Crude oil fell from a six-month high after the Federal Reserve said that recovery may fail to take root in the U.S., the world’s largest energy consumer.

Oil declined after minutes of the Federal Open Market Committee meeting on April 28-29 showed that some members want the central bank to boost its purchases of assets to revive growth. Total U.S. daily fuel demand in the four weeks ended May 15 fell 7.6 percent from a year earlier, an Energy Department report showed yesterday.

“The market has been getting overheated,” said Andrey Kryuchenkov, an analyst at VTB Capital in London. “The demand picture hasn’t justified the recent gains, and now that equity markets are pulling back traders are taking profits in oil as well.”

Crude oil for July delivery dropped as much as 87 cents, or 1.4 percent, to $61.17 a barrel, and was at $61.21 on the New York Mercantile Exchange at 9:46 a.m. in London. Yesterday, oil rose $1.94, or 3.2 percent, to settle at $62.04 a barrel, the highest closing price since Nov. 10.

Stocks in Europe and Asia retreated and U.S. index futures dropped. The MSCI World Index fell for the first time in four days, losing 0.3 percent at 8:03 a.m. in London, while futures on the Standard & Poor’s 500 Index slipped 0.3 percent to 897.5.

Refinery Rates

Crude oil may be poised to fall further, based on technical indicators used by traders. The 30-day relative strength index has climbed to 60.58 today. The last time it was near this level, at 60.90 on July 14, the oil price started a 22 percent drop from $145.18 a barrel to $112.87 on Aug. 18.

“We really haven’t seen any improvement in demand,” said Toby Hassall, a research analyst at Commodity Warrants Australia Pty in Sydney. “I just don’t think the fundamentals of the oil market can support prices up around the early $60s.”

U.S. refineries operated at 81.8 percent of capacity, down 1.9 percentage points from the prior week, the Energy Department report showed.

Flint Hills Resources LLC planned to restart a gasoline- making unit at the Corpus Christi, Texas, refinery yesterday after shutting down the unit a day earlier because of a fire.

Fizzling Rally

Federal Reserve officials, who see possible signs of “stabilization” in the U.S. economy, signaled they’re not convinced those improvements will persist.

Policy makers saw “significant downside risks” to the outlook for the economy, with the global financial system still “vulnerable to further shocks,” minutes of the session released yesterday said.

Crude stockpiles dropped 2.11 million barrels to 368.5 million in the week ended May 15, the Energy Department said. A 400,000-barrel decrease was forecast, according to a Bloomberg News survey.

Gasoline supplies plunged 4.34 million barrels to 204 million. A 1.2 million-barrel drop was forecast, according to the median estimate of 15 analysts surveyed by Bloomberg News.

Brent crude for July settlement fell as much as 84 cents, or 1.4 percent, to $59.75 a barrel on London’s ICE Futures Europe exchange.

Take a quick look at the oil price and you would think the market is rapidly returning to health. Yesterday, the market's main benchmark - West Texas Intermediate - jumped to a six-month high of $60.48 a barrel, up 85 per cent from February's low of $32.7.

Dig deeper into the world of physical oil and another picture emerges, however: the fundamentals of supply and demand are weak - much weaker than current prices imply.

Traders - some of the top executives at the world's largest oil companies - say the recent rise in oil prices is due to investor flows and bets about long-term supply and demand, rather than any improvement in the near-term physical market.

"It is difficult to reconcile the fundamentals with the surge in the prices," a senior executive at a large trading house says, reflecting a widely shared view. "The move from $50 to $60 was not based on fundamentals," adds another top executive at an important bank which trades physical oil.

To be sure, traders are not forecasting a return of the lows of the year of $30 a barrel. But many reckon prices need to fall $10 in order to align with fundamentals.

Most analysts agree. Adam Sieminski, chief energy analyst at Deutsche Bank in Washington, says: "Oil prices have been supported by rising sentiment in the equity markets."

Jeffrey Currie, head of commodities research at Goldman Sachs in London, says, while oil investors have been pricing-in the improving economic outlook, "the market can only do this as long as there is room to store the oil and bridge the gap between the currently weak demand environment and the anticipated stronger forward fundamentals.

"With inventories already at record levels, the risk is that oil inventories [will] breach storage capacity and force spot prices lower," he adds.

However, some analysts - and a few traders - disagree. They believe the surge does not represent any violation of fundamentals. On the contrary, Costanza Jacazio, an oil analyst at Barclays Capital in New York, reckons the rise is the result of "one of the most important" fundamentals, namely that prices at $40-$50 leave the market "dangerously far from equilibrium" in the long term.

The conflicting views suggest next week's Opec meeting in Vienna could be even more difficult than usual, with ministers caught between bearish near-term physical fundamentals and a bullish futures market.

Opec - with a vested interest in talking up the market - agrees with the downbeat physical traders' view, downplaying the sustainability of recent prices. In its latest monthly report, published last week, the cartel said oil prices "have remained above $50 a barrel due more to market sentiment than [to] fundamentals".

"Considerable risks remain as oil market fundamentals are far from balanced due to the persistent contraction in demand and growing supply overhang," it said.

Demand is contracting at its fastest pace since 1981. The International Energy Agency, the western countries' oil watchdog, forecasts a fall in consumption of 2.6m barrels a day this year compared with 2008. Such a fall would wipe out five years of demand growth, pushing average oil consumption this year to 83.2m b/d, the lowest since 2004. Traders say although demand appears to have hit a bottom - in part due to the seasonal pick-up in demand as the summer's driving season arrives - there is little sign consumption will rise substantially in the near-term.

The supply front is even more worrying for the oil bulls. After eight consecutive months of Opec production cuts, the cartel marginally lifted its production in April and it appears certain another increase will follow this month. Nonetheless, overall compliance with the cuts - at 80 per cent of the promised 4.2m b/d - is still impressive by historical standards. At the same time, non-Opec production has held up better than expected in spite of mature oil fields in areas such as the North Sea, Alaska and Mexico and lower investment elsewhere.

Overall, global oil production increased last month for the first time since October, rising 230,000 b/d to 83.6m b/d. With demand this quarter estimated at only 82.3m b/d, more oil was forced into storage, bringing inventories to record levels.

Developed countries' onshore inventories surged counter-seasonally in the first quarter and preliminary data suggest they increased further in March and April. Measured as days of demand, OECD total inventories are today enough to cover a massive 62.4 days of consumption, much more than the traditional range of 50-55 days. Although developing countries' statistics on inventories are, at best, sketchy, traders reckon they also increased in the first quarter, notably in China.

What is more, a record amount of crude oil and oil products is floating at sea in tankers.

Traders estimate about 100m barrels of crude and about 25-30m barrels of oil products - mostly distillates such as diesel and kerosene - are sitting in tankers waiting for a pick-up in demand.

That would represent a 40 per cent increase uponfloating storage levels in late March.

