The Wanbseck St extension also includes a new harbour-side walking and cycling track in Oamaru.
The New Zealand Transport Agency is paying for 67%, or about $528,000, of the costs, and the extension is expected to be completed by early April.
The first phase of the contract is the 185m extension of Wansbeck St, drawing visitors from the historic Harbour-Tyne precinct to the harbour-side area.
The second phase is construction of the walking and cycling track, starting at the Humber St end and continuing through to the blue penguin colony.
Waitaki Mayor Alex Familton said it was "brilliant" to get government funding for the "exciting" project.
Deputy mayor and harbour subcommittee chairman Gary Kircher said the project had been many years in the planning.
"It's been a long road for a short road," he quipped.
The aim is to improve access and activity in the harbour area as part of a redevelopment plan proposed by the council.
The overall contract is being undertaken by Downer EDI, with Network Waitaki installing underground wiring.
Victorian-style lamp posts will also be installed - the first has already been put up as an example.
The council is working with the Oamaru Whitestone Civic Trust, New Zealand Historic Places Trust and has consulted the Department of Conservation to ensure blue penguins in the harbour area are not disrupted.
