Centennial Coal is assessing the feasibility of turning Newstan Colliery at Fassifern into a pumped hydro storage site that could supply 600 megawatts of renewables to the grid.
The 125-year old mine has been on "care and maintenance" since 2014.
The site's existing grid connection, proximity to major transmission lines and water sources would reduce the cost of transforming the facility for pumped hydro.
The federal government is providing $995,000 through the Australian Renewable Energy Agency, and the state government is investing $4.1 million through the Emerging Energy Program to support the $13 million trial.
Modelling suggests the project could create up to 1,000 jobs during the construction phase, as well as ongoing employment opportunities.
If the trial is successful, it could lead to the repurposing of other retired mining sites.
"Pumped hydro is not only a great source of cheap, reliable electricity, it is a huge creator of construction jobs and investment for host communities and the broader economy," NSW Environment Minister Matt Kean said.
"This project could change the way we rehabilitate retired mine sites - breathing new life into existing infrastructure links and supporting existing workforces and local economies to continue their contribution to our energy mix."
Centennial Coal's head of external relations, Katie Brassil, said the project was an important and tangible step in the evolution of the company's business from one solely based on coal, to a diversified energy company.
"This project will explore the potential to utilise our existing assets of land, geographic proximity to infrastructure, gas and underground mining voids to provide energy storage and dispatchable generation in the future," she said.
Federal Minister for Energy and Emissions Reduction Angus Taylor said the trial would help determine if end-of-life mines could be repurposed.
"The government is focused on getting the best energy outcomes for Australian households and this requires new dispatchable sources of generation like gas and pumped hydro to complement intermittent renewables," Mr Taylor said.
"This study will give us a better understanding of the commercial advantages that underground pumped hydro energy storage provides.
"By repurposing old sites and taking advantage of the features at those facilities, we can bring more clean energy projects online that bring down emissions and deliver the secure and reliable power Australians need."
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