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Oil rally faces tidal wave of supply

Market also faces growing fears about economic weakness sapping demand worldwide

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US crude production hit a record 11.3 million barrels a day in August, and Russia's output rose to 11.4 million bpd, a post-Soviet era peak.

New York

THE oil market's two-year bull run is running into one of its biggest tests in months, facing a tidal wave of supply and growing worries about economic weakness sapping demand worldwide.

After topping out at more than US$75 and US$85 a barrel just a month ago, both US crude and Brent benchmark futures have grappled with near-relentless selling.

For a time, prices had some support on hopes that renewed US sanctions on Iran would force barrels off the market.

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That changed in the last week. The world's three largest producers - Russia, Saudi Arabia and the United States - all indicated they were pumping at record or near-record levels, while the United States said it would allow waivers that could allow buyers to keep importing Iranian oil, lessening the threat of a supply crunch.

Those factors, along with a spate of recent weak economic reports out of China and other emerging markets, have shifted the conversation back toward worries about oversupply, and pushed US futures to lows not seen since April, interrupting an upward move that had consistently found support during the rally's modest pullbacks.

The structure of the US crude futures curve had for several months indicated expectations for tighter supply, but future-dated contracts now suggest investors think markets could be awash in oil over the coming months.

"The magnitude of recent selling is strongly suggesting that global oil demand is weaker than expected as a result of tariff issues, especially between the US and China," said Jim Ritterbusch, president of Ritterbusch & Associates.

There has been an exodus among speculators as well. In the last two weeks, net bullish bets on oil have declined to the lowest level in over a year. Selling notably accelerated on Thursday after US West Texas Intermediate crude futures fell below US$65 a barrel, a level that had stood firm in previous sell-offs during the summer and autumn.

The oil market ran higher in anticipation of this week's formal re-imposition of sanctions against Iran by the US, and on concerns that supply from producers like Saudi Arabia would not be able to make up the difference.

However, the US government said on Friday it will temporarily allow several countries including South Korea and Turkey to keep importing Iranian oil when US sanctions come back into force on Monday, sparing them for now from the threat of US economic penalties. Still, some analysts believe the current sell-off has come too far, too quickly. Major Organization of the Petroleum Exporting Countries (Opec) producers won't be able to add more supply should it become necessary, particularly with production in Iran, Venezuela and Libya still at risk.

"A loss of one million bpd from Iran, further declines in Venezuela, coupled together with geopolitical disruption in Libya and Nigeria could easily wipe out what little spare capacity we have left," Bernstein analysts said last week.

Output from Opec, led by Saudi Arabia, rose to levels not seen in two years. US production hit a record 11.3 million barrels a day in August, and Russia's output rose to 11.4 million bpd, a post-Soviet era peak.

For US crude, the key area to watch is between US$64.45 and US$64.80, where prices had found support in the past, said Fawad Razaqzada, analyst at futures brokerage Forex.com. If oil dips below this point, "the path of least resistance would be to the downside," he added.

For Brent, Mr Razaqzada is watching the range between US$69.50 and US$69.60 a barrel, and if it were to slip below that, we could see a much-larger correction, he noted. REUTERS