The Chinese Government is risking rejection or modification of its ambitious bid to grab control of Rio Tinto by sanctioning the rejection of last week’s 33%-47% cut in iron ore prices that Rio reached with steelmakers last week in Japan and South Korea.

According to Beijing reports: “these prices do not reflect a mutually beneficial, win-win relationship for steelmakers and iron ore suppliers,” the China Iron and Steel Association said on Sunday in a terse, three-point statement posted on its website.

“Cisa therefore cannot accept these prices and will not follow them.”

The Chinese mills want price cuts of 45% to 50% or more for their favourite iron ore type, so-called “fines”, which are now 33% cheaper under the new Rio deal. Rio cut the price of lump ore by 47%: it’s the type of ore favoured by the Japanese mills. Chinese mills want parity with Japanese mills for their favoured ore type.

Individual Chinese steel companies aired their dissatisfaction last week with the Rio prices in its deals with the Japan and South Korea steel groups.

Chinese steel companies have been buying record amounts of iron ore on the spot market (they imported 57 million tonnes in April, a record after importing a record 52 million tonnes in March).

Cisa said Rio Tinto’s price cuts “do not objectively reflect” conditions in the international iron ore market, and would “result in overall losses among China’s steelmakers”.

It’s understood that Cisa has given Vale of Brazil, Rio and BHP Billiton, the three global iron ore giants just four weeks to close an agreement on prices for 2009-10.

If there’s no agreement, the prices paid would be determined by the spot market rather than the annually settled prices of the so-called benchmark system.

The miners have warned China that they will not settle benchmark prices below spot prices — which would happen if they signed up to Beijing’s request for a cut of up to 50% in contract prices.

According to industry reports, the big miners have told the Chinese steelmakers that they would rather move iron ore transactions into the spot market where prices for late this year are pushing above the settlement level for Rio’s deals in Japan and South Korea.

If this was to happen, Chinese steel mills would loose the certainty of contract pricing and guaranteed tonnages. That might be OK now, but when conditions eventually improve, it will leave them hostage to world prices and demand. The Japanese mills have been through all of this before in the past 30 years and prefer the certainty of formal contract arrangements, prices, but with room to be flexible on tax and pay clauses covering tonnages.

The decision to push for bigger discounts than offered has come with Chinese Government approval as it controls all the steel groups and the Association. It could be a sign that something has gone wrong in the Chinalco-Rio deal and no longer sees any need to play nice with Australia.

But it could also be a game of bluff with the Chinese Government telling the steel mills to play tough on pricing with Rio while the Australian Government moves towards the approval or extends the FIRB deadline that is due this month. That way it would be clear to Australians that China doesn’t control Rio, even with Chinalco holding the single biggest holding.