Oil retreats on bigger crude supply

Special Reportfull coverage

America's cheapest gas is in this town Summer drivers to get a break on gas Why gas prices are likely to keep climbing You'll pay a little less for gas this summer Expect relief from record February gas prices Why gas prices are rising

NEW YORK (CNNMoney.com) -- Oil prices fell Wednesday after the government said supplies of crude rose more than expected last week and on worries about a looming economic recession.

U.S. light crude for March delivery tumbled $1.27 to $87.14. Oil touched an intra-day high of $88.90 in electronic trading.

This is the lowest level at which oil has traded since Jan. 24, when oil dipped to $87.01 a barrel.

In its weekly inventory report, the Energy Information Administration said crude stocks rose by 7 million barrels last week, which are right in the middle of the average range for this time of year. Analysts were looking for a rise of 2.6 million barrels, according to a Dow Jones poll.

Distillates, used to make heating oil and diesel fuel, rose by 100,000 barrels while gasoline supplies rose by 3.6 million barrels. Analysts were looking for a 1.8 million barrel dip in distillates supplies and a 1.8 million rise in gasoline stockpiles.

For the second week in a row, refinery usage was low, operating at 84.3% capacity last week, slightly below estimates of 84.9%. Gasoline demand continues to be low, averaging just 9 million barrels per day over the past month, though these numbers are 1% higher than the same period last year.

Keeping oil prices from nosediving was a Labor Department report released Tuesday that showed workers were producing at a stronger-than-expected pace in the fourth quarter of 2007.

The report said productivity grew by an annual rate of 1.8% in the fourth quarter. Though the pace was down from the 6% growth rate in the third quarter, it still soundly beat analysts' forecasts of 0.5% in a Thomson/IFR poll.

"There is light at the end of the tunnel," said John Kilduff, an MF Global energy analyst, who noted that the productivity report added to this morning's lift before the oil industry supply report.

But the productivity report was limited good news after a troubling service sector report continued to drive down prices. The Institute for Supply Management released a report Tuesday that announced the typically strong service sector retreated for the first time in nearly five years, worrying economists that a recession is here or soon to come.

Oil prices fell Tuesday on traders' concerns that a weakening economy will result in less demand for energy.

"This is one time that you don't want to see oil prices fall," said Phil Flynn, senior market analyst at Alaron Trading in Chicago. He said he does not believe that the productivity numbers can counteract Tuesday's poor ISM service sector report.

"The demand for gasoline just isn't there," said Flynn. "People aren't driving because they feel the stress of the bad economy."

Flynn also said talk of an actual increase in Organization of Petroleum Exporting Countries production - even though the cartel voted last week to hold output steady - has weighed on prices.

The Organization of Petroleum Exporting Countries said in the meeting that oil output would remain at current level of 29.67 million barrels a day due to fears that the weakening world economies will translate into weakened demand for oil.

But some analysts believe that OPEC continues to increase production because they want to capitalize on oil's high prices while they last.

"These guys can't help themselves selling oil at these high prices," said Flynn. "OPEC sees the handwriting on the wall, and they want to try to make as much money as they can before oil prices start to come down."

Flynn noted that Iran continues to cheat their oil production quota, pumping out oil at the highest level since 1979 during the Iranian Revolution.

Oil prices topped $100 a barrel early this year, but have since pulled back amid fears of a recession in the United States, the world's largest economy.

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.