The 'very light rail' line between Dudley Port and the town was to open in 2019. But the route has now been changed.
It will now run from a newly built technology centre at the bottom of Castle Hill, through Dudley Tunnel, and terminate close to Cinder Bank.
The decision was made to keep the former freight line past Dudley clear for the planned Midland Metro extension from Wednesbury to Merry Hill.
Bosses say the very light rail line, which will serve as a testing facility for new railcar technology, required a stretch of tunnel.
Dudley Council's cabinet member for transport, Khurshid Ahmed, said changing the route of the service was part of 'looking at the wider picture'.
Earlier this year plans to revive the Midland Metro extension to Dudley, Merry Hill and Brierley Hill were bolstered by £100,000 of funding toward developing the scheme. Meanwhile, proposals are still on track for the technology centre, on the site of the former Dudley railway station, with expected opening in 2019.
The Very Light Rail Innovation Centre and testing track is part of a scheme by Warwick Manufacturing Group, which struck a deal with Dudley Council two years ago. It will employ 45 people at the outset.
Councillor Ahmed said: "This re-route of the line has happened because of the Midland Metro extension to Dudley. We have to think bigger and realise the potential of the Metro which will link Dudley with not just Dudley Port, but with Wednesbury and Merry Hill.
"This is not bad news, this is good news for the town – while at the same time we will see new rail technology being tested in our town centre. I'm looking forward to seeing the progress of both schemes."
The new route will be 2km in length and stop just before where the proposed Metro line would leave the freight line at Cinder Bank.
It ends immediate hopes of an end to a wait for a rail route between the town centre and Dudley Port railway station. The line was last used for freight in 1993, while Dudley Railway Station closed in 1964. The Metro line is proposed to pass the new innovation centre before heading up Castle Hill. It is planned to be open in 2022/2023.