Oil fell more than $1 to below $71 per barrel on Tuesday, paring three days of gains as expectations for a rise in U.S. crude inventories offset optimism over positive U.S. and Chinese manufacturing data.
U.S. light, sweet crude fell $1.05 to $70.53 a barrel by 1107 GMT, after having fallen earlier by as much as $1.30. ICE Brent crude fell 80 cents to $72.75 a barrel.
Analysts said Tuesday's price drop looked more like a pause for breath than a serious market reversal but suggested that weak fundamentals, with an abundance of supply in the United States and not much demand seen to mop it up, could win out.
As long as the optimism persists, I don't see much downside potential, but I definitely see downside potential going forward say two or three months, said Eugen Weinberg of Commerzbank.
Cautious statements from UBS
Norwegian oil and gas producer StatoilHydro
An increase in the visible signs of global economic recovery appeared to be limiting the downside for the oil market as investors' appetite for risk rises.
Global stock markets hit a nine-month high on Monday and Asian stocks climbed to an 11-month high on Tuesday.
Monday's gains took oil prices, still less than half the record high of over $147 hit in July 2008, within sight of this year's high of $73.38 set in June.
Oil will struggle to break $75 but there might be a support for the market at current levels because of the strong PMIs, Victor Say at Informa Global Markets said.
The U.S. manufacturing sector continued to shrink in July, but at a slower pace than in June and more slowly than expected, according to Institute for Supply Management data, while Chinese PMI data showed a fourth straight month of growth.
The dollar index <.DXY> against six other major currencies was around 77.489, little changed from late U.S. trade on Monday when the index fell as far as 77.451, its lowest since September 29.
A weak dollar can lend support to dollar-denominated commodities such as oil.
Analysts said the dollar's fall on Monday to its lowest level this year helped push up U.S. crude oil futures by 3 percent on top of a rally of almost 10 percent last week.
The market is looking to take a cue from weekly U.S. crude inventory data due later from the American Petroleum Institute and on Wednesday from the Energy Information Administration.
According to a preliminary Reuters poll, analysts expected a 1 million barrel rise in crude stocks last week, a 1.1 million barrel rise in distillate stocks and a 1.6 million barrel draw in gasoline stocks.
Output by 11 members of OPEC rose slightly in July, lowering its compliance rate to 71 percent of its agreed supply curbs compared with 72 percent in June, a Reuters survey showed.
(Additional reporting by Sambit Mohanty in Singapore; editing by Peter Blackburn)