By Nichola Groom

LOS ANGELES (Reuters) - The oil and gas industry is finding that less is more in the push to recycle water used in hydraulic fracturing. Slightly dirty water, it seems, does just as good a job as crystal clear when it comes to making an oil or gas well work.

Exploration and production companies are under pressure to reduce the amount of freshwater used in dry areas like Texas and to cut the high costs of hauling millions of barrels of water to oil and gas wells and later to underground disposal wells.

To attack those problems, oilfield service companies like Halliburton, Baker Hughes and FTS International, are treating water from "fracked" wells just enough so that it can be used again. Smaller companies like Ecosphere Technologies Inc have also deployed similar methods.

"It is a paradigm shift," Halliburton's strategic business manager of water solutions, Walter Dale, said.

Until recently, many companies considered recycling too expensive or worried that using anything other than freshwater would reduce well output.

But oil and gas companies are increasingly treating and reusing flowback water from wells, which unlike freshwater is very high in salt, with good results.

The practice scales down the amount of freshwater used for fracking, but environmentalists say it does nothing to assuage concerns about groundwater contamination, and only facilitates the extraction of fossil fuels that produce climate-warming gases.

"It doesn't lessen the potential for groundwater contamination, and it can increase the amount of contaminants that you are exposing the groundwater to," said Myron Arnowitt, Pennsylvania director for Clean Water Action.

Halliburton and Exxon Mobil Inc's XTO Energy earlier this year documented the use of Halliburton's H2OForward recycling service on XTO Energy wells in Eddy County, New Mexico in a paper at a Society of Petroleum Engineers conference. The study found cost savings of between $70,000 and $100,000 per well. The wells have shown no loss of production, Dale said.

The average cost of a well varies by region, but comes in at about $7.5 million in Texas' Eagle Ford shale formation, according to a Jefferies report from May.

FTS International said it is using up to 100 percent reclaimed water in some locations in Oklahoma and Texas, with results comparable to using fresh water.

Increased industry comfort with recycling comes as regulators are moving to require more recycling of water used in fracking. The Railroad Commission of Texas, which regulates the oil and gas industry there, adopted new rules in March to encourage recycling. Under those rules, operators no longer need a permit to recycle water if they are on their own land leases.

The U.S. Environmental Protection Agency could also implement rules concerning recycled water when it delivers its study of hydraulic fracturing next year.

Transportation is by far the costliest element of water management for fracking, and local communities like recycling because it takes trucks off the road.

But the industry has a long way to go, Halliburton's Dale said, adding that recycling is still in a "pilot" period.

Water use and resources are local issues, and approaches to managing water will vary by geography, XTO said in a statement, adding, "Recycling is not a universal solution."

PUMPS, VALVES AND PIPES

Rollout of recycling technology is in its infancy, but poised to lift demand for everything from water pumps to valves to pipes. Companies like Xylem Inc, which makes water testing and other equipment, Ecolab, which owns water treatment company Nalco, and Gorman-Rupp Co, a pump maker, are companies that could see an uptick in business, one portfolio manager said. All three currently trade close to their 52-week highs.

"Fracking has simply added the ability for incumbents in the market to grow earnings further," said Simon Gottelier, a portfolio manager who oversees water investing for London-based Impax Asset Management, which has $3.5 billion under management.

Some companies already forecast big revenue gains from fracking.

Layne Christensen Co, a provider of water management services, said it expects its new fracking-focused business to generate $200 million in revenue by 2017, with "meaningful" revenue generation beginning in 2015. It is completing development of its water recycling offering this year. Meanwhile, utility Aqua America Inc has said a water pipeline to supply frack sites in the Marcellus shale in Pennsylvania will eventually add 10 cents per share to its annual earnings.

For energy companies, the use of flowback water for fracking eliminates the need to truck wastewater to disposal wells. Water can be treated onsite and reused for the next frack.

Some say the water that comes from underground is better suited for fracking and requires less chemical treatment because it is compatible with a well's native geology.

"When you use water that's native to that formation, your chemical is either nil or not required at all," said Tom Whalen, Baker Hughes' vice president of water management.

Today recycling is only prevalent in the Marcellus shale, where about 90 percent of flowback water from wells is recycled, because there are few disposal wells in the region and water to be discarded must be trucked to Ohio to be injected underground.

A disposal well is a pipe into which waste water is injected for permanent storage. Pennsylvania's geology is less suitable for deep injection wells than other regions, and new wells are both costly to permit and often face opposition from communities concerned about groundwater contamination. In addition, a study found powerful earthquakes thousands of miles away can trigger swarms of minor quakes near injection wells.

INDUSTRY COMES AROUND TO RECYCLING

Baker Hughes debuted its water management offering, called H2PrO, about 18 months ago. At that time, the company's customers were interested, but not committed to using it every day, according to Whalen.

"In the last 12 months, that's totally changed," he said.

Baker Hughes now has about 300 employees working on water management in all the major North American shale plays. Its customers are saving 30 to 50 percent compared with trucking the used water to underground wells, according to Whalen.

Drought conditions in Texas have helped prompt the industry to recycle more in all geographies. Though fracking makes up less than 1 percent of overall water use in the state, it makes up more than 50 percent of water use in certain counties, according to a 2011 report by the University of Texas.

Savings vary by region depending on the availability of water and the proximity and number of disposal wells. A recent report by Jefferies estimated that oil and gas companies can save $370,000 per well in the Marcellus shale play in Pennsylvania and $70,000 in North Dakota's Bakken region. In Texas' Eagle Ford shale play, the cost of recycling would be about the same as using freshwater because disposal wells are abundant there.

The author of the Jefferies report, Brad Handler, said Halliburton and Baker Hughes will be the main beneficiaries of an increase in water recycling because of their expertise in the chemical makeup of water used in fracking.

"You need the confidence that Halliburton's chemists can bring," Handler said.

EcoSphere has also had success with its process, which it has used in 750 wells since 2008. It has worked with Newfield Exploration Co and Southwestern Energy Co. But, like many startups, it has had its share of difficulties breaking into the oil and gas industry.

EcoSphere has accused Halliburton of stealing its trade secrets in an ongoing arbitration case, and earlier this year the company that was the exclusive licensee of its technology, Hydrozonix, lost its exclusivity for failing to pay for water treatment units.

(Reporting by Nichola Groom; Editing by Ed Tobin, Patricia Kranz and Leslie Gevirtz)