Oil recovers after volatile session

Contract rises more than 6% as contract expiration leads to big swings in price.

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By David Goldman and Kenneth Musante, CNNMoney.com staff writers

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NEW YORK (CNNMoney.com) -- Crude oil prices recovered Tuesday, after falling to their lowest level in more than a month, amid volatility on the last day of trading for the current active contract.

U.S. crude for February delivery ended the day in the black, rising $2.23, or 6.1%, to $38.74 a barrel in New York.

Prices recovered after plummeting by as much as 10% to $32.70 earlier, the lowest level for crude since Dec. 19, as the dollar soared against the pound and euro on continued European economic turbulence.

Oil did not trade on the floor of the New York Mercantile Exchange on Monday in observance of Martin Luther King Jr. Day, though there was some light electronic trading. Crude continued the downward trend from Monday, when feuding Russia and Ukraine negotiated a deal that to restore Europe's supply of natural gas.

End of old contract, beginning of new

Tuesday is the final day of trading for the February contract. Oil for March delivery, which begins its front-month run Wednesday, settled down $1.73, or 4.1%, to $40.84 a barrel.

The price of the February contract rose as the difference between the two contracts equalized, according to Phil Flynn, senior market analyst with Alaron Trading in Chicago.

"The expiration is causing a lot of volatility today," said Flynn.

In a situation such as this, called a "contango" by traders, investors scramble to cover short investments or find the right time to sell. Oil often experiences big moves in one direction or the other in the last hour of trade.

Indeed, that's what happened with the February contract, which opened at $42.36 when it became the front-month contract on Dec. 20, compared to the January contract's closing price of $33.87. Since then, the February contract has fallen by as much as $10. However, now that the February contract is ending, "some of the people playing the contango are getting out," according to Flynn.

Crude stumbled earlier as the dollar skyrocketed against the weak European currencies. The dollar hit an eight-year high against the British pound a day after the U.K. government announced its new bank rescue plan.

The U.S. currency hit a one-month high against the euro too, continuing Monday's trend after the European Commission said the euro-zone economy will likely shrink 1.9% this year.

Oil tends to trade lower when the dollar is stronger. Traders, particularly from hedge funds, often invest in commodities like oil to protect against inflation, but when inflation fears unwind, they look for other places to invest.

When inflation fears dwindled in the late summer, oil prices began their rapid decline from all-time highs.

Furthermore, dollar-traded commodities become more expensive to foreign investors when the U.S. currency trades higher. That often leads to lower oil prices, as investors look for a day to buy when oil is less expensive in their local currencies.

Regarding supply, the president of the Organization of the Petroleum Exporting Countries oil cartel said Tuesday that OPEC's member countries are trying to match supply with demand, which has fallen off a cliff as the global economic crisis has deepened since September. OPEC countries have curbed output in the past months, and the president believes that oil will recover to $75 later this year.

Still, some analysts say the economy will need to recover before oil makes a material rise.

Meanwhile gasoline prices climbed 0.1 cent to a national average of $1.843 for regular unleaded, according to a daily survey of credit card swipes from motorist group AAA.

Part of the Obama stimulus package is a tax credit of $500 for individuals and $1,000 for couples (with some income restrictions). Tell realstories@cnnmoney.com what you will do with the money if Congress passes the measure. Your responses could be part of an upcoming story. To top of page

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