By Fredrik Dahl
VIENNA (Reuters) - A report by the U.N. nuclear watchdog is expected to show that Iran is pressing ahead with its nuclear program by further increasing its capacity to enrich uranium, diplomats said on Monday.
They said Iran also appears to have started making fuel for a heavy-water reactor that could produce plutonium, a development that concerns the West because of its potential to be used in a nuclear weapon.
On the other hand, the diplomats said this week's report by the International Atomic Energy Agency (IAEA) is also likely to include data showing that Iran is limiting growth of its most sensitive nuclear stockpile, a step that could buy time for negotiations with major powers.
If confirmed, such findings would give a mixed picture of Iran's atomic activities at a time when the outside world is waiting to see if its new president, Hassan Rouhani, will move to ease tension with the Islamic Republic's Western critics.
Iran says its nuclear program is for power generation and medical purposes only, rejecting Western allegations that it seeks the capability to make atomic arms.
Israel has threatened to attack Iran if diplomacy fails to curb its program and it amasses enough medium-enriched uranium to make a nuclear weapon, if processed further. But the election in June of the relative moderate Rouhani has raised Western hopes of breaking a deadlock in talks to address the decade-old nuclear dispute.
Envoys accredited to the IAEA cautioned against reading too much into the U.N.'s quarterly report, expected to be issued to member states on Wednesday, as it will mainly cover developments before Rouhani took office in early August.
It is expected to say that Iran has continued to install both first-generation IR-1 centrifuges and advanced IR-2m machines, the Western diplomats said.
Centrifuges spin at supersonic speed to produce enriched uranium, which Iran says it needs to fuel a planned network of nuclear power plants. But if further processed, uranium can also provide the explosive core of a nuclear bomb.
Outgoing nuclear energy chief Fereydoun Abbasi-Davani, a hardliner whom Rouhani has replaced with a pragmatist, said this month that Iran now has about 1,000 IR-2m centrifuges - a statement the diplomats said seemed credible.
Though the advanced machines are not yet believed to be operating, the report will be scrutinized for any sign of increased readiness to go into service, they said.
Abbasi-Davani's comments suggested, however, that the pace of IR-1 installation may have slowed from early this year.
A U.S. security institute last month said it believes that Iran will by mid-2014 will have the capability to produce, without being detected, sufficient weapons-grade uranium from its declared low-enriched stock for a nuclear explosive.
"Iran would achieve this capability principally by implementing its existing, firm plans to install thousands more IR-1 centrifuges and perhaps a few thousand IR-2m centrifuges," the Institute for Science and International Security said.
Rouhani, a former nuclear negotiator who oversaw a previous deal to suspend Iran's uranium enrichment, has pledged to improve ties with the outside world. But he insists on Tehran's right to refine uranium.
The diplomats said they believed Iran had continued converting some of its most controversial nuclear material - uranium gas refined to a fissile concentration of 20 percent - to make fuel for a medical research reactor in Tehran.
As a result, Iran's holding of 20 percent uranium gas is expected to show little growth since the IAEA's previous report in May and remain well below the 240-250 kg (529 to 551 lb) needed for a bomb.
This stock is closely watched in the West as it represents a short technical step from weapons-grade uranium.
Iran is also believed to have begun producing fuel for another research reactor, Arak, which Western experts say could yield plutonium for bombs once operational, diplomats said. Iran says Arak will make isotopes for medical and agricultural use.
Iran plans to commission the heavy-water research reactor in the first quarter of 2014. Israel, widely believed to be the Middle East's only nuclear-armed power, has bombed such construction sites in the region before - in Iraq in 1981 and in Syria in 2007.
(Editing by Mark Trevelyan)