Oil retreats more than $5 on weak data, eroding 25 percent rally

By Robert Gibbons

NEW YORK (Reuters) - Oil prices plummeted on Tuesday, settling 8 percent lower, as weak Chinese data extended a roller-coaster run that knocked oil to its lowest in 6-1/2 years last week before frenzied short-covering fueled a 25 percent three-session surge.

The past few weeks have been among the most volatile in the modern oil market's three-decade history, with prices plunging early last week as worries about China's economic strength sent shivers through risk markets, only to bounce back fiercely as bearish traders rushed to cash in short positions.

Traders took flight on Tuesday after seeing China's official Purchasing Managers' Index (PMI) drop to 49.7 in August and U.S. manufacturing sector growth slow to its weakest pace in more than two years, reinforcing fears of slowing global growth and weaker fuel demand.

"It was primarily the China fear factor," Carsten Fritsch at Commerzbank in Frankfurt told the Reuters Global Oil Forum.

Some also wondered if the 25 percent three-day surge through Monday, the biggest since Iraq's invasion of Kuwait in 1990, was overdone given a persistent global supply glut.

And an OPEC magazine commentary that some traders interpreted on Monday as signaling a possible subtle policy shift was nothing of the sort, OPEC insiders said.

Brent October crude fell $4.59, or 8.48 percent, to settle at $49.56 a barrel, then fell below $49 in post-settlement trade as U.S. equities deepened the day's losses to more than 3 percent.

American Petroleum Institute (API) data showing U.S. crude inventories soared 7.6 million barrels last week also pressured prices post-settlement.

Crude oil stocks were expected to have been unchanged last week, a Reuters survey of analysts said.

U.S. crude fell $3.79, or 7.7 percent, to settle at $45.41 following an 8.8 percent gain on Monday. U.S. crude fell as low as $44.15 after the API report.

The CBOE's crude oil volatility index surged more than 10 percent intraday Tuesday, nearing its highest since 2011 as oil traders scrambled to scoop up near record volumes of options.

Monday's rally was fueled in part by Energy Information Administration (EIA) revised data showing U.S. oil output peaked at just above 9.6 million barrels per day (bpd) in April before falling by more than 300,000 bpd over the following two months.

"Even with the EIA revision, we're still producing over 9 million barrels per day, so I'm not convinced we've seen the fundamental shift to justify the rally," said Gene McGillian, senior analyst at Tradition Energy in Stamford, Connecticut.

(Additional reporting by Christopher Johnson in London and Keith Wallis in Singapore; Editing by Steve Orlofsky and Lisa Shumaker)