Brent crude rose as high as $118.50 a barrel and U.S. oil hit its highest level since September 2008 on Monday on concern over wider supply disruptions in the Middle East before both markets pared gains.
While the Libyan crisis has cut supply from a country that normally provides almost 2 percent of world output, the prospect of unrest spreading to larger producers such as Saudi Arabia is a far more bullish scenario for oil markets.
The major risk remains the prospect of the political unrest spreading to the Gulf producing region, said Caroline Bain, economist at the Economist Intelligence Unit. However, even if there is civil unrest in Saudi Arabia, it is not a given that oil production will be affected.
Brent crude gained 55 cents to $116.52 at 1528 GMT. U.S. crude was up $1.04 at $105.46, having earlier risen as high as $106.95, the highest since September 2008.
Oil traders in New York and London said prices had fallen back as some participants decided to lock in profits and because of a rumor that Libyan leader Muammar Gaddafi was preparing to leave Libya.
In Saudi Arabia, security forces have 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.
Citigroup and Commerzbank raised their oil price forecasts on Monday and the latter is now looking for a Brent price of $120 in the second quarter, citing the risk that disruption could spread in the Middle East.
RISK PREMIUM HIGH
Brent's highest this year is $119.79 reached on February 24. The European benchmark crude traded as high as $118.50 on Monday.
Not only actual production losses but above all the threat of contagion spreading to neighboring regions will keep the geopolitical risk premium at a high level for the time being, Commerzbank said in a report.
The rally in prices has prompted the Obama administration to consider releasing emergency oil stockpiles as policymakers seek ways to contain a negative spillover to the world's biggest economy.
There has so far been no formal response from the Organization of the Petroleum Exporting Countries, which has brushed off the need to meet before a scheduled gathering in June.
OPEC ministers are holding informal consultations, but the group is not planning to hold an emergency meeting, an OPEC delegate said on Monday.
Libya, an OPEC member, usually produces 1.6 million barrels per day and its output has been cut by as much as 1 million bpd, according to the International Energy Agency.
(Additional reporting by Alejandro Barbajosa in Singapore and Karolin Schaps in London; editing by Jason Neely)