The work being done is part of a $45.8 million Dunedin Centre and town hall upgrade, but it is not yet known how long the project will be delayed and if costs will increase accordingly.
The town hall redevelopment is being overseen by project manager Octa Associates Ltd, while Amalgamated Builders Ltd has the construction contract.
Octa director and town hall project manager David Booth said a contractor digging up the town hall basement struck an offensive-smelling material on Wednesday morning.
The site was then cordoned off as a safety precaution.
"Quite a repugnant smell was released and, as a precaution, we closed the site. It's like a strong paint fume. It's not something you want to inhale a lot of," Mr Booth said.
Delta Utility Services, the Otago Regional Council and the Department of Labour are investigating.
The town hall basement is being excavated to create facilities such as more toilets and to accommodate air-conditioning ventilation ducts.
Mr Booth said the smelly material would be removed once it had been properly identified and tested in a laboratory.
"We believe it's a by-product of the old coal gas fuel, where they made gas from coal that used to be reticulated around Dunedin. The by-product is like an early form of asphalt and it's become mixed with ground water." He hoped the testing would be completed in a few days and the basement could be isolated so that work could resume on other parts of the town hall.
Those removing the material might have to wear respirators, he said.
"We are taking all steps to keep people safe until we know what it [the material] is. I'm unaware what the cause and effect may be at this stage." A similar substance was once uncovered at an Invercargill construction site, he said.
Because the chemical slurry was within an existing building and not exposed at an open site, the fumes were a particular issue, he said.
But the 15 to 20 contractors were not likely to be off-site for long, he said.
"We're certainly not panicking and I don't see it as a show stopper. We've sealed the whole site as a precaution but hope to open up other areas quickly." Redevelopment of the town hall began last November after the Municipal Chambers upgrade and is expected to be completed early next year.
