The Norwegian power trader who got caught on the losing end of a 4-sigma move in price spreads is being forced into bankruptcy after liquidating his entire estate. But in the US, two ex-JPM traders who wracked up comparably massive losses have managed to walk away, leaving the end-users and distributors on one of America's largest energy grids holding the bag.
BusinessWeek on Tuesday published a story about GreenHat Energy LLC, an ill-fated power speculator that bought a sizable position in long-dated financial transmission rights. FTRs, as they're more widely known, are an obscure power derivative designed to allow distributors to hedge against sudden spike in transmission costs when parts of the grid are temporarily taken offline (due to inclement weather or some other hazard). Houston-based Greenhat opened the positions via PJM Interconnection LLC, which oversees a wholesale electric grid serving 65 million people between Chicago and Washington, DC.
They are used in deregulated power markets to help energy buyers, generators, and distributors protect against localized price swings. Bottlenecks can sometimes form on the power grid—such as during an ice storm or when a plant goes down—creating what are known as congestion costs. Using an FTR, a big power buyer can get paid when congestion costs rise, offsetting its risk. But it might also end up owing money if there isn’t congestion.
Financial players can buy FTRs, too. Much of GreenHat’s portfolio was “long-dated”—meaning it was betting on transmission-line congestion patterns that wouldn’t start until June 2018. And based on historical patterns, most of those positions initially looked like smart moves, according to PJM. That likelihood of success brought a side benefit to GreenHat: Under PJM rules at the time, it could keep building up its portfolio without having to put up much money as collateral. But GreenHat would have to pay if congestion patterns turned out to differ widely from those in the past.
GreenHat opened its FTR position in 2015. By April 2016, the first signs of a problem had emerged. Around that time, another trader on PJM known as DC energy, one of the largest buyers of FTRs, complained to PJM about rival portfolios with no collateral attached.When PJM approached GreenHat, one of its partners, Andrew Kittell said his firm had offsetting contracts that would pay out more than $62 million should their FTR bet turn sour. PJM mentioned this in one of its filings to the Federal Energy Regulatory Commission.
But as it turns out, that was a lie. Two years later, Greenhat's position was in bad shape, thanks to renovations to transmission lines that reduced congestion. However, instead of cutting their losses, the Greenhat traders doubled down.
By spring 2018, GreenHat’s bets were looking bad. Upgrades had taken place to transmission lines across the Eastern U.S. that promised to lessen congestion on the grid. But instead of closing out its doomed positions, GreenHat did the opposite and doubled down. It bought additional hedges that expanded its PJM portfolio by almost half—while also serving to keep the company’s collateral requirements very low.
When their collateral cushion finally ran out, PJM sent the firm an invoice for $1.2 million that it never paid. Its position was soon declared in default. But since the power exchange lacks a coherent clearing mechanism to absorb the losses of traders who default, PJM was forced to spread the tab around to its other clients - i.e. the rest of us (virtually everybody who uses electricity connected to that grid will pay some of GreenHat's bill in the form of higher electricity prices).
On June 5, GreenHat received an invoice from PJM for $1.2 million to cover losses. It didn’t pay. On June 21, PJM declared GreenHat in default. Losses have continued to mount, according to PJM. The portfolio has more hedges that will probably keep losing money for three years, though it’s impossible to say exactly how much because of changing conditions with transmission lines. And that third party that GreenHat promised would cover losses? The unnamed entity told PJM that it doesn’t owe the firm anything, according to the PJM filing.
Now, members are debating whether changes promised by PJM will be enough to avoid something like this happening again in the future, while some smaller companies relying on PJM's transmission lines will need to pay about $10,000.
Since GreenHat isn’t paying for its losing bets, that leaves it for fellow PJM market participants to pick up the tab. Some are now in a debate about how to unwind the positions—book the losses now or let the bets run their course. In the meantime, PJM has begun to charge its thousand or so members, companies that use the transmission lines to move electricity or for other purposes. Smaller businesses have to pay about $10,000, while big, active PJM participants, including the likes of Exelon Corp. and American Electric Power Co., will need to absorb the rest. Members are also debating whether several changes adopted by PJM will be enough to prevent a similar incident. PJM said in a statement that it’s investigating the situation and its options for legal action.
Meanwhile, Kittell and John Bartholomew, the traders behind GreenHat, sought to distance themselves from company. By the summer of 2018, Kittell and Bartholomew were making no mention of GreenHat on their LinkedIn profiles. In fact - aside from a negative article about their behavior published in BusinessWeek - the two have walked away with relatively few consequences.
GreenHat "can easily walk away and leave other people holding the bag," said Susan Bruce, an attorney who represents the group PJM Industrial Customer Coalition. "Large steel mills, large manufacturers, your mom and pop dry cleaners - they’re going to pay a portion of this default. Everyone else is holding the bag."
Before taking on GreenHat as a customer, PJM should have probably done some more due diligence. Both Bartholomew and Kittell were involved in a high-profile scandal involving allegations that they helped manipulate wholesale power markets back when they were both traders at JPM. The bank ended up paying roughly $400 million in fines and penalties related to the scandal.
It's a story that's not uncommon in modern markets: Traders take massive risks with investors' money, and, when the risks pan out, they gladly claim their rewards in the form of massive fees. When they don't, traders can simply walk away.
"The whole thing is a mess and a disaster," said an employee at a retail energy distributor that uses PJM's grid. "GreenHat was allowed to take a very large position that may have made economic sense at one point. But like everybody else, they were probably hoping to hit the jackpot, and they didn’t."