Oil falls below $56, heads for biggest annual drop since 2008

By Alex Lawler

LONDON (Reuters) - Oil dropped below $56 a barrel on Wednesday and was heading for its biggest annual decline since 2008, pressured by weakening demand and a supply glut prompted by the U.S. shale boom and OPEC's refusal to cut output.

The price of global benchmark Brent crude has nearly halved in 2014 as demand growth slowed, the United States expanded output and OPEC, dropping its strategy of trimming supply to keep oil around $100 a barrel, chose instead to defend market share.

On Wednesday, prices came under further pressure from a survey showing China's factory sector shrank for the first time in seven months in December - a bearish indication on the strength of oil demand in the world's second-largest consumer.

"Here we are on the very last session of the year and Brent is making new lows, again," said Tony Machacek, an oil broker at Jefferies Bache in London. "There's no reason to see why the downtrend should not continue."

Brent was down $1.72 at $56.18 by 1326 GMT, after earlier dropping as low as $55.81, its weakest since May 2009. U.S. crude was down $1.19 at $52.93.

The annual decline for Brent is set to be the biggest since 2008, when demand crumbled in response to the financial crisis. Prices were, eventually, propped up by OPEC's last formal decision to cut production.

In contrast, OPEC at a Nov. 27 meeting this year decided against a cutback to defend its market share against shale oil and other competing supply sources, despite its own forecasts of a growing surplus in 2015.

Turmoil in Libya has effectively led to a drop in OPEC supply in December to a six-month low, a Reuters survey showed on Tuesday, although forecasts still point to a large excess supply next year.

Later on Wednesday, traders will focus on the latest U.S. government report on oil inventories to see if it confirms the unexpected increase in stockpiles reported on Tuesday by industry group the American Petroleum Institute.

U.S. crude inventories rose by 760,000 barrels last week, the API said, compared with analysts' expectations for a decrease of around 100,000 barrels.

The Obama administration on Tuesday bowed to months of growing pressure over a 40-year-old ban on exports of most domestic crude, taking two steps expected to increase the flow of ultra-light oil, or condensate, onto the global market.

"We expect a gradual, but slow increase of stabilized condensate exports over the next year," analysts at JBC Energy said in a report.

(Additional reporting by Seng Li Peng in Singapore; Editing by Michael Urquhart)