Police said the lower male torso was found yesterday by a tourist in a 13-foot deep dam near the town of Marla in South Australia state.
That is 750 miles south of the remote Outback highway where Mr Falconio and his girlfriend Joanne Lees were ambushed.
There has been no trace of Mr Falconio, of Hepworth, since the attack at Barrow Creek on July 14, 2001.
Barrow Creek is linked with Marla by the Stuart Highway which runs from north to south Australia.
Police Inspector Peter Batley said today the remains had been in the water for some time and there was no evidence that the torso had been severed from the rest of the body.
Batley added it was too early to speculate on the man's identity, but police had not ruled out that it could be Mr Falconio, who is believed to have been murdered.
"At this point in time the checks include all states and not just that particular file," he said. "Nothing is ruled out, we're coming into this with a very open mind."
Mr Falconio is believed to have been killed after he and Joanne were flagged down by a gunman as they drove along the Stuart Highway in the Outback.
Joanne managed to escape and report the attack to police, sparking one of the biggest manhunts in Australian history.
Bradley John Murdoch, 44, has been charged with murdering Mr Falconio. He is now awaiting trial on unrelated rape and abduction charges in South Australia, and is expected to be tried for Falconio's killing later.
The spot where the body was found is 750 miles from where Mr Falconio was last seen.
Police said today the lower male torso was found in a 4m-deep dam about 30km south of Marla yesterday afternoon.
The gruesome discovery was made by a tourist but Inspector Batley said there were no immediate signs of foul play.
He said the remains had been in the water for some time and there was no evidence that the torso had been severed from the rest of the body.
He said its condition could be just the result of normal decomposition
Inspector Batley said Northern Territory police had been contacted following the find but police were also doing a nationwide check on all missing persons' files.
British consular staff in Australia have been informed of the development.
The remains had been taken to the nearby Marla mortuary and were expected to be taken to Adelaide within the next day or two for forensic and DNA tests.
Some of those tests could take several weeks.
Today, police and volunteers searched the area around the 30 metre wide dam and a police plane was also involved.
Tomorrow police divers were expected to check the dam itself.
Marla is a remote roadside hamlet, some 480km south of Alice Springs and 1000 km north of Adelaide, two cities linked by the Stuart Highway.
It boasts a population of only 150 but has a motel and caravan site and is a stop-off for backpackers.
Miss Lees returned to Almondbury weeks after the ambush and is now living in Brighton, where she and Peter had lived.