Oil falls $2 after stockpile increase

Saudis boost oil output

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NEW YORK (CNNMoney.com) -- Oil prices settled more than $2 lower Wednesday after a government report showed an unexpected rise in crude stockpiles.

U.S. crude for August delivery settled down $2.45 to $134.55 a barrel on the New York Mercantile Exchange.

Prices fell as low as $131.95, or $5.05, earlier in the day after the Energy Information Administration's weekly petroleum report showed that crude supplies rose by 800,000 barrels during the week ended June 20.

Economists had expected supplies to fall by 1.7 million barrels last week, according to Platts information service.

The agency also reported that refineries were operating at 88.6% of capacity, down slightly from last week. Stores of distillates, used to make heating oil, rose by 2.8 million barrels, while motor gasoline stocks fell by 100,000 barrels.

Gas at the pump. The oil price decline came as the nationwide price of gasoline at the pump fell for its third day in a row, to an average of $4.067 from $4.069 a day earlier, according to a daily survey from motorist advocacy group AAA.

The price of regular gas hit a record high of $4.08 a gallon on June 16.

The price of diesel fuel, which is used by most trucks and commercial vehicles, rose 0.1 cent to $4.771 a gallon.

Fed rate hold. The Federal Reserve decision to keep its key interbank lending rate steady at 2%, was anticipated by many investors. The decision to hold rates where they were had only a small effect on oil prices.

Higher rates generally support the dollar, which in turn, can affect the price of oil, which is traded in U.S. dollars.

Traders picked apart the Fed's statement for clues about future interest rate policy. Some economists believe the Fed will hike rates down the road in order to combat inflation.

"I still think the market is going to go higher," said Mark Waggoner, president of Excel Futures in California. He said he expects the dollar to weaken further.

ECB challenge. Investors may also be jittery about a possible rate increase from the European Central Bank, which controls the strength of the 15-nation euro, according to Peter Beutel, oil analyst with Cameron Hanover.

On June 5, ECB president Jean-Claude Trichet said the bank may raise its interest rate by a quarter point to combat inflation. A European rate increase is the equivalent of a Federal Reserve rate decrease, said Beutel.

"There's a very good chance that we'll shift focus to what the ECB will do next," said Peter Beutel, oil analyst with Cameron Hanover.

Oil within range. Oil has traded fairly steadily in recent days, despite the threat of supply disruptions in Nigeria and, a disappointing production increase announced by Saudi Arabia.

Recent headlines "failed to garner a consensus in one direction or the other," said Stephen Schork, publisher of The Schork Report, an oil trading newsletter.

Wednesday's drop, though large, is not significant, said Schork. "Given the volatility over the past month, a lot of this can be attributed to noise," he said.

Oil continues to trade within a $4 plus-or-minus range. However, if Wednesday's decline exceeds $4.50, prices could turn consistently lower, according to Schork.

Supply concerns. On Monday, Chevron Corp (CVX, Fortune 500). said workers belonging to Pengassan, a white-collar union in Nigeria, had gone on strike.

And on Tuesday, just days after Saudi Arabia announced a lower-than-desired output boost, Chakib Khelil, president of the Organization of Petroleum Exporting Countries, blamed high oil prices on U.S. pressure against Iran and the weaker dollar, saying there was no need to raise supply.

Saudi Arabia announced over the weekend that it would build up its infrastructure to boost output to 9.7 million barrels a day, the highest levels since 1981.

Congress. Well-known oil researcher Daniel Yergin testified on Capitol Hill before the Joint Economic Committee as part of its ongoing inquiry into the possibility that prices are being driven up by speculators.

Yergin said speculative trading does play a role in higher prices, but so do the credit crisis and the weakened dollar.

Yergin's testimony likely had no effect on the markets Wednesday, according to Mark Waggoner.

"This is an ongoing thing... I think the prices of oil are going to back off about Aug. 1 anyway," he said.

He also cautioned that direct government involvement in U.S. oil trading is practiced could simply drive traders to other markets such as Dubai.

"I think they should make people accountable, but to actually intervene - raising margins - bad idea," he said.