The Scottish government has given the all clear for the project at Glenmuckloch near Kirkconnel.
It will require hundreds of workers during the construction phase and create up to 15 permanent jobs in the longer term.
Dumfries and Galloway Council gave its backing to the Pumped Storage Hydro (PSH) project earlier this year.
PSH works by releasing water from a higher waterbody to a lower one and passing it through a turbine or series of turbines to generate electricity.
Water is then pumped back up the hill and stored in the upper reservoir until further electricity is required.
Economy Secretary Keith Brown said: "The Scottish government believes there is a huge opportunity around PSH.
"This tried and tested technology can support peak demand and effectively store greater levels of electricity at times when renewable energy output is high but demand is low."
The scheme - led by Buccleuch Estates and 2020 Renewables - has an operational capacity of up to 400MW.
Developers have said the Â£150m scheme could generate power for more than a century but will need "major financial investment" from other partners to proceed.
The construction phase is expected to last about six years and is part of wider renewable energy park plans on the site.
Scottish Renewables policy manager Hannah Smith said: "The Glenmuckloch development is a perfect example of how green energy projects can make use of the infrastructure of the past and rejuvenate the local economy. PSH allows excess energy generated throughout the day to be stored and used when it's needed. It is vital that the UK government works to recognise the potential of this technology if we are to realise these benefits across the country."
Alan Baker, managing director of 2020 Renewables, said:  "Pumped storage brings considerable benefits to the country's energy system. Major pumped storage schemes already exist in Scotland - for example at Foyers and Cruachan - but no new projects have been built in over 30 years. The challenge is in finding the package of support measures which will unlock private investment in the project."
John Glen, chief executive officer of Buccleuch, said: "For five years we have been working closely with the local community and Hargreaves Surface Mining to restore and transform the site. Our vision is to create an energy park that will support local jobs and deliver major new investment in Dumfries and Galloway, and that has taken a step forward today."
MP for Dumfriesshire, Clydesdale and Tweeddale David Mundell said:  "This is a very welcome announcement for the communities of Upper Nithsdale where I am always pushing for investment to help boost the local economy. Buccleuch and 2020's plans for a major development will help sustain jobs in the region and I am very excited to see how the project progresses."
Dumfries and Galloway Councillor Colin Smyth said:  "As part of our commitment to build the local economy, our council has identified Upper Nithsdale as a key regeneration area where we want to encourage investment that will create jobs.  This development does just that by offering exciting job opportunities, which is so important for Upper Nithsdale. It also delivers a sustainable and environmentally friendly energy solution so it's a win-win situation for the area."
A hydro energy scheme at an opencast coal mine site in southern Scotland has been approved.