What are Demand Charges and How Do They Work?

by | Jan 13, 2020 | Commercial, Financial

About the Author:

Headshot of Reed Crossley, Digital Marketing Strategist at Independent Power Systems

Reed Crossley

Reed Crossley is a Digital Marketing Strategist living in Boulder, Colorado. Reed works with a variety of energy, sustainability, and social impact organizations to do groovy things with digital technologies and achieve meaningful organizational goals. He holds a Master’s degree in Environmental Management from CU Boulder and volunteers as the Marketing Coordinator for the Boulder chapter of the Colorado Renewable Energy Society (BCRES). Ever quick with a movie reference or fun fact about the cleantech industry, Reed can be found hiking or kayaking in the mountains in his spare time. Connect with Reed on LinkedIn.

If you are a commercial or industrial (C&I) customer, your utility bills are generally divided into two primary components: energy consumption and demand charges.

Energy consumption is relatively straightforward: it is a measure of your total electricity usage during a given period—usually a month. This amount of energy consumed, measured in kilowatt-hours (kWh), is then multiplied by the price of energy ($/kWh) to determine your billed amount for that month.

The other portion of your bill—demand charges—is less understood and has the potential to make up a significant portion of your total monthly energy bill. But what exactly are demand charges, and how do they fit into your utility’s rate structure?

Demand Charges Explained

C&I customers may already be familiar with time-of-use (TOU) pricing for electricity, where the $/kWh amount varies throughout the day to correspond to periods of peak demand in the market. Demand charges are similar in that utilities look at their customer’s maximum power consumption for a 15-minute interval within a given billing period, usually the month.

This high point of electricity use within the month is then multiplied by a specific peak-demand rate, and that determines the demand charge. The peak-demand rate is per kilowatt ($/kW), instead of the kilowatt-hour rate ($/kWh) used to determine energy consumption.

Let’s look at an example.

An auto dealership has fairly consistent energy consumption throughout the month of September. However, for one 15-minute interval among thousands that month, the dealership sees a surge of activity that drastically increases the power demand.

That interval was the highest average power draw in September, at 49 kW. The demand charge for September will be that power amount times the peak demand rate:

49 kW X $8.75/kW = $428.75

There are variations in how demand charges can be structured. The averaging interval is commonly 15 minutes, but can also go up to 30 or 60 minutes. The demand charges could also be connected to time-of-use or seasonal changes, with higher peak-demand rates imposed during elevated use times like summer afternoons.

Sometimes demand charges use a declining or inclining tier structure. In such a case, the rate could be $10/kW for the first 200 kW, and $5/kW over that amount. Demand charges can vary widely from utility to utility, so it is important to dig into your own provider’s rate structure.

solar energy and demand charges

What Is The Purpose Of Demand Charges

The reasoning behind demand charges is that they require customers who draw a lot of power over short periods to pay more of the cost of building and maintaining peak power infrastructure. These upgrades and maintenance may include transmission and delivery infrastructure or expensive peaker power plants that are on standby specifically to handle peak demand periods (and subsequently are seldom used).

You can think of the energy consumption charge on your bill as recuperating the costs correlated with producing that energy, such as fuel and operations expenses. Demand charges are used to help offset the cost of delivering a consistent level of energy to customers, with those customers with significant power needs paying more to maintain the system. While these customers may not necessarily operate at or near peak usage one hundred percent of the time, the utility needs to ensure they are able to maintain the grid in the event the customer was to have much higher usage.

Since commercial and industrial customers have higher peak power demands, they are usually the target for demand charges. There has been a worrying trend developing within the last couple of years where demand charges are starting to be leveled on residential customers who generate some of their own power with solar.

If you are a commercial or industrial (C&I) customer, your utility bills are generally divided into two primary components: energy consumption and demand charges.

Energy consumption is relatively straightforward: it is a measure of your total electricity usage during a given period—usually a month. This amount of energy consumed, measured in kilowatt-hours (kWh), is then multiplied by the price of energy ($/kWh) to determine your billed amount for that month.

The other portion of your bill—demand charges—is less understood and has the potential to make up a significant portion of your total monthly energy bill. But what exactly are demand charges, and how do they fit into your utility’s rate structure?

