By Aaron Sheldrick and Risa Maeda

TOKYO (Reuters) - Japan is embarking on its most ambitious attempt at electricity industry reform since 1951, with Prime Minister Shinzo Abe well-positioned for victory in a battle to break up powerful regional monopolies that is seen as a test of his political agenda.

The time is ripe for the government's push to reduce some of the highest electricity costs in the world by opening up the market for competition, with energy companies' public image battered in the wake of the Fukushima nuclear crisis.

Major reform is rare in Japan, but Abe's sweeping plan for the power industry is central to his drive to overhaul the country's economy, as high energy costs would derail efforts to turn back decades of stagnant growth and deflation. The government is pushing for recently submitted legislation to be passed before parliament goes into recess on June 26.

Change won't be easy as the politically well-connected utilities are part of an entrenched web of interests and have resisted attempts since the 1990s to liberalize the industry. The companies and their affiliates have ties with politicians, fund their campaigns and often give government officials executive roles.

"(Japan's power companies) are good for nobody but themselves. So we gotta to get rid of that, energy costs are so expensive," said Taro Kono, a lawmaker in the ruling Liberal Democratic Party, who has long been critical of government support for utilities and says the plans should go further.

The companies, including Tokyo Electric Power Co and Kansai Electric Power Co, still supply almost 98 percent of Japan's electricity and terms for access to their transmission lines make it onerous for new entrants.

Wrenching control of transmission from regional monopolies to create a national grid is also a key issue after the March 2011 earthquake that sparked the Fukushima disaster highlighted the inability to transfer power to areas suffering shortages.

HISTORIC PROPORTIONS

Toshimitsu Motegi, the Minister for Economy, Trade and Industry, told parliament in March that overhauling the market was at the core of attempts to reduce Japan's soaring energy costs, which have pushed it into a record trade deficit.

"This is a major reform of historic proportions, which fundamentally reviews the regional monopoly system that has continued for six decades," he said.

The monopolies, set up in 1951 during the American occupation after World War II, followed the U.S. model at the time, with regional utilities controlling all aspects of power generation and transmission with legally sanctioned profitability.

Tokyo Electric, which before the meltdowns at its Fukushima Daiichi facility was the most powerful utility, is under government control and is being split into separate units. The company will likely be the template for broader change.

"Tepco today is not the same Tepco as the Tepco of the past," said Gerhard Fasol, chief executive officer at consultancy Eurotechnology Japan KK.

Fasol said he expects the industry reforms to be pushed through unless there are significant political changes in the country, one of the last major industrialized economies to attempt to fully liberalize electricity markets.

NATIONAL GRID

Japan's ability to smoothly transfer power between regions is also hampered by it having two different frequencies dividing its eastern and western sides.

That is supposed to change in the first stage of the reforms, slated to be carried out over the next seven years. The government has submitted legislation to create a national grid company in 2015, with the bill also laying out a schedule for the following two phases of reform.

Hopes to pass the bill in the current session ending June 26 may be fading with some members of parliament holding up debate, according to a government official involved in drafting the legislation.

"We expect Minister Motegi to make a strong statement (to get parliament to start debating the legislation)," the official said.

In the second phase, the government plans to liberalize the market for homes, an important source of earnings for power companies.

The market to supply to customers using more than 50 kilowatts was opened up in 2005, but utilities can still block supply from independent power producers as they control transmission lines.

The final and most ambitious phase envisages breaking the monopolies into separate generation and transmission companies by 2020 and abolishing all price controls.

WATERING DOWN?

While the ultimate aim is to reduce electricity prices for Japanese business and voters, one of those who helped draft the scheme questions whether the reforms will drive down costs.

"Consumers in Europe and in the U.S. often found there was a rise in electricity bills after power sector deregulation," said Hiroshi Takahashi, a research fellow at Fujitsu Research Institute and a member of panel that advised on the reforms.

Subsidies for renewable energy, environmental taxes and higher fuel import bills kept prices in some countries from falling after deregulation, he said.

While the energy companies say they support the thrust of the proposed changes, they have repeatedly urged the government to prioritize stable power supply and to slow reforms if this cannot be guaranteed.

And the utilities may have had some success in watering down the legislation, Takahashi said.

"When compared with the METI panel's proposals in February, the bill looks to be somewhat weakened in terms of the authority of the (national grid company)," he said.

'REAL OPPORTUNITY'

Still, trading houses and other companies are watching the developments with interest, sensing this time around might be different.

"This a real opportunity I reckon, especially with Tepco in the state it is in," said Koji Takayanagi, a senior managing executive officer, at trading house Itochu Corp, when asked about the reforms at a recent earnings briefing.

Japan's trading houses say they are keen to enter or expand power generation businesses and they have plenty of funds, while the biggest regional electricity monopolies recently posted combined losses of $16 billion for a second year.

The shutdown of most of Japan's nuclear reactors for safety checks in the wake of the Fukushima disaster, has also sparked a search for alternative power sources such as renewable energy.

"The trading companies, and also other companies such as real estate companies, gas companies ... and telecoms companies such as Softbank have already entered the electricity market," said Fasol. "To some extent that is an avalanche, which will be difficult to stop now."

(Additional reporting by Linda Sieg, James Topham and Osamu Tsukimori; Editing by Joseph Radford and Simon Webb)