Brent crude was down 50 cents a barrel at $80.28 by 1320 GMT.
The rise, reported by the US Energy Information Administration was nearly triple what analysts had forecast and further eased prices, which had hit four-year highs of $86.74 earlier this month.
Jim Ritterbusch, president of Ritterbusch and Associates, said Saudi Arabia could cut as much as 500,000 bpd of crude production "as a warning shot" to discourage US sanctions.
"Numbers from the American Petroleum Institute surprised the market yesterday, with USA crude oil inventories declining by 2.13 million barrels over the last week, compared to expectations of a stock build", said ING commodities strategist Warren Patterson.
Venezuela and Libya also present geopolitical risks to global oil supply, and even Saudi Arabia's promise to increase its own production to make up for the shortfall hasn't soothed investors, according to Harry Tchilinguirian, global head of commodity markets strategy at BNP Paribas. USA light crude was 40 cents lower at $71.38.
Khashoggi is a columnist for The Washington Post, which reported Tuesday that U.S. Secretary of State Mike Pompeo arrived in Saudi Arabia with for talks with officials over the journalist's disappearance.
It's not yet clear to what extent, if any, China will curb shipments of Iranian crude due to USA sanctions.
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Saudi Arabia tensions did not cause the collapse in Saudi equities nor any move in crude oil.
The United States announced new sanctions after withdrawing from a nuclear deal with Iran in May.
"The market is reacting to the unexpected decline as inventories tend to rise at this time of year", said Tomomichi Akuta, senior economist at Mitsubishi UFJ Research and Consulting in Tokyo.
Falih said oil prices would "easily be at the three digit range had it not been for the extra effort the kingdom has done over many years by investing in capacity and then unleashing that capacity, delivering barrels over last few months, reversing inventory draw down". They also expect to see declines in stockpiles of gasoline by 1.52 million barrels and distillates by 1.5 million barrels.
The market has been supported by reports that Iranian crude exports may be falling faster than expected ahead of November 4, the date U.S. sanctions on the commodity are due to start.
"This has raised concerns that the Saudis may use oil as a tool for retaliation if any sanctions or other action is taken against it", Patterson said.