Keeping both customers and shareholders content is rarely easy for a power utility, as yesterday’s full-year figures from Scottish & Southern Energy attest. By being the last of the six retail energy suppliers to increase its tariffs – by some 15 per cent in March – the owner of Southern Electric and Scottish Hydro Electric gained an additional 700,000 customers in the past year, swelling its tally to 8.45 million domestic accounts and making it the country’s second-biggest supplier behind Centrica. The rub for shareholders is that surging energy prices – wholesale electricity and gas prices are up 31 per cent and 35 per cent respectively since March – mean the success of SSE’s tariff stance is in danger of backfiring. Those hard-won new customers may prove loss-making in the short term, and effectively wipe out the company’s supply profits this year. Such concerns, together with worries over the severity of forthcoming regulatory reviews, have sent SSE’s shares down more than 11 per cent since January, belying their safe-haven status that had hitherto enabled them to outperform.

But yesterday’s numbers show SSE’s investment case to remain intact. First, although current-year profits from generation and supply, up 13 per cent last year, will partly depend on further tariff increases, SSE also benefits from higher energy prices through its coal-fired power stations. With coal prices having risen less than gas prices – to which wholesale power prices are pegged – stronger generating margins should offset weakness in supply. SSE’s spread of generating assets helps in other ways. Some 10 per cent of its portfolio comprises renewable generation, against 5 per cent for the UK as a whole, for which higher wholesale prices are also positive.

Second, SSE has lost none of its obsession with raising its dividend, which was yesterday increased by 10 per cent to 60½p – providing a prospective yield of 4.2 per cent – and has doubled over the past seven years. The public stance is of a 4 per cent real annual increase – 7 per cent at current levels – for the next two years, but on most projections there is no reason to believe that a nominal 10 per cent should not be sustainable, despite plans to increase capital expenditure to £1.3 billion from £810 million last year.

Jitters over a potential political backlash – from a perception that utilities are profiting from high energy prices – are likely to persist. However, with SSE continuing to invest heavily in renewable energy to meet government objectives, not least in the £1.1 billion purchase of Airtricity, the wind farm operator, that threat should be kept at bay. At £14.66, or 13 times current-year earnings, SSE is a solid hold.

Wholesale gas prices for next winter are on the brink of a record of £1 a therm – fuelling fears of further bill hikes for millions of homeowners. The cost of a gas contract for delivery in January 2009 has reached 99.7p a therm on commodity markets, around double the level a year ago. It comes after the UK’s six main energy suppliers raised prices by up to 20% at the start of 2008 due to higher costs.

Scottish and Southern Energy will demonstrate its independent strengths on Thursday as market operators speculate on a further round of industry consolidation to follow the current auction for control of British Energy.The Perth group’s shares soared in heavy turnover last week on rumours that the German RWE or another of its Continental rivals could be tempted to swoop as part of a global rationalisation drive that has also seen the American NRG Energy group post a multi-billion dollar bid for Calpine Corporation.But SSE’s chief executive Ian Marchant is determined to show that his group is already a clear winner from current turbulent energy markets, with news of a lift in earnings before interest and tax from £1.18 billion to about £1.3bn, and could reward shareholders with another double-digit rise in dividend payments. He will also stress that the group’s decision to let others make the first move before imposing 15% price increases in the spring helped the Scottish hydro giant to boost its customer numbers to a record 8.5 million, up about 10% over the past year.

Brokers point out that SSE is still able to hold back longer than its rivals because it makes much of its money from selling surplus capacity to other distribution groups and also gains as a result of higher wholesale electricity prices for hydro-electricity and other output not connected with soaring oil and gas costs. Even so, most analysts believe that directors will follow British Gas group Centrica in warning of further tariff increases in the pipeline because of the jump in wholesale prices caused by the surge in oil to more than $130 a barrel and another leap in coal costs as a result of Chinese stockpiling after the earthquake cut the country’s hydro-electric production. Some believe that profit margins on the group’s distribution operations may have dropped to as little as 4% in recent weeks, down from more than 7.5% a year ago. Fraser McLaren at Merrill Lynch says that further tariff increases of 15% to 20% are “not inconceivable” later this year if the group decides to protect these retail margins. “But there is a question of whether the companies will be able to pass on the higher costs or deem it prudent to absorb some cost pain rather than risk further punitive action by the government or regulator,” he says. The issue of power prices was brought into sharp focus last week when Energywatch chief executive Allan Asher alleged that Scottish and Southern Energy and the other five big suppliers operated a policy of “tacit collusion”. An Ofgem investigation into the industry is due to report in September, and SSE has moved to win brownie points ahead of the findings with new plans designed to help 100,000 fuel poverty customers through cheaper tariffs. It has also won favour with the government because of its huge commitment to renewable energy at a time when the UK is falling well short in its drive to get 20% of production from green sources by 2020.

