* National conference crucial for stabilising Yemen
* Separatists rally in south
* Restoring stability an international priority (Adds British diplomat)
By Sami Aboudi and Mohammed Ghobari
SANAA, March 18 (Reuters) - Yemeni leaders seeking to end political upheaval started work on comprehensive reforms on Monday, with the scale of their task illustrated by the tens of thousands of protesters who marched in the south to demand their own state.
Stabilising Yemen, a U.S. ally grappling with al Qaeda militants, southern secessionists and northern rebels, is an international priority due to fears of disorder in a state that flanks oil superpower Saudi Arabia and major shipping lanes.
Yemen has struggled to restore normality since President Abd-Rabbu Mansour Hadi was elected in February 2012 following nearly a year of Arab Spring-style protests that forced his predecessor Ali Abdullah Saleh to step down after 33 years in power.
The national dialogue conference, promised under a Gulf-brokered deal, is the country's most important political gathering in fifty years and is intended to pave the way for elections in 2014.
It comprises representatives of various political parties from all over Yemen and is expected to last for six months.
Some 565 men and women will work in committees to draft a new constitution, prepare proposals on government decentralisation, discuss grievances of the former South Yemen and northern Shi'ite rebels and offer ideas on restructuring the armed forces.
Reforms of the military are expected to reduce the influence of army factions loyal to Saleh, still seen as a powerful politician.
Opening the conference at the presidential palace in Sanaa amid tight security, Hadi said the restive south was the main challenge.
"Any attempt to impose a vision to deal with this (southern) issue by force will lead to big failure and big dangers," he said.
The conference would place the first building blocks of a "new, unified, safe and free Yemen," he said.
Most of Yemen's fast-declining oil reserves are in the south.
The British ambassador to Yemen said the conference was an important moment for the country.
"The situation in Yemen is fragile," Nicholas Hopton told Reuters. "However it is much better than it was two years ago and I think the momentum is in the right direction," he added.
As delegates were taking their seats, tens of thousands of demonstrators gathered in the southern city of Aden to demand secession.
Flags of a once-independent southern Yemeni country fluttered from cars and buildings across the port city. There were separatist marches in other southern towns including Mukalla, Tarim, al-Shihr and Sayoum, witnesses said.
Hundreds of security forces took positions outside Aden's main buildings such as banks and government offices but no clashes were reported, the witnesses said.
Nasir al-Nouba, a leader of the secessionist Southern Movement, told reporters: "The conference in Sanaa will fail. Those who are taking part as representatives of the Southern Movement do not represent us. They represent themselves."
South Yemen merged with North Yemen in 1990 after the collapse of its main patron, the Soviet Union. Secessionists failed in a civil war in 1994 to reverse the unification.
Some secessionist leaders of a political grouping called Herak complain of discrimination by Sanaa, including appropriation of public land and dismissal of tens of thousands of administrators.
Hadi has set up committees to looks into these grievances.
Western nations suspect that attempts by some southern leaders to break away have the backing of Iran, arch-foe of Saudi Arabia and the United State. Yemeni officials have also accused Iran of backing the Shi'ite Houthi rebels who operate in northern Yemen.
Iran denies any interference in Yemen's affairs. (Additional reporting by Mohammed Mokhashaf in Aden; Editing by Erica Billingham)