TEHRAN (Reuters) - Iran said on Tuesday that any exchange of nuclear fuel must take place on its soil, underlining its rejection of a plan to ensure it does not amass possible atom bomb material.

EDITORS' NOTE: Reuters and other foreign media are subject to Iranian restrictions on their ability to film or take pictures in Tehran. A general view shows the nuclear power plant in Bushehr, about 1,215 km (755 miles) south of Tehran, November 30, 2009. REUTERS/ISNA/Mehdi Ghasemi

In a letter to the International Atomic Energy Agency, its first official reply to an IAEA-brokered fuel swap proposal, Iran said it would prefer simply to buy the fuel but would accept a simultaneous exchange on its territory.

That would be unacceptable to the United States and European allies, which hope to get new sanctions imposed in the coming weeks after failing to reach agreement on the fuel exchange. But China expressed reservations over sanctions again, saying greater diplomatic efforts were needed.

Western countries fear Iran wants to stockpile uranium to enrich it to levels that could be used for nuclear weapons. Iran says its sole aim is to run nuclear energy plants to generate electricity and produce isotopes for medicine or agriculture.

“In order to bring about a constructive interaction, we have declared our readiness for a fuel swap, provided it is done within the country,” said Iranian Foreign Ministry spokesman Ramin Mehmanparast, cementing remarks by other Iranian officials.

“We are prepared for a fuel swap even though we do not regard this condition of supplying fuel to the Tehran research reactor through a swap as correct.”

Washington called Iran’s response a “red herring” that brought nothing new to the discussion.

“The Iranian counterproposal is unacceptable, as we’ve made clear before, and we will continue to work within the IAEA but also we will continue to consult from the international standpoint on appropriate next steps, including prospective sanctions,” said U.S. State Department spokesman P.J. Crowley.

Earlier this month, Iran announced a start to higher-scale enrichment that would refine uranium to 20 percent purity -- the level needed for conversion into fuel plates for its Tehran research reactor, which makes isotopes for cancer patients.

Iran said it was boosting enrichment itself because the West was refusing to budge from terms drawn up by the U.N. nuclear watchdog under which Iran would ship 70 percent of its low-enriched uranium abroad and wait up to a year to get reactor fuel back in exchange.

Iran formally stated its position on the four-month-old fuel swap plan in its letter to the IAEA. The letter, obtained by Reuters, said the Tehran reactor’s fuel stock, imported from Argentina in 1993, was “approaching its end.”

Analysts say Iran lacks the technical means to make the reactor fuel itself and has earmarked for 20 percent enrichment a quantity of low-enriched uranium far in excess of the reactor’s needs. That raised suspicions it eventually aims to enrich the material to the 90 percent purity suitable for warheads.

The IAEA said in a report last week that Iran may now be working to develop a nuclear-armed missile, providing further grist to Western countries hoping to persuade China, which has U.N. Security Council veto power, to back harsher sanctions.

CHINESE RESISTANCE

China, which has faced Western sanctions itself in the past, has resisted calls for tough measures against Tehran.

“We hope relevant parties can show flexibility to create conditions for completely and properly solving the Iran nuclear problem through diplomatic efforts,” Foreign Ministry spokesman Qin Gang told reporters.

The State Department said the United States’ patience with negotiation was running out. “We have not closed the door to further engagement. But you actually have to have a willing partner to engage,” said Crowley.

“The fact is Iran makes these series of statements day after day, week after week, but it refuses to come to the table and actually negotiate in good faith.”

Both the United States and Iran appear to be upping the stakes in a seven-year stand-off over Tehran’s nuclear activity.

Iran said it had identified potential sites for 10 new enrichment plants, two of which could start construction this year. Analysts say Iran lacks the technical capacity to launch any for at least several years.

Israeli Prime Minister Benjamin Netanyahu called for an embargo on Iran’s huge oil and gas sector, even if the United Nations did not back such a drastic move.

Tehran accuses Western powers of fomenting unprecedented protests by opponents of President Mahmoud Ahmadinejad since his disputed re-election last June. The unrest plunged Iran into its worst internal crisis since the 1979 Islamic revolution.

The United States and Israel have not ruled out military action against Iran over the nuclear issue.

“No power can harm Iran,” Ahmadinejad said in a televised speech in the eastern province of Khorasan-e Jonubi. “The Iranian nation will chop off the hands from the arm of any attacker from any part of the world.”

Akbar Hashemi Rafsanjani, a key figure in Iran’s ruling elite, rallied support around Supreme Leader Ayatollah Ali Khamenei and the government in Iran’s twin conflict with domestic dissenters and foreign powers over the nuclear issue.

Ahmadinejad’s followers have criticized former president Rafsanjani for failing to give Khamenei unswerving support against the protest movement.

“Our focal point is clear and that is the constitution, Islam, the principle of the office of the jurisprudent and supreme leadership,” Rafsanjani told the powerful Assembly of Experts, which he heads.