The world’s dwindling oil and gas reserves will become the main cause of global political tension if consumers continue to “run on empty”, the head of one of Scotland’s leading energy companies warned yesterday. Ian Marchant, chief executive of Scottish and Southern Energy, told delegates at a renewable energy conference that world oil and gas production was rapidly reaching a plateau where demand would outstrip supply. He said: “If we carry on, oil and gas reserves will be the biggest source by far of global political tension and potential conflicts. “If we don’t sort this out, there will be wars fought over oil. You can argue there already have been.” His warning came in a keynote speech on the opening day of All-Energy 08, an annual showcase for Britain’s renewable energy industry in Aberdeen. It also came on a day when the price for US light crude smashed through the $130-a-barrel barrier for the first time, reaching a new high of $132.08 a barrel, while the price of the benchmark North Sea Brent, traded in London, rose to $127.34 per barrel amid growing fears of a global oil shortage. The price of oil on the futures market for delivery in 2016 also drove costs towards the $140 mark for the first time, fuelling inflationary pressures in the global economy. Mr Marchant said global oil consumption had soared by 30 per cent since 1990. He explained: “In the last 15 years, globally we have been using up more oil than we have been discovering. “Already, 20 per cent of the barrels we produce every day comes from fields over 40 years old. No field that produces more than a million barrels per day has been discovered for over 30 years. Even the United States has got to the point where it realises maybe the oil is running out.” He added: “The days of cheap, easy oil and gas are rapidly coming to an end. We will reach a plateau in the amount of oil we can produce sustainably. “Currently, oil demand is running at 86 million barrels a day. I can see us getting maybe 90 million barrels a day, but we have to fundamentally change how we think about oil and gas.” Mr Marchant stressed that dwindling supplies were also an issue for the UK, with the latest forecasts predicting a 14 per cent reduction in North Sea oil production and a 7 per cent cut in gas. “The UK’s oil is already clearly and demonstrably running out,” he said. “The debate is how we maximise the last remaining reserves. It’s a global problem and it’s a local problem.” Mr Marchant said that Britain had a long way to go in harnessing the potential of renewable energy alternatives.

And he forecast that, by 2020, the UK would only be half way to achieving the European Union’s target for 15 per cent of energy to come from renewable sources. Last week, Scottish and Southern Energy announced plans to invest £1.3 billion in the Greater Gabbard offshore wind-farm, the world’s biggest, a 500-megawatt development in the outer Thames Estuary. But Mr Marchant warned: “We are going to need around 25 gigawatts of offshore wind. We need four Greater Gabbards to go ahead every year for the next 12 years to meet that. “We need to get cracking on carbon capture and storage and marine energy, and we need to get research and development moving. We need pace, urgency and delivery. If we don’t step up our game, we will not succeed.”

How numbers add up on power

• 7 wind farms are owned by Scottish and Southern Energy (SSE).
• The Hadyard Hill wind farm in South Ayrshire is the first in the UK to generate more than 100 megawatts.
• 2,000 megawatts – SSE’s renewable generation capacity.
• 10 per cent of the electricity generated by SSE comes from renewables, 39 per cent from gas, 49 per cent from coal and 2 per cent from oil.
• £28 million of work is under way to build a deep-water wind-farm demonstrator unit in the Moray Firth.
• 100 megawatts to be generated by the massive Glendoe hydro-electric scheme near Loch Ness, which is under construction.
• £8 million invested in a hi-tech tidal underwater turbine demonstrator at the European Marine Energy Centre in Orkney.

How things have changed. A few years ago, you would have struggled to find a green energy tariff, and paid through the nose to get it. Nowadays, electricity providers are falling over themselves backwards to offer you green energy – and often at a competitive rate too. The trouble is, how do you know whether that so-called ‘green tariff’ really is green, and comes from renewable energy sources? Most people assume that, by taking out such a tariff and paying slightly more than a conventional ‘brown’ tariff, they are ensuring that the energy company generates more green energy. But is this actually the case? To understand this market, it’s vital to get your head around something called the Renewables Obligation. This places a mandatory obligation on the UK electricity suppliers to derive 9% of their electricity from renewable energy sources over the next year (increasing to 15% by 2015), or face a large fine. That means the biggest energy providers have to generate a substantial amount of green energy every year – even if none of their customers choose a green tariff. And as green energy is far more costly to generate than brown energy, this means their costs are rising. Luckily for these companies, it just so happens that green tariffs have become really popular in recent years and most of us think it’s perfectly acceptable to have to pay more for green energy.

So instead of being forced to either swallow their extra costs or spread price increases evenly among all their customers – which would effectively ensure that the brown energy users paid the same as the green energy users – the companies are choosing to charge green energy users a higher rate.

No longer seems quite so ‘green’, does it?

The Green Tariff Rip-Off: Of course, if you are a brown energy user, you may think it is fair that you should not have to pay for the extra costs associated with supplying green energy to National Grid. But the green energy user may feel very differently. Indeed, phrases like ‘ripped-off’ and ‘cheated’ may spring to mind. And partly, I feel the Government is to blame for this. There’s no doubt that it is a good thing that electricity providers have to increase their supply of green energy to the grid. But, in my view, companies should not be allowed to resell this compulsory generation as ‘green tariffs’, unless it is additional to their renewable obligation.

Unfortunately, at the moment, the big six electricity providers (EDF, npower, British Gas, Scottish & Southern, eon, Scottish Power) are a long way off achieving their 9% target. Certainly, they are not yet at the point of being able to supply additional green energy to the grid, on top of the amount they are now obliged to supply anyway.

