* Strong global demand has been outstripping production
* Supply overhang of 2014-2017 virtually eliminated - OPEC
* China refinery demand at second highest level on record (Updates throughout, changes dateline, previous SINGAPORE)
LONDON, May 15 (Reuters) - Oil prices hit a 3-1/2-year high on Tuesday, supported by tight supply and planned U.S. sanctions against Iran that are likely to restrict crude oil exports from one of the biggest producers in the Middle East.
Benchmark Brent crude oil reached $78.60 a barrel, up 37 cents and its highest since November 2014. By 0800 GMT, Brent was up 20 cents at $78.43.
U.S. light crude was 5 cents higher at $71.01 a barrel, also not far off its highest since November 2014.
World oil prices have surged by more than 70 percent over the last year as demand has risen sharply but production has been restricted by the Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, and other key producers including Russia.
Now the United States has announced that it will impose sanctions on Iran over its nuclear program, raising fears that markets will face shortages later this year when trade restrictions come into effect.
"The commitment of Saudi Arabia and the rest of OPEC to the production cuts is a major factor in supporting the price at the moment as well as the possibility of reduced exports from Iran due to sanctions," said William O'Loughlin, investment analyst at Rivkin Securities.
Global oil demand is rising sharply.
In China, the world's biggest oil importer, refinery runs rose nearly 12 percent in April compared with the same month a year ago, to around 12.06 million barrels per day (bpd), marking the second-highest level on record on a daily basis, data showed on Tuesday.
The tightening market has all but eliminated a global supply overhang which depressed crude prices between late 2014 and early 2017.
OPEC figures published on Monday showed that oil inventories in OECD industrialized nations in March fell to 9 million barrels above the five-year average, down from 340 million barrels above the average in January 2017.
U.S. crude is trading at a hefty discount to Brent, the international marker, thanks to sharp rises in U.S. production to 10.7 million barrels per day, which has left the American domestic oil market well supplied.
U.S. shale oil production is expected to rise by about 145,000 bpd to a record 7.18 million bpd in June, the U.S. Energy Information Administration said on Monday.
The Permian basin in Texas, the biggest U.S. oil patch, is expected to see output climb 78,000 bpd to a fresh record of 3.28 million bpd.
(Additional reporting by Henning Gloystein in Singapore; Editing by Susan Fenton)