The Prize Chapter 3: Competitive Commerce
Consider the following questions:
- What are the traits of a successful entrepreneur?
- How important is an understanding of local customs in conducting commerce?
American Control of World Oil Through the 1890s
Petroleum was virtually an international business right from the beginning in PA. Without the international markets, the industry could not have expanded as it did. There was strong demand in Europe stimulated by industrialization, economic growth, and urbanization. Everyone wanted some of the "new light" from America. American oil exports in the 1870s and 1880s accounted for nearly 50% of the total American oil output. Nearly 90% of this oil also passed through Standard's hands. Kerosene was the 4th largest U.S. export in value. By the end of the 1870s, not only was one country (America) dominant in oil production, but also one state (Pennsylvania) and one company (Standard Oil). However, the danger of emerging foreign competition was looming. This was mistakenly discounted by Standard Oil. With the credible Russian competition, to be discussed below, America's share of world oil fell from 78% in 1888 to 71% in 1891, while the Russian share rose from 22% to 29%.
Development of the Russian Oil Industry: The Nobels and Rothschilds
The vast Russian empire needed more of the new light as St. Petersburg, the capital, barely had six hours of daylight in the winter because of its geographic location. Meanwhile, the Russian oil industry was not competitive, as it was a state-run monopoly. The policies however changed in the 1870s, and a private competitive industry emerged, leading to explosive entrepreneurship and oil drilling. The drilling technique was based on American discoveries instead of hand-dug oil. The first wells were drilled in 1871-72 and, by the following year, many producers and refiners (more than 20) had sprung up; but many were still inefficient and technologically backward compared to the American Industry.
Things changed when Robert Nobel arrived in Baku looking for wood (walnut). He was the eldest son of Immanuel Nobel, a Swedish inventor who had immigrated to Russia in 1837. Robert's brother, Ludwig, who was in the armaments business, had secured a major contract to manufacture rifles and had given him money to search for Russian walnut to fulfill the contract. Robert was attracted to the oil development in the Baku area and, without consulting with his younger brother, Ludwig, invested the "walnut money" (25,000 rubles) in a small refinery. The Nobel brothers (Robert, Ludwig and Alfred) were well educated with science backgrounds and brought technology to Russian industries. Alfred, for example, was a great student of chemistry and finance, he had created an international dynamite industry. Ludwig, after Robert's investment of his money in oil, learned everything about the oil industry, and used science, innovation and business planning to enhance efficiency and profitability. By 1876, his first shipment of illuminating oil had arrived in St. Petersburg, and Ludwig had become "the Oil King of Baku." To overcome the high handling cost and transportation difficulties, Ludwig conceived the idea of shipping the oil in bulk tankers (instead of shipped wooden barrels). This launched a major revolution in oil transport. The first successful bulk tanker, Zoroaster, was put in service on the Caspian in 1878. With these advances, Russian crude production which was less than 600,000 barrels in 1874 reached 10.8 million (about a third of American production) 10 years later. In the early 1880s, there were about 200 refineries around Baku.
Although the Nobel brothers dominated distribution of oil in Russia, the geographic location of Russia locked the oil within the empire and made it hardly a factor outside the Russian borders. Even within the Russian empire were major challenges, including distance, terrain, weather, transportation, and effects if poverty. The growing Russian production forced Ludwig and producers at Baku to look beyond Russian borders for markets. The Russian markets were simply too small for Ludwig's plans. With financing from the Rothschilds, a famous and affluent Jewish family, a railway from Baku over the Caucasus to Batum (on the Black Sea) was built. This turned the Batum oil port into an overnight success in the world. The Rothschilds acquired, in exchange, a package of mortgages on Russian oil facilities.
