Oil falls to 12-week low on demand worries

Oil fell to its lowest level in nearly three months on Tuesday, extending a steep slide since mid-July on mounting evidence high prices and a souring economy were cutting into world energy demand.

The drop coincided with a firmer U.S. dollar, which may have reduced the appeal of commodities to some investors playing the strong negative correlation between the markets in recent months, analysts said.

OPEC President Chakib Khelil said on Tuesday oil could fall further to $70 to $80 a barrel in the long term but added he did not think the producer group should consider cutting output at this point.

U.S. crude dropped $2.54 to settle at $122.19 a barrel after dipping as low as $120.42, its lowest since May 6. Brent crude fell $3.13 to $122.71.

"We still believe that crude's rallies are vulnerable and we would advise not buying into them," said Edward Meir, analyst at MF Global.

Oil has fallen from a record peak of $147.27 set on July 11, pressured by signs that high prices and an economic slowdown are curbing demand, especially in the United States, the world's largest oil consumer.

The chief executive of BP Plc, Tony Hayward, said on Tuesday he saw demand destruction of 5 percent to 10 percent for gasoline in developed OECD economies as people drive less due to high fuel prices.

The Energy Information Administration said on Monday U.S. oil demand in May was 660,000 barrels per day less than previously thought. A separate government report said motorists drove 2.4 percent less during the first five months of the year than they did in the same period of 2007.

Limiting oil's drop, Shell declared force majeure on Tuesday on its Nigerian Bonny Light oil exports for July to September following Monday's attack by militants on an oil pipeline in the Niger Delta.

Tension over Iran's nuclear program also provided support. Iran is the second-largest producer in the Organization of the Petroleum Exporting Countries.

Attention on Wednesday will focus on the latest snapshot of U.S. oil supplies.

Crude oil stocks probably fell by 1.6 million barrels and gasoline rose by 200,000 barrels, analysts said in an expanded Reuters poll. Distillates inventories were expected to have risen by 1.9 million barrels.