Instead, the water authority says it will spend $380million on a new process to treat sewage to a more environmentally friendly class A while continuing to use the existing inshore outfall.

Clean Ocean Foundation sees the announcement as being "light at the end of the pipe", but cautions that "this does not mean that the outfall will be closed in the foreseeable future".

Lesser-treated class C sewage from the Mt Martha treatment plant will continue to be added to the discharge at Gunnamatta.

Clean Ocean chief executive Anton Vigenser said Melbourne Water's latest plan was an admission of 34 years of EPA licence guideline breaches, "causing ecosystem degradation and public health risk at Gunnamatta".

Melbourne Water says new technology will enable it to bring sewage to class A by the end of 2012 and save $400million by not being required to build the outfall extension.

The pounding seas of Bass Strait and physical difficulties of building a tunnel for the outfall pipe were major incentives for Melbourne Water to find another solution to its environmental problems without closing Gunnamatta.

Melbourne Water's general manager of asset planning Paul Pretto said a year of high-tech trials at the sewage treatment plant near Carrum had "culminated in a new understanding of how the 34-year-old facility could be upgraded to virtually eliminate impacts of treated effluent discharged into Bass Strait, near Gunnamatta".

Dr Pretto said Melbourne Water had asked EPA Victoria to approve an upgrade that focused "exclusively on advanced sewage treatment to improve the marine environment instead of also relying on a two-kilometre extension to an underwater outfall".

Although the State Government has ruled out piping the class A water to industries in the Latrobe Valley, Dr Pretto said Melbourne Water was hoping to find other markets for it and reduce flows to Gunnamatta.

Mr Vigenser said adding purified recycled water from the Eastern Treatment Plant to domestic supplies would have been a cheaper option than building a desalination plant near Wonthaggi and the north-south pipeline from northern Victoria.

"Thankfully, Melbourne Water is future-proofing the upgrade so the option to create purified recycled, drinkable water can be easily plugged into the system at a later date.

"The upgrade to purified recycled water for Melbourne should have came before desalination plant at a lower cost to the environment and society.

"The upgrade to class A is fantastic, but a lost opportunity for Victoria to become truly water sustainable."