A dramatic advance on Saturday won the rebels control of the town of Zawiyah, 50 km (30 miles) west of Tripoli on the coast, enabling them to halt food and fuel supplies from Tunisia to Gaddafi's stronghold in the capital.
Tripoli was not under immediate threat, but rebel forces are now in their strongest position since the uprising against 41 years of Gaddafi's rule began in February, controlling the coast both east and west of Tripoli.
"The fall of Zawiyah would be the biggest milestone for the rebels since the liberation of Misrata. It's a real morale booster for them and implies a sense of momentum," said analyst Shashank Joshi of the Royal United Services Institute in London.
"It's a triple blow to Gaddafi as it is home to the regime's only functioning oil refinery and may also in the medium-term allow the rebels to benefit from sales of oil; it also lies over his big supply line and blocks an important route from the Tunisian border to the capital."
Despite denials, men from Gaddafi's government were reported to be holding secret talks with rebels at a hotel in Tunisia, on a possible resolution of the 6-month-old civil war.
Libyans fleeing south in their cars said they had heard fighting in a place called Harsha, between Tripoli and Zawiyah. "I heard fighting there today on our way here," said one man who declined to give his name. He said rebels clashed with Gaddafi's security forces inside Tripoli on Sunday night.
"There is no gasoline, no electricity, food prices are up 300 percent. We just cannot live like this anymore," he said.
Another man fleeing Tripoli said friends had told him that on Sunday night someone threw an explosive device at a local government headquarters in Siya Heya, a district of the capital.
The rebels have help from NATO warplanes which, under a U.N. mandate to protect civilians, are bombing Gaddafi's army.
Gaddafi's latest exhortations to his supporters came in a speech early on Monday delivered over a poor quality telephone line and broadcast by state television in audio only. It was his first since rebels launched their biggest push in months.
"The Libyan people will remain and the Fateh revolution (which brought Gaddafi to power in September 1969) will remain. Move forward, challenge, pick up your weapons, go to the fight for liberating Libya inch by inch from the traitors and from NATO," said the 69-year-old Gaddafi.
"The blood of martyrs is fuel for the battlefield," he said, in what Libyan television said was a live speech.
On the Tunisian resort island of Djerba on Sunday, security staff turned Reuters away from a hotel where a source, who spoke on condition of anonymity, said the talks between rebel and government representatives were being held. ID:nLDE77D089]
In Tripoli, government spokesman Moussa Ibrahim blamed Western leaders and the media for the spread of rumours that the government negotiating Gaddafi's departure from Libya.
"This information is absolutely incorrect and it is part of a media war against us. Their target is to confuse us, break our spirit, and shake our morale," he said. "The leader is here in Libya, fighting for the freedom of our nation. He will not leave Libya," Ibrahim said.
Gaddafi's characteristically defiant speech followed a day of action across a swathe of northwest Libya during which rebels said they had seized the town of Surman, next door to Zawiyah.
There was also fighting in the town of Garyan that controls the southern access to Tripoli, and shooting could be heard near the main Libyan-Tunisian border crossing.
Rebels from the Western Mountains region to the south advanced into Zawiyah late on Saturday, and early on Sunday, about 50 rebel fighters milled around the central market.
If the various rebel units in the Western Mountains act in concert they can field a force of a few thousand fighters.
Rebel fighters told Reuters there were still forces loyal to Gaddafi in Zawiyah, including snipers on tall buildings. Bursts of artillery and machinegun fire could be heard.
One rebel fighter said Gaddafi's forces still controlled the oil refinery on the coast -- a strategic target because it is the only one still functioning in western Libya.
Fighting also spread west from Zawiyah along the coastal highway towards the main Ras Jdir border crossing with Tunisia. A rebel spokesman called Abdulrahman said rebels had seized Surman, the next town west along the coast from Zawiyah.
But at the border crossing to Tunisia, Libyan customs and immigration officers were operating as usual.