July 9 (Bloomberg) -- Crude oil rose, rebounding from its biggest decline in three months, after Iran test-fired a long- range missile capable of reaching Israel and the dollar fell.

Oil recovered as the Iranian exercise, reported on state television, heightened concerns of an attack by Israel on the Middle East's second-biggest oil producer. The dollar dropped against the yen and euro after the missile test, making commodities priced in the U.S. currency cheaper.

``While we're still in a phase of verbal attacks, the danger of military strikes is real and Iran might halt its oil exports,'' said Gerrit Zambo, a trader at BayernLB in Munich. ``This is driving the oil price up and the situation remains tense.''

Crude oil for August delivery rose as much as $2.24, or 1.7 percent, to $138.28 a barrel in electronic trading on the New York Mercantile Exchange. It traded at $137.91 at 1:48 p.m. London time. Yesterday, prices tumbled 3.8 percent, the biggest decline since March 31.

Futures reached a record $145.85 on July 3. Prices have surged 91 percent in the past year.

Iran's move comes a day after Ali Shirazi, an aide to Iran's Supreme Leader Ayatollah Ali Khamenei, warned that the Middle Eastern nation would strike Israel and the U.S. Navy in the Persian Gulf as a first response to any American attack on its nuclear program. The U.S. has accused Iran of uranium enrichment to develop nuclear weapons, while the Persian Gulf nation has said it's for electricity production.

Hormuz Blockade

Iran has said it may blockade the Strait of Hormuz, the shipping lane for a fifth of the world's crude, if its nuclear facilities are attacked. The country is the second-biggest producer in the Organization of Petroleum Exporting Countries.

Iranian President Mahmoud Ahmadinejad yesterday dismissed the possibility of a war with the U.S. and Israel over the issue, saying his country seeks to avoid clashes.

``We're making the utmost effort for providing peace and security at the world level,'' he said in Kuala Lumpur, where he attended a summit of the Eight Islamic Developing Countries.

The dollar traded at $1.5697 against the euro at 12:35 p.m. in London from $1.5670 in New York yesterday. The dollar fell to 107.54 yen as of 10:53 a.m. in London from 107.50 yen late in New York yesterday.

Brent Gains

Brent crude oil for August settlement climbed as much as $2.48, or 1.8 percent, to $138.91 a barrel on London's ICE Futures Europe exchange, and traded at $138.60 at 1:48 p.m. London time.

Yesterday, it declined $5.44, or 3.8 percent, to settle at $136.43 a barrel, the biggest drop since March 19. Prices climbed to a record $146.69 on July 3.

U.S. crude-oil inventories probably extended declines last week as refineries delayed purchases because of high prices, a Bloomberg News survey indicated.

Crude-oil stockpiles probably fell 2.05 million barrels in the week ended July 4 from 299.8 million barrels, according to the median of responses by 12 analysts before an Energy Department report today.

Analysts were split over whether gasoline stockpiles rose or fell. Supplies probably increased 50,000 barrels from 210.9 million barrels the prior week, according to the median of responses.

Supplies of distillate fuel, a category that includes heating oil and diesel, probably rose 1.95 million barrels from 120.7 million barrels the prior week, according to the survey. It would be the ninth-straight rise.

The Department of Energy report will be out at 10:35 a.m. local time in Washington D.C.

To contact the reporter on this story: Grant Smith in London at gsmith52@bloomberg.net; Nesa Subrahmaniyan in Singapore at nesas@bloomberg.net.

Last Updated: July 9, 2008 08:53 EDT