Oil pares most gains after warning market could 'drown in oversupply'

By Devika Krishna Kumar

NEW YORK (Reuters) - Brent crude rebounded on Tuesday from 12-years lows after data showed record demand in China, but a warning by the world's energy watchdog that the market could "drown in oversupply" limited the global benchmark's gains and sent U.S. crude down to its lowest since 2003.

Analysts also attributed much of Brent's bounce from under $28 a barrel on Monday to a brief short-covering rally after oil prices crashed over 20 percent this year, triggering a record volume of short positions in the week through Jan. 12.

"It seems to be a healthy upside correction in an otherwise downtrending market," said Tamas Varga, oil analyst at London brokerage PVM Oil Associates.

Brent settled up 0.7 percent or 21 cents at $28.76 a barrel. It traded as high as $30.24, rebounding from $27.67 on Monday, its lowest since November 2003.

U.S. crude settled at $28.46 a barrel, down 96 cents or 3.26 pct, at its lowest level since September 2003. The U.S. market was shut on Monday due to a public holiday.

The market drew support from preliminary Reuters calculations that showed oil in China, the world's No. 2 oil consumer, likely hit a record high in 2015 of 10.32 million barrels per day (bpd), up 2.5 percent from 2014.

Fears of oversupply, however, resurfaced after the International Energy Agency, which advises industrialised countries on energy policy, said the global oil glut was set to last until at least late 2016 due to unseasonably warm weather and rising supply.

The oversupply is set to worsen with the return of Iranian barrels to the market following the lifting of nuclear-related Western sanctions.

Iran said it could increase oil output by 500,000 barrels per day and issued an order to start the ramp-up on Monday, but the IEA estimates a more measured rise of about 300,000 bpd of additional crude by the end of first quarter of 2016.

The IEA, which issues regular reviews of the health of the energy market, said more price weakness could lie ahead as "... unless something changes, the oil market could drown in oversupply."

Analysts largely agree that one more big price fall was needed before a sustained or significant relief rally.

"There has to be one more major move down to blow everything out and then you'll see a v-shaped recovery that'll show you that the bottom's in - I don't think we've seen that yet," said hedge fund manager Michael Corcelli.

(Additional reporting by Karolin Schaps in London, Roslan Khasawneh and Henning Gloystein in Singapore; Editing by Marguerita Choy and Lisa Shumaker)