Energy Demand Charges Explained: What They Are and Why You Should Care

Energy Demand. It’s one of the most misunderstood components of a commercial energy bill. It’s also potentially the greatest unknown for predicting energy costs as corporations, factories, cities, schools, retailers and more transition to renewable energy.

What is demand and why does it play such a major role in lowering emissions and costs? Let’s start by looking at energy consumption and how it is accounted for on your energy bills.

Demand Charges Explained by Kaitlin Marin

To get the right answer, we’ve turned to our rate and policy professional Kaitlin Marin. Every day, Kaitlin helps customers navigate the often turbid (and potentially treacherous) waters of multi-state, multi-energy utility billing, incentives and penalties that are integral to today’s energy mix in the U.S.

Understanding Energy Consumption

chart showing demand charges over time

To understand “demand”, we have to start with what your energy bill tells you. Typically, there are three parts to commercial energy bills:

1. Baseline Charges
Often known as the connection fee. This is typically a set fee that everyone pays just to be part of the grid.

2. Energy or Usage Charges
This is the first load factor and reflects the quantity of what you use and when you use it. While energy usage can appear flat or in tiers (meaning the more energy you use, the higher the tier and charges), many utilities align energy charges to reflect Time of Use (TOU) for their commercial customers. A TOU schedule, which means energy consumed during peak energy demand hours will be more expensive and less expensive during low demand periods, is also becoming more commonly applied to previously flat or tiered energy charges.

TOU rate structures are more common for commercial customers, but are now rolling out to residential customers in states like California. In California and other areas of higher solar renewable energy penetration, supply and demand have shifted from midday as most expensive energy to early evenings when the sun doesn’t shine. Many western utilities have shifted their electricity peak hours and most expensive Usage Charges to cost the most on weekdays starting around 4:00 p.m. until as late as 9:00 p.m.

3. Demand Charges

The cost line that generates the most customer questions is demand charges, which is calculated on top of baseline and Energy or Usage. Demand is the hardest to conceptualize and one that most don’t pay attention to. It is a combination of how much electricity used and the rate at which it is consumed. Imagine how different watering your lawn would be using a standard garden hose on “gentle rain” nozzle setting versus a fire hose set on high. Then imagine everyone around you all using their fire hoses at the same time. That is demand.


Why are Energy Demand Charges Important to Commercial Ratepayers?

We find that no matter their job — whether corporate accounts payable or onsite energy managers — people are typically surprised to see that demand charges are a significant portion of their energy utility bill (often a third or more of regular bill charges.) So commercial enterprises of all sizes care about demand because it can radically shift costs from month to month.

Demand spikes can also shift which utility rate tariff an organization qualifies for. The max demand billing over the previous 12 months is frequently one of the primary qualifications in determining which rate tariff a customer will be placed on.  With more renewables like wind and solar powering our work and play, we see demand spikes and energy availability changing. This is evidenced by the oft-referred to “duck curve” that projects energy supply versus demand for California.

graph of california's electric grid daily usage


Why is Demand so Critical to Utilities?

Utilities also care about demand because energy availability, grid up-time, reliability and resilience are bedrock to their business. For most energy utilities in the U.S., keeping energy flowing and available at the flick of a switch is also a mandated requirement.

Utilities have uptime and reliability requirements, including safe operation of the grid and planning and investments in construction and infrastructure to meet future 24/7/365 energy demand. For example, California adopted Resource Adequacy (RA) policy framework in 2004 to ensure the reliability of electric service statewide. The RA policy is being constantly updated to reflect changes in the energy landscape, and it currently requires that Load Serving Entities (LSEs) demonstrate that they have procured 90% of their ratepayer needs for upcoming summer months, 90% of flexible requirements and 100% of its local requirements for the year.


How Are Commercial Electricity Demand Charges Calculated?

graph of demand charge rates versus solar plus storage over time

Above is a sample model that shows how much savings a typical commercial, municipal or industrial enterprise can save by using a combination of onsite solar generation with energy storage to lower their demand.

Across the US, demand charges are typically calculated based on 15-minute interval data, focusing on the most energy used during that time frame. So a single spike in one day will determine maximum power demand for any given customer for that entire month. In addition or alternatively, commercial customers under TOU rate structures may also be charged higher electricity rates during each utility’s defined peak hours.

That maximum power demand spike is then multiplied by the utility’s rate, which is typically an escalating rate over time. Some utilities have also implemented an annual max that is tied to a percentage of the annual peak demand from the previous 12 months.  We’ve seen some customers’ costs jump simply based on one or two demand spikes per year.


