* Sources say Australia leaning toward buying Japanese submarines
* But government under pressure to hold open tender
* European manufacturers would build vessels in Australia
* Country's manufacturing sector hit by car plant closures
* Government says weighing several options for submarine programme
By Matt Siegel
SYDNEY, Nov 7 (Reuters) - Prime Minister Tony Abbott is under pressure from regional officials, labour unions and members of his own party to have an open tender to build Australia's next-generation submarine, which would be a blow to Japan and the United States.
Reuters reported in September that Australia was leaning towards buying as many as 12 off-the-shelf stealth submarines from Japan in a deal that would net it a major portion of Australia's overall A$40 billion ($34.3 billion) submarine programme.
Senior U.S. naval officers have been enthusiastic about the possibility of Australia partnering with Japan, which would give the three navies increased interoperability at a time of greater American strategic focus on Asia and as China's navy grows rapidly.
But strong interest from European manufacturers willing to build submarines in Australia, a scenario that would bolster the country's anaemic manufacturing sector and mollify the government's blue collar critics, is making an overseas purchase a hard sell.
Buying the vessels from Japan could threaten Abbott's hold on power at the next election, said Martin Hamilton-Smith, the defence and trade minister for the state of South Australia, which is home to 27,000 defence-related jobs including 3,000 in shipbuilding.
"It would be a very brave government that went to a federal election in around 18 months time arguing that it was a good thing to export this amount of work overseas while the other side of politics was arguing that it was a good idea to spend that money in Australia," Hamilton-Smith, who defected from Abbott's Liberal Party this year to become an independent, told Reuters.
Two sources with knowledge of Japan's discussions with Australia said Tokyo might not take part in a tender if it meant getting embroiled in a bidding war, adding that Japan's diesel-electric submarines were the only ones big enough to fit Australia's needs.
If Australia wanted those vessels, Japan was ready to cooperate, said the sources, who declined to be identified because they were not authorised to speak to the media.
A separate senior Japanese source said if Australia held a tender, Tokyo would see what kind of vessel it wanted before deciding whether to bid.
Sources have previously said Australia was considering replacing its six ageing Collins-class submarines with vessels based on the 4,000-tonne Soryu-class ships built by Mitsubishi Heavy Industries and Kawasaki Heavy Industries .
Such a deal would mark Japan's re-entry into the global arms market, just months after Prime Minister Shinzo Abe ended a ban on weapons exports as part of his efforts to steer Japan away from decades of pacifism.
For Abbott, the deal would avoid the costs and risks of developing a homegrown champion from scratch, after the locally made Collins-class submarines were panned for being noisy and easily detected.
EUROPEANS EYE AN OPENING
Australia says it is mulling several options for the submarine programme, including building the vessels at home or overseas, and will make a final decision in a broad defence review expected early next year.
Defence Minister David Johnston said last month there was no time for an open tender, and that Australia faced a "capability gap" if it did not get new submarines in the water quickly.
A spokesman for Johnston said the cabinet would use a "two pass" process to decide the project's future, in which cabinet discusses the matter twice before reaching a decision based on advice from defence chiefs and procurement experts.
Abbott had previously pledged the submarines would be built in South Australia, where unemployment exceeds the national average, but his government began back-pedalling in July, signalling cost and schedule were paramount.
That shift coincided with a flurry of ministerial exchanges with Japan and an agreement on military equipment and technology transfers.
Manufacturers from Germany, Sweden and France have since intensified their interest.
ThyssenKrupp Marine Systems, which last month sent a team to Canberra, hoped to build submarines in Australia based on its HDW Class 216 vessel, a spokesman said, adding the German company would take part in any tender.
Swedish defence firm Saab said there was no word yet on a tender but that it was ready for any work.
France's state-controlled naval contractor DCNS confirmed its interest in building a version of its Barracuda nuclear-powered submarine in Australia.
"We have done it that way in Brazil and in India," spokesman Emmanuel Gaudez said.
An Australian naval source said the government was under enormous pressure to explore every option.
"My feeling is that everything is still under very close and tight consideration," said the source, who declined to be identified because he was not authorised to speak to the media.
DISAGREEMENT IN ABBOTT'S PARTY
Australia's manufacturing sector is still reeling from the decision by Ford Motor Co, Toyota Motor Corp and General Motors Co to stop production in Australia by 2016.
Buying the submarines overseas would have a disastrous impact on the shipbuilding industry and manufacturing more broadly, said Andrew Davies, senior analyst and director of research at the Australian Strategic Policy Institute.
"Obviously the impact would be negative in terms of workflow in Australian shipyards and it would make an already marginal enterprise more marginal," he said.
Those losses would hit major employers such as the Williamstown Shipyard in the state of Victoria, owned by British defence contractor BAE Systems Plc, and the Forgacs shipyard in New South Wales, said Glenn Thompson, assistant national secretary of the powerful Australian Manufacturing Workers Union.
Three South Australian senators from Abbott's party, Sean Edwards, Anne Ruston and David Fawcett, last month demanded an open tender, breaking with their party over the issue. The senators could not be reached for comment.
Nick Xenophon, an independent senator from South Australia, said the stance of Fawcett, a respected lieutenant-colonel and army test pilot before entering politics, underscored the pressure on Abbott.
"The government keeps saying that building submarines is not industry policy. I agree. But it should be based on the national interest, and the national interest includes strategic interests and economic interests," he told Reuters.
Senior U.S. naval officers have gone out of their way to voice support for Australia buying Soryu-class submarines from Japan. Washington has close but separate security pacts with both countries.
Australia would be comfortable operating such submarines, Vice Admiral Robert Thomas, commander of the U.S. Navy's Seventh Fleet, said in Tokyo on Oct. 24, describing them as the best diesel-electric submarines in the world. The United States operates nuclear-powered vessels.
"Any time you can have this common equipment spread amongst your allies, your partners, your friends, it just makes it so much easier than having to have to say we are going to have to make this modification to this system so that system can talk to this system," said Thomas.
But Xenophon said striking a deal with Japan on sensitive military technology could anger China, Australia's biggest trade partner.
"It looks as though a decision is being made for alliance reasons in terms of the United States, Japan and Australia, which I think are narrowly focused and would not be in Australia's national interests," he said.
(1 U.S. dollar = 1.1662 Australian dollars) (Additional reporting by Tim Kelly and Nobuhiro Kubo in Tokyo, Georgina Prodhan in Berlin, Andrew Callus in Paris and Helena Soderpalm in Stockholm; Editing by Dean Yates)