Crude prices rose above $40 US a barrel Monday as Israel and Palestinian militants exchanged rocket fire and the death toll mounted in the oil-rich Middle East.

Light trading contributed to market volatility in the final days of 2008, with price swings of close to $5 a barrel.

Light, sweet crude for February delivery rose $2.31 cents to settle at $40.02 a barrel on the New York Mercantile Exchange, the first time crude has ended the day above $40 in a week. Nymex will be closed Thursday for the New Year's Day holiday.

Retail gasoline prices in the United States continued to fall and neared $1.60 per gallon nationally Monday. In Canada, the price averaged 74.3 cents Cdn a litre, according to price-watching website Gasbuddy.com.

Crude prices flattened out in earlier trading after spiking by as much as seven per cent in overseas trading.

Prices were supported somewhat by indications that key OPEC members were acting on commitments to cut back production, in line with a decision earlier this month to take a daily 2.2 million barrels off the market.

Mid-east conflict

Israel expanded its deadliest-ever air offensive against Gaza's Hamas rulers Sunday and prepared for a possible ground invasion. Arab leaders protested the attacks and Syria broke off indirect peace talks with the Jewish state.

With the three-day death toll climbing to more than 300, Hamas fired rockets deeper than ever into Israel.

"There could be fear that an escalating Middle East conflict could disrupt supplies, though I don't see that happening at this point," said Gerard Rigby, energy analyst with Fuel First Consulting in Sydney.

"(Israel-Palestinian conflict) always causes a bit of a blip and is one component that could support prices short-term," he said.

There were also hints from China the government could go on a crude-buying spree to take advantage of prices below $40 per barrel. A senior government official writing in the People's Daily said China wants to increase its oil reserves to cushion supply shocks that it believes are inevitable.

China is encouraging companies to use all spare petroleum storage capacity to take advantage of the current low prices, the official said.

Asia's biggest refiner, the state-owned China Petroleum & Chemical Corp., recently completed construction of its largest storage project, a 38-tank facility with a total capacity of 32.4 million barrels.

Limits to growth

But any recovery could have its limits.

Oil prices have fallen 73 per cent since peaking at $147.27 a barrel on July 11 as a credit crisis in the U.S. sparked a steep drop-off in consumer demand and corporate earnings. And analysts expect more dismal economic news from the fourth quarter over the next few weeks.

"More bad profit reports, jobs reports, housing results will put pressure on prices," Rigby said.

"Once [U.S. president-elect Barack] Obama comes in, that might start changing sentiment and generate more optimism."

Obama is scheduled to be sworn in as president on Jan. 20.

Trading volumes have been low as many traders take off the week between Christmas and New Year's Day.