How Does Oil and Gas Fracking Work, Exactly?

Fracking is where it's at for U.S. oil production, but it's more than a little complicated.

In this week's episode of Industry Focus: Energy, Motley Fool analysts Sean O'Reilly and Taylor Muckerman walk investors through what they need to know about the fracking process and about some of the best-established businesses in the industry. Find out how the new technology lets drillers access more oil, what steps frackers take to make the process cleaner, a few ways investors can get exposure to the space without buying directly into an exploration company, and more.

Also, the hosts look into the sudden seat change at Arconic (HWM -0.14%), where CEO Klaus Kleinfeld has been abruptly ousted from his position by investment-management company Elliott Management.

Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, April 20, 2017, so we're talking about energy, materials, and industrials. I am your host, Sean O'Reilly, and to my left is Motley Fool Premium analyst and St. Louis Cardinals die-hard, Mr. Taylor Muckerman. What's up, Taylor?

Taylor Muckerman: Sporting my red today, got a sweep yesterday, first series win.

O'Reilly: You feeling good?

Muckerman: Better.

O'Reilly: Very good. I'm a Cleveland Indians fan. We're not going to talk about last year.

Muckerman: I would talk about last year. You lost in Game 7, but you still went to the World Series.

O'Reilly: How far did you guys get?

Muckerman: Oh, funny. That's why I'm saying, I would want to talk about last year if I was you.

O'Reilly: Thank you. If I were you? We need a couple of those editors from upstairs.

Muckerman: Yeah, hold up paper on the glass. "You said that wrong!"

O'Reilly: Use your commas! So, on today's show, we're going to walk our Foolish listeners through the fracking process. I know that sounds really attractive, doesn't it?

Muckerman: We use the word a lot, but we haven't ever really described it.

O'Reilly: That's true. And we'll, of course, mention a few interesting companies along the way, maybe some cool fracking sand companies.

Muckerman: If our listeners ask politely.

O'Reilly: We should have a chat sometime, "Tweet at us right now if you want ... "

Muckerman: We could. We do live chats with our members. We could do a live stream using Slido.

O'Reilly: Could we use Slido?

Muckerman: Yeah, you just have to throw a password over the podcast, and if people listen to it they get treated with the password.

O'Reilly: And, of course, the password, if you had to pick, would be Go Cardinals!, or something.

Muckerman: No, then people who don't listen every week wouldn't be able to figure it out.

O'Reilly: Yeah, OK. So we'll walk through the fracking process. But first, we have to briefly talk about what's going on with Arconic. Basically, this week, the sudden ouster of its CEO Klaus Kleinfeld. Arconic is the lightweight metals and engineering manufacturer. It's the successor --

Muckerman: Well, not successor, because Alcoa (AA) still exists. 

O'Reilly: It spun off the original aluminum production operations, and this is the advanced stuff. So Alcoa took the name.

Muckerman: Alcoa kept the aluminum production, and they spun off the aluminum products division into Arconic.

O'Reilly: Yeah. It was interesting to me, because in every press release I've ever seen for this, or analysis, Arconic is not mentioned as a spinoff. It's just, "We're separating, and that's it."

Muckerman: Yeah, I guess maybe not a spinoff, technically. 

O'Reilly: But bottom line, that's just semantics to this point. This happened about six months ago. The guy that steered Arconic through this process of becoming an individual company was, again, CEO Klaus Kleinfeld. Total surprise -- it was announced on April 17 that Kleinfeld has been forced out by investment manager Elliott Management. This is actually where it gets even weirder.

Arconic said that Mr. Kleinfeld's exit came after he sent an unauthorized letter to Elliott Management, that Arconic's board of directors said showed poor judgement. The company then said that Mr. Kleinfeld is stepping down by mutual agreement. I don't know what was in this letter. That sounds awesome. If somebody knows, tweet at me, I guess. Elliott said in a statement that the letter from Mr. Kleinfeld "read as a threat to intimidate or extort a senior officer of Elliott Management based on completely false insinuations, a threat that we took seriously and about which we immediately and privately informed the board." Whoa.

Muckerman: Yeah, I would believe them if they didn't already want him out of there for over a year. This is just their excuse.

O'Reilly: That's the final cap on this whole --

Muckerman: They were probably poking the bear for a year, and he finally woke up from hibernation.

O'Reilly: Arconic is going to have a shareholder meeting on May 16, and they had it on the docket to get him out. That letter, I want to know what's in that letter. That sounds insane, from a professional CEO of a large corporation.

