A guide to fracking © MSN Money

Three years ago, Exxon Mobil (XOM) had a dilemma. Many of its smaller competitors were finding enormous reserves of natural gas and crude oil in underground shale formations:: the Bakken Shale in North Dakota, the Marcellus and Utica shales in the Northeast, the Barnett and Eagle Ford shales in Texas.

Exxon didn't have the on-the-ground expertise to slowly get into what the oil-and-gas industry calls an "unconventional" business. And the oil giant didn't want to spend several years developing it. So Exxon bought its way in, acquiring XTO Energy, then one of the largest natural-gas producers, for some $31 billion in stock.

The reason is simple: There are huge reserves of oil and gas in these shales, rock structures typically 5,000 to 6,000 feet underground. To get at them, energy companies have embraced what's known as hydraulic fracturing, or fracking. 

Exxon has made itself a player, but not a driving force, in this trend. That helps explain why Exxon shares are having a so-so year, while companies more closely tied to fracking are surging. Fracking is hot, but it's a small part of Exxon's business; for the upstarts, it's everything.

So if you want to follow the fracking fever to the next energy giant, go with the upstarts. I have several candidates for you, including EOG Resources (EOG), Range Resources (RRC), Continental Resources (CLR) and Whiting Petroleum (WLL).

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Deep into the Earth

Hydraulic fracturing has been so successful that, as Oppenheimer analyst Fadel Gheit says, the domestic oil and gas business has been "totally transformed." Oil imports are falling as domestic production has increased. There's so much natural gas that Cheniere Energy (LNG) is building a terminal in southwestern Louisiana to export it out of the country. Some experts predict it will make the U.S. energy-independent at some point.

Charley Blaine

Charley Blaine

It's this excitement that makes fracking a hot issue with investors. Natural gas prices have slumped since the XTO deal closed, and crude oil prices have come off their highs as well. But the hope that this turns out to be a transformative technology carries a lot of weight.

If you're wondering whether Exxon is a better buy than, say, EOG Resources or Range Resources, consider which company can be transformed by this trend.

Exxon is a time-tested giant, a company that will generate some $460 billion in revenue in 2012, exceeded only by Wal-Mart Stores (WMT). For contrast, Apple's (AAPL) fiscal-2013 revenue may hit $192.1 billion. But as such, it is not an easy company to transform.

Exxon came to be, thanks to the 1911 Supreme Court decision that ordered the breakup of the old Standard Oil. It has operations worldwide. CEO Rex Tillerson can call President Barack Obama, and his call will be taken. It operates more drilling rigs in this country than any other company. It has the biggest refineries. It has a huge tanker fleet, some 650 vessels of various sizes. (One ship Exxon no longer owns is the Exxon Valdez, notorious for its 1989 oil spill in Alaska. Exxon sold the tanker in 2008; it's now being scrapped in India.)

Exxon has been a reliable performer for years, able to negotiate its way through myriad crises, including the Exxon Valdez spill. The shares have been solid -- and sometimes spectacular -- performers in recent years.

The big gains have come in years when oil prices were shooting higher. The shares are up 112% since the end of 1999, not including dividends, compared with 14.9% for the Dow Jones Industrial Average ($INDU) and a loss of 3.2% for the Standard & Poor's 500 Index ($INX).

The domestic energy picture

To understand why Exxon is investing big in fracking, and why you might want to as well, you need to consider how important it is.

The technique has resulted in the expansion of natural-gas and oil reserves all over the country, triggering two surprising developments:

  • U.S. dependence on foreign energy sources has dropped. The U.S. will produce an average of 6.41 million barrels a day this year, up 14% from 2011, according to a Dec. 11 Energy Department report. It's the biggest annual gain in the number of barrels since the first U.S. well was successfully drilled in 1859. It is also a big reason why bans on Iranian oil exports haven't sent crude oil prices soaring globally.
  • Carbon dioxide emissions nationally have fallen because cheap gas has replaced coal. In 2005, coal fueled half the electric power plants in the country. That share has dropped to 34%, according to an article by Michael McElroy and Xi Lu in Harvard Magazine.

At the same time, it's controversial. Fracking worries environmentalists and others who see it as threatening groundwater supplies and exposing the surface to potential hazards, including abnormally large releases of methane, which can produce worse greenhouse effects than those of carbon dioxide.

Fracking is a big deal in the Northeast, where activity abounds in the Marcellus Shale, a huge zone stretching from Maine to Virginia that contains very large natural gas deposits.

The fears of what the drillers might do to the environment in terms of pollution and noise from rigs are great enough that they're depressing prices for vacation homes in the Catskill Mountains outside New York City. The state of New York won't approve fracking until an environmental impact statement is completed and new rules governing fracking are drawn up. That's expected in 2013.

Why fracking is a game changer

It used to be that an oil company got its product -- crude oil or natural gas -- by trying to locate underground reservoirs, created when heat and pressure moved hydrocarbons from source rock into a more-defined space. Wells would be drilled to figure out how big a reservoir might be, then more wells would be drilled to tap the reservoirs.

With fracking, drillers aren't looking for reservoirs. Rather, they're going to the source rock and creating reservoirs by breaking up the rock, says Andrew Coleman, an exploration and production analyst at Raymond James & Associates.

Once a well has been drilled to a preset level, the drill pipe is literally -- and very carefully -- bent and pushed out horizontally. Explosives punch holes in the pipe. Then, large amounts of water, sand and chemicals are pumped under great pressure into the shales to free up the oil and gas. It can take as much as 10 million gallons of water before a well is fully operational, McElroy and Lu say. Most of the water and chemicals come up to the surface with the oil or gas via the bored well. The sand keeps the spaces between the fractured rocks open.

At least during the vertical phase, the drilling pipe is encased in concrete to prevent seepage.