Oil dropped to a one-week low in New York after the European Central Bank cut its euro-area growth forecasts and as US lawmakers struggled to reach agreement on a budget plan.

Futures fell as much as 2.5 per cent as ECB President Mario Draghi said the bank now projects the economy will contract 0.5 per cent this year, worse than the September forecast of a 0.4 drop. More than $US600 billion of new taxes and spending cuts, known as the fiscal cliff, will come into force at the beginning of 2013 unless US politicians agree on a federal budget.

"The reduction of the ECB growth forecast and Draghi's statements that economic weakness may be extended are adding to worries about the European situation," said John Kilduff, a partner at Again Capital LLC, a New York-based hedge fund that focuses on energy. "Concern about the fiscal cliff and what next year portends for energy demand have been in the forefront of investors' minds the last week."

Crude oil for January delivery fell $US1.73, or 2 per cent, to $US86.15 a barrel at 1:21 p.m. on the New York Mercantile Exchange. The contract touched $US85.68, the lowest level since Nov. 28. Futures have dropped 13 per cent this year.

Brent oil for January settlement declined $US1.62, or 1.5 per cent, to $US107.19 a barrel on the London-based ICE Futures Europe exchange. The contract touched $US106.63, the lowest level since Nov. 9.

The European benchmark crude grade was at a premium of $US21.04 to West Texas Intermediate oil traded in New York, widening for the first time in six days. It closed at $US20.93 yesterday, the narrowest gap since Nov. 2.

'Weak Activity'

"Weak activity is expected to extend into next year," Draghi said today at a press conference in Frankfurt after policy makers left the benchmark rate at a record low of 0.75 per cent. "Later in 2013, economic activity should gradually strengthen," supported by the central bank's accommodative monetary policy, Draghi said.

The ECB cut its 2013 forecast to a contraction of 0.3 per cent from 0.5 per cent growth, and projects expansion of 1 per cent in 2014, he said.

The euro slid as much as 0.9 per cent against the dollar, and is heading for the biggest decline since July 20, on the worsening European economic outlook. A weaker common currency and stronger greenback reduce the appeal of dollar-denominated raw materials as an investment.

"The market remains stuck between $US84 and $US90 a barrel and is searching for a signal of what direction it should move," said Gene McGillian, an analyst and broker at Tradition Energy in Stamford, Connecticut. "The market is hemmed in by concerns that there won't be a budget agreement in Washington and ongoing problems in Europe."

Budget Talks

The Congressional Budget Office has said the US economy will contract by as much as 0.5 per cent next year if Congress fails to stop the tax-and-spending measures from taking effect.

US President Barack Obama and House Speaker John Boehner spoke by telephone yesterday, Michael Steel, a spokesman for Boehner, said without giving details. A White House aide also confirmed the call, speaking on condition of anonymity.

The US accounted for 21 per cent of the world's oil consumption last year while the 27 members of the European Union were responsible for 16 per cent, according to BP Plc's Statistical Review of World Energy.

Prices fell yesterday after an Energy Department report showed that US fuel supplies surged last week as demand tumbled. Gasoline stockpiles rose 7.86 million barrels to 212.1 million, the highest level since April 13. Inventories of distillate fuel, a category that includes heating oil and diesel, climbed 3.03 million barrels to 115.1 million.

Fuel Demand

Total fuel demand dropped 3.3 per cent to 18.3 million barrels a day in the week ended Nov. 30, the report showed. Gasoline consumption declined 0.9 per cent to 8.35 million barrels a day.

"Supplies are more than ample and demand is weak," McGillian said.

Prices may rise tomorrow because of political tension in the Middle East, where one-third of the world's oil is produced, said Bill O'Grady, chief market strategist at Confluence Investment Management in St. Louis, which oversees $US1.4 billion.

Obama warned Syria's Bashar al-Assad on Dec. 3 not to use or distribute the country's stock of chemical weapons, as US officials saw evidence that the Syrian regime may be preparing to unleash such weapons to repel rebel fighters. Egypt's Republican Guard deployed around President Mohamed Mursi's palace after his opponents and supporters engaged in clashes.

Mideast Unrest

"A trader would have to be pretty bold taking home a short going into this weekend given the situation in Syria," O'Grady said. "The US has made it quite clear that the use of chemical weapons would be crossing a line. It's surprising that the situation in both Syria and Egypt hasn't moved the needle at all so far this week."

Electronic trading volume on the Nymex was 336,758 contracts as of 1:23 p.m. Volume totaled 450,961 contracts yesterday, 14 per cent lower than the three-month average. Open interest was 1.56 million, the highest level since Nov. 12.

BLOOMBERG