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 more than 1% on Wednesday, making oil more expensive for non-dollar buyers and pushing US crude futures to an intra-day trough of USD 88.16 a barrel and the lowest since December 20.

Oil prices pared losses after stronger-than-expected US jobs data for December.

By 1536 GMT, US crude was down 88 cents at USD 88.50 a barrel and around 4% below the 27-month peak hit in early January.

ICE Brent for February fell 44 cents to USD 93.09 a barrel but was still well supported relative to the US crude benchmark and held a near USD 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 a more than 4 mn barrel drop in US crude oil inventories in the final week of 2010, according to the Energy Information Administration (EIA).

Still, US crude futures for February held around USD 1 below March prices in a structure known as contango, which is associated with comfortable supplies.

The potential bullish impact of the EIA data was also tempered by bigger-than-expected builds in distillate and gasoline stocks, analysts said.

Analysts at MF Global saw the chance of a deeper correction for oil, although technical analysts pointed to immediate price support at USD 88 to USD 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 more than 10% 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 nearly 2% on Wednesday as early losses in European shares weighed.

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