Oil dropped $2 on Thursday as credit and economic fears pounded global financial markets and as a storm threat to U.S. Gulf refineries and rigs receded.

Oil had resisted Wednesday's declines on other markets as investors tracked two tropical storms in the Atlantic and reacted to a bigger-than-expected fall in U.S. crude oil stocks.

But latest forecasts projected Dean, upgraded to a hurricane, would miss U.S. oil facilities. Tropical Depression Erin crossed Texas without inflicting damage on the oil industry there, according to initial company statements.

U.S. crude fell $1.70 or 2.3 percent to $71.63 a barrel by 9:12 a.m. EDT, nine percent below its August 1 record high of $78.77. London Brent crude was down $2.13 at $69.51.

European shares fell to a five-month low and London's FTSE 100 hit a 10-month low below the 6,000 level as U.S. housing-loan problems and wider damage to global markets continued to worry investors.

Harry Tchilinguirian, senior 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 eurozone and Japan slow down that could have a moderating impact on the countries furnishing these goods, on China and India.

The U.S. consumer and his outlook is an important cyclical factor. Subprime issues are leading to a reappraisal of risk, credit tightness is increasing and that is a depressing effect on consumers.

Tony Dolphin, director of economics and strategy at Henderson Global Investors, agreed that the ripples from subprime loans were no longer just a Wall Street problem.

Today is certainly a serious growth scare. For the first time really, we've seen big falls in the Asian market that suggest that what's going on in global credit could actually impact global growth going forward.

The longer this thing drags on the more worried we get that this will have an economic impact.


Chip Hodge, energy portfolio manager with John Hancock Financial Services, said the Atlantic hurricane season was a wild card that could prop prices up, although he cautioned if there is no damage the effects would go away quickly.

Dean became the first named Atlantic hurricane of 2007 on Thursday. Projections showed a path missing U.S. Gulf rigs and refineries that were battered by Katrina and Rita in 2005.

The grim situation in the bond and stock markets against a backdrop of possible slowing growth will act as the more dominant influence on the energy markets, and should more than offset any hurricane-induced bounces, said Edward Meir, an analyst at MF Global Energy Group.

Tropical Depression Erin was moving across southern Texas with its centre about 25 miles northeast of the refining hub at Corpus Christi, the U.S. National Hurricane Center said.

In Nigerian oil city Port Harcourt troops and gangsters fought gun battles. Violence in Nigeria's oil heartland has shut down a fifth of output from Africa's biggest producer.

(additional reporting by Randy Fabi, Jonathan Leff in Singapore)