Prime Minister John Key expects a nitrogen cap the Board of Inquiry introduced for the Ruataniwha irrigation scheme in Hawke's Bay to be challenged in court.
The Board of Inquiry is yet to release its final report but in a draft decision introduced a stricter than anticipated nitrogen leaching limit for the Tukituki River.
Mr Key said on Tuesday he did not want to say too much at this stage but he understood the proposed nitrogen limits were causing problems.
"Look I've seen the intital findings and what I'd say is that we're at a sort of delicate time if you like because the Board of Inquiry have made their decision.
''Whether that means the dam is actually viable or not will depend, I think, on where this now goes, because as you'll be aware, a number of the agreed partners at the current levels of nitrate, levels set by the Board of Inquiry, have essentially withdrawn their support.
''The reason I'm reluctant to make too many comments is I think it's highly likely it will be challenged in the courts," Mr Key said.
However, Trustpower, the main investor in the Ruataniwha scheme, withdrew before to the board's draft report was published and before the nitrogen leaching limit was known.
Trustpower said the financial risks associated with the irrigation scheme were too high and the financial returns too low.
Hawke's Bay Regional Council chairman Fenton Wilson said the council is still waiting for the board's final report to be released, and that it's too early to say, whether there would be a legal challenge.
The final report is due on 28 June.
Meanwhile, an irrigation industry group warns that farming in New Zealand could be devastated if the stricter nitrogen water quality limits the Board of Inquiry set in Hawke's Bay are rolled-out nationwide.
Irrigation New Zealand is alarmed that the board's nitrogen cap of 0.8 milligrams of dissolved nitrogen per litre of water for the Tukituki River - could set a precedent.
The organisation has comissioned a map that shows that on a lot of plains, where agriculture is intensive, nitrogen leaching is already at or above this limit.
Irrigation New Zealand chief executive Andrew Curtis said the economy could be paralised if farmers have to claw back to this new limit.
"Hey look, if we do decide that if we want that (0.8mg/litre) as a number which would scare me because I don't think it is the right number,'' he said.
''But if we do decide for whatever reason that is the number yeah we need to have some realistic programmes in place to get there because we're a long way from it in some areas."
However, Massey University senior lecturer in fresh water ecology Dr Mike Joy said the claims are bordering on blackmail.
"What Andrew Curtis is saying is that New Zealand, it's almost to the point of blackmail, where he's saying 'if we have to proctect our rivers, if we have to stop stop polluting the rivers then we're going to go broke'.
''In other words, you are subsidising, all New Zealanders by allowing their rivers to be polluted are subsidising dairy the way we're doing it at the moment .... and the way Irrigation New Zealand would like to have us to do more of"
Dr Joy said the 0.8 level floated by the board is double the previous nitrogen leaching guidelines for agriculture - although he said those ANZAC guidelines of .44mg/l were ignored.
"So what we're talking about here is allowing twice that level, going up to 0.8mg/l, which I think is very generous for farming, allowing farmers to pollute rivers to levels that are going to do that kind of harm."
However, Mr Curtis said he's not against reducing nitrogen leaching but believes there must be ample time for farmers and communities to adjust.
"We're not saying not bring nitrogen down, what we're saying is put some realistic timeframes in place around these things.
''I mean if you start looking at that Board of Inquiry thing it was talking about that limit and 2018 is when things started kicking in, it's totally unrealistic.
''If you're going to set really tough limits like that, which basically just about protects everything, from my read of the science anyway, then you're going to have some really realistic timeframes around when you're going to get there," said Mr Curtis.