* Gulf of Mexico output returning to normal after storm
* Concerns over U.S. debt default cloud demand outlook (Updates prices to settlement)
NEW YORK, Oct 7 (Reuters) - Crude oil futures on both sides of the Atlantic pared losses on Monday after a sharp drop in earlier trade, following a report that a key pipeline delivering crude oil from Cushing, Oklahoma, had resumed shipping after an earlier outage.
Operations of the Seaway oil pipeline, through which crude oil flows from Cushing to Gulf Coast refineries, resumed after a brief shutdown, industry intelligence firm Genscape reported early on Monday. Cushing is the delivery point for the U.S. oil futures contract.
"There were a lot of concerns that the Gulf Coast was really in trouble" if Cushing's oil was unavailable, and with production curtailed in the Gulf of Mexico because of a tropical storm, said Phil Flynn, energy analyst at Price Futures Group in Chicago, Illinois.
Once Seaway was reported to be back online, Flynn said, the market was "pricing in relief" as WTI cut its losses.
U.S. crude oil slipped 81 cents to settle at $103.03 a barrel, after trading close to $2 a barrel lower at $101.86 earlier in the session. The contract slipped below the 100-day moving average of $102.45.
Brent crude futures reversed earlier losses to finish up 22 cents at $109.68 per barrel, after earlier trading as low as $107.89.
Brent's premium to U.S. crude widened to $6.65, a move of over $1 from Friday's close of $5.62 and its highest premium at settlement since early September.
Oil and gas production in the U.S. Gulf of Mexico was ramping up toward normal on Monday after Tropical Storm Karen faltered off the Gulf Coast. Storm warnings had prompted energy firms to shut in nearly two-thirds of oil output and half of natural gas production as of Saturday.
The Gulf of Mexico accounts for about 1.3 million barrels per day (bpd), nearly a fifth of U.S. oil output.
"Karen did not do any serious damage and I think Gulf production is going to come back online, and that's weighing on WTI," said Gene McGillian, an analyst at Tradition Energy in Stamford, Connecticut.
"I think with that and the worries about the debt ceiling, pushed Brent-WTI out a dollar today," McGillian said.
Economists are increasingly concerned that the budget showdown could prevent legislation to raise the country's borrowing limit by an Oct. 17 deadline, increasing the possibility of a sovereign debt default.
A stalemate between U.S. political parties over how to fund the government continued to weigh on the market as close to 1 million federal workers remained furloughed going into a second week. (Additional reporting by Jeanine Prezioso in New York, Christopher Johnson and Alexander Winning in London and Jacob Gronholt-Pedersen in Singapore; Editing by William Hardy, Steve Orlofsky, Carol Bishopric and Jim Marshall)