Union Oil Fever

"When you catch oil fever, it never leaves you."

by Byron W. King
Whiskey & Gunpowder
Posted July 11, 2005

"BEIJING (Agence France Presse) -- State-run energy firm China National Offshore Oil Corp. announced a bid on June 23 to buy U.S. oil major Unocal for US$18.5 billion cash, trumping a rival offer by Chevron Corp."

HIS FATHER operated a tannery in northwestern Pennsylvania. The teenage son's job was to collect the hides from local farmers. On the best of days, under the best of circumstances, the job stunk. On those hot, muggy summer days when the freshly skinned hides were particularly ripe, the job was all but unbearable to the young Lyman Stewart (1840-1913).

While driving his wagon across the simple farm roads of the sparsely populated region south of Lake Erie in the late 1850s, young Stewart occupied his mind with other things. He tried not to think of the smell of the hides, and focused his concentration by keeping an eye out for the mysterious seeps from whence flowed the dark "rock oil" for which the region was known.

The sticky, brown goo that came from the seeps and coated the surface of the streams was used at that time in patent medicines. The smooth-talking, itinerant peddlers claimed that a proper dose of their magic extract could cure almost anything, if not everything, that ailed you. Sometimes, a swig of "Seneca Oil" (named after the ancient Indian tribes of the area) actually worked as a cure. Usually, it just made you sick as a dog. When you recovered from the gut-splitting effects of ingesting the oil, you could barely recall what your former problem was.

In September 1859, word spread through the region that the "Crazy Colonel," a former railroad conductor named Edwin L. Drake, had found commercial quantities of oil in a shallow well near Titusville, Pa. Drake had utilized, for the first time, a novel drilling technique that kept the walls of the hole open. He had made a well, and it was producing oil that sold for $10 per barrel, a week's wages for a skilled working man back in those days. Looking for a way out of the business of hauling smelly hides to the tannery, Lyman Stewart came up with the idea of getting into the oil trade.

On Dec. 5, 1859, Stewart became one of the first oil well investors to follow in the footsteps of Col. Drake and his backers. Stewart staked his life savings of $125 on an oil lease located on a farm not far from the Drake well on Oil Creek. Stewart told acquaintances that he had a "nose for oil" and that he could smell the substance in the rocks below. Nose or not, after a period of pounding a hole into the Devonian sediments, the well produced not a drop of oil for the disappointed Stewart.

If the fortunate Drake had pioneered success in the oil fields, the unfortunate Stewart was in the vanguard of those who failed. Like so many others, then as now, Stewart had lost his shirt down a dry hole. Stewart was broken and financially ruined, and lacking other options, he went back to hauling hides for his father.

Ironically, the same farm on which Stewart's well let him down would, six years later, be the site of another well, drilled by another man, that produced at an initial rate of more than 300 barrels per day. Then as now, the site of one man's loss would turn into the location of another man's gain. In retrospect, Stewart's "nose for oil" may not have failed him, but more likely, his equipment was to blame. So there is a lesson to be learned here about using good equipment, but this gets away from our subject.

After two years of hauling hides and saving his funds, Stewart again had accumulated enough new capital to make a second attempt to drive a well into the Earth. In 1861, he and a handful of investors leased land on another farm, and this time fortune smiled upon his efforts. And perhaps, also, Stewart's "nose for oil" was working. The well proved to be a producer.

Unfortunately for Stewart and his partners, many other people also had funds to invest in the drilling of oil wells near, of all places, Oil Creek. In 1861, the oil age had not yet arrived. The market for oil was in its infancy and was based upon to a small number of specific applications for lubrication and illumination. Refining was still an art, and at most a relatively small cottage industry. Demand for oil was limited.

Because the markets for oil were flooded, prices were in the midst of a swoon, eventually falling to as little as 10 cents per barrel of oil (about $2 in today's prices). As the bills came due, Stewart and his partners could not make the payments necessary to hold their lease and maintain the well. Thus, Stewart eventually lost the lease on his second well.

Still, from Stewart's perspective, the smell of oil beat the smell of ripe hides, and the taste of money was not bad, either. Lyman Stewart had caught "oil fever." And as those in the know can tell you, when you catch oil fever, it never leaves you.

There are some things, however, that are beyond the control of any one person. Feverish or not from the smell of oil and the taste of money, Stewart was swept up by the tide of history. He could not avoid the call to arms of President Abraham Lincoln. Stewart spent a three-year tour of duty as a private in the 16th Pennsylvania Cavalry.

In this regard, by serving in the Union Army during the Civil War, Stewart was unlike another oilman of about the same age. This other fellow was an up-and-coming executive with the Pennsylvania Railroad and an investor in the Titusville oil patch named Andrew Carnegie, who paid for a replacement to take his place in the ranks.

