Brent crude fell towards $96 a barrel on Monday after weak factory data from top energy consumer China, while doubts remained over an EU deal which had helped prices post their fourth biggest daily gain on record in the previous session.
A European Union oil embargo on Iranian oil shipments, which took effect on Sunday, should lend some support to prices, but analysts said the grim global macroeconomic picture was likely to cap possible gains.
Brent crude fell $1.17 to $96.63 a barrel by 0551 GMT while U.S. crude shed $1.20 to trade at $83.76.
On Friday, Brent crude rose more than $6 a barrel while U.S. crude jumped by more than $7, their fourth largest daily gains in dollar terms since the contracts were launched.
The gains were largely due to the optimism that coursed through financial markets after European leaders reduced the risk of a euro zone break-up by striking a deal to strengthen the region's banking system and reduce the borrowing costs for Italy and Spain.
The upbeat mood soured after manufacturing activity in China, the world's second biggest economy, worsened in June with export orders, usually an indicator of the economic health of North America and Europe, posting their biggest fall since December.
"Chinese data is one of the contributors to the softer turn this Monday, but I think the oil market has had time to think about the implication of the EU deal over the weekend and is reacting now," said Ric Spooner, chief market analyst at CMC Markets.
"Until they (EU leaders) come up with an actual agreement there's still a fair way to go as we still need to see the details of the agreement and conditions attached to it."
A firmer dollar also weighed on commodities priced in the greenback.
China is the world's second largest oil consumer and a private sector survey on Monday echoed government data released earlier showing factory activity in China shrank in June at the fastest pace in seven months as new export orders tumbled to depths last seen in March 2009.
The economic outlook for Europe was also weak, with French Finance Minister Pierre Moscovici saying on Sunday the government would lower its growth forecasts for 2012 and 2013 given the worsening economic climate.
Lower output
Oil prices, however, were expected to gain support from a strike by offshore workers in Norway's oil sector that entered its second week on Sunday, with labour unions bracing for a long conflict and possible escalation to further lower output from the eighth largest oil exporter.
This coincides with the EU ban on Iranian crude imports, which is part of a push by Western countries aimed at choking Iran's export earnings to try to force it to curb a nuclear programme they fear includes weapons development. Tehran says it has no such plan.
Iran dismissed the embargo saying it was fully prepared to counter the impact of sanctions with a $150 billion war chest of foreign reserves.
Iran's supply slipped by 180,000 bpd to 2.95 million bpd in June, according to a Reuters survey of sources at oil companies, OPEC officials and analysts. That would be its lowest output since it produced 2.81 million bpd in 1989, according to figures from the U.S. Energy Information Administration.
The reduction in Iranian supply is expected to support Brent crude oil prices, though macro market performance will likely have a bigger impact, ANZ analysts said in a note on Monday.
"Calls by Iran for an emergency OPEC meeting to discuss oversupply and the impact on oil prices may also provide a boost this week, although external macro market performances will likely have a bigger influence."
Also in the Middle East, Iraq's oil exports dropped to 2.403 million barrels per day (bpd) on average in June compared with 2.452 million bpd in May, the oil ministry said over the weekend.
