Oil drops on U.S. distillate build as crude draw shrugged off

By Barani Krishnan

NEW YORK (Reuters) - Oil prices fell on Wednesday after the market ignored an unexpected drawdown in U.S. crude stockpiles to focus on a build in distillates, including diesel, that was twice as big than expected.

U.S. crude inventories fell 3.6 million barrels last week, the first drawdown after 10 straight weeks of builds, bucking a 300,000-barrel build forecast in a Reuters poll, the Energy Information Administration (EIA) said. [EIA/S]

Brent and U.S. crude's West Texas Intermediate (WTI) futures were up more than $1 a barrel in an immediate reaction to the data, before turning negative as the market's attention turned to the bearish distillate numbers.

Distillate inventories soared 5 million barrels, double the forecast and the sharpest rise since January, while demand for the fuels fell to its lowest level seasonally since 1998, the EIA said.

"The large rise in distillate fuels will likely work to make the report bearish by day's end," said John Kilduff, partner at New York energy hedge fund Again Capital.

Brent was down 20 cents, or half a percent, at $40.04 a barrel by 1:25 p.m. EST (1825 GMT), hitting a near seven-year low at $39.57. Brent has lost nearly $4, or 10 percent, since an OPEC meeting on Friday that virtually abandoned price support measures.

WTI slid 28 cents to $37.23, after a session high at $38.99.

Futures of U.S. ultra low sulfur diesel , also known as heating oil, slumped about 2 percent.

PIRA Energy, a closely-followed market consultancy, said crude would be under more pressure soon as onshore oil storage was likely to run out by the first quarter.

"Brent crude prices will continue to struggle due to a large global commercial oil stock surplus, which PIRA estimates will total 500 million barrels above normal levels by end-2015," it said.

The spread between Brent's prompt and second-months , however, narrowed - a sign some dealers anticipated tighter supply next month even as they expected a "lower for longer" price regime.

Some analysts thought the EIA data, which also cited a smaller-than-expected build in gasoline stockpiles , was supportive.

"I would call the data bullish," said Dominic Chirichella, senior partner at the Energy Management Institute in New York.

"U.S. production is also down in the lower 48 states," he said, citing a huge drawdown in the Gulf Coast region where crude stockpiles fell 7.3 million barrels, the most since December 2012.

Others were not too impressed by the crude draws, saying such declines were typical this time of year as refiners use up crude they have on hand before the end of the U.S. tax year.

"It's a tax consequence," said Tariq Zahir, trader at Tyche Capital Advisors in New York.

(Additional reporting by Simon Falush in London; Editing by Marguerita Choy)