Hume Coal's bid to drill 90 exploration boreholes as part of its Sutton Forest coalmine has been rejected on the basis it "is likely to have a significant cumulative impact on the environment".
In its determination, the Department of Resources and Energy told the company it must submit an environmental impact statement if it wanted to proceed, or amend the application.
Southern Highlands Coal Action Group convener Peter Martin said the decision was great news for landholders.
"What Hume was proposing promised to disrupt landowners' activities for a lengthy period of time, let alone increase the risk to the vital groundwater on which we all depend," he said.
"A full-blown EIS is a very big undertaking and Hume will have to address all the environmental issues, including the aquifer, very thoroughly."
However, Hume Coal project director Greig Duncan said the decision would not affect current studies on the proposed mine.
"The current ... proposal was designed to provide certainty for the community by including the balance of our planned exploration activities together in a single approval document," he said. "The assessment report accompanying this decision concludes there are unlikely to be significant impacts on land, flora, fauna or water as a result of the proposed drilling.
"Despite this we have been asked to conduct a more detailed environmental assessment or amend our original application."