* Judge approves rules for January auction

* Unions, retirees oppose sale that seeks to end labor pacts

* Walter Energy warns liquidity to run out by February

By Tracy Rucinski

CHICAGO, Nov 24 (Reuters) - Bankrupt Walter Energy Inc received court approval on Tuesday to auction its coal assets as part of a proposal to emerge from bankruptcy that has faced fierce opposition from unions and retirees in its home state of Alabama.

Walter Energy is one of four debt-laden U.S. coal producers that have sought Chapter 11 protection this year as plummeting commodity prices, weak demand and increased environmental regulation hurt operations.

The company has an offer from senior lenders for assets set to go on the auction block, including its mines in Alabama - the heart of its business - in exchange for cancelling $1.25 billion of its debt.

The lenders have also offered $5.4 million in cash.

The lenders' bid is subject to a higher proposal at the auction. The money raised will be distributed to other creditors.

To appease lenders' demands for the sale, Walter Energy has asked for court approval to reject collective bargaining agreements for more than 800 union workers and terminate retirement benefits for some 3,000 retirees.

United Mine Workers of America opposes the plan.

"If successful, Walter Energy will force many retirees into making life or death decisions about getting needed health care or buying food," UMWA said in a statement on Tuesday.

"Nobody gave them their health care and pension benefits - they earned them," it said.

U.S. Bankruptcy Judge Tamara Mitchell approved the rules for the auction, scheduled for Jan. 5, on Tuesday, and reminded workers and retirees in the court room that a separate hearing would be held on Dec 15. and Dec. 16 to discuss the labor pacts.

A hearing to approve the result of the auction is set for Jan. 6.

Walter Energy, which exports metallurgical coal globally, warned in court documents that its liquidity will run out by the end of January if the sale does not go through.

More than 90 percent of Walter Energy's coal sales in 2014 consisted of steel-making coal, which has suffered depressed prices and low demand from China. The company also produces coke and natural gas, besides thermal coal. Its operations in Canada are not part of the auction.

The case is In re Walter Energy Inc., 15-02741, U.S. Bankruptcy Court, Northern District of Alabama (Birmingham).

(Reporting by Tracy Rucinski; Editing by Bernard Orr)