Adds EIA data in paragraph 13, 14

By Nicole Jao

NEW YORK, May 6 (Reuters) - Oil prices fell sharply to two-week lows on Wednesday as optimism grew about a possible end to the war in the Middle East, with reports the United States and Iran were nearing an initial peace deal.

Brent crude futures LCOc1 were $7.63, or 6.94%, lower at $102.24 a barrel by 11:51 a.m. ET (1551 GMT), having earlier dropped below $100 for the first time since April 22. U.S. West Texas Intermediate CLc1 lost $7, or 6.84%, to $95.27.

A source from mediator Pakistan said the United States and Iran were closing in on an agreement on a one-page memorandum of understanding.

Iran said on Wednesday it was reviewing a new U.S. proposal. An Iranian foreign ministry spokesperson, cited by Iran's ISNA news agency, said Iran would convey its response soon via Pakistan.

Iran had said earlier that it would only accept a fair and comprehensive agreement.

U.S. media outlet Axios reported that the U.S. expects Iranian responses on several key points in the next 48 hours, citing sources saying this was the closest the parties had come to an agreement since the war began.

Both crude contracts hit their lowest in two weeks, with Brent hitting an intra-session low of $96.75 before paring losses after U.S. President Donald Trump said it was "too soon" to consider face-to-face talks with Tehran, and as a senior Iranian MP said the U.S. proposal was more of a wish list than a reality.

The U.S. military said on Monday that it destroyed several Iranian small boats as part of efforts to help stranded ships exit the Strait of Hormuz.

“A deal announcement would move futures further immediately, in fact even the potential of a deal is already triggering a decline in oil prices," said Rystad Energy chief oil analyst Paola Rodriguez-Masiu.

However, the global oil flow would take time to normalize even if the strait is restored. "The six-to-eight-week lag between credible access conditions and real flow normalization is not a conservative estimate, it is a structural feature of how shipping markets work," Rodriguez-Masiu added.

Crude oil supply losses from halted marine traffic through the strait since the war began in February have driven up prices, with Brent trading last week at its highest since March 2022.

The Strait of Hormuz closure has resulted in a drawdown in global oil and fuel inventories as refineries try to offset production shortfalls.

U.S. crude and fuel inventories continued to draw down last week, the Energy Information Administration said on Wednesday, as countries around the globe scrambled to fill supply gaps caused by disruptions from the conflict in the Middle East.

Crude oil stocks fell by 2.3 million barrels to 457.2 million barrels last week, the EIA said, compared with analysts' expectations in a Reuters poll for a 3.3 million-barrel draw.