Hopes the global oil oversupply is coming to a halt have sent oil prices rallying almost 20% the past month, but there's a major risk that could crush the rebalancing story - Libya.

The conflict-torn country has seen oil production collapse to less than a quarter of its capacity of around 1.5 million barrels a day following attacks by Islamic State and rival governments struggling for control over natural resources. A resolution of the conflict, however, could quickly see the country's output double, rekindling fears of a supply glut in the already-volatile oil market, said Christof Ruhl, global head of research at ADIA, the Abu Dhabi Investment Authority.

When asked what's the biggest risk to the oil market is he said: "The situation in Libya."

"There's a huge amount of oil potentially coming back. It's not coming back right now, but there's a huge disruption, which could be fixed," he said at the sidelines of the Platts Oil Summit in London last week.

A key reason global oil prices started to crumble in the summer of 2014 was an oversupply in the market. Since then, output has started to decline in several oil-producing countries, particularly in the U.S. This - along with a pick up in demand - is seen as potentially bringing the oil market back to balance, which could help give a boost to prices.

The battle for oil revenue

Since the fall of Moammar Gadhafi in 2011, Libya's government has struggled to control brigades of former rebels, which have been causing significant disruptions to the country's oil production, refining facilities and oil shipments.

The authorities that control the eastern half of Libya in early May moved to block oil exports from areas under their control, escalating a domestic fight over oil revenue. Under Libyan law, enforced by the United Nations, the country's oil must be shipped via its official National Oil Co., which is based in the western capital of Tripoli. Chairman of the NOC, Mustafa Sanallah, was scheduled to attend the Platts conference last week, but had to cancel in the 11th hour.

"[The risks to the oil market] are really large-scale production coming back from disruptions or existing spare capacity. The biggest spare capacity is in Saudi Arabia and the biggest disruption is in Libya," Ruhl from ADIA said. Ruhl was previously a highly respected chief economist at BP PLC.

The row over oil between the east and the west, coupled with ISIS attacks on key production facilities, have significantly hurt Libyan oil output. In April, the country produced 360,000 barrels of oil a day, down 160,000 barrels from April last year, according to the latest report from the International Energy Agency. It looks to be even lower in May, the IEA said, to just above 200,000 barrels a day because of the feud between the rival governments, disruptions at the Marsa El-Hariga port and limited storage capacity.

"But Libya may yet surprise to the upside as it has the potential to double output to more than 700 kb/d, provided the eastern ports of Ras Lanuf and Es Sider are reopened," the IEA said in the report.

'The Somalia of the oil markets'

The first step in resolving the conflict came over the weekend, when the eastern factions allowed oil to be shipped to refineries in the west again. However, the two sides have yet to agree on ending the export dispute from the Marsa El-Hariga terminal in Tobruk, which accounts for more than 150,000 barrels of oil exports a day, according to The Wall Street Journal.

Helima Croft, chief commodities strategist at RBC Capital Markets, said there are little hopes of ending the Libyan rivalries, dismissing fears the country will ramp up production and upset the oil market.

"Libya is a failed state," she said. "We still have a divided government there, multiple armed factions and now we have ISIS. I'm not sure this is the recipe for sustainable production I think of it as Somalia of the oil markets at this point".

Source: MarketWatch