Rate Design
Time of Use
Demand Charges
8 Min Read

Understanding Demand Charges and Your Commercial Utility Bill

For a business, managing when power gets used is perhaps even more important than how much.

All of us are used to looking at our home electric utility bill and our costs are based on the volume of electricity we used.  Managing our costs means reducing the amount of energy we use.  Easy!  However, business owners face a completely different challenge, and it’s getting harder every year.  Businesses are also charged based on when they use power.  Utilities have different names for these time-based charges like demand charges, coincident peak charges, ratchet charges and time-of-use charges.  What most businesses don’t realize is that these charges can represent up to 70% of their total annual costs, and they aren’t impacted by reducing the total amount of energy you use.  For a business, managing when power gets used is perhaps even more important than how much.

Energy vs. Demand

Electric utility bills are generally comprised of three main charge types:  

  • Fixed charges – non-volumetric charges, which are typically unavoidable and assessed for being connected to the grid.
  • Energy charges - dollar per kilowatt-hours ($/kWh) charges, which are volumetrically billed based on the amount of electricity consumed over a period of time.
  • Demand charges – dollar per kilowatts ($/kW) charges, which are billed based on the maximum amount of power (kW) consumed during any 15-min interval that month (your high water mark each month). 

Here’s a quick example from a fairly typical 50,000 sqft commercial retail building.  This building has 15 roof-top packaged HVAC units.  Each unit has a nameplate power rating of around 10 kilowatts (kW). To determine how much kWh energy (volume) would be consumed to run each unit for eight hours you multiply power x time:  10 kilowatts x 8 hours = 80 kWh.  If your utility charges $0.12/kWh, your cost for those 8 hours would be $9.60.  If this building ran 15 HVAC RTUs for an average of 5 hours per day in June, their total usage and bill would be:

15 HVAC units x 10kw x 5 hrs/day x 30 days = 22,500 kWh

22,500 kWh x $0.12 / kWh = $2,700

Demand charges are very different – the utility is billing you for your 15-minute high-water mark, each month.  Demand is measured in kilowatts, the more quickly energy is used, the higher the demand value will be.  Using the same building as the one above, let’s assume that all the other (non-HVAC) equipment in the building combined would draw 50kW of power, if it was all turned on at the same time.  Now imagine that all 15 HVAC units turned on as well – that would be another 150kW of power.  The total power draw of the entire building would be 200kW.  If all this equipment turns on at the same time for just 15-min during the month, that would set the high-water mark.  For this customer, the utility demand charges were $15/kW. 

So, the demand charges would be:

200kW * $15/kW = $3,000

Customer’s Total Bill

Energy - $2,700 (45%)

Demand - $3,000 (50%)

Fixed - $300 (5%)

Total = $6,000

If this retail building owner could reduce their volumetric usage by 90%,  they would only reduce their total bill by 40%.  Buildings need sophisticated software to manage and coordinate when equipment runs to effectively manage demand charges.

Why do Utilities have Demand Charges?

Maintaining sufficient power capacity to serve all electric customers at any moment is expensive and requires an over-building of generation, transmission and distribution resources for utilities. Demand charges allow utilities to equitably recover the costs associated with supplying and maintaining enough generation capacity. Electric customers with the greatest power requirements pay for their share of capacity. It’s not uncommon for commercial customers to have demand charges comprise over 50% of their total electric bill. Similar to energy charges, demand charges effectively incentivize customers to alter their consumption behaviors. However, demand charges are much more challenging to manage because they require real-time control of all the major electric loads in the building.  This is not something that can be effectively managed manually or with traditional building control technology that relies on rule-based controls or schedules.  It requires sophisticated software that is aware of the entire building’s energy use every minute, so it can predict or react to minute-to-minute changes and avoid peak loads.

Types of Demand Charges

  • Max/Non-coincidental - charged based on a customer’s highest kW demand within a billing period, irrespective of when the utility’s peak is set. 
  • Time-of-Use – charged based on the customer’s highest kW demand within a specific time period. TOU demand charges are generally aligned to be coincident with the utility’s system-wide peak. For example, the “on-peak” TOU demand period in California is 4 pm – 9 pm.  
  • Flat – $/kW demand charges that are assessed based on a single kW demand reading.
  • Tiered – $/kW demand charge that differs depending on whether a customer is above or below a specified demand threshold.  
  • Daily – $/kW/day demand charges that are measured and billed each day within a billing period.  

Demand charges have been part of the commercial electric bill for decades.  However, over the last ten years, demand charges have been rising even faster than volumetric charges, and continued increases are expected to continue for years to come.


Many demand charges have an associated ratchet that applies when determining the demand figure that will be used in billing. A demand ratchet can be viewed as a minimum level billed; a customer’s actual observed demand reading could be significantly lower than what they are billed for. Some demand ratchets can be quite complex, involving different equations and conditional calculations. The two most common ratchet types seen are 1) a fixed kW minimum and 2) a minimum derived from applying a percentage to a reference variable. 

An example of a complex demand ratchet can be found on the “Orange and Rockland Utilities – New York” SC 3 rate, which includes both demand ratchet types.  

 The billing demand shall be defined as the highest 15-minute integrated kW demand determined during the month by the use of a suitable demand indicator. The minimum billing demand shall be 100 kW.  
The billing demand for the billing months of October through May inclusive shall not be  less than 70% of the highest metered demand for the preceding billing months of  June through September inclusive.” 

The tariff excerpt above states that customers under this rate will never be billed less than 100 kW. In addition, during the winter months, the billing demand will not be less than 70% of the highest demand occurred during the summer months. For example, if a customer’s max demand during the month of November is 150 kW but their demand in August was 400 kW, their November bill will include 280 kW (400 kW x 0.70) as the billing demand. 

The energy analysts at Elexity are continually coming across new demand ratchet structures. It seems utilities are constantly getting more creative in designing new structures.  We can help any customer analyze their usage and rate schedule, including these complex demand ratchet-type tariffs. 

The Evolution of Demand Charges

Our utility rates team tracks different demand charge structures throughout the globe and has seen a number of changes over the years. One general trend that will come as no surprise to anyone is that similar to $/kWh energy charges, $/kW demand charges are generally continuing to escalate.  How demand charge increases are implemented varies widely. For example, in California utilities have lobbied in their recent (GRC) General Rate Case filing to move a larger percentage into TOU demand charges, and away from Max or Non-coincident demand charges. This is an acknowledgment that the utilities are most motivated to reduce their system-wide peak, which occurs during the “on-peak” period, currently defined as 4 pm – 9 pm on most tariffs. By levying higher “on-peak” demand charges customers are incentivized to shift their loads outside that time window. As mentioned earlier, we expect to see new experimental demand charge structures and ratchets get introduced. Examples being daily demand charge rates, or possibly a push by utilities to implement demand charges on residential customers. 

Solar and Demand Charges

Utilities are well aware of the fact that solar PV systems do not reduce demand charges as efficiently as they do energy charges.  Solar advocates have long accused utilities of shifting more of their cost recovery onto demand charges, as a covert way to weaken the value proposition of rooftop solar. Whether that was their intention or not, higher demand charges in exchange for lower energy charges, does reduce the bill savings that solar can capture. On the flip side, higher demand charges create an opportunity for load-management software and energy storage. Peak-shaving and demand charge management is generally the primary value stream or bill savings opportunity for these projects. Sophisticated energy efficiency, solar, and energy storage project developers are aware of these dynamics and strategically optimize their system sizes to reduce demand charges and the overall electric bill. 

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