Emergency services were called to Tungatinah Power Station at Tarraleah, in Tasmania's central highlands region, before 9pm on Wednesday.
The 142.2 megawatt above-ground hydroelectric power station is one of 11 across the state and the second to be built at Tarraleah.
It took 25 emergency crews and 45 personnel hours to bring the blaze under control.
"The fire is currently contained but the damage is significant," Premier Jeremy Rockliff told reporters on Thursday morning.
"Hundreds of households in the region are without power and work is under way to restore power to that area.
"This could take some time and I thank everyone for their patience."
The power outages are impacting about 300 customers in the areas of Bonnie Lake, Tarraleah and Dee Lagoon, authorities said.
Tasmania Fire Service deputy chief Matt Lowe said the building was in the early stages of collapse when fire crews arrived 27 minutes after the initial triple zero call.
"Due to significant amount of electrical infrastructure there, we will not commit crews to any building where we can't confirm that the power has been disconnected, so we had to wait until we had advice on that," he said.
"And then, due to the collapse (of part of the building), it wasn't safe for crews to enter."
Mr Lowe described the response time in the sparsely populated area as "excellent" and suggested it was too early to indicate the fire's cause.
"Our fire scene examiner is on the way up there at the moment and he will work together with detectives and with police forensics to determine the cause," he said.
There was no one at the power station when the fire broke out, Hydro Tasmania chief executive Rachel Watson said.
"These stations are remotely operated," Ms Watson said.
"And while people obviously come and go to do maintenance, they do run independently of having people there 24/7."
The damaged station supplies about five per cent of Tasmania's power but Ms Watson said the power network was secure.
"At its full capacity it's a bit over 140-megawatt power station, so kind of mid-size power station in our portfolio of 30 power stations," she said.
"We are very confident that we have sufficient generation capacity in the rest of our fleet to keep the power system in Tasmania secure."
Tamar Valley Power Station, which runs on gas, will be brought back online before the end of the week to replace the lost capacity.
No extra energy has been imported into Tasmania via Basslink to make up for the shortfall, TasNetworks' Renee Anderson said.
"We don't anticipate ... any long-term issues for the network security or the (reliability) of the power to those communities around Tasmania," she said.
Tasmania Police deputy commissioner Jonathan Higgins urged the public to stay away from the area, with the Lyell Highway closed between Victoria Valley Hill Road and Fourteen Mile Road.
"It is anticipated the road will be closed for around 24 hours," he said.
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