Muckerman: Yeah. If you're a shareholder of Alcoa -- because he's been the CEO of Alcoa before the split -- he pushed back against the split in 2012 and 2013, when the price of commodities started to fall, eventually succumbing to investors' demands, and successfully overseeing the split and then taking control as the CEO of Arconic. He's a visionary. He has long-term visions for Arconic, not these near-term visions that Elliott Management has. If you look at his success at Alcoa and Arconic now as a businessman and a relationship man with their customers, Boeing was going to go all composites, they were going to completely eliminate the aluminum products that they used from Alcoa and now Arconic. He had the CEO come to their plant, they hashed it out, and they proved that they needed to remain an Arconic customer. And it's one of their biggest contracts. And then you see the CEOs of Airbus, on top of Boeing, United Technologies, and to [General Electric] Aviation all voicing their support for Klaus Kleinfeld. But Elliott Management, they have some ulterior motives, some short-term motives, I'm sure.

O'Reilly: This is not news, yeah.

Muckerman: The stock did pop a little bit, but all these reports you see about his track record in the market for Alcoa, all say, "Oh, this stock's done so poorly since he's been there!" But they never mention the fact that the price of aluminum has also done quite poorly since he was CEO.

O'Reilly: Right. Lemons out of lemonade. Last thing before we move on, what you were talking about, he's a visionary. When the split happened six months ago, I saw it mentioned in The Wall Street Journal, he had this big, long production video of the future, 60 years from now. And he's like, "We're going to build the future, these towers, with robots, we're going to build it all," and it's like, oh my gosh, this guy is thinking long-term.

Muckerman: Using Arconic's products. As Fools, we appreciate that, and as Fools, we don't appreciate, at least I don't appreciate, what happened. I'm going to keep my eye on him and see where he ends up. If he doesn't choose to retire, I think somebody is going to want him on their board, or in their C-suite. I'd be interested which company that is. Hopefully they're public so I can follow along. 

O'Reilly: We've been doing this for a year and a half together. We've talked a lot about fracking. It's kind of all we talk about.

Muckerman: Well, it's what's disrupted the industry over the last decade or so, and it's what put American oil and natural gas back on the map.

O'Reilly: I have a good friend who's a petroleum geologist. I remember when he was in school 10 years ago, he gave a presentation about this, and I happened to be on campus. I was just passing through. He was talking about this and how revolutionary it was. He was talking about -- we're going to talk about it in a second -- drilling sideways and all this stuff. It was a big deal, and we hadn't been able to do that until recently. So, first and foremost, we need to clarify some terms. Fracking is actually what happens after a well is drilled. We've been drilling oil wells for over a hundred years.

Muckerman: The technology there has definitely improved, but it's not what fracking is.

O'Reilly: Have you ever been to Drake's Well, Pa.?

Muckerman: I haven't. That's the original, right?

O'Reilly: It's so anticlimatic.

Muckerman: Yeah, I'm sure. Kind of like the geyser in Yellowstone. Whatever, dude.

O'Reilly: The actual well drilling, which, again, going down, we can now go 360 degrees around. That immediately makes any given oil well more valuable. You used to just drill a hole and oil would come up, and that would be it.

Muckerman: And you would have to go straight down. But we're going up to 10,000, maybe even a little further down now.

O'Reilly: I saw this graphic, and they had Empire State Buildings down.

Muckerman: Yeah, multiple Empire State Buildings.

O'Reilly: Yeah, they had, like, five.

Muckerman: We can go over a mile horizontally once we're a couple miles below the surface. We're not just going straight horizontal anymore. We have directional drilling, where it's basically like a video game --

O'Reilly: Does the bit do any dances, like a shimmy-shimmy?

Muckerman: I imagine the movie Tremors, with that big monster eating its way through the ground, and choosing its path at will.

O'Reilly: Do you think they saw the movie and thought, "We need to do that"?

Muckerman: Yeah. I mean, it's not doing spirals. It has to have some sort of straight direction to it, because they have to have the casings and cement to fortify it. But yeah, we're not just going at a 90-degree angle anymore.

O'Reilly: Correct me, but, basically, when they're doing all these drills and the fracking, which we're going to touch upon in a second, a lot of what they do is to basically make sure the hole stays in place and together.

Muckerman: Yeah, a lot of pipe and a lot of cement go into this process. The first thousand or so feet, I don't know, it depends on the water level, but they have to protect them first and foremost.

O'Reilly: And that gets cased in cement.

Muckerman: It does. They lower the piping down, and before they drill any further, they force cement down the hole, and wraps around the pipe at the bottom, and then upfills, and once it's cemented then they can use the drill bit to drill back through the hardened cement, and then they can continue drilling down to the oil and natural gas. First and foremost, they're protecting the water level.

O'Reilly: So they're making a thousand-foot straw out of cement.

Muckerman: The whole thing is a straw, but that's the most heavily protected part of the straw.

O'Reilly: OK, and that's so things don't collapse --

Muckerman: Well, that and so we don't mess up the water table.

