* Iron ore prices should follow steel prices - CISA
* China will import less ore, use more steel scrap - CISA
* China mills will not accept cost rise from mining tax -CISA
By Ruby Lian and Lucy Hornby
DALIAN, China, Sept 28 (Reuters) - China reopened its war of words with global iron ore miners on Tuesday as the spokesman for the country's big steel mills vowed they would not be bullied into accepting unfavourable pricing systems.
Shan Shanghua, secretary general of the China Iron & Steel Association (CISA), said iron ore prices should be based on steel prices, a reversal of the current market in which China, the world's biggest steelmaker, is the top iron ore buyer.
"I view iron ore as an intermediate ingredient that only has value because it is processed into steel by the steel industry," Shan told a conference in the Chinese port of Dalian.
CISA, which represents 78 of China's top steel mills, has been fighting the pricing battle for years, determined to get the upper hand in negotiations with the big three miners, Vale SA (VALE5.SA), Rio Tinto (RIO.AX) (RIO.L) and BHP Billiton (BHP.AX) (BLT.L).
The rhetoric peaked last year when CISA failed to clinch an annual pricing deal and China arrested and jailed four Rio employees, including one Australian, for stealing commercial secrets and taking bribes. [ID:nSGE6740AL]
Australia is China's top source of imported iron ore and a major investment destination for Chinese companies, including steel mills, many of which have stakes in iron ore mines there.
Australia's Ambassador to China Geoff Raby said Chinese steel companies should consider setting up mills in Australia, since they had interests in local iron ore and could get ready access to coking coal and energy such as natural gas.
But Australian iron ore costs could also rise because Australian Prime Minister Julia Gillard has proposed a 30 percent tax on coal and iron ore mining profits from 2012.
Shan said Chinese mills would refuse to pay more because of the tax.
"Chinese steelmakers will not be able to accept rising costs from the Australian iron ore mining tax as steel prices will reach a ceiling, and downstream users including automakers and producers of home appliances won't absorb rising costs," Shan told Reuters.
CISA's failure to reach an iron ore pricing deal last year helped bring down a decades-old system of annual benchmark pricing, but miners and mills have yet to settle on a universally accepted replacement.
Big Chinese mills such as Baoshan Iron & Steel Co Ltd (600019.SS) have moved to quarterly pricing, but some miners favour prices that fluctuate more rapidly, such as price indexes.
Shan railed against iron ore pricing indexes, which he said reflected only a small portion of the iron ore trade that passed through the spot markets, and therefore should not be the determinant of seaborne iron ore prices.
"Spot trading is mostly through small mills and therefore not representative of the market."
Investigators had found evidence of collusion between end-users and traders to fake spot import contracts, he said.
China has boosted its own iron ore production in the last five years in a bid to displace some of its imports. Monthly output of iron ore, which was then similar to the volume of crude steel produced, has now grown to about 100 million tonnes, twice as much as steel.
But industry experts say China's iron ore quality is far lower than that of imports.
Shan said iron ore imports would fall this year, with domestic production expected to exceed 1.1 billion tonnes, adding that China would recycle more steel scrap, with 100 million tonnes expected to be generated this year and more in the future. (Additional reporting by Sussy Shao; Editing by Chris Lewis)