Oil prices settled unchanged on Wednesday after government data showing a smaller-than-expected drop in U.S. crude stocks offset a steep drop in gasoline inventories.

Crude stocks in the world's top consumer dropped 400,000 barrels in the week to August 28, less than the 600,000 barrel drop expected by analysts.

Gasoline inventories showed a steep 3 million barrel drop, however, as U.S. fuel demand -- battered by the recession over the past year -- rose slightly over year-ago levels.

The EIA inventory data is overall proving to be neutral, said Phil Flynn, analyst for PFGBest Research in Chicago.

Bearish in that the crude draw was lower than expectations and distillate stocks were up more than anticipated, and bullish because of the larger than forecast draw for gasoline.

U.S. crude for October delivery settled unchanged at $68.05, while London Brent crude fell 18 cents to $67.55 a barrel by 2:58 p.m. EDT.

Slumping oil demand sent crude prices tumbling from nearly $150 a barrel in July 2008 to below $33 in December.

Optimism a turnaround in the economy could boost fuel consumption has helped support prices since then, with traders eyeing equity markets and macro economic data for signs of an end to the recession.

U.S. stocks inched up as investors digested disappointing reports on the labor market and factory orders that increased worry the rally may have run too far ahead of the economy. <.N>


Traders were also eyeing news that big oil producers are increasing output. Russian oil output hit a record high in August, nearing 10 million barrels per day as the country launched a new giant field, while gas production recovered from its lows on improved demand.

August oil output rose to 9.97 million bpd, up 0.6 percent from 9.91 million bpd in July and 1.5 percent higher than 9.82 million bpd in August 2008.

Supply from the Organization of the Petroleum Exporting Countries rose in August for a fourth consecutive month, taking overall output discipline to 68 percent of the target from a revised 70 percent in July, a Reuters survey showed.

OPEC is likely to leave output targets unchanged when it next meets on September 9 in Vienna.

(Reporting by Matthew Robinson, Gene Ramos and Robert Gibbons in New York; Joe Brock in London; Editing by Marguerita Choy)