So you could argue there is not much point paying more for a ‘green tariff’ from one of the big six energy suppliers; it will not in any way increase – or, indeed, decrease – the overall amount of green energy being generated this year.

In fact, even if everyone in the entire country opted for a brown tariff instead of a green tariff this year, the big six energy providers would still have to substantially step up their generation and supply of green energy to the grid.

Go Green – Truly Green: But please do not infer from this that you should give up on green tariffs in despair. There is a way around this problem. All you have to do is switch to a green tariff with a smaller energy supplier that is generating more green energy than is strictly necessary, under the Renewables Obligation.

Because they supply less energy, these smaller companies have a much smaller target. And once they have fulfilled their target, any green energy they do supply is additional to the amount required by the Government.

This means that a green tariff with a small energy provider – particularly one that specialises in green energy – will usually increase the generation and supply of green energy, while a green tariff with a larger energy provider will not.

This situation may change if larger energy providers start meeting their Renewable Obligations targets, but as I say, right now that is a long, long way off.

For this reason, Florian Ritzmann at Xelector (which provides The Fool’s gas and electricity comparison service) believes the Government should introduce a kitemark to distinguish between tariffs which provide additional green energy to the grid and those that do not.

This certainly would make a lot of sense – although I doubt the bigger energy providers would be in favour of this idea.

Pay For Your Principles: OK so, after reading all this, you may have made up your mind to switch to a green tariff from a small provider which supplies additional green energy to the grid. The bad news is, you’ll just have to dig a bit deeper in your pocket to get this tariff. Unlike the big six, smaller providers do not benefit from economies of scale and so cannot spread the extra costs involved in generating green energy across a large amount of customers.

For example, Southern Electric currently has a green ‘better plan’ tariff which costs 12.25p per unit for the first 900kWh, and 9.26p per unit thereafter.

By contrast, Green Energy UK’s +10 tariff is more expensive: the unit price is 10.34p, and there is also a standing charge of £44.08 per annum.

This means the average Fool reader, using 5000kWh of electricity a year, would pay nearly £100 more if they went with Green Energy UK over Southern Electric.

But the energy Southern Electric would supply you with – while 100% renewable – will be generated anyway, even if you had chosen an even cheaper, brown tariff. However, the renewable electricity you would get from Green Energy will be additional green energy, generated solely because you took out that tariff. (And you would still save nearly £25 a year if you switched from an npower Standard Tariff to the Green Energy UK tariff.)

Still, the sad truth is, if you can’t afford to go for the truly green tariff from a small specialist green energy provider, you may as well plump for a large provider’s cheapest brown option rather than that provider’s slightly more expensive green tariff. The amount of green energy that is generated this year by that provider will be exactly the same, no matter which one you go for.

If you do want a truly green tariff, you can run a normal comparison search on The Fool and then click on ‘Electricity Only’ and then the ‘Green’ button at the top of the results page. Look for the names you don’t recognise, like ecotricity, Good Energy and Green Energy UK.

Of course, only you can decide what going green is worth to you. Just don’t make the mistake of assuming that, just because the tariff says it’s green, it’s worth paying extra for.

A cross-party group of MPs is to call for water meters to be installed in all homes in the UK as soon as possible to help to conserve water. It also wants the Government to look urgently at banning single-flush toilets and water fittings that are not efficient, possibly including power showers. The MPs believe that water meters could be crucial in restoring trust between water companies and their customers, which they claim has been damaged by the industry making high profits at a time of rapidly rising prices. Recent problems with leakage, flooding and fines from Ofwat, the industry regulator, related to customer service have all contributed to the deterioriation of trust between water companies and their cutomers, the MPs say. The group, chaired by Elliot Morley, the former water minister, has proposed that the five-yearly review of prices put in place at the time of water privatisation in the 1990s should be replaced with a 25-year strategic plan, in which capital expenditure is reviewed every ten years and prices every five years. The report on the future of the water sector, to be released this week, comes at a critical time for the industry, which is approaching another five-yearly price review in 2009. The price review will set tariffs and determine the level of investment in infrastructure for the next five years. The report proposes a wholesale shake-up of the structure that was put in place at privatisation and suggests a bigger role for the Consumer Council for Water, to protect customers. It says that existing levels of domestic water usage – the Government estimates it at 159 litres per person per day, the equivalent of one tonne of water per week – are unsustainable. Britain is one of a handful of European countries without full metering. At present 30 per cent of domestic properties in England are metered, although this varies from 7 per cent to 66 per cent, depending on individual water companies. Installation of a water meter can cost upwards of £200, a sum that initially is picked up by the water company but charged back to customers through bills. The high cost means that many companies have a haphazard approach to installing meters – for example, when there is a change of occupancy at a property. There is also concern that low-income families would be disadvantaged by compulsory metering. The MPs are suggesting that the tax credit and benefit system could be used to help vulnerable households. The report will say that this would encourage companies to take a longer-term view and iron out peaks and troughs of investment that can lead to higher costs from contractors who work in the industry.

