It is difficult to ignore the current rising price of crude oil. At the peak of its increase Brent had gained 33% since the start of the year to $39.08/bl while US crude rallied to new lifetime highs over $42/bl. The probability is for oil to settle in a new high price scenario with the average price of Brent for 2004 expected to be around $33-$34 based on a current average year to date Brent price of just under $33/bl.Although oil has little direct influence on the generation market, with oil-fired plant increasingly being replaced by gas and, in some cases, renewables, the rise in oil prices does have a strong indirect influence on the electricity generation and supply markets. Most gas prices are still indexed to oil – a legacy of gas being a replacement fuel for oil – and as such oil price increases and decreases are reflected in the gas price. Similarly in the UK, where the fully competitive gas market affords gas-on-gas competition as the primary price indicator, the strong rise in the oil price has pushed the winter gas price higher.But if we look at the European market there appear to be some anomalies. Taking the UK first, although gas pricing is effectively de-linked from oil it has tended to rally in concert with sharp oil price increases but this oil–gas relationship tends not to be reciprocal, ie when oil prices fall gas does not follow proportionately in the pattern of its its upside movements. This irrationality in the oil–gas relationship has no fundamental basis and suggests that oil price increases are being used as a convenient proxy for the gas market. Indeed the recent price support afforded by oil price increases followed a period of high winter gas prices which arguably had little fundamental basis – they had increased on the perception of reduced winter supply although this coming winter's supply is expected to be greater than last winter with National Grid Transco forecasting that supplies would be sufficient for a '1 in 50' severe winter scenario. Indeed, if the impact of oil on gas prices in Europe is considered it is evident that European gas prices, which are indexed to oil, have not increased as much as those in the UK which are not formally linked to oil. This supports the view that the UK gas relationship to oil is artificial.The reliance on oil as a convenient proxy market for gas has potential consequences for the European market. In July the European Internal Energy Market (IEM) will move a stage closer to fruition as European member states are required to introduce full wholesale competition in gas and electricity markets. The ethos of the IEM is to enhance market competition and promote gas and electricity more as commodity markets (as opposed to assets) and for them to be traded as such. But if the gas price is being directionally influenced by oil it is arguable that gas is still being viewed more as an asset than a commodity. Using oil as a proxy for gas (and electricity) has other consequences on trading and price signals. Oil is a very sophisticated traded market compared to gas and electricity, which are still largely developing traded markets, but gas and electricity are significantly more complex markets compared to oil, due to their dependence on locational supply and system balancing. As such, the over reliance on oil as a proxy market for gas and electricity can introduce basis risks and lead to incorrect pricing signals.The clear danger of incorrect pricing signals is that they impact on investment decisions for new gas and electricity plant and as such have an impact on capacity. The European Commission has argued that for this very reason gas should be de-linked from oil, and ideally this should be the case. This ideal is unlikely to be realised. Europe, and particularly the UK, is becoming increasingly reliant on gas imports, with most of these imports originating from the gas rich Middle East, Algeria and Russia. And these imports (which include liquefied natural gas) are likely to be based on long-term contracts (15 years plus), which are priced on an oil index.If we accept that the oil factor cannot be segregated from gas (and electricity) pricing then the market will have to modify its trading accordingly. To use oil as a proxy market for gas and electricity, although convenient, introduces additional pricing risks. With increased competition in the European gas and electricity markets expected with the introduction of full wholesale competition in July, the onus on the market is to increase its trading sophistication. And to achieve an increase in trading sophistication will require a greater understanding of the market fundamentals and how these impact on gas and electricity prices.Of equal importance will be the progress of energy towards an increasingly convergent market. While oil influences the price of gas and electricity these prices are also being increasingly influenced by emissions and coal. While emissions, through the EU Emissions Trading Scheme, are impacting on electricity prices and, as a consequence, gas, the price of coal is also influencing electricity (and gas) as generators assess the economics of switching between gas and coal plant.The problem the market faces is that while the oil market is highly liquid and transparent the other energy markets – gas, electricity, coal and emissions – are not. And until liquidity and transparency in these markets is increased oil may well remain a convenient proxy market.