Oil futures settled at their lowest level in two weeks Wednesday after a report showed U.S. oil supplies rose more than expected last week, confirming doubts that demand is keeping up with supply.

A disappointing reading on U.S. nonmanufacturing activity also raised concerns about weak U.S. fuel demand, weighing on prices.

Light, sweet crude for June delivery settled down $1.81, or 1.6%, at $109.24 a barrel on the New York Mercantile Exchange. Brent crude on the ICE futures exchange recently fell $1.28, or 1%, to $121.17 a barrel.

Oil inventories rose 3.4 million barrels last week, the Department of Energy said in its closely watched report on U.S. oil and fuel product inventories. Oil supplies have been climbing steadily in recent months as refineries switch gears to ramp up gasoline production for the summer driving season. But the increase was greater than the 2 million-barrel build expected from analysts, signalling less demand from refiners.

"This inventories report is not encouraging any buying," said Matt Smith, oil analyst at Summit Energy in Louisville, Ky.

Gasoline stockpiles fell 1 million barrels, while inventories of distillates, including heating oil and diesel, fell 1.4 million barrels, according to the DOE's Energy Information Administration.

Analysts predicted gasoline stocks would rise 100,000 barrels. They were looking for distillate stocks to climb 400,000 barrels.

Oil prices were lower throughout the day, beginning their steep drop after the Institute for Supply Management said the U.S. nonmanufacturing sector grew less than expected last month. Oil traders are closely scrutinizing reports on economic activity in the U.S., the world's largest crude consumer, and any sign that the recovery is not on track tends to weigh on prices.

The ISM's nonmanufacturing purchasing managers' index dropped to 52.8 last month from 57.3 in March. Forecasters surveyed by Dow Jones Newswires had expected the April PMI to slip to 57.0. Readings above 50 indicate expanding activity.

"We are moving on growth and if there is none, there goes oil," said Carl Larry, director of energy derivatives and research at Blue Ocean Brokerage in New York.

Crude on the Nymex has fallen more than 4% this week as concerns about U.S. demand levels have come into focus. The decline comes amid signs that consumers are starting to cut back on gasoline purchases as pump prices close in on the psychologically important threshold of $4 a gallon. A gallon of regular on Wednesday, on average, cost $3.98 a gallon, according to auto club AAA.

The EIA report showed gasoline demand last week fell 2.2%. For the full month of April, gasoline demand fell 1.9%--the biggest drop in four-week demand levels in more than a year.

On Tuesday, a SpendingPulse report released by MasterCard Advisors LLC showed U.S. weekly gasoline demand fell 1% last week.

Crude could see further losses later this week if additional readings on the U.S. economy fail to impress. The Labor Department's April nonfarm payrolls report, the most closely watched reading on U.S. hiring, is due Friday.

"This market has a lot of hot air between here and $106.75, so we're really going to drift lower," said Tony Rosado, a broker with GA Global Markets.

Front-month June reformulated gasoline blendstock, or RBOB, settled down 0.69 cent, or 0.2%, to $3.3225 a gallon. June heating oil settled down 4.78 cents, or 1.5%, to $3.1430 a gallon.