Chinese steel mills offered their first meaningful compromise on iron ore prices on Wednesday, scrambling to salvage annual supply deals with global miners who kept silent one day after a deadline to agree terms.

After holding out all year for a more than 40 percent price cut from last year, the China Iron and Steel Association (CISA) is now prepared to accept a reduction only slightly deeper than the 33 percent cut agreed by other Asian mills, a source familiar with CISA talks told Reuters, confirming media reports.

Citing CISA officials, the industry source, who declined to be identified, told Reuters China was also ready to move to a bi-annual price-setting regime -- offering more upside for miners if prices continue to rally -- if talks end quickly.

But it was far from clear that Rio Tinto , which had said it would adhere to the June 30 deadline for extending annual contracts, or BHP Billiton were ready to give up their take it or leave it stance, with the positions hardened by a recovery in spot prices.

Rio, which has said it would sell its ore on a spot basis after the deadline to settle prices for the year from April 1, declined to comment on Wednesday, while BHP maintained its policy of keeping quiet until most of its contracts are signed.

In Europe, where major deals are yet to be announced, Germany's top steelmaker Thyssenkrupp said it hoped to push through price cuts of more than 30 percent for iron ore suppliers.

SPLINTERED

Wednesday's sudden compromise offered by China highlighted its struggle to wield more clout on global commodity markets, even ones in which it is the dominant buyer. It now imports more than half the world's traded iron ore, but has struggled to form a united front.

Some of China's larger mills have tacitly reached agreements with miners and issued letters of credit to buy iron ore at the price accepted by Japanese mills, the official China Securities Journal reported separately, weakening CISA's position and ignoring threats to revoke import licenses.

It also reinforced China is far from ready to accept a dramatic break with the 40-year-old benchmark pricing system to embrace the volatility and instability of the spot market, where Rio is already selling half its supply and which BHP would like to use as a reference for prices based on indices.

Caijing magazine and the official Shanghai Securities News earlier said the mills were ready to discuss price cuts between 33 and 40 percent versus previous demands of 40 to 45 percent.

I suspect the discount will be relatively marginal. Just some means for CISA to save face, said Ben Westmore, commodities economist for National Australia Bank.

Goldman Sachs JB Were in a client note suggested a possible compromise would be a switch to an even more flexible pricing mechanism such as quarterly pricing, with greater ability to reflect short term markets.

HARD TO WIN

With insufficient and expensive domestic reserves and a the world's biggest steel industry to keep running, iron ore is one of the few sectors where China's vast buying power lacks punch.

The country's biggest steel mills for months argued unsuccessfully for a bigger discount to show the impact of the financial crisis on steelmakers, who ran into the red as they continued to pay record ore prices and steel prices plunged.

Abandoning the inflexible benchmark system for a more flexible basis would allow mills to project costs over a longer period than possible under the burgeoning and increasingly volatile spot market, the only alternative available.

BHP Billiton Chief Executive Marius Kloppers has made no secret of his wish to see pricing move to an index system that could be tied to average spot prices every quarter and better reflect market conditions at the time of delivery.

Rio Tinto has been less reluctant publicly to discard the benchmark system, saying it is for its customers to decide whether they wish to continue with annual contracts.

MARKET MOVES AGAINST CHINA

State-run CISA forged its original demands at the height of the world financial crisis but a recovery in steel prices at home and a rising global spot price for ore has since undermined China's case.

Spot iron ore prices have leapt by a fifth in just a month, to a 4-month high above $80 a tonne delivered in China, equivalent to around $65 free on board. This is higher than the contract price of $61 Japanese and South Korean mills pay.

While some analysts say prices may have peaked for now as domestic production becomes more economical, others warn that an infrastructure-led economic recovery could stoke further gains -- giving mills an even greater incentive to get a deal done.

By abandoning the benchmark price... Chinese mills run the risk that if the spot price rallies further, they could end up paying higher prices than the rest of the world, Macquarie analysts said on Wednesday in a report.

(Additional reporting by Humeyra Pamuk, David Stanway, Miyoung Kim and Nick Trevethan; Editing by Jonathan Leff and Peter Blackburn)

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