Underground longwall mining at Mount Kembla's Dendrobium coalmine will go ahead after the state government approved a scaled-back plan.
The subsidence management plan (SMP), which was accepted by the Department of Planning and Infrastructure last week, is designed to safeguard the region's water supply while expanding mining efforts.
BHP Billiton sought approval for the plan to mine 10 longwall panels in October last year, with a SMP required before mining could begin.
In making its decision, the department was satisfied the impacts of the operation would be negligible on the region's water supply, but imposed several conditions on the approval.
Mining will be allowed in the first five longwall panels only, with further approval required to mine the other five panels.
The company will also be required to submit a compensation package for possible swamp impacts and fund a $3.5 million research program to improve scientific understanding and industry practice in rehabilitating upland swamps affected by mining.
The plan is likely to result in damage to up to 12 endangered coastal upland swamps.
Northern Illawarra Sustainability Alliance co-convener Peter Turner said it was a disappointing outcome and a dark day for the catchment.
"There's no doubt there's going to be impacts," Mr Turner said.
"Those first five longwalls are quite critical."
Illawarra Coal, which operates the mine, said a rigorous environmental assessment had been incorporated in the plan.
President Troy McDonald said the company had been mining at Dendrobium without significant environmental impacts since 2001.
"Extensive monitoring and reporting to government shows no reduction in water catchment yield and no water transfer from Lake Cordeaux to existing underground workings," Mr McDonald said.
The plan also addressed specific actions to manage key environmental features, including Avon Dam and Wongawilli Creek.
"We have developed a mine plan which positions our longwall blocks well away from the full supply level of Avon Dam and several kilometres away from the dam wall.
"Illawarra Coal has led the industry with mine planning decisions which protect the region's unique environment, and recognises the value of the catchment area and its role in our region's water supply network.
Illawarra Coal has already completed mining across three areas in the Dendrobium complex, including mining near Lake Cordeaux, with negligible impacts on water supply.
The mine, which needed yesterday's approval to continue to operate, employs 400 workers and supports another 600 indirect jobs.
It plays a critical role in supplying premium coking coal to the Port Kembla and Whyalla steelworks.