Data Centers and ESG – two irreconcilable growth stories?
As a new year starts and we reflect on 2021, it feels like two topics made headlines around the world more than any other: COVID-19 and COP26.
COVID-19, an increased frequency and severity of floods, wildfires and drought, and COP26 brought the importance of sustainability into sharp focus. How companies address climate change and other ESG risks is now viewed by investors, employees, customers and regulators as critical to businesses and long-term sustainability and value creation.
For many, COVID-19 and the year 2021 also meant working from home, relying on virtual platforms like Microsoft Teams and Zoom (saying “You’re on mute” on repeat) interrupted by deliveries of online shopping before slumping in front of any on-demand entertainment streaming service. The world continued to move online, accelerating a digital transformation which was already well under way. But as we sat slumped binge-watching a streaming service, perhaps thinking of the positive impact decreased travel was having on our environment, did many of us pause to consider the impact that the accelerating digital transformation might have on the environment and what this might mean for one critical area of the real estate market: data centers?
The growth of data centers
Experts have predicted that the world's demand for data will increase exponentially over the next few years. It is expected that by 2025 around 463 exabytes of data will be produced globally every day.1 All that data flows through data centers and, as long as this data continues to flow, so too will the development of and investment in data centers worldwide. In 2021, the market saw a flurry of 10 and 11 figure deals that have broken records for the industry, including KKR’s and Global Infrastructure Partners’ acquisition of the data center operator CyrusOne for USD15 billion. Customer confidence also saw no let up, with Q3 2021 being the largest quarter take-up ever across the key FLAP markets (Frankfurt, London, Amsterdam and Paris). PwC’s Emerging Trends in Real Estate Report 2022 ranked data centers as the fourth best real estate sector for prospects in 2022. This growth story may be music to the ears of any investors in the sector, but nothing is ever straightforward.
The ESG agenda
Investors are also focused more than ever before on meeting their ESG strategy and complying with an increasingly complex ESG-focused regulatory regime. The whole real estate industry has a large part to play in the ambitious commitments to reach carbon neutrality by 2050 with the built environment widely quoted as being responsible for almost 40% of greenhouse gas emissions globally. The story for data centers is even more complex. Looking at the operation of data centers alone:
- Vast quantities of energy are required to power the complex IT infrastructure and to cool the excess heat produced to maintain optimal operation. On a global scale, 1% of all electricity used in the world goes to data centers (more than the electricity consumption of some countries). With the growing demand for data centers, future energy use predictions are indisputably a cause for concern. Some experts have highlighted that data centers could account for up to 13% of global electricity consumption by 2030.
- Data centers tend to be clustered in certain locations (such as the Slough area in the UK and Amsterdam Southeast, Amsterdam Science Park and Schiphol-Rijk in the Netherlands) where the climate, proximity to key metropolises and connectivity are favorable for developments. These hot spots can burden the landscape and energy infrastructure.
- Large amounts of water are often used both directly in cooling and indirectly though the water requirements of non-renewable electricity generation. This issue will increasingly come into sharp focus as climate change intensifies and data centers expand in markets with water scarcity.
Two irreconcilable growth stories?
With these sustainability challenges, where will the balance sit for Article 8 or 9 Funds under the Sustainable Finance Disclosure Regulation wanting to invest in data centers? Will investors move away from the market, retreating to more traditional areas of real estate to demonstrate the green credentials of their investments and satisfy their ESG agenda?
To do so would overlook several factors beyond the obvious criticality of data centers and their financial returns:
- A number of key players in the market are focused on the importance of building a sustainable model, with over 60 signatories to the Climate Neutral Data Centre Pact pledging to achieve climate neutrality by 2030 and deliver ambitious targets in the five areas of Energy Efficiency, Clean Energy, Water, Circular Economy and Circular Energy System. The largest hyperscalers have a hugely significant impact on the market and have committed to reducing their carbon footprint in all areas of their operations, with many aiming to be net-zero by 2030.
- As a high-tech and multi-layered asset class, data centers have many options, including immersion cooling, AI to better manage data center workloads, and sourcing renewable materials for use in construction. The market is already seeing increasingly innovative solutions in delivering against the five focus areas of the Climate Neutral Data Centre Pact. For example, Hydro66, a data center located just 50 miles away from the Arctic circle, in Sweden, relies on free-air cooling and is the world’s first 100% hydro-powered data center.
- The surplus heat produced as a by-product at a data center can be recycled to heat homes, schools and hospitals by connecting to local heat networks. In 2020, Facebook used surplus heat from a data center in Denmark to heat a hospital in the town of Odense. Once fully operational, this system has the potential to heat 6,900 homes.
- Government policies are likely to act as an accelerant for further change. For example, sustainability will be a bigger part of zoning requirements for new development, and more credits and subsidies will be put into place to hit carbon-cutting goals across jurisdictions. Singapore recently lifted its 2019 moratorium on new data center construction in 2022, just as Amsterdam did in 2020 following the moratorium introduced in 2019. Both markets, however, have (in the case of Amsterdam) and will (in the case of Singapore) put in place regulatory frameworks to ensure that data center development progresses in a way to meet commitments to mitigate climate change.
As BlackRock’s Larry Fink stressed in his 2022 letter to CEOs, divesting from entire sectors or simply passing carbon-intensive assets from public markets to private markets will not get the world to net zero. The most exciting option is to embrace a vision of investment capitalism as a powerful catalyst for change. Developers, operators and investors have the ability to drive forward the growth of data centers in a way that can, potentially, not only reduce their environmental impact, but deliver environmental benefits through circular energy systems. The growth of data centers and ESG cannot afford to be, and should not be, irreconcilable.