Oil drops 4 percent after China rate increase

NEW YORK — Oil prices fell more than 4 percent today to below $80 a barrel after China surprised markets by raising interest rates in an attempt to cool its red-hot economy.

Benchmark oil for November delivery was down $3.59, or 4.3 percent, to settle at $79.49 a barrel on the New York Mercantile Exchange. It was the first time oil settled below $80 a barrel since September.

Investors had been pushing oil prices higher since the U.S. Federal Reserve indicated in late August that it is prepared to pour more money into the nation’s economy to spur growth. That led to a steep decline in the value of the dollar.

Oil is priced in dollars, so it becomes cheaper for holders of foreign currency when the dollar falls. They then buy more oil and send prices higher.

The Chinese rate increase of 0.25 percent, its first such move in nearly three years, had the effect of strengthening the dollar, and investors sent prices of crude oil, gasoline, and heating oil lower. They also bailed out of other commodities like gold.

“It took the wind out of the sales of the oil market,” said Phil Flynn, senior energy analyst at PFGBest in Chicago. “It gave the dollar some momentum and commodity traders moved for the exits.”

The dollar rose 1.8 percent against an index of foreign currencies.

Oil has been trading in concert with the U.S. stock market recently, and that trend continued. The Dow Jones Industrial Average lost 165 points, or 1.5 percent, in afternoon trading.

Gasoline futures fell even more sharply than oil, nearly 5 percent to settle at $2.0483 cents a gallon. The futures had tracked oil higher, and also rose because strikes at oil refineries in France had made investors nervous about supply disruptions.

Though strikes continued today, these concerns were overwhelmed by the effects of the rising dollar.

Investors have pushed oil prices higher in spite of abundant supplies in the U.S. in part because of expected demand from China’s growing economy. “If you start to raise interest rates in China and their economy slows, then global inventories suddenly look higher,” said Flynn.

An oil supply report from the Energy Department’s Energy Information Administration – the market benchmark – will be out on Wednesday.

“High oil inventories combined with sluggish demand conditions in most advanced economies are expected to keep the oil market in surplus over the rest of 2010,” said National Australia Bank, which forecasts crude will average $78 a barrel in the fourth quarter.

Heating oil fell nearly 9 cents to settle at $2.1893 a gallon. In London, Brent crude fell $3.27 to settle at $81.10 a barrel on the ICE Futures exchange.

Natural gas, however, rose 2.4 percent, to $3.513 per thousand cubic feet. Natural gas is insulated from global supply and demand trends because so much is produced domestically. High supplies have kept prices relatively low even as oil has risen with the growing world economy. Analysts say investors have been selling gas when oil prices go up, and are now buying as oil is falling.