Oil firm after two-day rally, but China demand outlook caps gains

SINGAPORE (Reuters) - Oil futures continued to firm on Tuesday, adding to gains of more than 11 percent in the prior two sessions, but persistent worries over China's demand outlook capped prices.

Some investors are betting a bottom has formed to the seven-month long rout on the market, with signs that a fall-off in drilling activity into U.S. shale deposits has raised concerns about future production.

OPEC delegates, though, said prices may stay depressed until summer, due to weak seasonal demand, even as Saudi Arabia's strategy of curbing the output growth of rival producers shows results.

Brent crude oil futures were 84 cents higher at $55.59 a barrel by 0717 GMT (2.13 a.m. ET). U.S. WTI futures were at $50.18 a barrel, up 61 cents.

Prices jumped in the past two days after data showed the number of U.S. oil drilling rigs had fallen the most in a week in nearly 30 years. Month-end covering by traders taking profits on earlier short positions added to the rally.

"The seeds of an oil price recovery are being sown," Bernstein analysts said in a note, warning of further downside risk to oil supply in places such as the Gulf of Mexico, the North Sea and Brazil, as companies cut costs in response to a fall of up to 60 percent in oil prices since mid-June.

"Supply is unlikely to match expectations and demand will recover from last year's lows," the analysts said.

Others warned against getting too excited about falling rig counts in the United States. Analysts at Morgan Stanley said the relationship between rig count and production can be deceptive.

"Headline rig count declines may look impressive, but as we look at the data, much of the drop in oil rig count has come in low yielding vertical or directional rigs, i.e. the low-hanging fruit," they said.

Two OPEC delegates, one from a Gulf producer, said they could not rule out prices dropping to as low as $30 to $35, due to weak demand combined with global refinery maintenance in the first and second quarters of 2015.

Demand in Asia remained weak, with disappointing factory sector activity in China raising questions about energy consumption in the world's second-largest economy.

Morgan Stanley said in a note its China Pulse Business Condition Survey for Energy for last December showed two-thirds of respondents expect the factory sector's conditions to either worsen slightly or significantly, with just a third seeing no change.

No survey participants saw conditions improving slightly or significantly.

Strikes at U.S. plants with a combined 10 percent of the country's refining capacity enter a third day on Tuesday, potentially adding to the supply weighing on prices in the past seven months.

(Editing by Ed Davies, Tom Hogue and Clarence Fernandez)

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