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When the Oil Boom Turns to Bust

Environmentalists may smile over this, but there's an economic knock-on effect as well. When prices fall permanently, it means the value of "proven reserves" goes down. That makes production loans harder to get. People start losing money. There's a negative wealth effect across the oil patch. That was what I saw in my 1984 visit to Houston.

There was a price collapse quite recently in the natural gas market, although through careful management -- and no small amount of flaring in the Bakken -- the crash in prices there was reversed last year. Prices are now approaching $4/mcf, and CME Group( CME ) futures contracts show this firming through year's end.

The oil industry has found many ways to manage falling prices over the last few years, but once the value of reserves starts to drop the retreat could become a rout.

If what's in the ground is seen by a banker as being worth less than what you're pumping now, you're going to want to pump now. New fields in countries that haven't seen an oil boom before are going to be exploited, regardless of price.

All this will take careful political and financial management, over several years, to work through. That time will be called a recession.

But when I returned from my Houston trip in 1984, I found that my new home in Atlanta was seeing a great economic improvement, a real recovery based on its status as a trading center and airline transfer point.

For investors, this means you shouldn't become wedded to your energy investments, especially in U.S. exploration companies that based their valuation, in part, on proven reserves. Make sure you're diversified, even if your oil profits are gushing today. Don't get caught out when the boom inevitably turns to bust.

At the time of publication the author had no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
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