After the end of the Civil War, in 1865, Stewart returned to Titusville. It was as if he had landed in a different world. During his three-year absence, vast changes had taken place in the Pennsylvania oil fields, particularly in and around Titusville.

The Civil War expenditures of the federal government had flooded the nation with greenback paper currency. Inflation had reduced the value of the U.S. dollar. Speculation was rife in financial instruments, as well as in real estate. But a not-insignificant amount of the nation's excess money supply had found its way into tangible investment in the oil patch. The oil business had been transformed. There was a boom going on.

The formerly sleepy little town of Titusville had gone from having one hotel to having more than 20. The streets were lined with saloons and barrel-making shops, land and title exchanges, harness makers and blacksmith forges, variety stores and whorehouses. And the countryside was carpeted with oil derricks, spaced so close in some places that a nimble man could walk for a mile from drill deck to drill deck and never set foot on the soil of the Earth.

The technology of oil drilling had changed also, particularly in that people had begun to understand what they were doing. The occupations of driller and tool pusher, roustabout and roughneck, were bringing a level of professionalism to the day-to-day conduct of the business.

By the mid-1860s, drilling rigs -- with their complicated array of walking beams, steam engines and cable-tool apparatus -- had become far more reliable, and even portable, after a fashion. Metallurgical science, spurred on by the demand during the Civil War for improved cannons, was providing far more reliable drill-pipe and conductor casing. And people were beginning to use explosive "torpedoes" down the holes, in order to fracture the rock and increase the surface area through which oil could drain into a well.

By 1865, the oil business was no place for amateurs. And it has never been otherwise.

Lyman Stewart was an honored veteran of his nation's noble war with itself, but he had no funds with which to commence another plunge into the business of drilling wells. Still, Stewart was as determined as ever to make his make his way in the oil fields, and one can imagine that whenever he felt the slightest hesitation, he must have thought about the prospect of returning to his former job of hauling freshly skinned hides to the tannery.

After a short stint in New York, Stewart returned to Pennsylvania, in 1866, and opened a small office near Titusville, where he helped other investors negotiate oil leases with the local farmers and landowners. Using his previously mentioned "nose for oil," he made sure to take an override interest, in lieu of a fee, on certain of the better leases.

When the first of his wells struck oil, Stewart finally began to see some income, if not significant money. By 1868, Stewart had made a name for himself. He was highly regarded by his peers and was considered to be an established operator.

As is the nature of the oil business, however, some deals can be good and many can be bad. Then as now, there was nothing easy or predestined about pounding a hole in the ground and finding oil. You do the best you can with what you know. You win some, you lose some. Sometimes you lose big, and sometimes you lose it all.

In 1869, the bad deals caught up with Stewart, who fell on hard times. Despite his efforts in brokering titles and leases, his expenses exceeded his income. Finally, he lost his home and almost lost his family. But deeply religious, he never lost his faith.

Stewart spent the 1870s working in and around the oil fields of northwest Pennsylvania. He held a series of jobs that paid regular wages. Having tasted both success and failure, he kept his humility and kept his head above water.

In 1877, a relative of a friend came to Titusville from distant California. The man's name was Wallace Hardison. Hardison recognized the Pennsylvania oil boom for what it was, having seen the mining boomtowns out West. Hardison proposed to Stewart that they form a partnership and secure some oil property. Stewart honestly explained his embarrassing financial situation and his past indebtedness and declined the proposal.

Hardison would not take no for an answer, and offered to back Stewart based on Stewart's reputation as having a vast knowledge of the regional oil fields. Sealing the deal with a handshake, Lyman Stewart and Wally Hardison went on to be friends and business partners for many years to come.

Hardison and Stewart made a lot of good money out of a series of successful wells near Bradford, Pa. Then, the pair took advantage of the trend in the industry to sell out to interests controlled by the Standard Oil Trust. At about that time, John D. Rockefeller was consolidating the Eastern oil industry into his holdings, and the two partners made a virtue of necessity. They took the cash.

With the proceeds of their sale in hand, in 1883, the two partners moved West. And like so many others, then as now, Stewart and Hardison sought greater opportunities in the Golden State of California.

Like Pennsylvania, Ohio, western New York, and other states back East, California in the late 1800s had its own small armies of prospectors following the seeps and creek beds in search of the elusive oil patch. No one could have envisioned how, in the next century, oil and its products would change the way Californians lived, let alone the highway culture that would crisscross the Golden State and define an era in human history.

Instead, the California oil seekers viewed the black liquid as a local source of raw material for the manufacture of lubricants and lamp oil. And anyone who could supply those products locally could undercut the prices charged by even the mighty Standard Oil Trust, which was shipping product across the continent from the refineries of Cleveland. There was money to be made out West, if you knew what you were doing.

