By Peter V.K. Funk, Jr.
Mission Critical magazine
October 2, 2017

Due Diligence for Colocation Contracts

The term “colocation” historically has more than one meaning. In current usage, colocation (or colo) commonly refers to a data center facility which rents space for servers and other computing hardware. It has also referred to colocation of a data center with facilities providing services to that data center such as a power plant providing electricity.

A typical colo provides the building (or campus with multiple buildings), power, cooling, connections, racks, rooms and cabinets. Some colos provide servers. Most often, however, the colo tenant provides the servers and related equipment. Space in the facility can be leased by the rack, cabinet, or room. Some colos even offer management services. The relationship between the colo landlord and the colo tenant has many of the elements of a typical landlord/tenant relationship with the added consideration that it takes place in a highly technical environment in which the landlord must meet high standards of technical compliance and reliability.

A colo tenant is subject to the reliability and quality of the services that the data center landlord procures and, in turn, provides to the colo tenants. Whatever risks exist with respect to those services are also potential risks taken by the colo tenants. Among the most important obligations of the colo landlord is to provide continuous high-quality electrical power.

This article focuses upon data centers that provide colocation services that include either submetered power or power based upon occupancy measurements. Such data center providers may also seek to colocate with a power plant to provide power to itself that the colo landlord, in turn, provides to its colo tenants. Since the tenants in any colo will be affected by the landlord’s services procurement, each tenant should conduct sufficient due diligence to understand the benefits and risks of the services (including electrical services) that are being procured by the data center landlord to be provided to the tenants.

One key question presented to a data center landlord developing or operating a facility with large-scale electric power needs is whether it is advantageous for that facility to procure electric capacity (MWs) and energy (MWHs) from a nearby privately owned power plant instead of from the franchise utility as a full-service utility customer. By way of background, power plants can be owned either by utilities or private entities. Utilities also offer power transportation (wheeling) services to customers that purchase power from privately owned power plants or companies that buy and re-sell power such as power marketers and energy services companies.

Key considerations when signing a colocation contract are as follows.

1. Data Center Power Requirements

Any consideration of a possible data center – power plant colocation must start with a complete understanding of the existing or projected electrical requirements of the proposed data center colo landlord (and the colo tenants). I have seen organizations with internal departments such as engineering, procurement and operations that did not effectively communicate among themselves resulting in out- of-date or inaccurate information informing the power purchase transaction. To avoid such a situation, it may be advisable to limit the number of employees charged with interfacing between the data center and the power plant.

The following information must be ascertained.

a. Projected energy consumption and demand curve of the data center and its tenants. As a starting point, the total power consumption over the life of the data center colo, including proposed expansions, must be determined. This includes projected MW of capacity/demand and MHW of electricity to be required during each hour of each typical day including identification of expected peaks. A relatively constant load is described as a high load factor. High load factor customers are desirable from the power seller’s viewpoint and typically able to negotiate favorable pricing from independent power producers. Data centers generally have high load factors.

b. Timing. For new colo developments, having a realistic expected commercial operation date is important, since planning for large scale power to be available can require a long lead-in time. Even assuming an existing and operational power plant, if regulatory approval of transmission is required, this process is potentially quite lengthy.

c. On-site Generation. A plan for on-site generation must be established simultaneously with the power plant colocation plans, and these plans must dovetail with one another. Is the entire power load of the data center to be met by the power plant or is some percentage to be met by onsite co-generation or renewable generation? Alternatively, is on-site generation to be limited to emergency generation? Outages must be anticipated and provided for and a sufficient fuel supply should be available on-site to cover enough days for the power supply to be restored. It is particularly important for colo tenants to review and analyze on-site generation and the ability of the data center colo provider to handle emergencies.

2. Power Purchase Agreement

A key document for power procurement from non-utility sources is a power purchase agreement (PPA) that covers the purchase of electricity and capacity. There are different forms of PPAs to address various situations. The PPA covers the procurement, delivery, acceptance, financial and other terms. There are several other types of agreements that may be involved in power supply covering areas such as engineering, construction, maintenance, operation, monitoring and guarantees.

