UPDATE 2-NYC's Bloomberg opposes gas drilling in watershed

(Adds Albany protests)

* New York mayor lends political heft to drilling opponents

* Dueling protesters argue for, against the industry

By Edith Honan

ALBANY, N.Y., Jan 25 (Reuters) - New York City Mayor Michael Bloomberg issued his most forceful statements to date opposing natural gas drilling in the city's upstate watershed on Monday, in a boost for anti-drilling protesters amid competing rallies in the state capital.

Bloomberg's Department of Environmental Protection previously urged the state to ban shale gas drilling in the city's watershed. But Bloomberg had yet to add his personal political heft to the debate, relying on aides instead.

"The consequences are so severe that it is not a risk that I think we should run. I do not think that we should allow fractured drilling anywhere near our water supply," Bloomberg told reporters.

Natural gas companies have created a drilling boom in Pennsylvania with a technique known as hydraulic fracturing and want to expand their operations into New York state.

The Marcellus Shale formation underlying both states holds the promise of providing the United States with a valuable domestic energy source. But environmental concerns that drilling contaminates drinking water have created regulatory risk for the industry.

The city on Monday sought a permit from the state to acquire additional land to protect its watershed, an unfiltered source of drinking water for some 9 million people. The city watershed accounts for 6 percent of the shale area in New York state.

New York Governor David Paterson, facing a $7.4 billion deficit, proposed opening the Marcellus Shale to hydraulic fracturing, in which a combination of chemicals, sand and water are blasted through rock to free trapped gas.

The natural gas industry argues that drilling poses no risk to drinking water. But opponents say toxic fracking chemicals are contaminating drinking water, citing numerous reports of private wells near gas installations where water is discolored, foul-tasting or even flammable.

INDUSTRY VS. ENVIRONMENTALISTS

Bloomberg's comments came as more than 1,000 people attended dueling rallies on either side of the Capitol building.

Holding up signs that read "It's Safe, It's Green, It's Our Future" and "Drill Baby Drill," some 700 landowners stood in the pouring rain to make the case that gas drilling would create jobs and bring revenue to economically depressed parts of the state.

The rally, organized by industry group Independent Oil and Gas Association of New York State, did not address drilling in the watershed.

"We're the ones who own the land, we have to live on it, and we want to be able to use it for what we originally bought it for," said Drew Griffin, a member of the pro-drilling Joint Landowners Coalition. "This is America's fuel, it's America's future."

At a competing rally organized by environmental groups, about 600 people -- many of whom arrived by bus from New York City -- said the industry was putting profits ahead of safety and waved signs reading "You Can't Drink Money" and "Water: Our Best Resource."

"We can't let the gleam of potential profits leave us with a legacy of polluted water and industrialized landscapes," said Wes Gillingham, program director of Catskill Mountainkeeper.

The city and the U.S. Environmental Protection Agency have called on the state to exempt the watershed from drilling, even as Chesapeake Energy (CHK.N), the only gas company that holds leases in the watersheds, has said publicly it does not intend to drill there. (Additional reporting by Elizabeth Flood Morrow and Joan Gralla; Writing by Daniel Trotta; Editing by Dan Grebler)