From Guest Blogger Iannick Gagnon — Oil: The First Shock (1859-1865)

This article is submitted with the hope that it will set the tone for a series of others that will follow by covering the origins of the petroleum industry in the United States. The main objective of these pieces is to provide the reader with a historical understanding of shocks in oil prices. Later on, other writings will cover more recent material on the subject and a final piece will offer the reader some predictions of what the future of oil prices might look like in the short, medium and long term.

The task at hand is ambitious, but its value is considerable. Everyone feels a pinch when the prices at the pump crawl higher and higher with no end in sight. History has repeatedly proven to be the best thing we have to go on and that’s exactly what we’re going to do. As a result, we will establish a solid foundation from which we will make an educated guess about the future of the oil industry and what it means for civilization.

We will not cover the geological origins of petroleum here and we’re not going to enter the environmental debate. The scope of this paper is centered on the origins of the commerce of oil in the U.S and only that.

The search for the beginnings of the petroleum industry in the United States takes us back to the middle of the 19^th century in Titusville, Pennsylvania where Edwin L. Drake drilled the first commercial oil well. In 1859, after months of hard labor, Drake found an exploitable reservoir of oil at 69½ feet below the ground. His operation produced twenty-five barrels¹ of oil per day at a selling price of $0.50 a gallon as was reported in Derrick’s Hand-Book of Petroleum published in 1900 ($20.00/barrel). In today’s dollars, oil was selling for roughly $500 a barrel at that time and there were no shortages of buyers. The trade of oil was obviously very lucrative and soon after Drake’s success, the area was swarming with people from all over the country with the desire to make fortunes. The boom motivated a massive drilling effort that eventually oversupplied the market and led to a collapse in prices going as low as a dime a barrel. The oil business had lost its appeal and many prospective millionaires abandoned it by closing their taps.

It is worth noting that during its early stages, the petroleum industry was particularly exposed to cut-offs in supply much like the markets were in the 1970s and even more so today. The period between 1859 and 1862 serves as a powerful example of the upward pressure of high prices on supply. It is clear that stocks followed prices more than they followed demand back in the early 1860s and that, to say the least, is a subtle concept.

The impressive decline that brought oil at record lows was followed by a sharp reversal as the Civil War intensified and kerosene lamps became more abundant. A noticeable decline in yields from existing wells combined with the abandonment of supply sites considered unprofitable and high demand gave way to the first spike in oil prices.

Another important factor of the high demand of petroleum came in the form of taxes. Alternatives to oil as an illuminant such as alcohol were heavily taxed in comparison, giving petrol a strong competitive advantage. Other substitutes such as turpentine oil simply became too expensive because of unusually high demand caused by the war. From late 1861 until the end of the Civil War during the summer of 1865, the prices of oil had increased fourfold, but due to the confluence of several factors such as the lack of economical alternatives, buyers were ready to pay the price, whatever it may be.

We have intentionally left out the specific numbers and overcomplicated charts because we believe they would contribute very little to our effort. The main drivers of the 1862-1865 oil shock are the increase in demand in commodities caused by the war effort, the lack of commitment from the suppliers as a consequence to the downfall of prices motivated by the flood of the markets and the taxes that favored oil to its already established substitutes. One could expect that the industry would learn from this first boom-bust cycle and adjust itself accordingly, but as we will see, these cycles will permeate the trade of oil much like the cycles of other commodities and the economy as a whole.

1. Ida M. Tarbell, ” The History of The Standard Oil Company”, (McClure, Phillips and Co. 1904), p.10