Iran is shipping oil to its top buyer China despite a dispute over freight terms and has so far dispatched a third of the 12 million barrels due to load in the first 20 days of July, traders and shipping sources said.

The dispute over shipping costs had threatened to disrupt the flow of crude from Iran to China, one of Iran's few remaining customers after European Union and U.S. sanctions halved Tehran's total oil exports.

Chinese state refining giant Sinopec and the National Iranian Tanker Co (NITC) appear to be negotiating freight terms on a tanker by tanker basis and at least 4 million barrels of Iranian oil are on their way to Chinese refiners, said a Chinese crude trader familiar with the negotiations.

"Looks like the freight negotiations are not a package, but voyage by voyage," said the trader, who declined to be identified due to the sensitive nature of the matter.

The EU sanctions bar tankers carrying Iranian oil from accessing the Western-dominated insurance market and have forced Sinopec to rely on NITC for delivery of the 500,000 barrels per day of crude it buys from Iran.

U.S. and EU sanctions are aimed at choking Iran's oil revenues and forcing it to curb a nuclear programme the West believes is being used to build an atomic bomb. Iran says its nuclear activities are for civilian purposes.

China more than halved its Iranian crude imports in the first quarter of 2012 due to a dispute over contract terms, which won it an exemption from U.S. sanctions. Imports recovered in April, but the first quarter cuts were so deep that, averaged over the full year, China's oil imports from Iran are 14 percent less than 2011.

TERMS UNCLEAR

NITC wants Sinopec to pay a premium to use its tankers since the Iranian shipper is handling the insurance, but the Chinese refiner is seeking a lower freight rate. The arrangement the two firms struck to keep the oil flowing is unclear.

China last month requested that Iran deliver July-loading oil to Chinese ports and provide price quotes on a cost-insurance-freight basis.

China appears to have the upper hand in the shipping negotiations, as high inventories and a slowing economy have dulled demand for oil in the world's second-largest crude importer. China's total crude imports fell in June to their lowest level since December.

Iran, on the other hand, has been forced to shut off wells at its vast oilfields and reduce output to levels unseen in more than two decades as oil sales fall by more than half year-on-year and storage space runs out.

"The Iranians believe they have a right to ask for higher freight since they are bearing the shipping risks," said the Chinese trader. "The Chinese believe their request is also reasonable, since refineries are cutting back on runs and they don't need that much crude."

China has nominated about 15 million barrels of Iranian oil for July, sources have told Reuters, a level steady from April.

If all the 15 million barrel shipments, worth some $1.35 billion, are loaded, China would account for nearly half of Iran's total July exports, estimated at 1.1 million bpd.

Sinopec, Asia's largest refiner, buys Iranian oil via its own trading arm Unipec and state trader Zhuhai Zhenrong Corp in separate contracts with the National Iranian Oil Company.

Zhuhai Zhenrong, formerly an affiliate of China's defence industry, has dealt with the Iranians for longer but Unipec plays a more dominant role in annual supply talks and the freight negotiations, sources said.