Both Horde and Alliance players start as Neutral (0/3000) with the Sha'tar, the faction of naaru which rule the city, the Aldor, and the Scryers. The Aldor and the Scryers are at odds with each other. Doing quests for one faction will simultaneously raise your reputation with the questgiver's faction and lower your reputation with the opposing faction.
Khadgar gives you a quest (Allegiance to the X) that will give you a free 3500 rep with the faction of your choice (and -3850 faction with the opposing group) sending you to friendly with the faction you chose and hostile with the other. The Aldor have many Shadow Resistance patterns on sale for crafters while the Scryers have many Arcane Resistance patterns. (Updated as of the 10/09/06 beta patch)
Blood elves and draenei who complete this quest find themselves merely at Neutral status if they choose the opposite racial faction (blood elves choosing Aldor, for example). Furthermore, the opposite racial faction will be hostile by default (even if it is not listed on the reputation pane yet), so draenei players should not attempt to enter the Scryer's Tier unless they have already picked allegiance to that faction (and vice versa).
Quests that give reputation with Aldor or Scryer also often give gain with the Sha'tar. This gain does not show in the chat log, but can be confirmed in the reputation panel.
Shattrath City, meaning "City of Light," is a large hub and sanctuary city in Outland. A former naaru temple, it is now inhabited by several factions. The center is run by the Sha'tar, who worship the spiritual being A'dal. The Aldor and the Scryers are two factions working with Shattrath against the Burning Legion, but feud with each other. The Aldor are a draenic priesthood working with the Sha'tar, while the Scyrers are a group of formerly-hostile blood elves that recently offered to aid Shattrath.
The Lower City is its own faction--it is comprised of war-torn refugees of all races. Profession trainers and vendors with unique recipes are located down here, as well as the World's End Tavern with a variety of colorful NPCs.
A faction is a group of allies, either racial or ideological. Most in-game factions are described in Warcraft lore, but some were specifically introduced in World of Warcraft. The concept of a faction exists primarily in World of Warcraft. The use of factions in other Warcraft games is more for general grouping purposes and not quantitatively tracked like World of Warcraft.
Most factions are tracked in World of Warcraft by the reputation that a player character has with each faction. Some groups that are not tracked as factions appear in the organization list.
The term faction is also used to refer specifically to the two playable factions in World of Warcraft: the Alliance and the Horde. Each playable race (except pandaren) is specifically aligned with one faction or the other, and all player characters of that race automatically belong to that faction. Pandaren characters are the exception, and must choose a faction to leave the Wandering Isle, at around level 10. Once chosen, a character's faction cannot be changed through in-game means. However, there is a paid Faction Change service available that can perform this function. For all races except pandaren, using this service requires also changing your character to a new race, one that is aligned with the character's new faction.
A character's faction has numerous consequences. Characters can only talk, group, and create guilds with players from their own faction. Certain zones and cities in the world are also friendly to one faction while hostile to the other. The majority of the levelling experience will be determined by the character's faction, with different quests, NPCs and areas for each faction. Faction also determines a substantial amount of play: characters will fight the opposite faction in battlegrounds and world PvP; work to raise their reputation and earn the praise of the heroes of their faction; complete quests to aid their faction's efforts, and frequently fight against the other faction's NPCs; and generally spend the majority of their time in their faction's cities and surrounded by other members of their faction. Although many choose to play characters of each faction, some players develop a strong sense of faction pride, often leading to varying degrees of sparring and rivalry between players who identify with each faction.