* Opponents say oil could drive fish, tourists away
* Backers see new source of oil, gas off Lofoten islands
SVOLVAER, Norway, March 12 (Reuters) - Oil companies seeking new Arctic areas for exploration face a battle with environmentalists, fishermen and hotel owners over Norwegian islands where jagged snow-capped peaks rise sheer from the sea.
With oil production falling to a 25-year low this year and the state depending on oil revenues, Norway's ruling Labour Party is warming to drilling in Lofoten's pristine waters, setting up the issue as the year's biggest political fight ahead of elections in September.
"We've already got the winning lottery ticket by living in Norway. We shouldn't want to be even richer," said Erling Santi, a fisherman in Svolvaer, Lofoten's main town.
"Oil drilling could drive the fish away," said Santi who is also the managing director of Saga Fish, a cod packing plant.
Norway is one of the world's most prosperous nations with per capital GDP in excess of $100,000 but the fortunes of remote Lofoten, 1,000 kilometres (600 miles) north of Oslo, have been mixed. Unemployment remains above the national average and its young leave the area in search of jobs.
Lofoten has been off limits for exploration since Norway first struck oil in 1969, reflecting fears about nature in a scenic Arctic region that is a spawning ground for the world's richest cod stocks and home to sea eagles and puffins.
BP Plc's Gulf of Mexico spill in 2010, the worst offshore spill in U.S. history, may have added to scepticism.
After Prime Minister Jens Stoltenberg came down in favour of studying drilling last month, Norway's top three parties on left and right are now open to the idea, pitting them against smaller parties and many of Lofoten's own residents.
The fight will also be a test for how the industry and politics handle the move northward, with sights firmly set on the high Arctic, including the frozen Svalbard archipelago.
Backers say oil and gas finds are getting scarcer and that new technology means the risks of accidents are low enough to explore waters off Lofoten and the neighbouring Vesteraalen islands where cod has been king since Viking days.
"We need Lofoten but most of all, Lofoten needs the oil industry," said Knut Saeberg, chief financial officer (CFO) of North Energy, which is based in Alta higher in the Arctic. He said Lofoten needed jobs to counter a drift away.
Eivind Holst, the Conservative mayor of the Svolvaer region where the crest of arms depicts a large cod, said he was in principle in favour of oil and gas, partly as a source of jobs.
Lofoten's population has fallen to 24,000 people from above 30,000 in the early 20th century, with many moving to cities.
"There isn't necessarily a contradiction between running an industry and enjoying nature. It just has to be done carefully," he said. "Tourists don't come to Lofoten to see oil platforms in the midnight sun."
A ban on seismic surveys in the cod spawning season early each year and use of sub-sea installations were among measures that would protect fish stocks and tourism if the planned assessment gave a green light, he said.
A government report suggested that oil and gas in Lofoten could create 400 to 1,100 new jobs to the northwestern region. Hammerfest to the north has boomed as the landing area for gas from Statoil's Snoehvit field, he noted.
"The longer you wait, the fewer benefits you get," he said. "And there hasn't been an accident like the Gulf of Mexico here - knock on wood." He rapped his knuckles on a wooden table for good luck.
OIL OUTPUT HALVED
Oil output by Norway, the world's number seven exporter, fell to 1.5 million barrels per day in January and even a string of big finds, set to come online in the second half of the decade, will only halt the rate of decline.
"The industry needs access to new areas on a regular basis to sustain activities," said Einar Gjelsvik, chief executive of Noreco, an oil producer.
Lofoten could hold 8 percent of Norway's undiscovered oil and gas resources, the Norwegian Petroleum Directorate says.
It says that seismic tests have identified 50 prospects off Lofoten that could hold recoverable reserves or around 1.27 billion barrels of oil equivalent.
"We are developing new technology to reduce the risk," said Leif Borge, CFO of Aker Solutions. "Down the road, it's probably an important area."
Norway's worst oil spills were the Ekofisk Bravo blowout in the North Sea in 1977 that spilt 80,000 barrels and a spill of 27,500 barrels at the Statfjord field.
"You can never be relaxed about safety but you can see that Norway's controls are so much better than the Gulf of Mexico," said Geoff Turbott, CFO at Lundin Petroleum. "Opening the area is many years away and even from then, the first drilling is 3-4 years away."
An opinion poll by InFact in February showed that 49 percent of almost 1,100 people in Nordland county, which includes Lofoten, opposed oil and gas production off the islands with 34 percent in favour and others undecided.
It also showed that 44 percent favoured an environmental impact assessement with 43 percent opposed. Lofoten's people will be consulted but will not decide on oil and gas.
Lofoten has Arctic winter darkness that complicates drilling but the warm Gulf Stream current keeps it ice free. It is warmer than where the Exxon Valdez tanker ran aground off Alaska in 1989, even though it is further north.
Less chilly waters mean any oil would break down faster. "The problems for drilling here are the fish, the birds and the coastline," said Truls Gulowsen, head of Greenpeace Norway. "It's not typical of the Arctic."
The relative warmth makes Norway an exception for Arctic drilling - Shell has abandoned drilling off Alaska for this year after a string of setbacks in 2012.
Tourism operators fear that oil and gas could undermine business. "The oil can wait. We have had some big oil finds in recent years," said Ola Skjeseth, the biggest local hotel manager who runs 500 beds around Lofoten.
He said he was especially opposed to any oil or gas terminal on the islands, saying it would contradict publicly funded advertising campaigns that call Lofoten "the world's most beautiful coast" with white beaches and saw-tooth mountains.
And in winter, more tourists are starting to visit, hoping to see the northern lights, particles from the sun that can produce a show of green, pink and violet across the night sky.
Prime Minister Jens Stoltenberg's decision to favour an environmental impact study aligns Labour with the opposition right-wing Conservatives and the Progress Party. That makes a study likely after the September election, unless the balance of power falls to a small party opposed to drilling.
Mayor Holst said that a melt of Arctic sea ice caused by global warming was a bigger environmental threat than oil and gas because it raising risks of shipwrecks, including tankers, on a likely new route between the Pacific and the Atlantic.
That would be a turnaround for Lofoten, which has sometimes benefited from shipwrecks. Some old buildings in Svolvaer are built with timber washed from 19th century Russian wrecks - cold means trees don't grow big and thick enough on the islands. (Editing by William Hardy)