Let us briefly wrap our heads around the main points of our last article Oil: The First Shock. When the first oil well was drilled, its produce could be sold for something around $20 a barrel, which corresponds to roughly $500 in today’s money. Shortly after, thousands of new rigs were built and the markets were saturated with oil, i.e., supply outpaced demand, driving the prices all the way down to $0.10/bbl. The drilling business be­came unprofitable and people closed their taps. The demand for oil increased significantly during the Civil War (1862-1865), and due to low supplies, prices reached $80/bbl or around $1900 in inflation-adjusted terms. After the war, demand slumped and prices eventually fell to its previous low levels.

There are two things that, in our opinion, are very important to discuss about the period between 1859 and 1865 because they will help you understand similar events that will be discussed in the future. The first point we want to make is about the oil industry in general. It requires capital, lots of it. The flow of cash has to allow the industry to fund new projects, maintain existing infrastructures, attract qualified workers and train current employees just to name a few. If there is money missing in any of these segments, there are severe consequences for the others and, more often than not, this translates into diminishing outputs and higher prices. The second point is a generalization from the effects of the U.S. Civil War on the demand for commodities. In almost every case, war pushes the demand for things such as fuel (alcohol, turpentine, oil, etc.), steel and medicine to extreme levels along with their prices. When the conflict is over, demand crashes and stocks are accumulated. This drives the prices down sometimes lower than they were before.

It’s nice to know when the first commercial oil well was drilled in the US and all, but why did we even seek to exploit it on a large scale in the first place? Where did the interest come from? To answer such questions, we must first find out about the discovery of petroleum itself. It turns out that by the middle of the 19^th century, oil was old news; the Egyptians and the Greeks had already been using it for thousands of years as an illuminant. The Seneca Indians reportedly used it to treat a wide range of illnesses. The tribe gathered oil by skimming the surfaces of ponds where it settled and stored it for various purposes. Peddlers sought to make profits out of the alleged therapeutic properties of petrol by selling it under the name “Seneca Oil” and had very little success. At some point, oil was simply thrown away as an unwanted byproduct of the gathering of some other more valuable commodities such as salt.

Another important (read: crucial) aspect of the oil industry that wasn’t mentioned in the first article is refining. One of the first merchants of petroleum products by the name of Samuel M. Kier capitalized on the fact that oil was a very convenient, cheap and seemingly inexhaustible illuminant. Kier went on to establish the first American oil refinery in Pittsburgh, Pennsylvania in 1853 alongside an oil lamp business. Kier’s lamps used kerosene, which requires extensive refining. The price at the pump or “at the lamp” reflects a lot of different forces one of which is the cost of refining and that’s why it is important for us to acknowledge it’s historical origins.

_____Back when petroleum was refined for kerosene, a byproduct of distillation called NAPHTA was
_____thrown away because it was considered to be worthless. Today, NAPHTA is known as gasoline.

In short, at first, we sought to obtain oil in larger quantities because it was a valuable illuminant. We’re not arguing that oil had already been used for other purposes (medicine, construction, warfare, etc.) in the past, but since “Colonel” Drake’s first barrel of oil was sent to Kier’s refinery after his venture in the health business, we’re making a case that using the black greasy substance as a remedy wasn’t the main driver. We also made a point of the appearance of the petroleum refining industry in the United States and it’s influence on prices.

Full-size picture available here.