Who Really Pays for AI Data Centers?

[00:00:00] Speaker 1: America has about 65 gigawatts of data centers, according to the energy data firm Cleanview. It's planning another 413, and for the biggest projects, the completion date is listed as TBD. A gigawatt is enough electricity for roughly 800,000 American homes, so that pipeline is the equivalent of plugging in about 330 million new homes in a country with around 135 million households. Every one of those gigawatts needs a power station somewhere, and somebody's going to have to pay for it. The industry sales pitch for all of this is a little unusual. The people building artificial intelligence have spent the last few years explaining that it might take everyone's job, or possibly wipe out humanity altogether. They would now like to build the computers to run it next to the little league field, and they'd also prefer not to pay sales tax on the chips. Unsurprisingly, this hasn't gone down well. According to a recent poll, three out of four Americans would oppose a data center being built in their community, and data centers now poll worse than nuclear power stations and coal plants. Which is understandable. A coal plant has its downsides, but nobody has ever heard one bring up the singularity at a town meeting. This has left politicians in a bit of a tricky position. Governors from both parties have spent years competing to attract these projects for the tax revenue, and a lot of the construction unions love them too. The voters, on the other hand, have made up their minds, and they're not keen. Now, I know what you're thinking, Patrick, this is a channel about rap and, of course, rapping. Why are we talking about municipal zoning disputes? Well, because I do sometimes get distracted by financial topics, and this turns out to be one of them. The people standing outside these buildings holding protest signs are, through their pension funds, quite often helping to pay for them, which is not generally considered good protesting practice. So, before we get into the money, it's probably worth looking at what these people are actually upset about. There are three big concerns that come up over and over again. Water, noise, and electricity. The water argument mostly falls apart when you examine it. People tend to imagine these buildings draining the Great Lakes. But according to The Economist, a mid-sized data center uses about as much water as two golf courses do. And across the country, crop irrigation uses 74 times as much water as data centers do. If water was really the biggest issue, the protesters would be standing outside country clubs too. Noise is a real problem. The low-frequency rumble from data centers travels a long way and passes straight through walls, much more so than high frequencies do, and neighbors often say that they feel it as much as they hear it. That said, according to The Economist, a lot of the viral videos of screaming data centers turn out to be crypto mines, which are basically thousands of fan-cooled computers stacked in shipping containers, each one about as loud as a vacuum cleaner. And a big mine can have tens of thousands of them all running flat out all day. My friend Ben Jordan, who makes some of the most interesting science videos on YouTube, has been looking into the part of this noise that you can't hear at all. He traveled to data centers and crypto mines around the United States with specialist equipment and recorded infrasound, which is sound that is too low in frequency for humans to hear. He then ran a small pilot study playing it to more than 100 people who didn't know it was there, and the group exposed to it reported noticeably more discomfort and dizziness than the control group. As Ben pointed out in his video, the effects of infrasound are under-researched, and he's working on a much bigger study. As for noisy AI data centers, there's one notable exception in Memphis, where the loudest part of the operation turns out to be its power supply, but we'll get to that shortly. Electricity is where the complaints have the most substance. Data centers use an enormous amount of power, and the evidence on what that does to people's utility bills points in two directions. The Electric Power Research Institute, a group funded largely by the power industry, found that in the typical state, power would have been about 6% more expensive without the data centers that were built between 2019 and 2024. Most of that benefit came from places with spare capacity where the data centers helped cover the fixed cost of the grid. The problem is that a lot of that spare capacity has now been used up. In PJM, the grid that runs from Illinois to New Jersey, the independent market monitor estimates that about $6.3 billion of future capacity costs come from planned data center costs. He says the data centers aren't actually paying themselves. Both of these claims can be true at the same time, which is the kind of answer that has never once calmed down a town meeting. So, how has the tech industry tried to win people over? Well, before I get to that, let me tell you about this week's video sponsor, Surfshark, who's been my security app of choice for a good while now. You probably know Surfshark as an easy-to-use and affordable VPN that encrypts your internet traffic and runs on Windows, Mac, Android, iOS and pretty much everything else. 