Cloud computing for graphical simulations (like rendering lighting, LOD etc) doesnt make any sense to me. Microsoft is only in it for the money. How much would these cloud computing servers cost them? How much are they to run/maintain/cost of engineers? There becomes are point where the cost effectiveness dips, making it pointless business wise to them.

I envisage them using cloud computing for data simulation purposes. For example you have a persistent MMO, the player might log off but the cloud can continue to run the simulations. They could be used to hammer out really intensive algorithms and spit the output to everyone connected and store the data for people who are offline, when they log back in they can resync their game data and they won't have lost any progress. This method allows a users console to basically only focus on their local environment, and would give more availability of the computing power to graphical calculations.

tl;dr Cloud computing to run non-graphical calculations and simulations, freeing the console up to work on graphics.