Well here’s a bit of interesting news in the energy trading world. Google Energy LLC, a recently formed subsidiary at Google, has applied for approval from the Federal Energy Regulatory Commission (FERC) to “act as a power marketer, purchasing electricity and reselling it to wholesale customers.”

Yes, that’s right. Google wants to get into the business of energy trading.

Enron anyone…?

As noted in the San Francisco Chronicle, Google spokeswoman Niki Fenwick denies any similarity to the Houston based, now defunct, energy company. "We want to be able to procure more renewable energy as part of our carbon neutrality commitment," she said. Apparently securing “market-based rate authority” from FERC could allow the company to purchase power from alternative sources like wind, geothermal and solar.

(By the way, this is not an unprecedented move. Wal-Mart owns Texas Retail Energy, an electricity provider it helped create in 2004, to provide power to its stores. It has yet to sell electricity).

Google is not new to the energy sector. It already consumes massive amounts of energy to power its data centers. It is also no stranger to funding alternative and green energy initiatives through its philanthropic arm, Google.org. Many of Google’s facilities are also topped with solar panels. In a way, then, getting into the energy business seems like a logical step for a company used to venturing and investing in places it holds technological (or at least psychological) dominance, like books, video (YouTube), mobile phones (Nexus One), and more.

So if Google wants to get into the energy business in order to achieve a carbon neutral position, more power to them (so to speak). The red flag in this story, however, is in the trading capacity of Google Energy’s positioning. Again, from the Chronicle: “The company doesn't have any specific plans to actually trade or sell energy, but it wanted to ensure it had all the flexibility it needed to reach its goals, Fenwick said. For instance, she described one scenario in which the company could buy solar or wind power directly, strip off the renewable energy credits to offset the company's carbon footprint and then resell the energy.” Google says it has “no concrete plans” to sell energy… but that doesn’t mean it couldn’t.

Where are the potential pitfalls and risks in Google’s move? There will be trading issues, no doubt. How Google intends to buy and sell renewable energy on the open market comes with its own hazards. Same goes for buying and selling green credits and carbon offsets, a trading area still trying to get its legs. Moreover, as a utility, Google Energy will be falling under a new umbrella of state(s) and federal government regulation and compliance.

Further, is there a conflict of interest if the utility Google Energy purchases renewable power generated by companies funded by the philanthropic arm, Google.org?

Google always seems to be one step ahead of the curve, this one is worth keeping an eye on.

Read more >>

Posted by Shaun Randol at 11:28 AM 2 comments

Systemic risk has been defined many ways, in most cases explained in ways that best align with the interest of specific constituents ranging from bankers, economists, regulators and politicians. Regardless of the agenda, systemic risk is probably best summarized as that of an economic shock or event triggering market dislocation, illiquidity and the potential for failure of a group of institutions that jeopardizes the integrity of the local or global financial system.

Assessing systemic risk (especially in the “So What” rather than the What” sense) can be challenging or virtually impossible. Consider the following examples where, without sufficient warning (at least of the even-I-understand-that variety), market events triggered the failure of these entities and immediately threatened the financial system.

• LTCM, a hedge fund run by “the best of the best” saw its fortunes turn when an unexpected failure on Russian debt triggered a global flight to quality causing LTCM bets to go awry while creating disproportionately large margin calls due to excess leverage.
• Fannie Mae and Freddie Mac, two GSEs thought to be “default-proof” but whose use of excessive leverage and a hedge fund like operating strategy brought each firm to the brink of collapse costing taxpayers hundreds of billions in bailout funding.
• Bear Stearns and Lehman Brothers, a pair of iconic financial institutions whose lack of proper risk management and investment in an undiversified, illiquid, highly leveraged portfolio of mortgage backed securities led to the demise of each.

Assuming systemic risk can be measured in some meaningful way, what are the options for mitigation that would help with the So-What ??

• Creation of a systemic risk regulator is being discussed and on the surface sounds like a nifty idea. The problem is nobody really understands what any ex-ante actions can be taken or catalyzed by such an entity. The other problem is that it reeks strongly of a “lender of last resort” which brings us back to a moral hazard problem.
• Implementation of higher bank capital thresholds would provide a larger margin for error in the event a “systemic financial shock” permeates markets and causes an extensive drawdown in system-wide capital. But “higher” than what, and how high is enough?
• Regulation of leverage has in many cases been self imposed by financial institutions since the financial crisis (the question is does all this last beyond the immediate memory of the 2007-2009 brouhaha). Creating formal regulatory requirements around maximum leverage ratios for regulated financial institutions could go a long way toward mitigating systemic risk, ensuring we do not see a repeat of the crisis.
• Development of a market based systemic risk index used to account for and value a number of independent variables that, when combined, may signal a build-up in system wide risk. This I think is something definitely worth pursuing in the world of risk.
• Adoption of 21st century Glass-Stegal Act as been discussed in Washington recently and may be gaining support among legislators. The original Glass-Stegal Act was created during the Great Depression era to address many of the same questions and concerns we face today. While the complete separation of commercial banking and investment banking activities would certainly help alleviate systemic risk, it is unclear how this might be practically accomplished in today’s highly integrated financial system. More to come on this…..

My armchair view meanwhile is a convenient one now that I am not in a commercial enterprise: simply eliminate leverage altogether. There goes your systemic risk too !!

Read more >>

Posted by Jaidev Iyer, MD, GARP at 10:40 AM 10 comments