JERUSALEM (Reuters) -- Surrounded by aides, including one whose only task seems to be light his cigarettes, Mahmoud Abbas sits in a vast presidential office and speaks of his ambition to create a Palestinian state.

But outside his sprawling compound on the hills of the West Bank town of Ramallah reality on the ground is different -- his dream is being built over by ever-expanding Jewish settlements.

From Ramallah to Jerusalem 12 miles away, and all across the West Bank, the sprawling new communities, perched on hilltops that dominate the landscape, are testament to a shifting political geography and a reminder of the 64-year-old conflict and its winners and losers.

As Abbas resists pressure to resume talks on statehood until Israel halts construction, some Palestinians say he is too late to secure a viable national territory -- partly because Yasser Arafat, his predecessor, failed to grasp the challenge of the settlements when he agreed an interim peace nearly 20 years ago.

"There will be no Palestinian state," said Khalil Tafakji, a geographer who advised Arafat but says the late PLO leader, in exile for much of his life, did not appreciate how far Israelis had gone by the early 1990s in permanently colonizing the West Bank and East Jerusalem, captured in war from Jordan in 1967.

"Look at the facts on the ground," Tafakji said last week as he reviewed maps of Israeli towns and infrastructure, which the United Nations deems illegal on occupied land: "There is no geographic contiguity between Palestinian villages and cities," he said. "They have expanded settlements, built bridges and tunnels. We now have two states inside one state."

Aside from its tightening grip on East Jerusalem, Israel now directly controls about 60 percent of the West Bank, while the rest is administered by Abbas' Palestinian Authority.

The Oslo peace accords of 1993 left it to future negotiators to agree the "final status" of the division of territory between Israel and a Palestinian state. Failure to reach agreement has, in effect, left Israel drawing up its own map of the future.

Gloomy view

Nabil Shaath, a senior figure in the PLO and a veteran of peace negotiations going back decades, concurs with Tafakji's gloomy view of "facts on the ground" making it ever harder to establish a state:

"Every day we lose territory on the ground, we lose sovereignty, we lose people," he said in Ramallah, where the PA is based, in the hope of one day being able to set up a Palestinian capital in East Jerusalem. "They are grabbing as much land as possible to control the situation on the ground.

"Israel should not change the status quo on the ground during the negotiations," Shaath argued. "They should cease settlement building and any violation of the Oslo accord.

"But they want to draw the map of their land grab."

Tafakji reckons it might have been possible a decade ago to share Jerusalem with Israel but says that is no longer the case due to a policy of settling Jews in -- and around -- the east, including the Old City revered by three religions, as well as legal moves to bar Palestinian residents of Jerusalem from returning to the city if they spend time living abroad.

"Today you cannot divide Jerusalem," he said. "It is impossible," he added noting how Israeli settlers were moving in to houses inside Palestinian neighborhoods.

Palestinians are adamant that the east of the city will be capital of a state they demand on less than a quarter of what was British-ruled Palestine before the establishment of Israel in 1948.

Their national dream is endorsed by fellow Arabs and bolstered by the spiritual aspirations of a billion Muslims to regain control around the third holiest site in Islam.

But for Israelis the entire city, Yerushalayim in Hebrew, is the "eternal and indivisible" capital of a Jewish state, the home the Jews dreamed of throughout 2,000 years of bitter exile.

The 'Sharon map'

The ruling Likud party of Prime Minister Benjamin Netanyahu has come round to accepting the Oslo concept of a "two-state solution". But he rejects dividing Jerusalem and, while willing to redraw borders and give up some settlements, wants Israel to keep a security cordon around the West Bank in perpetuity.

For Tafakji, the settlement enterprise that has now matured long predates the Oslo process and the hopes it raised for a peaceful resolution of a century-long conflict between Palestinians and Jews over how to share the land.

That story begins in 1978 when Matitiyahu Drobless, head of the World Zionist Organization Settlement Division, prepared a first comprehensive plan for the establishment of colonies throughout the West Bank with a settler population intended to reach 1 million. For many Zionists, disappointed by partition of Palestine in 1948, victory in the Six Day War of 1967 was the chance to build a greater Israel across the whole territory.

The Drobless Plan for the hill country stretching 40 or so miles north and south of Jerusalem, known as the West Bank internationally or in Israel by the Biblical names of Judea and Samaria, was to scatter Jewish communities along the heights around Palestinian towns and cities.

