Brent crude surged to a 2-1/2-year high above $123 a barrel on Wednesday, before erasing gains in volatile trade as market players fretted the recent rally was overdone.
Brent's dip on Wednesday snapped a four-day rise that had seen prices climb almost $8 a barrel. Mounting evidence that the fighting in Libya could drag on and continue to disrupt oil supplies from the OPEC member has pushed prices up, alongside simmering tensions in the wider Middle East.
Members of the Organization of the Petroleum Exporting Countries said they could do little to control prices driven by speculators betting on worst-case scenarios, adding that the market is still well supplied.
Weekly inventory data from the U.S. Energy Information Administration was largely in line with expectations, showing crude stocks in the world's largest oil consumer rose slightly more than forecast and gasoline stocks fell slightly less than expected.
Oil prices are pulling back from earlier highs and consolidating as people are taking some profits, said Tom Knight, a broker at Truman Arnold in Texarkana, Texas.
This does not disturb the market's upward momentum. People are waiting for the expected ECB (European Central Bank) interest rate hike tomorrow and looking for further direction.
Brent crude traded down 46 cents at $121.76 a barrel by 1:48 p.m. EDT (1848 GMT), having fallen more than $1 from its earlier 2-1/2-year high of $123.37 a barrel.
U.S. crude oil futures were almost unchanged on the day at $108.35 a barrel after touching $109.15, the highest level since September 2008.
A Reuters poll of traders, bank analysts and hedge fund managers showed many think Brent's rally could be about to stall, with a majority expecting a drop below $120 a barrel by the end of the quarter.
However, many also said tensions in the Middle East could push prices to $130 or even $150 a barrel in the second half of the year.
The Paris-based International Energy Agency, adviser to industrialized nations on energy policy, warned that current oil prices could derail an economic recovery.
Oil at $120 or more has an effect on economic activity. We have seen similar levels during times of economic slowdown if not recession, its deputy director, Richard Jones, told Reuters in Dubai.
Concerns about rising inflation are expected to see the ECB hike interest rates on Thursday for the first time since the financial crisis. The euro rose to its highest against the dollar since January 2010.
Dollar weakness has buoyed hard assets priced in the U.S. currency, with the 19-component Reuters-Jeffries CRB commodity price index <.CRB> hitting its highest since early March.
But analysts have warned that tighter monetary policy is soon to follow in the United States, with the end of the second round of quantitative easing in sight. Cheap money is viewed by some as inflating the value of commodities such as oil, and prices could fall as central banks move to dampen inflation.
Central bankers will always claim that they have no influence on oil prices, said Olivier Jakob at trading advisory Petromatrix in Zug, Switzerland.
But recent history has repetitively shown that in the new world, where commodities are a global asset, central bankers can have a greater influence on oil prices than OPEC.
China raised retail gasoline and diesel prices by 5.0 percent to 5.5 percent on Wednesday, the day after it hiked interest rates for the fourth time since October in a bid to tame rising inflation.
(Additional reporting by Dmitry Zhdannikoz in London; editing by Dale Hudson)