Oil off more than $3; CFTC cites demand for run-up

The sell-off was a throwback to last week's sharp declines, and dragged crude to its lowest level since early June. It was oil's fifth decline in the last sixth sessions.

Light, sweet crude for August delivery fell $3.09 to settle at $127.95 a barrel in its last trading day on the New York Mercantile Exchange. Earlier the contract, which will be replaced by September crude Wednesday, dropped as low as $125.63.

The drop offered further evidence that investors who only a week and a half ago drove prices to a new high above $147 a barrel are now quickly pulling money out of the market. It was also a reminder that, with traders for the moment turning bearish, the absence of major news can push the market down--just as incremental supply concerns previously drove prices sharply higher.

"This is more of the long exit from the market by the hedge funds," said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates. "A lot of these investors who have been supporting prices are hitting the road."

In Washington, the Senate voted 94-0 to move ahead with a plan that would require the Commodity Futures Trading Commission to set limits on trading in oil markets by certain large investors.

A number of Democratic lawmakers and other critics have blamed the historic rise in prices on speculators that they suggest are manipulating prices.

However, a federal task force said in an interim report that fundamental supply-and-demand factors are most likely to blame for the sharp run-up in oil prices. The Interagency Task Force on Commodity Markets played down the role of speculators, saying its preliminary analysis "does not support the proposition that speculative activity has systematically driven changes in oil prices."

Oil prices rose Monday partly on fears that Tropical Storm Dolly could threaten oil and gas installations in the Gulf of Mexico.

That threat had largely subsided by Tuesday, however. Forecasters said Dolly was expected to make land in the vicinity of the Rio Grande late Tuesday or early Wednesday as a hurricane with sustained winds of 74 to 95 mph.

"Unless new projections put the storm on a more northerly track, it is unlikely to have a bullish impact on oil and natural gas prices," Addison Armstrong, director of market research at Tradition Energy, said in a research note.

Oil prices came under added pressure from a stronger dollar. The currency rose sharply against the euro after Charles Plosser, president of the Federal Reserve Bank of Philadelphia and a voting member of the Fed's Open Market Committee, said the central bank will probably need to boost interest rates "sooner rather than later."

The dollar's decline has been a major factor in oil's ascent, as investors bought dollar-denominated crude contracts as a hedge against inflation and a weakening greenback. When the dollar strengthens, such currency-related buying often unwinds.

Meanwhile, there were new indications that high oil prices are killing off demand, especially in the U.S., the world's largest oil consumer.

In its weekly pump spending survey, MasterCard found U.S. gasoline demand dropped last week for the thirteenth week in a row. Demand fell 3.3 percent compared with the same week a year earlier, according to the survey. Since the start of 2008, gasoline demand is down 2.2 percent.

At the same time, three more airlines posted hefty quarterly losses--including a $2.3 billion charge by No. 2 carrier United--primarily because of rising fuel costs.

Other energy commodities followed crude sharply lower.

Natural gas fell below $10 per 1,000 cubic feet for the first time since April. Prices for the power generation and cooking fuel settled at $10.067 per 1,000 cubic feet, down 44.3 cents. Earlier, prices dipped as low as $9.889.

Natural gas has plummeted since early July, when it reached its highest point in more than two years following a sharp run-up fueled by expectations of strong summer demand.

"We're not getting a real hot summer as some had forecast," reducing the need for gas-fired electricity to power air conditioning, Ritterbusch said. "Natural gas had a much larger rally than crude this year. Now we're seeing a much larger decline."

Oil's decline lifting some weight from motorists. Retail gas prices continue to fall away, with the cost for a gallon of gas dropping more than a penny overnight to $4.055, according to AAA, the Oil Price Information Service and Wright Express.

It is the first time since January that gas has fallen for two consecutive weeks, analyst and trader Stephen Schork said. Still, a gallon of gas still costs 30 percent more than it did last year, or more than 80 cents, he said.

In other Nymex trading, heating oil sank 6.97 cents to settle at $3.6782 per gallon, while gasoline futures tumbled 7.01 cents to settle at $3.147 per gallon.

In London, September Brent fell $2.27 to settle at $129.55 a barrel on the ICE Futures exchange.