Libya pumped around 1.6 million barrels per day (bpd), nearly 2 percent of global supply, before the war cut output. Most of Libya's high-quality crude flowed to European refiners, and tightening supply after Libyan exports stopped drove Brent toward a two-year high of $127.02 in April.
Brent crude dropped as much as $3.08 to $105.54 per barrel at 0627 GMT.
US crude fell 82 cents to $81.44 a barrel. The front-month September US crude contract expires on Monday.
It may take years for output from the world's 17th-largest oil producer to fully recover, but rebels hope to resume oil output -- Libya's main revenue earner. Analysts say output of as much as a million bpd could be feasible within months.
Rebels swept into the heart of Tripoli and crowds took to the streets to celebrate what they saw as the end of Muammar Gaddafi's four decades of power, but a government fightback was reported as dawn broke on Monday.
"You will see a relaxation in the supply of crude to the region as a result of what is happening in Libya," said Jonathan Barratt, managing director at Commodity Broking Services in Sydney on how supplies coming back are hitting prices.
Tight supplies of Libya's light sweet crude in Europe helped fuel a widening of the spread between Brent and US WTI crude. The spread is already narrowing and could contract further with the prospect of a resumption in Libyan supplies, Barratt said.
"The important thing to note is that Brent and WTI (spreads) should be trading at $1-$2. The spreads between WTI and Brent should continue to unwind as Libya's light sweet crude is added back to the market."
Concern about the health of global markets kept investors skittish on Monday.
"The longer term view is that WTI is going to fall off," said Tony Nunan, a risk manager with Mitsubishi Corp in Japan.
"The total market looks pretty weak because of what has happened in the last couple of weeks, with economic data now clearly showing that the US and Europe are slowing down."
European stocks looked set to extend four weeks of losses on Monday, tracking jittery Asian shares lower, while gold shot to new highs as investors worried about the sluggish US economic outlook and Europe's festering debt crisis.
Market players are awaiting a speech from the US Federal Reserve Chairman Ben Bernanke on Friday at a lodge in Wyoming's Jackson Hole, where policymakers and academics meet once a year to talk shop.
Last year, Bernanke used the podium to suggest the Fed could help growth by buying long-term bonds, a prelude to a program enacted soon afterward that did just that.
No grand new plan is expected to be hatched at this year's meeting, but investors are concerned the US may again fall into recession and will be watching closely for any sign of a downgrade in Bernanke's economic outlook.