Fresh from his embarrassing failure in the Saginaw salt business, Henry Flagler moved his young family to Cleveland in the summer of 1866. (Missed his earlier drama? Here’s Part 1 and Part 2 of Flagler’s tale!)
Cleveland meant a fresh start. And for the ever-optimistic Flagler, it must have felt like a welcome one. He’d managed to secure a post as a commission grain merchant with the brokerage firm of Clark & Sanford, a newer version of the same company that once had employed Henry’s business acquaintance, John D. Rockefeller. (It’s just possible that it was Rockefeller who helped Henry land his new job.)
By this time, Rockefeller himself was no longer in the grain business. He’d left to form an oil-trading partnership with Samuel Andrews, a talented chemist and inventor. But Rockefeller hadn’t moved his office very far. His new digs were on the second floor of the Sexton Building, a prime commercial site at the foot of Superior Avenue, overlooking Lake Erie.
As for Flagler, the brokerage firm that had hired him was located across the street from his friend and slightly downhill, at 35-41 River Street. Though only a block or two away, this was a gritty shipping/industrial zone lined with docks, warehouses, and freighting companies.
When Rockefeller offered Flagler a chance to rent a desk inside Rockefeller’s far-grander office, Flagler leaped at the chance. It was a logical spot to rub elbows with other grain merchants; the Corn Exchange had its home on the first floor of the same building. And perhaps most appealing of all for Flagler, it would give him an insider’s view of Rockefeller’s oil business.
Vast oil deposits had been discovered in Pennsylvania around 1859, and military demand during the Civil War had driven the price of oil sky high. By 1866, of course, the tragic war was finally over. But speculation in the new commodity was still running high.
The primary end-use for oil at the time was in the form of kerosene for lighting, and refineries were necessary to convert crude oil into that commercial product. The refining process wasn’t all that complicated and its costs were low, making the oil market an attractive one for ambitious folks like Rockefeller. And he had plenty of competition. Unlike others in the fledgling industry, however, Rockefeller sought out markets for his refinery’s by-products (such as tar), and aggressively targeted costs by hiring his own pipe-layers and barrel-builders instead of out-sourcing those tasks.
Meanwhile, Flagler was prospering in the commission grain business. In short order, he not only recouped the entire $100k loss from the unhappy flyer in Saginaw salt but bought out the brokerage company that had employed him, renaming it Flagler & Co. and once again taking in brother-in-law Barney York as his partner.
In 1867, just a year after moving to Cleveland, Flagler turned his efforts in a totally new direction, becoming partners with Rockefeller in the oil business. Once again, funds from the Harkness family likely eased the way; Stephen Harkness (Henry’s step-brother) sank $100k into this new partnership, becoming a silent partner as well. Now, the fledgling oil endeavor was no longer simply called “Rockefeller & Andrews”; instead, it became “Rockefeller, Andrews & Flagler.”
Despite their differing temperaments and ages, a strong bond developed between Flagler and Rockefeller. Tall and reserved, Rockefeller was known as shrewd, methodical, and ambitious. Flagler, the older of the pair by nine years, was described by contemporaries as dapper, charming and good-humored, not to mention exceptionally smart and a terrific negotiator. The two men maintained desks close enough to hand documents back and forth, and occupied similar-looking mansions on Euclid Avenue (Cleveland’s “Millionaire’s Row”), often walking to and from work together.
Rockefeller served as day-to-day operations manager for the oil partnership; Andrews oversaw the refining process; while Flagler had a knack for negotiating and drafting precise legal contracts. Several other family members also had a hand in the business: John Rockefeller’s younger brother, William, ran a New York City brokerage for the firm’s refined oil. And Andrews’ brother, John, was in charge of purchasing the crude oil in northwestern Pennsylvania.
The partnership not only bought crude and sold refined oil, it played the “futures” as well to wring additional profits from the oil market — using borrowed money both for operations and to speculate with. The business expanded rapidly. But this high-flying financial wheeling-and-dealing resulted in at least one near-disastrous cash crunch when, in November, 1867, a New York bank refused to honor the company’s IOU. But the partnership managed to survive.
Such high-risk financial practices were hardly unusual for the time. Prices in the oil market were fluctuating wildly, and the industry was rife with speculation. Profit margins were a slim 16% — a meager $2 on each barrel of refined oil. And that meant shaving every penny from costs. Among his other efforts, Flagler pressed Congress to eliminate the wartime 20-cents-a-gallon federal tax on crude oil, even visiting Washington to lobby for relief. (Whether or not due to Flagler’s efforts, the tax was indeed dropped in June 1868.)
