When a victim of spontaneous human combustion appears, no one even hesitates in calling Fringe division. They come in and discover that the victim was a pyrokinetic, someone who can control fire with their mind. It is at this point that Olivia begins to get glimpses into another universe, which leads her to find a second pyrokinetic, and the man who is activating them, Harris. While attempting to apprehend Harris, he locks Olivia in with the second pyrokinetic who is about to explode. But with Olivia's help, she focuses on Harris and burns him alive. Later Olivia confronts Walter about the drug trials that he and Bell conducted, but he can't remember them.
And where is the Observer? Well if you can't find him then you should leave right now. He can be found at the end of the episode in Walter's lab, just before he and Walter walk out the front door. The picture is below with a red box around the Observer, but if you seriously did not see him, then you really should get glasses or something.