It was a good thing that the two partners knew what they were doing, and especially that they understood how to drill for oil. It took seven dry holes before Hardison and Stewart brought in oil from a well that they drilled on their eighth attempt. Less bad luck than that has ruined many a venture, but these veterans of Titusville did not quit. By the time their eighth well hit oil, they were so deeply in debt that they had to sell their interest in the productive property to a third party. A few weeks after the sale, in a trick of fate as if to make up for their previous setbacks, the well went dry on its new owner.

After this episode, Stewart began to find his "nose for oil" in the California oil patch. His partnership acquired leases and began to drill wells that were productive and yielded significant quantities of oil. To his great credit, and following in the footsteps of Col. Drake, Stewart came up with an innovation that, in its time, revolutionized the oil industry.

It was standard practice, established back East, to use coal to heat the boilers that made steam to power the drilling rig engines. Depending upon the availability of coal, this proved to be expensive to an operator in California. Stewart came up with the idea of using crude oil to power the engines, thus making the drilling process a more-or-less self-contained system. This innovation was, in its own way, a means to apply more energy directly to the search for oil and its production, and served to increase drilling and production efficiencies.

Always an innovator, Stewart used his knowledge of Eastern production methods from his days around Titusville and Bradford to come up with a system for laying gathering pipeline from the oil wells to the storage tanks and refineries. Again, this was a great advancement in the California oil industry and raised efficiency.

In 1886, the two oilmen set up the Hardison & Stewart Oil Co. The company issued stock certificates with impressive and ornate printing on crisp rag paper with a complicated scrolled border around the edge and bearing the image of an oil well and a steamboat in the background. It was very pretty, if not impressive.

But unlike many companies of that time -- or of the present time, come to think of it -- these men actually had the skill and drive to turn the pretty corporate paper into a working business. In 1886, the Hardison & Stewart Oil Co. produced about 15% of all the petroleum lifted from the rocks of California. The men and their company were established players in the West Coast oil industry.

In 1890, Stewart and Hardison combined their oil assets with those of Thomas Bard, a prominent businessman, to form the Union Oil Co. of California, with offices located about 100 miles northwest of Los Angeles. True entrepreneurs, the three men worked to expand the uses for fuel oil in factories, steamships, and railroads. The company commonly assigned its own mechanics and technicians to convert power or heating systems to use oil instead of coal, in order to demonstrate fuel oil's superiority. And not coincidentally, this service also tended to earn the goodwill of future customers.

By 1900, California was among the leading oil-producing regions in the world, and both the capital stock and value of the Union Oil Co. had grown manifold. Over the past century, Union Oil Co. has had its ups and downs, from financial panics to the San Francisco earthquake, from oil booms and busts to the infamous Santa Barbara oil spill of 1969 that was the genesis of the modern American environmental movement.

Still, riding the economic waves, as well as the other waves of fate that control us all, from its base in Southern California, Union Oil expanded throughout the western United States to become a major independent oil company. Later, Union acquired acreage and drilled wells across the United States and in the Gulf of Mexico, and eventually, the company moved abroad, particularly into Asia.

The history of Union Oil -- and its successor, Unocal -- has been marked generally by able and honest management, business tenacity, and technological leadership. The company is an efficient finder and producer of oil and gas and is regarded within the industry as a leader in drilling technology.

Today, Unocal has expanded its business base within the field of Earth resources, and among other holdings owns a company called Molycorp. Molycorp is the leading Western resource for lanthanide (rare earth) products and conducts additional operations in extracting molybdenum and niobium.

Hence, when China's state-owned oil company China National Overseas Oil Corp. (CNOOC) announces that it is making a bid to take over Unocal, the successor to Union Oil, the implications are not those of a typical Wall Street takeover.

Unocal is, plain and simple, an American industrial icon. Through its founder, Lyman Stewart, the company's roots go back literally to the days of Col. Drake and Titusville in 1859.

At the same time, Unocal is, in its own way, a company of the future, both in worldwide energy production and through its subsidiary Molycorp. With respect to the latter, Unocal's Molycorp has an irreplaceable interest in U.S. properties that produce critical strategic minerals and materials that are used in the production of electronic components. There are no substitutes for what Molycorp produces. None whatsoever.

If an entity like CNOOC, a distinct arm of the Chinese government, takes title to a firm such as Unocal, the United States stands to lose its connection not just to the assets of Unocal but to a national industrial legacy that goes back over 145 years. No nation can replace that kind of industrial legacy by just going out and buying another. It is not too strong to say that there are no other industrial legacies like Unocal for sale at any price.

