UPDATE 3-Australia's Aquila fights to trim $7.6 bln cost of iron ore project

* Firm says project costs soar by a quarter just as Chinademand falls

* Aquila says could save A$2.3 bln by outsourcing port, rail * Aquila and partner also need to resolve budget dispute * Counting on Chinese funding

* Australia's $250 bln pipeline of planned mine investmentslooks on shaky ground

(Adds detail on cost spike, recasts)

By Sonali Paul

MELBOURNE, Oct 8 (Reuters) - Aquila Resources isscrambling to cut planned spending on an Australian iron oreproject after cost estimates jumped a quarter to A$7.4 billion($7.6 billion), putting the investment at risk in a sectorsqueezed by cooling Chinese demand.

Aquila aims to build a mine, rail and port in WesternAustralia with annual iron ore production of 30 million tonnes,but its half-owned project is under pressure due to weak Chinesesteel demand, soaring capital costs and a strong local dollar.

The West Pilbara Iron Ore project is one of the biggest in a$250 billion pipeline of planned mining investments in Australiathat may be frozen or delayed as bankers get nervous about theoutlook for iron ore and coal, and escalating costs.

Iron ore prices hit a three-year low of $86.70 a tonne lastmonth before reviving slightly, forcing miners from the world'slargest BHP Billiton down to the smallest to reviewtheir investment plans.

In an effort to cut capital spending, Aquila said on Mondaystudies had identified up to A$2.3 billion of possible savingsby outsourcing the operation, ownership and funding of suchtasks as ore processing, rail freight, ports, power and fuel.

Handing over those elements to other investors would addabout A$15 a tonne in operating costs, currently estimated atA$24.20 a tonne, Aquila said, adding that no decision had yetbeen made on the recommendations of its capital spending study.

Aquila said the cost of the project, previously estimated at$6 billion, had risen due to a general rise in costs since theprevious estimate in 2010 and because of changes in plans forthe new port by the Western Australian state government.

Australia is the world's biggest producer of iron, but afailure to get Aquila's project off the ground would mean a bigchunk of ore supply could be left stranded with BHP and RioTinto maintaining a lock on rail lines in the area.

The project's progress has been slowed by delays inapprovals and financing, compounded recently by the fall in ironore demand and prices.

It has been further set back by a dispute between Aquila andits partner AMCI (WA), a joint venture between private mininginvestment and trading group American Metals and CoalInternational (AMCI) and steel giant POSCO .

They had been in talks to conserve funds but the partnerswere unable to agree on a budget for the 2012/13 financial year,a dispute that now needs to be resolved by an arbitrator andcould result in one of the partners being bought out.

More than A$460 million has already been spent on studies,design work and state and federal approvals.

Aquila has around A$500 million in cash and no debt. It hasbeen shedding assets, including a stake in a coal mine that wasits only producing asset, to raise funds to help cover its shareof the iron ore project, on which it hopes to begin constructionin mid-2013.


Aquila, 14 percent owned by China's biggest listedsteelmaker, Baoshan Iron & Steel Co , has beencounting on China Development Bank to help fund the project.

To line up that debt funding, Aquila has to be able to showthat the port for exporting the ore will be built.

China Development Bank is reluctant to sign off on minefunding in light of the long delays and cost spikes that otherChinese iron ore projects in Australia have faced, includingCITIC Pacific's Sino Iron project. Costs on that minehave more than tripled to $8 billion.

Final environmental approval from the state of WesternAustralia for the port, a key hurdle, is expected before the endof this year, Aquila said.

The state had been encouraging joint development of theproposed port, Anketell Point, involving Aquila and Australia'sNo.3 iron ore miner Fortescue Metals Group , butdebt-laden Fortescue has slowed its expansion plans and does notsee a need to use Anketell Point in the next few years.

The initial plans are for Anketell Point to have an annualcapacity of 115 million tonnes, eventually expanding to 350million tonnes, and the state is eager to ensure whoever winsthe rights to build it will have the funding.

Lining up third parties to fund construction of the portcould help secure the state's go-ahead.

The West Pilbara Iron Ore project already has preliminaryapproval for a 282-km railway, which it needs to build as itwill not have access to existing railways in the area, owned bythe world's No.2 iron ore miner, Rio Tinto.

Shares in Aquila fell 1.1 percent to A$2.65 in a slightlysofter market, having tumbled from a 12-month high of A$6.83 inDecember.

($1=0.9767 Australian dollars)

(Additional reporting by Lincoln Feast in SYDNEY; Editing by EdDavies and Clarence Fernandez)