The fire was sparked by a large explosion at the Derrimut factory in the city's west on Wednesday morning.
Chemical drums were sent flying into the air at the height of the blaze, making the emergency response more dangerous for firefighters.
No one was injured and it was declared under control in about four hours, but the fire is expected to burn for days.
Toxic smoke from the huge blaze is still causing concern in the Derrimut area, west of Melbourne. (James Ross/AAP PHOTOS)
Locals have been told to avoid coming into contact with water in Cherry Creek, Anderson's Swamp and Kayes Drain after pollutants from firewater entered the downstream waterways.
Signage and warnings will be erected around affected areas as the focus shifts to water safety, Victoria Environmental Protection Agency's Steve Lansdell said.
"There will certainly be testing waterways and understanding what's going on," Mr Lansdell told ABC Radio Melbourne.
"We know what's been coming out of the firewater will have contaminants, so it's really important to avoid contact."
The EPA has not observed any ash impacts from the fire but urged people to wash down impacted surfaces and any fruit and vegetables before eating them.
Fire Rescue Victoria deputy commissioner Michelle Cowling said it was the most significant blaze in Melbourne in recent years and required an aggressive attack.
The nearby Western Freeway was shut for several hours and thousands of residents were urged to stay indoors because of health risks.
Industrial Fire - Advice for Swann Dr, Derrimut. You should Stay Informed. For more info: — Fire Rescue Victoria (@FireRescueVic) https://t.co/5kUvb1qvdX #vicfiresJuly 10, 2024
One worker died and two were injured in a fire at the same building in October 2023, which was also sparked by an explosion.
Ms Cowling said the was no connection between that incident and the fire on Wednesday but the cause was still under investigation.
The EPA issued the site with two notices and inspected the place nine times and found them compliant.
"We're really tough on environmental crime and and hold polluters to account, and we'll be working really closely with WorkSafe and other regulators, given that there were still investigations going into the previous incident," Mr Lansdell said.
The factory houses multiple businesses including chemical blenders and fuel distribution, with drums containing kerosene, fuel, methylated spirits, methanol and other substances stored at the site.
Aggressive firefighting tactics were used to contain the fire which is expected to burn for days. (James Ross/AAP PHOTOS)
University of Melbourne chemical engineering academic Gabriel Da Silva said all smoke was toxic and chemicals from the factory were likely destroyed in the blaze.
He said the biggest concern was the large amount of smoke in the area.
"The risk from the chemicals here has been largely providing that fire to happen, as opposed to people being exposed to compounds that are being released," the associate professor told AAP.
"Although there may be, particularly with water escaping from the site, some of these harmful compounds being carried away."
The air quality scientist said in the short term, he was most concerned about those with asthma as locals were still at risk while the fire burns.
Independent MP Moira Deeming and Legalise Cannabis MP David Ettershank questioned the management and storage of toxic chemicals in Melbourne's west.
"The west is traditionally a dumping ground for noxious storage and industries and I don't believe there is enough regard for the safety of residents in this setting," Mr Ettershank said.
