* Carmakers have discussed ways to combine Europe operations
* Discussions have split controlling Peugeot family -report
* Closer ties could face objections over jobs from France
By Ben Klayman and Arno Schuetze
DETROIT/FRANKFURT, Oct 12 (Reuters) - General Motors and PSA Peugeot Citroen are exploring ways to combine European operations in a second phase of the carmaking alliance they forged to save costs earlier this year, sources said.
The U.S. and French automakers have discussed combinations including a joint venture between GM's Opel division and Peugeot's core manufacturing arm, according to three people with knowledge of the matter. They asked not to be identified because the discussions were confidential.
Discussions began soon after the initial alliance deal and have covered "selling Opel to Peugeot, buying Peugeot's automotive business or putting them all together in a new entity," one of the sources said.
Volume car makers, which have lost market share to low-cost and premium car brands in recent years, are bearing the brunt of a European car market slump that shows no signs of ending.
As tight budgets keep buyers away from showrooms and industrial overcapacity saps earnings, mass-market players need to find new ways to cut costs to survive.
Both automakers declined to comment on Friday after French newspaper La Tribune reported that they were mulling plans for a 50-50 venture into which GM would inject more cash.
"We haven't commented on previous reports and we're not going to on this one," Peugeot spokesman Jonathan Goodman said.
The company "remains focused" on GM-Peugeot working groups due to report back by the end of the month on plans for several joint vehicle programs, Goodman said.
GM spokesman Selim Bingol said in an emailed statement: "We don't comment on speculation. We are focused on earning the benefits from our alliance with PSA that we have identified."
Peugeot shares rose as much as 5.3 percent on the report before giving up most of their gains to close 2.3 percent higher at 6.19 euros. GM's stock was down 1 percent at $24.41 in afternoon trading on the New York Stock Exchange.
The French automaker's stock has fallen 44 percent this year, the biggest decline on the 15-member STOXX Europe 600 autos & parts index.
GM paid 320 million euros for a 7 percent stake in Peugeot as part of the original alliance deal, though the value of that stake has plunged along with the French automaker's shares. GM said in August it may have to write down the value of its investment.
GM and Peugeot unveiled their initial agreement in late February with the goal of saving at least $2 billion annually within five years, evenly split between the partners.
Discussions on a deeper tie-up are aimed at bigger potential cost savings but are still at an early stage, the sources said.
"To the extent that GM is able to cut its losses in Europe or get another manufacturer to share some of their burden, that would seem to make sense," New York-based analyst Brian Sponheimer said.
"Structure is obviously the key," said Sponheimer, whose employer, Gabelli & Co, is a subsidiary of GM shareholder Gamco Investors.
Analysts don't expect that GM, which has lost money in Europe for 12 straight years, would announce anything until after it reached a new labor deal with its German hourly workers. But analysts have said automakers can't seriously tackle their costs in Europe unless they close plants.
German union IG Metall said on Friday it wants an agreement with Opel, which is looking to restructure its German business, by Oct. 26, which is five days before the U.S. automaker is scheduled to report third-quarter results.
However, Guggenheim Securities analyst Matthew Stover called a joint venture a "gimmick," and said it will take a long time for GM to fix its money-losing European unit.
"I don't think it would solve the problem, putting two troubled companies together and expecting it to become a better company," said Stover, who has a "neutral" rating on GM shares.
A joint venture or other tie-up plan also would likely encounter objections from the French government, which has been vocal in its defense of "national champion" industrial companies and their domestic jobs.
La Tribune said the discussions had also divided the Peugeot family, which controls the French automaker through a stake of about 25 percent, commanding approximately 38 percent of its voting rights.
French Industry Minister Arnaud Montebourg's office did not immediately respond to requests for comment on the report.
Peugeot and GM outlined five possible joint vehicle programs following talks with French unions in March: a family of small cars for emerging markets; larger sedans; a fuel-efficient subcompact design; compact crossovers or SUVs; and a dual-clutch transmission.