UPDATE 4-China's Baosteel to buy 15% of Australia's Aquila

* Gives China another foothold in Australian iron ore

* Deal struck at sensitive time in bilateral ties

* Australia seen likely to approve Baosteel stake in Aquila

* Baosteel to buy up to 43.95 mln Aquila shares at A$6.50 each

* Baosteel VP nominated to Aquila board. (Adds Baosteel in para 12, analyst comment in paras 19-22)

SYDNEY, Aug 28 - China's biggest steelmaker, Baosteel, agreed to invest $240 million for a stake in Australian iron ore explorer Aquila Resources , underscoring China's huge appetite for Australian assets.

The deal comes at a tense time for Australia and its biggest trading partner, with an Australian mining executive charged with commercial espionage, Beijing cancelling a top-level visit to Australia and the collapse of a $19.5 billion investment.

But analysts said this latest deal was likely to be approved by Australia's foreign investment watchdog, noting it would give state-owned Baosteel only 15 percent of Aquila, and the fact that Aquila was still only a prospector and not yet in production.

"I can't see any particular reason why they wouldn't approve it," said Mark Taylor, senior resources analyst at Morningstar. "It's not a huge deal in terms of dollars or resources."

The latest deal, which sent Aquila shares surging 11 percent to near a 10-month high, would give Baosteel the right to directly invest and co-develop most of Aquila's projects and give the Australian miner access to cheap loans from Chinese banks.

"I'd like to think this agreement with Baosteel will help take Sino-Australian relations off the bottom," Aquila Executive Chairman Tony Poli told Reuters by telephone from Perth.

He said Baosteel's investment will "go a long way" to bringing the company's projects into production.

Baosteel has agreed to acquire no more than 19.9 percent of Aquila, according to Poli. Anything over that would trigger a formal takeover attempt under Australian securities regulations.

Further cash could come via Brazilian mining giant Vale , which has an option starting in December to buy out Aquila's 24.4 percent stake in the Belvedere coal project in Queensland.

Analysts have said Aquila could use the proceeds to develop iron ore mines in Australia, or the funds could go towards Aquila's Eagle Downs coking coal project, also in Queensland.

Aquila has enough reserves to annually mine 32.5 million tonnes of iron ore and 11.4 million tonnes of coal, with production of both expected to begin in mid-2013, according to a recent presentation it made at a conference in China.

Baosteel said it had a "favourable view of the potential for Aquila's asset growth," adding the deal also "marked an important and solid step in Baosteel's internationalization process."

AUSTRALIA'S IRON-ORE BELT

Aquila's deposits lie in the West Pilbara iron ore belt, home to the massive operations of Rio Tinto and BHP Billiton <BHP.AX> , the world's second- and third-largest producers of iron ore.

Australia's relations with China soured in June when a then-indebted Rio Tinto ditched a planned $19.5 billion equity partnership with China's state-owned Chinalco and instead agreed a joint venture with rival BHP Billiton.

Soon after, Rio Tinto's top iron-ore salesman in China was detained with three other Shanghai-based Rio Tinto staff and later charged with commercial espionage.

Despite the recent political tensions, investment ties have proven resilient, with Australia last week agreeing a $41.5 billion deal to sell liquefied natural gas to PetroChina <601857.SS> from a yet-to-be-built project.

"Trade is still going to occur," said Steven Robinson, senior investment manager at Alleron Investment Management. "The Chinese are looking to secure raw materials for the longer term. The main thing for me is the security of supply."

He pointed to a recent deal whereby China would provide up to $6 billion in funding to Fortescue Metals Group in exchange for buying Fortescue's iron ore at a price discount. [ID:SP480759]

Matthew Whittall, Hong Kong-based analyst at CLSA, noted there were few Australian iron ore miners left that had not done a deal with the Chinese.

"Aquila's been one of the few that has a good project that hasn't had a partnership with China. Obviously they're going to need to develop these projects, and if you can tie in a strategic partner like Baosteel it's a massive positive." Whittall said many miners had trimmed capital expenditure in the global downturn, but China has the ability and desire to see projects come online to ensure raw material supply.

"They are having to structure deals that make sense to everyone, including the regulators," he said. "But the Chinese will continue to invest where there are opportunities." ($1=1.192 Australian Dollar)