Tourists arriving in Sydney on cruise ships could be greeted by the cranes and cargo containers of Port Botany instead of the arches of the Opera House and the Harbour Bridge.

The NSW Government is preparing a business case to develop Port Botany as a cruise ship hub to deal with increasing demand, after the Federal Government rejected plans for cruise ships to dock alongside naval vessels at Garden Island in Sydney Harbour.

Yarra Bay and Molineaux Point in Port Botany have been flagged as possible new sites for a third cruise ship terminal in Sydney, as the Overseas Passenger Terminal and White Bay struggle to service the number of ships arriving in peak season.

Yarra Bay has been earmarked as one of the potential sites for Sydney's third cruise ship terminal. ( Instagram: @darkrozez )

Prime Minister Malcolm Turnbull said Garden Island had been a naval base for over a century and "will remain so".

"I know there are some people that have argued in the cruise ship industry that the naval base should be vacated by the Navy … so that cruise ships can come in," he said.

"Garden Island is a naval base and the ships of the Royal Australian Navy will always have the priority there, not … cruise ships."

He said whether Port Botany was chosen as an alternative was "a matter for the State Government".

The chief executive of the Tourism and Transport Forum (TTF), Margy Osmond, said there was a need to support the cruise industry to cope with demand.

"If Port Botany is an option, let's get on with it," Ms Osmond said.

"This is an industry that pours billions of dollars into the Australian economy every year, bringing visitors from all over the world … and that visitor experience to date has begun with a colourful Sydney Harbour arrival.

"Failure to find the right solution in Sydney also has ramifications for our near Pacific neighbours who will also miss out on cruise traffic if Sydney loses its lustre as a cruise hub."

Cruise ships could do harbour lap

NSW Tourism Minister Adam Marshall said he was disappointed by the Federal Government's decision not to allow ships to dock at Garden Island.

"That was our first preference, both of the NSW Government and of the cruise industry," Mr Marshall said.

"But of course we don't own or control Garden Island, that is only controlled by the Commonwealth and they have the final say."

Sydney Harbour is getting too popular for cruise ships during the peak season. ( Supplied: Royal Carribean )

Mr Marshall said now that the plan had formally been rejected, it was time to investigate alternative options which could include cruise ships travelling through Sydney Harbour, allowing passengers to see the main tourist sites, before berthing at Port Botany.

"Certainly it's not ideal," he said.

"But internationally, there are many examples of cruise ship ports that are a long way away from the CBD of the city."

"Brisbane in particular is a long way away from the CBD, and certainly other ports in America and overseas are a long way away."

Mr Marshall said Sydney was "unique in the international cruise industry" for having an overseas passenger terminal in the heart of the city.

"That will continue to operate, we will continue to increase capacity at that terminal, but at the same time we need to build new facilities to cater for the overflow for the peak season," he said.

The NSW Government said it was also looking at developing ports in other regional towns, including Eden, Newcastle and Port Kembla.