By Philip Pullella
ROME (Reuters) - Italy, which did more than any other country to legitimize Libya and its mercurial leader, is going through a foreign policy nightmare as civil strife in its former colony threatens its energy supplies, international image and the stability of some of its blue chip companies.
"The stakes for our country are very high," said Roberto Aliboni, vice-president of Italy's Institute for International Affairs, who argued in a recent report that Italy should take a clear stand against Gaddafi and invest in the opposition.
But Rome is moving cautiously, realizing it has the most to lose among European nations as events unfold in the North African nation just 300 miles from Italy's southernmost island.
Six months ago Prime Minister Silvio Berlusconi and other officials fawned over Libyan leader Muammar Gaddafi, treating him like royalty on his third visit to Italy in two years.
Now, a 2008 "friendship treaty" that prohibited Italian bases from being used in any military action against Libya has been officially "suspended" while Italy seems to be grabbing at straws over what policy to take with Libya.
The numbers tell the story. Italy imports about 80 percent of its energy needs. About 32 percent of Libya's oil output goes to Italy -- making up about 25 percent of Italy's imports -- and about 12 percent of Italy's gas comes from Libya.
Under the friendship treaty, Italy promised to pay Libya $5 billion in compensation over 25 years for colonial misdeeds.
Libya has been spending petrodollars on stakes in Italian companies while Italian firms have won infrastructure and energy contracts in the country it ruled as a colony from 1911 to 1943.
The web of commercial interests includes banking, textiles, cars, construction, railways, aerospace -- and soccer clubs.
Rome was de facto guarantor of Tripoli's good behavior when Libya was warily welcomed back into the international community after renouncing terrorism and weapons of mass destruction.
While leaders such as British Prime Minister Tony Blair and U.S. Secretary of State Hilary Clinton dutifully went to Tripoli and appeared uneasy with Gaddafi, Italy pulled out all the stops and Berlusconi embraced him as "my great friend."
Gian Antonio Stella, a commentator for the Corriere della Sera newspaper, argued that Italy has to feel more responsible for a positive outcome to the Libyan crisis because Rome "revered and adulated" Gaddafi until only a short while ago.
When the Libyan unrest broke out Berlusconi seemed almost in denial, perhaps sensing that his one-on-one style of diplomatic relations had fallen flat, as Gaddafi returned to his old habit of insulting the former colonial power.
"In Gaddafi's case this (Berlusconi's personal style produced results that were grotesque and undignified," wrote political commentator and former ambassador Sergio Romano.
"We had to put up with the capriciousness of the colonel, his delays (in 2009 he failed to show up to address parliament) his insults, his uniforms, his tents in our parks," Romano said.
Rome's behavior can have far-reaching effects for Italy.
"Political imprudence by the government can risk unleashing resentment from whatever Libya emerges from the current crisis," said Aliboni of the Institute for International Affairs. "National interests would be gravely put at risk."
It is no surprise that Italy is no cheerleader for sanctions against Libya or of calls for the freezing of its assets or the imposition of a no-fly zone.
NO UNILATERAL ACTION
Rome has made clear that it is not considering unilaterally freezing Libyan holdings in Italian companies at present.
Libya owns stakes in blue-chip Italian companies including bank UniCredit and defense company Finmeccanica, and the fate of its holdings have been under scrutiny since the European Union imposed sanctions on Libya.
The EU agreed last week to freeze the assets of Gaddafi and a list of senior Libyan officials after Libyan security forces used violence to crack down on protesters.
But since that list does not mention the country's sovereign wealth fund, the Libyan Investment Authority (LIA), or the Libyan central bank -- entities that hold stakes in Italian companies -- Italy does not plan to freeze the holdings, a source familiar with the matter told Reuters.
The question is where do the assets of Gaddafi and his family end and where do Libya's assets begin.
"The problem is that in an authoritarian regime today, just like in the absolute monarchies of the medieval times, it is hard to distinguish between the personal goods of the sovereign and those of the state," said commentator Stefano Lepri in La Stampa newspaper.
Other European countries have been more aggressive in their pursuit of assets linked to Gaddafi and his top aides.
British publisher Pearson Plc last week said the LIA's 3.2 percent stake in the company had been frozen because of the sanctions, while Austria has widened an asset freeze list to include a top official at the LIA.
Also making Italy's position with Libya difficult is the prospect of a wave of illegal immigration, worse than the one that hit it in the early 1990s after the collapse of communism in Albania.
"The contrast between the moral imperative (to support democracy) and the political dividend is particularly stark because of the fear of the consequences the fall of Gaddafi's regime could have on migration," said Emanuela Paoletti of the International Migration Institute at Oxford University.
In 2009, Rome and Tripoli signed a deal allowing Italy's coastguard to return boatloads of illegal immigrants to Libya
Before then, Libya was a main staging post for illegal immigration from Africa and Gaddafi has made it clear that he could let the genie out of the bottle again if he wanted.
He told France's Journal du Dimanche on Sunday that if he fell "you will have immigration, thousands of people from Libya will invade Europe. There will be no one to stop them any more."
(Additional reporting by Giselda Vagnoni and Deepa Babington)
(Editing by Tim Pearce)