Oil rose towards $109 a barrel on Friday on a brighter outlook for the economy in China, the world's second-largest oil consumer, but worries about the impact of a possible U.S. fiscal crisis capped gains.
Brent crude was on course to eke out its first weekly gain this month. The January contract, which expires later on Friday, was up $1 to $108.91 a barrel by 1443 GMT.
U.S. crude was up 20 cents at $86.09 and on track for its fifth weekly gain in six.
Growth in China's vast manufacturing sector picked up in December, a survey showed, reinforcing recent indications of a revival in its economic recovery that could boost fuel demand.
"Oil is particularly dominated by Chinese potential demand, and any sign of an upturn in China tends to have a positive effect on oil," Tony Machacek, a broker at Jefferies Bache in London, said.
The HSBC flash purchasing managers' index for China rose to 50.9 for December, a 14-month high.
Data released earlier this week showed that China's November crude imports matched the third-highest daily rate on record as new refining units started operations.
But a ceiling is expected to stay on oil prices for as long as U.S. politicians are in a stalemate over how to avert the "fiscal cliff" of steep tax increases and spending cuts that kicks in early next year.
Frustration mounted over the lack of progress in budget talks as the year-end deadline loomed, overshadowing data that showed a drop in new jobless claims last week to a near four-year low and a rebound in November retail sales.
Also capping gains, a purchasing managers' index suggested that the euro zone recession has deepened in the current quarter after the bloc's private sector contracted for the 11th straight month in December.
The Organization of the Petroleum Exporting Countries (OPEC) is relaxed about the prospect of rising inventories in the first half of next year, the group's secretary general said on Thursday, as long as oil prices avoid extreme moves from their current acceptable level.
OPEC agreed on Wednesday to maintain its oil output target of 30 million barrels per day (bpd), a production level the group exceeded in November by 800,000 bpd.
But forecasts for lower demand suggest OPEC may need to cut output at some point next year.
However, Iraq said it "will never cut production", adding that other OPEC producers should shoulder the burden of cuts if a reduction in supply is required.
"Contrary to many news reports suggesting that the market is oversupplied and that production will need to be cut to avoid a massive stockbuild, crude market fundamentals are actually quite strong at present," analysts at Vienna-based consultancy JBC Energy said in a report.
"Both Dubai and Brent intermonth spreads are exhibiting strong backwardation, indicating that prompt demand for crude remains high."
Oil major BP is close to reaching a deal with Iraq to cut the final production target for the supergiant Rumaila oilfield to between 1.8 million and 2.2 million bpd, down from 2.85 million bpd agreed in 2009. (Additional reporting by Florence Tan in Singapore; Editing by Jane Baird and Jason Neely)