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And one account covers unlimited devices, so you can protect your own devices and your families too. There's no real risk in trying it as they offer a 30-day money-back guarantee. Go to surfshark.com/boil for four extra months of Surfshark. Click the link in the description to sign up today. So, the tech industry's response to all of this has been pretty much what you'd expect. It's tried to pay everyone off. A recent poll by the University of Virginia found that the median payment it would take for a resident to support a local data center is $10,000. People do like a round number. The Economist worked out that paying every resident of a median-sized American county would cost around $240 million, which it described as pocket change for the tech industry. It also noted that voters do seem quite open to bribes. The industry has been handing out cash. In Richland, Paris, Louisiana, the money flowing in from a metadata center meant that many local teachers got a bonus of $51,000, which is more than most of them earn in a year. One first grade teacher told the New York Times it really feels like something that happens to people in movies. The journalist could only hear her because the data center isn't finished yet. So, the running total is $10,000 a resident, $240 million a county, and $51,000 bonuses for a lot of the teachers. And still, the money isn't working. Part of the reason is the way these deals get done. As the journalist Jasmine Sun found out when she reported on this in Wisconsin and Michigan, developers tend to arrive in small towns behind front companies with friendly project codenames like Project Cannoli and The Barn. Local officials are often asked to sign NDAs so that residents don't find out what's being built until it turns up on the council's agenda. In Perry Village, Ohio, a village of 1,600 people, the mayor and key council members signed NDAs with a California developer before negotiations even began. According to the magazine Persuasion, the planned data center would cover about a sixth of the village and border the school baseball field. A county commissioner said that the contract required the village to deliver a clean deed free of any referendum. When residents forced a referendum anyway, the council rescinded the zoning then reinstated it at an evening meeting under emergency provisions so that it couldn't be put to a vote again. As the county commissioner put it, either a data center was being built or they were going to financially ruin the village. In Saline Township, Michigan, the board actually held a vote and voted 4 to 1 against rezoning the land. The developer then sued the township for exclusionary zoning and the town of a few thousand people settled in return for a few million dollars for the fire department and some schools. So, we can add that to the running total too. Overruling a town that has already voted no costs a few million dollars, payable to the fire department, which may turn out to be money well spent since the fire department is now responsible for a very large building full of computers and backup batteries. If someone makes your elected officials sign secret documents, writes a contract that rules out a referendum and then sues your town when it says no anyway, all of that money starts to look like the price of something. Ezra Klein made an interesting observation about this on his podcast recently. He said that in Silicon Valley people's worldview is formed by seeing impossible problems proved possible to solve, while in Washington people's worldview is formed by seeing possible problems prove impossible to solve. The AI industry spent years doing something that previously seemed impossible, but it did that in the world of code. It has now discovered that it is very difficult to put up a large shed in rural Michigan because building a shed turns out to be a Washington style problem. Code either works or it doesn't. A zoning board has to be persuaded and the industry has mostly tried to avoid doing that. Most of the industry is still working out how to do that. Elon Musk found another way. In Memphis, Tennessee, his AI company XAI was building its second supercomputer, Colossus 2, so that people on Twitter could use Grok to fact check each other's tweets. Supercomputers need a lot of electricity and adding new power stations and upgrading a grid can take years. So Musk came up with the innovative solution of bringing his own power plant. Just across the state line in South Haven, Mississippi, XAI set up a fleet of gas turbines to feed power to the data center. The gas burns in Mississippi and the electricity goes to Tennessee. Now, normally building a power plant that rivals the largest in the state involves things like air permits and