The completion of the Baku-Batum railway opened Russian oil to the west, and the Rothschilds formed the Caspian and Black Sea Petroleum Company, Bnito, in 1886. The arrival of the Rothschilds in the oil industry scene meant the Nobels now faced a major competitor. The Caspian and Black Sea Petroleum Company soon became the second largest oil group in Russian. There were talks about amalgamation, but nothing happened. Instead the Nobels and Rothschilds made aggressive sale campaigns in the European market that forced Standard Oil to take notice and wage an assault on them both through price cutting, spreading of false rumors on the quality and safety of Russian oil, including outright sabotage and bribery. However, the Nobels and Rothschilds fiercely and successfully fought back. When there was a bottleneck in transportation using the Baku-Batum railway, Alfred Nobel's dynamite helped build a 42-mile pipeline through the mountains in 1889. The railway only allowed six cars to be hauled over at any one time. The pipeline fixed this transportation chokepoint.
Unfortunately, at a young age of 57, Ludwig Nobel ("The Oil King of Baku") died from a heart attack on a vacation on the French Riviera. People often confused the Nobel brothers, and some newspapers mistakenly reported the death of Alfred. After reading his own premature obituaries that described him as "munitions maker", "the dynamite king", "a merchant of death who had made a huge fortune by finding new ways to maim and kill," Alfred revised his will, leaving his money to establish the Nobel prizes that were to forever associate his name in a way that would honor the best in human endeavors.
Opening up Markets to East Asia for Russian Oil: Marcus Samuel's Coup
The Nobels had a firm grip on the internal Russian market. The Rothschilds needed to find a way around Standard Oil to dispose their oil into the world market, especially to the East in Asia. The problem was how to get the oil to Asia, and they needed someone to help them open up markets. Fred Lane, a shipping broker, connected the Rothschilds to Marcus Samuels which resulted in a contract and an audacious scheme, a coup, which, if successful, would loosen the grip of Standard Oil on world kerosene trade.
Marcus Samuels' father was a "shell merchant" who, in addition to seashells, imported everything from ostrich feathers and partridge canes to bags of pepper and slabs of tin. Marcus was a Jew from the East End of London who was born in 1853 and went to work at the age of 16 with his father. He and his brother, Samuel, continued the business after the death of their father and were instrumental in facilitating the industrialization of Japan.
In 1891, Marcus secured a contract with the Rothschilds with exclusive rights until 1900. Samuel conceived a plan to wage a campaign against Standard Oil in all markets simultaneously by building technologically advanced bulk tankers to master transportation costs through the Suez Canal to the Far East (Asia). The savings on space and weight and the gains in volume were to result in significant cost reduction per gallon. To be successful, it required meticulous care, speed, and secrecy. The tankers needed innovations to incorporate safety features and the ability to be steam cleaned to enable them to return with food and goods from the Orient. In addition, for the coup to succeed, Marcus also needed guaranteed supplies of kerosene from Batum, access to the Suez Canal, large storage tanks at the major Asian ports, and established inland depots to distribute the oil to local consumers. The Suez Canal which opened in 1869, shaved off 4000 miles of the journey around Africa to the Far East.
Marcus overcame all the above obstacles and challenges, and on July 22, 1892, the first tanker, the Murex, sailed from Britain to Batum to be filled with Bnito kerosene. It subsequently passed through the Suez Canal on August 23 for the Far East where it discharged part of the cargo at Freshwater Island in Singapore and continued on to Bangkok. The Coup was brilliantly executed, except for one small oversight that almost ruined the plan. Marcus assumed that once the oil got to the Far East, the locals would come with their own blue Standard Oil cans to carry the oil home. The locals, however, had other plans for these cans and Marcus quickly had to ship tin plates to be used for customer cans. These cans were painted red to distinguish from the Standard Oil blue cans. Standard Oil was taken completely by surprise by "the Coup," and its representatives were shocked to suddenly find Samuel's shiny red kerosene cans everywhere. By the end of 1893, Marcus had launched 10 more tankers, each named after a seashell in honor of his father. By the end of 1895, 69 tankers had passed through the Suez Canal. By 1902, 90% of all the oil to pass through the Suez Canal belonged to Samuel and his group.
