The NSW government has announced a ban on all coal seam gas activity within two kilometres of residential areas and industry clusters across the state.
The decision was endorsed by state cabinet on Monday night.
The state government has also announced that chief scientist and engineer Mary O'Kane will review all coal seam gas activity in NSW and report on any risks by July.
It comes after energy company AGL suspended plans to expand its southwestern coal seam gas project due to increasing community anger.
The ban will apply to any coal seam gas proposal that has yet to be approved under the Environment Protection and Assessment Act or the Petroleum (Onshore) Act and the decision in effect ends AGL's plans.
Premier Barry O'Farrell said suburbs, country towns and other urban areas would become "no-go zones for CSG activities".
He said Ms O'Kane would also consider how to manage the impact of coal seam gas activity on residential properties in non-urban areas.
A new Office of Coal Seam Gas Regulation would also be established, the government said.
The government is expected to announce details of the decision, which includes a buffer zone around critical infrastructure clusters, later on Tuesday.
Community environment group Lock The Gate Alliance has welcomed the news, but says more reforms are needed.
Lock The Gate Alliance president Drew Hutton said the announcement would not quell public concern.
He said it would not prevent mining in residential areas with a concentrated population of less than 1000, rural residential areas or areas with vulnerable underground water systems.
"The O'Farrell government must accept the community's strong desire to have this challenge addressed with fundamental changes to the regulation of mining, not just piecemeal measures," Mr Hutton said in a statement.
Mr Hutton said the government should go further by banning all coal and coal seam gas exploration while Ms O'Kane undertakes her review.
The NSW Greens said the ban was a good start but questioned why agricultural land and rural residents had been passed over.
"It's just commonsense that you don't turn residential areas into gas fields, but the same protection should be implemented for our water catchments, aquifers and farm land," Greens mining spokesman Jeremy Buckingham said.
He said CSG activity should not be taking place in sensitive environments like the Sydney water catchment, the Northern Rivers, Gloucester Valley, Pilliga Forest, Southern Highlands and the Great Artesian Basin aquifer.
Australian Greens leader Christine Milne congratulated anti-CSG activists for standing up against the mining industry but said the ban was "too little too late" and designed to curry political favour in Sydney's west while failing to protect farmers.
"Barry O'Farrell is using coal seam gas as a political football to facilitate votes for Tony Abbott in Western Sydney," she said in a statement on Tuesday.
"He's not concerned at all about agricultural land, water or the environment."
Meanwhile, gas and electricity retailer AGL says the decision to ban coal seam gas mining in residential areas will add to the gas supply crisis in NSW and could cause gas and electricity prices to rise.
"The absence of multiple new sources of supply in NSW will add to substantial upward pressure on gas and electricity prices in the state," it said.
AGL said it has already relinquished prime agricultural land in the Hunter in response to community concerns about CSG activity.
The company is seeking an urgent meeting Premier Barry O'Farrell to get more details about the proposals.
"Natural gas production from coal seams in NSW remains a low impact and low risk industry," AGL said in a statement.
"Natural gas from coal seams can be safely produced without harm to the environment or human health and can comfortably coexist with other land uses."
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