China's manufacturing sector contracted in February as new export orders dropped sharply in the face of the euro area debt crisis, stirring fears about fuel demand in the world's second largest oil user.
Commodities rallied on Tuesday after the European Union approved a 130-billion-euro rescue fund to Greece, saving it from bankruptcy. But the long-term risk of a messy default and regional contagion, given deep-rooted mistrust over Athens' commitment to harsh reforms, continued to worry investors.
Brent crude for April delivery fell 45 cents to $121.21 a barrel by 0245 GMT. The contract settled at $121.66 on Tuesday, its highest since May.
U.S. crude for April was down 45 cents to $105.80 a barrel. The March contract, which expired on Tuesday, closed at $105.84 a barrel, the highest settlement for front-month NYMEX crude since May 4.
"Prices are correcting as we've already got the boost from Greece and Iran's pre-emptive stoppage of oil to Britain and France," said Tony Nunan, a risk manager at Mitsubishi Corp, adding that the slowdown in Chinese manufacturing activity also weighed on prices.
SUPPLY CONCERNS SUPPORT
Yet supply concerns have boosted oil prices in the past month on disruptions from Iran, as tightening U.S. sanctions make it tough for buyers to keep doing business with the second largest OPEC producer.
Asian and European buyers of Iranian crude are cutting their purchases from Tehran. Top Asian consumers of Iranian oil -- China, India and Japan -- are planning cuts of at least 10 percent in Iranian crude imports.
Crude output in Sudan, Yemen, Syria and the North Sea is also lower due to geopolitical and production issues.
"There's no supply cushion anymore," Mitsubishi's Nunan said. "Spare capacity is low, it's back to the same situation in 2004 and 2008 before the Lehman shock."
Oil still faces downside risks in the second quarter as refineries undergo maintenance and product consumption slides into the seasonal trough before the northern hemisphere summer, J.P. Morgan analysts led by Lawrence Eagles said in a Feb. 21 note.
"Supply risks remain elevated, as does the desire to build inventory, but at current rates it appears as if the market will be well-supplied this spring, creating the potential for prices to retrace, rather than collapse," the bank said.
A gradual economic recovery in the United States, also the world's largest oil consumer, has also supported prices.
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