April 13 (Bloomberg) -- Japan's government said it will allow oil and gas drilling in an area of the East China Sea claimed by China, a move that may worsen relations strained by anti-Japanese protests in Chinese cities.

The government today started procedures to grant drilling rights to Japanese companies in the area between the countries, the Ministry of Economy, Trade and Industry said in a statement in Tokyo. The government on April 1 said a field being developed by China's CNOOC Ltd. extends into Japanese territory.

China's demand for oil, gas and other natural resources has soared as its economy tripled in a decade to $1.6 trillion and Japan's stagnated. Rivalry over the fields may add to anti- Japanese sentiment since that country's government approved school textbooks that gloss over atrocities committed by Japanese troops in China before and during World War II.

``It is symptomatic of the emerging struggle between the two for dominance in East Asia overall, not just in energy,'' said Dane Chamorro, assistant country manager for China at global business risk consultant, Control Risks Group, in Shanghai. ``Japan is being eclipsed by China's greater economic and strategic clout -- energy is just one arena.''

More than 20,000 people turned out in Beijing, Guangzhou and Shenzhen to demonstrate against the textbooks, Japan's territorial claims and the country's bid for a permanent seat on the United Nations Security Council.

Smashing Windows

Protesters smashed windows at the Japanese Embassy and the ambassador's official residence in Beijing and rallied outside Japanese-owned department stores in the southern cities.

Japanese Prime Minister Junichiro Koizumi demanded that China ensure the safety of Japanese citizens in the country and protect property. Japan's Foreign Minister Nobutaka Machimura will travel to China on April 17 to discuss the protests.

Koizumi today said Japan's decision to allow drilling in the disputed area, which lies in the sea between Shanghai in China and the southern Japanese island of Okinawa, isn't in response to the anti-Japanese demonstrations. The decision won't hurt ties, Chief Cabinet Secretary Hiroyuki Hosoda said.

``We have been considering explorations for a while and have been in contact with China,'' Hosoda, the government's top spokesman, said at a regular press conference in Tokyo. ``We want China to provide details of its exploration and to halt development.''

Hiro Katsumata, a post-doctoral fellow at the Institute of Defence and Strategic Studies in Singapore, said the timing of the drilling announcement ``couldn't be any worse'' for relations between China and Japan. ``You'll see a negative cycle starting -- Japanese businesses in China will be affected.''

Winning Trust

China's government may oppose Japan's bid for a permanent seat on an expanded UN Security Council. China is a member of the Security Council and can block Japan's bid.

Japan must win the trust of other Asian nations, Chinese Premier Wen Jiabao said, according to the state news agency Xinhua, at the end of a state visit to India.

Japan also angered China by joining with the U.S. in designating Taiwan as a ``security concern'' within their defense umbrella. China claims sovereignty over Taiwan, which is regarded by the Chinese government as a renegade province.

``All of these issues together are going to increase tensions,'' said Stuart Witchell, Japan representative at International Risk Ltd., which provides political risk assessments to companies. ``A lot of big Japanese companies are now coming to us for risk assessments and are reviewing their crisis management plans.''

Japanese Companies

Japanese companies invested $5.45 billion in China last year, placing them behind those from Hong Kong, South Korea and the Virgin Islands. U.S. companies invested $3.9 billion.

Japan's combined trade with China and Hong Kong exceeded that of the U.S. in 2004 for the first time, the Japanese Ministry of Finance said on Jan. 26, underscoring their increasing importance as a market for the country's goods.

CNOOC, China's largest offshore oil producer, expects to produce as much as 1 billion cubic meters of natural gas a year from the disputed Chunxiao field in the East China Sea, CNOOC's Chairman Fu Chengyu said on March 29.

Royal Dutch/Shell Group and Unocal Corp. in September last year withdrew from the Chinese-led project, which extends over about 22,000 square kilometers. The gas field itself covers 1,225 square kilometers and lies in the 59,000 square-kilometer Xihu Trough area.

Fields

Japan's government on April 1 said the Chunxiao and Duangqiao fields extend over the border into Japan's exclusive economic zone.

``There is clearly some commercial and strategic value in that area,'' said Gavin Thompson, a Beijing-based energy consultant for Asia at Wood Mackenzie Consultants Ltd. ``If Japan explores this area and it proves high levels of hydrocarbons, then the Chinese are going to be furious.''

Japanese explorers Teikoku Oil Co., the largest producer of natural gas from fields in Japan, and Japan Petroleum Exploration Co., the nation's second-largest oil driller, applied for permission to develop the gas fields three decades ago.

Explorers may need to wait another ``two to three months,'' Hirofumi Katase, director of the petroleum and natural gas resource division in the trade ministry told reporters today. ``If major changes happen in the current circumstance, we may consider adjusting our decision,'' he said, when asked about a possible reaction from China.

Japan Petroleum Exploration, known as Japex, welcomed the move, Koichi Shimomura, a spokesman at the company said.

Coordinating Security

Japan's government will coordinate with the Japan Coastal Guard and the Defense Agency to ensure security for the companies involved, should drilling start, Katase said.

The escalating dispute between Japan and China may impede talks between 13 Asian nations, which consume almost a third of the world's oil, about linking to enhance the security of their energy supplies through measures including a joint emergency oil reserve. China and Japan are Asia's biggest oil consumers.

``Since Asian countries import oil from the Middle East, it is essential that Japan and China solve this dispute calmly as soon as possible,'' Nippon Oil Corp. President Fumiaki Watari told reporters today in Tokyo, at the monthly meeting of the Petroleum Association of Japan, of which he is chairman.

To contact the reporters on this story: Megumi Yamanaka in Tokyo at myamanaka@bloomberg.net; Sri Jegarajah in Singapore at sjegarajah@bloomberg.net.

Last Updated: April 13, 2005 07:21 EDT