Oil fell more than $3 on Tuesday as Goldman Sachs warned again of a price reversal and key forecasters said expensive crude could erode demand.
Oil extended its retreat from 32-month peaks reached early on Monday, with U.S. crude's 5.8 percent drop from Friday the biggest two-day percentage loss since May 2010, when the Greek and wider euro zone debt crises pressured commodities.
Oil led a broad commodities slump that also reacted to an upgrade in the severity of Japan's nuclear crisis, which rattled risk appetite and boosted U.S. Treasuries.
Brent crude for May fell $3.06 to settle at $120.92 a barrel. The May Brent contract expires on Thursday.
U.S. May crude fell $3.67 to settle at $106.25.
Fear of demand destruction is killing this market. There is a feeling that the recent rally lifted oil prices to unsustainable levels, said Phil Flynn, analyst at PFGBest Research in Chicago.
Sentiment was also diminished after two Saudi Arabia-based sources told Reuters that a lack of customer demand caused the kingdom to lower production after an increase in March to offset lost Libyan crude.
U.S. oil prices rallied above $113 on Monday, having jumped from an $83.85 low on February 15 in the wake of the ouster of Egypt's government and with unrest just beginning to spread in the region before engulfing Libya in a civil war.
In its second report in as many days, Goldman Sachs
Goldman expects Brent to fall toward $105 in coming months, the bank said in a note emailed to clients, after recommending on Monday that they close its trade on a basket of commodities that included U.S. crude.
CRUDE STOCKS RISE - API
U.S. crude oil stocks rose 1.2 million barrels last week, the American Petroleum Institute industry group said late on Tuesday.
Crude prices were little changed in post-settlement trading after the API report.
Gasoline stocks fell 4.6 million barrels and distillate stocks dropped by 3.7 million barrels, as refinery use slumped 5.1 percentage points to 78.9 percent of capacity, the API said.
A Reuters survey of analysts had forecast crude stocks to be up 1.0 million barrels, but projected distillate stocks to be up slightly and gasoline stocks to be down only 900,000 barrels.
The U.S. Energy Information Administration's inventory report is due on Wednesday at 10:30 a.m. EDT.
The draw in refined products is certainly supportive, said John Kilduff, partner at Again Capital LLC in New York.
The decline in utilization rates looks like a real retrenchment by (refiners).
High prices are beginning to dent oil demand growth, the International Energy Agency, an energy policy adviser to Western consuming nations, said. Slowed economic growth could cause prices to correct, the IEA said.
OPEC kept its 2011 oil demand forecast steady in its monthly report, but said the group saw a risk that higher oil prices could dent demand for transport fuel.
A slightly higher demand growth forecast for 2011 came from the EIA, but it did lower the forecast for 2012.
U.S. retail gasoline demand fell last week, with the four-week average down against the year-ago period, MasterCard said in a weekly report.
Saudi Arabia pointing to slow demand in deciding to reverse its recent output hike was treated by investors as another sign of slack consumption.
Sources said Saudi Arabia had trimmed production by around 500,000 barrels per day to around 8.5 million bpd due to slow demand.
Japanese consumption remains in question as economic damage from last month's earthquake is likely to be worse than first thought, Japan's economics minister warned.
Threats to supply remained as Libya's conflict continued, as did opposition to current regimes in Yemen, Syria and other countries in the region.
France and Britain urged NATO to do more to stop Muammar Gaddafi's forces from bombarding civilians in Libya, even as Qatar said it had marketed 1.0 million barrels of crude on behalf of Libyan rebels.
(Additional reporting by David Sheppard and Gene Ramos in New York, Ikuko Kurahone, Dmitry Zhdannikov and Zaida Espana in London and Chikako Mogi and Risa Maeda in Tokyo; Editing by Dale Hudson)