Environmentalists and rights groups warn the project will dramatically decrease water levels downstream all the way to Lake Turkana
The Gibe III dam, which reaches 243 metres (800 feet) in height, is the third-largest dam in Africa and the biggest in a series built along the Omo River.
When it comes fully online, the Gibe III is expected to produce 1,870 megawatts of power, enough to sell energy abroad including to neighbouring Kenya. The dam has been generating electricity for about a year.
"This hydroelectricity plant, with other ongoing projects, fulfils our domestic power needs and will be provided for foreign markets," Ethiopia's Prime Minister Hailemariam Desalegn said in a speech inaugurating the dam.
But environmentalists and rights groups warn the project will dramatically decrease water levels downstream all the way to Kenya's Lake Turkana, which derives 80 percent of its resources from the river.
The lives of hundreds of thousands of people who make their living in the Omo River valley and on Turkana, both UNESCO World Heritage sites, would be affected, they say.
UNESCO has previously condemned the project and Human Rights Watch has accused the Ethiopian government of uprooting people from the Omo Valley to free up land for state-run sugar cane plantations.
"The project has overcome challenges such as financial and environment issues," Desalegn said. "Some people who think they have a concern for the environment have been downgrading the project rather than being reasonable."
Project boosters say the dam will allow authorities to better regulate the flow of the Omo, which spools out over 700 kilometres. They also deny the dam is primarily a way to ensure a steady flow of water to irrigate cotton and sugar cane plantations.
Gibe III, located about 350 kilometres (220 miles) southwest of Addis Ababa, took nine years to build and cost 1.5 billion euros ($1.6 billion), with 60 percent of financing coming from the Chinese export credit agency China Exim Bank.
Ethiopia was the world's fastest growing economy last year at 10.2 percent, however the International Monetary Fund estimates that the worst drought in 30 years is likely to see this plummet to 4.5 percent in 2016.
With no natural gas or oil reserves of its own, the Horn of Africa country is banking on renewable energy to help foster energy independence and economic growth.
Its Grand Renaissance Dam on the Blue Nile, which is slated to be Africa's largest-ever dam, is expected to produce 6,000 megawatts -- tantamount to six nuclear reactors -- when it is completed in 2017.
The Blue and the White Nile rivers converge in Khartoum and from there run north into Egypt as the Nile.
But the project has poisoned relations with Egypt, which is almost totally reliant on the Nile for agriculture and drinking water, and fears the dam will hit its supplies.