FDR’s New Deal with Energy: Part II (oil refining)

By Robert Bradley Jr. -- January 9, 2019

“No matter how ela­borate may be the statistical technique employed, no matter how conscientious and fair-minded may be those who apply it, no mat­ter how zealous may be the endeavor to conceal its naked arbi­trariness by such descriptive terms as `scientific,’ `legiti­mate,’ or `equi­table,’ there is no escape from arbitrariness in [federal] quota fixing [for oil refiners].”

– Myron Watkins Oil: Stabilization or Conservation? New York: Harper and Brothers, 1937, p. 97.

Part I yesterday on the real New Deal centered FDR’s edicts on US crude oil production. (The natural gas industry was in its infancy.) Part II today, taken from Chapter 19 of my Oil, Gas, and Government: The US Experience, looks at the petroleum refining industry. (Part III tomorrow examines oil retailing.)

The major takeaway is that the beloved New Deal of the Progressive Left, and currently in vogue re the Green Energy New Deal, was marked by rampant business/government cronyism at the expense of consumers and taxpayers. Federal edicts flew in the face of natural self-interest and market adjustment, creating enforcement quagmires for a police-state. The experiment, roughly based on World War I planning, was mercifully ended by a court decisions in 1935.

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With the discovery of several large southwest oil basins in 1927, major oil companies began a quest for price stability. This was not confined to the wellhead. In refining, as in petroleum marketing [Part III tomorrow], efforts to narrow competitive practices and maintain margins were undertaken. Early voluntary efforts within the American Petroleum Institute (API) needed greater formalization to have a chance of success, which came under FDR’s National Industrial Recovery Act. 

The Oil Code’s refinery control program would last only two years before the Supreme Court invalidated the NRA and pursuant codes of fair competition. Gasoline pools lingered until 1936 when a federal antitrust suit put an abrupt end to seven years of cooperative stabilization efforts in the industry. Elusive stabilization came with effective state wellhead proration, which after years of struggle was finally achieved with the end of the hot-oil war in 1936.

The API Code

On December 5, 1928, the General Committee of the American Petro­leum Institute approved a voluntary marketing code, which identified 19 classes of undesirable trade practices to be discouraged if not eliminated to tame competition from the refinery gate to the service station. 

The goal was higher prices and lower refinery costs. Many traditional refiner inducements to retailers, such as equipment leasing, start-up loans, station leasing, free construction, and free product delivery, were censured. Throughput and output quotas for refineries, however, were disregarded in the plan. From this beginning, refining/marketing stabilization would be a central industry issue until the about-face industry conditions brought on by World War II.

Before mandatory measures came about, influential members of the industry begged their brethren, particularly independents who comprised much of the alleged problem, to substitute group action for individual business decision-making. The sectoral committees of the API, representing the major companies, led the effort. W. R. Boyd, Jr., head of the Institute’s Division of Refining, made the urgency of the matter clear in a 1931 address:

We, in the petroleum industry, are absurdly demoralized.  Our business nerves are raw and frayed.  Our business vital­ity is low. We say irresponsible things; we commit fool­ish deeds. We cry aloud for “leadership” when already there is a surfeit of it. What we need most right now are followers . . . to adopt operations to the recommendations contained in the reports of the committees on economics of the Institute and of the Federal Oil Conservation Board.

Peer pressure, along with a sanction (exception) from antitrust law by the Federal Trade Commission, enabled this self-help measure. But the powerful, legal incentive was to profit-maximize by overproducing in the parts to break the artificial whole. Consequently, the voluntary moratorium on entrepreneurship would have limited effec­tiveness.

The NRA Code

With price demoralization continuing with petroleum, as for many other industries, pressures for mandatory coop­eration led to the June 16, 1933, enactment of the National Industry Recovery Act. In addition to pro­hibiting interstate transportation of illegal oil, the NRA gave the President broad authority to prescribe federal intervention to revive business and approve industry­-sponsored “codes of fair competition.” 

This was no idle mat­ter for refiners as for marketers.  For API refiners, a code with teeth promised the reform necessary to regain their pre-1927 prof­itability; for non­affili­ated field refineries living off flush pro­duction, en­forced “stability” was a threat to their survival.  As they did against state pro­ration edicts, small refiners would attempt to enjoin federal regula­tion in court.

On July 11, 1933, Section 9(c) of the NRA was invoked to stem the flow of hot-oil interstate; three days later, Regulation 6 was issued to require affidavits from refineries to ensure that gasoline was refined from legal crude output.  Both actions brought lawsuits from independent refiners who challenged the constitutionality of the broad depression relief measure.

