China's steelmakers should not try draw their government into iron ore price talks with Australian miners, Australia's trade minister said on Monday, as the mills struggle to pin back soaring raw material prices.

Any overt efforts by Beijing to influence iron ore prices would likely deal the coup de grace to the decades old annual benchmark pricing mechanism, already teetering on the brink of collapse due to increasingly volatile market conditions and the growth in the spot market.

The China Iron & Steel Association (CISA) and the heads of more than 10 mills wrote a joint letter to Premier Wen Jiabao on March 11, the official China Securities Journal has reported, asking him to take up the issue of rising iron ore import prices at a national level.

With BHP Billiton highlighting the 100 percent gulf between spot and contract prices and Brazil's Vale demanding a 90 percent hike in contract prices, China's steel industry is worried about exploding costs that they say cannot be passed onto users.

We recognize China's market economy status, all we ask in return is that it acts in accordance with market principles, Trade Minister Simon Crean told reporters.

He added that Chinese steelmakers, locked in talks with Australia's two biggest iron ore miners, Rio Tinto and BHP Billiton over pricing of hundreds of millions of tonnes of ore for delivery over the next 12 months, should not seek to get government involved.

The annual negotiations have previously taken on a political angle, with relations between the two countries strained by the arrest last year of four members of Rio Tinto's iron ore negotiating team, and often contentious Chinese bids for stakes in Australian producers.

Some of the strain was eased by a report by China clearing Rio Tinto and Australian government of blame for the collapse of a $19.5 billion tie up between Rio and Chinalco last June.

The iron ore negotiations are always going to be robust negotiations, Crean said, adding that prices had been discussed in the past with the Chinese government, although not at recent meetings.

In 2009, government-backed CISA's leadership of ore negotiations, and in particular its much-trumpeted demand for more favorable price terms than other Asian mills, left the benchmark system in tatters.

It's unrealistic to think the likes of BHP, Rio or Vale would welcome a government role in negotiating prices at a time when more than ever they want to see the market determine the price, said an analyst who asked not to be named because he did not want to appear to be siding with miners in the talks.

Indeed, the three big miners may have already given up on seeking an annual prices with Asian miners, after steel mill sources in Japan said BHP had proposed a quarterly price for iron ore.

The companies seeking the premier's intervention included Baosteel, Wuhan Iron & Steel, Anshan Iron & Steel and Hebei Iron & Steel, according to the China Securities Journal.

The steel mills are caught between a rock and hard place. But it's of their own making. Their overcapacity has created huge demand for iron ore, ANZ's senior commodities analyst Mark Pervan said.

Beijing wasn't prepared to make the tough decisions to consolidate and cut capacity so it's been left to the market to make the decision for them through higher prices.

Chinese mills aren't alone in voicing concern iron ore prices will skyrocket in 2010 as global industrial activity rebounds.

European steel industry group Eurofer last week said hefty price hikes of 80 to 90 percent forecast by analysts could hurt European economic recovery.

Spot market prices for iron ore have soared above $130 per tonne, double the 2009-2010 contract price.

(Additional reporting by Michael Perry; Editing by Michael Urquhart)

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