Oil Settles Below $56, Down 9% in Two Days

Front month contract oil prices settled at their lowest level since June 2005, after the U.S. government reported higher-than-expected inventories of gasoline, heating oil and diesel fuel amid warm winter temperatures.

An unseasonably mild winter in the Northeast and Midwest has led to a buildup in inventories and, as a result, weaker prices.

"There is no winter at all, thus we have a lot of supplies with no home and prices have nothing to do but fall," said James Cordier, president of Liberty Trading Group in Tampa, Fla.

Light, sweet crude for February dropped $2.73, or 4.7%, to settle at $55.59 a barrel on the New York Mercantile Exchange. The settlement follows a 4.5% decline Wednesday and represents the lowest settlement price since June 15, 2005.

The Energy Department said supplies of gasoline and distillates rose more than expected last week. Gasoline inventories increased by 5.6 million barrels, while distillates, which include heating oil and diesel fuel, rose 2.0 million barrels.

Crude supplies fell by a bigger-than-expected 1.3 million barrels during the week.

"It's bearish to the gasoline, and gasoline is half the barrel, so this could be a significant tug on the rest of the complex," Jim Ritterbusch, president of Ritterbusch & Associates told Reuters.

While warm U.S. weather has been weighing on prices, CNBC's Sharon Epperson said other factors are also in play. The stronger dollar and a lack of trading momentum are pulling oil down.

An unusually warm winter in the U.S. has exerted downward pressure on oil prices in recent weeks. The U.S. National Weather Service said above-normal temperatures were likely to continue in the Northeast at least through mid-January.

Weather has played an increasingly important role in oil prices in recent years. Prices surged to $70 a barrel for the first time in 2005 as Hurricane Katrina ravaged the Gulf of Mexico Coast. They broke above $78 a barrel in July 2006 on worries of another bad storm season, and then sank to $60 a barrel when those expectations weren't met.

"For now, it still appears the weather outlook will continue to be the focal point for the energy complex," wrote Mike Fitzpatrick, vice-president for energy risk management at Fimat USA, said in his daily note to clients.