Demand Charges: Explained

C&I customers may already be familiar with time-of-use (TOU) pricing for electricity, where the $/kWh amount varies throughout the day to correspond to periods of peak demand in the market. Demand charges are similar in that utilities look at their customer’s maximum power consumption for a 15-minute interval within a given billing period, usually the month.

This high point of electricity use within the month is then multiplied by a specific peak-demand rate, and that determines the demand charge. The peak-demand rate is per kilowatt ($/kW), instead of the kilowatt-hour rate ($/kWh) used to determine energy consumption.

Let’s look at an example.

An auto dealership has fairly consistent energy consumption throughout the month of September. However, for one 15-minute interval among thousands that month, the dealership sees a surge of activity that drastically increases the power demand.

That interval was the highest average power draw in September, at 49 kW. The demand charge for September will be that power amount times the peak demand rate:

49 kW X $8.75/kW = $428.75

There are variations in how demand charges can be structured. The averaging interval is commonly 15 minutes, but can also go up to 30 or 60 minutes. The demand charges could also be connected to time-of-use or seasonal changes, with higher peak-demand rates imposed during elevated use times like summer afternoons.

Sometimes demand charges use a declining or inclining tier structure. In such a case, the rate could be $10/kW for the first 200 kW, and $5/kW over that amount. Demand charges can vary widely from utility to utility, so it is important to dig into your own provider’s rate structure.

solar energy and demand charges

What Is The Purpose Of Demand Charges

The reasoning behind demand charges is that they require customers who draw a lot of power over short periods to pay more of the cost of building and maintaining peak power infrastructure. These upgrades and maintenance may include transmission and delivery infrastructure or expensive peaker power plants that are on standby specifically to handle peak demand periods (and subsequently are seldom used).

You can think of the energy consumption charge on your bill as recuperating the costs correlated with producing that energy, such as fuel and operations expenses. Demand charges are used to help offset the cost of delivering a consistent level of energy to customers, with those customers with significant power needs paying more to maintain the system. While these customers may not necessarily operate at or near peak usage one hundred percent of the time, the utility needs to ensure they are able to maintain the grid in the event the customer was to have much higher usage.

Since commercial and industrial customers have higher peak power demands, they are usually the target for demand charges. There has been a worrying trend developing within the last couple of years where demand charges are starting to be leveled on residential customers who generate some of their own power with solar.

Solar advocates have been fighting this trend, as it has the potential to stall or kill home solar development by greatly extending payback periods. In 2019 the largest utility in Montana, Northwestern Energy, had its proposal for demand charges on residential solar customers rejected.

How Can Solar and Storage Help With Demand Charges

Solar has a relatively straightforward impact on reducing the energy consumption portion of a utility bill. The more solar power generated on-site, the less energy that is needed to be purchased from the utility.

There can be savings on the demand charge portion too, but it is not as consistent or straightforward. Solar generation needs to coincide with the peak demand period of the month to have a savings impact. There is not a guarantee of that, but C&I customers whose peak usage is during the day have the best chance of benefiting.

Of course, solar generation is subject to weather. A chance rainstorm during the peak 15 minutes of power in the month would negate any demand charge savings. For this reason, it is not possible to guarantee demand savings, but using probabilistic analysis, a customer can get an estimate of expected demand charge savings.

Coupling energy storage with solar dramatically improves the situation. Even with little to no solar insolation, a battery system can provide power during peak demand events and reduce charges. As demand charges increase and battery systems get cheaper, this could be a significant growth opportunity for the energy storage market.

The energy storage industry may also be boosted by such a policy. Massachusetts recently became the first state to enact a Clean Peak Standard, which requires peak loads to be met with a certain percentage of clean energy, which also includes stored clean energy.

In Conclusion

Demand charges are not going away anytime soon, though they are not without their critics. Customers who work to understand their own demand charge structure better are taking an important first step in lowering their monthly energy bills.

Solar generation and battery storage are increasingly being used to reduce energy consumption and the burden of demand charges on C&I customers, saving customers a significant amount of money on their energy bills. If you are in a region with a demand charge program, reach out to one of our solar plus storage experts to see what savings opportunities exist!

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