Oil Drops to $71 as Economic Fears Spur Fund Selling

Oil dropped as much as $3 Thursday, as credit and economic fears pounded global financial markets and spurred investor selling.

U.S. light, sweet crude closed down $2.33 at $71.00 per barrel, after falling as low as $70.10 earlier, down from the Aug. 1 record high of $78.77.

London Brent crude settled $2.22 lower at $69.42 per barrel.

Oil fell as Tropical Depression Erin crossed Texas without damaging the oil industry there and as the U.S. National Hurricane Center forecast Hurricane Dean would plow into Mexico's Yucatan peninsula in about five days.

Investors scrambled for safety in government bonds as stock markets around the world again fell sharply on fears that a tightening of credit in the U.S. subprime housing sector will spread throughout the economy.

Analysts said investors who have seen big returns from oil as part of a four-year bull run that tripled prices were selling off positions, potentially as hedge funds raise money to cover positions in other parts of their portfolios.

"These hedge funds are players in all arenas, and we know how long they are in the liquids complex, so I would think part of this sell-off is derivative of margin calls in other parts of their portfolios," said Stephen Schork, president of The Schork Report.

Other experts said the sell off could be a sign of investors looking for safer havens.

"Oil getting hit hard does not necessarily suggest it's being targeted as a source of cash, but rather more of a risk reduction as well as commodities are not the place to be for a downturn," said Caprock Risk Management analyst Chris Jarvis.

The yen had its biggest one-day gain versus the dollar in almost nine years Thursday as investors unwound risky trades financed with borrowed yen.

Harry Tchilinguirian, oil market analyst at BNP Paribas Commodity Derivatives, said the credit squeeze that started in the U.S. subprime loan market threatened to have a knock-on effect on the wider economy and ultimately on oil demand.

"A slower U.S. economy has ripple effects. If the advanced economies of the United States, the euro zone and Japan slow down, that could have a moderating impact on the countries furnishing these goods, on China and India," he said.

Prices of metals, grains and other commodities were also caught up in a global rush out of risky investments. The Reuters/Jefferies CRB Index, a basket of 19 commodity futures, fell 3.8 percent at midday to a seven-month low.


Oil markets are also keeping an eye on Hurricane Dean, which forecasters said could strengthen into a Category 4 hurricane over the next few days. Traders are watching weather models to see if Dean will enter the Gulf of Mexico, where fields account for roughly a third of U.S. oil production.

Tropical Depression Erin, meanwhile, produced heavy rains over portions of Texas as it weakened after moving inland over the south Texas coast this morning.

Thirteen oil and natural gas production platforms and five drilling rigs were evacuated due to Tropical Storm Erin, the U.S. Minerals Management Service said Thursday.

About 2,563 barrels per day of oil output and 10.5 million cubic feet per day of natural gas output was shut in.