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Asia refiners shun Iraq crude in spot markets on conflict worries

* Trade in Aug-loading Basra Light muted

* Potential buyers say worried about risk of supply disruptions

* But conflict still a long way from Basra

* Weak refining margins also sapping demand for crude

SINGAPORE/SEOUL, June 30 (Reuters) - Many Asian refiners say they are shying away from buying the flagship grade of Iraqi crude in spot markets, worried that the militant insurgency in the country could spread to the area where the oil is churned out and exported.

Although the mounting conflict that has swept parts of Iraq is still hundreds of kilometres away from the southern region which produces and ships Basra Light crude, Asian buyers say they are concerned about possible supply disruptions.

"The Iraqi situation is unpredictable, which makes it hard for us to buy Iraqi crude on the spot markets," said a Seoul-based refining source. He declined to be named as he was not authorised to speak with media.

"To a refiner, stable crude supply is the priority."

Trade in August-loading Basra Light has been muted this month as risk-averse refiners in Asia have sated their need for crude by buying oil originating in other Gulf producers such as Saudi Arabia and Abu Dhabi, market participants said.

That is unlikely to have any short-term impact on volumes of Iraqi exports, set to hit a record this month, as they are all shipped via term contracts agreed between buyers and Iraq's State Oil Marketing Organisation (SOMO), with some then being resold in spot markets.

But it could impact negotiations for future term contracts if spot resales look likely to be more tricky.

SOMO has term agreements to sell nearly 1.7 million barrels per day (bpd) of Basra Light to refiners and trading firms in Asia this year.

Asia typically imports more than half the output of the grade, with China and India the main buyers in the region so far in 2014.

Fears of supply disruption due to the insurgency have pushed up prices for global benchmark Brent crude by 3.4 percent so far in June - its best monthly showing since August.

ALTERNATIVES

Taiwanese refiners Formosa Petrochemical and CPC Corp have opted for Oman for August instead of Basra Light, sources said, while an Indian refiner said he may replace the Iraqi grade with West African crude.

Demand for spot cargoes has also been hit as any purchases made now will arrive in September, a low-season for oil product usage, and as many refiners have scaled back production as excess capacity in the sector has squeezed their profits.

Spot trade could also be dwindling as sellers wait until July 10 for SOMO to inform them what volumes they will be entitled to in August.

But some traders said refiners would buy Basra Light if prices were low enough.

"I don't think there is any big risk to physical disruption but risk is risk ... That's why refiners may try to buy at a level that takes care of this risk," said a Singapore-based trader.

August-loading cargoes may eventually be sold at discounts to the grade's official selling price (OSP), down from a single-digit premium for July, traders said, in light of the sharp fall for differentials of comparative grades such as Oman that have traded for August.

(Additional reporting by James Topham in Tokyo; Editing by Joseph Radford)