Crude oil posted its sharpest fall since May on Monday as world stock markets plunged after an unprecedented downgrade of the US credit rating fueled fears of a double-dip recession in the world’s biggest economy.



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The benchmark US West Texas Intermediate crude for September delivery slipped below $80 in after-market trading, down more than $6.00 to its lowest level since November 2010, as the Dow Jones Industrial Average plummeted by 634 points in response to the US debt downgrade.

Analysts said oil markets, already jittery over growing signs of a renewed economic slowdown in the US and Europe, followed equities sharply lower after Standard & Poors’ downgrade action cast fresh doubts on US lawmakers’ ability to agree on economic policy after protracted negotiations on raising the national debt ceiling.

The debate over the debt ceiling prompted earlier volatility in energy markets that the extension of the debt ceiling has failed to placate.

“It’s generalized macroeconomic pessimism and risk aversion,” said Bob McNally, president of The Rapidan Group, a Washington DC energy-consulting firm. “The downgrade really impacted sentiment.”

Oil traders see a higher probability of recession following the recent downward revision of US gross domestic product data, and the public acrimony between lawmakers and President Obama over a deficit-reduction package, McNally said.

European Demand Hit

Oil markets were also unnerved by the prospect that Europe, too, may see a downturn in oil demand if Italy and Spain are forced to enact further austerity measures in response to a growing debt crisis.

“A lot of people are scared right now and they are dumping their positions,” said Phil Flynn, senior market analyst at PFG Best in Chicago. “They want to get out of everything.”

Although oil traders are concerned about the US economy, the market was driven primarily by European fears, Flynn said. “Europe is more disturbing from the demand aspect,” he said.

Prices could fall further in coming days if the WTI front month breaks below $80, a level that’s an important psychological support for the market, Flynn said.

Crude oil markets may also be facing increasing competition from bio-oil companies that are finding ways to produce oil from biomass. Read the story: Get Ready For The Biocrude Boom.

Flynn warned that further declines could prompt a third round of bond buying by the Federal Reserve in another attempt to stimulate the economy at a time when official short-term interest rates are already near zero.

Fed Watchers

With the possibility that the Fed might launch another round of quantitative easing, traders should be wary of betting the market will drop into the $70-a-barrel range or below, Flynn said.

Going forward, oil traders will pay particularly close attention to upcoming global inventories data from the International Energy Agency at a time when some OPEC producers have raised output to meet a previously anticipated increase in demand.

The International Energy Agency previously acted to limit oil price increases by releasing strategic reserves.

The demand outlook will also depend on whether China reacts to the latest indications of economic slowdown by stimulating its economy, as it did during the 2008 financial crisis, or whether its ability to do so is constrained by concerns about domestic inflation in a rapidly growing economy.

David Greely, head of energy research at Goldman Sachs, said oil prices had reacted to concern about both the European and the U.S. economies.

“The US recovery is looking very soft right now,” he said.