Feb. 22 (Bloomberg) -- Chinese steelmakers, the largest buyers of iron ore, will reject Rio Tinto Group's demand for a minimum 71 percent price increase in an attempt to slow accelerating costs for raw materials, two people familiar with the negotiations said.

The mills want to pay no more than 65 percent extra for ore from London-based Rio's mines in Australia, said the people, who declined to be identified because the talks are confidential.

Rio, the world's second-biggest iron ore exporter, wants a higher price because of its premium ore and proximity to China, which reduces shipping costs. Chinese mills have failed to arrest a tripling of iron-ore prices and a doubling of coking coal in the past five years.

``It's inconceivable to me that they could not achieve some higher outcome,'' Ken West, who helps manage the equivalent of $2.8 billion at Perennial Investment Partners Ltd. including Rio shares, said by phone from Melbourne. Rio ``would be disappointed with 65 percent,'' he said.

Rio dropped 137 pence, or 2.4 percent, to 5,685 pence at the close on the London Stock Exchange. BHP Billiton Ltd., the world's third-largest iron ore exporter, slipped 31 pence, or 1.9 percent, to 1,615 pence.

Australian producers are in a ``strong position'' to match the 71 percent gain in price for premium Carajas ore won by Brazil's Cia. Vale do Rio Doce, the biggest exporter of the raw material, because it is of similar quality, Merrill Lynch & Co. Inc. analysts led by Vicky Binns wrote in a Feb. 18 report.

`Strong Position'

Cash prices in China for the ore have more than doubled in the past year and are trading at four times Australian annual contract prices.

Analysts at Goldman Sachs JBWere Pty. estimated in November that 2008 contract prices would rise 30 percent. Credit Suisse Group last month increased its predicted gain to 70 percent, from 35 percent in November, after the surge in cash prices.

Rio will meet Chinese steelmakers for further talks next week, the people said. Negotiations with steel mills are continuing, Rio spokeswoman Amanda Buckley said today from Melbourne, declining to be more specific. BHP spokeswoman Samantha Evans wouldn't comment.

``It may just be a face-saving exercise,'' Peter Chilton, who holds Rio shares among the $1.4 billion he helps manage at Constellation Capital Management in Sydney, said by phone. ``The Chinese somehow or other have to be seen as winners. On the revenue line, a few cents here conceded is probably millions of dollars.''

Japanese Mills

Vale this week won its 71 percent increase for Carajas ore for the year starting April 1 from Nippon Steel Corp., JFE Holdings Inc, and Posco, Asia's three largest steelmakers. It gained a 65 percent gain in prices of so-called Southern System fines. Rio said Feb. 18 that it regards Carajas ore as the ``relevant reference'' for its own supplies.

Baosteel Group Corp., China's largest steelmaker, today said it agreed to pay the same price as its Asian rivals for the two kinds of ore. Meng Haibiao, a company spokesman for Baosteel, declined to comment on the talks with Rio.

Rio is also demanding that Asian mills pay a freight premium to reflect the lower cost of shipping ore to Japan and China from Australia than Brazil, where Vale is based. It costs about $20 to $30 a metric ton less to ship ore from Australia than Brazil, Merrill Lynch said in July.

Freight Premium

Chinese steelmakers have rejected paying a freight premium, the two people said. BHP, the world's largest mining company, failed to win a premium in talks three years ago.

``This is a way to make the Australians earn the 71 percent and hopefully put them at bay for further pricing adjustments,'' Mark Pervan, a senior commodity strategist at Australia and New Zealand Banking Group Ltd., said today from Melbourne. ``We may be talking weeks, three to four'' before prices are settled, he said.

Asian steelmakers buying iron ore from Australia saved $34.85 a ton last year compared with shipments from Brazil, according to Bloomberg calculations based on Baltic Exchange data. The average cost of hauling Brazilian ore to China last year more than doubled to $59.19 a ton, compared with $24.34 from Australia, according to prices from the London-based exchange.

The contract price for Rio's benchmark Hamersley fines ore, which doesn't include shipping and insurance, was set at $51.47 a metric ton for the year starting April 1, 2007. Including freight, contracted iron ore was sold in December for $85 a ton, Rio said Dec. 18.

China increased imports of iron ore by 17 percent in 2007.

To contact the reporters on this story: Jesse Riseborough in Melbourne at jriseborough@bloomberg.net; Helen Yuan in Shanghai at hyuan@bloomberg.net

Last Updated: February 22, 2008 13:14 EST