By Matt Siegel

SYDNEY (Reuters) - One of Australia's poorest states is emerging as an unlikely key battleground in July 2 elections that could hand the balance of power to a folksy independent senator and threaten the government's economic agenda.

Prime Minister Malcolm Turnbull dissolved both houses of Parliament in May, blaming intransigent independents in the upper house Senate for stymieing his agenda, but the election campaign has thrown up a political firebrand.

The growing appeal of Nick Xenophon, a senator from South Australia, which is battling high unemployment despite being home to the naval shipbuilding industry, is forcing Turnbull to divert much needed resources to protect previously safe seats.

"This is a federal election like no other," South Australia Liberal Senator Sean Edwards told Reuters. "For the first time in modern political history we're faced with a three-way contest, which we take very seriously."

Xenophon, whose party named for himself is fielding almost 50 candidates in the election, could emerge as kingmaker in a hung parliament.

That scenario looks increasingly likely, as opinion polls put Turnbull's Liberal-National coalition government neck and neck with opposition Labor. Online bookmaker Sportsbet has increased its chances of a hung parliament from A$5 to A$4.

Xenophon told Reuters any common ground he found with Turnbull's economic agenda must include his election plank of adding manufacturing jobs.

"Right now we need to deal with the existential threat posed by the collapse of manufacturing in this country, and they don't get it. They just can't get it through their heads."

Xenophon has built his position by exploiting widespread political fury sparked by former Prime Minister Tony Abbott's 2014 decision to buy a A$50 billion ($37.27 billion) fleet of 12 submarines from Japan.

That decision shattered a promise Abbott had made to build the vessels in Adelaide, the capital of South Australia, and Xenophon relentlessly pushed the government to open up the process and hold a tender.

France's DCNS emerged the winner, beating out Japan and Germany, but not before the badly weakened Abbott had been ousted in a party coup.

Turnbull has pledged almost A$90 billion in naval contracts but South Australia's ten lower house and six senate seats are very much up for grabs, forcing the diversion of key resources from traditional battlegrounds like Western Sydney.

YOU DON'T KNOW WHAT YOU'RE GETTING

It will take a decade for jobs to materialize from the naval contracts, and with nearly 60,000 South Australians now out of work, Xenophon lures away voters by talking about the reality of their struggles, said Greens Party Senator Sarah Hanson-Young.

"They know the submarines aren't the silver bullet to the jobs crisis," she said.

"They want to see the positive vision being displayed by the other players, the Greens and Nick Xenophon, rather than reverting back to the devil they know."

With June unemployment running at 6.9 percent, a full point above the national average, South Australia's economy illustrates how hard it is to shift away from resource extraction to services and high-tech manufacturing.

Chinese demand for high-quality iron ore and coal fueled more than a decade of unparalleled economic growth for Australia, but now, faced with record low commodity prices, it has to change tack quickly.

But Australia has seen kingmakers crumble before.

In 2013 mining magnate Clive Palmer's Palmer United Party won three senate seats and briefly held the balance of power, before imploding spectacularly.

"We're a known quantity," said South Australian Labor Party Senator Anne McEwen, the opposition Senate Whip, urging voters not to succumb to the temptation to vote for parties centered on individuals.

"These personality-based political parties, like the Xenophon one, you don't know what you're getting. A political party based around a personality is not going to be particularly stable."

Xenophon said he was counting no chickens, however.

"A lot of politicians suffer from premature exultation," he said. "I'm not one of them."

(Additional reporting by Wane Cole in SYDNEY)