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Fable III is the third game in the award-winning, best-selling Fable series of action role-playing games developed by Lionhead Studios and published by Microsoft Game Studios and is a semi-direct sequel to Fable II.

Microsoft attended  X10 event in San Francisco, we had an opportunity to meet with Peter Molyneux and spend between 20 and 30 minutes checking out Fable III. As we watched the game being played, Molyneux pointed out a number of key new features. While there are clearly still a lot of things that aren’t being talked about yet, we came away from the presentation feeling like Molyneux’s claims that this is going to represent a huge step forward over Fable II are well founded.

The first portion of the demo took place in a city where Molyneux’s character was walking around looking for his young daughter and showing off some already-impressive visuals in the process. As he strolled across a bridge, he spotted the daughter playing with some of her young friends and being watched intently by another member of the family: the dog. As he approached the group, the daughter’s friends ran away, and–perhaps as a result–the young girl became quite upset. How does a father comfort and cheer up his daughter in a situation like this one? Well, in Fable II, you might have resorted to dancing in front of her. Relentlessly. But in Fable III, emotes like that one are being replaced by touch and mapped to a single, context-sensitive trigger button.

Using said button, he bent down to pick up his daughter and proceeded to play with her–tossing her up and down until her sobbing gave way to girlish giggles. Then, using the same button, he gently reached for her hand and walked her down the street with the dog following dutifully behind. Molyneux appeared to contemplate popping into a pub at one point, but his daughter was quick to point out that he really shouldn’t do that with her in tow. Next, we were shown how the touch command will work with a very different character who, on this occasion, was a beggar asking for money. Appearing sympathetic to the man’s plight, Molyneux took his hand and started walking him through the town–perhaps to buy him a hearty meal or some new clothes. The beggar was clearly familiar with the way that Molyneux plays these games, though, (or perhaps just with the layout of the town) because not a minute into the walk, he started protesting and doing everything he could to resist being pulled along. Molyneux’s plan, as it turned out, was to sell the beggar to a factory–whether the beggar was going to be put to work there or turned into an affordable meat product wasn’t clear, but he was clearly opposed to the idea either way. Other uses for touch, we’re told, will include guiding children to schools or orphanages, picking up someone who’s injured to rescue him or her, and greeting people with gestures that are appropriate for your relationship with them. A handshake used the first time you meet someone might be replaced with a hug as you become better acquainted with them, for example.

And why exactly should you want to spend your time getting to know people and being nice to them? Well, because you’ll need their help if you’re to stand any chance of overthrowing the evil king. Followers will be an important consideration in Fable III, both prior to when you become king and during your reign on the throne. And, there will be a number of ways to gain their loyalty. One of the more interesting examples we were given, for example, involved wooing a powerful woman who had plenty of her own followers to make them your own. Other characters will be more easily pleased and might simply be impressed by your prowess in combat.

Based on what little combat we saw in Fable III today, it seems that it’ll play out in much the same way as it did in Fable II, with buttons devoted to magic use, projectile weapons, and melee weapons. Molyneux hinted that there will be some improvements, but what he was most excited to talk about was the way that weapons will work. Molyneux’s hope is that no two weapons in Fable III will be the same because–like your character–they’ll morph based on your actions and even your gamerscore. The most obvious way that weapons will transform is that they’ll grow bigger and more powerful the more you use them, but there’s much more to it than that. The visual style of your weapon will change quite radically according to how you use it. So to give you the examples that we got to see for ourselves today, the head of a large axe that has presumably been used to kill a lot of skeletons or beasts appears to be made of bones, while a sword that has been used to commit evil acts, such as killing innocents, will forever appear to be covered in blood. And if you’re still not excited, perhaps hearing that you’ll be able to trade your unique (or at the very least, uniquely named) weapons with other players online might do the trick.

As you progress through the story, there will apparently be a number of occasions where you’re encouraged to give up your unique weapons–perhaps for financial gain or some other temptation. Molyneux’s hope, though, it seems, is that you’ll feel so attached to your weapons–which you’ll ultimately be able to store in your own armory–that you’ll be reluctant to give them up. And perhaps you should be reluctant because while they will grow more powerful as you progress through the game, it’s not yet clear if the same will be true of your character. All we know for sure is that experience points are a thing of the past, along with your health bar and anything else that resembles a heads-up display.

You know what else will be a thing of the past? Having to play co-op as some generic character that is of absolutely no interest to you. That’s right, in Fable III, you’ll be able to play co-operatively with a friend, and both of you will get to use your own characters, work on improving your own weapons, and even bring along your own dogs. Molyneux also pointed out that you’ll be able to use the touch command with each other, but we chose not to pursue that potential line of questioning. This was partly because the character that we were seeing on the screen didn’t really look like one we’d ever want to touch.

This character, which we watched battling against generic bad guys inside an impressively detailed cavern of some sort, was far and away the most evil looking that we’ve seen in a Fable game. Glowing red markings on his dark skin were somewhat reminiscent of those on Illidan from World of Warcraft or Devil Jin from the Tekken series. And that idea was reinforced when, during combat, he appeared to sprout horns and wings. Said appendages didn’t appear to be parts of the character’s physical form but rather translucent visual motifs that served no obvious purpose other than to look really cool. For characters at the opposite end of the good-and-evil scale, these demonic visuals will be replaced with angelic ones. This was evidenced by a video clip we saw showing a character that appeared to have large white feathered wings.

Before our time with Molyneux and Fable III came to an end, we were told that becoming king in the game will unlock at least two major new gameplay elements that–for the moment–aren’t being shown. We were given a brief outline of what one of them will be, though, and the gist is essentially that with great power comes great responsibility. As king, you’ll have access to a huge treasury, and having spent time on the streets gaining and getting to know your followers previously, you’ll find yourself having to make difficult decisions when it comes to putting all of that gold to work. You might not want your people to starve, for example, but what if the money that’s needed to feed them is also needed to assemble an army so that you can defend them? Unlike some of the choices in previous games from developer Lionhead Studios, these are unlikely to be black and white. You’ll still be able to wander around your kingdom after ascending to the throne, and mechanics like combat and touching will still be a big part of the game. We were told that if you’re confronted by someone badmouthing you in the street, for example, you could take him by the hand and choose to either throw him to the ground or, if you have something you’re feeling guilty about or would just like kept quiet, lead him to your treasury and offer him a bribe to keep quiet.

During the brief question-and-answer session that followed the demo, Molyneux mentioned the existence of a second continent named Arora. And, on the subject of Natal support, he stated that Fable III is being designed for the regular Xbox 360 controller first and foremost, but that some Natal surprises are coming. We look forward to bringing you more information on Fable III, Natal, and player characters being able to “touch” each other cooperatively as soon as it becomes available.