Detective Senior Sergeant Malcolm Inglis said police were called to a Jensen St address about 12.50am on Monday after reports from the public of an explosion and fire.
''Obviously, there was a reasonable noise involved,'' he said.
Neighbours spoken to by the Otago Daily Times said they heard nothing on Sunday and only knew something was amiss when police cars were seen at the address on Monday.
What police uncovered was ''illegal activity involving drugs'', Det Snr Sgt Inglis said.
A shed was ''extensively damaged'' and a 29-year-old man was taken to Dunedin Hospital for treatment for burns after butane gas ignited in the shed just before midnight on Sunday, he said.
St John South Island region communications adviser Ian Henderson said St John was alerted to the incident about 1am on Monday.
The 29-year-old man had serious burns to his arms and hands, Mr Henderson said.
A Dunedin Hospital spokesman said the man was discharged on Monday night.
Det Snr Sgt Inglis would not comment on whether the operation was commercial or for personal use, or what charges the man might face.
The shed ''wasn't a methamphetamine lab'', he said. He would not be drawn on what drugs were being produced.
Butane is sometimes used to produce hash oil, a class B substance under the Misuse of Drugs Act.
New Zealand Drug Foundation executive director Ross Bell said the use of butane hash oil was increasing in New Zealand and had come to prominence in the United States after Colorado legalised cannabis this year.
''We simply don't know the prevalence in New Zealand,'' he said.
''But I think it's going to be the future of cannabis consumption.''
It was a ''fairly new phenomenon'' and he believed people were producing it for their own use.
Home production was dangerous ''because of the risk of explosion''.
The other danger was the concentration of THC - the principal psychoactive compound in cannabis - which can be as high as 85% in butane hash oil.
Det Snr Sgt Inglis said home-based drug manufacturing presented risks for producers and those in nearby areas.
''These drug manufacturing operations are dangerous and have resulted in loss of life in New Zealand,'' he said.
''Any manufacturing of drugs is serious in any suburb or community and anyone aware of such activity should contact us.''
Associated Press reported explosions caused by butane hash oil production in Colorado had soared after cannabis was legalised in the US state.
