UPDATE 1-China denies mulling iron ore premium for BHP, Rio

(Rewrites with Chinese denial, comments)

By Alfred Cang and James Regan

SHANGHAI/SYDNEY, April 28 (Reuters) - Chinese steel industry officials said on Monday that China's mills are not considering paying a freight premium demanded by Australian iron ore miners BHP Billiton Ltd (BHP.AX) and Rio Tinto Ltd (RIO.AX), denying a media report.

The demand has become a sticking point in tense negotiations over annual term-contracted iron ore supplies, which the Chinese officials said should continue to be based on free on board (FOB) prices that exclude freight rates.

The Australian newspaper said on Monday that Zou Jian, chairman of the China Metallurgical Mining Association, told an industry gathering in Shanghai that steel firms were considering including freight rates in their annual iron ore supply contracts.

But Zou told Reuters on Monday that the report misquoted him and that high freight rates were an unusual factor this year that did not warrant altering the long-term pricing system.

"If you look at it from the Australian side, it would be understandable to ask that freight fees be added to iron ore prices," Zou said.

Freight rates from Australia to China are $11 per tonne, clearly lower than fees from Brazil to China of $25 to $30 a tonne, he added.

"We don't want to abandon the long-term system just because of the freight rates, because the rates are volatile and will change in the future," he said.

Rio and BHP declined to comment.

Chen Xianwen, a director at the China Iron and Steel Association, told Reuters on Monday that the industry association would always insist on an annual pricing system based on FOB prices during negotiations.

SPOT MARKET

Without an agreement, China's steel industry, the world's largest, has been forced to buy iron ore in the spot market, where prices are much higher than they would be under one-year term contracts.

But the Chinese have been reluctant to accept an agreement exceeding the 65 to 71 percent price hike set by this year's benchmark deal with Brazil's Vale (VALE5.SA) (RIO.N) in February.

Rio and BHP, the world's second- and third-largest iron ore miners, will be free to sell more of their ore into the spot markets only after June 30 if there is no contract agreement by then.

"I can't see the Chinese mills holding out too much longer to Rio's and BHP's demands. The alternative is just to costly," said DJ Carmichael & Co analyst James Wilson.

China's booming steel industry has become increasingly reliant on iron ore imports, estimated to reach more than 400 million tonnes this year.

In the first three months of 2008 alone, steel output in China rose 8.6 percent to 124.9 million tonnes, outpacing a 5.6 percent global increase, International Iron and Steel Institute figures show.

Negotiations between the two Australian miners and Chinese buyers have been difficult, with some buyers angry that the miners were trying to shift cargoes to the spot market, where returns are higher than for contract prices.

Considerations of whether to give in to the miners' demands at the talks are further complicated by BHP's proposal to acquire Rio, which has raised concerns in Beijing of further concentration of power among the sellers of the raw materials it needs to fuel industrial growth.

Rio Chief Executive Tom Albanese has warned his company would sell more ore on the spot market while the freight discrepancy existed. So far, Rio has sold about 15 million tonnes of iron ore at spot. Before that, Rio had little, if any, exposure to spot sales. (Editing by Edmund Klamann)