FRANKFURT - Foreign utilities and investors such as CEZ or Macquarie face another setback in the lucrative German power market, this time beaten by an eastern German city.

Foreign competitors have had trouble expanding in Europe's largest power market after initial successes several years ago by utilities like Sweden's Vattenfall and France's EDF.

All four of Germany's dominant utilities -- E.ON, RWE, Energie Baden-Wuerttemberg (EnBW) and Vattenfall's German unit -- are selling assets.

But life is being made difficult for foreign players by the fact that most municipalities hold stakes in local utilities and are seeking to regain control.

In the case of Dresden, the city has formed an alliance with 163 local communities from eastern Germany to buy EnBW's Geso unit, which holds stakes in 11 local utilities.

Dresden is competing with bidders such as infrastructure investors EQT and Macquarie as well as German utility Gelsenwasser, according to two people with knowledge of the matter.

Gasag -- which supplies gas to the city of Berlin and is owned jointly by Vattenfall, GDF Suez and E.ON -- has also bid, the people said.

CEZ, the power giant in the neighbouring Czech Republic, has said it is also bidding. EnBW, Macquarie, EQT, Gasag and Gelsenwasser declined to comment.

TAKING CONTROL OF LOCAL AFFAIRS

But Dresden is in a strong position as it holds 55 percent of Geso unit Drewag, the energy provider to the city of Dresden, and has invoked its right to buy back the remaining shares in the utility by the end of 2012 -- even though EnBW is disputing that right.

Dresden's municipal partners hold a stake in another Geso unit, Enso, and are therefore better clued in about that part of Geso's business.

The group has an edge over all competitors, said a person involved in the sale who asked not to be named.

The bids value Geso at around 950 million euros ($1.42 billion), including debt, the people said.

But it is by no means certain that EnBW will see through the sale of Geso. It might well decide to keep the eastern German utility if the bidding process remains uncompetitive -- and if another transaction pans out differently than planned.

EnBW is buying a 26 percent stake in northern competitor EWE and has to sell Geso in order to get approval from the German cartel office, which wants to prevent the two companies from getting a dominant position on the eastern German gas market.

But alternatively, the two companies could also sell EWE's 48 pct stake in gas supplier VNG.

That has not been on the agenda as EnBW was keen to buy EWE's VNG stake, considering eastern Germany's largest gas company the more attractive asset.

But EWE has so far failed to get the necessary approval from VNG's other shareholders -- including Gazprom and GDF Suez -- putting that transaction into doubt and raising the possibility that EWE might sell VNG, and EnBW keep Geso.

A decision about EnBW's future course will probably be taken on Nov. 30, when the company's supervisory board meets, a person with knowledge of the matter said.

The sales processes come as part of wider sale of stakes in small utilities in Germany.

The German unit of Sweden's Vattenfall said on Aug. 31 it agreed to sell its 80 percent stake in Schwerin-based Wemag for 170 million euros to the 268 municipalities that hold the remainder of Wemag. (Editing by David Cowell)

($1=.6699 Euro)

Germany E.on Energy