* Australia cites national security concerns over documents
* Dispute could affect division of $40 bln Pacific gas field
* Australia already embroiled in spying row with Indonesia
By Thomas Escritt
AMSTERDAM, Jan 21 (Reuters) - Australia rejected on Tuesday East Timor's demand that it return seized documents, arguing they may threaten its national security in a case relating to their negotiations over oil and gas reserves worth tens of billions of dollars.
Lawyers made the claim on the second day of hearings at the International Court of Justice (ICJ) in The Hague in a complex legal case pitting Australia against its tiny, newly independent southeast Asian neighbour East Timor, also known as Timor Leste.
East Timor wants the ICJ to order the return of the confidential documents, confiscated in a raid last month by Australia's domestic spy agency on the Canberra office of a lawyer representing the country.
Timor says the documents show Australia spied on it to gain the upper hand in talks about the large energy deposits that could transform the impoverished country's economic fortunes.
"The materials of which Timor Leste asserts privilege may include written statements ... by a former (Australian intelligence) officer made to Timor Leste disclosing national security information," Australian lawyer Justin Gleeson said.
"Timor Leste seeks to prevent Australia from taking steps properly available to us under our domestic law to protect ourselves from a threat to security apparently posed by a disaffected former officer," he told the ICJ judges.
Gleeson added that East Timor had no legal right to expect that its official documents should be dealt with in a privileged fashion when they were on the territory of another state.
The case is part of a wider dispute involving spy agencies, bugging claims and potentially huge rewards from developing the maritime Greater Sunrise oil and gas fields between Australia and East Timor, which won independence from Indonesia in 2002.
The fields, which lie partly in waters jointly managed by East Timor and Australia, contain an estimated 5.13 trillion cubic feet of gas that analysts say is worth $40-50 billion, or nearly 40 times East Timor's annual economic output.
East Timor's allegations come at a sensitive time for Australia, which is already embroiled in a dispute with Indonesia, a major trading partner with a population of 240 million people, over claims that it tapped the phones of top Indonesian officials.
Australia and East Timor disagree over revenue-sharing as well as how best to develop the reserves located 150 km (90 miles) southeast of East Timor and 450 km (280 miles) northwest of Darwin, Australia.
The lawyers representing Australia at the ICJ said they had no knowledge of the content of the seized documents but insisted they could not be used to underpin or inform Canberra's negotiations with East Timor.
The documents are believed to contain details of East Timor's negotiating strategy in a pending arbitration suit under the 2002 Timor Sea Treaty between the two countries.
East Timor brought the arbitration case to The Hague over allegations the Australian Secret Intelligence Service (ASIS) bugged East Timorese government offices in the capital, Dili.
Australia's Woodside Petroleum is contracted to develop the Sunrise LNG plant but is stuck in the middle of the political dispute.
While Woodside prefers a floating LNG plant, East Timor is pushing for an onshore plant that will provide jobs for locals, leaving the project at a stalemate.