Oil fell more than $1 on Monday after forecasts projected Hurricane Dean would skirt to the south of the U.S. Gulf of Mexico that is home to half of U.S. refining capacity and pumps a third of its oil.

U.S. crude was down $1.48 at $70.50 a barrel by 1547 GMT, erasing Friday's rally when the U.S. Federal Reserve cut its discount rate to restore order to financial markets and as Dean menaced.

London Brent crude fell $1.27 to $69.17.

The U.S. National Hurricane Center forecast Dean would remain south of the U.S. portion of the Gulf and cross the Yucatan Peninsula en route to the east coast of Mexico.

Barring a sudden northerly veering of the track of the storm, Gulf of Mexico production should be materially unaffected, Citigroup analysts said in a research note.

But Mexico's Bay of Campeche, home to 70 percent of Mexican oil output including the giant Cantarell field, was vulnerable to the storm, analysts noted. There are no significant refining operations in the area under threat, however.

Hurricane Dean, packing winds of 150 miles, was likely to become a Category 5 hurricane before making landfall on the Yucatan peninsula early Tuesday morning, the U.S. National Hurricane Center said.

As of Sunday, U.S. operators had shut around 23,000 barrels per day (bpd) out of 1.3 million bpd of Gulf oil output and 54 million cubic feet out of 7.7 billion cubic feet of natural gas.

Mexico's state oil company Pemex said it had begun evacuating more than 13,000 workers from rigs. It halted shipments of crude oil from the 300,000 bpd Dos Bocas as the hurricane approached.

Mexico is among the top crude oil suppliers to U.S. refiners, with Mexican exports to its neighbor averaging 1.469 million bpd this year.

Oil had rallied on Friday, recovering from its lowest close in a month and a half after the Federal Reserve's move to cut its discount lending rate by a half percentage point lifted stock markets battered by the credit market squeeze.

European stock markets continued to rally on Monday.

Last week's losses in financial markets had taken a toll on oil as investors sold to cover positions, knocking U.S. crude prices nearly 10 percent down from the record high on August 1.

Should the Fed's action prove insufficient to calm market concerns, we believe that further liquidation could cause U.S. WTI prices to drop to the mid-$60 a barrel level given the large remaining net speculative length in the energy market, Goldman Sachs wrote in a research note.

It listed three factors that may trigger further liquidation: continued fund redemptions and the need to obtain liquidity; data suggesting a credit contagion to the real economy; data such as a U.S. oil stock build.

Longer term, the continuing global credit turbulence raises significant risks for oil demand growth, but in the short term the biggest impacts on oil markets will likely be a flight to safety and a need to liquidate holdings to unwind leveraged positions elsewhere, PFC Energy said in a report.

(Additional reporting by Fayen Wong in Sydney)

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