* Newspaper quotes Rio chairman as saying deal is dead
* Rio liable for $275.5 mln break fee if walks from deal
* BHP, Rio Tinto shares up 2.6 pct in Australian trade
* Potash pursuit could become BHP priority - fund manager (Adds fund manager, dealer, lawyer comments)
SYDNEY, Oct 6 (Reuters) - Global miner Rio Tinto looked set to abandon its $116 billion iron-ore joint venture with rival BHP Billiton, a deal unpopular with customers, regulators and many of Rio Tinto's own investors.
An Australian newspaper, quoting from an extraordinary leak of Rio Tinto boardroom discussions, said on Wednesday the world's second-largest iron ore miner was determined to walk away from the venture.
BHP Billiton has talked about a Plan B if the joint venture does not go ahead, which would give them at least some of the $10 billion in savings that are the big prize in the joint venture.
They first need the Western Australian parliament to lift restrictions on sharing port and rail infrastructure and blending of iron ore, as the state's premier agreed with the companies in June.
If BHP fails to win approval for the iron ore joint venture after having aborted a full takeover of Rio Tinto two years ago, investors said BHP may not want to try chasing the iron ore infrastructure sharing arrangements.
"Do they come back for a third bite? Perhaps BHP has now moved on to different things -- I refer to potash," said Perpetual's Bruce, referring to BHP's $39 billion bid for the world's largest fertiliser maker, Potash Corp.
RIO OUTLOOK IMPROVED
The venture was announced last year when Rio Tinto was heavily in debt and iron ore prices were less than half today's prices. Under the deal, Rio Tinto would hand over 5 percent of its Australian iron ore operations to BHP Billiton for $5.8 billion, a price many Rio Tinto investors now view as too cheap.
"Given the movements in the market over the last 18 months it's difficult to see the value to Rio shareholders in approving the deal as proposed," said James Bruce, portfolio manager at Perpetual Investments, which owns shares in both Rio and BHP.
Analysts said Rio may just be looking to be proactive, given that it no longer needs the deal like it did last year.
"There was a widespread expectation that the European Commission was going to put hurdles in their way. Do you want to wait until you have lost (on competition grounds) or be seen to be putting your destiny in your own hands?" said Grant Craighead, managing director of Stock Resource.
On Wednesday, the Sydney Morning Herald quoted Rio Tinto Chairman Jan du Plessis addressing a board meeting on Monday in terms that assumed the joint venture was all but dead and buried.
"I think with regard to the (joint venture) and why it didn't succeed ...we should simply work on the basis that both parties worked well and in good faith to make this thing work and both parties agreed, simultaneously, it wasn't possible," du Plessis was quoted as saying in the front-page report.
Rio Tinto said in a statement after the newspaper report that it had yet to make a final decision on the venture, though it confirmed the issue had been discussed at Monday's board meeting.
BHP Billiton said it remained committed to the proposed venture's regulatory process but declined further comment.
HURDLES
The companies have been awaiting approval from competition regulators in Europe, Australia and Asia since last December.
If Rio walks away from the deal before regulators rule on it, it would have to pay a $275.5 million break fee.
The venture has also worried international steel mills, which feared the two miners would gain more power over pricing of the steel-making raw material.
"I don't believe regulatory approval will be forthcoming," said UBS resources analyst Glyn Lawcock in Sydney.
"Steelmakers are up in arms," he added, noting that iron ore miners already made gross profit margins of around 80 percent.
Rio Tinto and BHP Billiton shares both jumped 2.6 percent in Australian trade, in line with a stronger overall mining sector, up 3 percent.
Dealers and fund managers said the share price jump had little to do with the potential scrapping of the proposed joint venture, as regulatory delays and the changes in the market had hurt chances of the deal going ahead for months.
"This has been pretty well factored into the market for quite some time," said Patersons Securities dealer Martin Angel.
Under the joint venture, regulatory approvals and a final agreement must be completed by the end of the year.
Competition lawyers said if the companies did want to pursue an infrastructure sharing agreement, the companies would be smart to seek authorisation from the Australian Competition and Consumer Commission even if not required.
"The ACCC will be interested in it. It would make sense for BHP and Rio to go proactively to the ACCC to say this is what we're going to do," said a lawyer at a major firm in Australia, adding that the threshold for approval would be much lower. (Reporting by Mark Bendeich, Sonali Paul and James Regan; Editing by Ed Davies and Lincoln Feast)