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* Combined group would create fourth European utility
* Shareholder Criteria wants smaller stakes in bigger groups
* Gas Natural-EDP merger seen as good strategic fit -sources (Adds details about the deal and context)
By Andrés González
MADRID, July 3 (Reuters) - Spanish power and gas company Gas Natural has approached Portuguese rival EDP about merging to form Europe's fourth biggest utility by market value, people familiar with the matter said on Monday.
Talks over a potential 35 billion euro ($40 billion) deal and its potential structure are still at an early stage and there is no certainty over their outcome, four sources said, although Gas Natural chairman Isidre Faine has already sounded out his Portuguese counterpart Antonio Mexia about a tie-up.
A deal would create an Iberian champion competing with France's Engie and EDF and not far behind heavyweights Enel and Iberdrola.
And it could trigger a long expected wave of consolidation among Europe's biggest utilities as they seek to gain scale and shift their revenue streams towards renewables to protect profits from steep competition and narrower margins.
A Gas Natural-EDP merger is seen as a good strategic fit as EDP has made big headway in renewable power while Gas Natural remains strong in gas-fired or coal generated electricity.
The two have a complementary footprint, especially in Latin America where the Spanish firm is strong in Chile and Mexico and the Portuguese group in Brazil as well as in the United States.
"The combination of the two companies is quite attractive as Gas Natural lacks power generation in Latam and renewables. But the key to the deal is the politics", said a major shareholder in one of the two firms.
Gas Natural and EDP declined to comment.
Any attempt to consolidate Europe's fragmented energy market has so far raised eyebrows among European competition authorities who fear it could translate into higher prices.
But sector insiders say the mood for cross-border deals has changed since the French election victory of Emmanuel Macron who has been a strong advocate of creating European champions.
Meanwhile, Spain's prime minister Mariano Rajoy and his Portuguese counterpart Antonio Costa, are working on increasing connections between the energy grids of the two countries and with Europe and none of either group's main shareholders is seen as raising objections if the price is attractive.
A merger would also mark the latest effort by Spain's Criteria, which owns direct or indirect stakes in Caixabank , Abertis, Gas Natural, Repsol or Telefonica, to restructure its portfolio.
The holding company, which is also managed by Faine, wants to focus on smaller stakes in bigger companies with potentially less political influence but higher financial returns.
Criteria, which is reviewing a potential tie-up between toll road operator Abertis and Italy's Atlantia, declined to comment. But it has a track record for such deals and in 2014 exchanged 100 percent of Agbar for 5 percent of Suez.
"Faine has done it with Agbar and is about to do it again with Atlantia and Abertis," a source with knowledge of the deal said. "Now, he is looking towards Portugal to replicate the move with Gas Natural and EDP." ($1 = 0.8802 euros) (Editing by Julien Toyer and Alexander Smith)