UK gas prices at the National Balancing Point were a touch firmer Thursday as colder weather approached, traders said. Within-day was up 0.6 p to 57.35 p/therm by noon London time (11:00 GMT), while day-ahead was up half a penny to 58.6 p/th. The fundamental picture was fairly steady, repeating the patterns of the first half of the week. National Grid data showed demand at 228.6 million cubic meters/day at 11:00, 56.4 million cu m/d below seasonal norms. The system was 13 million cu m long at that time. The Continent continued to import very little gas through the UK-Belgium Interconnector, traders said, while domestic retail demand also stayed fairly low, despite a drop in temperature. One trader said it looked like temperatures were not yet low enough to raise demand. But colder weather still was expected for the weekend and into the following week. That kept a premium on the weekend and working days next week contracts, both of which were up about half a penny by midday, to 59.25 p/th and 60.25 p/th respectively. “Earlier on people thought next week might end up with even higher demand,” one trader said, adding that movement on those contracts seemed to have died down by noon, however. Supplies were again fairly steady, with flows through the Netherlands-UK BBL pipeline up to about 18 million cu m/d again after dropping back by some 8 million cu m/d late Wednesday. However, flows into St Fergus Total, fed by the Norway-UK Vesterled pipeline, dropped back by 8 million cu m/d, leaving the overall picture fairly static. Near curve contracts traded up in line with the prompt, with June up 0.1p to 60.6 p/th by 12:00 and July up 0.4 p to 64 p/th. On the far curve, seasonal contracts were fairly buoyant, reflecting some recovery in crude oil prices after Wednesday’s $2 drop. But gas volumes traded were fairly low, one trader said, adding that the market seemed to be long already with few players willing to sell.Winter 08 was half a penny to 86 p/th by noon, and had traded up to 86.25 p/th earlier in the session, while summer 09 was up a penny to 74 p/th. The back end was also fairly bullish, with winter 10 up a penny to 83.2 p/th and summer 10 up the same amount to 72.25 p/th. “The back end’s performing well at the moment, it looks fairly cheap when you look at the oil formulas,” one trader said. He added that financial players seemed to be the main buyers of those contracts.

UK clean energy provider Green Energy UK has today launched two new tariffs designed to allow customers to distinguish between genuinely zero carbon energy and low carbon energy from biomass or combined heat and power (CHP) generators. The company said its Deep Green tariff would offer customers energy from zero carbon sources such as solar, hydro and wind-powered projects, while its Pale Green tariff would provide customers with a “cocktail” of low-carbon ” green electricity”, predominantly from CHP sources. It added that while this “Pale Green” energy would result in some carbon emissions, the enhanced energy efficiency of CHP systems or use of biomass as the primary fuel source meant it would emit about 65 per cent less carbon than the national average for energy production. “All customers of Green Energy UK contribute to reducing the impact of their electricity use on the environment,” said Doug Stewart, Green Energy UK chief executive and co-founder. “[But] with Deep Green and Pale Green, we are giving customers greater choice and making green electricity more accessible.” In addition to the new tariffs, the company also launched a promotion that will see new customers offered 400 shares each in the company. Stewart said that the offer would allow shareholders to attend the company’s annual general meeting and contribute to the development of the business, as well as provide them with an additional incentive to opt for green energy.

The Energy Retail Association (ERA) has highlighted as a crucial step towards the introduction of smart meters in every home in Britain. The final stages of the Energy Bill in the House of Commons coincides with the publication of the Government’s long awaited report into billing and metering. This report accepts the industry view that smart meters and not electricity display devices are the biggest prize in revolutionising Britain’s energy industry. During the third reading MPs will also debate an amendment that that brings smart metering closer to fruition. Last week the ERA welcomed the Government’s backing for new metering technology and its decision to consult on the impact of a national roll-out of smart meters rather than the lesser prize of electricity display devices. Smart energy meters are the big prize as they allow two-way communication between electricity and gas meters and energy suppliers. They represent a far greater benefit to consumers than electricity display devices, which will only show units of electricity used and will not show gas consumption or an accurate reading of the cost of the energy used. Only smart meters will enable energy suppliers to provide customers with accurate billing and replace the expensive and inefficient system of estimated billing and meter reading currently in use. New research announced today by the ERA shows that the vast majority (82 per cent) of people in Britain want to see an end to estimated energy billing. The YouGov survey shows that young people (aged 25 to 34) are the least happy with outdated billing and metering technology and are the most interested in having access to accurate bills that new smart metering technology will make possible. The recent YouGov survey shows that the public are keen to take advantage of the technology, which allows two-way communication between energy supplier and consumer. Of more than 1,950 people surveyed in Great Britain, 45 per cent are unsatisfied with this system of billing. It is among the next generation of young adults that dissatisfaction is the strongest with almost half (48 per cent) of 25 to 34 year olds being unhappy with the current system of billing. The vast majority of people recognise the appeal of smart meters with over four fifths (82 per cent) of those people questioned being in favour of the new technology. Yet it is young adults who appreciate this benefit the most with 85 per cent of 25 to 34 year olds acknowledging the appeal that new smart meter technology will offer. Smart meters will reward consumers for conserving energy by displaying information in real time on the energy used, the cost of this energy and their carbon impact on the environment. This real time data could potentially be displayed on a handheld mobile device, online or even via mobile phone, as it is shared instantly with the energy supplier. The ERA believes that smart meters are the next generation of electricity and gas meters. Duncan Sedgwick, Chief Executive of the ERA, said: “It is encouraging to see that the Government has listened to the concerns of both the industry and consumer groups and tabled an amendment to the Energy Bill that has effectively opened the door for smart metering. The Government’s backing for smart meters rather than the lesser prize of electricity display devices will also be vital in keeping costs low for consumers and providing customers with what they really want – accurate billing. “Our research shows that estimated billing is unpopular and that most people would welcome the chance to know exactly how much energy they are using. “The Government must now give industry a mandate and a clear timetable for the roll out of smart meters and we will work closely with them to ensure this is delivered.”