CNOOC's business plan is to use U.S. dollars, lent at preferential rates by the Chinese government, to finance its takeover of Unocal. When a foreign government has billions of U.S. dollars to lend in such a manner, it is a clear sign that the United States has lost control of its monetary destiny. To the extent that the dollars serve to purchase title to an irreplaceable American icon, it is also a clear sign that the United States is losing control of its industrial destiny in general and its energy and strategic mineral destiny in particular.

CNOOC is a publicly listed firm whose shares sell on the New York Stock Exchange. CNOOC is subject to all of the legal requirements of other publicly listed firms. But CNOOC is also acting on behalf of the strategic mandate of its 70% majority owner, the government of the People's Republic of China.

Neither China nor CNOOC are in this acquisition game for Unocal just for capitalist sport. On behalf of the government of China, CNOOC is acquiring energy reserves.

Contrary to the expectations of many pundits and policymakers in the United States, China is not "going Japanese" and using its surplus dollars to buy up expensive artwork or signature properties like Rockefeller Center or Pebble Beach Golf Course. It was one thing when the Japanese bought the fancy golf course or the architecturally significant landmark office building in New York. Those assets are still here in the United States and, at the end of the day, are still available for U.S. citizens to use.

But in this Unocal case, Chinese interests are attempting to buy a U.S. industrial legacy with oil and minerals in the ground in North America and overseas. There is a qualitative difference here, with long-term implications for U.S. national strategic interests.

China is doing this because it has its own form of oil fever. In this case, I call it "Union Oil Fever." If CNOOC gains title to the Asian oil and gas interests of Unocal, among other things, China could remove very much energy production from world markets and send it home to the motherland to feed its growing internal demand.

CNOOC, however, is well counseled in this matter. CNOOC is putting the best possible face on its effort to acquire Unocal. CNOOC is offering to cooperate with the U.S. government in conducting a review of the national security implications of its potential acquisition of Unocal. CNOOC is offering to divest Unocal's nonenergy business segments, probably meaning that it will sell Molycorp. CNOOC is promising not to divert Unocal's current oil and gas production from existing customers or markets and divert the product to China. This is all very reassuring.

Furthermore, CNOOC is promising to minimize layoffs at Unocal if it acquires the company. Obviously, the people at CNOOC have read the newspapers on this subject and know where the sensitive nerves are.

Under the current plan, which is for Chevron to take over Unocal, the transaction will mean large numbers of layoffs from the acquired firm, in that typical modus operandi of modern American corporate governance. Chevron certainly has a history of laying off people from the oil companies that it has acquired in past decades, starting with Gulf Oil Co. in 1983. Or you can ask some of the former hands at Tenneco or Texaco.

Iconic or not, the corporate culture of Unocal would probably vanish not long after a Chevron takeover, as thousands of former employees make their way to the local unemployment compensation offices. But the Chinese tend to revere history and pay homage to honorable legacy. If CNOOC is successful in its effort, it actually might do more to preserve the corporate culture of Unocal, if not its iconic role in American industry, than Chevron ever would. It's funny how these things work, isn't it?

The fate of one company is not the fate of a nation. But a single event can highlight a trend. The competition over who will acquire Unocal is a wake-up call to the United States, if not to the West in general, that international relations on this planet are going to be different on the back side of Hubbert's Peak.

Clearly and obviously, China sees its future energy supply in terms of its own national strategic interests. China has U.S. dollars in the bank available to spend, courtesy of its massive trade surplus with the States. And the Chinese can read the charts. They can spend those dollars now while they are worth something (say, $60 for a barrel of oil), versus waiting for inflation to depreciate the value.

Make no mistake in understanding what is going on: The Unocal takeover effort is a test by the Chinese government of U.S. national will. The Chinese have an energy-based national strategy, and they are acting upon it. You can disregard this at your peril.

I hold no animus against China or CNOOC or China's people or its leaders. In fact, I have to admire them all for their level of logical thinking, their sense of grand strategy, and their straightforward approach to international competition. There is nothing inscrutable about what is going on here. If you understand what you are observing, there is no subtlety about this event. None at all.

For those who still might not get it, I think that the Chinese may as well be taking out an a full-page ad in The Washington Post stating, "We are going to buy up the oil and gas of you Westerners. And to accomplish this task, we are going to use all of those dollars you have been sending us for the past 10 years. And just what are you going to do about it?"

Yes, just what are we going to do about it? My hope is that the Unocal takeover competition will be as much of a wake-up call to America over its fundamental economic and monetary issues as the Union Oil well blowout in Santa Barbara in 1969 was, which galvanized the current environmental movement. If not, the United States has only itself to blame.

Until we meet again...

Byron W. King

Whiskey & Gunpowder is a free, twice-per-week, e-mail service brought to you by a team of rebellious brigands.

Click here to see more, or click here to subscribe.