There was much more regulation to come.  On September 2, 1933, the NRA Oil Code, replacing the largely symbolic API Code, became ef­fec­tive to closely regulate all phases of the oil business.  Article 4, Refining, unveiled a plan to divide the coun­try into eight refining dis­tricts for planning purposes and

achieve greater accuracy in balancing production and consumption, to prevent the injur­ious effect . . . of an unbalanced accumulation of gasoline in­ventories in any part of the country, and to facilitate equitable access of refiners to the allow­able supply of crude oil.

From “proper statis­tical study,” ratios between gasoline inventories and sales were to be “recommended” by district committees appointed by the Planning and Coordi­nation Committee (PCC), an industry organ appointed by the Petroleum Admin­i­strative Board (PAB). Claimed inequities by individual firms were subject to arbitration.

Storage of gasoline in amounts greater than needed to meet seasonal demand, as determined by the PCC, was declared an “unfair trade practice” and prohibited.  The Code allowed refiners to obtain additional crude if cur­rent supply was “inadequate” and if it was reported to the appropriate subcommittee, “which then may prohibit further withdrawals.” 

Numer­ous other restrictions were specified for refiners relating to mar­keting practi­ces, including maximum credit terms and a ban on equipment loans or sales, free deliveries, money loans, free repairs, free equipment, free construction, and subsidizing marketing within integrated companies.

Refiners had to “conspicuously post” prices and leave them unchanged for at least 24 hours. Differ­ent prices corresponding to “classes, types, methods, and quantities of deliveries” were covered.  Sales below cost plus reasonable ex­penses were prohibited. These requirements brought another suit against the NRA, in addition to the pending Panama suit, from a group of 9 refineries.

Before the specific refinery regulations were issued, several interim changes to the Code were made by Harold Ickes, appointed by President Roosevelt on August 29 as administrator of the code. The crude oil inventory drawdown ceiling (Article 1, Section 2) was relaxed for refiners with “low” gasoline inventories; oil now could be purchased or drawn from stocks for gasoline distillation if certified by the PCC.

Second and more important, an October 18 promulgation gave the PCC authority to “recommend to each and every refiner in the United States gasoline inventories, current runs and/or gasoline manufacture.” Behind the amendment were the 24 API refiners who recog­nized that inventory controls were not enough and price controls were too much.

NRA Refinery Control Program

On November 25, 1933, Ickes announced the refinery control program. Eight refining districts (adopted from the Bureau of Mines classifi­cation) were specified, and gasoline inventory/sale ratios were recom­mended for the November-December period.  The eight regions were: 

1: East Coast; 2: Appalachian; 3: Indiana, Illinois, Kentucky; 4: Oklahoma, Kansas, Missouri; 5(a): Inland Texas; 5(b): Texas Gulf Coast; 6(a): North Louisiana-Arkansas; 6(b): Louisiana Gulf Coast; 7: Rocky Mountain; and 8: California.

A March 31, 1934, inven­tory goal of 52.5 million barrels of gasoline was set for monthly recommenda­tions to work toward.  (April 1 was considered the beginning of gasoline season.) Consumer demand for gasoline was estimated from the number of active automobiles and average mileage. [1]

Inventory and output assignments for individual refineries within each district were the job of regional com­mittees working within the aggregate recommendation.  Volumetric re­finery regulation, for the first time and only time in the history of U.S. refining, joined wellhead pro­ration in the quest for stability.

A two-month honeymoon period greeted the refinery control program. Independent refiners and majors alike considered general objectives over internal profit-maximization. Gasoline output was near the recommended amounts, with run reductions between 8-25 percent in many areas of the U.S.

In the first months of 1934, problems with the program appeared. Large drawdowns on crude stocks were made with academic ex post reporting, particularly by small refiners, and crude was distilled into half-finished gasoline to maximize flexibility under the regula­tions.  “Hot-gasoline” was also refined in excess of recommendations from hot-oil.

With Article 4 thwarted by extralegal and illegal means, Ickes responded with the first major revisions to the program on February 5, 1934.  Section 3 was canceled, and the PCC was instructed to make public all inventory drawdowns to provide

closer supervision over such withdrawals . . . to prevent supplies . . . from upsetting the gen­eral program for balancing production with con­sumptive de­mand.

Along with a March recommendation that dropped all reference to crude and gasoline stocks to exclusively emphasize gaso­line output, this measure reduced opportunities to “game” the regula­tions.  “Hereafter,” concluded the Oil & Gas Journal,

there will be no excuse for jockeying stocks and production or juggling unfi­nished oil.  It will be a plain limita­tion on produc­tion.

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[1] The “self-justifying” estimation was censured by economist Myron Watkins (Oil: Stabilization or Conservation? (New York: Harper and Brothers, 1937, p. 97): “No matter how ela­borate may be the statistical technique employed, no matter how conscientious and fair-minded may be those who apply it, no mat­ter how zealous may be the endeavor to conceal its naked arbi­trariness by such descriptive terms as `scientific,’ `legiti­mate,’ or `equi­table,’ there is no escape from arbitrariness in quota fixing.”