www.energy-retail.org.uk/smartmeters.html

British Gas will tomorrow warn householders that their annual gas bills may jump by as much as 30% next winter. The huge rise, the result of soaring wholesale gas prices, would push the average household energy bill to more than £1,200 a year. The company, which provides gas to nearly half the nation’s homes, said it was being forced to put up prices because its retail gas business would otherwise plunge into the red. Forecast wholesale prices for next winter put gas at 85p a therm compared with 47p last winter. The coded warning of more increases in gas prices will come in a trading statement tomorrow, just five months after parent company Centrica reported annual profits of £1.9bn. It will come as yet more unwelcome economic news for the Government, which is battling to fight inflation in the face of soaring domestic energy bills and petrol at £5 gallon. The wholesale price of gas is rising because Britain is forced to import more rather than relying on North Sea supplies. Last year the UK imported 27% of its gas needs, but this figure is expected to hit about 40% in 2008. Centrica is considering buying a third share of a giant £2.5bn wind farm in the Thames Estuary. Shell is selling its stake in the London Array project seven miles off the north Kent coast, which when completed will be the biggest wind farm in the world, with 300 turbines. Sarwjit Sambhi, Centrica’s director of power generation and renewables, said: ‘We would certainly be interested in acquiring this stake.

Energy suppliers are threatening to shut down the UK’s only consumer helpline dedicated to tackling fuel poverty. In the Budget, Chancellor Alistair Darling ordered companies to triple spending on subsidised ‘social tariffs’ for their poorest customers to £150m. But now suppliers are lobbying the regulator Ofgem to allow them to use some funds to keep the Home Heat helpline running. A spokesman for the Energy Retail Association, which runs the helpline on behalf of suppliers, admitted that the service could be ditched if the government did not agree. ‘There is no plan B at the moment,’ he said. Companies also want to be allowed to use a further tranche of the £150m pot on mail shots advertising their subsidised rates and on providing insulation. Adam Scorer, campaigns director for consumer group Energywatch, said: ‘It would be inconceivable for that Budget commitment to be stretched and contorted until it includes every piece of corporate social responsibility spend.’

· NIE Energy, which supplies all of Northern Ireland’s homes with electricity, will this week announce it is increasing prices by up to 30 per cent this year.

BizzEnergy, the UK’s leading independent energy provider, today announces it has successfully installed its 1000th Smart Meter. The company, renowned for its innovative approach in a market dominated by six large suppliers, is committed to delivering Smart Meters to 20% of its business customer base by the end of 2008. The Meters are designed to help businesses run their energy more efficiently, and in turn reduce costs. BizzEnergy already has advanced orders for an additional 1000 meters which it will install by the end of May. BizzEnergy pioneered the introduction of Smart Meters in 2004 when they were the first energy company to install the technology. The Smart Meters use GPRS technology to send actual meter readings to energy suppliers putting an end to estimated bills, a common complaint for business customers who need to keep a close eye on cash-flow. Recent studies conducted by the Energy Savings Trust have shown that the implementation of Smart Meters can reduce energy consumption by as much as 20%. Following successful trials of the technology throughout 2006, BizzEnergy has boosted its campaign to have Smart Meters installed with the majority of its customers. A BizzEnergy Smart Meter enables customers to track their energy consumption and costs by providing the data in half hourly segments. Each month this data is downloaded to BizzEnergy and customers can use it to see when they are using energy and identify what steps they could take to reduce their costs and environmental impact. James Constant, COO at BizzEnergy comments: “We’re always relentless in our efforts to improve the way in which we do business, and the installation of our 1000th Smart Meter is a significant milestone for us. The fact that we have already taken orders for another 1000 meters to be installed by the end of May signifies our commitment to making this technology available now, rather than sitting back and waiting for Government mandate or subsidy. It’s clear that customers no longer want or expect estimated bills, and why should they when the technology exists to make these a thing of the past? The additional visibility that Smart Meters bring means that customers are truly empowered to take more control over costs and cash-flow, whilst still doing their bit for the environment.”

The price of a barrel of oil has passed the $122 mark for the first time.US light crude hit a fresh high of $122.73 in New York trading, while London’s Brent crude has passed $120 for the first time, hitting $120.99. Oil has been rising because of fears over possible supply disruptions in Nigeria and in northern Iraq and predictions of higher US demand. Economists warn higher oil prices are continuing to drag on global economies already weakened by the credit crunch. Oil has continued to hit record levels since it reached $100 a barrel for the first time in January 2008. It has risen by 25% in the last four months and by about 400% in the last seven years.