"Taking in account supply, demand and stocks, we should see oil at $40 rather than $60," one senior oil trader estimates.

One of the few good pieces of news in the current economic crisis (maybe the only one) is that oil prices have gone from the 147$ a barrel of July 2008 more than 100$ down to less than $50 a barrel on the international markets. However, in the last days we have seen oil prises rising and reaching the price of $58 a barrel for the first time in nearly six months. Nevertheless low oil prices are also good news for gas, since gas prices are normally linked to those of oil. If we remember the difficulties that European fishermen and truck drivers had last year we can imagine what their problems with be if in the middle of an economic crisis they had to deal as well with prices over 100% a barrel.

However, we should not be under any illusion. The current fall of oil prizes is just the consequence of an even more dramatic fall in demand due to economic crisis. I add to that the fears in the financial markets you will understand why investments in futures of any commodity except the safest ones (gold, for instance) are so rare. But the fundamentals that drive the energy markets have not changed. Once the economic crisis is over demand for hydrocarbons will soar again, particularly in the developing world. And some countries are preparing for that. For example the Chinese government has granted a credit to Russian State owned oil companies Rosneft and Transneft $25 bn. against daily supplies of 48,000 tonnes of oil for the next 20 years.

The world is aware that the production of the existing oil wells is decaying and that new discoveries are more scarce and more expensive. Some experts consider that global oil production may have peaked at 94 million barrels a day. The current economic crisis can make the situation worse. The lower prices that we are enjoying now can be in fact bad news. At this price oil producers have been forced to postpone many necessary investments in new production capacity. These investments take decades to be accomplished. In consequence, if the current economic crisis finished and demand recovers we could be facing huge shortage of supplies that can lead to extremely high prices.

How high? According to the Secretary General of the International Energy Agency (IEA), Nabuo Tanaka, oil prices could go up to as much as 200$ a barrel in the next 4 years. A quick look back on the situation of last year when prices were at a mere 147$ a barrel maybe gives an idea of what the consequences may be if the prices goes a 25% higher.

The current relatively low oil prices give a respite to prepare for the coming new oil crisis. We have to reduce our dependency in all those areas in which black gold is not indispensable, such as heating, or electricity production. For those areas which will have to continue to depend on it, like transport, we need to accelerate the research for alternatives, like biofuels, electric cars or hydrogen. And in all sectors, we have to accelerate our efficiency being aware that every barrel of oil that we are using is one of the last.

It is difficult to forecast when the next oil crisis is going to come. As Nobel Price Niels Bohr once put it “prediction is very difficult, particularly about the future”. But one thing is certain, one day we are going to run out of oil, and to prepare for that day we may be running out of time.

Advances in technology have allowed Canada to overtake Russia as the world's second largest holder of recoverable reserves, a new report claims.

According to the team at IHS Cambridge Energy Research Associates (IHS CERA), the breakthroughs made in oil sands extraction has put Canada on the global stage as a key player in future oil supply, with reserves thought to be second only to Saudi Arabia.

The study claims that oil sands have moved from a fringe energy source and are now playing a central role in the global energy debate.

Ongoing development of the oil sands has made Canada the primary foreign supplier of oil to the US, with growth projections set to firmly establish an integral alliance between the two countries in the coming decades.

In March, IHS CERA offered its latest assessment of the effects that low oil prices have had on global supply growth, with the group warning that shortfalls in investment could lead to a supply aftershock as the world pulls out of recession.

Brazil's oil industry is turning to China for cash in the latest sign of how Beijing's clout is growing amid the global economic downturn.

Brazilian President Luiz Inácio Lula da Silva was set to arrive in Beijing Monday to meet with Chinese President Hu Jintao, who is expected to unleash billions of dollars of credit to help Brazil exploit its massive oil reserves. Brazil will return the favor by guaranteeing oil shipments to Chinese companies.

The nations are being thrust together by the global financial crisis. Brazil's state-controlled oil giant, Petroleo Brasileiro SA, wants to spend $174 billion over the next five years to elevate Brazil into the major leagues of oil-producing nations. With international capital markets on life support, China is among the few remaining sources of cash.

Petrobras, as the company is known, is turning to China at a time when China's appetite for raw materials has lifted economies across commodity-rich Latin America, blunting the impact of the global downturn. In March, China passed the U.S. as Brazil's biggest trade partner.

Terms of the arrangement had yet to be finalized before the Brazilian leader departed, a senior Petrobras official said, although a broad outline of the talks was announced by Petrobras earlier this year. On the table is a $10 billion loan in exchange for as many as 200,000 barrels per day. China's chief goal, however, is to use the loans to win deals to provide services and equipment at a time when Brazil is becoming tougher in dealing with foreign companies, industry experts said.

Even before a deal is done, the months-long negotiations between Chinese and Brazilian officials have illustrated a competitive advantage for China's government-backed companies at a time when credit markets are dry. Underscoring China's importance as a lender of last resort, Brazil engaged China even though many of its past investment initiatives with the nation have ended in disappointment.

"The U.S. has a problem," Sergio Gabrielli, chief executive of Petrobras, said recently when asked about the loan talks. "There isn't someone in the U.S. government that we can sit down with and have the kinds of discussions we're having with the Chinese."

Mr. Gabrielli was referring to the fact that Chinese government banks are willing to extend huge foreign loans to further China's long-term energy-security goals: ensuring diverse global supplies and winning entree into competitive regions for its oil companies. A string of recent oil loans to Russia, Kazakhstan and others has pushed China's total commitments to more than $45 billion.

Such direct government lending is an increasingly powerful tool in an era when three-quarters of the world's oil reserves are in the hands of state-controlled oil companies. By dealing directly with governments in oil-supplier nations, China can use its wealth to reduce the role of big oil companies -- the traditional intermediaries between oil producers and oil consumers.

"What you are seeing is the new geopolitics of oil, where deals start from a political understanding and cut out the international oil companies," says Roger Diwan, a partner at PFC Energy, a Houston-based consultancy.

To be sure, international oil companies such as Exxon Mobil Corp. and Royal Dutch Shell PLC have important advantages in technology and managerial know-how over state companies. Brazil's most tantalizing oil reserves lie miles beneath ocean, rock and unstable layers of salt. Getting it out likely will require the expertise and muscle of the industry's top companies.

What's more, China's willingness to fund oil projects should ultimately help the U.S. consumer, experts say. Most of the world's oil is sold on the international spot market to the highest bidder. China's willingness to extend credit to oil producers should keep prices from rising simply by increasing the global supply of oil.

Brazil's Petrobras, which is controlled by the government but operates with a free-market ethos and has shares trading on the New York Stock Exchange, is in an unusual position for the global oil industry after notching major oil and gas finds. The company is sitting on far more reserves than it has people and money to pump.

Brazil hatched an ambitious plan to change that, and it has vowed to make it happen even in the downturn. "It's willing to do deals where necessary," says Matthew Shaw, a senior Latin American analyst at Wood Mackenzie, a Scotland-based oil consultancy.

