Brent crude climbed above $110 (Dh404) yesterday, extending gains from last week, as rising tensions between Iran and the West increased the risk of disruptions to crude shipments by Opec's second-largest oil exporter.
The dispute over Teh-ran's nuclear programme heated up over the weekend after Iranian media reported their country's military had shot down a US reconnaissance drone, although a US official said there was no indication the aircraft had been hit.
Brent crude rose 88 cents to $110.82 a barrel by 0722 GMT, after posting a weekly gain of more than three per cent, in its best weekly percentage gain since mid-October.
US crude climbed 53 cents to $101.49 a barrel. The benchmark posted a gain of 4.3 per cent last week.
"Oil traders are pricing in a 20 per cent chance of a military conflict with Iran, which could push prices above $200, so they're buying insurance now," said Gordon Kwan, head of energy research at Mirae Asset Management in Hong Kong.
An Iranian official said on Sunday any move to block its oil exports would result in oil prices soaring above $250 a barrel.
The US has in recent weeks repeatedly warned against a strike on Iran, although recent official comments suggest that Israel remains unmoved by Washington's lobbying.
On Friday, US defence secretary Leon Panetta made one of his most extensive arguments to date against any imminent military action against Iran over its nuclear programme, saying he was convinced sanctions and diplomatic pressure were working.
Israeli Prime Minister Benjamin Netanyahu responded indirectly by saying that Israel had in the past made the right decision to go it alone even when allies objected.
Israel has called a nuclear-armed Iran an existential threat to Israel, and along with the US has said that all options are on the table to deal with such a threat. Iran says it is enriching uranium for peaceful purposes.
Iran is also unlikely to support production hikes when the Organisation of Petroleum Exporting Countries (Opec) meets in Vienna next week, increasing the risk the grouping will fail to raise output at a time when high energy prices threaten to push the global economy into recession.
"The market is also watching for the Opec meeting on December 14, and recent hawkish statements about no need for production increases despite high prices," said Kwan.
Oil ministers from Opec members Kuwait, Oman and Bahrain yesterday said the market was well supplied, echoing similar comments by Qatar's energy minister and the Opec Secretary-General Abdullah Al Badri a day earlier.
Events in the Middle East overshadowed the debt crisis in Europe, which has weighed on oil prices for months and enters a critical phase this week as European leaders are set to unveil a definitive rescue plan at a crucial summit.
"Over the past week, markets have been positioning themselves to reduce the risk of being caught on the wrong side of initiatives that will improve the situation in Europe," said Ric Spooner, chief market analyst at CMC Markets in Sydney.
"Markets will also be encouraged by news that new Italian Prime Minister Mrio Monti has won cabinet approval for a package of austerity measures."
Asian shares and the euro were steady yesterday ahead of an eventful week in Europe, which also sees the European Central Bank's last monetary policy meeting for the year on Thursday, with an expectation for a rate cut.
Later yesterday, French President Nicolas Sarkozy and German Chancellor Angela Merkel were to meet to outline joint proposals for greater budget discipline in the Eurozone, which they want all 27 EU leaders to approve at Friday's summit.
The Chinese economy showed further signs of slowing yesterday, raising hopes the central bank would take more action to support growth in the world's No. 2 oil consumer. The HSBC Purchasing Managers' Index (PMI) for China's services sector fell to 52.5 from 54.1 in November.