May 14 (Bloomberg) -- Crude oil fell more than $1 a barrel after an Energy Department report showed that U.S. supplies of distillate fuels, including diesel, rose more than forecast.

Stockpiles of distillate fuel gained 1.34 million barrels last week, the report showed. Supplies were forecast to climb 1 million barrels, according to the median of analyst forecasts in a Bloomberg News survey. U.S. fuel consumption dropped last week, the department said.

``The distillate number was a little bit better than expected,'' said Eric Wittenauer, an energy analyst at Wachovia Securities in St. Louis. ``The most striking thing is the demand figures, which have been very weak because of high prices, the economy and changes in behavior.''

Crude oil for June delivery fell $1.58, or 1.3 percent, to settle at $124.22 a barrel at 2:49 p.m. on the New York Mercantile Exchange. The contract surged to a record $126.98 yesterday. Today was the first time in eight days that oil didn't reach a record. Prices are 99 percent higher than a year ago.

Heating oil for June delivery declined 8.11 cents, or 2.2 percent, to settle at $3.6178 a gallon in New York. Futures jumped to $3.7228 a gallon today, the highest since trading began in 1978. Some traders use heating-oil futures to hedge their diesel and jet-fuel purchases.

Total implied U.S. fuel demand fell 2.7 percent from a year earlier to 20.3 million barrels a day last week, the report showed. Consumption averaged 20.5 million barrels a day in the past four weeks, down 0.3 percent from a year earlier.

Consumers React

``Consumers are reacting to higher prices by reducing demand for gasoline and other fuels,'' said Ron Planting, an analyst with the Washington-based American Petroleum Institute. ``The airlines are using fuel more efficiently because of higher costs. Demand for jet fuel is down in spite of increased passenger miles.''

Demand for jet fuel, which rose 2 percent to 1.5 million barrels a day last week, is down 11 percent from a year ago, the Energy Department report showed.

``There's been a demand impact here in the States but prices will continue moving higher until demand growth is killed globally,'' said Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $4.5 billion energy-company bond portfolio. ``Supply is still tight. Whenever there's a flare-up on the political front, prices rally.''

Refinery Activity

Refineries operated at 86.6 percent of their capacity last week, up 1.6 percentage point from the week before, the highest since the week ended Jan. 11, the department said. Analysts forecast that operating rates would rise 0.7 percentage point.

Crude oil supplies rose 176,000 barrels to 325.8 million barrels, the report showed. A 2.25 million-barrel gain was forecast, according the median of responses by 14 analysts surveyed by Bloomberg News. The gain left inventories 0.8 percent above the five-year average for the week, the department said.

The Energy Department released its weekly report on inventories at 10:30 a.m. in Washington.

OPEC will have to cut output of lower-quality grades because of weak demand, Iran's OPEC governor said today. Iran is holding 20 million barrels of crude oil on tankers, about five days of production, people familiar with the situation said last week. Iran's oil includes some of the heaviest and most sulfurous grades sold, making them less desired by refiners.

``If OPEC isn't cutting production officially, they will do it in secret because the price is so high'' and supply cuts would not be popular with consuming nations, Hossein Kazempour Ardebili said in a phone interview from Tehran. ``Cuts will start on a voluntary basis, and will have to become formalized once secondary sources make the numbers clear.''

OPEC Plans

Oil ministers from the Organization of Petroleum Exporting Countries have said there is no need for any change in official policy before the next scheduled gathering in Vienna on Sept. 9.

``This is evidence that there's no shortage of oil,'' said Phil Flynn, a senior trader at Alaron Trading Corp. in Chicago. ``They are paying money to just have the heavy oil sit in tankers. This underscores the importance of oil quality.''

President George W. Bush is heading to Saudi Arabia, the world's largest oil exporter, at the end of this week, where he will raise concerns about high oil prices during his meetings with King Abdullah.

Brent crude oil for June settlement declined $2.24, or 1.8 percent, to settle at $121.86 a barrel on London's ICE Futures Europe exchange. The contract touched a record $125.90 on May 9.

To contact the reporter on this story: Mark Shenk in New York at mshenk1@bloomberg.net.

Last Updated: May 14, 2008 18:00 EDT