A group of retired senior U.S. military officers has concluded that the country's reliance on fossil fuels undermines its capacity to defend itself. Citing a "serious and urgent threat to national security," the group has urged the Pentagon to take the lead in shifting to a new age in energy.

The dependence on oil-based fuels left the U.S. military seriously over-extended in Iraq and Afghanistan, according to the officers' report, issued on May 18 by CNA, a military think tank based in Alexandria, Va. The 62-page report asserts that the true cost of fuel, including logistics and the military protection of sea lanes, can run to hundreds of dollars a gallon.

"Our energy posture is not sustainable. It can be exploited by those who want to do us harm," retired Air Force Lieutenant General Larry Farrell, a co-author of the report, said in an interview. Finding a suitable alternative fuel and scaling it up to the size of the U.S. economy "is a 30-year project," Farrell said. "We've got to get started now."

The report, called "Powering America's Defense: Energy and the Risks to National Security," was written by CNA's military advisory board, comprised of 12 retired generals and admirals. It's a follow-up to a 2007 report by the advisory board called "National Security and the Threat of Climate Change."

Retired Admiral John Nathman, another of the co-authors, said in an interview that the board deliberately tried not to inject itself into the debate over climate change, instead accepting the view that temperatures are rising. Yet the report coincides with a fierce debate in Congress over so-called cap-and-trade, a proposal to control greenhouse gases by parceling out the right to emit them.

A New Senior Pentagon Post for Energy
The report also coincides with an elevation of economics and specifically energy in debates over U.S. national security. Nathman said the Pentagon is in the midst of assigning a senior officer to study the energy challenge; the officer would serve under Ashton Carter, an undersecretary of defense for technology and acquisitions. Already, Nathman added, each of the military service arms has assigned a three-star general to study how they are using energy. Plus, Jim Jones, President Barack Obama's national security adviser and a former marine general, is expected to create a new senior slot on the National Security Council for global energy.

In addition, the report discusses the U.S. electricity grid, which it says is "unnecessarily vulnerable." It cites a 2003 cascading blackout that affected 50 million people in the U.S. Northeast and Midwest and Ontario as evidence of how a fragile power grid can leave huge areas without working gas stations, rail service, and cell-phone coverage. While a threat to the country overall, the frailty of the grid is specifically a peril to the military, the report says. "An extended outage could jeopardize ongoing missions in far-flung battle spaces," it concludes.

Reliance on oil, however, is the report's focus. It estimates that refueling military jets in flight raises the cost of each gallon of fuel to $42; on the ground the cost ranges from $15 a gallon to as much as hundreds of dollars a gallon depending on how much security and logistics are required to get the fuel to where it needs to be.

Wasted Fuel, Heavy Batteries
A full accounting of the cost of fuel would include the U.S. Navy's protection of sea lanes, the maintenance of military bases in countries such as Bahrain, and the stationing of massive numbers of troops abroad, according to the report and interviews with its authors. In Iraq, just 10% of fuel used for ground forces went to heavy vehicles such as tanks and amphibious vehicles delivering lethal force; the other 90% was consumed by Humvees and other vehicles delivering and protecting the fuel and forces. "This is the antithesis of efficiency," the report says.

Another problem is batteries. In Afghanistan, each U.S. soldier is burdened by carrying 26 pounds of batteries, which "hinders their operational capability by limiting their maneuverability and causing muscular-skeletal injuries," the report says.

The retired generals urge the Pentagon to take the lead in developing new technologies to take the place of fossil fuels and making these technologies economically reproduceable on a large scale. It notes the Pentagon's role in creating and incubating nuclear power as well as the Internet. It also points out that the military has served as an incubator for cultural change, such as integration, a fact that could prove crucial if the country needs to make a dramatic lifestyle shift because of a disruptive technological change surrounding how it powers itself.

"People will see that if it works for the military, it will work for a lot of other things as well," Farrell said.

Nigeria’s oil output has fallen to less than half capacity because of militant attacks in the main producing region over the past three years, Petroleum Minister of State Odein Ajumogobia said.

The country is pumping 1.2 million barrels a day out of a total capacity of 3.2 million barrels a day, with Royal Dutch Shell Plc’s onshore fields worst affected by the insecurity, Ajumogobia said in remarks broadcast by the state-owned Nigerian Television Authority today.

Nigeria, the fifth-biggest source of U.S. oil imports, holds Africa’s largest hydrocarbon reserves of more than 36 billion barrels of crude and 187 trillion cubic feet of gas.

Armed groups, including the Movement for the Emancipation of the Niger Delta, or MEND, have attacked oil plants and pipelines in an upsurge of violence since 2006. MEND claims to be fighting for the poor in the Niger Delta region, saying they’re yet to share in its oil wealth. Criminal groups also hijack vessels and kidnap oil workers for ransom.

Jeroen van der Veer has won widespread praise for the way he has steadied the ship as chief executive of Royal Dutch Shell, after the reserves misreporting scandal that threatened to sink the company when it was exposed early in 2004.

The message from shareholders at Shell's annual meeting yesterday was that however great his achievement might be, it did not deserve to be rewarded as generously as Shell's remuneration committee believed.

The decision to pay bonuses to executives even though performance targets had been missed has made Shell a lightning rod for anger about executive pay.

As Martin Simons, a British retail investor who spoke to the meeting in The Hague via video link from London, put it: "What really troubles me about the board is you have not had the nous to realise the general public concern about the behaviour of large companies. The gravy train has got to stop."

At first glance, Shell seems an unlikely flashpoint for anger. Post-tax profits for 2008 were $31.4bn, and even though they fell 58 per cent in the first quarter, they were still a healthy $3.3bn. The decline was in line with Shell's leading rivals BP and ExxonMobil.

In recent years, while Shell's performance in terms of total shareholder return has been at or near the bottom of its peer group of the five "super-major" oil companies - the others being Exxon, BP, Chevron and Total - the remuneration committee is right to point out that the difference between Shell in fourth place and Total in third for 2006-08 was very small.

And while Mr van der Veer's pay rose sharply last year, it is still much lower than the rewards paid to rival chief executives.

Shell's problem is in part that its huge profits last year were seen as unde-served. If you are producing more than 3m barrels of oil and gas per day when commodity prices hit record highs, you do not require any special brilliance to make a lot of money.

More particular, however, is the sense it conveys that shareholders' concerns are not taken seriously.

Guy Jubb, head of corporate governance at Standard Life Investments, who described Mr van der Veer's award as "not acceptable", said his company had not supported a vote on Royal Dutch Shell's remuneration report since 2003.

Speaking after the meeting, Sir Peter Job, former chief executive of Reuters who is a non-executive director at Shell and has chaired the remuneration committee since 2007, said Shell "takes the outcome of this vote seriously".

