Interiro Secretary James G. Watt suffered his first major policy setback yesterday, backing down on the politically explosive issue of oil drilling off the coast of northern California.

Watt announced that he was dropping, without a recommendation to President Reagan, an Interior Department study that could have led to oil-lease sales in four offshore tracts ranging north from San Francisco to Eureka.

Watt's move kills any possibility of lease sales in the area until at least 1983, and perhaps forever. It also could have some impact on his hopes to open up 1 billion acres of offshore waters to oil leasing over the next five years, although he steadfastly denied that.

Watt went to elaborate lengths to play do wn the impact beyond California and especially to diminish the role that politics and White House uneasiness played in the decision.

He said political considerations were not part of his decision and that he informed the White House of the decision only hours before announcing it. He also insisted repeatedly that the White House had not instructed him to take the action.

But Watt's eariler decision to even consider leases off northern California, a decision he made in one of his first acts after joining the Reagan Cabinet, caused a storm of protests from Republican and Democratic leaders in California, as well as environmentalists.

At one point the California Republican state chairman, Tirso del Junco, wrote Watt warning that the issue could cost the GOP control of both houses of the legislature as well as the California governorship in next year's elections.

White House aides ahve made it clear privately that they wanted the California oil-leasing controversy off their backs well before the elections.

The issue also was instrumental in beginning an all-out assault on Watt by environmental groups. At the height of the controversy the Sierra Club, a San Francisco-based environmental group, began a nation-wide petition drive demanding Watt's removal.

The environmental group, which says its petiton now has 700,000 signatures, interpreted yesterday's action as a significant retreat for Watt and "a total repudiation of $[his] antienvironmental policies." The Sierra Club called Watt "his own worst enemy" and contended that "he has lost, and lost big."

Watt said the decision meant no such thing, and denied that it had anything to do with the environment. He said he remained convinced that offshore drilling is "environmentally safe" both off northern California and in most other regions.

He said the decision was made solely because of the "chilling effect" of a federal judge's ruling in May that the Interior Department had not given proper weight to California's objections to 34 leases in the Santa Maria Basin just south of the four northern California tracts.

Watt expressed confidence that the ruling, based on a state's right to control development of its coastline under the Coastal Zone Management Act, would be overturned by higher courts.

But in the meantime, he contended, the value of future California leases would be reduced because of probable legal challenges, and the lawsuits would mean "long and costly court battles at taxpayer expense."

Watt denied that his decision would have a negative impact on bidding and leasing in tracts off other states because challenges then would go to a different federal judge "and we would win in another court." He also implied that the California ruling, by U.S. District Court Judge Mariana Pfaelzer, was tainted by local pressures that would not hold up in appellate courts.

The controversy over the northern California tracts became highly symbolic because of both timing and circumstances.

After years of furor in California, then-interior secretary Cecil D. Andrus removed the four tracts from the leasing schedule just days before the 1980 presidential election. Andrus said the amount of oil in the tracts, estimated by the U.S. Geological Survey to be less than a dozen days' national supply, was not worth the risk to the environment and California fishing grounds.

Because of a tightly imposed five-year schedule for bidding on offshore oil tracts, Watt had only weeks after taking office to make up his mind about whether to go along with Andrus' decision or reopen the controversy. He reopened it, set off alarm bells in California that finally reached inside the White House, and then closed it again yesterday.