3. Power Plant.

a. Ownership. The ownership of the power plant must be understood, together with the rights of the ultimate owners and financers which may have “backstop” management control and also have the right to take possession of the plant in the event of a default.

b. Merchant Power Plants. Electric utility deregulation in many states has resulted in lightly regulated merchant power plants operating in the service territories of franchised electric utilities. When permitted by state law and regulation, this has enabled end-use customers to purchase power from non-utility power plants (and other sources).

c. Capacity Obligations. Prior to contracting with a power plant, the data center should obtain information such as the total capacity of the power plant net of parasitic load and the contractual obligations of the power plant to other customers.

d. Life of the Power Plant. The life of the power plant and future plans for retirement or “life-extension” must be checked. If the projected life of the power plant is less than that of the data center, it is necessary to ensure that sufficient power will be available when needed from anticipated utility or other sources to power the data center.

e. Reliability. Reliable power is a key to data-center performance and is dependent upon the reliability of a power plant colocated with a data-center. Any prospective large-scale customer such as a colo landlord must perform due diligence regarding the reliability of such a power plant.

f. Fuel. Due diligence includes a review of the source of fuel(s) for the power plant and the risks associated with those fuels. A hydro plant dramatically reduces fuel-based risks, but there are potential problems including drought, failure of the dam structure or the construction of a dam further upstream. Any possible changes to the equipment of the power plant contemplated in response to environmental regulations that could affect the fuel type must be reviewed and the impact of the change assessed.

4.  Power Transmission

a. Direct or Wheeled by Utility. The manner in which electricity is transmitted to the data center is a key consideration. Will it be direct or over private property? If by a utility, how long will the transmission line be since this cost may have to be borne by the customer? The answers to these questions are extremely important to any analysis of the feasibility of data center and power plant colocation.

b. Franchise. An electric utility will have a franchise to provide power to customers in a state. It is necessary to check the applicable laws and regulations to understand the limitations of the franchise and, if feasible, configure the transmission to be over private property. Some states permit independent power plants to supply electricity to customers on adjacent or nearby property.

c. Extension of Utility Power Lines. The size and length of power lines are important considerations. State regulations govern the extension of power lines. For example, Article VII of the New York Public Service Law applies to the extension of electric transmission lines sized at 125 kV or larger having a length of over one mile. An Article VII proceeding requires expensive and time-consuming procedural steps and environmental studies. To avoid falling under the requirement of an Article VII proceeding, it is essential to make certain that the feeder lines sized at 125 kV or larger should be less than one mile in length. Similar requirements generally exist in other states.

d. Independent System Operator Approval. In light of the power needed by large data centers such as colos, another regulatory hurdle may be independent system operator (ISO) approval of the interconnection between the data center and the grid. ISOs control wholesale power transmission within states or groups of states. ISO requirements are greater if the data center wishes to have the ability to sell capacity and/or electricity generated on site as opposed to simply consuming it.

5.  Incentives

There is competition between the states and power sellers to attract data centers such as colos. This competition could result in highly beneficial tax or other incentives being made available.

6.  Real Estate Considerations and Site Control

Dealing with purchasing power from adjacent power plants can involve complex real estate issues – primarily relating to transmitting the power to the data center. These issues are beyond the scope of this article.

7. Colo Lease and Billing Disputes

a. Responsibility for Power Supply. Any proposed colo tenant should carefully review the terms of its lease regarding power supply, on-site generation, and preparations to meet electric outages. A tenant should seek to have the lease provide that the landlord is responsible for the supply, capacity, reliability, and quality of the power supply except in very limited force majeure conditions.

b. Energy Supply & Billing Disputes. The lease should include detailed provisions addressing the landlord’s provision of electricity to tenants who install and maintain their own servers and related equipment. The cost of electricity consumed will be in addition to the rental and generally submetered. The submeters will be maintained and read by the landlord or an outside metering company. The most common type of dispute is when a tenant believes it has been overcharged and that the submeter is inaccurate, that the wrong rate has been applied or that a space-based charge has been inaccurately calculated. There are steps that a tenant can take when it believes it has been overcharged such as hiring an electrical engineer to perform an analysis and installing an additional “check” meter.

The lease should have provisions regarding billing disputes. Since such disputes do not involve utility sales of electricity but rather submetering by a landlord to commercial tenants, privately owned meters and billing rates established by lease, the tenant and landlord must resolve any dispute between themselves in accordance with the lease. Such a tenant cannot be expected to have the right to complain to a state regulatory agency such as a Public Service Commission. The parties can agree to address such a situation in advance by a lease provision requiring metering disputes to be referred to one or more independent consultants.

Conclusion

Both colo data center landlords and tenants should take steps to fully inform themselves regarding their own power requirements together with power supply issues relating to outside power plants and on-site generation. Colo leases should properly address power issues and billing disputes and reasonably allocate rights and responsibilities between the parties.