John Ramsey was intrigued by one item in a haul of suspicious substances gathered by police at the Creamfields dance festival in Cheshire, north-west England, last August. A pre-rolled cigarette packaged as "Spice" contained something that looked like cannabis - and was bought in the belief that it would deliver the same effect as the illicitly smoked plant extract.

Ramsey, director of Tictac Communications, a London-based consultancy that identifies fake medicines and real narcotics alike, is able to track trends in drug use across the UK. By the time Ramsey saw his first sample of Spice, others were already on to it. The Early Warning System, an electronic network that links police, customs officials and drug specialists around Europe, had been circulating questions about the new product for some time. Alerted by discussion on internet message boards and growing imports of the product, Sweden, Switzerland and Jersey had begun to seize batches for analysis in 2006 but had failed to identify any banned substances within it.

In early 2008, the European Monitoring Centre for Drugs and Drug Addiction, based in Lisbon, which co-ordinates the Early Warning System, identified a dozen online distributors of Spice across the European Union, half based in the UK and another third in the Netherlands. The product, which is also offered for sale in a growing number of high street "head shops", seemed to be the latest in a long line of suspicious-looking but largely innocuous tobacco-like substances dubbed "herbal" or "legal highs".

"They have always been pretty much a rip-off and never done anything," says Ramsey. "Our antennae were not sufficiently high to be suspicious about Spice till recently. But then people started saying that it works."

Slickly presented in small sealed pouches and ever more widely smoked, Spice has sparked growing concern among officials who have learnt much more about the substance in recent weeks, triggering bans last month in Austria and Germany, and customs seizures in the US. Yet in most countries, including the UK, where it seems to have been marketed first, its promoters have been able to generate substantial income and stay several steps ahead of regulators.

On Greenwich Church Street in south-east London, set apart from the neighbouring cafés and boutiques by its bright orange decor, is a shop called Shiva. A poster inside promotes Spice as "the only herbal smoke that actually works. Nicotine and tobacco-free. Anytime, anyplace (except when operating heavy machinery)."

Behind the till, packets of Spice and similar products are displayed on small plastic shelves, like cigarettes in a newsagent. "Spice Diamond is much stronger than Spice Gold," explains the well-spoken sales assistant with a stud in her lip. "Here's a smaller sample pack if you want to try it first."

Travel 30 minutes from Greenwich to the heart of north London and Spice is hard to avoid. You can spot Spice on sale in almost every shop on Camden High Street leading up towards Regent's Canal. Taped to the shelves in one - next to a sign saying "no photographs" - are small sachets. There is San Pedro Cactus, EcSess, Amsterdam Gold, Devil's Weed, Hyper X. But most slick is a series of products wrapped in silver, gold and green foil, bearing the trademark stylised eye logo above the brand name. "Enjoy the enchanting aroma of Spice," reads the blurb on the back. "Not for human consumption".

The shopkeeper, his voice half-drowned out by techno music, tells a different story. "It's like marijuana," he says to three curious French teenagers. Shortly after, when I try to buy a sachet, he asks me for £30, then, after some haggling, drops to £22, eventually throwing in a packet of Rizla cigarette papers, which leaves little room for doubt about the product's use.

Even with the discount, Spice is substantially more expensive than cannabis. A 3g packet - enough for half-a-dozen joints - is several times the price of weed bought on the street. But it has one obvious advantage for sellers and buyers alike: it isn't illegal. Outside the shop, two police officers walk by, scrutinising the crowds. They show no interest in stopping the transactions taking place within a puff of smoke of them.

Spice may be legal but does it offer the same effect? According to some internet forums, yes. As long ago as September 2006, a user named "Mexican Seafood" posted this message on the bluelight site, which specialises in drug discussions: "So, an old friend of mine told me that he and some of my other friends have been buying this stuff called 'Spice', which is a legal smoking herb blend. He said he only had a little bit, and he found the high pretty impressive, and several other friends I know and trust swear by it."

