Oil drops as China says it will raise fuel prices

Prices also were given a downward push by the Iraqi Oil Ministry's announcement that it is close to signing oil service deals with several major Western oil companies in an effort to boost its crude output.

Retail gas prices, meanwhile, slid overnight.

Light, sweet crude for July delivery fell $4.75 to settle at $131.93 a barrel on the New York Mercantile Exchange.

China disclosed that it will raise prices for gasoline and diesel fuel 16 percent and 18 percent, respectively, beginning Friday.

Growing Chinese demand for oil has underpinned the multiyear rally in oil prices, but higher prices could crimp that demand. Concerns about spiking Chinese demand for diesel due to cleanup operations in the aftermath of last month's earthquake contributed to oil's recent run-up.

"This could change the psychology of the market completely," said James Cordier, president of Tampa, Fla.-based trading firms Liberty Trading Group and OptionSellers.com.

Lower demand in China "would be a major factor in driving prices down," said Phil Flynn, an analyst at Alaron Trading Corp. in Chicago.

Also pressuring prices Thursday was Iraq's announcement.

The service agreements would be the first major Iraqi contracts with big Western companies since the 2003 U.S.-led invasion. In March, Iraq's Cabinet said the ministry could sign deals worth around $500 million each. Baghdad hopes to boost output by 600,000 barrels a day over its current 2.5 million barrels per day.