public hearings. But Mississippi allows portable equipment to run for up to a year without an air permit. So, the turbines arrived on trucks and if your power plant has wheels, legally speaking, it's traffic. In January, the company said it was running 27 turbines. By July, Mississippi's regulators had counted 69. Of course. They are all temporary, although the newest ones are allowed to stay until July, 2027. The people of South Haven are a bit less impressed with the innovation. An acoustics firm found that the low frequency noise near the plant could be 4 to 16 times louder than the background in a quiet neighborhood. And residents describe it as sounding like a plane that's taking off but never leaves. The turbines are also not the cleanest way to burn gas. Portable turbines are less efficient than normal gas plants. And according to the NAACP's lawsuit, the South Haven fleet could produce about 26 times the smog forming nitrogen oxides of the TVA gas plant down the road. Residents have filed a class action lawsuit over lost sleep and falling property values. And the NAACP has sued arguing that this is an unpermitted power plant. One South Haven alderman summed up the legal position nicely. So, are they unpermitted? Yeah, but they're not illegal. The Justice Department and the Pentagon have since stepped in on XAI's side. The Justice Department asked the court to dismiss the suit, arguing that keeping Grok running is a matter of paramount national security. Memphis has at least got something out of the deal. The city passed an ordinance sending 25% of the property taxes from XAI's facilities, up to $100 million, to the neighborhoods around them. And to be fair to XAI, the mayor says it never asked for a tax break. So, we get to add that $100 million to the running total. XAI also promised Memphis a plant to recycle the water it uses for cooling. But construction then stalled with the plant half built. Finishing it would cost about another $100 million. And according to Scientific American, that's less than three days of what Anthropic is paying to rent the computers, which is $1.25 billion a month. So, the supercomputer built to fact check tweets is now being rented out to one of its competitors. That is, revenue of course, rather than profit. Last quarter, SpaceX took in $14.6 billion and spent $19.6 billion on chips, data centers and the rest. And Musk says that spending will roughly double this quarter. According to the Financial Times, SpaceX has now more computing capacity installed than CoreWeave, the largest listed company in the business of renting out AI chips. That brings us to the money. Building supercomputers is not cheap, and tech companies are currently borrowing a kajillion dollars to pay for them. To be clear, I didn't make that number up. Matt Levine at Bloomberg estimates the figure out about a kajillion, and he's usually right about that sort of thing. The issue with borrowing to build AI data centers is the collateral on these loans. A lot of this debt is secured against the computer chips themselves, and Nvidia keeps releasing better and faster ones. The buildings will last for decades, but it is pretty much guaranteed that the chips inside them will be obsolete long before that. So, lenders are being asked to put up long-term money against something that goes out of date very quickly. Carlos Mendes at Crayhill Capital described it to the FT as being like financing a fax machine, and then someone invented email. The bond market has started worrying about this too. Back in April, a data center developer called QTS issued 4.6 billion dollars of bonds, and investors eagerly bought them at a yield of 5.7 percent. Mostly because Microsoft was going to be the tenant. But then investors read the terms and conditions more carefully and realized that the bonds wouldn't be fully paid off before Microsoft's initial lease runs out. Which means that at some point QTS will need to find a new tenant for a very large, very empty building. By August, when QTS went back to the market to borrow more, investors demanded an interest rate of 7.2 percent, which is about what junk rated companies pay. Things are even worse at CoreWeave, the specialist cloud company I mentioned earlier, which relies heavily on high yield debt to pay for its data centers, a lot of it backed by its chips. Now, if you own data center debt, you might want to buy some insurance in case the AI boom turns into an AI bust. The type of insurance you would buy is called a credit default swap. You pay a regular fee, and if the company whose bonds you own defaults, the seller of the swap covers your loss. Normally, you pay that fee in small quarterly installments, much like the way a lot of people pay their car insurance. Toby Nangle at the FT looked at the pricing of CoreWeave's credit default swaps, and the insurance is quite expensive. If you want to insure $10 million of CoreWeave debt for five years, you have to pay $1.95 million up front, plus $125,000 every quarter. That works out to be about 11% of the amount insured every year. The reason