UPDATE 5-Oil falls, more Saudi supply seen

* Saudi Arabia to produce more crude in Q2 -sources

* Seaway pipeline to operate below capacity

* U.S. crude stockpile to rise, refined product stocks to fall -poll

* Coming up: U.S. housing data for January; 1330 GMT

* Coming Up: APP weekly oil stocks data; 2130 GMT

(Recasts with latest price action, adds quote, updates prices)

LONDON, Feb 20 (Reuters) - Oil fell on Wednesday as the prospect of more Saudi supply offset optimism about an improving global economy bolstering demand.

April Brent crude futures were 40 cents down at $117.12 a barrel after posting their first gain in four sessions on Tuesday. U.S. crude added 16 cents to $96.82. The contract expires later on Wednesday.

Saudi Arabia, the world's top exporter of crude oil, expects to raise its output in the second quarter to satisfy higher demand from China and drive economic recovery elsewhere, oil industry sources said, but the exact rise in volume was unclear.

Saudi Arabia's move to cut output sharply by about 700,000 barrels per day (bpd) in the last two months of 2012 had helped tighten supply and supported oil prices.

These higher prices are starting to have an impact on demand, Olivier Jakob at Petromatrix said.

"We're entering the demand destruction price zone - when you start to have some fears about global demand," he said. "It's really a price level when you need to take into account the risk that demand could take a hit."

Overall the market has stayed in a narrow range between around $115 and $119 since the start of the month, and analysts think there is scope for it to be there for some time.

"Crude oil prices have been pushed very high and it would take quite a lot to push them above $120," said Filip Petersson, commodity strategist at SEB.

"As long as we don't see a bearish trigger, prices could stay at this level for a while longer."

Crude supply is expected to improve in the second quarter due to refinery maintenance in Asia and Europe, and as the United States continues to displace imports with rising domestic production, he said.

U.S. SUPPLY GLUT

Supply is also rising in the United States, where weekly oil inventories data is expected to show a build in crude stockpiles, which can be bearish for prices. Refined product inventories were expected to have declined.

A supply glut in the U.S. Midwest will persist as oil shipments on the Seaway pipeline between the U.S. Midwest and the Gulf Coast will run below daily capacity of 400,000 barrels.

The pipeline was expanded this year as operators had aimed to divert crude from bloated tanks in Cushing, Oklahoma, the delivery point for West Texas Intermediate (WTI). Despite the problems, U.S. crude futures settled up 80 cents on Tuesday.

Signs of strength in U.S. economic data due later this week could whet investors' appetite for riskier assets such as equities and oil. Bullish sentiment in the U.S. equities markets rubbed off on oil on Tuesday, leading both benchmarks to close up.

Investors are also watching the outcome of Iran's nuclear talks with major world powers next week although analysts do not expect any breakthrough until after Iran's elections in June.

"It's probably neutral to bullish for oil markets," Tony Nunan, a risk manager at Mitsubishi Corp said. "Oil can stay strong because of geopolitical risks that are inherent in the system, but I think it's kind of overdone again."

(Editing by Jeremy Gaunt)