Yes, IT can be sold like a barrel of oil (but it’s going to take some work)

Big companies use commodity contracts to ensure predictable prices for oil, wheat, electricity, metal and other crucial supplies that keep their businesses going. These days, a crucial supply for many companies is cloud computing power — raising the question of whether that too can be bought and traded in the same way as oil or oranges.

A recent partnership suggests the answer is yes, and that we’re heading to a world where companies won’t just turn to Amazon Web Services or Microsoft Azure for cloud services, but to a commodities market that offers the best price, on the spot or in the future, for a range of interchangeable IT infrastructure.

The financial platforms and the raw resource already exist to support cloud as a commodity. So do the people. But the question is whether someone can bring this all together, and overcome some big obstacles that stand in the way.

Cloud computing by the bushel

Earlier this year, a Raleigh, N.C.-based cloud company called 6Fusion signed a deal with the Chicago Mercantile Exchange, the world’s biggest market for commodities and derivatives contracts. If all works out, the deal will mean that buyers and sellers of cloud computing services can do business on a spot exchange and, in a few years, trade derivatives too.

The exchange will be a place to buy hours of “WAC,” a term invented by 6Fusion that stands for Workload Allocation Cube. The idea behind the WAC is to create a standard unit of cloud computing infrastructure that can be bought and sold by the thousands.

Under 6Fusion’s current definition, a WAC hour is composed of six metrics, including ones related to compute, networking and storage, that can be sold at a single price. Here is how 6Fusion portrays a WAC:

6Fusion WAC hour

According to 6Fusion spokesman Ryan Kraudel, the WAC is akin to a watt of power because it provides a standard measure of output, which in turn removes barriers to trading cloud computing as a commodity.

“The fundamental problem no one’s been able to solve till now is ‘what is the barrel or bushel’ [of cloud]? Now, there’s a basis for contracts in the future of infrastructure services,” said Kraudel.

6Fusion is not the only one proposing such an arrangement. In Europe, a company called Zimory is working with the German exchange Deutsche Boerse to sell cloud computing units.

In theory, the creation of these common metrics means companies can now use forward or futures contracts, based in WAC’s, to exercise more control over IT costs, which represent a growing percentage of many corporate budgets. Kraudel predicts that IT-intense enterprises like banks or universities will be among the first adopters.

What this could mean on the ground is that the IT infrastructure of a company like JP Morgan could soon consist of private cloud servers for sensitive data, supplemented by public cloud supplies purchased from an ever-changing roster of third party cloud computing providers. At the same time, such purchases of cloud computing “by the bushel” would also mean lower prices as traders, rather than vendors, start to set the price of key ingredients of IT infrastructure.

Skeptics might note that this idea of cloud computing brokers has been around for a while, but now its arrival finally appears close at hand. Kraudel says a spot exchange for bilateral contracts should be running by the end of the year, and that a derivatives market will be up and running by late 2015 or 2016. But that doesn’t mean, of course, those markets will succeed.

You can build it, but will anyone come?

The idea of WAC’s, and a derivatives market for IT infrastructure, is well and good in theory, but that doesn’t mean it’s actually going to happen.

6Fusion can define WACs and the Chicago Merc can provide a place to sell them, but the plan will only work if a critical mass of buyers and sellers agree they are worth trading. And that could be a challenge.

Unlike a barrel of oil or a bushel of wheat, there is no consensus on what a commodity unit of cloud computing should look like. While 6Fusion has offered a definition, not everyone will accept it and some will challenge the choice of metrics that make up a “WAC hour.” The task of defining the “cloud bushel” is harder still since the industry is evolving rapidly, and even accepted references points like an M3 instance from Amazon, may be soon outdated.

If no one can agree on what to trade, in other words, there will be no trading.

The problem is daunting but not insurmountable and, as it turns out, it’s hardly a new issue in the world of commodities. According to James Mitchell, a former commodities trader at Morgan Stanley, any traded good, no matter how standard it may seem, will be subject to changing definitions.

[pullquote person=”” attribution=””]Unlike a barrel of oil or a bushel of wheat, there is no consensus on what a commodity unit of cloud computing should look like.[/pullquote]

Mitchell, whose company Cloud Options has advised 6Fusion, points out that oil comes in a variety of standards — Brent Blend, West Texas, etc — and that orange juice contracts include a variety of conditions that let traders adjust the final price based on size, seeds and so on.

The same is likely to hold true when it comes to cloud computing commodities. Contracts for “WAC hour” futures, if the market adopts them, may include adjustment mechanisms for traders to tweak at the end of the deal.

“Everyone hedges against, then trues up against how off-spec it is,” said Mitchell, speculating on what would happen if a bundle of WAC hours didn’t correspond to the exact cloud resources that a buyer had sought to obtain.

“In the truing up process, you might have a disproportionate amount of CPU. If 6Fusion does a good job, they’ll choose a middle ground that doesn’t require a correction.”

Mitchell added that, for now, the biggest impediment to a functioning futures market is that traders and techies are still learning to speak to each other. IT people have a good idea of what a unit of cloud computing resources looks like, but this knowledge is still being translated into standard contract language of a sort that brokers can instantly recognize and trade upon, he said.

800-pound gorillas don’t like to trade

Let’s say the IT buyers and the traders do agree on a common cloud commodity (a WAC or otherwise) and the exchange is up-and-running as 6Fusion promises it will be. We’re still only halfway there since an exchange also needs sellers.

And right now, the cloud infrastructure industry is dominated by a giant called Amazon Web Services that will likely be reluctant to offer up its wares to a commodity exchange. The reason is that commodities, by definition, are interchangeable and sold at a price lower than any one seller can dictate.

So for Amazon, which is already selling cloud infrastructure at fire sale prices, a commodities exchange would not only depress prices further, but invite a host of other competitors to replace its branded AWS products with a generic bushel. But one way to prevent that from happening is for Amazon, and other big cloud service providers like Rackspace or Microsoft, to simply sit this out and try to ensure the commodities is not liquid enough to be viable.

6Fusion’s Kraudel acknowledged that Amazon, which declined to comment for this story, would be reluctant to participate, and noted that the company already offers its own on-the-spot cloud pricing as well as a form of futures called “reserve instances.” Still, he thinks the market will be liquid enough anyways.

“Amazon Web Services is an 800-pound gorilla, but there is a very long-tail to this market,” he said, explaining that there are many other providers capable of offering analogous cloud infrastructure, and that more will enter the market to meet what is still ever-growing demand. (It’s also possible that recent price pressure from two well-financed competitors, Google Cloud and Microsoft Azure, could nudge Amazon towards selling on an exchange).

Finally, the history of commodities markets may once again be instructive in trying to guess the future role of the current cloud gorillas. That history, according to Mitchell, shows that incumbents may dislike the loss of pricing power that comes with commoditization, but sooner or later the traders get the upper hand.

“Exxon tries not to use wholesale price of oil, but that doesn’t dictate the price of oil. It’s traders who are long and short who set the prices, not those like Amazon who are fundamentally long.”