Rising energy costs are making the cloud more expensive

Since winter, around the start of the war in Ukraine, energy costs have risen drastically — particularly in parts of Europe historically dependent on Russian fuel. That’s impacted data centers, which aren’t directly reliant on resources like natural gas but which often draw on power grids and backup generators that generate a portion of their electricity using fossil fuels.

According to a July report from power generation supplier Aggreko, data center operators in the U.K. and Ireland have seen their energy bills increased by as much as 50% over the last three years, with the steepest climbs occurring within the last year. Fifty-eight percent of those in the U.K. said that energy bills have had a “significant impact” on their company’s margins.

It seems inevitable that the energy premium data center operators are being forced to pay will be passed along to customers. Indeed, it’s already happening.

Way back in November 2021, Manchester-based cloud services provider M247 hiked prices a whopping 161%, blaming “unprecedented times in the European energy markets.” Cloud providers OVHcloud, based in France, and Hetzner, based in Germany, both recently announced that they would raise prices by 10% in the coming months to combat soaring energy costs and inflation. In an earnings report, OVHcloud told investors that it expects “electricity costs in 2023 will account for around a mid-to-high-single digit percentage of its revenue, up from mid-single digit in 2022,” Reuters reported.

In a conversation with TechCrunch, Gartner senior director analyst René Buest noted that the era of constantly falling cloud prices has been over for some time. (Google Cloud, for instance, increased the prices of its core services in March independent of rising energy costs.) But he agreed that rising costs — and the associated inflation — have accelerated the upward cloud pricing trend.

“It’s hard to say which types of cloud services will be most affected by price increases, but organizations should be prepared for price increases across a cloud provider’s portfolio of services,” Buest said. “In much of Europe, regardless of how electricity is generated, its price is coupled with natural gas prices. Even in areas with high levels of renewable energy — take Scotland, which produces three times its annual energy consumption from renewable sources — the price is still tied to gas to cover for the fact that sometimes the wind doesn’t blow and often the sun doesn’t shine.”

TechCrunch contacted major cloud providers including Google Cloud, Amazon Web Services, IBM Cloud and Microsoft Azure, but none responded. Startup Paperspace was the most transparent, saying it anticipates 2023 will be “a difficult year” for cloud service margins in the European Union, especially those that are computationally intensive.

“Power costs account for a fairly significant percentage of the overall cost of sales,” CEO Daniel Kobran told TechCrunch via email, adding that, moreover, they “constantly fluctuate whereas most other costs for cloud services are fixed.”

Paperspace is positioned to weather the storm well compared to some — its presence in the EU represents less than a quarter of its overall business. Kobran said that the plan is to keep pricing consistent for now, absorb the impact into 2023 and reevaluate in early 2024. “[If] the crisis persists into 2024, it’s possible we may raise prices in this region,” he said.

Others, like Microsoft, aren’t so lucky. The company last week said that it expects to incur over $800 million in additional energy costs this year, bringing operating margins down.

“A lot of it is in Europe, and it’s not just for the winter,” Microsoft CFO Amy Hood said during the company’s Q3 2022 earnings call (per Bloomberg), referring to where the expenditure is expected to be incurred. To Hood’s point, the climbing energy costs aren’t strictly tied to supply chain issues. Pent-up demand for travel has contributed substantially to the uptick in worldwide fuel prices as economies reopen.

Buest does believe that, in general, large providers are less likely to be impacted by the increasingly variable energy costs. He pointed out that small providers have to buy power from the grid, while large providers in some locations can choose their provider, contracting for a fixed amount of energy for a fixed price.

“Given the scale and predictability of demand, large data center operators are sought after contracts by electricity providers,” Buest said. “While the average data center and cloud provider will absolutely be facing these kinds of increases in costs, large cloud providers will face a much more muted effect.”

Still, Buest predicted that, as overall spending on energy increases, the larger cloud industry will see the pace of product innovation slow down. Cloud providers will rush to protect their margins and bolster efficiency, he said, increasing the prices of services to offset rising costs in data center equipment, electricity usage and labor.

“Cloud providers will seek to improve energy efficiency in data center operations and expand efforts to utilize renewable energy sources,” Buest said. “Hiring will be reduced to control costs, and proprietary innovations will drive increased efficiencies and differentiated capabilities among the leading cloud providers.”