The NSW government said it had approved the drilling by Santos of eight exploration coal seam gas wells in one of the biggest remaining temperate woodlands in eastern Australia, provided "strict" environmental conditions are met.
Santos won approval to drill two sets of four wells in the Pilliga Forest in north-west NSW in August with details only made public in recent days.
The company also secured approval for stage one of its water management project.
Environmental groups, such as the Wilderness Society, queried how the same arm of the government taking Santos to court on Friday over the spill in mid-2011 of waste water from the nearby Bibblewindi water treatment works could also give the nod for further drilling in the area.
A spokesperson for NSW Trade & Investment said the wells and water management project had been approved on August 16 "subject to strict environmental reporting and monitoring conditions".
"Before Santos can produce water from these wells they are required to lodge and have approved a produced water management plan," the spokesperson said.
The company will need approval to transfer water via flow lines to its Leewood facility outside the Pilliga Forest before the wells can start producing water, she said.
Naomi Hogan, a campaign manager for The Wilderness Society, said a longer-term plan was necessary since Santos' Leewood ponds now operate solely as evaporation sites.
"They have no clear plan for how they will handle the water when it gets to the ponds," Ms Hogan said, adding the water was often contaminated with heavy metals and salts. Any water management plan should be "on the public record" and be a "long-term scientifically researched outcome," which is not yet the case, she said.
A spokesman for Santos said the company would abide by the conditions set by the state government.
The aim is to begin drilling in the final quarter of 2013, assuming the company obtains state approval and also a separate nod from the incoming federal government under the existing environment rules, the spokesman said. "It is also worth pointing out that there has been extensive groundwater modelling done that shows the proposed exploration program will have no significant impact on the groundwater source in the region," a spokesman for Santos said.
The NSW Environmental Protection Authority, meanwhile, said it had yet to complete investigation of a possible leaking at the large pond at Bibblewindi earlier this year.