Oil prices start to cool

Video

More video

Oil continues to hover around $100 a barrel as investors believe OPEC may be cutting output. Play video

NEW YORK (CNNMoney.com) -- Oil prices fell Thursday, despite a government report showing supplies of fuel used to make heating oil declined much more than expected.

Early Thursday afternoon, U.S. light crude for April delivery fell $2.39 cents to $97.31 a barrel. Oil traded up as much as 10 cents to $99.80 a barrel after the report's release at 10:30 a.m. ET, but have since retreated.

Traders initially thought the decline in distillates was demand-related, as colder temperatures in the Northeast have increased demand for heating oil, according to Phil Flynn, senior market analyst at Alaron Trading in Chicago.

But now Flynn believes that traders realize the weak supply is refinery-related, suggesting an overall decline in demand.

"The market's coming back down to earth," said Flynn. "$100 a barrel isn't a price anymore, it's a destination. It gets to the level, then it backs off."

In its weekly inventory report, the Energy Information Administration said crude stocks rose by 4.2 million barrels last week. Analysts were looking for a rise of 2.9 million barrels, according to a Dow Jones poll.

But distillates, used to make heating oil and diesel fuel, fell by 4.5 million barrels while analysts were looking for a 1.5 million barrel decline.

Refinery usage was lower than the previous week, operating at 83.5% capacity last week. And gasoline demand continued to fall, averaging just 9 million barrels per day over the past month.

These numbers are only a little higher than the same period last year.

Gasoline supplies rose by 1.1 million barrels, just above forecasts for a 1 million barrel rise.

Oil prices have soared recently as whispers of supply cuts and lower interest rates sent oil above $100 Tuesday and Wednesday.

Demand for gasoline has continued to weaken, leading some traders to believe that the Organization of Petroleum Exporting Countries will decide to cut its output at a March 5 meeting.

Also, in Federal Reserve meeting minutes released Wednesday, the U.S. central bank issued a weaker economic forecast for 2008, predicting slower growth, higher unemployment and higher inflation for the rest of the year. Some economists believe that the report indicated another interest rate cut is on its way.

An interest rate cut usually sends the dollar lower - and oil prices higher - as investors sell dollar-denominated securities and buy commodities as a hedge.

Also, oil is priced in dollars worldwide, so a falling dollar provides less incentive for oil-exporting counties to increase output, or for foreign consumers to cut back on oil use.

"It's a double-edged sword," said Flynn, who noted that when the Fed says the economy is bad, oil prices should go lower. But the Fed's solution to the weak economy - interest rate cuts - sends oil higher.

"So bad news is bullish news for oil," added Flynn.

After oil prices topped $100 a barrel for the first time on January 3, they pulled back to the mid-$80 range amid fears of a recession in the United States, the world's largest economy; however, oil prices have risen again by nearly $14 a barrel in the past few weeks.

Oil prices have risen nearly five-fold since 2002. Most analysts blame rising demand and tight supply. That has also attracted floods of investment money, and exaggerated the effects of supply disruptions.