However, he also said the discretion used by the remuneration committee in making incentive payments, which was the focus of shareholder opposition, had been explicity approved in the 2005 vote.

His offer to shareholders was merely that "we will be discussing the implications of this vote with them".

Shell is introducing new rules for its incentive plans, which it says follow consultation with shareholders. However, by introducing operational performance measures as criteria, it risks further blunting the focus on shareholder return.

Russia and Italy agreed on Friday to increase the capacity of the planned South Stream gas pipeline under the Black Sea, in a move that will intensify concerns about the European Union’s reliance on Russian supplies.

The South Stream project is intended to open a new route for Russian gas to reach the west, avoiding Ukraine. Disputes between Russia and Ukraine have disrupted Europe’s gas supplies, most seriously in January this year when 20 countries suffered shortages.

Vladimir Putin, the Russian prime minister, and Silvio Berlusconi, his Italian counterpart, oversaw a deal between Gazprom, the Russian gas export monopoly, and Eni of Italy to double South Stream’s capacity to 63bn cubic metres a year – enough to supply more than four-fifths of Italy’s total gas consumption.

Paolo Scaroni, Eni chief executive, said South Stream would improve Europe’s energy security. “What is the meaning of this capacity extension of South Stream? It means 1bn cubic meters more here will be 1bn cubic meters less gas crossing Ukraine.”

South Stream is a rival to the Europe-backed Nabucco project to bring Caspian gas to Europe across the Caucasus and Turkey, easing Europe’s dependence on Russian supplies. But Nabucco investors have struggled to secure gas supplies for the pipeline, a drawback underscored last week when Turkmenistan and Kazakhstan refused to join Azerbaijan, Turkey and Greece in committing to the project.

Mr Putin said South Stream, estimated by Gazprom to cost €8.6bn ($11.6bn, £7.64bn), would improve European energy security.

“If we build multibillion-dollar projects, we are tied to our consumers. This will guarantee stability on the European market,” he said.

Mr Berlusconi said the “EU should itself take steps to build relations with Russia ensuring that there were no problems with [gas] supplies”, Interfax reported.

Eni and Enel, the Italian energy group, agreed to sell Gazprom a 51 per cent interest in three gas fields in west Siberia for $1.5bn to be developed in a partnership by all three companies.

Russia also signed deals with Bulgaria, Greece and Serbia – countries that South Stream will cross. Gazprom said it would complete the project in six years.

Additional reporting by Carola Hoyos in London

What do you get from an Austrian, a Hungarian, a Kurd and two Emiratis? If you believe in the deal signed at the weekend between OMV, the Austrian energy group, MOL, its Hungarian neighbour, the Sharjah-based Crescent Petroleum and Crescent’s affiliate Dana Gas, you get the most important energy project to come out of Iraq since the removal of Saddam Hussein.

With luck and a following political wind, the $8 billion (£5 billion) investment by Pearl Petroleum in Kurdish Iraq could be the most significant since the discovery of oil at Kirkuk by the Iraqi Petroleum Company in the 1930s.

It could equally well be sunk by squabbling Baghdad politicians, dysfunctional ministers in Brussels and bellicose generals in Ankara.

That would be a pity, because the Pearl partners have a plan to extract gas from Khor Mor and Chemchemal, two giant fields in Kurdish Iraq, and pipe it across the Turkish border. From there, the gas would be carried by Nabucco, an as-yet-unbuilt European Union flagship pipeline, into Central Europe.

This may be the last chance for Nabucco, a project to bring Central Asian and Middle Eastern gas into Europe that has been on the drawing board for seven years.

Last week, Gazprom, arch-foe of Nabucco, was trumpeting a deal with Eni, the Italian energy group, that would double the size of South Stream, a rival pipeline project that would bring Russian gas across the Black Sea and into the Balkans, avoiding troublesome transit through Ukraine.

Until Sunday, Nabucco’s prospects seemed bleak. Backed by the former Bush Administration, as well as by Brussels, Nabucco has been a pipeline seeking a gasfield.

One by one, initially enticing gas reserves in Central Asia vanished as geopolitics and geography intervened. Turkmenistan grew tired of talk about trans-Caspian pipelines and looked to China for an alternative customer.

After years of debate and the sight of Russian tanks entering Georgia, Kazakhstan and Azerbaijan decided that discretion and Gazprom’s offer of a better gas price were better than valour and a speculative deal with Nabucco’s partners. Until Sunday, there was no other supplier bar Iran, still a bridge too far.

Iraq’s gas reserves are unknown, but sure to be big. The old regime never bothered to develop its gas. There are small gas recovery projects in the south and Shell is toying with a plan to win gas from the Kirkuk oilfield.

The Pearl partners reckon that their two fields alone could deliver three billion cubic feet a day into pipelines heading north, equal to a third of UK daily consumption. Swift to protest, the Oil Ministry in Baghdad denounced the deals, insisting that Kurdish Iraq could not export gas without central government consent.

There is jealousy in Baghdad over the upstart Kurdish regional government’s success in developing an independent oil industry. Baghdad initially blustered over exploration licences for tiny foreign explorers in Kurdistan, arguing that the Kurds were giving away too much oil profit to foreigners.

But a fortnight ago, Baghdad granted export licences for two Kurdish projects. Meanwhile, impatience with the failure of Iraq’s central government to bring oil output to even the levels before the 2003 invasion is turning to anger. A petition signed by 140 Iraqi MPs last week criticised the Oil Ministry.

The mood is also changing in Ankara, where Turkish distrust of Kurds is giving way to realpolitik and business deals. Turkey’s Government wants stability in Iraq, but also aspires to the role of Europe’s eastern energy hub.

In a future Iraq, without the iron glove of American security, the Kurdish region is an oil and gas prize, lonely, unprotected, bordered by a hostile Iran and a chaotic cauldron to the south and west. If not Turkey, who will protect Kurdistan?

The Kurdish government last month assigned its option over a quarter of Tawke, an oilfield found by DNO, of Norway. It should be no surprise that the beneficiary was Genel Enerji, the Turkish oil group.

The Obama administration plans to set tougher fuel economy and emissions rules for car manufacturers in a move likely to please environmentalists but add to the industry’s challenges.

A senior administration official on Monday said that the new plan would bring “historic levels of fuel efficiency”, introducing the first rules designed to reduce carbon emissions from cars and accelerating by four years an existing plan for new vehicles to achieve an average of about 35 miles per gallon by 2020.

The corporate average fuel economy standard, which was first introduced in 1975 as a response to the oil embargo imposed on the US by Arab oil producers, had been due to rise from 25.3mpg today to 35mpg by 2020 but the new efficiency target would rise to 35.5mpg between 2012 and 2016.

The dual approach to mitigating environmental damage would see the US adopt a plan comparable in scope to that of California, which has been attempting to adopt stricter targets to fight pollution independent of the federal government.

