China steel mills continue talks with BHP

BEIJING (Reuters) - Chinese steelmakers are still trying to reach an iron ore deal with BHP Billiton BHP.AXBLT.L, after agreeing to a higher-than-expected rise in term prices with rival Australian miner Rio Tinto RIO.AXRIO.L that sent their share prices down sharply on Tuesday.

Baosteel agreed on Monday on behalf of its Chinese rivals to pay up to 96.5 percent more for iron ore under a term contract with Rio Tinto, higher than the 65 to 71 percent that Japanese mills and Brazilian miner Vale VALE5.SARIO.N clinched in February.

But it failed to reach a settlement with BHP Billiton in a meeting on Tuesday morning, a source close to the talks said.

Shares in listed Chinese steel makers dropped as investors factored in narrower margins as steelmaking costs rise. Baosteel 600019.SS fell by its daily trading limit of 10 percent, before ending the morning session down 7 percent.

This year is the first time that miners have not all accepted the same percentage change in iron ore prices, opening the door to further differentials by quality and region.

“The benchmark pricing has system has now increased in complexity. There is now a benchmark for each product,” said an industry executive.

That could change the tenor of annual term price negotiations, in which traditionally all mills and miners accept whatever settlement is reached first. That system has proven too inflexible as rapidly expanding Chinese steel capacity has caused spot iron ore prices and freight rates to balloon over the last few years.

BHP Billiton has called for annual price talks to be replaced by a more flexible index pricing system.

BHP and Rio are each striving to show shareholders that they can squeeze more value from their iron ore business, as Rio fights off a takeover bid from BHP.

The Chinese industry would have had to begin paying much higher spot rates for iron ore from Rio Tinto had it failed to reach a settlement by June 30.

Steelmakers in South Korea and Taiwan are still waiting for Japanese mills to finish negotiations with Australian miners, but are able to continue to pay last year’s prices through September.

While the Vale deal differentiated the price rise based on the iron content of the ore, the Rio deal establishes a premium for lump ore which moves it closer to pellet prices. Lumps and pellets can be directly used in blast furnaces.

Baosteel agreed to a 79.88 percent price rise for Rio Tinto’s Pilbara blend fines and Yandicoogina fines, and a 96.5 percent price rise for Pilbara blend lump for the fiscal year 2008.

No price has yet been announced for Rio Tinto’s lower quality Robe ore.

The higher ore prices will raise the cost of producing one tonne of crude steel by 120 yuan (8.88 pounds) compared with last year, for mills that supplement term contacts with domestic supply, according to an analysis by Helen Lau of Daiwa Securities.

($1=6.874 Yuan)