the seller wants almost $2 million on day one is that if CoreWeave defaults next week, they don't want to be on the hook for paying out $10 million, having collected almost nothing. According to Bloomberg, the swaps market is now pricing in a more than 60% chance that CoreWeave defaults within the next five years. Now, you might think that this would worry the people who run CoreWeave, but that same week, the company's co-founder, Brannon McBee, explained to the Financial Times that the plan is to get investment-grade ratings on more of its debt, so that insurance companies can buy it. You said that insurance capital is unlimited, like that's all the money in the world that sits in the insurance tranche. There is a lot of money in the insurance tranche. Whether it wants to lend to a company whose debt costs almost 20% up front to insure is a slightly different question. Matt Levine points out the structural problem here. If you want to buy insurance against AI data centers failing, the people you typically buy it from, like banks, hedge funds and insurance companies, already own a huge amount of AI data center risk. They don't want any more of it, so they will only take it on if they are paid a huge sum. And as Levine notes, this risk is almost entirely systematic. If one data center company goes bust through bad management, someone else can buy the building and rent it out. That's an idiosyncratic risk, and it can be diversified away. But if demand for AI computing turns out to be a lot lower than people are projecting, all of the data centers have the exact same problem at the exact same time, and you can't diversify away that risk. Five years ago, Levine points out you could buy five-year CDS on Oracle for about 0.33% a year. Today, with Oracle strapped into the AI build-out, the same insurance costs about 3.3%. So, our running tally is getting quite comprehensive. A town resident costs $10,000, teachers bonus $51,000. Overruling a township costs a few million, payable to the fire department. And ensuring $10 million of AI debt costs $1.95 million upfront, plus $125,000 a quarter. And this all brings us to the obvious question. If the smart money is charging this much to take the risk, who is actually holding the bonds? Well, as Robert Armstrong pointed out in the Financial Times, there is no way for an infrastructure build-out of this size to happen without the investment-grade bond market. The whole point of getting an investment-grade rating, which is exactly what Corweave is currently trying to do, is that it allows the debt to be bought by pension funds, annuities and life insurance companies. Which means that if you have a pension, an annuity or a life insurance policy, there is a decent chance that you are financing the very data center you are also protesting against. And that is just the debt. According to Armstrong, the six hyperscalers and the big chip makers are now worth about 20% of the entire world stock market. So, if you own an index fund, you own quite a lot of them too. I checked my own pension and I am afraid that I am part of the problem. The good news is that the people protesting outside the data center are probably part owners of it. So, if the AI boom works out, their pensions will do quite nicely. The bad news is that the people who live next door own the least of it. They get most of the noise and very little of the upside. And if it all goes wrong, they will probably get a share of the losses too. Then, there is the physical building. If the AI boom goes bust, somebody has to deal with it. People in the Midwest already have some experience with this. Back in 2017, the electronics manufacturer Foxconn arrived in Mount Pleasant, Wisconsin, promising 13,000 high-paying jobs. The village of 28,000 people put hundreds of millions of dollars into roads, water lines and tax incentives to accommodate them. Foxconn then more or less changed its mind. And the village ended up with about 1,000 jobs and the bill for the infrastructure. Today, the land that was cleared for Foxconn is home to a Microsoft data center where the neighbors are now suing over the hum. Similarly, New York State spent almost a billion dollars building a factory in Buffalo for Solar City, the solar company that Tesla later bought, which was supposed to bring thousands of jobs. The state's controller later worked out that it got about 54 cents of economic benefit for every dollar it spent. Today, utilities are upgrading their grids to handle the enormous power requirements of these new data centers. Many states now require data centers to sign long contracts or pay exit fees to cover that. But, as the Electric Power Research Institute itself points out, if the expected demand never shows up, utilities are left recovering their fixed cost from fewer customers. Which means the people who didn't leave end up paying for the transmission lines. And then there's the last resort. Matt Levine notes that OpenAI once suggested the US government should be the insurer of last resort for AI credit risk. He described that as an annoying suggestion