MELBOURNE/SYDNEY- A $68 billion merger of coal giants Xstrata and Anglo American would rattle a global steel industry that is already reeling from a tie-up between two of its biggest iron ore suppliers.

Xstrata wants a merger with Anglo American that would create the second-largest producer of steel-making coals and also mirror developments in iron ore, where major suppliers BHP Billiton and Rio Tinto plan a joint venture.

The prospect of BHP and Rio Tinto joining forces in iron ore has brought cries of unfair competition from Asian and European steel bodies fearing a loss of price control.

But in both coking coal and iron ore, the miners could argue they are simply doing now what steel mills have long endorsed for themselves: merging and cutting costs.

Steelmakers bulked up in a round of tie-ups earlier in the decade, culminating in Tata Steel swallowing Corus and Lakshmi Mittal buying Arcelor to create ArcelorMittal.

If Xstrata acquires Anglo American, it would control 11 percent of the world's metallurgical coal market, according to Australia's AME Mineral Economics. That would make it second only to BHP in terms of coking coal production.

This would put the supply of coal in fewer hands and at a time when price is a sensitive subject, said Patersons Securities coal analyst Andrew Harrington.

That can't sit well with the buyers.

Global pricing of iron ore, which is based on benchmarks set in annual price negotiations between producers and steelmakers, is already under strain. An Xstrata deal with Anglo American could add to pressure to shift to index-pricing for bulk commodities, including iron ore and coking coal.

The steel industry has inevitably got to try and respond in a rational way, said Ken West, a partner at fund manager Perennial Growth Partners.

For now, coal miners are bracing for a sharp drop in revenues as global recession hits steel production. Global steel output fell 23 percent in January-February from a year earlier, according to the World Steel Association.

In March, BHP Billiton Mitsubishi Alliance (BMA) agreed to accept a price cut of around 60 percent from Japan's Nippon Steel, effectively setting the year's benchmark.

In Japan, spokesmen at Nippon Steel and JFE Holdings declined to comment on a possible Xstrata-Anglo American marriage, though analysts see trouble looming for the mills.

It's going to have a negative impact on steelmakers as more consolidation in the raw materials sector would mean their bargaining power would grow in line, said Yang Ki-in, a Daewoo Securities steel analyst.

It's something they would not welcome and may have a longer-term impact.

NO RIVAL BIDS

BHP and Rio are unlikely to try and block Xstrata and Anglo American merging in the hope of saving the spoils for themselves.

I can't see either Rio or BHP being particularly interested in doing anything on the corporate side with Anglo or Xstrata, said Neil Boyd-Clark, portfolio manager at Fortis Investment Partners.

BHP Billiton CEO Marius Kloppers has been telling analysts his company has not come across any opportunities to rival the planned Rio iron ore joint venture.

Both BHP and Rio are focused on their iron ore plan, where they see at least $10 billion in savings. Rio is also concentrating on paying down nearly half its debt. It plans to raise $15.2 billion in a rights offer of new shares this month.

Brazil's Vale, the world's top iron ore producer, is also less likely to join the fray after being spurned by Xstrata in an approach last year.

(Additional reporting by Miyoung Kim in SEOUL, Taiga Uranaka in TOKYO and Nick Trevethan in SINGAPORE)

(Editing by Ian Geoghegan)

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