Doubling Down – with Other People’s Money
UPDATED: How Two Traders Linked to 2013 Scandal Left Members Holding the Bag for Millions
Imagine a casino where you could produce $548 million in paper profits — or $100 million in losses — with only $600,000 of collateral. That’s essentially what Andrew Kittell and John Bartholomew saw when they began trading financial transmission rights in PJM in 2014, the beginning of a saga that has now spiraled into the largest default in the history of the RTO’s financial markets.
After the default of Tower Research Capital’s Power Edge hedge fund in 2007, FERC ordered an end to collateral-free trading in Order 741. PJM and other RTOs tightened their credit rules as a result.
But the changes weren’t enough to protect PJM against Kittell and Bartholomew’s GreenHat Energy, which purchased a staggering 890 million MWh of FTRs — the largest FTR portfolio in PJM — before the company defaulted in June.
In hindsight, RTO officials should have been wary of Kittell and Bartholomew, who came to FERC’s attention for their roles in J.P. Morgan Ventures Energy Corp.’s (JPMVEC) scheme to manipulate the CAISO and MISO markets between 2010 and 2012.
The GreenHat debacle has led to proposals for additional changes to PJM’s credit policy and questions about the competence and vigilance of RTO staff involved. PJM’s failure to respond promptly to warnings from other FTR traders allowed GreenHat’s $10 million loss in 2017 to grow — leaving other market participants on the hook for as much as $145 million. [Editor’s Note: FERC issued rulings in two FTR dockets on Sept. 25. See update at bottom.]
Here, based on interviews, PJM records and FERC filings, is how it happened, a cautionary tale of inadequate safeguards, opportunistic traders, foot dragging to patch loopholes and, finally, a botched effort to obtain more collateral that may have netted the RTO nothing. GreenHat’s principals did not respond to requests for comments sent to their attorneys, David Gerger of Houston and John N. Estes III of D.C.
Aggressive Purchases
After becoming a PJM member in 2014, GreenHat began amassing its FTR portfolio in the 2015 long-term FTR auction. The company focused most of its activity on positions in the 2018/2019 planning year, securing the rights to 54 million MWh each month. That accounted for 73% of its portfolio. It held another 18 million MWh (24%) for the 2019/20 planning year and 2 million MWh (3%) for the 2020/21 planning year.
The company stuck mostly to long-term auctions — which are held three times a year and offer positions for the following year and two more beyond that — buying many of the same paths year over year. Between 2015 and December 2017, GreenHat participated in at least five long-term auctions. The positions seemed like good bets at one time: PJM calculates that in the 2015/2016 planning year, GreenHat’s portfolio would have netted $548 million in profits.
How much did GreenHat pay to amass such a large position? Nothing at the time. It bought on credit, having to post only its initial $600,000 in collateral. Yet there were indications that GreenHat was not well capitalized: On one document, it listed its address as 826 Orange Avenue, Suite 565 Coronado, Calif. — a UPS store between a nail salon and a RiteAid.
GreenHat’s positions, had the company held them, would have remained profitable, though less so, in the 2016/17 and 2017/18 planning years.
But the profitability of GreenHat’s positions was falling as transmission upgrades approved in PJM’s Regional Transmission Expansion Plan to alleviate congestion were added to the FTR model. The implied profits of GreenHat’s portfolio, based on the auction clearing price, were $0 from the December 2015 long-term auction, and they generally decreased with each subsequent auction. By the December 2017 auction, the portfolio appeared to be a $45 million loser.
During those years, GreenHat posted no more collateral than the $600,000 it originally provided as a requirement to trade in PJM’s market. FTR auction participants do not pay the purchase price of FTRs until settlement, when the price is combined with or netted against any congestion revenue credit owed to or by the FTR holder. PJM calculates collateral based on a comparison of the purchase price to the “adjusted FTR historical value,” a three-year, weighted average of the day-ahead congestion previously experienced on the FTR’s path.
The comparison calculations are cumulative, so a negative number for one position can help offset a positive number for another. In that way, GreenHat was able to consistently balance out its portfolio so it could continue acquiring positions without owing collateral.
Doubling Down
In April, PJM implemented FERC-approved revisions to its credit policy that factored future transmission upgrades into credit calculations, essentially reducing the expected clearing price on affected paths (ER18-425). The changes would have created a $60 million collateral call for GreenHat’s portfolio, according to PJM, but the rule included a 13-month transition period, which GreenHat would exploit to increase its holdings.
During the transition, GreenHat participated in its only annual FTR auction, for the 2018/2019 planning year, acquiring enough new seemingly winning positions to negate a collateral call. The additional purchases would ultimately add nearly $35 million more in anticipated losses to the company’s portfolio.
“The buying activity in PJM’s PY18/19 auction by [GreenHat] did not appear to be designed to reverse or offset [GreenHat’s losing] positions. Instead, the buying activity was focused on entirely different parts of the PJM network, with a particular focus on buying FTRs with high adjusted FTR historical values (even after accounting for transmission upgrades) relative to their auction clearing prices, which as a result reduced [GreenHat’s] collateral requirements,” DC Energy noted in a FERC complaint seeking immediate changes to PJM’s credit requirements (EL18-170).
Going to Settlement
GreenHat’s positions started going to settlement with the beginning of planning year 2018/19 on June 1, and PJM issued GreenHat a $1.2 million bill for its initial losses on June 5. By the time PJM declared GreenHat in default on June 21 — after a waiting period required by the Tariff — the anticipated losses had ballooned to $110 million.
At a stakeholder meeting in August, Vitol’s Joe Wadsworth said he used recent market results to determine that it could be upward of $145 million and “is getting worse.”