Carmakers, including the big three US companies and foreign manufacturers with US operations such as Toyota, have previously lobbied against proposals to impose tighter fuel-economy standards, arguing that they would hurt an already reeling industry by imposing a higher cost of manufacturing.

But General Motors is struggling to avoid joining Chrysler in bankruptcy. Both companies have accepted billions of dollars in US government aid. The three large US carmakers, including Ford, based in and around Detroit have suffered from a sharp decline in sales.

The administration has sought to engage with the industry, however, and executives are expected among a gathering of officials when the plans are laid out in more detail on Tuesday.

One point in the new regulation’s favour from the industry side is the prospect of a uniform national standard imposed by the federal government, rather than a patchwork of state regulations with different deadlines and targets.

The return of the fuel efficiency issue to the political spotlight comes as President Barack Obama is attempting to push restrictions on carbon emissions through Congress as a means to fight global warming. It also follows his commitment to energy security made during the presidential campaign.

California has long pushed for lower limits on emissions as it battles against pollution. The state’s attempts to enforce tougher legislation of its own, however, were stymied under the Bush administration.

“I am very pleased by the reports that the Obama administration has brought together the federal government, the state of California, and the auto industry behind new national automobile emissions standards that follow California’s lead,” said Barbara Boxer, a Democratic senator from California and chair of the Senate environment committee.

“This is good news for all of us who have fought long and hard to reduce global warming pollution, create clean energy jobs and reduce our dangerous dependence on foreign oil,” she said.

A separate initiative to promote fuel efficiency, which includes the so-called “cash for clunkers” legislation, is being considered in Congress. This would pay a subsidy to owners of older, dirtier vehicles when they trade them in for more fuel-efficient models.

The administration’s auto task force, which is attempting to restructure GM and Chrysler, has also made fuel efficiency a condition for several elements of the government-backed merger between Chrysler and Fiat, the Italian automaker.

WASHINGTON — As Congress weighs imposing a mandatory limit on climate-altering gases — an outcome still far from certain — it is likely to turn to a system that sets a government ceiling on total emissions and allows polluting industries to buy and sell permits to meet it.

That approach, known as cap and trade, has been embraced by President Obama, Democratic leaders in Congress, mainstream environmental groups and a growing number of business interests, including energy-consuming industries like autos, steel and aluminum.

But not long ago, many of today’s supporters dismissed the idea of tradable emissions permits as an industry-inspired Republican scheme to avoid the real costs of cutting air pollution. The right answer, they said, was strict government regulation, state-of-the-art technology and a federal tax on every ton of harmful emissions.

How did cap and trade, hatched as an academic theory in obscure economic journals half a century ago, become the policy of choice in the debate over how to slow the heating of the planet? And how did it come to eclipse the idea of simply slapping a tax on energy consumption that befouls the public square or leaves the nation hostage to foreign oil producers?

The answer is not to be found in the study of economics or environmental science, but in the realm where most policy debates are ultimately settled: politics.

Many members of Congress remember the painful political lesson of 1993, when President Bill Clinton proposed a tax on all forms of energy, a plan that went down to defeat and helped take the Democratic majority in Congress down with it a year later.

Cap and trade, by contrast, is almost perfectly designed for the buying and selling of political support through the granting of valuable emissions permits to favor specific industries and even specific Congressional districts. That is precisely what is taking place now in the House Energy and Commerce Committee, which has used such concessions to patch together a Democratic majority to pass a far-reaching bill to regulate carbon emissions through a cap-and-trade plan.

The bill is poised to win committee approval this week, although with virtually no support from Republicans. If there was a single moment when cap and trade crossed the threshold from relatively untested economic concept to prevailing government policy, it came in May 1989 in the West Wing office of C. Boyden Gray, counsel to President George H. W. Bush.

Mr. Gray had gathered a number of Mr. Bush’s economic and environmental advisers to try to come up with a politically palatable plan to break a decade-long deadlock on the problem of acid rain, caused by sulfur dioxide emissions from coal-burning power plants in the Midwest.

Mr. Gray and the other Bush advisers knew that the power companies — and their allies in Congress — would vigorously oppose a tax on sulfur emissions or stringent new regulations to control them. But the environmental costs of the problem were too big to ignore.

One of Mr. Bush’s outside advisers, Daniel J. Dudek, an economist with the Environmental Defense Fund, recalled that after years of unsuccessfully trying to sell the idea of setting a national limit on such emissions and letting companies trade permits or allowances to pollute, he finally came up with an analogy that broke the ice.

“I told Boyden: ‘Imagine you just fired up the government printing presses and dumped an endless stream of money into the system. You’d have no way of controlling the money supply,’ ” Mr. Dudek said. “He understood totally and intuitively the importance of maintaining the cap, the key ingredient in our acid rain policy.”

A month later, the Bush White House sent Congress a cap-and-trade plan for sulfur dioxide emissions that 18 months later became the linchpin of the 1990 amendments to the Clean Air Act, considered by many to be the most successful domestic environmental legislation ever enacted.

But the proposal came under ferocious political assault during those months. The final bill reflected a series of compromises needed to keep the coalition supporting it together. But the sulfur dioxide cap, a roughly 50 percent reduction in emissions over the next decade, held. The Environmental Protection Agency estimates that compliance with the program is close to 100 percent.

“Our proposal was at first ridiculed by environmentalists as little more than a license to pollute,” said Representative Jim Cooper, a moderate Democrat from Tennessee and an early supporter of tradable permits. “But today, few dispute it is one of the government’s most successful regulatory programs ever.”

Representative Henry A. Waxman, a California Democrat and chairman of the energy committee, and his allies are marshaling many of the same arguments for the cap-and-trade approach as they used two decades ago for acid rain. A cap-and-trade program brings support from industries that prefer it to a top-down federal regulatory scheme, they say.

Many regard it as the lowest-cost solution to a global pollution problem and a means of producing clean-energy breakthroughs. And it is a much easier political sell than a tax on fossil fuels. A measure of the political appeal of the final compromise on the 1990 cap-and-trade plan can be seen in the final votes: 401 to 25 in the House and 89 to 10 in the Senate.

But despite its success in the relatively contained problem of acid rain in the United States, cap and trade has proved less useful in other environmental problems and has gotten off to a troubled start in Europe.

Even some early devotees of a system of tradable emissions permits believe that it will not work for carbon dioxide, by definition a planetary problem. A straightforward tax on each ton of carbon dioxide emitted by any source, they say, would provide more a more predictable price and a simpler system to police.

“If a philosopher king could design a system, he or should might pick a taxation system,” said Robert Hahn, a White House economist under Mr. Bush who backed the acid rain program but is skeptical that it will work for the much more pervasive problem of carbon dioxide.

Former Vice President Al Gore has long supported a carbon tax. “Tax what you burn, not what you earn,” he says, as a way of both attacking global warming and remedying some of the inequities in the income tax.