The International Oil Wars of the 1890s: Competition, Courting, and Cartel Attempts
The international Oil Wars in the 1890s involved the four rivals: Standard Oil, the Rothschilds (with Marcus Samuel), the Nobels, and the other Russian producers. They were at one moment or the next battling fierce markets, cutting prices, and trying to undercut each other; or courting one another and trying to apportion world markets among themselves; or exploring mergers and acquisitions; or doing all three at the same time. In 1892 and 1893, Standard, the Nobels and the Rothschilds almost brought oil production under one system but failed when Standard, even with its 85-90% control of American oil, failed to bring the American independents into the arrangement.
Standard, suspecting that Samuel was the weaker link in his relationship with the Rothschilds, made an attractive offer to pull Samuel away into Standard, but the offer was rejected out of his need to continue to be independent and patriotic to Britain. Standard then signed on March 14, 1895 a grand alliance with the Rothschilds and the Nobels "on behalf of the petroleum industry of the U.S." and "on behalf of the petroleum industry of Russia." The agreement gave 75 % of the world export sales to the Americans and 25% to the Russians. The agreement never came into effect due to the opposition of the Russian Government. Standard realized now that the only way to turn things around was for it to acquire access to crude much closer to the Asian market or in Asia itself. It subsequently turned its attention to Sumatra in the Dutch East Indies where Royal Dutch was carving out a name for itself in oil.
Dutch East Indies (Sumatra) Oil: Royal Dutch and the Acquisition Attempts
Seepages had been sighted in the Dutch East Indies for hundreds of years and used for medicinal purposes, and in 1880, Jans Zijlker observed on a coastal strip of Sumatra the use of oil by the locals and recognized the kerosene smell and sent a sample off to Batavia for analysis. The result was 59-62% kerosene. He won concessions from the local Sultan of Langkat and got the Dutch government to sponsor the development of oil in the area. The first successful well was drilled in 1885, and the Royal Dutch company was launched in 1890. Unfortunately, Zijlker died suddenly in the autumn of 1890, and the leadership passed on to Jean Baptiste Kessler, born in 1853. Although the working conditions in the Far East were awful, in 1892 a 6-mile pipeline was completed to link the wells in the jungle to the refineries on the Balaban River. By April 1892, while Marcus Samuels was preparing to send his first cargo via the Suez Canal, Kessler had already delivered the first cases of Royal Dutch kerosene, Crown Oil. In addition, Royal Dutch had begun using tankers and building its own storage tanks near its markets.
Between 1895 and 1897, Royal Dutch's production increased fivefold, and it could no longer remain invisible to its competitors. Standard Oil sent two representatives to Asia to assess the threat posed by Royal Dutch in the East Indies. Based on the assessment, the representatives recommended assimilation with successful companies, especially Royal Dutch, as they had been very impressed with everything from Kessler's leadership to Royal Dutch's marketing system. Interestingly, Samuel's group was also interested in Royal Dutch, and in 1896-1897 intense negotiations took place between the two groups (Samuel and Kessler). Their objectives were, however, different as Royal Dutch was looking for a joint marketing arrangement in Asia, while the Samuels wanted to buy Royal Dutch (RD) outright. Thus, nothing came out of the intense negotiations except that Marcus and Kessler remained friends. Standard having tried without success to acquire Ludwig Nobel's and Marcus Samuel's companies presented a very attractive formal proposal to Kessler and Royal Dutch but, upon the strong recommendation of Kessler, Royal Dutch's board rejected the offer. To guard against the possibility of Standard finding other ways to acquire RD, its board of directors created a special class preference stock, the holders of which controlled the board. To make acquisition almost impossible, admission to this exclusive rank of holders of the "special class preference stocks" was by invitation only!
Yergin, Daniel. (2008). The Prize: The Epic Quest for Oil, Money, & Power. New York: Free Press.