UPDATE 1-Italy aims to thin out local utilities, form big national firms
* PM Renzi wants to slash number of public service companies
* Government to offer incentives for privatisations, mergers (Adds potential foreign interest)
MILAN, Aug 28 (Reuters) - Italy is planning legislation to prise hundreds of public utilities from the control of local authorities in a move toward consolidating a highly fragmented sector to create big, national companies, according to ministry sources and draft documents.
On Friday the centre-left government of Matteo Renzi is set to announce a package of measures aimed at shoring up some of the weakest points of Italy's sluggish economy.
The measures are likely to include financial incentives for public owners to sell stakes in utilities and other local service companies, according to draft proposals seen by Reuters.
Italy has more than 8,000 service companies controlled by city and regional governments, including around 1,500 local utilities. Renzi recently said he wanted to see the 8,000 service companies cut back to around 1,000.
"The aim is clear - Rome intends to send a strong message that these small utilities need to be privatised or merged into bigger players," a top industry source who has seen the draft proposals said.
The package, which still need a final blessing from the cabinet, will be included in a decree that must be approved by parliament within 60 days.
One proposal will call on the owners of public waste management companies to list at least 60 percent of capital on the stock market or sell a minority stake to an industrial partner, a ministry source said.
Smaller utilities will be encouraged to merge with larger players to create companies that have the critical mass to compete, especially in the water sector, according to draft proposals seen.
It was not clear from the draft proposals whether foreign companies would be encouraged or allowed to take controlling stakes. But some big firms such as GDF Suez have expressed an interest in parts of the Italian utilities market.
France's EDF already owns Italy's No. 2 power utility Edison and some analysts have said they could be interested in expanding further.
To promote mergers the government is expected to offer city and regional owners a series of incentives including approval to use the proceeds from any stake sale for local investments.
One of the sources told Reuters the government was keen for smaller utilities to merge with bigger regional multi-utilities such as A2A, Hera and Acea.
Bologna-based Hera has made a series of acquisitions in recent years in Italy's affluent north-east, while top regional player A2A has interests outside Italy, including 43.7 percent of Montenegrin power utility EPCG.
"Rome wants to get rid of small inefficient players and bulk up bigger regional operators, and to help fund the whole process, it's mulling bringing onboard state-owned investment funds like Fondo per lo Sviluppo e la Coesione (The Fund for Cohesion and Development)," the industry source said.
Friday's decree could also include measures to boost investment in domestic oil and gas exploration by offering regional governments a share of royalties, a second ministry source said.
The government is looking to double domestic oil and gas production in an effort to cut energy import costs and boost supply security. (additional reporting by Giulio Piovaccari; editing by Jane Baird and Keiron Henderson)