May 29 (Bloomberg) -- Crude oil fell more than $4 a barrel, the biggest drop since March, on signs that record prices will prompt U.S. consumers to reduce fuel purchases and as the dollar rallied, diminishing oil's appeal as a hedge.

Fuel consumption averaged 20.5 million barrels a day in the four weeks ended May 23, down 0.7 percent from a year earlier, the Energy Department said today. The dollar reached a three- month high against the yen as U.S. stocks gained, brightening the economic outlook of the world's biggest energy consuming country.

``There's a lot of demand destruction taking place,'' said Nauman Barakat, senior vice president of global energy futures at Macquarie Futures USA Inc. in New York. ``We are probably headed for $120 in the near term.''

Crude oil for July delivery fell $4.41, or 3.4 percent, to settle at $126.62 a barrel at 2:57 p.m. on the New York Mercantile Exchange, the lowest close since May 16. It was the biggest drop since March 31. Futures reached a record $135.09 on May 22. Prices have more than doubled over the past year.

Crude oil inventories declined 8.88 million barrels to 311.6 million last week, the department reported. It was the biggest drop since Sept. 17, 2004 when Hurricane Ivan forced the closing of U.S. oil platforms in the Gulf of Mexico. The decline was caused by ``temporary delays'' in unloading tankers, the department said.

Oil traded at $129.23 a barrel, down $1.80, before the release of the report at 10:30 a.m. in Washington. Futures rose more than $2 from yesterday's close to $133.12 a barrel after the report's release.

``The initial reaction to the numbers was a big jump,'' said Tom Bentz, a broker at BNP Paribas in New York. ``There are a lot of questions about the numbers, which explains why prices didn't stay up at those levels.''

Early Release

The Energy Department made its weekly supply report available on its Web site before the scheduled release time, Jonathan Cogan, a department spokesman said in a note. Initial indications suggest a malfunction in the system that allows the loading of data while keeping it from public view before the scheduled release time, he said.

``The report just doesn't seem to make sense,'' said Christopher Edmonds, the managing principal of FIG Partners Energy Research & Capital Group in Atlanta. ``I can't help but wonder if next week there will be a reaction and we'll get a large inventory build.''

Declining Demand

U.S. gasoline demand dropped 5.5 percent last week as prices at the pump reached records, according to MasterCard Inc., the second-biggest credit-card company.

``For several years rising energy prices have had a significant impact on consumers,'' said Jerry Webman, chief economist and head of fixed income at Oppenheimer Funds Inc. in New York, which manages about $220 billion. ``We are starting to see that consumers are cutting back on spending.''

Indonesia, Taiwan, Sri Lanka and Pakistan have decided to raise fuel prices as the cost of subsidies mounts, and Malaysia plans to announce a revision to its subsidies on May 30. India's Oil Secretary M.S. Srinivasan said higher domestic gasoline and diesel prices are inevitable because of rising global prices.

Brent crude oil for July settlement declined $4.04, or 3.1 percent, to settle at $126.89 a barrel on London's ICE Futures Europe exchange. The contract touched a record $135.14 on May 22.

Dollar's Rally

The dollar advanced the most in three weeks against the euro as the government said gross domestic product was stronger last quarter than initially estimated. The rally started yesterday after Federal Reserve Bank of Dallas President Richard Fisher said the central bank will raise interest rates should consumers expect faster inflation.

``The dollar's strength and the outlook for higher U.S. interest rates are putting pressure on prices,'' said John Kilduff, vice president of risk management at MF Global Ltd. in New York.

The weakening dollar and higher global demand for raw materials have led to records this year for commodities including gold, corn, soybeans and rice.

The dollar climbed to 105.60 yen at 4:06 p.m. in New York, from 104.69 yesterday, and climbed to the highest since Feb. 28. The U.S. currency strengthened 0.9 percent to $1.5503 per euro, from $1.5638 yesterday, and touched the strongest since May 19.

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

Last Updated: May 29, 2008 16:44 EDT