Second seed Nikolay Davydenko of Russia, third seeded Spaniard David Ferrer and fifth seed Tomas Berdych of the Czech Republic also suffered early exits. The Spanish world number two Nadal lost his serve in the opening game but repaired the damage to take the first set before the Italian world number 42 fought his way back into the match.
Seppi displayed the same determination as he did in the first round when he upset 2004 winner Australian Lleyton Hewitt, taking the second set before building a comfortable double break in the third.
Nadal survived two match points at 5-2, forcing Seppi to wait a bit longer before securing his place in the quarter-finals.
"It is very disappointing to lose because I wasn't playing bad," Nadal told reporters.
"(I) started well today and took the first set playing fine tennis but then I somehow lost my concentration, so it was a bit of a mental problem."
"I can't explain how that happened but I kept fighting.
"I will not use the circumstances or the balls as an excuse as they were the same as yesterday when I won my first round match."
World number four Davydenko was humbled 6-3 7-5 by unseeded Frenchman Michael Llodra, while German qualifier Mischa Zverev ousted world number five Ferrer 6-2 7-5.
Llodra, who won the Adelaide International title in January, avenged his first-round defeat by the Russian at last month's Australian Open.
Davydenko was hampered in the second set when he needed a timeout for treatment on his right shoulder and elbow.
"That has all to do with the heavy balls they use over here which are the same used at the U.S. Open," the Russian told Reuters. "I felt the problem in training sessions and it has to do with the vibration the balls cause.
"There are other players complaining about it. It is sad I lost today but it will give me extra days to recover before the Dubai Tennis Championships."
Unseeded Croatian Ivo Karlovic hit 17 aces as he beat Berdych 6-4 6-4. He next meets Zverev.