The link-up -- not a merger, according to the two companies' carefully worded statements -- will lead to the creation of the Shandong Steel Group, named after the east Chinese province where both are headquartered.

"The organization will bring the respective strengths of the two parties to bear and solidify the market position of both steelmakers," Jinan Iron and Steel said in its statement.

The news is likely to trigger interest abroad since Luxembourg-based steel giant Arcelor said in February it had won initial approval to buy a 38.41-percent stake in Laiwu Steel for 2.09 billion yuan (260 million dollars).

Arcelor, subsequently acquired by Mittal Steel to form the world's largest steel company, was not immediately available for comment on the reports when approached by AFP Tuesday.

The two Chinese companies each exceeded 10 million tonnes in crude steel output in 2005.

Combined the new entity would be in second place behind industry leader Baosteel, with current output of nearly 23 million tonnes.

The proposed reorganization bears the mark of Shandong provincial agencies seeking to create a local champion, making it more difficult for outside parties to take control.

"The provinces want their steelmakers to have a unified voice," according to Chen Dongming, associate director of Fitch's corporate ratings team in Beijing.

Provincial governments are hoping to resist future mergers or takeovers by encouraging steelmakers within their jurisdictions to enter into alliances, he said.

"Many steelmakers are under the control of provincial governments, which in turn are not willing to relinquish power and lucrative local tax income," he said.

"Therefore, cross-border acquisitions involving different Chinese regions will remain difficult in light of local protectionism."

For now, however, executives at the two enterprises emphasized that each would remain a separate entity.

"We and Jinan Iron and Steel will continue our operations as separate legal persons," said Liu Chuanjia, an official at Laiwu Steel.

He said the transaction was similar in nature to a link-up between steel makers Angang and Bengang in 2005.

The deal between Angang and Bengang did not involve stock changing hands but led to the unification of resource use, technology development, marketing, raw material purchases and foreign trade, earlier reports said.

"It's a global trend for the steel industry to consolidate, as the Arcelor and Mittal case shows," said Tian Shuhua, a Beijing-based steel analyst with Galaxy Securities.

"And in China, many of the problems the steel industry faces result exactly from a lack of consolidation," he said.

One of the chief problems caused by the low level of concentration and atomized decision-making is overcapacity, as steel companies have often failed to coordinate their investments in new mills.

Curbing overcapacity is now the "main mission" of China's steel sector, the secretary general of the China Iron Steel Association, Luo Bingsheng, said Monday.

"This year has seen no respite in the overcapacity problem in the country, and by year-end an additional 91 million tonnes will likely be brought on-line," Luo said on the association's website.

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