China's Yanzhou Coal Mining Co. (YZC) is in preliminary discussions with Gloucester Coal Ltd. (GCL.AU) to create a coal giant worth up to 8 billion Australian dollars (US$7.9 billion) by merging their Australian assets, according to three people familiar with the matter.

Sydney-based Gloucester in a statement to the Australian Securities Exchange said it had requested trading in its shares be halted until Thursday, by when it expects to make an announcement in connection with a "possible change of control transaction."

It said it wasn't yet in a position to make such an announcement.

Gloucester, which operates two open-pit mines and holds exploration licenses, last traded at A$7.03 a share for a market capitalization of A$1.44 billion (US$1.42 billion).

Yanzhou's board secretary and deputy general manager, Zhang Baocai, last week said the company was considering a reverse takeover to fulfil commitments to Australian regulators made at the time of its A$3.2 billion acquisition of Felix Resources in 2009. The state-owned company must float at least 30% of its Australian assets, known as Yancoal Australia, by the end of next year.

Gloucester Coal and Noble Group (N21.SG), Gloucester's majority shareholder with a 64.5% stake, declined to comment on a possible deal. Yancoal also declined to comment.

UBS and Citi are advising Yanzhou, and Lazard is advising Gloucester.

Demand for Australian coal assets has been heated in recent years as companies seek sources of the commodity both for fuel and a key steelmaking ingredient to feed the massive appetites of China, India and other rapidly industrializing countries.

In a recent wave of consolidation, Rio Tinto PLC (RIO) and partner Mitsubishi Corp. (8058.TO) bought out the remaining shares they didn't hold in Coal & Allied Industries Ltd. in a deal that valued the target at A$10.8 billion. Among other deals in recent months, U.S. coal giant Peabody Energy Corp. (BTU) in November gained control of Macarthur Coal Ltd. with a A$4.9 billion bid, and Whitehaven Coal Ltd. (WHC.AU) this month agreed to buy smaller Aston Resources Ltd. (AZT.AU) for almost A$2.3 billion.

Credit Suisse analyst Adrian Prendergast said potential merger was very positive.

"Since the Felix takeover in 2009, I think Yancoal has been sizing up all of the potential fits for them as a way of backing in the assets and listing," he told The Wall Street Journal. "From the product point of view, it gives it substantial scale and really broadens their market ability in terms of coal type."

Prendergast said the combined entities of Yancoal-Gloucester, as well as Whitehaven-Aston, would both be attractive targets for global players. However, Chinese companies have little track record of selling out of assets that they control, and Yanzhou's growth strategy is centered on Australia as it is experiencing stagnant coal production at its mines in Eastern China's Shandong province.

-By Gillian Tan, The Wall Street Journal; gillian.tan@wsj.com

--Robb M. Stewart of Dow Jones Newswires in Melbourne contributed to this article.

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