Blue green algae is flowing out of some household taps and forcing residents to drink bottled water.
High levels of blue green algae have been detected in Chichester Dam and residents north of the Dungog Water Treatment Plant - who receive untreated water from the Chichester Trunk Gravity Main, have been told not to drink the water.
In an email to affected customers sent on August 1, Hunter Water said raw water was not safe to consume and residents would be reimbursed for the cost of buying bottled water.
It also noted algae could remain in the Chichester and Wangat Rivers - and Chichester Dam, "for some months due to the hot and dry conditions".
A Hunter Water spokeswoman said 62 customers were affected and algae had been detected in the system since June.
"Drinking water from the Dungog Water Treatment plant remains safe. The Dungog Water Treatment Plant removes the algae and compounds produced by the algae," she said.
"While we have advised [the affected customers] on numerous occasions that this water is not safe for drinking, we are currently reimbursing them for the cost of bottled water until algae levels subside."
The spokeswoman said plans were afoot to provide an alternative drinking water source for the customers.
She said Hunter Water was working with the residents to find a solution and rainwater tanks and point of entry filtration systems were among the options being considered.
The region's water supply is fast becoming a casualty from the unrelenting drought.
Hunter Water confirmed on Friday that its total combined storage level had dropped to its lowest level in 21 years and was now sitting at 65.9 per cent.
Level one water restrictions are supposed to kick in at 60 per cent.
Modelling shows that will happen in mid September if significant rain does not fall in the catchment area.
"As the dry conditions persist, we need to do everything we can to preserve our supplies over the months ahead to ensure we start summer in a reasonable position," Hunter Water Chief Investment Officer Darren Cleary said.
Hunter Water is urging households and businesses to reduce their water usage.