Instead of grandstanding round Germany and donning his really serious look for the G8 meeting tonight, Prime Minister Rudd would be better placed turning his attention to the sudden escalation of the pricing dispute between Rio Tinto and the Chinese steel mills.

China, which is our fastest growing export destination, especially for resources, has suddenly gone off the rails — if media reports of police involvement are correct. Media reports in Australia and worldwide splashed with the news that four Rio executives, including one Australian (a Chinese man with an Australian passport) were arrested and detained without explanation on Sunday.

This is the first time this has happened in resource contract talks between Australian companies and major customers.

Not even when relations between Australia and Japanese buyers of sugar, coal and iron ore were fraught with tension in the late 1970s and then through the 1980s did the Japanese Government resort to this sort of behaviour.

It is a direct warning to the Australian companies about the power of the Chinese state to get what its commercial arms want and it suggests that Rio’s rejection of state owned Chinalco as its saviour last month still rankles, despite Chinalco tipping $US1.5 billion into Rio’s rights issue last week.

Rio walked away from Chinalco’s strategic $US19.5 billion investment in favour of an iron-ore joint venture with BHP Billiton in Western Australia and a $US15 billion rights issue to help repair its balance sheet. The issue was completed last Friday, with Chinalco’s money included and no complaints.

The arrests came as reports in the Australia media suggested Rio’s iron ore team had been meeting in Hong Kong and Singapore, fearing that their phones and emails were being bugged and information passed onto the China Iron & Steel Association.

The Financial Times said:

Rio said it “intends to co-operate fully with any investigation the Chinese authorities may wish to undertake and has sought clarification on what has occurred”.

Rio gave no details of the employees’ nationality, or of their positions at the company. The four worked in Rio’s Shanghai office, one of the company’s main centres in China and its chief base in the country for iron ore sales and marketing.

“Our embassy in Beijing and the consulate general in Shanghai are seeking to confirm the reports of the detention of an Australian man by Chinese authorities in Shanghai on 5 July 2009 and are seeking urgent consular access to him,” said a spokesman for the Australian government in Washington.

Governor Glenn Stevens has pointed out several times this year the importance of China’s recovery to Australia’s economy. But now the Chinese seem to have dramatically altered the game and its rules.

Rio and BHP want the Chinese steel mills to settle on the same basis as the Japanese mills did: a general cut of around 37% (45% for lump ore, the favoured ore type of the Japanese and non-Chinese mills). China wants more, especially for fines, its favoured ore type: up to the 45% cut for lump ore). The Chinese steel association has been controlling the talks and has refused to budge from its demands for a deal better than the Japanese won.

The Chinese argue that seeing they are the biggest buyers in the world, and such they should have the best deal.

BHP Billiton and Rio have told the Chinese that they will sell their iron ore into the spot market and they can buy it there. However spot prices are currently around $US14 a tonne above the average 2009 price for iron ore in the Japanese mills contracts of $US64 a tonne.

Some media in China claim the Australian companies have threatened to withhold iron ore from the market. The Chinese mills have also threatened to cut their purchases from the Australian companies. Such a rapid escalation of a commercial dispute to one involving the Chinese Government and police is dramatic and needs more than the Australian Foreign Affairs Department ‘doing’ something.

The Prime Minister, who has made a case for close ties with China, has indicated that while he respects China, he is also wary of the country’s authoritarian ways.

Chinese President Hu Jintao is on his way home from Italy because of the rising level of unrest in China’s Xinjiang Uygur Autonomous Region. That dispute has increased tensions in China and means the police intervention in the Rio case should be taken more seriously than at other times.

Mr Rudd should ask himself, what’s more important: this serious problem in the Australia-China relationship, or the G8 summit?