The lecture for the Prize Chapter 1: Oil on the Brain: The Beginning
Consider the following questions:
- What motivated the quest for a whale oil substitute?
- Oil lamps created a new market. Can you suggest some recent examples of inventions creating new markets?
- “Only the wealthy used whale oil.” What are the social implications of cheap fuel for lighting?
- What are some possible solutions to the problems created by the rule of capture?
- Are there any modern booms & busts in other industries?
- What was the role of expectations in oil land pricing?
- What was the psychological impact on the industry of Pithole’s demise?
Read through the online notes that follow here on this page below. These online notes are intended to summarize, enhance, complement or reinforce what is presented in the text.
Later, towards the end of this lesson, you can watch the related video episodes from the documentary film series based on the text. The documentary is narrated by actor Donald Sutherland.
The Switch-Point: Transition from Whale Oil to Petroleum
Up until the 1850s, oil seepages were collected in various parts of the world for medicinal purposes using primitive oil-gathering methods involving skimmings and oil-soaked rags.
The demand for productivity gains from light led to the invention of fuel lamps. Among the fuel used were animal grease, vegetable fat, camphene, town gas and whale oil. Whale oil had the highest quality and was the most expensive. As an illustration, the whale population had been exhausted in the Atlantic and whalers had to travel long distances into the Pacific, resulting in prices as high as $2.50/gallon. Entrepreneurs had to find a cheaper, high-quality substitute.
The need for a cheap illuminant (primary) and lubricant (secondary) started entrepreneurial innovations to meet these needs in the late 1840s and early 1850s. For example, Dr. Abraham Gesner, a Canadian, developed an extraction process to get oil from asphalt and other hydrocarbon substances. He called the refined product kerosene to sound more like the illuminant camphene, a derivative of turpentine. By 1859, about 34 companies in the U.S. were producing $5 million a year worth of kerosene from coal & other sources and the market and demand were growing. Also, by 1859, Galicia in Eastern Europe had a thriving kerosene business from crude oil mining; European crude production in 1859 was estimated at 36,000 barrels, primarily from Galicia and Romania. What the Eastern European crude oil industry lacked was the technology for drilling for oil.
In the US in the 1850s, the spread of kerosene faced two availability challenges: the source of the supply and a cheap lamp well-suited to the burning of kerosene. Both were overcome. The first challenge (the source of supply) was overcome through the vision and determination of George Bissell and the other (cheap lamp) by the importation of an improved Vienna lamp by a New York salesman. Bissell, who worked his way through Dartmouth College, was self-supporting from age 12 and became a professor of Latin and Greek, a journalist in Washington DC, and a high school principal and superintendent of public schools in New Orleans. He also studied in his spare time to become a lawyer. Bissell got a glimpse of the primitive oil producing methods when he passed through Western Pennsylvania on his way back to the northeast in 1853 due to poor health. The man of many talents, Bissell soon became one of the key figures in oil discovery in America.
The Founders and Technological Innovation
George Bissell was the driving force behind the creation of the modern oil industry as we now know it. He knew that oil was flammable and conceived that it could be used as a high-quality illuminant. He also saw an advertisement for medicinal oil that showed salt drilling derricks and thought that oil could be obtained by drilling instead of digging. What was needed was a cheap way to get the raw material (crude or Seneca/Rock oil in Western PA) for kerosene. Salt “boring” or drilling had been developed more than 1,500 years earlier by the Chinese.
Bissell partnered with James Townsend, a banker who helped to fund the idea. To help raise additional funds for the innovative idea of drilling for oil, Bissell and Townsend hired Professor Silliman, a prominent chemistry professor at Yale, for a fee of $525.08 (about $5,000 in 2000) to analyze the substance for the properties of a quality illuminant and lubricant. The credibility of the world-famous Prof. Silliman, if the results turned out positive, was all the investors needed to achieve their fundraising goals. Fearing that the investors would not pay him once they got their report, Silliman gave the report to a friend for safekeeping and skipped town demanding to be paid first (smart guy!). When the report, dated April 16, 1855, was released after payment, it was better than the investors had anticipated. The report showed that crude oil could be distilled into various hydrocarbon fractions and that one of the fractions was a very high-quality illuminating oil. They quickly raised the necessary funds and formed the Pennsylvania Rock Oil Company. Even Silliman bought 200 shares of the company.
