* Iran says seized vessel was smuggling fuel
* Britain, U.S. pledge to defend shipping interests
* Oil prices still down sharply this week
* GRAPHIC-U.S. petroleum stocks: https://tmsnrt.rs/2XkQF8e(Updates prices)
By Jessica Resnick-Ault
NEW YORK, July 18 (Reuters) - Oil fell about 2.5% a barrelon Thursday, weighed down by weakness in U.S. equities marketsand an expectation that crude output would rise in the Gulf ofMexico following last week's hurricane in the region.
Prices were further weighed down by economic concerns asU.S. equities were on track for a third consecutive decline.
Brent crude futures settled down $1.73, or 2.7% at$61.93 a barrel.
West Texas Intermediate crude futures were down $1.48a barrel, or 2.6% at $55.30.
The longer-term outlook for oil has also grown increasinglybearish, market participants said on Thursday. Speculators haveexited options positions that could have provided exposure tohigher prices in the next several years, they said.
U.S. offshore oil and gas production has continued to returnto service since Hurricane Barry passed through the Gulf ofMexico last week, triggering platform evacuations and outputcuts. Royal Dutch Shell, a top Gulf producer, saidWednesday it had resumed about 80% of its average dailyproduction in the region.
"You have people that were trying to ride the whole stormand a 9 million(-barrel) draw (in U.S. crude inventories) thatwent with it last week," said Bob Yawger, director of energy atMizuho in New York. "This week the situation has totally changedand everyone is trying to get out of the market."
The retreat from early session highs accelerated after eachbenchmark fell below yesterday's low, which had providedtechnical support, Yawger said.
Oil had fallen on Wednesday in response to a sharp rise inU.S. stockpiles of products such as gasoline that pointed toweak demand during the U.S. driving season.
Data from the U.S. Energy Information Administration showeda larger-than-expected drawdown in crude stockpiles last week.
The summer driving season normally entails increasedconsumption of gasoline.
In addition to the U.S. storm, Middle East tensions havedictated market moves in recent weeks.
Crude rose early in the session after Iran said it hadseized a foreign tanker in the Gulf. Prices pulled back after itemerged that the vessel had only a small cargo and was detainedon Sunday for fuel smuggling.
"The oil price reaction on Thursday shows once again thatthe conflict in the Middle East is far from solved and tensionscould flare up at any time," UBS analyst Giovanni Staunovo said.
"As oil keeps flowing, prices are likely to rise onlytemporarily," Staunovo added.
Britain pledged to defend its shipping interests in theregion, and U.S. Central Command chief General Kenneth McKenziesaid the United States would work "aggressively" to enable freepassage after recent attacks on oil tankers in the Gulf.
Iran said the vessel impounded was the one it towed onSunday after the ship had sent a distress call. U.S. officialssaid on Wednesday they were unsure whether an oil tanker towedinto Iranian waters had been seized or rescued.
Reuters reported on Wednesday that shipping companies werehiring unarmed security guards for voyages through the Gulf.
(Additional reporting by Aaron Sheldrick in Tokyo andBozorgmehr Sharafedin in London; Editing by Marguerita Choy,Jason Neely and Richard Chang)