Wholesale British gas prices have surged this year, outpacing European markets and raising the prospect of bigger energy bills for homes and businesses soon. European gas prices are linked to oil, which hit a record of $119.93 last week, but the effect has been stronger on Britain’s liberalised market, where traders are adding a risk premium over concern that enough fuel will come to the country next winter. Some analysts say forward British gas prices are unsustainably high and should tumble by the time winter arrives. But, with the Organization of the Petroleum Exporting Countries among those warning oil could keep rising, others see little chance of a big fall in energy costs. “The key driver here is economic growth in the Far East and while that remains strong it is difficult to see any short-term relief from high oil prices,” Andrew Wright, director of markets at energy regulator Ofgem told an industry seminar last week. “I would take the very strong gas prices for next winter very seriously.” Wholesale British gas prices for next winter hit a contract high of 85 pence per therm on April 22, almost 50 percent higher than in January, and have remained above 80 pence since. Winter prices are not quite at the levels seen after Britain’s biggest gas storage site, Rough, caught fire in early 2006, stoking fears of possible winter supply shortages. But the surge in prices that followed the fire was a serious threat to supplies and came before Britain’s import capacity was boosted by new pipelines from Norway and the Netherlands. “You can understand two years ago why the prices were very high because we were very short of gas. But the supply situation is very comfortable for the coming winter,” Niall Trimble, managing director of the Energy Contract Company said. “You have got 85 pence for the winter, it’s absolutely absurd.” Although most British gas supply contracts are not directly linked to the price of oil, long-term supply contracts in the rest of Europe tend to be. Whereas before Britain was largely self sufficient, it must now compete for supplies from big producers like Norway. That has made traders add a risk premium for gas to be delivered during the peak demand winter season, as declining North Sea gas production makes it more dependent on imports. There is a knock-on effect for power prices, as much of Britain’s power is generated from gas. The more bearish analysts say British prices have already risen enough to attract gas from Europe this winter. “European gas prices will go up but they won’t go up anywhere near that much. Sooner or later gravity will reassert itself and it will all come crashing down,” Trimble said. Trimble estimates that oil at $115 a barrel would price Continental European gas contracts at around 65-68 pence for the fourth quarter of this year. In late April, Q4 contracts traded above 82 pence, although prices have since come down. “The forward market looks overcooked where it is at the moment. But you can see why there is a lack of sellers, why people aren’t willing to take risks,” said Mark Daubney, head of market reports at energy consultants John Hall Associates. “The gas may fail to flow again at the required levels. We haven’t got the storage that the rest of Europe has as a security blanket. If the gas flows this winter, that will soften prices but until that happens and it’s proven then there’s obviously a risk premium built into it.” A British gas trader said the surge in forward prices since the start of April had been overdone and that prices were already high enough to attract plenty of gas from Belgium, Norway and the Netherlands next winter. “There’s already healthy premium to European contract prices. Yet you will still see people buying because oil has gone up,” he said. “There’s nothing intelligent about what’s going on.” Britain’s big six household energy suppliers have all raised their gas and power prices once this year, blaming rising wholesale energy prices. Because utilities buy much of the energy they need to supply their customers on forward contracts, this year’s rise in wholesale prices has not been passed on to most consumers yet. But unless there is a sustained decline in wholesale prices, gas and electricity bills will inevitably get bigger for everybody. When that happens will depend on what terms suppliers have bought the energy for their customers and how long they are prepared to wait before passing the higher wholesale costs on.

The price of crude oil today is not made according to any traditional relation of supply to demand. It’s controlled by an elaborate financial market system as well as by the four major Anglo-American oil companies. As much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds. It has nothing to do with the convenient myths of Peak Oil. It has to do with control of oil and its price. How?

First, the crucial role of the international oil exchanges in London and New York is crucial to the game. Nymex in New York and the ICE Futures in London today control global benchmark oil prices which in turn set most of the freely traded oil cargo. They do so via oil futures contracts on two grades of crude oil-West Texas Intermediate and North Sea Brent.

A third rather new oil exchange, the Dubai Mercantile Exchange (DME), trading Dubai crude, is more or less a daughter of Nymex, with Nymex President, James Newsome, sitting on the board of DME and most key personnel British or American citizens.

Brent is used in spot and long-term contracts to value as much of crude oil produced in global oil markets each day. The Brent price is published by a private oil industry publication, Platt’s. Major oil producers including Russia and Nigeria use Brent as a benchmark for pricing the crude they produce. Brent is a key crude blend for the European market and, to some extent, for Asia.

WTI has historically been more of a US crude oil basket. Not only is it used as the basis for US-traded oil futures, but it’s also a key benchmark for US production.

‘The tail that wags the dog’

All this is well and official. But how today’s oil prices are really determined is done by a process so opaque only a handful of major oil trading banks such as Goldman Sachs or Morgan Stanley have any idea who is buying and who selling oil futures or derivative contracts that set physical oil prices in this strange new world of “paper oil.”

With the development of unregulated international derivatives trading in oil futures over the past decade or more, the way has opened for the present speculative bubble in oil prices.