The anonymous recommendations, whether genuine or fabricated by those with a commercial interest, have spiralled since. Last December, on The Vaults of Erowid site, "Ottomatic" wrote, presumably while inhaling: "I hit it once, felt a head change. After the second hit i deffinately felt something reminsicent of a weed high. 10 minutes and a third hit later, i was stoned. Not 100% like good old pot but damn close. Lethargic, red-eyed, and i got the munchies. What more could i ask for. I will smoke this product untill THE MAN makes it illegal."

"Legal highs?" scoffs David Carter, as I hand over the pack of Spice. "I'd call them illegal medicines or illegal highs. Some of them are garbage. They are only called legal highs because the Misuse of Drugs Act has not caught up with them. There's a lively market in these products. A lot of them work on the basis of hype."

A soft-spoken man with a forensic eye, Carter is head of the "borderline section" at the Medicines and Healthcare Products Regulatory Agency (MHRA) in Vauxhall, London. The agency's job is to authorise new medicines and medical devices according to the Medicines Act. It is also responsible for enforcement against counterfeits and other products that do not meet its standards of safety and efficacy.

He peers at the label, rubs the mixture of herbs between his fingers, sniffs deeply and calls it "chocolatey" as though he is sampling a vintage wine. He carefully reads the contents label on the back, which lists a concoction of a dozen exotic plants, and nods in recognition. Last autumn, the MHRA received a referral from the manufacturer concerning Spice.

Officials decided Spice was subject to the Medicines Act. The MHRA wrote a stern letter to Psyche Deli, the manufacturer, concluding that it needed to apply for a licence. Most companies the MHRA contacts with similar decisions withdraw their products at this point but the warning had no effect. Sales continued to grow and there is little current sign of, or potential for, enforcement.

The problem, Carter concedes, is that such products fall into a regulatory hole. The herbs cited could have legitimate uses and are not always provided in the form that has hallucinogenic effects. They are not included in the periodically updated list of banned narcotic substances in the Misuse of Drugs Act, supervised by the UK Home Office.

But are the contents listed on the Spice label accurate and comprehensive? Do they tally with the high that its users describe? Elizabeth Williamson, professor of pharmacy at the University of Reading and a specialist in herbal medicines, has never seen Spice before. She studies the information on the packet with interest. "The people who have done this know the law. None of the herbs are illegal," she says.

If there were to be a prosecution, it would be necessary to identify precisely what the product contains. "These things are remarkably expensive and difficult to analyse," she adds. Williamson promises to examine the contents of the sachet to determine whether they contain any real cannabis, which might explain the reported effects. A few days later, she sends an e-mail. "I couldn't find any of the features associated with the herb, so I think we can be confident that they don't contain cannabis."

Holger Rönitz is business development director and co-founder of THC Pharm, a rather unusual pharmaceutical company based in Frankfurt, Germany. In the early 1990s, his business partner had a car accident that left him in a wheelchair. He was struck by how many other patients in rehabilitation around him were using cannabis. They turned, often reluctantly, to the weed when prescription drugs failed.

"We knew there was a market and we talked to some of the big companies but they didn't want to touch it," says Rönitz. "There was a stigma." In response, he helped set up THC Pharm in 1996 as a "patient initiative". It derived THC, the principal hallucinogenic compound in cannabis, from legal hemp, and persuaded doctors to offer it to patients with a long history of chronic pain. Rönitz's organisation is also studying synthetic compounds that can reproduce the plant's effects.

In November last year, the Frankfurt drug department approached THC Pharm after local universities failed to identify the compounds in Spice. "We had a hunch," Rönitz says. By early December, THC Pharm was proved right, finding at least two artificially manufactured chemical substances that had been added to the product's herbal ingredients. The company's researchers were able to recognise them because they already had the "fingerprints" of these compounds: both were among dozens of synthetic cannabinoids already described in academic journals, and which THC Pharm had synthesised as it experimented with potential manufactured variants of cannabis. One is called JWH 018; the other CP 47,497.

