By Simon Falush
LONDON (Reuters) - Oil futures fell towards $112 per barrel on Tuesday, pressured by signs of a thaw in relations between Iran and the West although market players saw scope for gains if violence in Iraq threatened production from OPEC's second-biggest producer.
Islamic militants have seized towns in the north of the country in the past week, although Iraq's 3.3 million barrels per day of oil exports remain unaffected so far.
"(The rally) has paused rather than come to an end and it will go substantially higher if there's any threat to the south (where the majority of oil production is centred)," said Christopher Bellew at Jefferies Bache.
"A threat to Baghdad could affect mechanisms for buying and selling oil, too."
BP Chief Executive Bob Dudley said on Tuesday the oil company's operations in Iraq were unaffected by the violence.
Still, Iraq's oil growth targets look increasingly at risk, the International Energy Agency said, the threat to supplies from political instability and violence.
Highlighting that threat, Iraq's biggest oil refinery, Baiji, has been shut down and its foreign staff evacuated, refinery officials said on Tuesday. Brent crude for August delivery was down 24 cents to $112.70 per barrel by 1028 GMT. The contract settled 48 cents higher on Monday, after touching an intraday high of $113.28.
U.S. July crude was down 56 cents at $106.34 a barrel, after closing 1 cent lower. The U.S. July contract expires on June 20.
Brent prices rose around 4 percent last week, the most since July last year, but the rally has paused since the Iraqi government tightened security.
Andrey Kryuchenkov, analyst at VTB Capital, said that there is a $5 risk premium in the oil price, but added that the outage of Libyan oil exports, which are down to almost nothing from above 1 million barrels per day, were also an important factor.
IRAN, UKRAINE
Britain plans to re-open its embassy in Iran, Foreign Secretary William Hague said, two and a half years after a mob ransacked the embassy.
The UK's announcement came as U.S. and Iranian officials discussed the Iraq crisis although both ruled out military cooperation. They met on the sidelines of a meeting which started on Tuesday in Vienna as Iran and six world powers aim to narrow differences and end a decade-old nuclear dispute.
A successful outcome could see additional Iranian crude exported to global markets if sanctions are eased, although no such move is expected imminently.
There were threats to supply elsewhere, however. Russia cut off natural gas supplies to Ukraine on Monday in a dispute over unpaid bills that could increase demand for alternative fuels such as oil.
(Additional reporting by Jacob Gronholt-Pederson; editing by Jason Neely)
