Brent crude oil fell to US$126 on Monday and US crude futures slipped after touching a two and half-year high on prospects of a Libyan peace agreement and as Saudi Arabia restated its ability to pump more oil if needed.
By mid-morning, ICE Brent crude for May was down 60 cents to $126.05 a barrel after earlier falling over $1 to an intraday low of $125.54.
The African Union said Muammar Gaddafi had accepted a roadmap to end the civil war in Libya, including an immediate ceasefire, but an opposition representative said it would only work if Gaddafi left power.
Carsten Fritsch, an analyst at Commerzbank, remained sceptical about the prospects for peace: "We have seen such peace plans before -- remember some weeks ago we had the Venezuelan plan. Unless Gaddafi steps down I think there is little room for discussion from the rebel side," he said.
The conflict in Libya has cut the country's 1.6 million barrels per day oil output by around 80 per cent, with much more of an impact on Brent prices than US crude.
US crude for May delivery was down 27 cents to $112.52 a barrel after rising as high as $113.46 earlier, the highest since 22 September 2008. Brent surged over $4 on Friday to settle above $126 a barrel, the highest level in 32 months, as commodities rallied due to a weaker dollar and continued fighting in Libya.
"It's a small correction after a huge jump on Friday," said Fritsch. "Oil prices have now reached levels that are no longer justified -- just driven by supply fears, not facts."
He pointed to Saudi comments at the weekend that it stood ready to produce 12.5 million bpd if needed. "So there is still a lot of spare capacity available," Fritsch said.
The market was also watching the outcome of a bailout for Portugal which could be bearish for oil if it does not go smoothly, ANZ analyst Serene Lim said.
Unrest in other parts of Africa and the Middle East that could disrupt oil supplies is still a key concern for investors.
Dozens of unemployed university graduates and teachers staged rare protests in two Saudi cities on Sunday to demand jobs and better wages in the biggest Arab economy, which is struggling to reduce joblessness.
In Syria, a crackdown on popular dissent now in its fourth week killed three people on Sunday, while Gulf Arab countries called on
Yemen's President Ali Abdullah Saleh to hand over power to his vice president and allow the opposition to lead a transition government that would prepare new elections.
The energy markets are also following the progress of elections in Africa's most populous nation Nigeria, which produces 1.9 million barrels of oil per day.