Oil fell over 2 percent to below $74 a barrel on Tuesday as concerns that the conflict between Israel and Hezbollah would spread eased after U.S. Secretary of State Condoleezza Rice said a cease-fire should come as soon as possible.

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U.S. light sweet crude settled down $1.76 at $73.54 a barrel after hitting a high of $76.55 a barrel earlier in the day. London's Brent crude for September deliver settled down $1.56 at $74.36.

Oil has given up nearly $3.50 this week on signs Middle East violence may not engulf major regional crude oil producers.

Prices came off sharply late Tuesday after Rice said a cease-fire should happen "as soon as possible when conditions are conducive to do so."

"We were thinking over the weekend that this conflict would expand, possibly to involve Syria and Iran. Now there is growing belief that this will not enlarge, though it may drag on for a while," said Mark Waggoner, president of Excel Futures in Huntington Beach, California.

Rice's comments came after Israeli warplanes battered Lebanon, killing 31 people, and more Hezbollah rockets struck the Israeli city of Haifa.

Crude was also pressured by a 3.4 percent fall in gold prices during late U.S. activity. Metals and oil have frequently traded closely this year as funds increase exposure in commodities.

"People are looking at the possibility of a cease-fire in the Middle East, which would ease this market. Also, the metals are down, which is something you wouldn't expect," said Tom Bentz of BNP Paribas Commodity Futures Inc.

IRAN CONNECTION

Oil in New York hit a record high of $78.40 Friday and is up 25 percent this year largely because of the Middle East fighting, a dispute over Iran's nuclear program and a flow of investor money into commodities.

The conflict threatens to suck in Hezbollah's Syrian and Iranian allies and to inflame the nuclear row between the West and Iran, keeping the heat under prices, analysts say.

Iran, the world's fourth-biggest oil exporter, funded and supplied Hezbollah during the 1980s but denies providing weapons in the latest round of violence.

Israeli Prime Minister Ehud Olmert on Tuesday accused Hezbollah of coordinating its abduction of two Israeli soldiers last week with Iran, to divert attention away from Tehran's nuclear program.

Israel's army also said Hezbollah was smuggling weapons from Syria but added that it did not regard Syria as a target for attack.

Rising demand in the United States, the world's largest oil consumer, and strong economic growth in China have also supported recent strong oil prices.

Gasoline inventories in the United States, where the peak demand driving season is in full swing, were predicted in a Reuters survey to have fallen by 500,000 barrels last week.

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