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UPDATE 11-Oil drops after rally on pipeline outage; Brent premium narrows

* Brent premium peaks, then narrows on heavy trading in U.S. crude

* North Sea's Forties pipeline shut after cracks found

* U.S. crude inventories expected to fall for 4th week (New throughout, updates prices, market activity and analyst comments)

HOUSTON, Dec 12 (Reuters) - Oil prices fell sharply on Tuesday, as traders took profits after prices surged early to a two-year high on an unplanned closure of the pipeline that carries the largest North Sea crude oil grade.

Closure of the pipeline crimped the flow of global benchmark Brent crude, but traders said Brent came under pressure when its premium over U.S. crude widened to the most since 2015.

Volume was strong, with U.S. crude seeing more than 700,000 contracts changing hands, compared with the 200-day moving average of 626,000 contracts.

The WTI-Brent spread widened out to as much as $7 <CL-LCO1=R>, the highest in more than two years, then narrowed to $6.23. WTI has lagged Brent, and the discount has helped boost U.S. exports.

"It's definitely a sign of profit-taking in that long position," said John Kilduff, partner at Again Capital LLC.

Brent crude lost $1.58, or 2.4 percent, to $63.09 as of 2:11 p.m. EST (1911 GMT). U.S. crude fell $1.08 a barrel to $56.91.

The Forties pipeline, which carries crude from the North Sea to a processing terminal in Scotland, was shut on Monday after cracks were found. Traders believe is the first unplanned outage for some years in the line, which was scheduled to pump 406,000 barrels per day (bpd) in December.

Its closure pushed Brent prices higher on Monday, and the rally continued into early trading Tuesday, with Brent rising above $65 a barrel for the first time since June 2015..

Forties is important for the global oil market because the crude it carries normally sets the price of dated Brent, a benchmark used to price physical crude around the world and which underpins Brent futures.

"With U.S. oil supplies keeping the WTI price in check its going to be difficult to get a sustained wider spread between WTI and Brent," said Richard Hastings, a macro strategist for Seaport Global Securities in Charlotte, North Carolina.

OPEC members like Nigeria could step up production to replace lost Forties barrels. However, Nigeria faces a nationwide strike that two oil unions are set to launch on Dec. 18.

Nigeria "has room under the OPEC deal to expand oil output, but they cant simply turn a valve to increase production to export," said Robert Yawger, director of energy futures at Mizhuo.

U.S. crude stocks are expected to fall by 3.8 million barrels, a fourth straight week of decline, according to analysts polled ahead of reports from industry group American Petroleum Institute and the government's Energy Information Administration.

The API will release its data at 4:30 p.m. EST. The EIA follows on Wednesday.

Oil supply cuts led by the Organization of the Petroleum Exporting Countries this year have helped whittle away an excess of inventories that persisted for nearly three years.

U.S. crude has lagged the rally in Brent in part because of rising U.S. oil production <C-OUT-T-EIA>.

(Additional reporting by Henning Gloystein; Editing by Susan Fenton and David Gregorio)