Oil prices tumbled below $38 a barrel Tuesday on fresh evidence of weakness in the United States housing market and a shrinking gross domestic product that suggests the recession may be worsening.

A report by the Commerce Department showed that sales of new homes fell in November to the slowest pace in nearly 18 years, while new home prices dropped by the biggest amount in eight months.

"The energy markets are reacting first and foremost to bad economic news and it seems like they're almost waiting for something bad to occur," said oil analyst Peter Beutel of Cameron Hanover.

Light sweet crude for February delivery fell nearly five per cent, or $1.89, to US$38.02 on the New York Mercantile Exchange. Prices fell as low as US$37.79 earlier in the day.

Contract fell

Overnight, the February contract fell $2.45 to settle at $39.91 a barrel after Toyota Motor Corp projected its first-ever operating loss since it began reporting such numbers in 1941.

In London, February Brent crude tumbled more than 4 per cent, or $1.73, to US$39.72 a barrel on the ICE Futures exchange.

A steady outpouring of gloomy economic news has pushed to the background events that over the summer may have led to price spikes, like OPEC's announcement this month of unprecedented production cuts, Beutel said.

Prices have fallen 73 per cent since July, from a peak of US$147, with massive job layoffs and weak consumer spending eating away at energy use.

"Boy, it really looks ugly for the start of 2009," said Tom Kloza, publisher and chief oil analyst at Oil Price Information Service.

"It's really difficult to find something between now and inauguration time that says people are going to feel better, they're going to drive more, they're going to ship more packages," Kloza said.

Small decline

Economists now believe a small decline in US economic activity in the third quarter has worsened significantly.

The Commerce Department said Tuesday that the gross domestic product, the broadest measure of economic health, declined at an annual rate of 0.5 per cent in the July-September quarter.

Corporate profits fell 1.2 per cent.

Some economists believe the economy's decline in the October-December period could be as large as six per cent. If so, that would be the worst quarterly drop since 1982.

The pain appears to have spread through almost every level of the economy.

Cardmaker sank

On Tuesday, shares of cardmaker American Greetings Corp sank to their lowest level in 21 years after the company reported that it swung to a loss in its third quarter.

On Monday, Ogden, Utah-based oil company Flying J Inc and two of its subsidiaries filed for bankruptcy protection, citing a steep drop in oil prices and the lack of available financing due to the disruption in credit markets.

Flying J operates 250 travel plazas and fuel stations in 41 states and six Canadian provinces.

"They won't be the last marketer or refiner that may have to go the bankruptcy route in the next year or so," Kloza said. "It's been pretty rugged out there."

Toby Hassall, an analyst at investment firm Commodity Warrants Australia in Sydney, predicted crude prices could fall as low as US$25 a barrel next year before any recovery occurs.

Slash production

OPEC said last week it would slash production by 2.2 million barrels a day, its largest cutback ever, reducing the amount of oil produced each day by four million barrels in all when earlier cuts are included.

"It will take time for output cuts to flow through, but there's some doubt about whether there will be full compliance," Hassall said. "I wouldn't be surprised if OPEC cut again in January or February. There's been quite a significant demand side deterioration."

Gasoline futures on the Nymex tumbled 5.3 cents to US$0.833 cents a gallon.

Heating oil fell 2.7 cents to US$1.3141 a gallon while natural gas for January delivery rose nearly 17 cents to US$5.462 per 1,000 cubic feet.

- AP