineries, pipelines gave Standard Oil a transportation advantage over competitors and would

be competitors that was never seriously challenged as long as oil production remained relatively concentrated in the Appalachian and Lima-Indiana fields. Standard Oil was therefore the training ground for pipeliners active during the first half of the period covered by this study, just as it was the originator of many, though not all, of the business practices and techniques that characterized oil pipelining down to World War II.

The key to Standard's strategy of overland oil movement lay in its construction and operation of pipelines as parts of an integrated structure. This strategy recognized that the essence of the oil industry is the continuous movement of oil from the places where nature has secreted it to the consumer. In this flow process, of course, oil is stored and oil is processed, but to provide profits it must move efficiently, continuously, and therefore in volume.

For Standard Oil, as for those who followed in its wake, these considerations added up to a need to control pipelines as part of an


23 H.R. Doc. 606, 59 Cong., 2d sess.

26 U.S. Bureau of Corporations, Report of the Commissioner of Corporations on the Petroleum Industry, Part I: Position of the Standard Oil Company in the Petroleum Industry, xix (1907).

25 Id. at 34.

26 Brief for Appellants, vol. II, 109 Standard Oil Company of New Jersey v. United States, 221 U.S. 1 (1911).

7 Ind. Reorg., part 9 at 637.

« PreviousContinue »