The partnership’s well-run refinery could successfully churn out 900 barrels of refined product a day. But their Cleveland location made reining in transportation costs especially challenging. Competing refineries in Pittsburgh sat closer to the Pennsylvania crude oil fields. And New York and Philadelphia refiners had rail routes that gave them a competitive edge for shipping refined oil to Europe. By contrast, hauling crude oil west to Cleveland for refining meant not only a costly detour but a greater distance later for the refined product to reach New York.
The cheapest (and slowest) freighting solution at first was to use the Erie Canal for shipping refined oil east. But once winter set in, ice on the canals scuttled this option. As an added worry, canal companies typically refused to guarantee delivery once the weather began to grow colder. Railroads were the alternative, but they raised their rates every winter, taking advantage of their cold-weather monopoly.
Flagler did the best he could to manage transportation costs. He tried to cut “very favorable” agreements with the railroads, and wangled delivery guarantees from reluctant canal companies in the fall by threatening to abandon canal shipping entirely unless they conceded.
There were, at least, have two possible rail options in Cleveland: the “Atlantic & Great Western” (which connected with the Erie Canal), and the “Lake Shore.” Due to lower canal costs, Flagler’s oil partnership typically used the Atlantic rail lines whenever possible. But in February 1868, suspecting some collusion between the railroad and the canal folks, the partnership considered contracting with its competitor to ship solely by rail year-round. Flagler also began talking with a different railroad, the “Empire,” about a permanent rail contract.
Under pressure, the Atlantic/Erie camp eventually agreed to lower its shipping rates. The partnership also benefited from a “drawback” agreement with this railroad – a small kickback on each barrel of oil its competitors shipped over tbeir rails in the same period.
In the spring of 1868, however, a fresh transportation opportunity began to emerge. Eager to dominate the Erie canal business, entrepreneur Jay Gould needed confidence that oil shipments via the canal would continue. Gould therefore set his sights on boosting crude deliveries to Cleveland, where his firm’s Atlantic Railroad arm would pick up the refined product and transfer it east to the canal — cutting two competing rail lines (Pennsylvania/Empire and New York Central) out of the picture.
As part of his plan, Gould purchased the Allegheny Transportation Company, then wangled a trio of agreements binding Cleveland’s three major refiners (including the Flagler/Rockefeller partnership) to using the Atlantic/Erie railroad line at most-favorable rates. Sweetening the deal, the three refiners each received a 25% interest in Allegheny, allowing them a commensurate share of Allegheny’s shipping profits. Best of all, they were granted e a 75% rebate on the cost of any oil they shipped using Allegheny’s pipelines.
Satisfied that he now had the steady supply chain in place that he needed, Gould leased the entire Atlantic railroad line in 1869. But his rail line still faced competition from Lake Shore, an informal rail consortium led by Amasa Stone. Stone’s group soon organized itself into the “Lake Shore and Michigan Southern Railroad” and built a short line to haul crude from the oil-producing regions. Meanwhile, yet another railroad player — the Pennsylvania — was pushing oil companies to ship their crude by rail directly from the oil-producing regions all the way to the Atlantic coast, bypassing intermediate refiners entirely.
Competition in the oil industry was growing fiercer than ever, with more and more refiners entering the business. As a result, Flagler fretted more than ever over the cost of freight. Despite his firm’s recent partnership with Allegheny, he began to make inquiries about rail rates for crude over Amasa Stone’s new line.
After what must have been a great deal of hard thought and long discussion, Flagler, Rockefeller, and their partners decided the best way to secure their market share and bolster their finances was incorporation. On January 10, 1870, incorporate they did – officially becoming The Standard Oil Company of Ohio. Flagler himself drafted the company’s short incorporation document, despite his lack of formal legal training.
Standard Oil was initially capitalized at a million dollars, with its 10,000 shares of stock valued at $100 per share. The company was hardly small, even at the outset; already it accounted for some ten percent of the nation’s refining capacity. Its assets included two refineries on a 60-acre parcel in Cleveland, plus tank cars, warehouses, and a barrel-making plant. It also had warehouses and storage facilities for refined oil in New York.
John D. Rockefeller was the new corporation’s first president and the single largest shareholder, with 2,667 shares. Flagler was named secretary and treasurer, with 1,333 shares of stock, plus voting control over a similar number held for his stepbrother, Stephen Harkness, making Flagler (voting-wise) essentially Rockefeller’s equal. Two additional shareholders (William Rockefeller, and Samuel Adams) held 1,333 shares apiece, while O.B. Jennings (a distant relation of William Rockefeller) owned 1,000 shares. That left another 1,000 shares of the new corporation available for sale.
Amasa Stone – head of the rail line formerly known as the Lake Shore (now Cleveland & Erie), who also happened to be vice president of a Cleveland bank – snapped up 500 of the new company’s outstanding shares.
And that’s when the railroad rate wars really began.
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