Oil hits 12-month high of $79 a barrel

Oil hit a year-high above $79 a barrel on Monday, driven by bullish sentiment across financial markets, but later slipped back as traders questioned whether ample fuel supplies justified current price levels.

US crude for November delivery touched a session high of $79.05 in early trade, the strongest since October last year, before paring gains to $78.61 by 1428 GMT, up 8 cents from the previous close.

London Brent crude dipped 7 cents to $76.92.

"The gains were overwhelmingly driven by financials and market optimism rather than fundamentals," said analyst Richard Gorry at JBC Energy in Vienna.

Crude prices have gained more than 10 percent in October, spurred by a weak U.S. dollar and bullish sentiment across financial markets, interpreted by some oil speculators as outlying indicators for a potential return to demand growth.

"Oil market participants are betting that equity markets only take a pause and that positive third-quarter results in the US corporate sector and better US housing market data will continue to fuel economic optimism," said analyst Carsten Fritsch at Commerzbank Commodity Research.

In excess

Financial markets are expected to keep seeking direction from earnings to come later in the week.

The US dollar is close to 14-month lows against the euro and edged lower against a basket of currencies Monday. Commodities priced in dollars are cheaper to non-dollar investors as the US currency weakens, which has the effect of driving up the nominal oil price as investors move in.

MSCI's benchmark all-country world stock index was up around 0.5% early on Monday, recovering after investors were disappointed by General Electric and Bank of America on Friday.

Thomson Reuters Proprietary Research shows that with around a quarter of companies in the U.S. S&P 500 index having reported, 79% have beaten analysts expectations.

In a typical quarter the percentage is 61%.

But oil market players remain mindful that fuel demand is only expected to recover gradually, and that large volumes, including refined products, are now in excess following a contraction in energy use triggered by the financial crisis.

"OPEC spare capacity has reached 6 million barrels per day, refining margins are depressed, OECD demand remains lacklustre and the world has yet to come to terms with the massive middle distillate stock surplus. Oil looks a little overblown at $79," JBC's Gorry said.

Oil stocks equate to around 62 days of forward demand, a number the Organisation of the Petroleum Exporting Countries previously would have said was around 10 more than it would like.

Even flow

At least some of the oil market's gains have come from speculative flows, with money managers hiking net long crude oil positions on the New York Mercantile Exchange in the week to October 13, the Commodity Futures Trading Commission said in a report on Friday.

"As long as liquidity is so ample and interest rates are low, a lot of investors will be coming into the market," said Fritsch at Commerzbank.

Other support came from signs of economic strength in China, the world's second-biggest energy user after the United States.

A senior official from the National Development and Reform Commission said Chinese gross domestic product grew more than 7 percent in the first nine months of 2009.