'Last year, spot sales accounted for about 30 per cent of iron ore trades in China, compared with about 60 per cent in 2009,' Clive Murray, chief executive of London Dry Bulk, told Bloomberg.

The China Iron and Steel Association (CISA), which led the talks for the first time this year, was seeking a 45 per cent reduction on 2008-09 prices, even after a 33 per cent cut in benchmark iron ore prices had already been set with steel mills in Japan, South Korea and Taiwan.

CISA felt that as the world's biggest importer, it deserved a bigger reduction. It was also under pressure to secure a favourable outcome, having taken over from Baosteel, the negotiator in the previous year's talks that was regarded as having mishandled them - China's steel mills paid a significant premium to 2007 prices, when they were expecting a discount.

The negotiating climate this year further soured when China arrested Australian Stern Hu, the head of Rio's iron ore business in China, and three Chinese Rio employees, charging them with illegally obtaining commercial secrets, after a more serious accusation of stealing state secrets was dropped.

In a process that is increasingly being regarded as obsolete, the big iron ore producers sign long-term supply contracts with steel mills for periods of two to five years, and then every year sit down with either a regional or country representative to agree on a benchmark price.

It is the only commodity that is negotiated this way, with others such as copper and oil linked to an index which makes for greater transparency and gets away from the rancour that has accompanied the iron ore talks this year.

The price the producers agreed with other Asian countries in May amounted to about US$61 per tonne 'freight on board', the price sellers demand for transporting the ore to an Australian port and loading it onto a ship. The spot price then was lower than the benchmark price, at about US$58 per tonne, but around the middle of the year it jumped to about US$110 per tonne, causing many Chinese steel mills to criticise CISA for not agreeing to the lower price offered by the producers in May.

The spot market for iron ore has become increasingly significant in China since about 2004. It was at that time that the mainland began to develop its voracious appetite for steel, with many mills unable to secure long-term contracts with the big suppliers because they were either too small or not sufficiently creditworthy.

Most of the spot market is supplied by India, which provides 11 per cent of world exports, making it the world's third-largest exporter after Brazil and Australia. Spot market prices can be volatile since they are literally negotiated by the boatload.

Negotiations were more complicated this year, analysts say, as CISA came to the negotiations determined to come away with a good result following the disappointment over Baosteel's efforts in 2008.

This desire for lower prices was compounded by the collapse in the spot price for iron in the fourth quarter of last year in the wake of the global financial crisis.

Analysts say CISA felt this price was the basis for negotiation with the ore producers, apparently minimising the impact that Beijing's massive 4 trillion yuan (HK$4.5 trillion) economic stimulus package would have.

Meanwhile, the spot price for ore fell below the cost of producing iron ore domestically. Since Chinese iron ore is of lower quality than most ore from countries such as Australia, it has to be crushed and ground down to a powder and then separated using magnets. It is a process that is the most energy-intensive and expensive of any mining operation globally. As a result the average production cost of a tonne of iron ore is about US$80, well above prices elsewhere. So late last year, less domestic ore was produced on the mainland.

Also, over the past few years the central government has been closing down steel mills that were too small, inefficient or environmentally dirty. The aim was to consolidate the hugely fragmented Chinese steel industry. As a result, analysts said, many steel producers closed down smaller mills and built bigger ones, leading to a situation in which there were numerous mills without long-term contracts looking for ore.

A number of the larger mills that were obliged to take delivery of agreed tonnage used the lack of an agreed contract price to defer delivery in some cases and buy from the spot market.

The outcome has been a confused market, which has hurt the industry.

With negotiations for the 2010 price due to begin next month, many participants feel it is time to move away from what is being seen as an outmoded process for setting prices.

The industry has been talking about including elements of the spot price and index linking into the negotiations, as well as going for shorter contracts. CISA has yet to be persuaded, but the miners are keen, no doubt spurred by the prospect of less bruising negotiations next year.

The cost of going local

The low grade of Chinese iron ore means it is expensive to produce

The cost, per tonne in US dollars, of producing mainland iron ore is about: $80