SAN FRANCISCO (MarketWatch) — Natural gas has played the part of an outcast, wallowing in a supply surplus, even as most other commodities managed to turn heads with their impressive gains over the past several months.

“Natural gas is the ugly duckling of the commodities,” said Ben Smith, president of First Enercast Financial, an information vendor serving energy markets.

But just like the beloved Hans Christian Andersen fairy tale, the natural-gas story has the potential to transform — if investors are patient enough to wait.

Many commodities had seen a downtrend since the peak in prices in 2008, but copper, gold and agricultural commodities have been making new highs, and oil and iron ore have rebounded, said Evan Smith, co-manager of the $900 million Global Resources Fund PSPFX, +0.21% , which climbed 38% last year.

“Natural gas is probably the only commodity that has set lows recently, with no rebound,” he said.

Natural gas prices NGG11 have dropped 68% from a peak of about $13.60 per million British thermal units in July 2008, finishing Thursday at $4.37. They sank to a low of $2.50 in September 2009.

Natural gas has “truly undergone a significant fundamental shift, with the discovery of cheap and plentiful shale-gas supply,” said Ben Smith.

The U.S. Energy Information Administration estimates domestic recoverable unproved shale-gas resources at 827 trillion cubic feet, according to a preliminary 2011 Annual Energy Outlook report released in mid-December. That’s more than double the estimate of 347 trillion in the 2010 report.

The larger resource also leads to about double the shale-gas production and over 20% higher total natural gas production in the lower 48 states in 2035, than was projected in the 2010 report, the EIA said. Read more about the impact of shale gas production.

The shale-gas resources are “very large, prolific deposits of natural gas,” said Evan Smith. “Many of these fields were known but are now rediscovered” so the market’s seen a “big swing from offshore to onshore production as a portion of overall supplies.”

At the same time, the natural-gas market has had about $28 billion of capital come in over the last couple of years, in the form of joint ventures, largely from foreign oil companies such as India’s Reliance Industries Ltd. (500325) or France’s Total S.A. TOT, +3.00% , he said.

There’s too much capital coming in from foreign oil companies, and this “has largely led to continued drilling, which keeps the supply higher than it should be,” he said. And it could take a year before the market sees an incremental decline in drilling activity from companies reducing capital commitments to drill natural gas.

Even then, it could take even longer before the market reacts.

“The market currently believes this massive [shale] supply windfall will keep prices suppressed for many years,” Ben Smith said.

Futures contracts traded on the New York Mercantile Exchange don’t show prices above $6 until the December 2015 contract.

Tough love

That certainly doesn’t seem to bode well for natural-gas prices, but with natural-gas prices as cheap as they are, there are some good reasons for investors to jump back into the market.

It’ll take some convincing first, and here’s why.

Natural-gas futures fell Thursday even after the EIA reported that domestic supplies in storage dropped 174 billion cubic feet for the week ended Jan. 21, slightly above some analysts’s expectations. Read more about Thursday’s natural gas trading.

“It appears that all this cold weather is draining storage levels at an extremely high rate,” said Ben Smith. “More than 1 billion cubic feet per day is flowing from storage in the Gulf region currently.”

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It’s still not enough to rally the prices.

Shale production is among the big reasons for that. After all, by applying new technology, Southwestern Energy Co. SWN, , for example, with its sizable land position in the Fayetteville Shale formation in Arkansas and surrounding states, has been able to see a 400% increase in productivity over the last two years, according to Evan Smith.

And natural-gas producers continue to go strong because prices for natural-gas liquids remain attractive.

Natural-gas liquids include butane and propane, which are parts of natural gas that turn to liquid at the surface and are separated from the gas.

“As it turns out, companies are doing well selling natural-gas liquids, which seems to make it worth drilling for natural gas,” said Chris Mayer, a managing editor for Agora Financial and contributor to the Daily Reckoning.

Right now, pricing for natural-gas liquids is so strong that natural gas producers with wells rich in NGLs can do well even if natural-gas prices are low, he said, noting that NGL prices “vary all over by region.”

“In some places, the NGLs might be more than half of the value of what comes out of a well,” said Mayer. Read his articles on commodities.

“NGLs relate more to the price of crude and motor gasoline than they do natural gas, since a lot of the propane and butane come from crude,” said Beth Sewell, a managing partner at Quantum Power & Gas Services.

“Crude is truly an international commodity and can easily seek the highest price markets, whereas natural gas is pretty much contained within the borders of the country is produced from” because [liquefied natural gas] capabilities aren’t huge,” she said.

Against this backdrop, Charles Perry, president of energy consulting firm Perry Management, said he expects natural-gas prices to stay where they are now for 2011 — in the $4 to $4.50 range.

Unfortunately, that’s a rather precarious pricing range.

“Whenever the price drops to $4, the producers quit drilling shale wells and LNG diverts to other markets. When the price rises to $4.50, the producers start drilling shale wells again and some LNG diverts to the U.S.,” said Perry, a former member of power giant TXU Corp.’s board of directors.

Patience is a virtue

Weather has and always will be a key factor for natural-gas demand — and cheap prices certainly make the energy source even more appealing.

“We’ve officially established the fact that we have ample cheap natural-gas supply to last us many years,” said Ben Smith. But “it is the demand growth rate in response to all this cheap supply that will eventually support this market going forward.”

It’ll take time.

“Much of the growth in demand takes time to build the needed infrastructure to support higher gas use, so the recovery of natural gas will most likely be a gradual occurrence that takes several years,” Ben Smith said.

“I’m seeing positive changes happening in demand growth already, which indicates that cheap prices are working to cure cheap prices,” he said.

Total gas demand has risen by 5.2% since the bottom in 2009, and vehicle use has climbed 11% in 2010 from 2009 figures, he said, citing data from EIA.

Weather reports are also supportive. AccuWeather.com chief long-range forecaster Joe Bastardi said the current winter season could end up being the coldest for the nation as a whole since the 1980s.

“This month and next, gas prices should move with the weather forecasts,” said James Williams, an economist at WTRG Economics. “A hot summer would also support prices.”

Meanwhile, many producers are unable to profitably produce natural gas at current contract prices, so offshore and conventional gas supply is in sharp decline, said Ben Smith. “Natural gas is currently cheaper than coal to burn for electricity generation, [and] we can expect to see continued demand growth from utilities.”

So “yes, it takes years to create all this infrastructure to support demand, but this is the futures market, and I believe the market will see the future,” he said.