Andrew Forrest’s Fortescue Metals Group has undercut its bigger rivals, BHP Billiton and Rio Tinto and settled its 2010 iron ore contracts with Chinese steel mills and the embattled China Iron and Steel Association.

Fortescue will get an average 35% less from the Chinese mills, while the Australian majors are holding out for a 33% cut (on average), based on their settlements with the Japanese, South Korean and Taiwanese mills.

Fortescue doesn’t ship iron ore into non-Chinese markets, but its settlement will give the Chinese the victory they need to try pressure BHP and Rio to settle at larger discounts to the Japanese, and give China a face-saving deal.

In fact the average price cut for lump ore for Fortescue is 50%, 3% more than the 47% cut obtained by the Japanese mills, which prefer to use lump ore. That will also give the Chinese bragging rights over the Japanese mills.

The news of the settlement, the first official deal announced between Chinese mills and Australian suppliers, was revealed in a statement to the ASX today.

In addition to what looks a favourable deal for China, Fortescue and Mr Forrest seem to have linked it to a huge refinancing of the company’s debt.

“A condition subsequent to this agreement is the completion of finance by 30 September 2009, by Chinese financiers on terms acceptable to Fortescue. This is estimated by Fortescue to be an amount of US$5.5 billion to US$6 billion,” the statement said.

“Under the Agreement, CISA (China Iron and Steel Association) has guaranteed that a priority will be given to FMG to negotiate iron ore prices for 2010 if the annual pricing negotiation is conducted.”

It would seem that in return for giving the Chinese a facing saving victory (but not a big one: they wanted a cut of 45%), Fortescue will get a cheap refinancing of its debts, and the lead position in 2011’s price negotiations next year with CISA. CISA in returns gets a well known Australian iron ore supplier to cave-in and give it a win which helps it save face and gives it some legitimacy in the price negotiations from now on.

CISA’s aggressive attitude to Australian suppliers and the way that Rio had by-passed it are said to have been a factor in the Chinese Government’s move to detain and then arrest and charge Rio executive, Stern Hu and three Chinese co-workers.

Fortescue is partly owned by Chinese steel mills such as Hunan Valin group, and the comments today by Mr Forrest in the company’s statement will raise some hackles around the local mining industry, and confirm to others the dangers of selling equity to Chinese end users.

Hunan Valin owns more than 17% of Fortescue’s issued capital, and is the second biggest shareholder behind Mr Forrest.

The involvement of CISA is significant as it gives the embattled body a much needed win after it botched its demands to be the only authorised contract negotiator.

But it wasn’t a complete win for CISA; Baosteel, China’s biggest producer, was involved and named in today’s statement. There have been reports on Chinese Government affiliated news websites that Baosteel might replace CISA to resolve the 2010 contract talks.

Bloomberg reported that at a Beijing press conference this morning, CISA secretary general, Shan Shanghua said the Chinese mills will pay 94 U.S. cents a dry metric ton unit for fines, the most commonly traded product with Chinese mills (lump ore is preferred in Japan).

“The price agreement will apply for the second half of 2009,” he said.

“China had sought a discount of as much as 45% this year, more than the 33% offered by Rio Tinto Group, arguing it should enjoy a bigger cut as the largest buyer. The price for lump iron ore will be 100 cents a dry metric ton unit, or 50% lower,” Shan said.