Parliament's chief environmental watchdog says using the lignite from large underground deposits in Southland would be too environmentally damaging.
At least six billion tonnes of lignite lie just beneath the surface of Southland, and have as much stored energy as 70 Maui gas fields.
State-owned coal miner Solid Energy and energy company L&M Group want to extract the mineral to make products like diesel, fertiliser and solid fuel briquettes.
But Parliamentary Commissioner for the Environment Jan Wright says because lignite is poor quality coal, extracting energy from it creates high emissions of carbon dioxide.
Ms Wright says New Zealand has promised to reduce greenhouse gas emissions but has in fact increased them, and making diesel from lignite would widen the gap between promise and reality by 50%.
She says the resource should remain in the ground until the greenhouse gas problems associated with it are dealt with.
Solid Energy new energy manager Brett Gamble, says new technologies, which it will use, will offset high emitting plants offshore, and mining the resource cannot be easily dismissed.
He says the report is narrow in focus and a decision on the future of lignite needs to consider all the facts.
Green Party co-leader Russel Norman says a single plant turning lignite into diesel would add 7% to New Zealand's greenhouse gas emissions and taxpayers would have to pick up the bill to cover the carbon cost.
Chris Baker of mining lobby group Straterra says the world won't use less lignite if New Zealand decides not to mine the resource - it will simply get it from somewhere else.