Oil falls below $89 on dollar strength

Oil prices fell further from 27-month highs on Wednesday as a strong dollar sapped investor appetite for commodities, despite signs of tighter oil supply fundamentals in top consumer the United States.

Oil staged a sharp rally in late December, helping to make commodities the top performing asset class in 2010, but prices have since retreated as part of a wider commodities sell-off.

The US dollar index rose by nearly 1 percent on Wednesday, making oil more expensive for non-dollar buyers and pushing US crude futures to an intra-day trough of $88.16 a barrel and the lowest since Dec. 20.

Oil prices pared losses after US jobs data showed the number of planned layoffs fell in December. By 1339 GMT, they were down 56 cents at $88.82 a barrel and around 4 percent below the 27-month peak hit in early January.

ICE Brent for February fell 53 cents to $93 a barrel but was still well supported relative to the US crude benchmark and held a near $4 premium.

“The price had gone up too high. There was quite a flow of funds coming in, and people have been taking profits. It’s not unexpected — we’ve got all that spare capacity upstream and downstream and still high stocks even though there have been some draws,” said Roy Jordan, an analyst at Facts Global Energy.

Losses on Wednesday came despite data late in the previous session showing a much larger-than-expected 7.5 million barrel drop in crude inventories in the final week of 2010, according to industry group American Petroleum Institute. Still, US crude futures for February held around $1 below March prices in a structure known as contango, which is associated with comfortable supplies.

Data from government statistics body US Energy Information Administration, generally seen as a more authoritative source, are due to follow on Wednesday at 1530 GMT.

Analysts at MF Global saw the chance of a deeper correction for oil, although technical analysts pointed to immediate price support at $88-$89 a barrel.

“Markets could see somewhat more weakness on Wednesday as the current correction may have more room to run,” said Edward Meir at MF Global, adding that this week’s selloff resembles a similar trend in early 2010, when prices fell over 10 percent in January.

One fundamental factor other than falling stocks that could help limit downside on oil prices is strong demand due to cold weather in the northern hemisphere, according to JBC Energy.

This month could be the coldest January for top oil consumer the United States since the 1980s, according to Accuweather.com.

In other markets, world stocks as measured by MSCI fell by over half a percent on Wednesday as early losses in European shares weighed.

European industrial orders rose by 14.8 percent in October from the previous year but less than a forecast 17 percent rise in a Reuters poll.