Spiking Power Costs In Big Markets Pushing Some Data Center Developers Away

Rising power costs and energy market volatility are changing the development calculus for colocation data center providers.

Over the past year, data center operators have seen the cost of electricity shoot up in some of the industry’s most important markets. Northern Virginia’s average industrial power rate has increased nearly 35% since 2021, while New Jersey saw a more than 56% increase during the same period according to JLL. Atlanta at one point saw rates spike to more than double the prior year’s pricing before stabilizing.

This volatility has not deterred developers that lease to massive hyperscalers from pursuing big projects in markets that have seen significant cost increases, but it is a different story for colocation data center providers that focus on filling their facilities with smaller enterprise tenants. 

For these firms, the cost of electricity is now a top consideration when it comes to siting new development, pushing them to markets where power rates are cheaper and more predictable.

“What I look for first and foremost right now and will over the next 24 to 36 months is power pricing,” said Flexential Chief Operating Officer Ryan Mallory, speaking at Bisnow’s DICE Northeast event in July. “The changes in power costs that we've seen just in the last 12 months have gone up 5% to 40% on a month-over-month basis, so that's the No. 1 contributor to where we're building.”

Significant shifts in the cost of power began in 2022 but have continued this year. Data center markets like Los Angeles, Austin/San Antonio, Las Vegas/Reno and New Jersey have seen average industrial power rates jump more than 20% over the last year, according to JLL. Northern Virginia and Houston saw average power costs grow more than 15% compared to last year. 

While pricing has moderated in some key markets this summer, the year-to-date average industrial energy rate nationwide is still north of where it was a year ago, and prices in most markets remain far above 2021 levels, according to the U.S. Energy Information Administration.

Over the past two months, some data center markets that had been among the most stable in terms of power pricing — particularly those in the Mountain/West hubs like Denver and Utah — have seen significant rate increases and face the potential for more.  

Utilities have pointed to a range of factors that have contributed to price hikes, from expensive infrastructure improvements to the cost of decommissioning fossil fuel power plants and transitioning to renewables. But experts say the primary force driving the recent volatility has been the price of natural gas and other fossil fuels, with markets more reliant on these fuels typically seeing the most significant price hikes and variability.

“A lot of it has to do with the fuel mix that’s supporting the market,” Andy Cvengros, a managing director at JLL and the firm’s U.S. data center lead, told Bisnow. “You look at Illinois, which is primarily nuclear in terms of generation so it's pretty stable, whereas the Ukraine crisis has really driven volatility in natural gas pricing, and that had a greater impact on Atlanta and Ashburn and some of the other markets. The states that have higher degrees of nuclear have more consistent power pricing across the board.”

For colocation providers focused on enterprise tenants, the dramatic shifts in energy prices hitting many traditional data center markets have moved the needle when it comes to planning future development. Power pricing has always mattered in an industry where product is measured in megawatts, but industry insiders say, compared to just a few months ago, it has moved to the top of the stack of considerations in evaluating target markets for expansion.

“The No. 1 factor is power costs,” Flexential’s Mallory said.

Power costs are almost always passed through to tenants. So while they don't directly impact a colocation operator’s bottom line, higher electricity prices mean higher monthly bills for tenants that may have potential customers looking elsewhere or demanding concessions in leases that can pinch margins. 

Even in markets with relatively low average power rates, the potential for significant pricing fluctuations — even temporarily — makes it difficult for tenants to reliably predict their operating costs. Enterprise customers may think twice before leasing capacity in a market where they may not be able to reliably plan their budget, experts said. 

For companies like Flexential, this means prioritizing development in markets with relatively cheap, stable power costs — often locations with a high percentage of nuclear power. Mallory expects this to expand the colocation map, with the need for predictable, low-cost power forcing tenants to get comfortable leasing far from established data center hubs like Virginia and Dallas.

 “It's not Field of Dreams where you build it and they will come, but we have a lot of land in the United States that is affordable and has power,” Mallory said. “When you're talking about customers consuming 10, 30, 50 megawatts, you can have very static, locked-in pricing so they can have predictability in their budgets.”

This reactivity to power pricing doesn't hold true across every segment of the industry. 

For hyperscale cloud providers, large-scale tech tenants and the developers and wholesale data center firms who cater to them, the shifting price of power in key data center markets has proven to be less important than whether power is available at all. Companies like Microsoft and Google are racing to lease hundreds of megawatts at a time to support cloud and AI applications, snapping up new capacity as fast as the data center industry can develop it.

Amid this imbalance between supply and demand, large tenants have proved willing to stomach higher costs, and power pricing hasn't shifted the geography of hyperscale leasing or development, experts say. Indeed, a July report from Cushman & Wakefield shows only a rough correlation between the changing cost of power and hyperscale and wholesale lease rates in the six largest data center markets.

For some large tenants, leaving major markets for lower cost alternatives may not be an option at all. Experts point to cloud and “as-a-service” providers, whose customers may require region-specific, low-latency performance and connectivity that can only be achieved by leasing in major hubs.

“It's easy to say you want to migrate from high-cost regions, but the problem is that customers are very specific about where they want to be,” said John Hawkins, IBM’s global cloud data center real estate lead, speaking at Bisnow’s DICE South event in August. “A lot of times, you have to do the best you can in a rising price climate. We continue to look for alternatives to Ashburn or even Dallas, but it's very difficult.”

Still, experts say the considerations around power costs are often different for smaller tenants looking for capacity measured in the tens of megawatts, not hundreds. Tenants with fewer deployments tend to be more sensitive to price, JLL’s Cvengros said. For hyperscalers with dozens of deployments in markets around the world, changing power costs in a single market is relatively insignificant to their overall cost structure. But for a company with just a pair of 15-megawatt leases, that cost looms far larger. 

“Hyperscalers are doing this on 100 different sites, whereas enterprise guys will do one site in 10 years,” Cvengros said. “It’s just a different level of sensitivity.”