Oil dropped more than a dollar on Tuesday after the CME Group hiked trading margins for US crude futures by 25 per cent following a sharp jump in the previous session.

Brent crude fell $1.38 to $114.52 a barrel by 0200 GMT, a day after its second-largest gain on record, off an early low of $114. Nymex crude for June tumbled $1.55 to $101 a barrel, erasing nearly a third of Monday's gains of more than $5. It fell as low as $100.46.

CME, parent of the Chicago Board of Trade, said on its website it had hiked margins for crude oil futures on the New York Mercantile Exchange by $1,250 per contract. With open interest in the contract topping 1.65 million lots last week, that would amount to a total increase of over $2 billion increase.

"Having high margin requirements makes it more difficult for speculative traders to enter the market, so naturally that will cause less speculative activity in oil markets," said Ben Westmore, commodity economist at National Australia Bank.

It also raised the margins for Brent crude by 23.8 per cent and for RBOB gasoline by 21.7 per cent.

Margins are deposits paid by investors in futures markets, where full payment is made when contracts mature, to an exchange or clearing house to cover the risk of default by that investor and typically are based on the largest most-likely daily market move.

CME's move comes after a volatile, frenzied week of oil trading that saw US crude prices fall from over $114 a barrel -- the highest level since 2008 -- to $94 a barrel.

That drop was part of a wider commodities sell-off last week, spurred in part by steep margin increases of 84 per cent in silver over the past two weeks.

The impact of the margin hike on oil prices may be less severe than in silver, which fell more than 30 per cent from a record high in late April due to a succession of margin hikes that nearly doubled trading costs for the precious metal.

"It won't be as significant as the impact on the silver market because silver prices have just risen so strongly and based very little on fundamentals," Westmore said.

Volatility remained high with the Chicago Board Options Exchange's oil volatility index up 0.65, or 1.57 per cent, at 42.09 on Tuesday. The index touched 48.64 last Thursday, the highest in nearly a year.

Oil markets are also under pressure from a downgrade of Greece's credit rating by Standard and Poor's. The cut further into junk category reflects growing doubts that the euro zone's most fragile economy can manage its debt without imposing losses on private bondholders.

A troubled euro zone economy has bearish implications for dollar-denominated crude prices not only because any dollar gain against the euro makes crude costlier in Europe, but because Europe's economic woes may curb its oil demand.

Supporting prices

Other market pressure came from factors ranging from the death of Osama bin Laden to the impact of higher fuel and commodity costs on consumer nations.

Bearish sentiment was limited by rising concerns over US gasoline supply ahead of the summer driving season.

Traders eyed a fire at Chevron's Pascagoula refinery and Mississippi River flooding near several US refineries, though none has been affected.

A Reuters poll ahead of weekly industry and government reports forecast US gasoline supplies had eased last week for the 12th consecutive time, falling 100,000 barrels, while crude stockpiles rose 1.3 million barrels.

US gasoline futures fell 1.61 cents to $3.2622 a gallon, after jumping 6 per cent on Monday.

Brent is expected to retrace to $110.84 per barrel, as a rebound that started from the May 6 low of $105.15 has been completed, while US oil faces a strong resistance at $102.88 and is expected to retrace to $99 per barrel, Reuters market analyst Wang Tao said.

Continuing unrest in Libya and other countries in the region also helped stem a slide in prices. A number of blasts were heard from apparent NATO missile strikes targeting Libyan leader Muammar Gaddafi's compound and other sites in Tripoli on Tuesday, witnesses said.

The blasts came against the backdrop of a stalemate in the  war to unseat Gaddafi and the resulting dilemma for Western powers over whether to offer covert aid to the rebel cause. – Reuters