Mr Iemma says long term projections show that supply for generating power capacity is fine till 2008, but could be under pressure by 2009.
He says he has decided to quarantine 40-billion-litres of water in a strategic reserve in case the worst happens.
Mr Iemma says the National Energy Ministers Meeting in Melbourne will be briefed on the plan today.
"There’s no immediate threat to power supplies – but we do need to take necessary steps to protect our future supplies," he said.
The water is being held in the Glenbawn dam in the Upper Hunter, and will be diverted to power stations if the drought continues.