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BHP to buy nickel ore from Poseidon to feed Australia refinery

* Contract to run for 2 years

* Will help improve Nickel West productivity before any sale

* Covers 350,000-500,000 T of nickel ore annually

By James Regan

SYDNEY, Oct 2 (Reuters) - BHP Billiton (NYSE: BBL - news) on Thursday agreed to a two-year contract to buy nickel ore from Poseidon Nickel Ltd to feed its Nickel West operations in Australia.

The step indicates that BHP plans to keep running the loss-making division as it looks to sell it.

BHP surprised markets in August when it left Nickel West out of a $15 billion spinoff of unwanted assets, saying it was better suited for an independent sale and leaving analysts to ponder its fate in the absence of a buyer surfacing quickly.

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The contract to buy between 350,000 and 500,000 tonnes of ore annually is conditional on Australia-listed Poseidon completing the refurbishment of its Mt Windarra mine to meet the February shipment start date, Poseidon said in a statement.

Nickel West has been holding talks with nickel miners to lift its intake of ores and concentrates to improve productivity at its downstream smelting and refining arms following the abrupt closure of one of its mines due to an earthquake.

BHP was not immediately available for comment.

"Whomever the purchaser (of Nickel West) is faces the same fundamental problem of the concentrator running very, very sub-optimally," Poseidon Chief Financial Officer Gareth Jones told Reuters.

Jones said the Leinster concentrator plant where Poseidon's ore will be shipped was only processing around 600,000 tonnes of ore annually, well below its capacity of 3 million tonnes.

The shortfall can be partly blamed on the loss of BHP's Perseverance mine in November due to earthquakes damage, he said.

Poseidon's contract runs for two years, with options to extend for a further 1-2 years and increase the amount to 700,000 tonnes.

Shipping at a rate of 500,000 tonnes would yield Nickel West an additional 6,000 tonnes of nickel, according to Jones.

At today's prices, that would be worth roughly $96 million.

Other Australian miners may be looking to partner with BHP.

Sirius Resources NL is holding negotiations with major nickel smelters to supply up to 26,000 tonnes of nickel in concentrate annually from its soon-to-be-developed Nova mine.

Meanwhile, Western Areas Ltd in August opened a tender for 13,000 tonnes of nickel in concentrate a year, pushing forward its plans to open the tender to capitalise on the sale process of BHP's Nickel West. Western Areas is expected to name a successful bidder by year-end. (Reporting by James Regan; Editing by Joseph Radford)