Monday, November 29, 2010

Examining Compute Commodities

Over the last several weeks I've been doing quite a bit of studying of the commodities markets, mostly around the emergence of energy trading in the early 1990's. During my research a few things have become pretty clear to me. I thought I'd outline a few of the more interesting observations.

In looking at corollaries in treating compute resources as a commodity, the closest is probably that of energy creation and power plant financing. In the energy world, commodities trading desk are used to protect power companies from dramatic price shifts, using a so called "Hedge". These hedges are done in a number of very interesting ways. First of all, most of the major banks act as both a provider of capital for buyers and sellers of power plant assets and the companies themselves. The majority of the major finance players in the energy world also have commodities desks, allowing them to operate in the commodities market as well as in the more traditional loan / financing businesses. They can offer issuers (power providers) access to commodity markets where hedges can be created to protect an energy company from dramatic changes in prices of coal, natural gas or oil. Many utilities that provide electricity, for example, use coal to fire their plants are protected from price swings and more importantly the banks who are trading these commodities have greater influence and protection from these price spikes by sitting on both sides of the deal. In essence dovetailing leverage finance with commodities. In return, these banks are granted the ability to not only finance the development of the power plants, they also buy the future contracts on the energy itself which in turn gives the energy providers a guarantee of future revenue which then can be used as collateral for the development of their various energy assets and reduces the risk for all involved.

Let me explain this concept using the data center space as an example. Imagine being able to build a data center with a guarantee that a portion of your capacity will be bought at a certain price for an extended period of time before you even built your data center? This in a nutshell is the driver for the commoditization of computing resources. It has less to do with the actual computing resources so much as the ability to provide enhanced insight into future cash flows while reducing the risk surrounding the un-certainty of future utilization levels. Data centers are the new power plants.

What SpotCloud does is provide a general structured framework for the creation of a Compute Spot Market - an essential requirement before you can potentially have the ability to buy future capacity in bulk. Now imagine for a moment a SpotCloud Price Index (SCPi) where buyer are given a normalized average (a weighted average) of prices for a given class of compute services (based on a key hardware metric) in a given region, during a given interval of time. This is where things start to get interesting, an index is a requirement for any futures market. Without this critical statistic, it would be very difficult to compare how compute prices, taken as a whole, differ between time periods or geographical locations. With this data, hedges and arbitrage are now possible regardless of whether the quality of compute resources differs because you can use the average with traditional finance methodologies allowing for differences among providers answering the problem of not all compute resources are actually the same. Money itself being the great equalizer.

I readily admit that selling any debt in the current market is tough, but given the current trends in computing and the ever increasing need for computing resources around the globe, it's a fair bet to say that the demand for these types of resources will continue for the foreseeable future.

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