Brent crude fell below $106 a barrel on Thursday, erasing earlier dollar-fueled gains, on investor concerns that the European debt crisis could spill over to France and harm global economic growth.
Brent crude fell by 95 cents to $105.73 a barrel in a choppy trading session, after earlier rising more than $1 on a weak dollar. U.S. oil futures were down 41 cents at $82.48 by the same time.
Market talk of an impending downgrade of France's credit rating and concern about the financial health of one of its key banks have rattled markets, although three major ratings agencies have reaffirmed its AAA rating.
French bank Societe Generale's boss vehemently rejected rumors that questioned the banks financial solidity and its battered shares recovered some ground.
"Volatility is about people trying to balance fundamentals against the macroeconomic environment. We had constructive numbers on oil stocks but there's macroeconomic uncertainty especially with worries over French banks," said Tony Hall, chief investment officer of Duet Commodities, referring to a drop in U.S. crude stocks the previous day.
Oil prices had rallied on a weaker dollar, with investors reluctant to hold it after the Federal Reserve pledged to keep interest rates near zero. Commodities including oil tend to rally when the dollar falls since it makes them cheaper for non-dollar buyers.
World stocks staged a tentative rally on Thursday and edged up from this week's 11-month low as higher U.S. stock futures calmed frayed investor nerves after a steep selloff this week which shook investor faith in global growth.
Uncertainty about the economic outlook hit oil prices hard in early August, with Brent dropping from around $117 a barrel to briefly dip below the psychologically important $100 a barrel threshold earlier this week.
While prices have since recovered, rising by around 4 percent in Tuesday's session, many analysts still consider the outlook for oil demand very uncertain.
The West's energy watchdog the International Energy Agency said in its monthly report on Wednesday that a global economic slowdown may stifle oil demand growth, potentially cutting it by more than half to only 600,000 barrels per day.
"They are telling the market not to take their demand numbers too seriously. It could revise them lower. But at the moment, we are not trading on fundamentals but macro factors," said Eugen Weinberg of Commerzbank.
Sentiment in the oil market was given a boost by news on Wednesday that U.S. crude stocks declined 5.23 million barrels to 349.75 million barrels in the week to August 5 as imports fell slightly and refinery utilization increased, according to the U.S. Energy Information Administration. Analysts polled by Reuters had projected a 1.5 million barrel build on average.
The drawdown came after companies operating in the Gulf of Mexico shut production briefly due to the threat of Tropical Storm Don. Private forecaster AccuWeather.com said on Wednesday there is a possibility that three more storms will form in the tropical Atlantic in the next couple of weeks.
Prices are expected to be on a rising trend of $100 to $130 a barrel over the next 12 months as the current risk-off trade subsides, even with potentially slower economic recovery in OECD countries, Barclays Capital said in a report.
"Global oil demand growth is on a solid upward trajectory, as structural changes in non-OECD countries underpin most of that rise. The ineffectiveness of the supply side to catch up with it has created an extended period of supply capacity tightness, which will be apparent in 2012," said Barclays analyst Amrita Sen.
(Reporting by Manash Goswami and Emma Farge; Editing by William Hardy)