U.S. crude back below $40 as oil erases early gains on glut worry

By Barani Krishnan

NEW YORK (Reuters) - Oil prices fell more than 1 percent on Tuesday, erasing early gains and pushing U.S. crude back below $40 a barrel as persistent worries of a glut offset the impact of a weak dollar that initially propped the market.

A slide in U.S. equities also forced U.S. crude futures, which plunged below the $40 level on Monday for the first time since April, to give back early gains of as much as 2 percent, traders said.

"There is much talk about the product glut replacing the oil glut, and this is a worrisome indicator for crude demand," said Frank Klumpp, oil analyst at Stuttgart-based Landesbank Baden-Wuerttemberg.

U.S. West Texas Intermediate (WTI) crude was down 50 cents, or 1.3 percent, to $39.56 a barrel by 12:15 p.m. EDT (1615 GMT). It had risen to $40.91 earlier.

Brent crude fell 30 cents, or 0.7 percent, to $41.84 a barrel, after rising to $43.18 earlier.

The dollar hit a six-week low, propping oil initially, before U.S. stocks fell to a three-week trough, mitigating the rebound.

"I am bullish here overall but worry about being too early," said Scott Shelton, energy futures broker at ICAP in Durham, North Carolina. "I also wonder if the market is going to chop around a bit first, like it did in late May to June before dropping after many threw in the towel."

Oil hit 2016 highs above $50 a barrel between late May and June as crude supplies tightened from disruptions in Canada, Nigeria and Libyan energy sectors, and a near economic meltdown in OPEC member Venezuela. The rally faded soon after as higher prices spurred more crude and refined product output.

Oil traders and investors expect the U.S. government to report on Wednesday that crude inventories fell 1.4 million barrels last week after a surprise build the previous week that broke a nine-week drawdown. Trade group American Petroleum Institute (API) will issue a preliminary report at 4:30 p.m. EDT on Tuesday ahead of the government data.

But the forecast draw pales to the global oil inventory situation. Fuel stockpiles across the world are brimming as refineries have churned out huge volumes of diesel, gasoline and jet fuel, squeezing refining margins as demand lagged supply.

Meanwhile, crude remains oversupplied as top oil producers in OPEC pump at near record high levels. Saudi Arabia also cut at the weekend its crude selling price to Asian customers, signaling the start of another price war and tussle for market share among producers.

Hedge funds have turned rather bearish toward both crude and refined products over the last two months amid signs of a gasoline glut.

"With the market continuously focussing on oversupply, this bearish trend seems hard to change in the near term," said Hans van Cleef, ABN AMRO senior energy economist.

(Additional reporting by Karolin Schaps in LONDON and Henning Gloystein in SINGAPORE; Editing by Dale Hudson and Marguerita Choy)