* Iraq exports more than a third of its oil to Asia
* Third largest supplier to China, India, South Korea
* Feb Iraqi Basra oil as much as $1.10 cheaper than Saudigrade
By Florence Tan and Peg Mackey
SINGAPORE/LONDON, March 18 (Reuters) - Fast-growing oilexporter Iraq is selling its crude cheaper than any comparablesupply, undercutting regional rival Saudi Arabia to grab abigger slice of the Asian market.
Three years into an oil expansion following decades of warand sanctions, Baghdad has risen to the rank of third largestsupplier to China, India and South Korea - prompting SaudiArabia to seek to safeguard its top slot.
Executives from state oil giant Saudi Aramco discussed aresponse to Iraq's aggressive pricing at a strategy meeting inLondon earlier this month, industry sources said.
"Iraq is raising its production. We have to play verysmart," said a source familiar with Saudi oil marketing policy."We don't want to hurt ourselves."
To win more customers in Asia, Baghdad has upped its pricinggame - marking down Basra Light crude by $1.10 a barrel againstrival Saudi Arab Medium, the lowest discount in nine years.
Saudi Arabia reacted by cutting the price of Arab Medium fortwo months running, a move traders and refiners said was in partto preserve the kingdom's market share.
"The Saudis are feeling it more than everyone else," atrader with a Western firm said. "It's direct competition andthat is why the Saudis dropped their official selling prices bigtime."
Riyadh, pumping about 9.2 million barrels per day (bpd)after cutting supply sharply towards the end of 2012, may alsobe marking its territory ahead of OPEC's May 31 meeting inVienna.
"The sharp price cuts and rumoured efforts to push refinersto take full contract volumes may constitute a gentle warningthat Saudi Arabia is not going to forego its market share tomake room for Iraq," said a senior Western oil executive.
"But this is a long-term game and the Saudis appear fairlysanguine about the overall market balance for the moment."
For their part, Iraqi oil officials do not see Baghdad in afull-on battle with Riyadh for market share.
Iraqi oil marketers want to craft a sales policy that doesnot jeopardise production growth that began in 2010 afterBaghdad secured service contracts with the likes of BP,Eni, Exxon Mobil and Royal Dutch Shell.
"We're building a strategy to increase exports and keep ourcustomers happy," said an Iraqi oil official. "And we're on theright track."
Already OPEC's second-largest producer after overtakingIran, Iraq aims for average rates this year of 3.7 million bpd,up from 2.9 million bpd last year.
That would be just shy of an all-time high of 3.8 million,hit in 1979.
Baghdad's lofty output target, revealed by Oil MinisterAbdul Kareem Luaibi just before OPEC's last meeting in December,did not go unnoticed by Saudi Arabia - the only producer in theOrganization of the Petroleum Exporting Countries with asignificant cushion of available supply.
"Luaibi's big numbers unnerved us," said a source from aGulf producer who declined to be identified.
Global demand growth is moderating at 800,000 to 1 millionbpd and Baghdad could supply nearly all the new requirements ifit were to achieve its production objective.
Iraq's exports have surged even though it is recovering from20 years of war, sanctions and civil strife and is grapplingwith export constraints, creaking pipelines and otherinfrastructure and security threats.
Since Iraq's oil expansion got underway, output has risen bymore than 600,000 bpd.
But ongoing bottlenecks suggest Iraq's production is morelikely to grow on average by about 300,000 bpd this year, sayWestern and Iraqi oil experts, leaving some distance from its3.7 million bpd target.
"The big increase from Iraq has not materialized, so there'sno real fight for market share now," said the source from theGulf producer.
"But growth of more than 500,000 barrels a day would send anegative signal and could trigger the battle."
SHARE RISING
Iraq supplied 11 percent of China's total oil imports in January 2013, up from 5.8 percent in 2012. Saudi is the topsupplier to the world's second-biggest oil consumer after theUnited States and had 22 percent share in January, up from 20percent in 2012.
In India, Iraq's share rose to 14 percent in January, from13 percent in 2012. Saudi held the top slot with 17 percentshare in January, up from 16 percent in 2012.
Baghdad is set to gain even more. Indian refiner HindustanPetroleum Corp is in talks with France's Total to buy up to 40,000 bpd of Basra on top of its 60,000bpd supply contract with Iraq, say industry sources. Total issaid to be offering a 10-15 cent/bbl discount to Iraq's OSP.
At the same time, HPCL plans to reduce its imports fromSaudi Arabia to 50,000 bpd from 60,000 bpd, the sources said.
In South Korea, Iraq moved up one notch to replace Qatar asthe third-biggest supplier in January.
Working in Iraq's favour is the steep cuts made by Asianbuyers of Iranian oil as tough Western sanctions to force Tehranto halt its nuclear programme made it difficult to pay and findtankers to ship the oil.
A possible unexpected halt in imports of Iranian crude byIndia due to the lack of insurance for refineries has alsospurred demand for Basra crude.