Updates with closing prices, adds bullet, Trump and Fed comments in paragraph 5, 18, section on oil inventory drawdown

By Siddharth Cavale and Laila Kearney

NEW YORK, May 21 (Reuters) - Oil prices were volatile on Thursday, ultimately settling about 2% lower as uncertainty over prospects for resolving the U.S.-Israeli conflict with Iran weighed on the market.

Brent crude futures LCOc1 settled at $102.58 a barrel, down $2.44, or 2.3% on Thursday, while U.S. West Texas Intermediate futures CLc1 closed at $96.35, down $1.9 or 1.9%. Both futures closed at their lowest in nearly two weeks.

Earlier in the session, prices had surged as much as 4% after Reuters reported that Iran's supreme leader issued a directive that dented hopes for a swift resolution to the war, before reversing course later in the day.

The Reuters report about that directive, which cited two senior Iranian sources, signaled that Tehran is hardening its stance on a key U.S. demand. The directive from Supreme Leader Ayatollah Mojtaba Khamenei could further complicate negotiations and frustrate U.S. President Donald Trump’s efforts to broker an end to the war.

Trump, later on Thursday, said the U.S. will eventually recover Iran's stockpile of highly enriched uranium - which Washington believes is destined for a nuclear weapon though Tehran says it is intended purely for peaceful purposes.

These developments came a day after Iran announced a new “Persian Gulf Strait Authority,” which would oversee a "controlled maritime zone" in the Strait of Hormuz.

Prices whipsawed throughout Thursday's session. Gains accelerated after U.S. Secretary of State Marco Rubio said a proposed tolling system in the strait would make a diplomatic deal unfeasible. Prices pared gains later after he added that officials from Pakistan, which is acting as a mediator, will travel to Iran for talks.

"We’ve been in this situation multiple times before, which ultimately led to disappointment," ING analysts said in a note on Thursday, forecasting an average Brent price of $104 a barrel in the current quarter. Separately, UBS raised its oil price forecasts by $10 a barrel on Thursday, projecting Brent crude at $105 a barrel and WTI crude at $97 in September.

Iran warned against further attacks and unveiled steps entrenching its control of the strait, which remains mostly closed. Before the war, the strait carried oil and liquefied natural gas shipments equal to about 20% of global consumption.

Economic activity in the euro zone shrank at its sharpest rate in more than 2-1/2 years in May as a war-driven surge in living costs hammered demand for services across Europe and firms accelerated layoffs, surveys showed on Thursday.

Seven leading OPEC+ oil-producing countries will likely agree to a modest hike in July output when they meet on June 7, Reuters reported on Thursday, citing four sources.

OIL STOCKPILES DRAWDOWN

The start of peak summer fuel demand combined with the lack of new oil exports from the Middle East and depleting stocks could push the oil market into the "red zone" in July-August, International Energy Agency head Fatih Birol said on Thursday.

Even if the Middle East conflict ended now, full oil flows through the Strait of Hormuz will not return before the first or second quarter of 2027, Sultan Al Jaber, the CEO of Abu Dhabi National Oil Company (ADNOC) said.

Iran effectively closed the strait in response to the U.S. and Israeli attacks that started the war on February 28. Most of the fighting has stopped since an April ceasefire, Iran is limiting traffic through Hormuz, while the U.S. has blockaded its coastline.

Since the war started, supply losses from the key Middle Eastern producing region have fallen nearly 10 million barrels per day forcing countries to tap their commercial and strategic inventories at a rapid rate, raising concerns about draining global oil stockpiles.

In the United States, an Energy Information Administration report on Wednesday showed that the country withdrew nearly 10 million barrels of oil from its Strategic Petroleum Reserve last week for its biggest drawdown on record. U.S. crude inventories also fell by more than expected last week, according to EIA data.

And on Thursday, Richmond Fed President Thomas Barkin said how businesses and consumers respond to ongoing economic shocks will determine if the U.S. Federal Reserve can "look through" current high inflation or needs to consider raising interest rates.