* State panel imposes tight conditions on project

* Canberra expected to approve Narrabri

* Santos to spend 12-18 months on appraisal drilling

MELBOURNE, Sept 30 (Reuters) - An Australian state on Wednesday approved a A$3.6 billion ($2.6 billion) gas project planned by Santos Ltd, clearing the biggest hurdle for a long-opposed development that the government says could help fill a supply gap expected from 2024.

The New South Wales Independent Planning Commission said it has imposed strict conditions on a "phased" approval of the Narrabri coal seam gas project, after thousands of critics raised fears it would drain and contaminate groundwater, damage the Pilliga State Forest and worsen climate change.

"Following its detailed deliberations, the Commission concludes the project is in the public interest and that any negative impacts can be effectively mitigated with strict conditions," the state commission said.

The Narrabri project, 520 km (320 miles) northwest of Sydney, could meet up to half of New South Wales' gas needs, helping to replace gas from the rapidly depleting Bass Strait fields that have supplied Australia's southeast for 50 years.

The Australian government has the final say on the project. It is expected to approve it as part of a strategy unveiled this month to boost gas supplies, drive down energy prices and fuel a recovery from the coronavirus pandemic.

"Approval of projects like Narrabri backs both our gas sector and all Australian gas users - creating jobs in New South Wales as we recover from COVID-19," Australian Energy Minister Angus Taylor said in a statement.

The country's environment minister, Sussan Ley, has 30 business days after receiving the state's report to reach a decision on the project.

Santos welcomed the approval nine years after acquiring the project and accepted all the imposed conditions.

It plans to spend 12 to 18 months on appraisal drilling after receiving all approvals, but did not say when it aimed to make a final investment decision (FID) on the project, on which it has already spent A$1.5 billion.

"We'd aim for an FID within basically a couple of years," Santos Chief Executive Kevin Gallagher told Reuters on Aug. 20.

The commission required Santos to provide more information on its groundwater modelling before allowing it to move from appraisal to construction.

Planning approval for a gas pipeline from the project would also have to be in place before Santos could start construction.

Pipeline operator APA Group said on Wednesday it plans to build a A$500 million pipeline to transport Narrabri gas across the state.

The Climate Council, which opposes the project, said Santos could still face financing and environmental hurdles due to growing opposition to fossil fuels.

"Approving this project and developing new gas is fundamentally at odds with protecting Australians from climate change," said the Climate Council's Will Steffen, a researcher at the Australian National University.

($1 = 1.4004 Australian dollars) (Reporting by Sonali Paul; Editing by Richard Pullin and Tom Hogue)