A Chinese steel executive detained along with four Rio Tinto employees is being investigated for leaking China's bottom line on iron ore prices, a source with knowledge of the probe said on Friday.
Tan Yixin, the head of iron ore imports for state-owned steelmaker Shougang, is suspected of revealing China's negotiating strategy to Anglo-Australian miner Rio Tinto Ltd, the source told Reuters, requesting anonymity.
The case has stunned the global steel industry, which was already transfixed on the marathon iron ore talks. After more than six months of cat-and-mouse, China appeared to be boxed in, forced to accept Rio's price or to abandon long-term deals and risk destroying a decades-old pricing system.
The shock detentions appear to have left the price talks in limbo and cast a shadow on relations between Beijing and Canberra, whose economies have been welded together in recent years by China's huge demand for metals and minerals.
As Australia sought to avert the diplomatic row, the China Securities Journal said Shanghai's State Security Bureau accused the three local Rio staff and senior Australian executive Stern Hu of bribing unidentified Chinese steelmakers during tense iron ore price negotiations this year.
This seriously damaged China's economic security and interests, said the paper, published by the state-run Xinhua news agency. The activities of Stern Hu and the others violated Chinese law as well as international business morality.
Asked if negotiating strategy meant iron ore prices, the Reuters source said: Yes, China's bottom line.
China dominates the steel industry, making as much as the next eight biggest steel-producing countries put together, and its iron ore imports, which play a major role in setting global shipping prices, have hit unprecedented levels this year.
The episode has put the industry, which relies on open market information for trading and pricing, in an ice box, said one Chinese iron ore analyst. Several state-owned steel company executives from Beijing expected a wave of change to sweep through the sector after the investigation, which they said was much wider ranging than the five detentions so far.
The government is not investigating Rio only, it is checking all the industry. Rio's case is not a single case, I feel the government wants to take the change to regulate the iron ore market, said one executive.
Shougang officials could not be reached for comment.
China's ambassador to Australia was summoned to the Foreign Ministry late on Thursday to discuss what local newspapers called a fast-escalating crisis.
A Rio spokesman expressed surprise at the turn of events, saying the group was not aware of any evidence that would support these allegations.
Chinese security authorities detained the four Rio employees on Sunday, alleging they were involved in stealing state secrets. They were later formally arrested.
Chinese law is vague on what that constitutes, but economic data such as gold holdings and currency movements have at different times been deemed secret, so it would not be a stretch for information about a lucrative state-owned industry such as steel to be included.
Australian Foreign Minister Stephen Smith told reporters in Perth that China appeared to have a broader definition of what amounted to industrial espionage than many other countries.
It's very hard for the Australian government to see the connection between what might be daily commercial and economic negotiations and national security issues, he said.
RUDD UNDER FIRE
Smith said Canberra was treading warily.
Such a serious matter is a matter which goes very much to the relationship between Australia and China, so we are treating this as a very, very sensitive and difficult issue, he said.
He said the latest row would not derail negotiations with China on a free trade pact, under way since 2005.
China buys about 15 percent of Australian exports and supplies about 16 percent of Australian imports, so Canberra's diplomatic options in the face of such economic muscle appear limited.
Given the significance of the Chinese market, it is unlikely that this will discourage business people or governments from doing business with China, added Ken Boutin, a north Asia specialist from Deakin University's School of International and Political Studies in Australia.
The detentions came after the two sides missed a June 30 deadline in the iron ore talks and Rio ditched a $19.5 billion tie-up with Chinese state metals firm Chinalco last month.
Chinalco, Rio's major shareholder, said the arrests were unrelated to dealings between the two firms and expressed mutual concern for the current situation with their staff.
Australian Prime Minister Kevin Rudd, a Mandarin-speaking China expert, promised all steps needed to secure the release of the executives and Trade Minister Simon Crean left for China on Friday.
Australian media reported that consular officials met Hu for the first time on Friday, but no further details were available.
Rudd has faced criticism at home for not intervening with Chinese President Hu Jintao on behalf of Hu and his employer.
Mr Stern Hu is one of us, he is a fellow Australian. He has been denied basic human rights in China, and ... Rudd should take this matter up directly and personally with the Chinese government, opposition leader Malcolm Turnbull said.
The Australian dollar, knocked sharply lower on Thursday amid China export ructions, steadied on Friday, although the market was closely following developments. Rio shares traded up to 1.9 percent higher after a Standard & Poors rating upgrade.
China is Australia's second-largest export customer behind Japan, buying A$36 billion ($28 billion) of mostly commodities in the 11 months ended May 2009. In 2008, more than half of China's imports from Australia were iron ore.
Australia, along with Chile, is the largest recipient of Chinese investment this year, worth $3.9 billion, with Chinese companies anxious to lock in access to resource exports.
(Additional reporting by Tom Miles and Benjamin Kang Lim in Beijing, Ben Blanchard and Alfred Cang in Shanghai, Fayen Wong in Perth, Jeremy Laurence in Singapore; Editing by Nick Macfie)