The draft law, which could yet be changed as it passes through the country's parliament, would permit commercial fracking for shale gas and coal bed methane at depths of over 3,000 meters. Drilling in water protection zones would still be banned.
Fracking at shallower levels would be allowed for exploration purposes, subject to the assessment of a new six-person expert panel.
If the proposed rules are passed into law, the first fracking in Germany could start in 2019.
Environmental groups have criticized the plans and called on the government to focus on implementing the Energiewende — Germany's transition to renewables and energy efficiency.
Environment Minister Barbara Hendricks argued that the law would apply the strictest rules ever seen in the fracking industry, with strong protections for the environment and drinking water.
And Maria Krautzberger, president of Germany's federal environment agency (UBA), suggested it was important to establish a legal framework for hydraulic fracturing, ensuring that any fracking that takes place in the country is adequately regulated.
She told the Guardian it was unlikely that shale gas fracking would be developed in Germany on a large scale.
"We are on the side of the environmentalists," Krautzberger added. "Their goals are our goals but we say we should not close the door on a technology that might be fruitful in the future for exploring geothermal and other energies that do not harm the environment."