NEW YORK (CNNMoney.com) - Oil prices dived below $70 a barrel Wednesday despite signs of strong demand and depleted crude stocks in the government's weekly inventory report.

U.S. light crude for July delivery plunged $1.96 to $69.80 a barrel on the New York Mercantile Exchange. Oil was down 86 cents just prior to the report.

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Gasoline supplies rose for the fourth consecutive week, swelling by 2.1 million barrels last week, the Energy Information Administration said. Analysts were looking for a build of 1.2 million barrels, according to Reuters.

Stocks of distillates, used to make diesel fuel and heating oil, rose by 2.5 million barrels. Analysts were looking for a 400,000 barrel drop in distillate inventories.

But crude stocks fell 3 million barrels, far more than the 800,000 predicted. And in another bullish sign for oil prices, demand rose despite near record prices rose for gasoline, distillates and jet fuel.

Gasoline demand, averaged out over the last month, rose by 0.3 percent over the same time last year, while distillate demand grew by 0.9 percent, the report said. Jet fuel demand soared 8.1 percent.

"It's sort of a mixed bag," said Andrew Lebow, a broker at Man Financial in New York. "There's a draw in crude, but an increase in products."

Gasoline stockpiles have been closely watched in recent weeks as the U.S., the world's biggest oil consumer, enters its summer months when motorists take to the road and can cause a jump of 10 percent or more in gasoline demand.

Heavy refinery maintenance and a switch in gasoline blends stretched supplies particularly thin this spring, which helped drive gas prices to near record highs.

As of Wednesday, a gallon of regular gas averaged $2.87 cents, according to the motorist organization AAA. That's down 4 cents from last month but it's still 35 percent higher from a year ago, according to AAA.

It's also close to its all-time inflation adjusted high of $3.18 set in the spring of 1981, according to the Energy Department.

Meanwhile, crude oil prices have swung wildly in recent days, tumbling more than 5 percent last week as part of a general commodities selloff sparked by fears that rising inflation would slow worldwide growth and crimp demand.

But oil, like most commodities, bounced back this week, jumping about 2 percent Tuesday as investors bet inflation's impact, and the flight from commodities, had been overestimated by traders.

Oil prices remain about 12 percent higher for the year and are near the inflation-adjusted highs of around $80 a barrel reached in the early 1980s following the Arab oil embargo and the Iranian revolution.

In the latest developments with Iran, officials from several European countries met in London Wednesday to put together a package of incentives and threats that they hope will convince Iran to give up its uranium enrichment program, Reuters reported.

But observers remained skeptical Iran will bite at any of the offerings. "I wouldn't bet my house on any resolution there," one energy economist told Reuters.

Iran has refused to abide by a United Nations Security Council order to stop enriching uranium, which it says is for peaceful power-generating purposes, but much of the international community says is intended to build a weapon.

Yet any immediate action, either economic or military, against Iran is unlikely. President Bush, while not ruling out any military option, has said he still supports pursuing the matter through diplomatic channels.

And economic action against Iran would be difficult as China and Russia, both Security Council members with veto status, are not keen on sanctions. Iran has also said it would not use an oil embargo as a political weapon.

Still, oil traders are not reassured, and the prospect of confrontation with the country, the world's fifth largest oil producer, is helping keep prices high.

Although geopolitics has traders worried, other factors have caused oil prices to triple over the last three years. Continued strong demand in the U.S. and surging demand from China, India and other developing countries has played a big part.

And big investment funds, chasing higher returns given relatively low global interest rates, have invested heavily in commodities.

Lastly, many in the oil industry say that new discoveries of large, high-quality, easily recoverable oil deposits are probably a thing of the past.

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