John W Huffman lent his initials to the first compound. A chemistry professor at Clemson University, South Carolina, he first described it in a paper published in 1998. The letters of the second compound stand for Charles Pfizer - the giant US pharmaceutical company that developed this and many similar potential drugs in the 1970s that they then abandoned. "They were looking for analgesics but all they got were extremely potent cannabinoids," says Huffman.

He confirms that JWH 018 could prove tempting to manufacturers. It acts as an "antagonist", triggering the CB1 receptor in the human body that simulates the calming effect of cannabis. It is many times more potent than the natural plant and will probably remain in the body much longer. Yet because its structure and behaviour is different, it would not be detected in conventional urine or blood tests for cannabis. Furthermore, it is cheap and easy to make from widely available raw materials, and involves only a two-step process. "A good chemistry undergraduate could do it," says Huffman.

What he doesn't know is the dangers that his compound could pose to humans. "We had no idea that anyone would be stupid enough to use it," he says. "If you want to get high, marijuana is easily available." One concern is quality. He stresses that synthesising JWH 018 - an amber gel - requires a purification process. Yet since word began to spread on the internet at the end of last year that Spice contained JWH 018, he has been contacted by a number of people describing the versions they have produced as powdery or like black tar. "I have had numerous calls and even more numerous e-mails," he says. "It is clear that some people did not know what they were doing."

Rönitz raises a further worrying issue about the use of JWH 018, that of concentration. "In different packages of Spice, it was between 0.2 and 3 per cent," he says. "That is like drinking a pint with 4 per cent alcohol content and one with 60 per cent." Even the weight of the herbs in Spice packets, all nominally 3g, varies widely. "The real issue is that something is being sold without the consumer having any knowledge of what's in there. It's a bit like Russian roulette. I'm not a big fan of demonising it but I think it's a bit scary. Thousands of people have consumed it," he says.

Not all users enthuse about Spice. Posting on The Vaults of Erowid, "PippUK" wrote: "I went on to have a full on panic attack, the like of which I have never had before. The paranoid thoughts reached a crescendo of pointless gnashing of what ifs and other self loathing nonsense."

Les King, an adviser to the UK Home Office and the pre-eminent expert on cannabis, says: "This is the first synthetic drug like cannabis. We don't know the risks. Synthetics were only developed a few years ago, and not much is published on their effects. If it's interacting with the natural cannabis receptors in the brain, it could cause short-term psychosis, and possible long-term psychotic illness. The government would likely take a precautionary line as it did with cannabis."

But official action is slow. King describes the current EU regulatory system as a "lumbering giant", with no likelihood of an EU-wide ban, even if the evidence is strong enough, until at least 2010.

So what of Spice's producers? Working largely through intermediaries, online and in person, they give only a website address on their products: psychedeli.co.uk. The site has now disappeared but official company records show that Psyche Deli does exist. Its two shareholders and directors are Richard Creswell and Paul Galbraith. The scant and tardy accounts give some idea of the size and growth of the business: assets rose from £65,000 in 2006 to £899,000 in 2007.

I head up Holloway Road in north London to find the registered office. Behind a security gate in the nondescript two-storey Archway Business Centre, neighbours point to an office without a nameplate. A woman opens the door and explains she is a friend of Galbraith's, closing up the office. She says Psyche Deli has been sold to a Dutch "head shop", De Sjamaan, and the owners have moved to the Netherlands too.

As I turn to leave, my eye lights on a pile of boxes. Inside are packs of Spice. On the side of one box is an air waybill showing that the consignment was delivered to Heathrow from Qingdao in China. It looks as though all production takes place in Asia. On top of another box is a roll of sticky labels for a product called Genie. "Release the magic of the enchanting potpourri aroma," it reads.

While the regulators gear up to move against Spice, its purveyors are moving on to the next product, always one step ahead of the law.

Andrew Jack is the FT's pharmaceutical correspondent