UPDATE 3-Iran in major nuclear expansion, UN oversight harder

* Iran now adding 2,000 more centrifuges to production line

* Enrichment rate increasing, potential for a bomb reached

* IAEA struggling to keep effective watch on Natanz plant

(adds analysis, paragraphs 9-10; edits)

By Mark Heinrich

VIENNA, June 5 (Reuters) - Iran has significantly expanded uranium enrichment with almost 5,000 centrifuges now operating and this has made it harder for U.N. inspectors to keep track of the disputed nuclear activity, an IAEA report said on Friday.

Obtained by Reuters, the restricted International Atomic Energy Agency report said Iran had increased its rate of production of low-enriched uranium (LEU), boosting its stockpile by 500 kg to 1,339 kg in the past six months.

Iran's improved efficiency in turning out potential nuclear fuel is sure to fan Western fears of the Islamic Republic nearing the ability to make atomic bombs, if it chose to do so.

Oil giant Iran says it wants a uranium enrichment industry solely to provide an alternative source of electricity.