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US oil closes 35 cents lower, or 0.93%, at $37.16 a barrel

Oil inventories fall 3.57M barrels
Oil expectations slip as crude flirts with 7-year lows
Commodities crush

Oil prices settled lower on Wednesday after traders and investors ignored an unexpected drawdown in U.S. crude stockpiles to focus on a build in distillates, including diesel, that came in twice more than expected.

Crude inventories across the United States fell 3.6 million barrels last week, the government's Energy Information Administration (EIA) said. It was the first stockpile drop after 10 straight weeks of builds, bucking a 300,000-barrel build forecast in a Reuters poll.

Futures of Brent and U.S. crude's West Texas Intermediate (WTI) were up more than $1 a barrel in an immediate reaction to the data, before turning negative later as the market's attention turned to the bearish distillate numbers.

The EIA said distillate inventories jumped by 5 million barrels, double the forecast and the sharpest rise since January, while demand for the fuels fell to its lowest level seasonally since 1998, according to the data.

"The large rise in distillate fuels will likely work to make the report bearish by day's end," said John Kilduff, partner at New York energy hedge fund Again Capital.

Oil will be almost double in next year: Pro

Brent crude oil futures were down 6 cents at $40.20 a barrel at 2:33 p.m. EDT, hitting a near seven-year low at $39.57 a barrel. Brent lost about $4, or 10 percent, since an OPEC meeting last week that virtually abandoned price support measures.

U.S. West Texas Intermediate (WTI) crude futures settled at $37.16 a barrel, down 35 cents, or 0.93 percent.

Futures of U.S. ultra low sulfur diesel, also known as heating oil, slumped more than 2 percent.

PIRA Energy, a closely-followed market consultancy, said crude would be under more pressure soon as onshore oil storage was likely to run out by the first quarter.

"Brent crude prices will continue to struggle due to a large global commercial oil stock surplus, which PIRA estimates will total 500 million barrels above normal levels by end-2015," it said.

Some analysts thought the EIA inventory data, which also cited a smaller-than-expected build in gasoline stockpiles, was supportive.

"I would call the data bullish," said Dominic Chirichella, senior partner at the Energy Management Institute in New York. "U.S. production is also down in the lower 48 states. (The) Main crude oil inventory decline is in PADD 3."

Crude stocks in PADD 3, or the Gulf Coast, dropped 7.3 million barrels, the most since December 2012, likely due to inventory unloading that is typical at this time of year, as refiners use up crude they have on hand before the onset of the U.S. tax season.

"It's a tax consequence," said Tariq Zahir, trader at Tyche Capital Advisors in New York.

Andy Lipow, president of Lipow Oil Associates, told CNBC crude deliveries into the Gulf region had also been delayed by fog in the ship channel last week.

—CNBC's Tom DiChristopher contributed to this report. Patti Domm contributed reporting.