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The legislation — the first of its kind in Australia — will be introduced into State Parliament later this year.
Premier Daniel Andrew said the ban would protect the reputation of Victoria's agriculture sector and alleviate farmers' concerns about environmental and health risks associated with hydraulic fracturing, known as fracking.
"We've listened to the community and we're making a decision that puts farmers and our clean, green brand first," he said.
The legislation will also extend the moratorium on conventional onshore gas until 2020, but offshore gas exploration and development will continue.
The Government said the decision, which responds to a parliamentary inquiry, acknowledged the risks involved outweighed any potential benefits.
The inquiry last year failed to reach a consensus on whether to implement a temporary or permanent ban on the sector, instead recommending further studies be undertaken, including a review into the potential human health impacts.
Union slams move to extend moratorium on conventional gas
The Australian Workers' Union welcomed the announced fracking ban, but said extending the moratorium on conventional gas for four years would threaten jobs and investment.
Opposition energy and resources spokesman David Southwick said the Government had slammed the door on future opportunities.
"By shutting the door on future exploration of conventional gas, Daniel Andrews is condemning Victorians to higher energy costs at a time when cost of living pressures are making life tough," he said.
The Coalition last year called for the moratorium on onshore unconventional gas extraction to be extended until 2020.
Unconventional gas, such as coal seam gas, shale gas and tight gas, is found in complex geological systems and is difficult to extract.
Conventional gas is found in sandstone reservoirs and can be easily extracted with traditional well-drilling techniques.
Farmers 'erring on the side of safety'
Victorian Farmers Federation president David Jochinke said while some landholders might miss out on an opportunity to make money if they have gas on their land, the decision was in the state's greater good.
"The science isn't conclusive that it isn't going to affect other landholders. So one landholder may say 'Yes', but that affects the whole aquifer if something doesn't go right or we don't understand what is going on.
"We're erring on the side of safety on this, and making sure that everything's in place, and for us this is a good outcome that achieves that."
The Greens said it was disappointed the Government had left the door open for conventional gas drilling after the next state election.
"We won't stop fighting until all onshore gas drilling is banned," spokeswoman Ellen Sandell said.
"Today's announcement is a big step in that direction, but we won't relax until farmers and regional communities know they are protected from all onshore gas mining."
A moratorium on fracking has been in place in Victoria since 2012.