Oil settles lower after rally on pipeline outage; Brent premium narrows

* Brent settles down 2 percent after early rally

* North Sea's Forties pipeline shut after cracks found

* U.S. crude oil stocks fall 7.4 mln barrels (Updates prices, adds API (Stuttgart: 565969.SG - news) data, analyst comments)

By Bryan Sims

HOUSTON, Dec (Shanghai: 600875.SS - news) 12 (Reuters) - Oil prices fell sharply on Tuesday, as traders took profits after prices surged early to a two-year high on an unplanned closure of the pipeline that carries the largest North Sea crude oil grade.

Brent crude settled down $1.35, or 2 percent, at $63.34. U.S. crude settled at $56.91 a barrel, 82 cents lower, or 1.4 percent.

Selling picked up after the U.S. Energy Information Administration said in its monthly short-term energy outlook that U.S. crude oil output will rise by 780,000 barrels per day (bpd) to 10.02 million bpd in 2018.

Last month, it expected a 720,000 bpd year-over-year increase to 9.95 million bpd.

"The market is respecting what is saying but they're taking it with a grain of salt," said Phil Flynn, analyst at Price Futures Group.

Volume was strong, with U.S. crude seeing more than 780,000 contracts changing hands, compared with the 200-day moving average of 626,000 contracts.

The WTI-Brent spread widened to as much as $7 (CL-LCO1=R), the highest in more than two years, then narrowed to $6.38. WTI has lagged Brent, and the discount has helped boost U.S. exports.

The Forties pipeline, which carries crude from the North Sea to a processing terminal in Scotland, was shut on Monday after cracks were found. Traders believe it is the first unplanned outage for some years in the line, which was scheduled to pump 406,000 barrels per day (bpd) in December.

Its closure pushed Brent prices higher on Monday and early on Tuesday, with Brent rising above $65 a barrel for the first time since June 2015.

Forties is important for the global oil market because the crude it carries normally sets the price of dated Brent, a benchmark used to price physical crude around the world and which underpins Brent futures.

Industry group the American Petroleum Institute said on Tuesday that crude stocks fell by 7.4 million barrels, more than expected.

But gasoline stocks were up by 2.3 million barrels, and distillate inventories rose by 1.5 million barrels, compared with expectations for a 902,000-barrel gain, the API data showed.

Analysts expect data on Wednesday from the U.S. Energy Information Administration (EIA) to show crude stocks fell 3.8 million barrels last week.

(Additional reporting by Henning Gloystein; Editing by Susan Fenton and David Gregorio)