Chinese steel mills and Australian miner Fortescue Metals Group Ltd. (FMG.AU) Monday said they have reached an agreement on iron ore prices that represents a 35% discount from last year's term prices.

The China Iron and Steel Association, which represented Chinese steel mills in this year's price negotiations, said the price agreed is 94 cents per dry metric ton unit for iron ore fines, the grade that most Chinese mills buy.

That is about 3% below the 97 cents a dry metric ton unit that Australian miners Rio Tinto Ltd (RTP) and BHP Billiton Ltd. (BHP) agreed with Japanese and South Korean steel makers for iron ore fines earlier this year.

Fortescue will sell iron ore pellets at 100 cents/dry metric ton, down 50.42% from 2008 levels.

Fortescue Chief Executive Andrew Forrest said the deal breaks the market impasse that had enveloped the Chinese steel industry, creating uncertainty and increasing the risk for individual companies.

It is the first time Fortescue is setting a term price for its supplies to China and in a departure from past practice, the deal is only for six months with prices to be renegotiated after that.

The deal is only a small step forward for China which is yet to agree on this year's term prices with bigger miners such as Rio Tinto, BHP Billiton and Vale S.A (VALE) which together control around 70% of the global sea-borne trade in iron ore.

Fortescue didn't have a term price agreement last year and its annual capacity is around 45 million tons, a very small amount considering China has regularly been importing in excess of 50 million tons of iron ore a month this year.

But announcing the deal at a news conference, CISA said it hoped the terms of its deal with Fortescue will be accepted by the big three miners.

"We need to (talk) further with (those) other miners," and the association hopes the pricing terms struck with Fortescue will be the basis for those talks, CISA Vice Chairman Luo Bingsheng said.

Both BHP and Rio Tinto declined to comment on CISA's latest agreement with Fortescue.

The pact with Fortescue, a miner with big ambitions in China, is the first the Chinese have made in their protracted iron ore negotiations this year. Despite Rio Tinto, BHP and Vale setting prices with other Asian mills at a discount of around 33% for iron ore fines, the Chinese have been holding out for deeper price cuts.

China has insisted that as the biggest buyer of the product, it should have a greater say in pricing decisions. More recently, the price talks have also got entangled in a controversy surounding China's detention of four Rio Tinto employees on charges of securing information related to price talks using illegal means.

Fortescue said its deal with Chinese mills is conditional on the completion of a funding deal with Chinese financiers for between $5.5 billion and $6 billion by Sep. 30.

As the deal is part of an arrangement to secure financing, it is unlikely to have a negative flow-on effect for spot prices, said Justin Smirk, senior commodities analyst with Westpac in Sydney.

Fortescue is willing to forego price in return for funding security given the company is a small player which wants to get itself into position of strength in the longer-term, Smirk said. "Naturally China is going to try and leverage this deal for pricing, but the size of the deal looks too small."

But Fotescue's Forrest said the deal was important for the company as well as the overall industry. "It creates a realistic and agreed iron ore price that delivers value for all parties and provides strong support for Fortescue's continued growth," he said.

The contract with Fortescue runs from July 1 through Dec. 31, 2009, CISA said. It will start iron ore negotiations for the 2010 term in December, it said.

-By Chuin-Wei Yap, Juan Chen and Alex Wilson, Dow Jones Newswires; 8610 6588-5848; chuin-wei.yap@dowjones.com