Oil extends decline towards $89 as dollar strengthens

Oil fell for a second day on Wednesday, extending the previous session's 2.4% drop, as investor enthusiasm for commodities diminished with a stronger dollar, following a sharp year-end rally in raw material prices.

US crude for February shed 27 cents to USD 89.11 a barrel at 0305 GMT, after reaching a 27-month high of USD 92.58 on Monday.

Tuesday's drop was the biggest single-day percentage loss since November 16, when prices closed almost 3% lower.

"Ninety dollars a barrel already has a very strong economic picture built into the price," said Tony Nunan, a risk manager with Tokyo-based Mitsubishi Corp.

"Maybe people think the price is starting to get too high, and if the dollar is stronger, we should have lower commodity prices."

ICE Brent for February fell 36 cents to USD 93.17, while the dollar strengthened almost 0.2% against a basket of currencies.

Investors said abrupt selling across energy, metal and agricultural markets reflected a correction to the rally that capped 2010, rather than a sudden reversal of the optimism that made commodities the top asset class last year.

Gains in US fuel stockpiles outpaced a drop in the nation's crude inventories during the last week of 2010, industry group the American Petroleum Institute reported on Tuesday.

Crude inventories plunged 7.5 mn barrels in the week through December 31, much greater than analyst expectations of a 1.8-mn-barrel drawdown in a Reuters poll.

But gasoline stocks rose 5.6 mn barrels, far outstripping analyst expectations of a 300,000-barrel build, while distillate stocks rose 2.2 mn barrels, compared with forecasts for a 400,000-barrel rise.

Government statistics from the US Energy Information Administration will follow on Wednesday at 1530 GMT.

Traders have noted that there was an expectation that oil inventories will rebound in the new year and provide pressure on prices after companies drew down stored supplies for tax reasons at the tail end of 2010.

Commodities fell sharply on Tuesday as energy, metals and agricultural investors took profit on the heady gains made on thin holiday volume over the past two weeks.

The Reuters-Jefferies CRB index dropped nearly 2% in its sharpest one-day fall since mid-November after investors and traders worldwide returned to work from holidays to find many markets had run up to their highest in two years or more.

In other markets, Wall Street also pulled back after a strong December boosted equities to two-year highs, with consumer and energy stocks weaker.

The dollar held firm early in Asia on Wednesday in the wake of further evidence that bolstered hopes of a sustainable U.S. economic recovery, while the Australian dollar was pressured by a correction in high-flying commodity prices.