CHINA'S plans to acquire iron ore assets in mid-west Australia received a setback after local firm Murchison Metals unveiled an A$1.5 billion merger proposal for Midwest Corporation, trumping Sinosteel's A$6.38 a share bid, which valued the company at A$1.36 billion.

Under the Murchison merger proposal, Midwest will remain the listed entity. The merger terms will be 0.575 Midwest shares for each Murchison share, implying a value of $7.17 for a Midwest share.

Murchison Metals has a market capitalisation of A$1.65 billion and a merger would create an A$3 billion entity with operations across western Australia.

The merged company would be able to develop the Jack Hills and Weld Range iron ore deposits which have a combined annual production capacity of 40 million tonnes.

Midwest Corporation said its board has recommended an all-share offer from Murchison Metals Ltd, which values Midwest at about  A$1.5 billion (US$1.4 billion) or $7.17 a share. The recommendation for the Sinosteel offer still stands while it assesses the latest proposal, Midwest said in a statement.

The new proposal for a reverse takeover by Murchison of its 19.9 per cent owned Midwest comes as Sinosteel was almost sure of clinching the deal that includes rights to build an A$3 billion port and rail infrastructure for western Australia's emerging iron ore supplier.

Midwest and Murchison, which own iron ore projects in western Australia, said their assets were complementary, making the merger the best way for developing western Australia's iron ore resources.

Chinese state-backed Sinosteel was also expected to bid for Murchison, in which it has already built a small stake.

Sinosteel, which already owns almost 20 per cent of Midwest shares, is likely to improve its offer to stay in the race. The Chinese company has a 2.4 per cent stake in Murchison as well.

The Western Australian government is studying proposals by a Murchison-Mitsubishi joint venture and the Sinosteel-Midwest backed joint venture for the ports and infrastructure project.

However, US fund manager Harbinger Capital  and South Korea's Posco, with holdings of 19 per cent and 9.8 per cent, respectively in the Australian miner, support the Murchison-Midwest merger.

"The two are existing in parallel ... at some point in time shareholders will need to make a decision and it's basically being pushed back to shareholders," Midwest chief executive Bryan Oliver said.

Meanwhile, reports said Sinosteel was planning to buy an eight per cent stake in Fortescue Metals from Harbinger, which holds a 16 per cent stake in the Pilbara's new iron ore miner.

"They can either accept Sinosteel's cash offer, sell their shares on market at a potentially significant premium, or retain their shares and support the merger," Midwest said in a statement.

Murchison shares jumped 9.7 per cent to A$4.43 at the close on the Australian stock exchange, while Midwest surged 12 per cent to $7.00.

By acquiring iron ore mines in western Australia, the Chinese steel mills would be able to control the spot market for iron ore and thereby suppress contract prices.

Owning a smaller share of the market makes sense for Chinese steel mills as it would help shift the balance of power in their price negotiations with BHP Billiton, Rio Tinto and Brazilian miner Vale.