(Adds Nasrallah quote in paragraphs 14-15)

By Khaled Yacoub Oweis

DAMASCUS, Aug 14 (Reuters) - Syria and Lebanon agreed on Thursday to resume work towards formally demarcating their border but Damascus said the boundaries of the disputed Shebaa Farms would not be drawn until Israel withdrew from them.

Demarcation of the border between Syria and Lebanon would be a major step towards meeting international demands on Damascus to formalise ties with its smaller neighbour.

Lebanese President Michel Suleiman and his Syrian counterpart Bashar al-Assad also agreed at a two-day summit to establish diplomatic relations at ambassadorial level, a move that underlined a thaw in ties between the two neighbours.

Opening diplomatic ties was another step which countries including France and the United States had demanded of Syria, which dominated its neighbour until 2005 when the assassination of former Lebanese Prime Minister Rafik al-Hariri forced it to withdraw its troops from Lebanon.

"The two presidents agreed on ... the resumption of the work of the joint committee to define and draw the Syrian-Lebanese borders," said a joint statement read at the end of the summit.

Asked whether that includes the Shebaa Farms, Syrian Foreign Minister Walid al-Moualem said: "The definition of the Shebaa Farms cannot happen under occupation." The Lebanese Shi'ite group Hezbollah, which is backed by Syria and Iran, cites the occupation of the Shebaa Farms by Israel as one reason for keeping its weapons.

Israel considers Shebaa Farms part of the Golan Heights, Syrian territory which it has occupied since 1967. Syria and Lebanon say the land is part of south Lebanon, from which Israel withdrew in 2000.

The United Nations declared Israel's withdrawal from south Lebanon complete. A 2006 U.N. Security Council resolution urged Syria to demarcate its borders, especially in areas where they are uncertain.

Officials did not say how long the process would take. Lebanese Foreign Minister Fawzi Salloukh, speaking alongside Moualem, noted that the border committee had been established in the 1940s.

Demarcating borders has also been a demand of Lebanese leaders who accuse Damascus of being behind the Hariri killing and have tried to curb Syrian influence in Lebanon since his death. Syria has denied involvement.

Saad al-Hariri, Rafik al-Hariri's son and political heir, welcomed the establishment of diplomatic ties, describing it as an accomplishment for Lebanese who had worked to shake off Syrian tutelage.

"We cannot forget that this is a great result of the independence movement," the Saudi-backed Sunni politician said in a statement.

Hezbollah leader Sayyed Hassan Nasrallah said the visit laid "the ground for a new period and indicates a qualitative development in ties between Lebanon and Syria".

"We hope that nobody obstructs these efforts or complicates them," he said in a televised address.

The two presidents also pledged to step up the efforts of a Lebanese-Syrian committee trying to discover what became of Lebanese who went missing in the 1975-90 civil war and who, their relatives say, were taken to Syria.

Suleiman's election was part of a Qatari-mediated deal that ended 18 months of bitter political conflict between Hariri and his allies and an alliance led by Hezbollah.

Suleiman, who was army chief before his election, has good ties to Damascus. (Additional reporting by Beirut bureau; Writing by Tom Perry, editing by Tim Pearce)

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