at many levels. But added that he kind of gets it as this is a market wide risk and we're kind of all in it together. And we've already seen that when XAI's turbines were challenged in court, the Justice Department turned up on its side. Now, to be fair to the tech industry, there is a strong case for building these things too. And it's entirely possible that this isn't a bubble at all. For one thing, data centers are providing a lot of very well paid work for the people building and wiring them. A union official for the electrical workers wrote in the New York Times that his members' hours have doubled in a decade. And that unlike the railroad and auto booms, this industry has included labor as a meaningful participant from the start. A 23-year-old drainage worker in Ohio told The Economist, "I'm 23 years old and I make $204,000 a year." Which is about what a junior investment banker earns. There is also the geopolitical argument. As The Economist puts it, if America makes it harder to build AI infrastructure, it will simply hand the advantage to China, whose leaders can put data centers wherever they choose. But the strongest argument against this being a bubble is that demand currently exceeds supply. As David Wallace-Wells points out, this isn't a classic bubble where speculative construction outran demand. The AI labs are actually rationing what they sell because they can't get enough computing power to keep up with demand. The catch is that this is demand at today's prices. And for most people, today's price is zero. Most people who use chatbots use the free versions and the companies providing them are spending far more than they bring in. Nobody quite knows how much demand there would be if everyone had to pay the full cost. If we compare AI to the railroads, in fairness to the railroads, nobody in the 1870s was getting a free trial. This is also why the local moratoriums probably won't slow things down much. The Princeton professor, Arvind Narayan, calculated that the average one-year state-level moratorium would slow the growth in AI capabilities by a matter of hours. The projects don't stop, they just move to a state that hasn't banned them yet. As with most things, Ireland got there first. And that was before the AI boom. Mostly thanks to ordinary cloud data centers, the kind that store your emails and photos. Data centers now use more than a fifth of the country's electricity. A few years ago, the grid operator effectively stopped connecting new ones in Dublin. That didn't end the build-out, it just produced a new set of rules under which developers have to bring their own power and buy renewables. The industry simply adapted. To put the scale of this in perspective, the economist Stinn van Nuremberg estimates that the AI build-out will cost about 3.6% of America's GDP every year until 2032. That's the same as the railroad boom, the interstate highway system, and most of the electrification of America all at the same time. Which brings us back to railroads. On a Microsoft earnings call, Satya Nadella described a new history of the railroad bubble of 1873 by the Pulitzer Prize winning author Leaquad Ahmed as the book to be read. I wasn't entirely sure if he was reading it as a cautionary tale or as an operational manual. It turns out that Ahmed isn't sure either. He told Derek Thompson that he thinks Nadella took the wrong lesson from it. Each company can be perfectly sensible on its own and the combined result can still be wild overbuilding. As Ahmed told the FT, they are not taking into account that all the other tech companies are doing the exact same thing. In the railroad boom, American towns and counties borrowed heavily, selling bonds to buy the shares in railroads they hoped would come through town. When the panic of 1873 hit, around a billion dollars of railroad bonds defaulted. A lot of local governments defaulted on their own debts and states rewrote their constitutions to limit how much towns could borrow. Midwestern farmers furious about railroad raids organized into the Granger movement, which eventually helped produce America's first federal regulator, the Interstate Commerce Commission. And yet, the railroads still got built and they built the country. It is just that the people who paid for the build out never got their money back. Today, the towns are in a similar position, only this time the exposure is a bit better hidden. It comes through their pension funds, which own the shares and the debt, and through their power bills, which will cover the cost of the new grid if the data centers ever leave. We now know that the median price to get a resident to accept a data center is $10,000. Nobody has asked them what they charged to take on the risk of the whole thing going wrong, which is probably just as well because through their pensions, most of them already have. If you enjoyed this video, you should watch this one on the Anthropic IPO next. Don't forget to check out our sponsor Surfshark using the link in the video description. See you in the next video. [00:30:56] Speaker ?: Bye. *music*