We'll know in a few weeks time if any of this is true.

Larger size HD-DVD baby.

That would be completely stupid. Blu-ray is the choice of physical media now so using anything else would not be a smart decision at all.

It is not a bad idea, do you really need another device to play DVDs and Blu-rays at your home? The focus for Nintendo is games only, the focus for Microsoft is to push the streaming and downloading of content. This way they can avoid some costs in the product (not paying for the playing capabilites), using standard technology anyway and offer the option as a download application so those who want it can use it, and not everyone has to pay for it. Looks like a win-win situation for Microsoft.

A dual layer HD DVD can store up to 60 gigs of data and look just as good as blu-ray DVDS did. Also MS wouldn't have to pay a dime to Sony for royalities. They can still stream the Zune/XBox Movie marketplace and get their revenue there.  Last I checked blu-ray sales were only amounting for 20% of DVD sales, and most people can buy a cheap blu-ray player if they really wanted to. I think that would be a win-win for Microsoft.

I love Blu-Ray and I think it'll be cool if the Nextbox has it for movie playback but I don't think it's a must have. I can't imagine many people are sitting hoping for a BR playing 720 so they can finally enjoy the format. My guess is that most people who really care already have a stand alone player like I do and that option will remain (as will the reducing cost of owning said device).

For gaming, as others have pointed out, I see no reason why they can't/won't go another route.

Where do you get the idea that Blu-ray royalties are in anyway significant relative to the benefits having a Blu-ray drive would provide?

Should the Xbox and 360 have not played DVDs?  Do you think Blu-ray licensing costs are significantly higher than those of DVD?

Yes I think bluray playback licensing is more expensive than DVD playback.  Didn't have time to search a ton, but here is some of the info:

" Fees for the new product licenses will be $9.50 for a Blu-ray Disc player and $14 for a Blu-ray Disc recorder; disc fees will be $0.11 for a read-only disc, $0.12 for a recordable disc, and $0.15 for a rewritable disc."

http://www.pcworld.com/article/160247/blu_ray_disc_licensing.html

"An MPEG-2 decoder. The licensing rights for the MPEG-2 standard are made up of a pool of patents contributed by their inventors. The pool itself is managed by MPEG LA, which collects and distributes royalties on behalf of the patent owners, under a master license agreement. Those rights cost $2 per device. The maker of a cheap DVD player sold at Costco pays $2 per unit for the MPEG-2 rights. Microsoft pays An OEM PC maker who licenses Windows from Microsoft must pay $2 in MPEG-2 licensing fees to enable DVD playback in every copy of Windows 7 Home Premium, Professional, and Ultimate. [Edited to clarify payment requirements]"

http://www.zdnet.com/blog/bott/if-vlc-can-ship-a-free-dvd-player-why-cant-microsoft/4962

So Blu Ray is about 7.50 more. I am not sure if the blu ray license also covers DVD play back, the article wasn't too clear on that. So it may be and additional 9.50 over the 2 dollars for dvd play back, and than probably a few more cents to dollar for cd play back.  On top of the difference in cost for the actual drives themselves. Not sure how much that would be. Maybe osmeone who has more time and or knowledge can get better costs. But it looks to be a minimun of 7 dollars more, and up to 20-30 depending of the cost difference in the drives.

HD DVD holds 30 GB dual layer.  Blue Ray holds 66 GB DL and can be quadruple-layered.  Max Payne 3 takes up over 30 GB already on PC.  Expect most games to take up 30-50GB by the end of next gen.

It could have blu ray and play games but it could be lockef for moives.
But blu ray drives are cheap like 25 bucks