But Mr. Gore also says a domestic cap-and-trade system would be easier to coordinate with other countries’ carbon control programs.

Cap and trade evolved from an academic debate that began in the early 1960s when Ronald H. Coase, then a professor at the University of Chicago Law School, wrote an influential paper, "The Problem of Social Cost,” that examined when government should intervene in cases where a private entity causes public harm.

In 1971, W. David Montgomery, a Harvard graduate student in economics, fleshed out the idea of emissions trading in his doctoral thesis and has spent much of the last three decades trying to figure out how the marketplace can deal with environmental problems that are caused by relatively few actors but have consequences felt globally.

He supported the acid rain trading program, but said it was based on “unique historical and economic circumstances” that did not apply to the much more difficult problem of carbon dioxide emissions.

Mr. Montgomery, now a vice president at Charles River Associates International, a consulting firm, said Mr. Waxman’s proposal would ultimately act like a tax on carbon-producing industries, disguised by a complex cap-and-trade system.

“It is a steel fist of regulation covered by a velvet glove of emission trading,” Mr. Montgomery said. “Why not just impose a carbon tax?”

The recent upturn in Asian economies is creating a dangerous optimism that almost wilfully ignores the difficulties ahead. Future historians will mark 2008 as the year that the development model that has driven much of Asia’s rapid growth for the past two decades went bankrupt. While the next decade will represent a difficult transition towards a new development model, unfortunately many Asian countries are responding to the economic crisis with policies that may temporarily boost growth but that are only likely to make the transition more difficult.

At the centre of the Asian development model, with China providing a steroid-fuelled example, were policies aimed at mobilising high levels of domestic savings and channelling massive investment into productive capacity. These policies boosted savings by constraining consumption even while they forced rapid growth in domestic production. One of the consequences of the Asian development model has been that production outgrew consumption for decades. When a country produces more than it consumes, it must run a trade surplus to export its excess capacity. The Asian model consequently required high and rising trade surpluses that allowed Asian producers to produce far in excess of what Asian consumers could afford to absorb.

But there cannot be trade surpluses without trade deficits elsewhere. A fundamental requirement for the Asian model was that foreigners were able to run the requisite trade deficits. In practice, only the US economy and financial system were large and flexible enough to play this role. The Asian model, in other words, implicitly involved a massive bet on the willingness and ability of the US to continue to run large and rising trade deficits.

For nearly two decades US households borrowed recklessly to finance the consumption binge that allowed Asian exporters to continue exporting excess capacity but, as household balance sheets in the US became vastly overextended, it was just a question of time before a long deleveraging process would occur. The global financial crisis is part of this very process.

As a consequence, US consumption will grow more slowly than US gross domestic product for many years. This is another way of saying that the US trade deficit must fall and may even become a trade surplus. Since it is clear that Europe, the only other economy large enough to replace the US, is too sickly and indebted to take up the slack, for the next several years Asians will not be able to continue running massive trade surpluses to absorb their excess capacity.

So what can they do? If Asian countries could boost domestic net consumption as rapidly as US net consumption declines, none of this would matter. Unfortunately, and if history is any guide, this is going to take much longer than many hope. The transition from an export-led economy to a domestic consumption-led model involves a long restructuring of the financial system and household behaviour, and a major reversion away from political structures and industrial policies that powered growth in the past.

But, wedded as they are to an outmoded development ideology and rigid industrial and financial systems, many Asian policymakers are making things worse. They are attempting to raise domestic consumption by accelerating the policies that are bankrupt.

These investment-oriented policies raise consumption indirectly, by boosting production, and so although they temporarily boost growth, they cannot result in a sufficiently large increase in domestic net consumption to replace American buying. What is worse, in some cases these policies will sharply constrain future domestic consumption, just when it is needed most.

For example, the unprecedented loan expansion that Chinese policymakers have encouraged in the past five months is not only targeted primarily at boosting investment, but will almost certainly result in a massive expansion in future non-performing loans. As these become apparent and threaten the viability of the banking system, Beijing will be forced to respond, as it did in the past, with policies that further constrain consumption – either by forcing lower deposit rates to increase bank profitability or by capturing savings to recapitalise the banks.

The risk is that China’s transition will be made worse by policies whose effect will be to cause a short-term and unsustainable rise in fiscal borrowing, bank debt and corporate inventory. Eventually working these off will make the transition to a domestic-led economy slower and more painful.

The assumption that implicitly underlay the Asian development model – that US households had an infinite ability to borrow and spend – has been shown to be false. This spells the end of this model as an engine of growth. The sooner Asian policymakers accept this and force through the necessary economic and political changes, the less painful the transition will be. Unfortunately this does not seem to be happening.

The writer is a senior associate at the Carnegie Endowment and a finance professor at Peking University

Back in the 1970s, North Sea oil was seen as the saviour of the British ­economy. The money would be spent modernising industry so that it could play in the big league with the ­Germans, the Japanese and the ­Americans. Instead, we spent the money on ­unemployment benefit and tax cuts. The industrial ­renaissance never happened.

By the time the oil started to run out, financial services were the next big thing. The City would be Britain's unique selling point, we would pay our way in the world through banking, insurance, arranging bids and deals and by being better speculators than our rivals. With the banks bust and the financial sector in a state of petrification, we are now going to find out what life is like without artificial stimulants.

Dreamland

It won't be nearly as much fun as the years of living in a dreamland, but stripping away the pretence that there is some easy, painless solution to Britain's long-standing problems represents the first stage to recovery.

Britain has no shortage of talented people. There is plenty of creativity and always has been; the problem is that it has not always been channelled in the right directions. If ever there was a moment to remedy that systemic ­failure, it is now, because this crisis has only just begun. The first phase involved banks; the second phase will be energy.

Oil prices nudged above $60 a barrel briefly last week before falling back on news that inventories are high and that demand for crude is set for its biggest fall this year since 1981. An oil price at these levels looks suspiciously high amid the first fall in global gross domestic product since the second world war, although there are possible explanations. One is that commodity traders believe there will be a more rapid recovery in the global economy than anybody is expecting. A second is that the money central banks are pumping into financial markets through quantitative easing is spilling over into speculation. Third, and most worrying, the days of cheap oil may be a thing of the past. If this is the true explanation, there will be serious consequences.

In the post-war years, there has been a clear link between oil prices and global growth: the long boom of the 1950s and 1960s was an era when crude was dirt cheap; all four major recessions (1974-75, 1980-82, 1990-92 and 2007 to now) followed a spike in oil prices.

The last trough in oil prices occurred at the end of the 1990s, coinciding with the dotcom bubble and talk in the US of the new paradigm economy. Since then, the trend has been inexorably up, with supply struggling to keep up with strong demand from the mature markets of the developed world and the big emerging economies such as China and India.

Chris Sanders, of Sanders Research Associates, traces the origins of the current crisis back to the turn of the millennium, when the fall in production from the big finds of the late 1970s – Alaska, deepwater Mexico and the North Sea – ended the era of cheap oil.

