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Australian iron ore giant Fortescue Metals Group (OTCPK:FSUMF) just struck a deal with China’s largest steel company Baosteel Group to sell iron ore below the benchmark 33% discount set by the large mining firms with Korean and Japanese steelmakers. Baosteel, together with The China Iron and Steel Association (CISA) won a 35% reduction in iron ore prices. Supposedly however, the iron ore pricing is conditioned upon Fortescue getting an US$5-6 billion round of funding from Chinese capital by September 30.The deal gives CISA/Baosteel the opportunity to buy iron ore fines at a price of US$0.94 PDMT (per dry metric ton) over the next six months. “This price equates to approximately $US55.50 PDMT for Fortescue grade iron ore,” the company said (Bloomberg).

The deal gives CISA a lot of face
. After the financial crisis CISA insisted on a discount of 45% this year, a price from which it wouldn’t budge despite iron spot prices surging to over US$100/ton. For months, neither CISA nor the large iron ore companies were willing to move (until now).

But one might wonder why Baosteel got this deal and not Hunan Valin Iron and Steel, Fortescue’s largest shareholder.

Perhaps this is because of the history between Baosteel and Fortescue. While Valin now owns a large chunk of Fortescue, the “favored” Chinese suitor has always been Baosteel. For over a year, Baosteel and Fortescue courted each other but Baosteel was not interested in paying the hefty stock premium demanded by Fortescue. After a while, Baosteel gave up on talks, thinking that Fortescue would become more pliable as as its debt load would force them to the brink of liquidation. It was Baosteel’s exit that left an open space space for the adventurous and aggressive Valin Iron & Steel to acquire a 17% equity stake in Fortescue from one of its investors–US-Based Harbinger Capital Partners.

The deal was announced in February 2009 and has since closed. Unlike Chinalco and Minmetals, which are state-owned enterprises, Valin is controlled by the Hunan provincial government. Historically, it has been a struggling steel maker in a province lacking iron ore and coking coal. Nevertheless, its ambitious Chairman Li Xiaowei brought in much needed capital by listing of some of its assets on the Shanghai Stock Exchange. He subsequently persuaded Arcelor Mittal (NYSE:MT), the world’s largest steelmaker, to invest close to US$500 million. Valin has since risen from relative obscurity to become a major steel player in China. It is a company to watch.

So what’s next? For starters, we see this deal providing pressure to Rio Tinto (RTP), BHP and Vale (NYSE:VALE) to match Fortescue’s pricing. We also see a potentially major investment in Fortescue from sources in China (most likely CIC, China’s US$200 billion sovereign wealth fund). Stay tuned…