Oil prices fell sharply yesterday as the Bush Administration moved to diffuse Middle East tensions, softening fears of a wider war that could disrupt the region's huge oil flows.

Reference Brent North Sea crude for May delivery dropped to $26.70 (€30) a barrel in late trading from $27.31 on Thursday evening. In New York, light sweet crude May-dated futures gave up another 88 cents a barrel to $25.70 a barrel, extending the past two days of losses, despite a call from Iran for Arab states to halt oil shipments to the west.

The losses bring oil prices down from six-month highs above the $28 mark that were reached on Thursday, when violence between Israel and the Palestinians escalated in the West Bank and tensions simmered on Israel's border with Lebanon.

"This week's inexorable move higher was the result of the tremendous uncertainty, and the President sending in Powell lessens that uncertainty," said a New York analyst.

Oil dealers shrugged a call from Iran's supreme leader Ayatollah Ali Khamenei yesterday for Arab states to set up a "symbolic" one-month oil embargo against western countries to pressure them to stop supporting Israel.

"Arab governments can use oil as a weapon. They can cut off the flow of oil to all the countries which have good ties with Israel," Ayatollah Khamenei said in a sermon during the Muslim prayers in Tehran.

Leading Arab oil exporters Saudi Arabia and Kuwait have both rejected the idea of an embargo, first raised by Iraq on Monday. Non-Arab Iran, the world's second-largest crude oil producer, has tried to cultivate closer ties with fellow OPEC members in order to boost its position in the cartel and assure stronger prices.

OPEC secretary-general Mr Ali Rodriguez said yesterday that OPEC oil exporters were not planning to release any extra crude supply onto world markets this year, even though prices had jumped by one-third in six weeks.

"My opinion is that there should be no increase in production if prices rise due to speculation. If there is demand growth and the market needs more oil, of course we should do so," he said from OPEC's Vienna headquarters.

OPEC has cut production repeatedly in the past year to buoy prices and, most recently, decided to extend output restrictions until at least its next meeting in June. - (Reuters)