Lerwick Power Station is set to close by 2021, with the loss of about 20 jobs.
Scottish and Southern Electricity Networks (SSEN) is proposing to contract the National Grid to lay a cable from Caithness to Shetland to provide electricity for the islands.
This is instead of building a new power station. Diesel generators would be installed as back-up.
Shetland MSP Tavish Scott said the plan was bad news.
Energy regulator Ofgem is to consult the community during the summer.
Lib Dem MSP Mr Scott said: "This is a disastrous policy for Shetland and we must not accept this very bad decision.
"Our future energy needs will be dependent on a seabed cable. What happens when that breaks? We will then be reliant on a diesel generator. So much for security of supply."
Dale Cargill, SSEN's director of customer operations, said: "We are pleased to have reached this important milestone in securing the future of Shetland's electricity supply.
"Working closely with the energy regulator Ofgem, our priority throughout the tender process has been to find the optimum solution in terms of economics, efficiency and reliability to meet Shetland's long-term electricity needs."