Differing views on a plan to limit oil output also pressured prices. Kuwait, producing 3 million barrels per day (bpd), said it will freeze output only if all major producers participate, including Iran, which has balked at the plan.

Brent settled down $1.19, or 2.9 percent, at $39.65 a barrel after hitting a 2016 high of $41.48 during the session. Despite the day's decline, it was up 46 percent from a 12-year low of $27.10 struck on Jan. 20.

U.S. crude closed down $1.40, or 3.7 percent, at $36.50, after rallying earlier to a three-month high of $38.39.

"Today's selloff didn't feel like the beginning of a sustained price decline," said Jim Ritterbusch of Chicago-based consultancy Ritterbusch & Associates.

"We feel that this one-month $8-9 price advance simply got ahead of itself with newly positioned longs anxious to accept some profits," he said, expecting tight trading ranges going forward.

Prices did not rebound on a U.S. government forecast that domestic crude output will fall by 760,000 bpd this year, above a previously forecast drop of 740,000 bpd.

After settlement, preliminary data from the American Petroleum Institute (API), an industry group, showed U.S. crude stockpiles rose by 4.4 million last week, hitting a record high for a fourth week in a row. [API/S].

An updated Reuters poll of oil analysts forecast a build of 3.9 million barrels for last week. The U.S. government's Energy Information Administration (EIA) will issue official inventory data on Wednesday. [EIA/S]

Goldman Sachs said in a report crude prices need to be low to prevent U.S. shale producers from ramping up output. "Otherwise, an oil price rally will prove self-defeating, as it did last spring."

A global oil glut, estimated at a billion barrels above consumption in 2014/15, brought crude prices off their long-standing perch above $100 a barrel.

In Europe, monthly loading data shows North Sea crude supply should hit a four-year peak in April, holding above 2 million bpd for an eighth consecutive month.

In Asia, China's crude imports jumped 19 percent between January and February to 31.80 million tonnes. But Brent's rally to $40 could slow oil purchases in the second quarter, trade sources say, amid questions about China's economic health after a plunge in February exports.

(Additional reporting by Karolin Schaps in LONDON and Henning Gloystein in SINGAPORE; Editing by Meredith Mazilli and David Gregorio)

By Barani Krishnan