CORRECTED - UPDATE 2-Rio Tinto:Iron ore sales strong, China deal stalled

(Corrects third paragraph to make clear Rio's production report due to be released on July 15, not July 16; also adds Reuters Instrument Codes for Rio in first paragraph)

* Q2 iron ore shipments surge, talks with China stalled

* Rio believes in benchmark price system

* Customers can choose between spot and benchmark

(Adds details)

By Bruce Hextall

SYDNEY, July 6 (Reuters) - Chinese steel mills are paying Rio Tinto (RIO.L)(RIO.AX) spot market prices for its iron ore that are higher than the benchmark, and the company is shipping material at a record rate, a company spokesman said on Monday.

With business and iron ore prices booming, Rio seems to be in the driving seat in talks with Chinese steel mills, who are demanding a cut from 2008 term iron ore costs greater than the 33 percent secured by Japanese and Korean rivals.

"We're selling everything we make, we've never been as busy," Rio Tinto Iron Ore spokesman Gervase Greene said, speaking ahead of the firm's second-quarter output report due on July 15.

"Instead of buying under contract, they just choose to buy at whatever the prevailing rate is on the day. At the moment, that's about $82 so we're selling it at a higher price than if they had agreed so that's where it's at," he said.

"We believe in the benchmark system but if, at the end of the day, customers want to pay spot prices that's up to them," Greene said, adding negotiations were moving slowly.

Rising iron ore prices have weakened China's bargaining position, forcing the world's biggest buyer of the steelmaking ingredient to make its first compromise last week when it said that it was willing to accept less than the 40 percent cut it had been demanding. [ID:nSHA123901]

Spot prices for iron ore are at four-month highs around $82.50 a tonne delivered in China. That is equivalent to around $65 free-on-board and above the benchmark price of some $61 that Japanese, South Korean and Taiwanese mills pay.

Because of strong spot prices and deals struck with steel mills outside China, analysts believe iron ore miners, including BHP Billiton (BHP.AX) (BLT.L) and Brazilian giant Vale (VALE5.SA) (VALE.N), are not in a position to offer China deeper cuts demanded by the China Iron & Steel Association (CISA).

"Iron ore producers cannot offer China a lower benchmark price than Japanese customers, or risk invalidating the entire negotiation process. A short-term hybrid pricing solution may be announced to save some face for the CISA," Citi analyst Alexander Hacking said.