A serious recession in the wake of the dotcom bubble was only averted because policymakers – Alan Greenspan in particular – manipulated interest rates to create another unsustainable boom. This did not mean the problem had been solved; indeed, putting it off for another day simply meant the problem grew bigger. Seen from this ­perspective, what we are witnessing is not the early stages of a new bull market, but a ­temporary lull in a much longer ­crisis that will see recovery hampered by high and volatile energy prices. Indeed, the volatility of crude over the coming years is likely to be as damaging as the fact that fuel will be becoming steadily more expensive.

To envisage this scenario, you don't have to accept that we are at – or close to – peak oil. There are many oil experts who have deep reservations about the notion that the moment of maximum petroleum extraction is at hand; they argue that rising prices will encourage exploration and make it viable for oil companies to extract crude from parts of the globe that were uneconomic at a price of $20-$30 a barrel. New and better technologies will be deployed to keep oil supply in tandem with demand.

Price signals

There is no doubting the economic validity of this case. Price signals do matter, and oil companies are far more likely to beef up their spending on exploration and new refineries if the oil price is $100 a barrel than if it is $10 a barrel. That's the good news.

The bad news is that even if the peak oil sceptics are right and there is plenty of untapped crude in the South Atlantic, Canada's tar sands or Central Asia, it is going to be more expensive to extract it. Oil has been critical to the development of industrial societies but energy firms, unsurprisingly, went for the oil that was easiest to get at and of the highest quality, since that meant low extraction costs and high profits.

In other words, the energy required to get fuel out of the ground was small; the energy return on energy investment (EROI) was high. But as companies have moved to tougher environments, the EROI on oil and gas production has fallen – one estimate is from 33:1 in 1999 to 19:1 in 2005. This global trend mirrors what happened in the US, where oil is still produced in large quantities but much less efficiently than it was 75 years ago. From an estimated 100:1 in 1939, the EROI for American oil production dropped to 30:1 by 1970 and 11:1 in 2000.

As Sanders puts it: "Today we are attempting to extract oil and gas in commercially viable quantities from offshore deposits that lie under more than 25,000 feet of water, rock and hot salt. It may well be possible to do so, but what is highly unlikely is that it will be possible to do so in sufficiently large flows to make a material difference to general prosperity. Another way of putting this is that economic growth rates are going to have to slow."

On the basis of what has happened in the recent past, we are likely to see oil prices on an upward trend but with wild gyrations. Frequent oil spikes when the global ­economy appears to be on the mend will be ­followed by a crash in prices as the impact of dearer energy raises business costs and bites into consumer spending power.

There is a silver lining to this cloud. Another half century of global growth at 5% a year powered by cheap fossil fuels would almost certainly be the death of the planet as we know it. But we are as ill prepared for the post-fossil fuel age as we were for war in 1939.

But we are at our best when we have our backs to the wall: let's ­establish a ­Bletchley Park for renewable energy schemes, where the best ­scientists work out how ­Britain will survive when the oil runs out. And let's do it now.

As an investment tip it is unlikely to inspire a rush: put your money in rubbish. Nevertheless, new figures reveal that the price of recyclable waste has doubled in the past six months.

The news will provide a boost to Britain's flagging recycling movement, and go some way towards reversing the gloom over mountains of glass bottles and newspapers piling up across Britain after the drop last year in the value of recyclables.

It will also be a welcome change for UK waste collection companies and councils, hit hard by a drop in demand last autumn for paper, bottles and cans from countries such as China and India. There had been calls for warehouses and disused airfields to be made available for storing rubbish that could not be sold.

A huge global drop in the volume of waste being produced, partly due to the economic downturn, is thought to have sparked the recent sharp rise. The price of cardboard has trebled to £59 per ton since November, while PET – the plastic used in drinks bottles – has also more than doubled from £75 per ton to £195. During the same time period, the price of gold has risen by just 14 per cent, and crude oil by 16 per cent.

"The main reason for this is that the quantity of recycled material available around the world is lower than it was six months ago. It is a question of supply and demand," said George Broom, the owner of the commercial recycling company Environmental Support Services. "Also, the international demand that had dropped off is coming back."

Reports are also suggesting that overseas demand for recyclable materials is slowly increasing. "Prices are creeping up," said Lorna Langdon, managing director of Paperchasers. "The price for highgrade paper fell last year from £60 a ton to nothing at Christmas time, but has now risen to around £35 a ton. All industries have had a downturn, which includes the recycling industry. I'm sure it will improve."

Figures released by the government waste watchdog Waste Resources and Action Programme (Wrap) last week confirmed that the price of recovered materials is continuing to rise. The latest figures show that plastic bottles are increasing in value, with PET bottle prices currently at, or above, last year's peak, and paper prices are edging higher.

Although the slump in the value of recycling materials did not have a measurable impact on levels of household recycling across the UK, reports of the slump in prices did little to help consumer confidence.

"Wrap tracks consumer recycling very closely, and there has been absolutely no evidence of a significant fall in recycling behaviour since the fall in prices," said a spokesperson. "But it's also clear from the research that consumers want to be confident that what they put out is actually recycled into something useful. So this evidence of rising prices and rising demand should definitely help reinforce consumer confidence that recycling remains worthwhile."

THE wind industry has accused the government of “sabotage” over a proposed fourfold tax increase that could lead to the scrapping of up to half Britain’s 150 onshore projects.

The hike has infuriated energy groups, which are warning of a wholesale retreat from the struggling sector just weeks after the government unveiled a package of aid measures designed to support it.

In a letter seen by The Sunday Times, Eon accused the government of “giving with one hand and taking with the other”. Infinis, the renewable-energy group owned by Guy Hands’s Terra Firma, said the changes would “amount to between 40% and 50% of [its] portfolio not proceeding past the consent stage”.

Every five years the Treasury’s Valuation Office Agency (VOA) resets business rates. Its latest proposal would raise rates from next April from £5,000 per megawatt to £20,000 per megawatt.

Business rates make up about 5% of an onshore wind farm’s running costs, which under the proposal would increase to about 20%, rendering many of the 150 projects planned in Britain unviable. Offshore farms are exempt.

The dramatic difference in rates is due to the inclusion by the VOA of the per-megawatt subsidies that the government has introduced to encourage investment. A spokesman for the BWEA, the industry lobby group, said: “We won’t be able to deliver on the government’s targets if schemes are no longer profitable.”

Government claims that it is leading a green energy revolution were condemned after it emerged that funding for five prominent environmental initiatives had been cut by 25 per cent this year.

Details of funding for the organisations, which include the Energy Savings Trust (EST), the Waste and Resources Action programme (Wrap), the Carbon Trust, the National Industrial Symbiosis Programme (NISP) and Envirowise, surfaced in a parliamentary answer from Joan Ruddock, a junior minister at the Department of Energy and Climate Change (DECC).

