* Kerry shuttles between Middle East leaders
* Settlements and security key issues in peace effort
* Netanyahu: Israelis don't want a bi-national state
U.S. Secretary of State John Kerry's drive to revive Middle East peace talks hit familiar warning signals on Thursday as Israel's prime minister stressed security needs and a Palestinian negotiator denounced Israeli settlement building.
Kerry, on his fifth visit to the region, met Jordan's King Abdullah for talks focused on both the peace process and the Syrian civil war, which has driven more than 500,000 refugees into Jordan.
He later met Israeli Prime Minister Benjamin Netanyahu in Jerusalem and was to return to Amman for talks with Palestinian President Mahmoud Abbas on Friday.
Israeli settlement building on occupied land Palestinians seek for a state remains a main stumbling block to the resumption of peace talks that collapsed over the issue in 2010.
Kerry's arrival in Amman on Wednesday coincided with news Israel had approved 69 new housing units in a Jewish settlement in East Jerusalem, while building continues elsewhere.
"Obviously steps like this are unhelpful, but we remain hopeful that both parties will recognise the opportunity and the necessity to go back to the table," the State Department said.
Abbas has long demanded settlement activity stop before peace talks resume, despite U.S. and Israeli calls for negotiations without preconditions.
"Settlement activity in and around occupied East Jerusalem is one of the main reasons why the two-state solution is disappearing, as without East Jerusalem there will be no Palestinian state," Palestinian negotiator Saeb Erekat said.
Netanyahu, professing his support for the creation of a Palestinian state, which he says must be demilitarised, has quietly frozen most housing starts in settlements in the occupied West Bank and East Jerusalem.
But in a speech on Thursday, he appeared to put the United States on notice that he would stick to his security demands even at the risk of failed peace efforts should they resume.
The prime minister said Israelis "do not want a bi-national state" - a reference to the possibility of Palestinians eventually vying for equal standing were Israel to merge with the West Bank. But he said Israelis understood that security is a "fundamental condition for our existence".
Netanyahu has called for an Israeli military presence along the eastern border of a Palestinian state, a demand opposed by Abbas, and spoken of the danger of rocket fire at Israel from the West Bank unless tough security arrangements are agreed.
Kerry has revealed few details of his strategy to bring the sides together. But he has said he wants to show progress before September, when the U.N. General Assembly, which has already granted de facto recognition to a Palestinian state, resumes its debate over the Middle East.
Netanyahu is concerned that the Palestinians, in the absence of peace talks, could use the U.N. session as a springboard for further statehood moves that circumvent Israel.
By playing his cards close to his chest, Kerry wants to avoid building expectations over a process that has broken down many times before. Talks are currently focused on finding common ground from which to launch negotiations.
The broader issues, however, are essentially still the same: the borders of a future Palestine, the fate of Palestinian prisoners and refugees, Israeli security and Jerusalem's status.
Kerry has introduced an economic component, being overseen by former British Prime Minister Tony Blair, that would see an estimated $4 billion in new investment for the Palestinians.
Israeli newspapers expressed scepticism that Kerry's mission would achieve anything substantial.
"Kerry is still not trying to twist the leaders' arms to get them to sign a painful historic peace, but only to sit down together," said an editorial in Israel's popular Maariv daily.
"The fact that the Americans have become bogged down in the attempts to resume the talks is telling, in and of itself, of American weakness, and projects pessimism as to the process itself, which has not yet begun."
In a possible trial balloon related to Kerry's mission, Israel's Haaretz newspaper quoted an unnamed minister from Netanyahu's right-wing Likud party as saying the prime minister knew a peace deal would mean giving up most of the West Bank.
"Netanyahu understands that for a peace agreement, it will be necessary to withdraw from more than 90 percent of the West Bank and evacuate more than a few settlements," the minister said. "He knows this is one of the things that will be discussed."
In an address to the U.S. Congress in 2011, Netanyahu talked of a land-for-peace bargain, but gave no percentages.
The bulk of West Bank settlers live in blocs that take up 5-6 percent of the territory, so a pullout on the scale envisaged by the minister could leave most of them in place.
A spokesman for Netanyahu said he had no comment on the Haaretz report.
Most countries deem all Israeli settlements in the West Bank illegal. Israel, which captured the land in the 1967 Middle East war, disputes this. There are about 120 government-authorised settlements in the West Bank and dozens of outposts built by settlers without official sanction.