By Ingrid Melander and Marcin Grajewski

BRUSSELS, March 9 (Reuters) - European Union leaders are on the brink of striking an agreement on Friday to set a binding pan-European target for renewable energy sources as part of an ambitious strategy to fight climate change.

German Chancellor Angela Merkel said the 27 leaders had committed themselves to slash overall European greenhouse gas emissions by 20 percent by 2020, and to challenge industrialised and emerging nations to join the EU in still deeper cuts.

"That will put us in a position to show the international community that Europe is playing a pioneering role," Merkel, who holds the rotating EU presidency, told a late-night news conference on Thursday after the first day of the EU summit.

Swedish Prime Minister Fredrik Reinfeldt said the leaders had agreed in principle to set a mandatory target for renewable sources such as wind, solar and hydro-electric power, and to share out the burden among member states later.

But Merkel was cautious, saying while she was hopeful of a compromise on Friday further negotiations would be needed.

Several leaders said under an emerging compromise the EU would set a goal of achieving a European average of 20 percent of energy consumption from renewable sources by 2020 but take national circumstances into account in allocating the load.

Polish President Lech Kaczynski, whose coal-burning nation was initially opposed, said: ""Poland is ready to accept binding targets as long as they are the European average and specific conditions of various countries are taken into account."

French President Jacques Chirac accepted a binding target but told fellow leaders nuclear power must also play a role in Europe's drive to cut greenhouse gas emissions, blamed for global warming.

At what will be his final EU summit in Brussels, the veteran French leader said: "At the very least, the burden sharing on renewables must take account of the place of low-carbon energy -- nuclear and clean coal -- in our national energy choices."

Merkel said nuclear power was not a renewable energy form but could help to reduce overall carbon dioxide emissions.

EU diplomats said new central European member states Hungary, Slovakia and the Czech Republic that were holding out against a binding renewables goal could be "bought off" with the pledge of hosting a small nuclear energy forum.

Several EU states are fundamentally opposed to using nuclear power or in the process of phasing it out.

As this year's chairman of the Group of Eight leading industrialised nations, Merkel wants the EU to set the agenda on the environment.

Renewables currently account for less than 7 percent of the EU energy mix.

The summit outcome will form the basis of the EU's position in international talks to find a replacement to the U.N. Kyoto Protocol, which expires in 2012.

Environmentalists want the bloc to go further in its efforts to fight climate change but European business is concerned it will foot the bill by losing competitiveness to dirtier but cheaper foreign rivals.

"In terms of binding obligations on renewables, nobody has the foggiest idea what the costs can be," Ernest-Antoine Seilliere, the Frenchman who presides over the BusinessEurope lobby group, told a pre-summit news conference with Merkel.

EU leaders were set to endorse a plan for biofuels to make up at least 10 percent of vehicle fuels by 2020 but differ over how to open electricity and gas markets to more competition.

The European Commission proposed that big utility groups be forced to sell or separate their generation businesses and distribution grids in a process known as "ownership unbundling", but Merkel said she did not expect such an agreement.

"I know the Commission would like us to go a bit further but I don't think we'll succeed," she said.

Any signals from the summit will be scrutinised for moves that could affect energy companies, including Germany's E.ON <EONG.DE> and RWE <RWEG.DE> and Gaz de France <GAZ.PA> and EdF <EDF.PA>.

For a FACTBOX on the summit issues click on [nL08525169].

(additional reporting by Marcin Grajewski, Jan Strupczewski, Paul Taylor, Jeff Mason)

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