They show that the five organisations would receive £68 million less from the Government this year than they did during 2008, a drop of more than 25 per cent from £270 million to £202 million. The figures show funding for Envirowise, which offers businesses advice on reducing the waste they send to landfill, as well as on water and energy use, more than halved from £22 million to £9 million.

Funding for NISP, which helps companies to identify new uses for waste products, including as raw materials for other industries, was cut from £10 million to £5 million. Wrap, which works to increase recycling levels among UK businesses and households, had its funding trimmed from £62 million to £43 million.

Greg Clark, the Conservative energy spokesman, said: “What the market needs is long-term certainty. This sort of stop-start funding is anathema to any business trying to establish itself in these key industries.”

Martin Horwood, energy spokesman for the Liberal Democrats, said that such “huge budget cuts” were undermining Britain's plans to improve sustainability and cut its emissions.

A spokesman for the Department for Environment, Food and Rural Affairs (Defra), which oversees Wrap, NISP and Envirowise, claimed that a general increase in public understanding of green issues had led to the funding cuts. “The support we offer is now focused on providing the necessary evidence to encourage businesses to change their behaviour, rather than financially supporting individual business projects,” the spokesman said.

A spokesman for DECC, which supports the Carbon Trust and EST, acknowledged that there had been an overall drop in government support for the groups. However, the spokesman said that EST's cut was because of a failure on its part to secure contracts that public sector bodies had put out to tender.

Cuts at the Carbon Trust were the result of an anomaly, the spokesman said. “Carbon Trust funding has increased year-on-year since the Trust was set up in 2001. We expect the upward trend to continue, particularly in light of the Budget which announced an additional £165 million for loans to SMEs and the public sector.”

The financial condition of some of Britain's train operating companies is so parlous that the Government needs to make contingency plans for keeping the railways running "in the event of multiple failure", a cross-party committee of MPs warned today.

Some of the companies running rail franchises around the UK were already earning significantly less from the contracts than they expected and some could fail if the recession further eroded passenger revenues, the Commons Public Accounts Committee (PAC) said. Edward Leigh, its chairman, added: "Revenues are likely to fall for the companies and the Department for Transport should develop robust contingency plans to keep services running if a number of train operators fail financially."

Under the rail franchises awarded by the Department for Transport (DfT) between 2005 and 2007, train operators pay to offer services, or in some cases receive subsidies, with the terms of the contracts based on projections of how passenger volumes and revenues will grow in the years ahead. However, the contracts were signed before Britain began sliding into an economic downturn and many companies are now finding the projections they made were over-optimistic.

Despite the changing economic environment, the PAC said franchise holders should not be allowed to renegotiate contracts. Mr Leigh added: "The DfT should hold train operators to their contract terms, even where the original bid might have included revenue assumptions which now look too rosy."

That conclusion will upset National Express, which runs the East Coast Main Line and is the most high-profile casualty of the downturn so far. National Express, which in December 2007 agreed to pay £1.4bn to run trains between London and Edinburgh until 2015, is currently lobbying the Government for a relaxation in the terms of its franchise. Earlier this month, it said passenger revenues grew by only 0.3 per cent in its last financial year, compared to the 9 to 10 per cent forecast when the franchise was awarded.

Most rail franchises do have provisions for less demanding financial terms if passenger revenues fall short of expectations, but the concessions only kick in after a minimum period, typically four years. FirstGroup, for example, which runs services to the West Country, received a £50m Government subsidy last year after its revenues came in well below expectations.

Douglas McNeill, a rail analyst at broker Blue Oar, said almost all franchise holders were suffering from the downturn. "Passenger numbers were buoyant until quite recently but they are now on their way down," he said. "The other problem is that people are travelling in standard class rather than first class, or planning further ahead to save money on fares."

Nevertheless, Mr McNeill said fears of multiple failures among rail operators were likely to prove exaggerated, because of the support written into franchises after the minimum period elapses. "Companies are unlikely to incur losses indefinitely," he added.

However, the PAC also warns today that, even without failures, financial pressures threaten customer service, with some operators likely to scale back their plans to tackle overcrowding, or to withdraw service they are not legally obliged to provide.

The MPs added that the DfT's efforts to reduce the burden of financing the railways borne by the taxpayer had seen costs to passengers rise sharply. Unregulated fares rose by up to 20 per cent in January, it pointed out.

Mr Leigh accused train operators of over-complicating fare structures and denying some passengers access to the cheapest tickets, by making them available only to those booking online.

A compelling case for the first big electrification programme for 20 years will be presented on Friday by the company that runs Britain’s railways – a move that would cut rail costs and lead to faster, more reliable and cleaner journeys.

The Network Rail consultation will say electrification of much of the Great Western route from London to western England and Wales and of the Midland main line from London to Sheffield makes most sense. Neither project would need any government grant or subsidy.

Geoff Hoon, transport secretary, has welcomed the report, calling it a “valuable step”. The Department for Transport is due to decide later this year on a resumption of rail electrification.

“The government is committed to electrification because of the benefits it brings to rail passengers, through more reliable and comfortable electric trains and a reduction in the country’s carbon emissions and the cost of running the railway,” Mr Hoon said.

He is likely to come under pressure from train operators to decide fast in order to lift uncertainty over whether new electric or diesel trains should be ordered for routes.

The last big electrification project was on the London-Edinburgh east coast main line, authorised in 1984 and completed in 1991. Since privatisation in the mid-1990s, only further small sections of line have been electrified, usually to provide extra routes for electric trains round engineering work. Only 40 per cent of the network is electrified, a far lower proportion than in countries such as Germany and France.

Electric trains cost 33 per cent less per mile to maintain than diesel trains, the document says. They cost 45 per cent less in fuel, 18 per cent less to lease and produce less damage to track. Passengers should also enjoy shorter journeys thanks to electric trains’ superior acceleration.

While emissions vary between train types, carbon dioxide emissions per mile from electric trains can be less than half those for comparable diesels.

The cost of putting up electric wires on the Midland main line from Bedford to Nottingham and Sheffield, and on the Great Western route from Maidenhead to Bristol and Swansea is likely to be relatively low. The Midland route cost would probably be about £100m and the Great Western about £120m.

However, neither figure includes the cost of new electric trains, any new signalling required or alterations to bridges and tunnels. There are 90 structures on the Midland main line that would require alterations, while on the Great Western main line the main obstacle is the four-and-a-half-mile long Severn tunnel, which leaks heavily.

The east coast main line project cost £306m in 1984 prices, including new trains and signalling, although many observers believe savings on the overhead line equipment in that project have contributed to its unreliability since.

Apart from the Midland and Great Western routes, the document identifies some projects – including electrification of much of the inter-city cross-country network – whose benefits outweigh costs to the government by five or more times.

A government subsidy would be required, however, because many of the benefits would be non-financial ones such as a cleaner environment.