* Fracking wrong and an overrated solution - Minister
* Drinking water, health a priority
* Government expected to present draft fracking law this year
By Madeline Chambers
BERLIN, June 5 (Reuters) - The German government made clear on Thursday that new rules it is preparing on the controversial technique of fracking for gas would set tough environmental standards that will all but rule out the widespread exploration of shale gas.
News on Wednesday that Economy and Energy Minister Sigmar Gabriel is working on new guidelines for fracking had raised hopes that Germany was opening the door to shale gas extraction despite concerns about its environmental impact.
However, while the new rules will allow a resumption of fracking for deep-lying, or "tight" gas after a two-year moratorium, Environment Minister Barbara Hendricks said they would stop well short of giving a green light to shale gas.
"I think fracking is not only a wrong but also an overrated solution to the energy question," Hendricks told the Ruhr Nachrichten newspaper. "Drinking water and health are the absolute priority."
Hendricks, who is jointly responsible for legislation on fracking with Gabriel, said she expected the government to present a draft law on fracking this year.
"According to what was agreed in the coalition deal, unconventional fracking using toxic substances, in particular for shale gas, will be banned," said Hendricks, like Gabriel, a member of the centre-left Social Democrats (SPD) who share power with Chancellor Angela Merkel's conservatives.
Hydraulic fracturing involves pumping water and chemicals at high pressure through drill holes to prop open rocks. Many Germans oppose it due to environmental worries, in particular fears about the possible contamination of drinking water.
But German industry, worried that rising energy costs at home and a shale gas boom in the United States are hurting competitiveness, is keen to exploit Germany's shale gas reserves. The Ukraine crisis has also stoked a debate here about reducing Germany's dependence on Russian gas imports.
Yet even in Lower Saxony, home to 95 percent of Germany's gas reserves, politicians are wary of the methods used in the United States.
Olaf Lies, the economy minister of the state of Lower Saxony, told Reuters that while he wants a clear legal framework to allow fracking for conventional gas, he was against fracking for shale gas which is usually found nearer to water supplies.
His state has tried to speed up an end to the ban on fracking for tight gas with a legal initiative in the Bundesrat upper house.
"Fracking in shale gas rocks has not yet been practically tested and is linked to unforeseeable environmental risks. Therefore, the government of Lower Saxony rejects fracking of unconventional deposits," said Lies in emailed answers to Reuters.
Germany's WEG oil and gas association welcomed the prospect of a clear legal framework which Merkel's conservatives and the Social Democrats (SPD) had outlined in a 2013 coalition deal which stressed the potential environmental risks of fracking.
"We think the conditions will be tough but we hope this will at least be a first step and that we can push ahead with fracking for conventional tight gas, of course under the terms set for environmental checks," said a WEG spokeswoman.
"At a later stage we hope we will be able to research our shale gas potential," she said, adding the rules had been a long time in the pipeline.
Germany's Federal Institute for Geosciences (BGR) two years ago put shale gas potential between 0.7 trillion and 2.3 trillion cubic metres.
Some companies, including the Wintershall oil and gas unit of chemicals group BASF, have long lobbied to maintain existing gas production and look for new domestic resources.
The company welcomed any steps that would help develop conventional gas reserves with the help of hydraulic fracturing and said Germany should also allow research into fracking for shale gas to better assess the risks involved.
"It's important to enable research in this field, irrespective of whether or not there will be future commercial use in Germany," said a spokesman.
Germany's BDI industry association says that Germany could cover more than 35 percent of its gas consumption from domestic sources in the next few decades.
"The most important lesson from the tensions with Russia is that Germany has to focus more on domestic raw materials. The BDI thinks that the extraction of shale gas by fracking should be possible, of course with the guarantee of environmental protection," the BDI said in a statement. (Additional reporting by Noah Barkin and Ludwig Burger; editing by Susan Thomas)