Silliman’s study was the turning point in the establishment of the petroleum industry; it indicated that oil could be brought to various levels of boiling and thus technologically distilled into several fractions, all composed of carbon and hydrogen (hydrocarbons) with one of these fractions being a very high-quality illuminating oil. The task now boiled down to finding someone to undertake the drilling of oil in Western PA - the candidate was “Colonel” Edwin L. Drake.
By chance, James Townsend and Edwin Drake lived in the same hotel in New Haven and became quick friends. Drake was a jack-of-all-trades who had been on sick leave as a railroad conductor. Townsend soon talked Drake into the scheme of the Rock Oil venture and even convinced him to buy shares in the company. Soon, they sent him to Titusville, an impoverished village of 125 people in northwestern PA, to survey the prospect of obtaining oil. His first job was to acquire the titles to the prospective oil lands. To impress the people in Titusville, Townsend pulled out a stratagem by sending a letter ahead of Drake's arrival addressed to “Colonel” Drake even though he was not a colonel. The stratagem worked as he was well received and welcomed as “Colonel” Drake when he arrived in December 1857. By the time he returned to Titusville in 1858 for his second job, drilling for oil, the investors had established a new company, the Seneca Oil Company, with Drake as its general agent.
Drake informed Townsend that he would be boring/drilling for the oil (and not digging), as it would be cheaper. He asked for more money, and Townsend sent him $1,000. Townsend was the only one who continued to believe in the project and continued to fund it with his own money. After one year, Drake had nothing to show for his efforts and the investment. The salt drillers he hired, who had a reputation for whiskey and drunkenness, thought he was insane and did not believe in his idea of drilling for oil and treated the job accordingly. But in spring 1859, Drake found his driller, a blacksmith called William A. Smith (“Uncle Billy” Smith) who with his two sons hit oil at 69 feet on Saturday afternoon on August 27, 1859. It is interesting to note that towards the end of August, Townsend, in despair for the lack of return on investment, sent money to Drake to make all his final payments, close shop, and return home to New Haven. Coincidentally, the letter also arrived on August 27, 1859! The price of the first oil drilled from PA was about $40 per barrel.
It took George Bissell’s intuition, James Townsend’s resources, Edwin Drake's discovery, and the persistence of all three men, and six years to pull it off. Bissell and Townsend wasted no time visiting Titusville and subsequently became very wealthy, but things did not go as well for Drake. By 1866, he had lost all his money and become a semi-invalid living in poverty and physical pain. In 1873, the state of PA granted him a small lifetime pension for his services, which brought him some relief for his financial and physical difficulties.
The Boom Phenomenon
With the discovery of oil production via drilling, the farmers along Oil Creek started shouting “The Yankee has struck oil,” and the news started a mad rush to acquire sites and begin drilling for more oil. The population of Titusville multiplied overnight, and land prices shot up instantaneously, and flats quickly leased. More money was spent frantically by Bissell and company, leasing and buying farms in the Oil Creek area. By November 1860, 75 wells were producing in Cornplanter, later renamed Oil City, and the Titusville and Oil City areas were referred to as the Oil Regions. Whiskey barrels were used to collect and store the oil, more wells were drilled, more rock oil became available, and the only item in shortage was whiskey barrels! To date, oil is measured and sold per barrel.
The initial wells were modest producers, and the oil was pumped. It was not until April 1861 that the first flowing wells (gushers) were drilled. One week before that, the South had fired on Fort Sumter to start the Civil War, and the news of the oil gushing at an astonishing rate of 3,000 barrels per day and the subsequent ignition of the accompanying gases that resulted in an explosion and fire that killed 19 people and blazed for three days was temporarily lost.
Many factors quickly made kerosene from crude oil more desirable than whale oil as an illuminant, and that led to the establishment of a large and steady market for the new commodity of crude oil. These factors included the price (as more oil was produced and supply exceeded demand, the prices fell); the civil war (the war cut off shipments of turpentine from the South causing a shortage of camphene in the North which was quickly replaced with kerosene); growth of oil export/revenue (with the South seceding, the North no longer benefited from cotton revenues which were replaced by oil exports); and the quality (kerosene burned longer and with a brighter light than other oils used).
