Crude falls on Europe woes, shrugs U.S. draws

Traders work in the crude oil and natural gas options pit on the floor of the New York Mercantile Exchange in New York, July 18, 2011.

NEW YORK (Reuters) - Crude oil futures slumped more than 2 percent Wednesday as Europe's debt crisis worsened, outweighing U.S. government data that showed unexpectedly large drawdowns in domestic crude and product stockpiles.

Crude futures fell sharply in early trade after Italian 10-year bond yields shot up well above 7 percent, a level widely deemed unsustainable. That triggered sharp falls in equities and lifted the dollar against the euro, prompting investors to trim holdings in risky assets.

Later, the euro fell further after euro zone officials said they have no plans for a financial rescue of Italy, the euro zone's third largest economy.

In London, ICE Brent crude for December delivery was down $2.50, or 2.2 percent, at $112.50 a barrel by 2:35 p.m. EST (1935 GMT), after hitting a session low of $111.78. The contract fell for the first time in five sessions, having settled on Tuesday at its highest level since September 15.

"People are scared that Italy's too big to bail out," said Michael Hewson, analyst at CMC Markets. "It's driving people out of risky assets and it's reinforcing fears about a double-dip recession, which will hit demand sensitive assets like oil."

U.S. crude for December settled at $95.74, falling $1.06, or 1.1 percent, dropping back from a session high of $97.84, the highest since August 1. The contract slid after five days of gains and closing on Tuesday at the highest since July 28.

Brent's premium against U.S. crude narrowed to below $16, from $18.20 at the close on Tuesday.

A flurry of late dealings pushed Brent crude trading volume to 26.5 percent above its 30-day average, according to Reuters data. U.S. crude volume was 10.4 percent above its 30-day average.

U.S. crude inventories fell more than expected, by 1.4 million barrels last week on lower imports, data from the U.S. Energy Information Administration showed.

Distillate stocks, which include heating oil and diesel fuel, plunged more than 6 million barrels, with average four-week demand rising 3.9 percent from the year ago level.

Following the fall in distillate stocks, the heating oil future contract's premium over RBOB gasoline futures rose above $19 a barrel for the first time since 2008.

Gasoline stocks fell 2.1 million barrels, their lowest weekly level since June 2009, defying forecasts for a modest build.

"Today's EIA data was bullish across the board, with a big draw for crude and product stocks (but) headlines out of Europe, specifically Italy, will likely remain the large elephant in the room for the direction of energy prices," said Chis Jarvis, president at Caprock Risk Management in Rye, New Hampshire.

"With the euro weakening today, it will be difficult for commodity prices, including oil, to move higher given the global macroeconomic backdrop," Jarvis added.

Also providing some support to the oil market, Britain's Foreign Secretary William Hague said the government is looking at imposing further sanctions against Iran's financial and energy sectors because of its nuclear work.

Western leaders called for expanded sanctions against Tehran following Tuesday's report from the U.N. International Atomic Energy Agency that Iran has worked to design atom bombs, but veto-wielder Russia indicated it would block new measures at the Security Council.

EURO DIPS FURTHER AGAINST DOLLAR

The euro slid against the dollar, extending losses after midday after euro zone officials said they had no plan to rescue Italy.

German Chancellor Angela Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, calling for changes in EU treaties to accelerate and deepen integration of the euro zone countries.

There is now a 60 percent chance of a euro zone recession, according to the consensus of 250 economists, up sharply from 40 percent in a Reuters poll conducted in October.

Europe's sovereign debt crisis was cited by OPEC as a risk to expectations for demand growth in the producer group's 2011 World Oil Outlook.

(Additional reporting by Robert Gibbons, Eileen Moustakis and David Sheppard in New York; Simon Falush and Philip Baillie in London; Francis Kan in Singapore; Editing by David Gregorio)