U.S. oil fell 2% on Tuesday after Britain and Iran said they were willing to use diplomacy to end their standoff over 15 British sailors and marines seized in the Gulf.
U.S. crude gave up $1.30 or 2% to settle at $64.64 a barrel, while London Brent fell more than a dollar, following comments by British Prime Minister Tony Blair on apparently conciliatory remarks by Iran.
"We're not looking for a confrontation over this and, actually, the most important thing is to get people back safe and sound. And, if they want to resolve this in a diplomatic way, the door is open," Blair told a radio station in Scotland.
The March 23 detention of the British service personnel propelled U.S. oil above $68 last week, to their highest level in more than six months.
Markets had been on edge for months because of a dispute between OPEC member Iran and the U.N. Security Council over Tehran's nuclear program.
Ali Larijani, the secretary of Iran's Supreme National Security Council, said Iran wanted to resolve the matter of the seized sailors through diplomacy and without a trial.
The drop in crude prices helped boost U.S. stocks, with most major indexes up about 1%.
U.S. oil had traded as low as $63.96 earlier Tuesday, but retraced some of those losses following comments by British Foreign Secretary Margaret Beckett that urged caution against speculation of a rapid solution to the latest dispute.
Brent crude, which is more sensitive to developments in the Middle East because of proximity, commanded a record $3.93 premium to U.S. oil on March 19, according to Reuters data.
"Something will eventually have to give in the current crisis and, when it does, we could be in store for a rather sharp move in either direction," said Edward Meir, an analyst at Man Financial Energy Group in London.
Analysts say it would be difficult to replace the roughly 2.5 million barrels per day of oil exported by Iran, and U.S. President George W. Bush said the standoff had "spooked" markets.
"The price of crude oil is on the rise because people get spooked, for example, when it looks like there may be a crisis with a crude oil producing nation like Iran," he said.
Iran also borders the strategically important Strait of Hormuz, the entrance to the Middle East Gulf and conduit for two-fifths of globally traded oil.
Phil Flynn, an analyst at Alaron Trading, said the "risk premium" associated with Iran was eroding. Prices climbed $6 in the days after the British personnel were seized.
"People think the risk of oil supply from the Middle East being disrupted is diminishing," Flynn said.
U.S. refinery glitches and a drawdown in fuel stocks in the world's top oil consumer ahead of the peak summer driving season also have been supporting the market.
Analysts polled by Reuters forecast U.S. government inventory data to be released on Wednesday would show declines of 300,000 barrels in gasoline stocks for the week to March 30. Crude stocks were expected to have risen 600,000 barrels.
NYMEX May RBOB gasoline fell 2.51 cents or 1.2% to settle at $2.0177, trading from $1.9857 to $2.0430.
NYMEX May heating oil lost 2.38 cents or 1.3% and settled at $1.8387, trading $1.81 to $1.86.