"My own advice to the Iranians is to create an environment that will allow the negotiations to go forward," Mr Annan told reporters as Tehran warned of a world oil crisis if sanctions are imposed over western accusations that Iran is covertly seeking to build nuclear weapons.
"I think they (Iranians) should not escalate, they should not press ahead with their nuclear fuel research. We need time to build confidence and trust so that these negotiations will take place in an atmosphere which is appropriate," the UN chief said.
He spoke as the United States and key European nations scrambled to line up support to haul Iran before the UN Security Council, which can impose sanctions in cases of threats to international peace and security.
Britain, France and Germany, backed by the United States, have called for an emergency meeting of the International Atomic Energy Agency (IAEA) on February 2, a first step before possible UN Security Council referral.
Russia, which is Iran's main partner in the growing civil nuclear program, has been trying to steer away from a showdown at the United Nations.
China, which, like Russia, has veto power in the UN Security Council, has also opposed such a step.
Iran insists it is not seeking to build nuclear weapons and that it has the right to develop atomic energy for electricity generation.
It has threatened to suspend snap inspections by the IAEA if it is brought before the Security Council.
Vacuous talks
The Western powers have rejected Iran's call for a return to direct talks, Britain describing it as "vacuous", unless there is a return to the fuel cycle suspension.
"I would hope that as the discussions go on, the Iranians would see the need to come back to the table but come back to the table in a genuine spirit of searching for a solution," Mr Annan said.
"Because if indeed their intention is a peaceful nuclear capability the international community have given assurances that they will make sure they do have the fuel necessary."
International conference
US Secretary of State Condoleezza Rice is expected to bring up the Iranian nuclear dispute at an international conference in London, at the end of the month.
Secretary Rice is expected to push the plans to refer Iran to the UN Security Council on the sidelines of the two-day meeting, chaired jointly by UN Secretary General Kofi Annan, Afghan President Hamid Kharzai and British Prime Minister Tony Blair.
The crisis escalated after Iran's resumption last week of uranium enrichment research which had been suspended for two years under deals with the Europeans.
Senator urges sanctions
A US senator has announced legislation that would urge the international community to impose tough sanctions on Iran over its nuclear program.
Democrat Evan Bayh said he plans to introduce his resolution tomorrow calling for Iran to be excluded from international forums, events and organisations, and calling on foreign governments to sever economic relations with Tehran.
The legislation also calls on the Bush Administration to cut assistance to countries whose companies are investing in Iran's energy sector, including pipelines to export Iranian crude, and to block supplies of refined gasoline to Iran.
The bill also calls for a worldwide ban on the sale of weapons to Iran, and urges the United Nations Security Council to impose a rigorous new inspection regime on the country.
"The United States must make the government of Iran understand that if its nuclear activity continues it will be treated as a pariah state," a passage of the legislation read.
Senator Bayh told US television that the Bush administration has paid too little attention to the potentially enormous nuclear threat posed by Iran.
He said time is running out for action. "I just came back from the region, and it is increasingly clear that Iran presents a real menace not only to the national security interests of the United States but to the rest of the civilized world, as well.
"They are the foremost sponsor of terrorism in the world," Senator Bayh told Fox News.
"Now they are seeking nuclear weapons, and that is an outcome we cannot allow to happen," he added.
Exclusion from Olympics
Senator Bayh's office said the international ostracism would extend to excluding Tehran from the Olympics and this year's World Cup football tournament in Germany, as well as international political and economic groups such as the World Trade Organisation.
"We need tough action now, including economic sanctions, cultural sanctions, cutting off their supply of gasoline, arms sales, those kind of things, to convince the radical leaders of Iran that nuclear weapons are something they just cannot have," Senator Bayh told Fox News.
"The window for action here may be as little as a few months" before Iran succeeds in developing nuclear weapons, he warned.