China's huge and fragmented steel sector is facing a painful period of restructuring and only the best companies will survive, the head of one of the country's biggest mills said on Saturday.

Zhu Jimin, the head of the Beijing-based Shougang Group <000959.SZ>, told reporters that while he was neither optimistic nor pessimistic about the prospects for the sector in 2010, demand would remain strong but the industry would still have to resolve some of its long-standing problems.

The industry is facing many, many uncertainties at home and overseas, he said at a briefing on the sidelines of the latest session of China's parliament, the National People's Congress.

For many kinds of historical reasons, Chinese steel firms are very dispersed, and this affects transportation costs and affects the pace of industry restructuring, he added.

Surging demand helped keep smaller mills in operation last year as the government's 4 trillion yuan ($586 billion) stimulus package drove a nationwide construction boom, but Zhu said the perennial problem of overcapacity still had to be addressed.

A wide-ranging plan to rectify the sector had already been submitted to the State Council, China's cabinet, for approval, he said, and in the next few years programs aimed at improving energy efficiency and eliminating outdated and polluting capacity would eventually winnow out the worst performers and force the big players to switch to more high-end steel products.

The steel sector is facing significantly higher costs this year, with prices of key raw materials like iron ore and coking coal surging as a result of higher demand, but the mills have been unable to pass the increased burden onto their customers.

Many, including the China Iron and Steel Association, have blamed the smaller, privately-owned mills for blindly expanding capacity and causing a glut on the market, thereby eroding the margins of the bigger steel enterprises.

Chinese steel firms are also facing higher contract iron ore prices, with some analysts saying Australia's Rio Tinto and BHP Billiton and Vale of Brazil could demand an increase of as much as 80 percent during this year's benchmark iron ore talks.

Zhu refused to comment on the price negotiations, saying they were being led by Shanghai's Baosteel <600019.SS> and that his own company was not involved.

(Reporting by David Stanway; editing by James Jukwey)