China steel mills continue talks with BHP

By Lucy Hornby

BEIJING (Reuters) - Chinese steelmakers are still trying to reach an iron ore deal with BHP Billiton (BHP.AX)(BLT.L), after agreeing to a higher-than-expected rise in term prices with rival Australian miner Rio Tinto (RIO.AX)(RIO.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.SA)RIO.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.