Too Much Oil: Revisiting the 1930s Texas/Oklahoma Bonanza (throwback Tuesday)

“The supply of oil from [East Texas] was so great that at one time crude oil sank to 10 or 15 cents a barrel, and gasoline was sold in the East Texas field for 2 1/8¢ a gallon. Enforcement by Texas of its proration law was extremely difficult.”

Okay, this is Throughback Tuesday, not Thursday. But some energy history is good from time-to-time on any day of the week. And here in the summer of 2021, with oil prices swinging a bit on a lot of different news, it might surprise the reader that the traditional problem here in the U.S. has been too much oil, not not enough.

Here is the story in the 1920s/1930s as recalled in an antitrust suit under the Sherman Act, United States v. Socony-Vacuum Oil Co. et al. 310 U.S. 150 (1939) at 163.

The record shows that … the distress of the oil industry was so acute as to call for remedial concerted action. It also shows that this condition was recognized not only by the industry, but by the state and federal governments.

There was no dispute as to these facts. The situation was caused primarily by two abnormal and destructive competitive practices, resulting in surplus crude oil and surplus gasoline as a distress product.

Faced with these conditions the respondents engaged in a voluntary cooperative effort to remove one of these competitive evils–distress gasoline….

The mere removal of distress gasoline from the competitive market would obviously result in a more normal price, not because of the absence of competition, but by reason of it. The undisputed testimony is that this was all the respondents hoped to accomplish, and the record shows that in fact this was all that resulted….

The Great Reversal (too little … too much)

Beginning about 1926 there commenced a period of production of crude oil in such quantities as seriously to affect crude oil and gasoline markets throughout the United States. Overproduction was wasteful, reduced the productive capacity of the oil fields and drove the price of oil down to levels below the cost of production from pumping and stripper wells.

When the price falls below such cost, those wells must be abandoned. Once abandoned, subsurface changes make it difficult or impossible to bring those wells back into production. Since such wells constitute about 40% of the country’s known oil reserves, conservation requires that the price of crude oil be maintained at a level which will permit such wells to be operated.

As Oklahoma and Kansas were attempting to remedy the situation through their proration laws, the largest oil field in history was discovered in East Texas. That was in 1930. The supply of oil from this field was so great that at one time crude oil sank to 10 or 15 cents a barrel, and gasoline was sold in the East Texas field for 2 1/8¢ a gallon. Enforcement by Texas of its proration law was extremely difficult.

Orders restricting production were violated, the oil unlawfully produced being known as “hot oil” and the gasoline manufactured therefrom, “hot gasoline.”

Hot oil sold for substantially lower prices than those posted for legal oil. Hot gasoline therefore cost less and at times could be sold for less than it cost to manufacture legal gasoline. The latter, deprived of its normal outlets, had to be sold at distress prices. The condition of many independent refiners using legal crude oil was precarious. In spite of their unprofitable operations they could not afford to shut down, for if they did so they would be apt to lose their oil connections in the field and their regular customers.

Having little storage capacity they had to sell their gasoline as fast as they made it. As a result their gasoline became “distress” gasoline–gasoline which the refiner could not store, for which he had no regular sales outlets and which therefore he had to sell for whatever price it would bring. Such sales drove the market down.

In the spring of 1933 conditions were acute. The wholesale market was below the cost of manufacture. As the market became flooded with cheap gasoline, gasoline was dumped at whatever price it would bring.

On June 1, 1933, the price of crude oil was 25¢ a barrel; the tank car price of regular gasoline was 2 2/8¢ a gallon. In June 1933 Congress passed the National Industrial Recovery Act (48 Stat. 195) . Sec. 9(c) of that Act authorized the President to forbid the interstate and foreign shipment of petroleum and its products produced or withdrawn from storage in violation of state laws. By Executive Order the President on July 11, 1933, forbade such shipments.

On August 19, 1933, a code of fair competition for the petroleum industry was approved. The Secretary of the Interior was designated as Administrator of that Code. He established a Petroleum Administrative Board to “advise with and make recommendations” to him. A Planning and Coordination Committee was appointed, of which respondent Charles E. Arnott, a vice·-president of Socony-Vacuum, was a member, to aid in the
administration of the Code.

Addressing that Committee in the fall of 1933 the Administrator said: “Our task is to stabilize the oil industry upon a profitable
basis.” Considerable progress was made. The price of crude oil was a dollar a barrel near the end of September 1933, as a result of the voluntary action of the industry, but, according to respondents, in accordance with the Administrator’s policy and desire.

In April 1934 an amendment to the Code was adopted under which an attempt was made to balance the supply of gasoline with the demand by allocating the amount of crude oil which each refiner could process with the view of creating a firmer condition in the market and thus increasing the price of gasoline.

This amendment also authorized the Planning and Coordination Committee, with the approval of the President; to make suitable arrangements for the purchase of gasoline from non-integrated or
semi-integrated refiners and the resale of the same through orderly channels. Thereafter four buying programs were approved by the Administrator. These permitted the major companies to purchase distress gasoline from the independent refiners. Standard forms of contract were provided. The evil aimed at was, in part at least, the production of hot oil and hot gasoline.

… these buying programs were not successful as “the production of gasoline from ‘hot oil’ continued, stocks of gasoline mounted, wholesale prices for gasoline remained below parity with crude-oil prices, and in the early fall of 1934 the industry approached a serious collapse of the wholesale market. Restoration of the price of gasoline to parity with crude oil at one dollar per barrel was not realized.

The flow of hot oil out of East Texas continued. Refiners in the field could procure such oil for 35¢ or less a barrel and manufacture gasoline from it for 2 or 2 1/2¢ a gallon. This competition of the cheap hot gasoline drove the price of legal gasoline down below the cost of production. The problem of distress gasoline also persisted.

The disparity between the price of gasoline and the cost of crude oil which had been at $1 per barrel since September 1933 caused losses to many independent refiners, no matter how efficient they were.

In October 1934 the Administrator set up a Federal Tender Board and issued an order making it illegal to ship crude oil or gasoline out of East Texas in interstate or foreign commerce unless it were accompanied by a tender issued by that Board certifying that it had been legally produced or manufactured.

Prices rose sharply. But the improvement was only temporary as the enforcement of §9(c) of the Act was enjoined in a number of suits. On January 7, 1935, this Court held § 9 (c) to be unconstitutional. Panama Refining Co. v. Ryan, 293 U. S. 388. Following that decision there was a renewed influx of hot gasoline into the Mid-Western area and the tank car market fell.

Meanwhile the retail markets had been swept by a series of price wars. These price wars affected all markets—service station, tank wagon, and tank car. Early in 1934 the Petroleum Administrative Board tried to deal with them—by negotiating agreements between marketing companies and persuading individual companies to raise the price level for a period.

The story of state and federal governments trying to achieve “dollar oil” would continue until World War II price controls reversed the situation from surplus to shortage. That story awaits another “throwback” day.