UPDATE 2-Nippon Paper, Rengo plan paper production overhaul

(Recasts, adds background)

TOKYO, May 30 (Reuters) - Nippon Paper Group Inc (3893.T) and its smaller partner, Rengo Co (3941.T), said on Friday they plan to overhaul their paper production but rejected a report that they may merge.

The Asahi daily had reported that the two companies are considering an integration to create Japan's biggest paper maker, with the aim of improving efficiency and to counter rising material prices and saturation in the domestic market.

Shares in Nippon Paper were up 4.6 percent after a short suspension in trading. Rengo's shares were flat.

Nippon Paper, Japan's second-largest paper maker, and fourth-ranked Rengo had taken small stakes in each other in 2007 as part of a three-way alliance with trading house Sumitomo Corp (8053.T) to better compete at home with industry leader Oji Paper Co (3861.T) and expand into growing Asian markets.

One possibility that Nippon Paper and Rengo are now considering is a merger between Rengo and Nippon Paper subsidiary Nippon Daishowa Paperboard, the Asahi paper said.

"We are examining various measures, including an overhaul of the companies' production structure, to quickly realise the effects of our alliance, but there is no truth to what is written in the report," Nippon Paper said in a statement.

Japanese paper makers have formed a web of alliances in the past two years or so, sparked by a hostile and ultimately unsuccessful bid by Oji Paper for sixth-largest maker Hokuetsu Paper Mills Ltd (3865.T).

Nippon Paper blocked Oji's acquisition attempt by taking a stake in Hokuetsu.

Daio Paper Corp (3880.T) has also taken a stake in Hokuetsu, while speciality paper maker Tokushu Paper Manufacturing merged with Tokai Pulp Co.

Despite the flurry of alliances, Japan's paper industry still suffers from excess capacity. It is also grappling with rising prices for raw materials, pushed higher by voracious demand for paper in China.

According to the Asahi, Nippon Paper is also considering eliminating some equipment at a factory in Saitama Prefecture, near Tokyo. In turn, capacity utilisation at a Rengo factory in Saitama would be boosted.

Rengo might also close its Yodogawa factory in Osaka, with production consolidated into a Nippon Paper plant in Hiroshima Prefecture, western Japan, the paper said.

(Reporting by Sachi Izumi, editing by Brent Kininmont)