Energy consumption is one of the largest operating expenses for a data center, contributing to nearly 50 percent of total operating expenses. Due to 2013/2014 winter’s “polar vortex” that caused a deep freeze in much of the U.S., many large energy consumers in unregulated markets saw their energy prices quadruple. In fact, we have seen a tremendous amount of volatility in energy prices over the last decade.

The beginning of 2015 has seen continued energy volatility with oil prices down approximately 50% from the fall of 2014.  All the experts differ on when and if the prices will rebound.  Natural gas prices this past winter were relatively stable; however, some regional markets saw significant swings due to cold weather in the eastern half of the country.  Part of the volatility continues to stem from gas pipeline/capacity constraints in various regions.

Data center operators and owners can minimize the impact of unpredictable energy markets by better understanding the markets and establishing smart energy procurement strategies. Below is background on energy pricing trends, factors likely to impact future pricing, and proactive strategies for procuring energy in an unpredictable market.

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FACTORS IMPACTING PRICING

There are a number of factors impacting natural gas and electric rates, including:

1. Natural Gas Storage: In the beginning of 2014, natural gas stockpiles hit the lowest level since 2004 as a result of cold weather and winter storms. The deficit was closed due to the mild weather during the summer of 2014, record gas production and a mild start to the 2014-15 winter season.  By the end of February 2015, storage was about 500bcf higher than the same time in 2014, but about 140bcf below the five-year average.

What do these numbers mean for energy pricing? Storage should be in pretty good shape heading into the summer 2015.  But the question will be how hot the weather will get.  A very hot summer will mean more gas being used at electric power plants, which will reduce the amount of gas going into storage.

2. Retirement of Coal-Fired Power Plants: Natural gas generation of electricity continues to grow as coal-fired power plants are retired. This has created a permanent increase in demand for natural gas. A few key statistics are:

• Natural gas has become the fuel of choice for electric generation, especially as new EPA standards impact 1,400 coal and oil units.
• Scheduled coal plant retirements between 2013 and 2020 will result in increased natural gas generation.
• Approximately one-third of electricity in the U.S. is generated using natural gas. Another one-third is coal and the last one-third is comprised of all other (nuclear, renewable, etc.).

As coal-fired power plants are retired, the increased base load natural gas demand for electric generation will increase price sensitivity.

3. Natural Gas Exporting (Liquid Natural Gas): In 2015-2016, large energy companies will begin exporting natural gas to Asia and Europe where they can achieve prices roughly triple the price in the U.S. This will cause a longer term change to the supply-demand balance. It will also begin what could be a transition from a North American natural gas market to a global natural gas market (similar to oil).

Worldwide Natural Gas Prices – Snapshot as of June 2014:

• United States: $3.80 /dth
• Europe: $7.80 /dth
• Asia: $14.00/dth
• South America: $15.00/dth

WHERE DO PRICES GO FROM HERE?

Natural gas and electric prices are at very attractive levels and are not far off from a 10-year low.  How long prices will stay here remains to be seen.  Weather will certainly be a driver in the short term.  Longer term, we see demand for natural gas increasing due to coal plant retirements and increased natural gas exports.  This increased demand will put upward pressure on both natural gas and electric prices.  At these current levels, customers should give serious consideration to locking into a longer term deal.

Proactive Management in an Unpredictable Market

Energy procurement should not be an annual task, or something reviewed just prior to the expiration of a supply contract. This is an ongoing process which, if managed correctly, can lead to positive bottom line results despite the extremely volatile market.

There are two important strategies that can be employed when structuring an energy supply agreement to limit exposure to price run-ups or spikes:

1.  A Fixed Price Agreement: This is a common strategy that provides a customer with price and budget certainty. In this case, usage becomes the only variable that needs to be monitored and managed.

2.  A “Block and Index” Structure: Here, a customer can fix all or a portion of the price. The pricing can be locked in blocks or percentage levels at different times. While this requires more management and oversight, it allows a company to dollar-cost-average their price, similar to what an investor would do with a stock purchase.

Given the energy factors discussed above and current market pricing for electric and natural gas, we could be faced with rising rates in the future. As a result, businesses need to look at the importance of proactively managing their energy procurement now in order to reduce the potential negative exposure that could be coming down the road.