Domestic energy production has experienced a renaissance over the last few years, mainly driven by natural gas production. While oil prices hovered around $100/barrel for most of 2011 natural gas prices hit lows not seen since the 1990’s. As this chart shows, the relative price of oil to natural gas (shown in gold) was fairly stable during the 1990’s and most of the 2000’s but has soared over the last few years. In the short term some divergence is understandable, but over the long term these two energy sources are substitutes and we would expect to see energy consumers switch from oil to natural gas given the price differential.

The line in gray shows the number of natural gas drilling rigs in the U.S. and the explosion of drilling in 2006 and 2007 led to the increased production and lower prices we see today. What is also interesting is natural gas drilling activity has remained fairly stable over the last two years while oil drilling activity has reached levels not seen in the last twenty years (black line). Will the increase in oil drilling lead to more production and lower prices? If natural gas is any indication, Americans might see more oil production and lower prices at the pump in the years ahead.

For all the press coverage of rising gold and oil prices, commodity prices during the first half of 2011 showed a tremendous degree of dispersion across different sectors. Silver saw the greatest increase in value as it rose by more than 12%, but wheat fell by more than 26%, thus creating a spread between best and worst of almost 40%. Despite hitting a price of $1,600 / ounce earlier this week, gold rose by less than 6% through the first 6 months of 2011; in fact, only 6 of the 14 commodities on the chart actually increased in price. The main take away from this chart? Commodity investors must have a keen understanding of their underlying exposures, as the large dispersions of individual commodity returns can lead to vastly different results across products and strategies.