Australia summoned China's ambassador on Monday for a second time to press for details of the detention of Rio Tinto's top iron ore salesman in China and three other staff accused of spying.
The detentions of the four and protracted price talks between Rio and Chinese steel mills helped push down shares on Monday in BHP Billiton and Rio Tinto, two of the world's largest iron ore firms.
Australian Prime Minister Kevin Rudd, who attended last week's G8 summit in Italy, flew home on Monday as the diplomatic storm strained bilateral ties. Rudd would be on informal leave for the rest of the week, said his office, despite calls for the former Beijing diplomat and fluent Mandarin speaker to intervene in the Rio detentions and call Chinese President Hu Jintao.
Australia has urged Chinese authorities to consider the wider risks for international business confidence in China. But Australia, which has relied on China's insatiable appetite for its minerals to protect its economy from the global financial crisis, is treading carefully.
Australia will not use megaphone diplomacy to pressure Beijing to release the Rio staff, Finance Minister Lindsay Tanner told Reuters Television.
Our dealings with the Chinese government are going through formal channels. It is always important in these very delicate situations for governments and ministers to be very careful about their public commentary ... where an individual's freedom is at stake.
Australia's Foreign Ministry also summoned the Chinese ambassador on Thursday.
During his 2007 election race, Rudd promised deeper Australian engagement with Asia, especially China. He has forged a close relationship with China's leadership, phoning Premier Wen Jiabao in September 2008 to discuss the unfolding financial crisis and addressing President Hu in Mandarin at a 2007 regional leaders' conference.
Anglo-Australian miner Rio was in intense price negotiations with China when Australian Stern Hu and the three others were detained in Shanghai, accused of stealing state secrets and bribing Chinese steel makers for information.
Chinese media reports say information from an internal meeting of the China Iron and Steel Association on the negotiations was leaked and that the investigation has extended to several senior figures in the Chinese steel industry, including within the association itself. A senior executive at Shougang, China's eighth-largest mill, has also been detained.
Sources say some Rio Tinto computers were removed in the course of the investigation, which could potentially expose the company's negotiating strategy as well as contractual terms with the mills it supplies. Rio has not commented on the computers.
The arrests came as local media reported Chinese steel mills had given in on annual iron ore prices, agreeing to the same 33 percent cut other Asian steel makers set earlier.
That capitulation would be a loss of face for the state-backed Chinese Iron and Steel Association, which had vowed to the central government it could achieve a deeper discount.
Chinese and Rio officials have denied any agreement was reached, although news that top mill, Baosteel, on Monday would raise steel product prices by 9-13 percent next month renewed speculation that mills had given up hope for lower prices, passing on higher-than-expected costs to customers.
Executives and analysts in the steel industry, which relies on open market information for trading and pricing, now fear the investigation could spread.
Chinese state-owned companies have been trying to portray themselves as independent, commercial entities as they roam the world buying up companies and sourcing raw materials, but may now face suspicions they are fronts for Beijing, analysts say.
The Sydney Morning Herald reported on Monday the Rio investigation appears to be part of a realignment of how China manages its economy amid the global financial crisis, with spy and security agencies promoted to top strategy-making bodies.
It said that President Hu endorsed the Rio investigation.
Peking University international relations professor Zha Daojiong said he did not think President Hu intervened personally in the Rio case and did not believe the arrests would make it harder for foreign firms to operate in China.
(Police intervention) is very normal. That should not really be magnified. Let's face it. Corruption is part of the game in this business and it is a matter of how you define it, Zha said.
CHINESE BUSINESS CULUTRE
The inquiry into Rio began before it broke off its $19.5 billion investment deal with Chinese metals firm Chinalco and instead formed an iron ore joint venture with rival BHP Billiton on June 5, the Herald reported.
Obviously a lot of this has to do with the emotions surrounding the Chinalco-Rio Tinto deal, said Zha, citing concerns over a concentration of ownership of iron ore resources.
Zha said China had been attempting to streamline and rein in new capacity in its steel making sector since 2003.
There is too much disorder in the sector, and relentless adding of production capacity. This chaotic system in the trade is partly to blame for all this, he said.
But Zha said he did not believe the Rio arrests would make it difficult for foreign firms to operate in China and Australia's Tanner said Chinese steel makers were unlikely to drop their current long-term contracts with Australian iron ore producers and move to the spot market instead.
The contract system, which traditionally governs Australia's $14 billion in annual iron ore exports to China, faces an uncertain future, with Chinese steel mills unable to agree contract pricing this year with major iron ore miners.
Iron ore is Australia's second-largest export behind coal.
(Additional reporting by David Stanway)
(Writing by Michael Perry; Editing by Nick Macfie)