UPDATE 3-Japan's $1 bln plane project gets off the ground

(Adds details, background)

By Yuko Inoue and Nathan Layne

TOKYO, March 28 (Reuters) - Mitsubishi Heavy Industries (7011.T) said it would launch a $1 billion project to build Japan's first passenger jet, taking a big gamble on a market dominated by Canada's Bombardier Inc (BBDb.TO) and Brazil's Embraer (EMBR3.SA) (ERJ.N).

Japan's largest heavy machinery maker has spent several assessing the likely demand for a small, lightweight, fuel-efficient jet carrying 70-90 passengers over shorter and mid-range routes.

The project won a vote of confidence on Thursday when All Nippon Airways Co (9202.T), Japan's second-largest airline, said it would buy up to 25, the first carrier to commit to the jet.

Demand for smaller jets is expected to increase rapidly as carriers bolster domestic routes and look to offset surging oil prices with aircraft that consume less fuel are are more likely to have their seats filled.

But Mitsubishi is not the only newcomer in the market.

Russia's United Aviation Co has teamed up with Boeing (BA.N) to build a jet for 75 to 95 passengers, while China's efforts got a boost on Friday from news that General Electric's (GE.N) leasing arm signed a preliminary agreement to buy five regional jets developed by a state-owned firm. [ID:nSHA23009]

"In terms of the macro picture, demand is there for this type of jet. Money-losing regional routes could turn profitable by using them," said Mizuho Investors Securities senior analyst Yuichi Ishida. "But the real question is whether there is room left in this market for Mitsubishi Heavy."

A subsidiary will be set up on April 1 to oversee the project. It will start out with capital of 3 billion yen ($30 million) and aim to increase that over about a year to 100 billion yen, two-thirds of which will be shouldered by Mitsubishi Heavy itself.

It plans to tap automobile giant Toyota Motor Corp (7203.T), trading houses Mitsui & Co (8031.T), Mitsubishi Corp (8058.T) and Sumitomo Corp (8053.T), and the state-owned Development Bank of Japan for the rest of the capital.

Mitsubishi Heavy said it hopes to have the jet in the air by 2013 and will aim to sell 1,000 over the next 20 to 30 years, grabbing one-fifth of expected new demand in a market forecast to roughly quintuple to more than 5,000 planes by 2026.

BIG RISK

Mitsubishi Heavy has focused until now on developing and making parts such as the composite wing box for Boeing's (BA.N) new 787 Dreamliner and cargo doors for Airbus jets.

"Mitsubishi Heavy has always been just a partner of Western aircraft makers," Mitsubishi Heavy President Kazuo Tsukuda said at a news conference. "Now we want to take advantage of changes in the marketplace such as high fuel costs and a greater need for environmentally friendly aircraft."