TrustPower projects manager Jim Pearson said a hole about 1.5m wide developed in the Mahinerangi canal on Thursday night.
The project, which was commissioned earlier this year, diverts water from Deep Stream and puts it through a canal and penstocks, and two power stations, before the water is put into Lake Mahinerangi.
Lee Stream farmer Peter Doherty said a large quantity of muck and clay had come down Broad Stream and into Lee Stream, which looked like "brown porridge" on Friday and Saturday, and was still discoloured yesterday.
Several pools and fishing holes had filled with clay and silt, he said.
Mr Pearson did not know how much water had breached the canal, but the scheme had been shut down as soon as alarms alerted the power company to the problem, he said.
Repairs had been under way during the weekend and he expected the scheme would be running again today or tomorrow.
Schemes often had issues, such as engineering or mechanical problems, in their first few months of operation, he said.
"Once things bed in a bit, the problems really drop off. During the first couple of months, you have really got to keep an eye on things."
He did not know what had caused the hole in the earth canal, but suspected it might have been caused by erosion.
Dunedin City Council water production manager Gerard McCrombie said he was not aware of the issue, but it was unlikely the city's water supply would have been affected.
Water-level monitors at the Deep Stream intake and turbidity monitors had not shown any increases.