O'Reilly: Important also.

Muckerman: Yeah, so the oil and natural gas aren't seeping out into the water table through cracks in the casings. Basically, what you can imagine is, the top of this hole has the widest casing, and then they just put smaller and smaller casings down through, so it's kind of like a police baton when they snap it out.

O'Reilly: Right, or an inverted skyscraper. That's actually a good analogy, the baton. Respect. So, hydraulic fracturing is the use of -- this is what I got offline -- fluid and material to create and restore small fractures and rock formations. One that hopefully has oil and natural gas in it, of course.

Muckerman: Yes, you would hope. There's companies out there that help them arrive at that conclusion.

O'Reilly: Right. So, historically, you find these geologic formations, and we know the types of rock that usually have reservoirs of oil. That's easy.

Muckerman: Yeah, that's called conventional oil.

O'Reilly: Yeah, that's conventional oil, and it's easy. It's drilling a hole and There Will Be Blood.

Muckerman: Big basins, generally long-lasting wells.

O'Reilly: Right. That's what Saudi Arabia has with their Ghawar Field; that's what we're talking about here. This is going down there thousands of feet, and there's oil stuck between the tiniest of rocks. It's actually crazy to think about, that we're getting it out.

Muckerman: Yeah, it's thin layers that are separated by sediment and rock. So they drop a wire line into these drilled wells and send an electrical charge through this wire that then creates, like you said, a small explosion, and they do it over stages.

O'Reilly: Are you saying they're fracturing the rock, Taylor?

Muckerman: They are, they're fracturing the rock. Through the steel casing, and then through the rock, with pellets and things that diffuse reaction. They do it in stages. That's one reason why we're producing more oil now, because we're being able to tighten the spacing, so we can have more stages per well. They frack, they plug, they frack, they plug, they frack, they plug. Then, once they've fracked all the stages, they remove the plugs, and then they start the process of forcing the fluids and proppants down into the fractures.

O'Reilly: This is like putting a man on the moon. This is really complex.

Muckerman: Maybe even more complicated.

O'Reilly: You ever hear the computers they used for the first Apollo 11, the original Game Boy had more computing power than those computers.

Muckerman: Yeah, now you're just walking around with several of those in your pocket.

O'Reilly: Yeah. We've covered a lot of ground here. What companies --

Muckerman: Yeah, there's companies in every stage of this.

O'Reilly: If I have some acreage in the Delaware basin over there in West Texas, one, I'm obviously a millionaire, automatically. But do I sell the land to EOG Resources or Pioneer [Natural Resources] and call it a day? Or can I hire a company to just do the fracking for me?

Muckerman: EOG and the exploration and production companies aren't necessarily buying the land. Maybe sometimes they do, but they're leasing it. Then, as an acreage holder, you get lease payments, and you probably negotiate some royalties on top of that.

O'Reilly: So that's what I would do, theoretically.

Muckerman: Yeah, theoretically, yeah. We're not going to talk about the producers today, because those are some of the bigger names we mention all the time, because they're the folks that are most directly impacted by the price of oil. But yeah, you're calling companies, A, you can call a company that can do pretty much everything, which is going to be a Schlumberger, Halliburton, Baker Hughes, or Weatherford -- those are the ExxonMobil of the drilling and fracking world. They do everything.

O'Reilly: But they do not own or produce or sell the oil.

Muckerman: They don't. Maybe there's some kind of way that they can negotiate a contract with royalties, but no, for the most part, you're buying a stock in these companies because they're going to do the dirty work.

O'Reilly: And then they get a day rate, and that's it.

Muckerman: They get a day rate for the rigs, and then for all the equipment they use, and rental prices and things like that, yeah.

O'Reilly: So all along, they were giving oil companies a break on these day rates and stuff. But now, they're like, "All right, now that oil is up, we need to ... "

Muckerman: They have to eat, too. So you get them to provide some of the equipment to do the drilling, to do the fracking, to do the completing. And then once the oil starts flowing, they throw the wellhead on it, sometimes call it a Christmas tree because that's what it looks like when it's sitting on top of the well. Then, once the oil is producing --

O'Reilly: On to the next one.

Muckerman: They clean their hands with some of the orange automotive soap that really degreases everything, and then they move on to the next one. Another reason why we're producing and drilling so much more efficiently is because we have what we call pad drilling now, where they basically put some of these rigs on tracks, and without disassembling them like they used to have to do, they used to have to take apart the drilling rig every single time.

O'Reilly: I'm picturing a crane.

Muckerman: It's like a bulldozer or a tank. It's basically on a track. It's called pad drilling, where they can slide it over to the next well site. Disassembling these rigs was the bulk of the time these companies were spending on actual drilling.