Since the advent of oil futures trading and the two major London and New York oil futures contracts, control of oil prices has left OPEC and gone to Wall Street. It is a classic case of the “tail that wags the dog.”

A June 2006 US Senate Permanent Subcommittee on Investigations report on “The Role of Market Speculation in rising oil and gas prices,” noted, “there is substantial evidence supporting the conclusion that the large amount of speculation in the current market has significantly increased prices.”

What the Senate committee staff documented in the report was a gaping loophole in US Government regulation of oil derivatives trading so huge a herd of elephants could walk through it. That seems precisely what they have been doing in ramping oil prices through the roof in recent months.

The Senate report was ignored in the media and in the Congress.

The report pointed out that the Commodity Futures Trading Trading Commission, a financial futures regulator, had been mandated by Congress to ensure that prices on the futures market reflect the laws of supply and demand rather than manipulative practices or excessive speculation. The US Commodity Exchange Act (CEA) states, “Excessive speculation in any commodity under contracts of sale of such commodity for future delivery . . . causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity, is an undue and unnecessary burden on interstate commerce in such commodity.”

Further, the CEA directs the CFTC to establish such trading limits “as the Commission finds are necessary to diminish, eliminate, or prevent such burden.” Where is the CFTC now that we need such limits?

They seem to have deliberately walked away from their mandated oversight responsibilities in the world’s most important traded commodity, oil.

Enron has the last laugh

As that US Senate report noted:

“Until recently, US energy futures were traded exclusively on regulated exchanges within the United States, like the NYMEX, which are subject to extensive oversight by the CFTC, including ongoing monitoring to detect and prevent price manipulation or fraud. In recent years, however, there has been a tremendous growth in the trading of contracts that look and are structured just like futures contracts, but which are traded on unregulated OTC electronic markets. Because of their similarity to futures contracts they are often called “futures look-alikes.”

The only practical difference between futures look-alike contracts and futures contracts is that the look-alikes are traded in unregulated markets whereas futures are traded on regulated exchanges. The trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron and other large energy traders into the Commodity Futures Modernization Act of 2000 in the waning hours of the 106th Congress.

The impact on market oversight has been substantial. NYMEX traders, for example, are required to keep records of all trades and report large trades to the CFTC. These Large Trader Reports, together with daily trading data providing price and volume information, are the CFTC’s primary tools to gauge the extent of speculation in the markets and to detect, prevent, and prosecute price manipulation. CFTC Chairman Reuben Jeffrey recently stated: “The Commission’s Large Trader information system is one of the cornerstones of our surveillance program and enables detection of concentrated and coordinated positions that might be used by one or more traders to attempt manipulation.”

In contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversight. In contrast to trades conducted on regulated futures exchanges, there is no limit on the number of contracts a speculator may hold on an unregulated OTC electronic exchange, no monitoring of trading by the exchange itself, and no reporting of the amount of outstanding contracts (“open interest”) at the end of each day.”

Then, apparently to make sure the way was opened really wide to potential market oil price manipulation, in January 2006, the Bush Administration’s CFTC permitted the Intercontinental Exchange (ICE), the leading operator of electronic energy exchanges, to use its trading terminals in the United States for the trading of US crude oil futures on the ICE futures exchange in London ­ called “ICE Futures.”

Previously, the ICE Futures exchange in London had traded only in European energy commodities ­ Brent crude oil and United Kingdom natural gas. As a United Kingdom futures market, the ICE Futures exchange is regulated solely by the UK Financial Services Authority. In 1999, the London exchange obtained the CFTC’s permission to install computer terminals in the United States to permit traders in New York and other US cities to trade European energy commodities through the ICE exchange.

The CFTC opens the door

Then, in January 2006, ICE Futures in London began trading a futures contract for

West Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and delivered in the United States. ICE Futures also notified the CFTC that it would be permitting traders in the United States to use ICE terminals in the United States to trade its new WTI contract on the ICE Futures London exchange. ICE Futures as well allowed traders in the United States to trade US gasoline and heating oil futures on the ICE Futures exchange in London.

Despite the use by US traders of trading terminals within the United States to trade US oil, gasoline, and heating oil futures contracts, the CFTC has until today refused to assert any jurisdiction over the trading of these contracts.

Persons within the United States seeking to trade key US energy commodities ­ US crude oil, gasoline, and heating oil futures ­ are able to avoid all US market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York.

Is that not elegant? The US Government energy futures regulator, CFTC opened the way to the present unregulated and highly opaque oil futures speculation. It may just be coincidence that the present CEO of NYMEX, James Newsome, who also sits on the Dubai Exchange, is a former chairman of the US CFTC. In Washington doors revolve quite smoothly between private and public posts.

A glance at the price for Brent and WTI futures prices since January 2006 indicates the remarkable correlation between skyrocketing oil prices and the unregulated trade in ICE oil futures in US markets. Keep in mind that ICE Futures in London is owned and controlled by a USA company based in Atlanta Georgia.

In January 2006 when the CFTC allowed the ICE Futures the gaping exception, oil prices were trading in the range of $59-60 a barrel. Today some two years later we see prices tapping $120 and trend upwards. This is not an OPEC problem, it is a US Government regulatory problem of malign neglect.

