Australia's No.3 iron ore miner, Fortescue Metals Group , has agreed to supply China at a 3 percent discount to prices offered by its bigger rivals, in a deal that will allow Chinese steel mills to claim a partial victory in their quest for a better iron ore settlement.

At 35 percent below the key Australian iron ore price last year, the price is significantly higher than the 40 percent cut which the China Iron & Steel Association (CISA) had hoped to win.

But it will bring a reprieve for CISA's Secretary General Shan Shanghua, who announced the deal on Monday and who had staked the body's reputation on winning a better price than the 33 percent price cut offered by Rio Tinto .

The deal, for 20 million tons of ore in the rest of 2009, will cover only a fraction of China's iron ore imports, which are running at more than 50 million tons a month.

But it will bolster Fortescue's campaign to break into an iron ore market dominated by Rio, BHP Billiton and Brazil's Vale .

Fortescue agreed to supply iron ore fines at US$0.94 per dry metric ton unit and iron ore lumps at $1 per dry metric ton unit for the second half of 2009, Shan at an emergency press conference in Beijing.

The deal will allow CISA to point to a success as its talks with the big firms appear to have reached stalemate, mired in a diplomatic row over the arrest of four Rio employees suspected of stealing commercial secrets and bribery.

Chinese iron ore price talks have achieved an important and periodical success, but are not at all finished, CISA vice chairman Liu Zhenjiang told reporters. He said the price was reasonable and benefited all parties.

CISA will negotiate with the three miners using the Fortescue prices as a reference, Shan said. He said Fortescue had promised to supply to all Chinese clients at one price.

CISA has long wanted Chinese importers to agree to stick to one price, rather than driving up local prices by re-selling to each other, but has so far failed to win any agreement.

FMG has been wooing Chinese steel makers and investors, marketing itself as an alternative supplier to its two much larger Australian rivals.

CISA says the three top miners have too much pricing power, but the rapid growth of the Chinese steel industry means the iron ore market is still a sellers market.

Shan said the agreed prices include a 35.02 percent drop on year for fines, and a 50.42 percent drop on year for lumps, besting the 33 percent drop that major Asian mills -- and some Chinese mills -- have signed with BHP and Rio.

Fortescue signed the agreement with CISA and with Baosteel, China's top steel mill, which led the annual pricing talks with the top global miners until CISA took over this year. Shan said that although CISA was the organizer of the negotiations, Baosteel was the real representative for the mills.

The deal with Fortescue also broke with the format of traditional annual iron ore pricing deals by only covering six months from July 1.

Shan said next year's conditions would determine whether China continued to negotiate on a half-year basis.

FMG is slated to produce 95 million tons in 2010, Shan said. That is dwarfed by China's expected iron ore imports of 500 million tons in 2009.

(Editing by Ken Wills)