* Brent bounces off two-month low
* U.S. crude reverses two weeks of losses
* Libya, Iran supply expectations limit gains in Brent
By Elizabeth Dilts
NEW YORK, Jan 17 (Reuters) - Demand for heating fuels andrising gasoline prices drove oil higher on Friday, but gainswere limited by a stronger dollar and expectations for increasedsupply from Libya and Iran.
U.S. heating oil and gasoline futures both climbed more than1 percent on higher demand as the U.S. prepares for another coldsnap and as traders bought contracts to cover short positions inheating oil.
The spread between the European and U.S. crude oil futuresbenchmarks contracted to its narrowest point since the start ofthe new year due to the start-up of a major U.S. pipeline, whichis expected to bring more oil to refining markets.
"The Gulf Coast ULSD (heating oil) contract is showing morestrength because its underlying fundamentals are tighter thangasoline," said Gene McGillian, an analyst at Tradition Energyin Stamford, Connecticut. "We have forecast for cold weather,and we know we are going to see more export demand in the comingmonths."
Brent oil for March delivery settled up 73 centsat$106.48 a barrel, rebounding from the two-month low of $105.44it hit earlier in the day. U.S. crude settled at atwo-week high, up 41 cents at $94.37 a barrel, reversing twoweeks of losses.
Floor trading will be closed on Monday and there will be nosettlement on the New York Mercantile Exchange due to the MartinLuther King, Jr. Day holiday.
Brent prices have fallen almost 10 percent since August onexpectations for increased supply from Libya and Iran. TheEuropean benchmark's premium to U.S. oil ended thesession at $11.89, the narrowest since Dec. 20 when it reached$11.86.
TransCanada's Gulf Coast pipeline is expected to startpumping 300,000 barrels per day of U.S. crude oil from the U.S.storage hub in Cushing, Oklahoma, to the Gulf Coast next week,further narrowing the U.S. discount to Brent.
Front-month RBOB gasoline futures ended the day up2.53 cents at $2.6204 per gallon, rising from Thursday's morethan two-month low of $2.5882.
Ultra low-sulfur diesel futures (ULSD), commonly known asheating oil, settled 3.92 cents higher at $3.0237 per gallon.
Refiners in Asia, Europe and Russia are shipping around halfa million tons of heating oil and diesel to the United Statesthis month after bitterly cold weather last week sharply reducedfuel stocks. At least a dozen tankers have been booked so far inJanuary to ship gasoil and diesel to the U.S. East Coast,according to traders and shipping data.
The U.S. dollar index, a measure of the dollar's strengthagainst a basket of currencies, was last trading .41 percenthigher at $81.247. A stronger dollar is bearish for commoditiespriced in the greenback as it makes them more expensive forholders of other currencies.
LIBYA, IRAN
The restart of crude oil production at the El Sharara fieldin Libya two weeks ago and a jump in exports from Iraq'ssouthern terminals in the first two weeks of 2014 have weighedon Brent crude prices. However, Iraq's supply could be cut inFebruary because of loading delays caused partly by bad weather,which would support prices.
As well, the market awaited news of increased Iranian oilexports. Sanctions have cut Iran's oil exports by more than halfover the past 18 months to about 1 million barrels per day(bpd). But Iran may be able to release more into world marketsif a dispute over its nuclear work can be resolved.
A preliminary accord between Iran and a group of worldpowers is effective starting Jan. 20, while talks on a finalsettlement will start in February.
