The NSW Land and Environment Court has rejected Verdant Earth Technologies' appeal to establish a biomass power station near Warkworth.
The company was seeking to burn biomass at Redbank Power Station instead of coal to produce electricity and hydrogen production.
However, the court ruled that changing the fuel used at Redbank from coal to wood was not permissible under the existing approval.
It followed Singleton Council's deemed refusal of the project last June.
The latest decision is a significant setback for Verdant, which must now prepare a new development application and environmental impact assessment.
Verdant could not be contacted for comment.
Independent Upper House MP Justin Field called on the state government to ban biomass.
"This is a welcome decision by the court but the idea that our precious native forests could be logged for electricity needs to be knocked on the head by the NSW Government once and for all," he said.
"There needs to be a clear regulatory statement by the NSW Environment Minister James Griffin that native forests will not be allowed to be burnt for energy.
The Minister has that power and should exercise it so the community won't have to face a new development application by Verdant for what is an unacceptable and damaging proposal"
Nature Conservation Council chief executive Chris Gambian said while the court's judgement was welcome, the the project still posed a threat to native forests and wildlife.
"It takes decades to grow trees and centuries to grow forests but only seconds to burn them. This proposal will destroy forests and fast-track the extinction of forest species," he said.
"Biomass from native forest timber has no social license in NSW, and never will. The community campaign against this proposal will be relentless - we will not rest until this proposal is withdrawn."
