Oil drops after early rally, Brent premium unwinds

NEW YORK Mon Mar 7, 2011 5:59pm EST

Traders work in the crude oil and natural gas options trading pit on the floor at the New York Mercantile Exchange March 3, 2011. REUTERS/Brendan McDermid

Traders work in the crude oil and natural gas options trading pit on the floor at the New York Mercantile Exchange March 3, 2011.

Credit: Reuters/Brendan McDermid

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NEW YORK (Reuters) - Brent crude oil prices fell more than 1 percent on Monday, reversing steep early gains as traders assessed efforts to stem the conflict in Libya and took profits in Brent's unprecedented premium to U.S. futures.

U.S. crude closed at its highest in 2-1/2 years, buoyed by traders who sold Brent and bought WTI, unwinding a popular trade that had blown out to a record $17 a barrel last week. The Brent/WTI spread has shrunk by more than $7 since then, ending Monday at its narrowest since January.

Trading was volatile, with investors first reacting to attacks by Libyan ruler Muammar Gaddafi's supporters to retake an oil hub from rebels. Then selling kicked in on a report that Gaddafi was seeking a deal to secure a safe exit.

Al-Jazeera later reported rebel leaders had rejected the offer.

Brent crude futures for April delivery fell 93 cents to settle at $115.04 a barrel, pulling back from a session high of $118.50.

U.S. crude futures for April delivery rose $1.02 to settle at $105.44, the highest close since September 2008. But U.S. gasoline and heating oil futures ended lower, slumping with the Brent contract.

"The WTI-Brent spread is starting to unwind, but the Libya fighting and concerns about Saudi Arabia and the region remain," said Richard Ilczyszyn senior market strategist at Lind-Waldock in Chicago.

Brent's premium to its U.S. counterpart fell $1.57 cents to end post-settlement trading at $9.75 a barrel, narrowing for a third day after two months of unprecedented volatility caused by expectations of a long-term glut of landlocked U.S. crude.

LIBYA TURMOIL

Oil prices have surged $12 in just over two weeks as Libyan protests turned into open warfare threatening to leave a lasting scar on the oil sector, also fueling fears unrest could spread to top producers like Saudi Arabia.

The outlook for Libyan production remained uncertain. Government forces seeking to dislodge rebels from Libya's strategically important coast struck at the Ras Lanuf oil town while Britain and France said they were seeking U.N. authority for a no-fly zone.

News that U.S. companies have quit trading in Libyan oil at all due to U.S. sanctions further complicated matters. This raised the risk that even the estimated 600,000 barrels per day (bpd) of crude still being produced -- about one-third of the norm -- might struggle to find buyers.

A leader of Libya's ruling establishment appealed to rebel leaders for dialogue, the clearest sign yet Gaddafi may be ready to compromise with opponents challenging his rule. Rebel leaders dismissed the offer.

NATO has begun 24-hour surveillance of Libya with reconnaissance aircraft as the alliance plans potential steps to address the unrest, the U.S. ambassador to NATO said.

Oil traders also remained on heightened alert for signs of further unrest in other producers, particularly Saudi Arabia, amid sectarian strife in neighbors like Bahrain.

Saudi Arabia's security forces detained at least 22 minority Shi'ites who protested last week against discrimination, activists said on Sunday, as the kingdom tried to keep the wave of Arab unrest outside its borders.

STRATEGIC RESERVE OPTIONS

While prices remain volatile, Brent has traded between $112 and $117 for most of the past week, and both OPEC nations and producer countries are taking a wait-and-see approach before taking any further action to curb prices.

OPEC ministers are holding informal consultations, but not planning an emergency meeting ahead of the next scheduled gathering in June, an OPEC delegate said. Saudi Arabia has said it has increased production significantly.

And a senior IEA official reiterated that a coordinated release of strategic oil stocks was not yet needed because the Libya supply disruption is not that big.

In Washington, officials repeated that releasing the Strategic Petroleum Reserve was one option being considered, but that the government would look at other factors beyond price when making a decision.

(Reporting by Robert Gibbons in New York, Alex Lawler and Karolin Schaps in London and Alejandro Barbajosa in Singapore; Editing by David Gregorio)

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