Oil prices rose slightly on Tuesday as investors bought commodities to hedge against a weaker dollar and the U.S. government forecast an increase in world oil demand.

The U.S. dollar dropped after Australia's Central Bank unexpectedly raised interest rates, a move investors took as a signal world economies may recover soon, boosting fuel demand.

The U.S. dollar also weakened after Britain's Independent newspaper reported that Gulf Arab states were in secret talks to abandon the greenback as the currency they use to price oil.

The world's largest oil-producing states, including Saudi Arabia and Russia, swiftly denied that report, saying they expected no broad shift away from dollar pricing. Iran, OPEC's No. 2 oil producer, moved away from pricing oil in dollars this year.

Because oil is denominated in dollars for global trading, it tends to rise when the U.S. currency falls as oil becomes cheaper for holders of other currencies. A move away from dollar-based pricing of the world's leading commodity could further weaken the greenback.

U.S. crude for November delivery rose 25 cents to trade for $70.66 a barrel by 1756 GMT (1:56 p.m. EDT). Oil prices earlier rose to a two-week high of $71.97 a barrel, but pared gains as the dollar recovered some of its earlier losses in afternoon trade. Brent crude was up 47 cents at $68.50.

Iran's success at moving to a euro basis for its oil sales ... sparked reports about a possible broader shift away from dollar-based pricing, said Tim Evans, energy analyst at Citi Futures Perspective in New York.

But it looks as though other major oil exporters are sticking with the U.S. dollar, at least for now.

Stock markets also rose Tuesday, helping push oil higher.

It's all about the dollar for commodities and it's all about the dollar for equities, said Chris Jarvis, senior analyst at Caprock Risk Management in New Hampshire.

The U.S. Energy Information Administration raised its outlook Tuesday for world oil demand during the fourth quarter and for 2010, citing expectations of economic recovery in Asia.

EIA raised its global oil demand estimate by 170,000 barrels a day for the fourth quarter of 2009, and said it expected consumption to rise 1.1 million barrels a day next year, versus earlier expectations of a 910,00 bpd rise.

U.S. retail gasoline demand last week jumped 7 percent from the same period last year and rose 0.6 percent from the previous week, according to a MasterCard SpendingPulse report released on Tuesday.

Demand recovery optimism is helping boost oil prices, but most analysts still expect data to show that U.S. crude oil inventories rose last week.

EIA data will likely show that U.S. crude stocks grew 2.2 million barrels in the week to October 2, as refinery utilization and feedstock usage dipped on poor refining margins, according to the average estimate of 14 analysts polled by Reuters.

Weak demand data is stopping prices rallying and maybe fund support is stopping it sinking, said Christopher Bellew, oil broker at Bache Commodities in London.

The American Petroleum Institute will release its inventory report on Tuesday at 2030 GMT, while the EIA will publish its supply data on Wednesday. (Additional reporting Gene Ramos in New York and Christopher Johnson and Joe Brock in London; Editing by David Gregorio)

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