We are about to find out how clever and strategic the Chinese Government and companies in the steel industry are.

The settlement by Rio Tinto of the 2009-10 iron ore contract pricing with the Japanese steel mills will tell us whether the Chinese have any subtly and finesse, or are just another bunch of clumsy state-run pen pushers and cadres.

That Rio, and not BHP Billiton or Vale, reached this agreement with the Japanese, and not with the Chinese, tells us something about resource policy dynamics at the moment.

There is one factor involved here and one factor alone: Chinalco.

The 33% price cut for iron ore fines with the Japanese was played up, even though it’s not an important type of ore for their blast furnaces. They prefer lump ore, and there Rio agreed to a 44% price cut. Chinese mills prefer iron ore fines, so they are now stuck with a pricing benchmark above their demands for price cuts of 45% to 55%.

Last year, the Chinese, who settled ahead of other consumers, accepted a price rise for fines of 85%. But they also agreed to a 96% increase in the price of lump ore. This set a benchmark for lump ore that put the Japanese steelmakers at a disadvantage. Those higher prices achieved by BHP and Rio were said to include a premium for Australia being closer to China and Japan and for the mills not having to charter as much shipping to supply them.

The Chinese mills would like to see a 44% price cut for fines to match the price advantage the Japanese mills have won for their preferred raw material type. But they won’t.

Why? Because of Chinalco and the Chinese government’s obvious wish to see Chinalco succeed (it’s a state owned company) in getting 18% of Rio and stakes in Hamersley iron ore, the bauxite operations of Rio in Queensland and the Escondida copper mine in Chile.

If the Chinese steel industry monsters Rio into accepting a 44% cut for fines or higher cuts for any other type of ore, the opponents in Australia will point to that and argue that it supports their claims that Rio will bend to Chinese wishes if Chinalco gets 18% of the company and 15% of Hamersley. Watch Senator Barnaby Joyce hop into that one. They would argue that Rio has bent to Chinese demands before even Chinalco has lifted its stake from around 9.7% to 18%.

Such a capitulation by Rio would also worry the Australian Government, who might impose tougher conditions on the deal.

The Chinese are likely to settle around the Japanese price, but with a component of any agreement to be met (or allowed to be bought) via the spot market. Prices there are around the new price, but spot prices for December delivery are above it at around $US72 a tonne compared with the new contract price level of around $US62 a tonne. Rio mines the stuff for a cost per tone of around $US33-$US35 a tonne, so the profit margin remains solid, not outrageous as the 2008-09 settlement was.

The Chinese mills will huff and puff, credulous western reporters will claim that ‘price clash looms’ between Australian producers and Chinese buyers, but in the end Chinese strategic needs will prevail.

Chinese mills have imported record amounts of ore in March (52 million tonnes) and April (57 million tonnes). Chinese steel production in the four months to April is up slightly, but it fell in April. Prices remain weak, steel exports are weak, imports of steel products has risen a touch: the financial position of the Chinese industry isn’t solid at the moment, but it would be a lot better than the Japanese steel companies who have all forecast losses for the next 12 months.

Chinese iron ore production is falling: Rio said yesterday the slump in domestic production had forced up demand, hence imports and its mines in WA were ‘running flat out” according to iron ore chief Sam Walsh.

All this was forgotten by the silly Australian reporting of the iron ore settlement Rio struck with the Japanese mills. From estimates of $40 billion of lost national income in the Sydney Morning Herald, to $14 billion in the Financial Review, there was a slant in the reporting that this was a “bad deal” or a “loss”.

Far from it: it is the second highest iron ore price settlement in history after last year’s prices rose 500% in around six years: they are now come back just 33%-44%, with much of that lower price to be shared by overseas owners and buyers, just as they shared in the gains of the past two years.

Goldman Sachs JBWere analysts this morning said: “The fines settlement is considerably better than our forecast of -40%. We believe that consensus had moved to c. -35%, so this is also probably a little better than consensus. The lump settlement is in line with our forecast of -45%. To put this in another perspective, this is the second best price settlement in history; a remarkable outcome given today’s macro-economic environment.”

“While Chinese steel mills have been looking for a bigger price reduction, we think there is now a reasonable probability that they will follow this benchmark for some contracts. However, we would also expect that significant tonnages into China will continue to be transacted on a spot market basis.”