Rio Tinto, the mining giant being stalked by rival BHP Billiton, is threatening Asian steelmakers that it will sell iron ore on the lucrative spot market unless they agree to pay higher prices for the metal.

Iron ore prices on the spot market, where commodities are sold for cash and delivered immediately, recently reached $216 per tonne and are hurting steelmakers' profit margins and stoking inflation into steel prices.

Rio Tinto is arguing that the spot price is currently $100 per tonne higher than a recent agreement struck by Vale, the Brazilian mining giant with its customers.

It adds its iron ore should fetch a higher price than alternative supplies from Brazil because it costs less to ship the metal from Rio's mines in Western Australia to Asian mills.

Sam Walsh, Rio's iron ore chief executive, said the company will sit tight until it secured the right price.

Mr Walsh said: "Until some recognition of the natural premium of geograhic proximity is possible, and while the spot market continues to reward those without long-term benchmark supply contracts with customers, then we will do what we cant to secure an appropriate return for our shareholders."

Typically, the three major iron ore exporters - Rio Tinto, Vale and BHP Billiton - fall into line on price after the first miner secures a long-term agreement with a major steelmaker.

However, the threat of takeovers is changing the commercial landscape.

Vale's deal which raised the price of Brazilian ore between 66 per cent and 71 per cent, may have been rushed through ahead of its negotiations to acquire Xstrata, the Swiss-based mining group.

However, Rio is defending itself from a bid from rival BHP Billiton which has its own iron ore operation in the Pilbara region of Australia. With its profitability under intense scrutiny, Rio will want to secure the maximum price for its iron ore and the extraordinary spot market surges will encourage the miner to hand on for more.

Shipping costs are playing a big role in the pricing of commodities as bulk carriers are in short supply. The cost of shipping a tonne of ore from Brazil to China is about $67, roughly three times the cost of carriage from Western Australia.

Iron ore exporters secured a 71 per cent price increase in 2005, a 19 per cent increase in 2006 and a 10 per cent hike last year.

If Rio is successful in its stand-off, it could secure a record-breaking price increase for 2008, causing more pain for steelmakers and increase the pressure for consolidation in the steel industry.

Separately, Rio said it would spend $475 million to raise output at the Iron Ore Company of Canada.

The investment to expand its Labrador mining operation and increase capacity on the rail link to Sept-Iles in Quebec would increase output from 18 million to 22 million tonnes and then to 25 million tonnes by 2011.

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