But energy dealers said the downside potential for prices would be limited by fears of security risks in the oil-rich Middle East and worries US fuel stocks would be drained as the summer driving season picks up, despite the latest supply increase.

US light crude for July dropped 65 cents to $37.84 per barrel on Monday, more than 10% below a 21-year high of $42.45 traded last week.

London Brent crude was down 72 cents at $34.95 a barrel.

The fall in prices will be welcome news for leaders of the world's leading industrialised nations, known as the G8, who meet from Tuesday in the United States.

Prices dropped last week after the Organisation of the Petroleum Exporting Countries (OPEC) pledged to raise official output by two million barrels per day (bpd) from July and a further 500,000 bpd from August.

Increased output

Saudi Arabia, the world's biggest exporter, and fellow OPEC member United Arab Emirates said they would pump an extra one million bpd between them, regardless of OPEC policy.

"Saudi Arabia looks determined to soften oil prices with more oil production. Expect a summer inventory build, as Saudi pumps up over 9 million barrels per day"

Deutsche Bank report

"Saudi Arabia looks determined to soften oil prices with more oil production, said Deutsche Bank in a report. "Expect a summer inventory build, as Saudi pumps up over 9 million barrels per day".

US crude stocks rose in the latest weekly data to their highest since August 2002 and fuel stocks increased, offering some relief after the world's biggest oil consumer entered its so-called driving season, when Americans hit the roads for vacations.

However, the data showed that fuel stocks still remain close to four million barrels below a year earlier and stocks are below five-year averages, supporting concerns that supplies could tighten once again.

Reinforcing the worries, the US Energy Secretary Spencer Abraham urged US refineries to run at full capacity to ensure supplies.

"I made it clear to them that we wanted to see no diminishment in refining capacity during this peak summertime period," he said on Friday.

Middle East dependence

US petrol prices, which reached a record high retail price last month, have become a key issue before the November presidential vote.

With healthy world economic growth leading to higher than expected oil demand, some analysts fear that oil supplies will remain tight for some months to come.

The US is the world's biggest oil
guzzler

Analysts say the increase in OPEC's official supply ceiling to 25.5 million bpd from 23.5 million bpd will make little difference to actual world supplies because OPEC is already pumping more than two million bpd above its limit.

Last week Dr Fatih Birol, chief economist at the International Energy Agency, told Aljazeera.net that long-term oil prices would spiral because of the world's overdependence on Middle East energy.

He said: "I think the market is very nervous at the moment and is reacting in an exaggerated way. But the real point is that we have to start looking away from the Middle East for reliable oil supplies. So in a sense you could say the current high oil prices may force the world to do that."

As for OPEC's future production trends, Dr Birol projects that in 20 or 30 years the oil cartel will have increased market share by 50%.

"This will make them even more powerful and that cannot be a good thing for developed and developing countries alike," he said.