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A steel worker at a foundry in Handan Steel Plant in Hebei province. [Agencies]

Chinese steelmakers' decision to pay up to 96.5 percent more for iron ore from Australian miners is expected to further squeeze their earnings. But the rise of steel product prices this year can offset the rising production cost from surging iron ore prices, analysts said.

Baosteel agreed on Monday to pay 19.88 percent more to Pilaral Blend Fines and Hiy Fines, and 96.5 percent more to Pilbara Blend Lump and Australian Rio Tinto for 12 months beginning April 1, 2008.

Analysts said the result of Monday's agreement was better than expected, and going by past experiences, Australia's BHP Billiton is expected to accept the price.

"The price increase of ore fines, which accounts for 60 to 70 percent of imported ore, is lower than prior expectations of around 85 percent," said Luo Wei, an analyst at China International Capital Corporation Ltd.

In February, Baosteel had agreed to pay 65 to 71 percent more to Brazil's Cia Vale do Rio Doce for ore fines.

Luo said shipping fee fluctuations aside, this year's iron ore price negotiations have made steelmakers' production cost rise by 454 yuan per ton if using Australian ore and 385 yuan per ton if using the Brazil variety.

"However, the spot steel price has risen by 1,000 to 1,800 yuan per ton, or over 30 percent, from the beginning of this year, and the rise of steel product prices for large domestic steel manufactures can fully offset their rising costs," said Luo.

Yang Baofeng, an analyst at Orient Securities, said the impact of iron ore price rise on steel companies depends on the extent of its Australian ore imports.

"The production cost of Baosteel, with 60 percent of its ore imported from Australia, will increase by 70 yuan per ton, or 65 percent," said Yang.

But Zhou Tao, an analyst at Sinolink Securities, said Australia's third largest miner Fortescue Metals Group Ltd has begun to supply iron ore to Baosteel, which is expected to strengthen Baosteel's power in the following year's iron ore negotiations.

Analysts said the gap of production cost between large steelmakers that fix price by long-term agreements and other steel manufactures that go by spot prices is expected to be widened. Nie Xiuxin, an analyst at Ping An Securities, said the gap is expected to be 800 yuan per ton.

Zhou Xizeng, an analyst at CITIC Securities, said companies with more Contracts of Affreightment (COA), including Baosteel, Wuhan Iron & Steel and Magang (Group) Holdings Co Ltd, can save costs by an average of 100 yuan per ton.

Shares of Baosteel plunged 7.83 percent to close at 9.06 yuan yesterday, while Magang Holdings dropped 0.75 percent to close at 5.31 yuan. Jinan Iron and Steel Co Ltd, which posted over 50 percent increase in net profit from January to June, slid 4.17 percent.

"After the large fall, many listed steel companies are now undervalued. Around one-third of steel companies are expected to increase earnings in the first half of this year," said Zhou at CITIC Securities.