TEHRAN (Reuters) - Iran started war games on Monday and its president rejected a demand by major powers that it stop enriching uranium as "illegitimate", showing no sign of backing down in a stand-off over Tehran's nuclear ambitions.
Missile units of the elite Revolutionary Guards' naval and air forces began war games, Iranian news agencies said, hours after the U.S. Navy said it had begun exercises in the Gulf.
Speculation about an attack on the world's fourth biggest oil exporter over its nuclear programme rose after a report last month said Israel had practised such a strike. Fears of military confrontation helped send world oil prices to record highs.
Iranian President Mahmoud Ahmadinejad said on Monday his country would not stop enriching uranium, work which Tehran says is aimed at generating power but which the West fears may be part of a covert nuclear weapons programme.
It was Ahmadinejad's first comment on the dispute since Iran delivered its response on Friday to a package of incentives offered by world powers seeking to curb its nuclear activities. Details of the response were not made public.
"They offer to hold talks but at the same time they threaten us and say we should accept their illegitimate demand to halt (enrichment work)," Ahmadinejad told reporters in Malaysia, where he was attending a summit of eight developing countries.
"They want us to abandon our right (to nuclear technology)," the president said.
By contrast, Iran's Foreign Minister Manouchehr Mottaki spoke during the weekend of a "new environment" for diplomacy over Iran's nuclear programme.
The United States, China, Russia, Britain, France and Germany demand that Iran suspend its enrichment work before formal talks can start on their revised package of incentives, which includes help to develop a civilian nuclear programme.
Tehran has repeatedly refused to stop producing enriched uranium, which can be used as fuel for power plants, or, if refined much more, can provide material for nuclear weapons.
The offer of trade and other incentives proposed by the world powers was presented last month by EU foreign policy chief Javier Solana to Iran's chief nuclear negotiator Saeed Jalili.
Iran has put forward its own bundle of proposals aimed at resolving the dispute and has said it was encouraged by common points between the two separate packages.
So far the Iranian government's formal response to the latest offer has not been made public and there have been mixed signals in statements by its senior officials.
Senior officials from world powers held a conference call on Monday to discuss Iran's response, the State Department said.
"We are consulting with our partners in the P5+1 (permanent five U.N. Security Council members plus Germany) on issues related to that response and what we might hear and what we have heard thus far," a spokesman said of the conference call.
The goals of Iran's war games included raising combat readiness and the capability of missile units. Exercises started a few hours ago, the Fars and Mehr news agencies said, without giving details on where the manoeuvres were taking place.
The Guards often hold manoeuvres in the Gulf.
The Revolutionary Guards' head said in remarks published in late June that Tehran would impose controls on shipping in the Gulf and the strategic Strait of Hormuz if it was attacked.
The U.S. Navy last week vowed that Iran would not be allowed to block the Gulf waterway which carries crude from the world's largest oil exporting region.
The U.S. Navy on Monday said two U.S. vessels were taking part in its exercise alongside a British warship and one from Bahrain, a Gulf Arab ally which hosts the Fifth Fleet.
Democratic presidential candidate Barack Obama said on Monday that harsh U.S. rhetoric toward Iran appeared to be contributing to the surge in oil prices and that a calmer approach might help soothe the markets.
"There are some geopolitical issues that affect the price of oil," he added. "So for us to ratchet down the rhetoric when it comes to Iran, for example, and engage in tough, principled diplomacy, as I've called for, might calm the markets down."
Before news of the Iranian war games, oil dropped over $4 a barrel Monday on profit taking and signals that Iran could be more flexible in negotiations over its nuclear programme.
U.S. crude settled at $141.37 a barrel, down $3.92 and below Friday's low of $143.22. Brent crude settled at $141.87 a barrel, down $2.55.
Additional reporting by Hossein Jaseb, Hashem Kalantari and Fredrik Dahl in Tehran and Dubai and Washington bureaux; Writing by Peter Millership; Editing by Keith Weir