By not requiring the ICE to file daily reports of large trades of energy commodities, it is not able to detect and deter price manipulation. As the Senate report noted, “The CFTC’s ability to detect and deter energy price manipulation is suffering from critical information gaps, because traders on OTC electronic exchanges and the London ICE Futures are currently exempt from CFTC reporting requirements. Large trader reporting is also essential to analyze the effect of speculation on energy prices.”

The report added, “ICE’s filings with the Securities and Exchange Commission and other evidence indicate that its over-the-counter electronic exchange performs a price discovery function — and thereby affects US energy prices — in the cash market for the energy commodities traded on that exchange.”

Hedge Funds and Banks driving oil prices

In the most recent sustained run-up in energy prices, large financial institutions, hedge funds, pension funds, and other investors have been pouring billions of dollars into the energy commodities markets to try to take advantage of price changes or hedge against them. Most of this additional investment has not come from producers or consumers of these commodities, but from speculators seeking to take advantage of these price changes. The CFTC defines a speculator as a person who “does not produce or use the commodity, but risks his or her own capital trading futures in that commodity in hopes of making a profit on price changes.”

The large purchases of crude oil futures contracts by speculators have, in effect, created an

additional demand for oil, driving up the price of oil for future delivery in the same manner that additional demand for contracts for the delivery of a physical barrel today drives up the price for oil on the spot market. As far as the market is concerned, the demand for a barrel of oil that results from the purchase of a futures contract by a speculator is just as real as the demand for a barrel that results from the purchase of a futures contract by a refiner or other user of petroleum.

Perhaps 60% of oil prices today pure speculation

Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate.

In June 2006, oil traded in futures markets at some $60 a barrel and the Senate investigation estimated that some $25 of that was due to pure financial speculation. One analyst estimated in August 2005 that US oil inventory levels suggested WTI crude prices should be around $25 a barrel, and not $60.

That would mean today that at least $50 to $60 or more of today’s $115 a barrel price is due to pure hedge fund and financial institution speculation. However, given the unchanged equilibrium in global oil supply and demand over recent months amid the explosive rise in oil futures prices traded on Nymex and ICE exchanges in New York and London it is more likely that as much as 60% of the today oil price is pure speculation. No one knows officially except the tiny handful of energy trading banks in New York and London and they certainly aren’t talking.

By purchasing large numbers of futures contracts, and thereby pushing up futures

prices to even higher levels than current prices, speculators have provided a financial incentive for oil companies to buy even more oil and place it in storage. A refiner will purchase extra oil today, even if it costs $115 per barrel, if the futures price is even higher.

As a result, over the past two years crude oil inventories have been steadily growing, resulting in US crude oil inventories that are now higher than at any time in the previous eight years. The large influx of speculative investment into oil futures has led to a situation where we have both high supplies of crude oil and high crude oil prices.

Compelling evidence also suggests that the oft-cited geopolitical, economic, and natural factors do not explain the recent rise in energy prices can be seen in the actual data on crude oil supply and demand. Although demand has significantly increased over the past few years, so have supplies.

Over the past couple of years global crude oil production has increased along with the increases in demand; in fact, during this period global supplies have exceeded demand, according to the US Department of Energy. The US Department of Energy’s Energy Information Administration (EIA) recently forecast that in the next few years global surplus production capacity will continue to grow to between 3 and 5 million barrels per day by 2010, thereby “substantially thickening the surplus capacity cushion.”

Dollar and oil link

A common speculation strategy amid a declining USA economy and a falling US dollar is for speculators and ordinary investment funds desperate for more profitable investments amid the US securitization disaster, to take futures positions selling the dollar “short” and oil “long.”

For huge US or EU pension funds or banks desperate to get profits following the collapse in earnings since August 2007 and the US real estate crisis, oil is one of the best ways to get huge speculative gains. The backdrop that supports the current oil price bubble is continued unrest in the Middle East, in Sudan, in Venezuela and Pakistan and firm oil demand in China and most of the world outside the US. Speculators trade on rumor, not fact.

In turn, once major oil companies and refiners in North America and EU countries begin to hoard oil, supplies appear even tighter lending background support to present prices.

Because the over-the-counter (OTC) and London ICE Futures energy markets are unregulated, there are no precise or reliable figures as to the total dollar value of recent spending on investments in energy commodities, but the estimates are consistently in the range of tens of billions of dollars.

The increased speculative interest in commodities is also seen in the increasing popularity of commodity index funds, which are funds whose price is tied to the price of a basket of various commodity futures. Goldman Sachs estimates that pension funds and mutual funds have invested a total of approximately $85 billion in commodity index funds, and that investments in its own index, the Goldman Sachs Commodity Index (GSCI), has tripled over the past few years. Notable is the fact that the US Treasury Secretary, Henry Paulson, is former Chairman of Goldman Sachs.

F. William Engdahl is an Associate of the Centre for Research on Globalization (CRG) and author of A Century of War: Anglo-American Oil Politics and the New World Order. He may be contacted at info@engdahl.oilgeopolitics.net

1 United States Senate Premanent Subcommittee on Investigations, 109th Congress 2nd Session, The Role of Market speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat; Staff Report, prepared by the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs, United States Senate, Washington D.C., June 27, 2006. p. 3.