SYDNEY, March 8 (Reuters) - Senior executives at two of the world's biggest iron ore miners, Brazil's Vale and Australia's Fortescue Metals Group , first raised the idea of an alliance a year ago after a relentless slide in ore prices.
At the time iron ore was fetching under $50 a tonne, a quarter of its 2011 peak, and applying unprecedented pressure on profit margins.
Under the pact unveiled on Tuesday, the pair plan to blend up to 100 million tonnes of their ores in China, producing the benchmark product preferred by local steel mills and squeezing out a little extra margin in the process.
"It's the kind of arrangement that made immediate sense to everyone," said an observer close to the deal. "Vale gets paid market price for its higher grade ore and FMG (Fortescue) sees a bump-up in price for its lower grade ore and the mills get a specifically blended feed appropriately priced."
The deal fits with the Chinese steel industry's drive to modernise under a directive from Beijing, which includes maximising usage of imported raw materials.
China's no.2 steelmaker Hunan Valin, which holds 14 percent of Fortescue's stock, had "shot their hand up to take the first of these cargoes," said Fortescue chief executive Nev Power.
If and when Fortescue moved to forge a partnership with a bigger rival, it was always going to be Vale.
Of the four major global iron ore suppliers - Vale sits at the top and Fortescue the bottom - Vale mines the highest and Fortescue the lowest grade ore.
Fortescue's much closer competitors in Australia, Rio Tinto and BHP Billiton , long ago fine-tuned their blending to maximise margins and satisfy their customers and had no need for Fortescue's poorer ore.
The potential for a tie-up with Vale can be traced back to 2013 when Fortescue opened a second mining complex in Western Australia's Pilbara region, 200 kms (125 miles) from its original mines in the Chichester Range.
Having a second operation allowed Fortescue to blend ore with high iron grades - but also high levels of unwanted alumina and silica - with ore bearing fewer impurities but lower in iron richness. This allowed for custom blending product for the Chinese market.
"The (Vale) relationship has developed around mutual interest of looking at these possibilities of providing a stronger supply base to China and providing a more competitive consistent blend," Power said after announcing the deal.
At the same time, Vale gets a foothold in the backyard of Rio Tinto and BHP.
The memorandum of understanding provides a framework for Vale to directly invest in 5 to 15 percent of Fortescue, via buying shares on market.
Vale was blocked once from exploiting an inroad to the Australian sector when a joint venture partner in coal, Aquila Resources, which also held rights over iron ore acreage, was bought in 2014 by China's Baoshan Iron & Steel Co.
However, Fortescue founder Andrew "Twiggy" Forrest will still hold a controlling one-third stake in the company.
Reporting by James Regan; Editing by Richard Pullin