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* Iraq to supply 40 percent of new refinery's crude
* Edges out competition with sweeter terms
* Sinochem Corp to become one of Iraq's top oil buyers
By Judy Hua and Chen Aizhu
BEIJING, Nov 4 (Reuters) - Sinochem Corp will become one of Baghdad's top oil buyers next year when the Chinese state company starts its first wholly-owned refinery, the latest example of Iraq beating Middle Eastern rivals in the competition for new markets in Asia.
Iraq's output has increased rapidly after years of unrest and China is the most important battleground for exporters looking for new markets. China overtook the U.S. as the world's largest net oil importer in September and has driven global fuel demand growth for a decade.
Iraq said China is seeking to increase purchases of its crude by more than two-thirds next year. To boost sales it has offered sweeter payment terms to buyers than competitors.
Sinochem plans to use Iraqi crude for 40 percent of the capacity of the new refinery, replacing a preliminary agreement to use more expensive oil from Kuwait, Chinese traders said.
"Kuwaiti crude is pricier than Iraqi oil and it is non-tradable, making it less competitive," said a trading source with knowledge of the deal. Sinochem would still likely buy some crude from Kuwait, he added.
Sinochem's 240,000-barrels-per-day Quanzhou plant on China's southeast coast is expected to process about 100,000 bpd of Iraqi crude after completing test runs due to start in December, the trading sources said.
Sinochem may still need to honour, at least partially, a non-binding agreement inked in 2007 with OPEC-member Kuwait to buy 240,000 bpd Kuwaiti oil for the Quanzhou plant.
"(Sinochem) can't burn the bridge behind it," said the source, estimating the volume from Kuwait could be only two million barrels per quarter, or about 22,000 bpd, less than a tenth of the preliminary deal.
Sinochem's informal tie-up with Kuwait helped it obtain state approval for its refinery since Beijing requires large new refineries to secure oil supply first.
But Sinochem had never formalised the supply deal with Kuwait, traders said, partly because the OPEC member does not appear to have any immediate plan to boost its oil output beyond the current 3.2 million bpd.
A Sinochem trading executive said that while Kuwaiti oil is what the refinery was designed for, economics would be the most important criteria when deciding which crude to use.
For test runs, the Quanzhou plant will process sweet crude from West Africa - including 3 million barrels of Angolan Cabinda crude - before switching to lower quality sour grades after entering normal operations, traders said.
Sinochem, one of Baghdad's long-standing Chinese customers, is already lifting under it 2013 contract some 200,000 bpd of Iraq's flagship crude Basra Light.
Most of Sinochem's contracted barrels now go to Chinese refineries owned by top Asian refiner Sinopec Corp .
Sinochem's Quanzhou plant was also likely to buy crude from other Middle East exporters such as Saudi Arabia, traders said.
Sanctions-hit Iran was also on the potential suppliers' list, said the Sinochem executive, if and when sanctions ease.
"We are closely following the progress of the Iranian nuclear talks. We shall be prepared to take Iranian oil once the sanctions are lifted," he said.
By offering deeper discounts in pricing and extending credit payment durations, Baghdad is also luring other key Chinese buyers including state refiner Sinopec Corp and smaller state traders Zhenhua Oil and state-run China National Offshore Oil Corp (CNOOC).
CNOOC lifts oil from Iraq's Maysan oilfield, which its listed arm CNOOC Ltd is involved in developing.
Sinopec will raise its Iraq term purchases next year after nearly doubling this year's volume to around 270,000 bpd, traders said.
"The volume will grow, and by not a small rate," said a trading official who was familiar with Sinopec's crude purchases but declined to give a more specific estimate.
Smaller trader Zhenhua Oil is likely to more than double its Iraqi term crude in 2014 from this year's 22,000 bpd, said another source with knowledge of China's oil trades.
Iraq expects China to seek 70 percent more crude - or a total of 850,000 bpd - in 2014 versus current contract levels, its deputy prime minister for energy Hussain al-Shahristani said earlier this month.
Total exports are now running about 2.5 million bpd, but in the first quarter of 2014 Iraq expects its export capacity to rise to 4 million bpd, al-Shahristani also said.
Iraq expects its oil output to hit 3.5 million bpd by the end of the year, as it counters infrastructure and security issues that have this year hampered its efforts to maintain steady output and exports. (Editing by Tom Hogue and Simon Webb)