NEW YORK (Reuters) - Oil prices climbed on Thursday, with U.S. crude hitting a three-and-a-half year high, bolstered by supply concerns due to U.S. sanctions that could cause a large drop in crude exports from Iran.

Crude oil is dispensed into a bottle in this illustration photo June 1, 2017. REUTERS/Thomas White/Illustration

West Texas Intermediate (WTI) crude CLc1 futures rose 69 cents, nearly 1 percent, to settle at $73.45 a barrel. It reached $74.03 earlier in the session, the highest since Nov. 26, 2014.

Brent crude LCOc1 futures rose 23 cents to settle at $77.85 a barrel.

The United States this week demanded countries halt imports of Iranian oil from November, a hardline position the Trump administration hopes will cut off funding to Tehran.

On Thursday, officials said they would work with countries on a case-by-case basis. China, the biggest importer of Iran’s oil, has not committed to the U.S. position.

“The sanctions are trying to isolate Iran a bit more, and that potentially cuts more oil off from the overall global arena as a whole,” said Mark Watkins, a regional investment strategist at U.S. Bank Wealth Management.

“If you’re having Iran’s oil taken off the market, then you have a decrease in supply and by all means, that’s going to put more pressure on the price of oil to move up.”

The U.S. demands follow a decision by the Organization of the Petroleum Exporting Countries last week to increase production to try to moderate oil prices that have rallied more than 40 percent over the last year.

Oil prices have rallied for much of 2018 on tightening market conditions due to record demand and voluntary supply cuts led by OPEC and other producers including Russia.

Unplanned supply disruptions from Canada to Libya and Venezuela also have supported prices.

U.S crude futures extended gains after data showed inventories at the Cushing, Oklahoma, delivery hub fell by 3.1 million barrels in the week through June 26, traders said, citing data from market intelligence firm Genscape.

Front-month WTI's premium to the second month CLc1-CLc2 surged after the data and hit a session high of $1.81, while U.S. crude's discount to Brent WTCLc1-LCoc1 narrowed to the smallest in three months at $3.92 a barrel.

“You look at the front spreads for crude oil, and it’s been the front-month contracts that have blown out, almost like this is a knee-jerk reaction to a headline versus a long-term structural uptrend that is still intact,” said Brian LaRose, senior technical analyst at ICAP-TA.

Not all indicators point toward an ever-tightening market. U.S. crude production C-OUT-T-EIA is approaching 11 million barrels per day (bpd), and Saudi Arabia expects to match that in coming months as well.

But analysts say the market has little spare capacity to deal with further disruptions.

“With inventories still declining and spare capacity uncomfortably low, there is very little cushion for any supply disruption caused by rising geopolitical risks,” ANZ bank said.

To view a graphic on Russia vs Saudi vs U.S. oil production, click: reut.rs/2IvGmGz

To view a graphic on U.S. crude oil production, storage levels, click: reut.rs/2tAHzHT