The Chinese press generally accepted that Stern Hu and his colleagues engaged in espionage that inflicted grievous damage to China’s national economic interest. Many Australian commentators saw it as a calculated insult designed to express China’s displeasure over the rejection of state-owned aluminium giant Chinalco’s bid to acquire a strategic stake in Rio in early June. This has certainly influenced China’s actions, but the overriding considerations seem to be China’s determination to consolidate and restructure its large and highly fragmented steel-making industry, and to combat skyrocketing iron ore prices, however much sense the use of this instrument to try to control the market might have made.

The Chinese steel industry consists of hundreds of small and medium-sized firms, which compete intensely with one other for supplies of iron ore, especially the prized long-term benchmark-priced iron ore coming into China at two-thirds the price of other supplies. Competition and disunity within the industry has spelt disaster for the Chinese iron ore negotiating position in the past. Chinese sources estimate that the price of iron ore increased by over 400 per cent over the last six years, and as a result Chinese steel mills paid an extra RMB 700 billion (US$ 103 billion).

In an effort to unite steel producers and collectively bargain for better prices, the government sidelined the large Shanghai-based producer, Baosteel, from its usual lead in iron ore negotiations and replaced it with the China Iron and Steel Association (CISA). Determined to prove itself, CISA demanded a 40 per cent price cut from last year’s agreements. Mining firms refused to accept this sharp reduction and neither side budged as negotiations dragged on well beyond their deadline.

As many Chinese steel mills grew frustrated with the protracted bargaining, Rio and other mining companies allegedly took advantage of their impatience, pursuing a ‘divide and conquer’ strategy by offering them the attractive long-term benchmark prices. Many jumped at the opportunity to purchase cheaper ore. Watching its unified front disintegrate, CISA pleaded for the government to intervene and put a stop to unauthorised transactions.

The small and medium-sized Chinese steel mills’ embrace of Rio’s tempting offers may have been the straw that broke the camel’s back. With CISA’s bargaining position looking increasingly weak, rumours spread that it was ready to abandon its hardline 40 per cent price reduction and accept a face-saving deal. Many believe Rio’s confidence and aggressive demands derived from its intimate knowledge of the Chinese negotiators’ bottom-line and details about production and storage in Chinese steel mills. Reports from China’s state media assert this information was found on computers seized from the Rio Tinto office in Shanghai.

The arrest of Stern Hu and his colleagues might be seen as part of a larger effort to stem the perceived leakage of sensitive information from the Chinese steel mills. It is also a powerful warning from Beijing determined to bring order back into the iron ore import market and crack down on any unauthorised dealings.

The arrests, however, seem retaliatory, the product of a general feeling of frustration amongst Chinese government officials over dealings with Rio. No special status has been accorded to China, which, as the largest customer, imports more than 70 per cent of all seaborne trade in iron ore.  In the current round of negotiations, CISA is again openly toying with the idea of a special ‘China Price’.

What remains unclear is exactly who instigated the proceedings against the mining company? Given the collateral impact on China’s commercial standing more broadly, why and how was the case allowed to proceed at this time? Assessing these questions will be critical to understanding the fallout from the affair and properly managing commercial relations with China relations in the future.

The most alarming and bizarre aspect of Stern Hu’s arrest was the involvement of the Ministry of State Security. This domestic counterintelligence outfit is charged with safeguarding the party and the state from foreign operatives, separatists and other ‘enemies of state.’ Its role in the affair shows that somehow or other Beijing elevated the hotly-contested negotiations beyond a commercial or economic perspective to the level of national security, mirroring the broader shift in China’s resource security strategy.

As China became a net energy importer in the early 1990s, it grew conscious of the need to secure strategic raw materials. After its global shopping spree was thwarted by regulators in the United States and Australia, however soundly based, there was a growing sense in China that resources could not always be fairly procured on the global market. Hence the move to an integrated strategy involving the collaboration of government ministries and agencies to secure vital resources. Security services were likely drawn into an increasingly large role in this plan.

Many foreign enterprises operating in China question the legal basis for the espionage charges initially brought against the Rio employees. The ambiguities in law can be traced to the vagaries of China’s 1989 State Secrecy Law, which loosely defines secrets as matters concerning ‘national security and interests.’ These include ‘secret matters relating to national economic and social developments.’

According to internal research conducted by the Internal Affairs and Judicial Committee of the National People’s Congress (NPC), state bureaucracies and corporations arbitrarily classify documents as state secrets for fear of being accused of leaking sensitive information. This reflects China’s poorly defined secrecy law, which authorises almost all of officialdom to label documents as secret.

The Chinese government is conscious that its catch-all secrecy law needs some serious fine-tuning, yet the old principle of secrecy by default remains operational.

If anything positive results from Stern Hu’s case, it is that lawyers may be able to probe the boundaries of what constitutes state secrets, establishing a litmus test for China’s professed progress towards greater transparency and openness, giving the idea of a market with integrity new meaning. For the time being Mr. Hu and his colleagues will remain sacrificial lambs for China’s national security and the opaqueness of the relationship between the market and the state.

Peter Yuan Cai is a visiting scholar at the Australian National University and is an assistant editor at the East Asia Forum.