A standoff between Iran and the West over Iran's nuclear plans could erupt in military conflict, a Chinese state newspaper said on Wednesday, after the release of a U.N. report likely to increase pressure on Beijing to curb its Iranian ties.

Chinese policy-makers are caught between their demand for Iranian oil and worry that the United States and its allies will demand harsher sanctions against Iran, even risk military action, after the International Atomic Energy Agency concluded Iran appeared to have worked on designing an atomic weapon.

It is clear that contention between the various sides over the Iranian nuclear issue has reached white hot levels and could even be on the precipice of a showdown, the overseas edition of the People's Daily said in a front-page commentary.

If Iran refused to back down in the face of growing U.S. conviction that it was developing nuclear weapons, the risks of war will grow, said the paper, noting reports that Israel could consider a military strike on Iranian nuclear sites.

The People's Daily is the top newspaper of China's ruling Communist Party and broadly reflects official thinking.

A commentary in the small-circulation overseas edition of the newspaper falls short of a formal government response, but it suggests the anxieties weighing on Beijing after the latest U.N. nuclear agency report.

China's official Xinhua news agency also suggested that Beijing would respond warily to the report. The U.N. watchdog still lacks a smoking gun, Xinhua said in a commentary.

There are no witnesses or physical evidence to prove that Iran is making nuclear weapons, it said.

In dealing with the Iran nuclear issue, it is extremely dangerous to rely on suspicions, and the destructive consequences of any armed action would endure for a long time.

China is likely to face difficult choices as it tries to keep steady ties with the United States, which is likely to introduce new unilateral sanctions on Iran.

If these sanctions harm China's substantive interests, then China will have to respond in some way, said Li Hong, the secretary general of the China Arms Control and Disarmament Association, a government-controlled body.

It would certainly have an impact on bilateral relations, Li said in an interview.

ONUS ON CHINA?

Iran is China's third-largest crude oil supplier, shipping 20.3 million tonnes in the first nine months of the year, up by almost a third on the same time last year, according to Chinese data. Overall trade between the two countries grew to $32.9 billion in value in the first nine months, up by 58 percent.

The onus will really be on China, as the only country whose economic relations with Iran have grown, Suzanne Maloney an expert on Iran at the Brookings Institution, a think tank in Washington, said in a telephone interview.

Over the past year or more, China has quietly stalled on oil and gas investments in Iran, seeking to ward off stricter unilateral sanctions from Washington while preserving a foothold in Iran. But that implicit deal will come under growing pressure, especially from Congress, said Maloney.

They've had a compromise for the past 18 months of a go-slow in investment. But it's difficult to see how that bargain can hold in the wake of the latest revelations, said Maloney.

Citing what it called credible information from member states and elsewhere, the IAEA said Iran appeared to have carried out activities applicable to developing nuclear weapons, such as high explosives testing and developing a trigger that could be used for an atomic bomb.

China has kept close bilateral ties with Iran, but also backed past U.N. Security Council resolutions criticising Iran's position on nuclear issues and authorising limited sanctions.

But China has repeatedly resisted Western proposals for sanctions that could seriously curtail its energy and economic ties with Iran. As one of the Security Council's five permanent members, China holds the power to veto any resolutions.

China has also denounced the United States and European Union for imposing their own separate sanctions on Iran, and said they should not take steps reaching beyond the U.N. resolutions.

This week and last, China urged Iran to show flexibility over its nuclear programme and warned that the use of force to resolve the issue was the last thing the Middle East needed.

Li from the Chinese arms control association said Beijing was worried about the tension, but war remained a slim risk.

Overall, I think the international conditions show governments couldn't stomach armed conflict over Iran, he said.

The U.S. economy is in poor shape, and Europe has its debt crisis, he said. Iran is not like Libya; it has the strength to counter attack.

(Editing by Robert Birsel)