How Can Demand Charges Be Reduced?

Energy efficiency is the place to start to cut demand spikes. As refrigeration, heating and cooling are often the greatest peak electricity draws when grid demand is greatest, deploying more energy-efficient equipment is the low hanging fruit to decrease overall grid demand, whether at residential or commercial scale.

Peak shaving, the process of lowering peak demand spikes by shifting loads off grid-sourced energy to onsite means such as solar-charged energy storage, requires batteries, software and analysis of operations to reduce demand. In the US, more than a dozen states are incentivizing battery storage in front of the meter (on the utility or grid side) as well as behind the meter (onsite, at your home or business).

Another option is enrolling in programs like Demand Response.

chart of reported c&i demand response capacity

Demand Response initially referred to utilities offering financial incentives to their customers when they reduce consumption during “energy events”, such as high heat index days. By reducing usage to pre-agreed amounts (ex. 20% reduction for specified number of hours), organizations are rewarded with cheaper overall commercial electricity rates and penalized with higher fees if not in compliance.

Demand Response programs vary widely by utility and location nationwide. Customer Initiated Demand Response programs enable commercial and industrial customers to accept signals from their local electric utility for when to curtail usage. The customer can then choose how to reduce and modify load accordingly. Common examples of lowering demand include decreasing heating or cooling by a few degrees or deferring processes, such as large production calls, that use a lot of electricity.

A relatively small portion of our customers have signed up for Demand Response. But with the advent of load shifting using battery energy storage and with more utilities initiating automatic opt-ins for these programs (which may include guarantees protecting you from cost increases in the first year), Demand Response rates are becoming more prevalent nationwide.


How Does Solar Storage Assist With Peak Demand Management?

chart of battery storage price points

A good portion of utilities across the U.S. use demand to calculate which rate tariff and commercial charge to use for their customers.

When energy storage (typically provided via lithium ion batteries coupled with solar generation) is used instead of pulling power from the grid at high electricity demand times, demand spikes are evened out. Enterprises become eligible for lower rate tariffs. And the cost-benefit of energy storage blossoms.

For example, NREL modeled in 2018 that $15 per KW cost is a threshold at which energy storage pays for itself — and that rate is falling every year. So on-site energy storage directly lowers demand charges while also helping to displace one of the highest greenhouse gas emitting sources: peaker power plants.


What Are Peaker Power Plants?

image of peaker plants releasing smoke into air
Brown Coal Power Station, North Rhine-Westphalia, Germany, Europe

Peaker power plants are safeguards that generate enough energy on rare occasions when there is very high electricity demand.

Peaker plants are also attributed with large greenhouse gas emissions.

As our climate changes, more of the U.S. is suffering from really hot summer days. As air conditioners become heavily used and refrigerators are condensing well into the night, on-demand power or peaker power plants fill the gap on reliable energy supply.

The problem is that these rarely-used (often less than 2 percent of the entire year) peaker power plants are also older fossil fuel plants. In New York, dozens of coal or gas-fired peaker plants are spread across the state. Many of these are 50 years or older. The old fossil fuel burners emit as much as one-third of toxic nitrous oxide emissions for the state. They cost far more to maintain and operate as well.


How Can We Decrease Our Dependence On Peaker Plants?

We can decrease our dependence on peaker plants through monetary incentives as well as by reducing emissions.

Shifting energy use and tapping energy storage when the grid is overtaxed will eliminate the need for peaker plants. Many State, Federal and local incentives recognize this combination with monetary incentives

New incentives designed to decrease demand, lower emissions and support grid resiliency and reliability are appearing across the U.S. One great example is New York’s multifaceted Value of Distributed Energy Resources (VDER) program. This is important to demand reduction because it compensates distributed generation (DG) projects according to location and timing of energy pushed onto the grid. These mechanisms are tied to carbon emissions reduction and annual peak demand reduction, among other grid benefits.

As we learn more, resiliency and reliability solutions are changing too. For example, load shifting and energy storage batteries will not operate exactly the same as “always-on” baseload power plants or on-demand peaker plants. The shifts to and from using energy storage are more dynamic than steady-state baseload but much steadier than a peaker plant.

The future requires renewable energy integrators to help businesses, municipalities, schools, universities, hospitals, retailers and the utilities that serve them to understand that the demand curve is changing. And it will continue to change, so demand charges must change with them.


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