Kerosene is a manufactured product obtained by refining hydrocarbon fuels. Note that crude oil, coal, natural gas, tar sand, and oil shale are all hydrocarbon or fossil fuels. After the discovery of oil, most coal-oil refineries by the end of 1860 had converted to refining oil or went out of business. The three main processes typically used in refineries for crude oil processing are distillation, cracking, and reforming. Distillation separates the components based on the differences in their volatility or boiling point; cracking breaks the heavy molecules into lighter hydrocarbons, and reforming changes the chemical structure or nature of the hydrocarbons into ones with more desired properties. Interestingly, after crude oil was processed, one of the by-products (gasoline!) at that time was simply dumped or used as a solvent.
The gushers created overnight boomtowns in the Oil Regions. A classic example was Pithole, on Pithole Creek, about 15 miles from Titusville. After oil was struck there in January 1865, by June it produced one third (about 2,000 barrels per day) of the total oil output of the Oil Regions, had grown to 15,000 people by September, and land speculation was at its peak. Land that was worthless a few months earlier sold in July 1865 for $1.3 million and resold in September for $2 million!
The Bust: The Backside of the Boom Phenomenon
Interestingly, a few months after the boom, there was the bust when the oil production gave out as quickly as it had begun, and by January 1866, only a year after the first discovery, people had deserted the town for new hopes and opportunities elsewhere. Land that once sold for $2 million in 1865 was sold for $4.37 in 1878!
Excessive “flush production”-the initial high flow rate/yield of a flowing well under its own pressure, damaged the reservoir via excessive premature exhaustion of the gas pressure, which resulted in less oil recovery. Three reasons accounted for this practice: the lack of geological knowledge, the expected large and quick rewards, and the nature of the leasing terms that put a premium on producing quickly.
The most important concept in shaping the legal context of American early oil production was the “rule of capture” which was based on an English common law practice of shooting migratory game birds on one estate from another. In American oil production, the rule of capture meant that various surface owners atop a common pool could take all the oil they could get, even if they disproportionately drained the pool or reduced the output of nearby wells and neighboring producers. This rapid overproduction led to instability in both production and prices.
The boom and bust cycles occurred regularly throughout the birth of the oil industry that finally resulted in a depression. Between 1866 and 1867 the price of oil dropped to as low as $2.40 a barrel, from a high of $13.75 after the end of the war in 1865, due to the frantic speculation and overproduction of oil. Volatility was remarkable – very characteristic of so-called “thin” markets.
Pennsylvania: The Dominant Oil Producing Region in the World from 1860-1890
The wild oil markets in the 1860s are illustrated below:
- Production in PA:
- In 1860: 450,000 bbl; in 1862: 3,000,000 bbl; in 1866: 3.6 million bbl
- Wild Fluctuations in Price:
- In Jan 1861: $10/bbl, June: 50 cents, Dec: 10 cents (Demand lags behind supply (rapid overproduction))
- In 1862: $4/bbl; in 1863: $7.25/bbl ($100 / bbl 2004$); 1865: $13.75/bbl (Demand catches up with supply)
- 1866/1867: As low as $2.40/bbl (Depression in the industry)
Despite the wild fluctuations, enthusiasm for oil still had no limits, fueled by stories of instant wealth. One well, for example, was reported to have generated $15,000 profit for every $1 invested. Innovations and organization were even also imposed upon the industry. As an example, to overcome the teamster’s stranglehold on transportation, an ingenious method of transporting oil through wooden pipelines was developed between 1863 and 1865. By 1866, most of the wells in the Oil Regions were connected by pipelines to the railroads. Also, more formal exchanges where buyers and sellers could agree on prices emerged by the early 1870s. The Titusville Oil Exchange opened in 1871. Oil was bought and sold on three bases: “spot” sales required immediate payment and delivery; “regular” sales required the transaction to be completed within 10 days; and “futures” sales required a certain quantity to be sold at a certain price within a specified time in the future. One country (America) and one state (Pennsylvania) clearly continued to be the dominant oil producer in the world through the 1860-1890 period.
Yergin, Daniel. (2008). The Prize: The Epic Quest for Oil, Money, & Power. New York: Free Press.