Now numbering over 540,000, that Israeli settler population is a mix of people who see the West Bank offering cheaper housing and an easy commute to Tel Aviv or Jerusalem and those who see themselves as pioneers exercising an ancestral right to the lands.

While many of the other six million Israelis are ambivalent about the settlements, which few ever visit, the drive to expand them acquired real momentum in the early 1980s when then defense minister Ariel Sharon drew up a grand plan known as Military Order No. 50. Later, like Netanyahu, the leader of Likud, Sharon ordered a network of roads through and around Jerusalem that connected settlements and separated Palestinian villages and districts.

Already in the "Sharon map" of the 1980s, said the cartographer Tafakji, the outlines of what have now become more than 200 isolated, Palestinian-administered areas were defined by the routes of the Israelis-only highway network: "If you transpose all the roads onto one map you can see the cantons clearly, in the north, in the south, inside Jerusalem," he said.

Sharon, by then housing minister, developed further a plan to ensure control of Jerusalem before the Oslo process got under way by surrounding East Jerusalem with four major settlement blocs -- looming from the West Bank hills, some said, like modern Crusader castles.

No longer possible?

Addressing parliament in 1991, Sharon explained: "We have set for ourselves a goal of guaranteeing that in Jerusalem, the capital of the Jews and the eternal capital of Israel, there will be a Jewish majority.

"We are proceeding today with a far-reaching vision that in the greater Jerusalem area there will be a million Jews."

Today, some two thirds of the 750,000 population of the Jerusalem municipality are Jewish, about 200,000 of those in East Jerusalem, where about 250,000 Palestinians also live.

For Tafakji, Sharon has succeeded: "As a technician, not a politician, I say that a Palestinian state is no longer possible when you look at the facts on the ground."

He said Arafat, whom he advised during the Oslo talks and who died in 2004, never fully grasped the scope and ambition of the settlement enterprise: "When he entered into negotiations I think Arafat had no idea about facts or settlements."

Arafat agreed to leave resolving the fate of settlements for the "final status" negotiations. "They did not freeze settlement building," Tafakji recalls of the Oslo negotiators. Since then, Israel has built 38,000 new housing units on occupied land.

"I told Arafat ... that a Palestinian state was no longer possible," Tafakji said, forecasting that Netanyahu's new unity coalition will go on consolidating Israeli control in Jerusalem and beyond to make "the West Bank look like Swiss cheese".

Like many Palestinians, who have also seen the other part of their territory, the Gaza Strip on the coast, taken over Hamas who rejects Abbas' control, Tafakji fears the statehood project is doomed: "You see, there is no peace here, there is no hope," he said, musing only on a miracle of Jerusalem proportions: "Maybe Jesus will come to the Third Temple."

Time is running out

While the many Christian pilgrims to Jerusalem await the second coming of Jesus in the city, many Jews pray for the rebuilding of their Biblical Temple, the second and last of which was razed by the Romans.

Not everyone agrees with Tafakji's assessment and some diplomats in the city say a separate Palestinian capital in East Jerusalem can still be envisaged. Maps do exist, as to elaborate plans for public transport routes cutting across "foreign" land by means of bridges and tunnels to link districts together.

However, few disagree that time is rapidly running out, with settlement building to the south of the city, toward Bethlehem, set to further isolate Palestinian neighborhoods.

Abbas said he would not return to the negotiations without Israel freezing settlement activities. He said Netanyahu must realize they were destroying hopes of peace and must cease.

The Israeli prime minister says his government is building less than previous administrations and argues that recent construction is focused on expanding neighborhoods in existing settlements, rather than creating new blocs.

His office also stresses that the actual settlements take up just 3 percent of the total West Bank territory. However, Israeli map experts say these Jewish communities take up closer to 8 or 10 percent, once industrial and agricultural areas which are under direct Jewish control are taken into account.

Netanyahu says the issue should be resolved in face-to-face talks, giving no indication he is ready to accept Palestinian conditions that settlement building halt before they resume.

Western diplomats in the city tend to agree with Abbas that the settlements are a major hurdle. Arguing that it was hard not to conclude that Israel was deliberately seeking to break up the West Bank into separate Palestinian "cantons", one senior diplomat said: "Settlements are unbelievably corrosive. It destroys any faith on the Palestinian side that they are serious and totally corrodes international sentiment."