O'Reilly: You can imagine it's complex.

Muckerman: Yeah, exactly. And if one bolt is wrong, you're screwed.

O'Reilly: Let's talk a bit about water and sand.

Muckerman: Water and sand make up about 98%-99% of what you're forcing down there, and then you have some chemical additives that are used for --

O'Reilly: Like slickwater solutions, whatever that is.

Muckerman: -- to reduce the growth of bacteria, which can be dangerous, releasing gases. It also provides a bit more of a fluid environment. Yeah, predominantly water and frack sand and some sort of proppant, depending on what kind of well you're drilling.

O'Reilly: There are companies like U.S. Silica and Hi-Crush Partners that literally just make the sand for these guys.

Muckerman: Yeah. U.S. Silica is not just sand. I don't even know if they do just strictly sand.

O'Reilly: Silica implies some kind of glass, too.

Muckerman: Yeah, they can actually create a very specific proppant for a specific well.

O'Reilly: Based upon the geologic properties that are downstairs.

Muckerman: Yeah. And a company like Core Labs can tell you what kind of proppant might work best, because they're a core and fluid analysis company that's used by pretty much everybody in the business.

O'Reilly: And you can send them a core to their lab and make them tell you stuff.

Muckerman: You can send it to them; they can come get it for you. We visited them a couple years ago, and they were telling us that companies even as big as Exxon and Chevron were outsourcing their core sample analysis to Core Labs because they did it so much better than everybody else. But they've been hurt recently because their future was very heavily reliant on deepwater, so once that comes around, maybe that's another company to look at. But you analyze the core sample, and then you can determine your water to sand, water to proppant chemical ratio that's specific for each individual well. Again, technology helping us produce more oil and natural gas per individual well.

O'Reilly: All this stuff, over the last five years, I assume they've been getting better at what we just described even in just the last five years and that's kind of what we're talking about with these companies lowering their cost of production even since 2012.

Muckerman: But you look at these companies using much more sand -- so, not only the companies you mentioned, but CARBO Ceramics as well, and a couple smaller ones, Fairmount Santrol Holdings and Emerge Energy Services, all companies you can look at on the proppant side of the business -- as these companies use more and more proppants, demand should drive the price up, as long as they don't create too much supply too soon.

O'Reilly: Right. Before we finish up here, what's the flushing stage? It's just using water to flush out the well when you're done?

Muckerman: Basically, yeah. Clean up on aisle oil. But a lot of these companies now, the wells aren't being cleaned out as quickly because they're going back and using carbon dioxide to go back in and try to force more oil out.

O'Reilly: And that's usually on really old wells, as I understand.

Muckerman: Yeah, really old wells. They're even going back and trying to fracture conventionally drilled wells --

O'Reilly: From 100 years ago, I hear, sometimes.

Muckerman: You're not getting nearly 100% of the oil and natural gas out of these wells. I would be surprised if some of these wells or even reaching 70% or 80%.

O'Reilly: The conventional wells?

Muckerman: Yeah. And fracking wells are leaving even more, percentage-wise, in the ground than conventional. You're going back and trying to use carbon dioxide, more water flowing through these, and refracking things in different stages after they've exhausted the conventional resource. There's a lot of activity going on -- not only those companies that we've mentioned, but National Oilwell Varco, huge equipment supplier. If you're looking at the drilling rigs, Nabors is the largest land drilling rig provider in the United States.

O'Reilly: Distribution NOW gets these guys all the parts that they need when things happen.

Muckerman: Helmerich & Payne is a very widely respected rig operator and rig manufacturer. Then, Patterson-UTI as well. Different stages. If you want the whole thing outside of the proppants, look at a Halliburton, Schlumberger, Baker Hughes, or Weatherford. If you want to get more specific, you can go proppants with the companies we mentioned -- U.S. Silica, Hi-Crush Partners, CARBO Ceramics, and those other smaller ones. Then, if you want the rig providers and operators, Helmerich & Payne, Patterson-UTI, and Nabors. They do other things, but that's the bread and butter of those three companies, the rig and drilling side of it.

O'Reilly: Cool. Thanks for your thoughts, Mr. Muckerman.

Muckerman: Yeah, I appreciate it. It's very important, it's going on all over the United States and the world, eventually, on the same scale that we have here.

O'Reilly: Watch out.

Muckerman: Yeah, you can definitely not invest in the exploration and production companies and still profit from fracking.

O'Reilly: Awesome, cool. That is it for us, folks. I want to remind our listeners that the Tech show is tomorrow. Tune in to get Dylan Lewis's thoughts. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at [email protected]. If you want to hit Taylor and I up on Twitter, tweet at us @TMFEnergy. As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly. Thanks for listening and Fool on!