Demand charges explained: What you need to know

In the past few years, utilities across the country— from Indiana to Massachusetts to Arizona—proposed mandatory or voluntary demand charges for residential customers. With the right resources and knowledge, it is definitely possible to reduce your monthly bill on a demand charge rate. But in many situations, including often for people with solar on their roofs, demand charges can lead to more expensive bills overall.

In most cases, utilities rely on volumetric electric rates for residential customers to track electricity consumption. A typical volumetric electric bill is made of fixed and variable charges that are combined into a rate that you pay based on your consumption every month. That's the cents per kilowatt-hour (c/kWh) rate that forms the basis of your electric bill, and "volumetric billing" is just another name to call electric billing by the amount of energy you consume. A volumetric electric rate is like retail shopping—the more you buy, the more you pay.

However, every electrical appliance and process in your household also requires a certain amount of power to operate. Instead of total consumption, a household's demand charge is based upon the maximum amount of power required over a single hour (or fifteen-minute period) in a given month. Because your demand charge is set based on your maximum hourly power requirement, there is less incentive to reduce your overall usage throughout the month but rather to adjust how much electricity you require at once. If you're on a demand charge electric rate, the only way to decrease your electric bill is to use less power all at once.

At its core, a demand charge shifts the charge on your electric bill from how much electricity you consume over an entire month to the maximum electricity you need at a single point during the month. Demand charges have historically been used for larger industrial electric customers but are beginning to appear for residential customers.

As a customer on a demand charge rate, you will still be billed for your monthly consumption as well as for your demand. However, in comparison to a purely volumetric bill, the balance of your bill will shift from being driven by your overall consumption to being driven by your peak demand. To offset the increase in the fixed charge portion of your electric bill, the increase in the demand charge is necessarily met with a reduction in the volumetric rate, meaning consumption will be billed at a much lower rate than on a typical residential electric bill.

To understand how demand charges work and impact your electricity bill, it is important to understand how utilities charge for electricity. Providing reliable electricity requires utilities to plan for and provide enough electric generating capacity to meet peak demand (expressed in kilowatts: kW), generate enough electricity to meet annual consumption on the grid (expressed in kilowatt-hours: kWh), and maintain and operate the transmission system that will deliver that electricity to each customer.

Each step in this process requires rigorous planning to ensure that the grid remains operational under worst-case scenarios, as well as to guarantee that the maximum possible demand on the system can be met. In other words, if every building and every home turned on air conditioners at full blast during the hottest hour of the hottest day of the year, would the electric system be able to satisfy all of the demand?

Providing all of these services costs money. Historically, utilities recovered costs through volumetric billing—that is, billing each customer for the quantity of electricity they use in a given month or year, measured by consumption (kWh). But with demand charges, utilities hope to shift to billing customers based upon their share of the total peak demand for energy on the system, measured in power requirement, kW instead of kWh.

A typical volumetric electric bill is made of fixed and variable charges that are combined into two separate pieces of the bill: a transmission and distribution charge (T&D) that keeps the poles and wires that connect houses to the grid operational; and a supply charge that represents the cost of generating the electricity we consume.

The total monthly cost of this type of utility bill is simple to calculate. Both the T&D and the supply charge are expressed as a rate—i.e., 15 cents per kWh. As a result, the more electricity you consume, the more your electric bill costs.

In most cases, if you are billed on a volumetric rate, then production from your solar panels allows you to avoid a certain percentage of your overall bill. If, for instance, your solar array is sized to provide 80 percent of your generation every month, then you will reduce your electricity bill by 80 percent every month because you avoid purchasing electricity from the grid.

With demand charges, the portion of your bill that is avoidable with solar energy may be reduced. For one, your household's peak energy consumption may not align with peak output from your solar array if you use your appliances in the morning and at night when the sun isn't shining as much or at all. As such, solar may not help reduce your maximum hourly demand. Additionally, net metering becomes less of a benefit on a demand charge rate because the energy from your solar panels that are placed back onto the grid would be compensated at a lower rate.

Utilities are proposing demand charge rates for a reason: to incentivize electricity customers to think not just about how much electricity they use over an entire month but about when and how much they are using at once. With that in mind, it's certainly possible to turn a residential demand charge rate into monthly bill savings.

Given that demand charge rates reduce the rate you pay per kWh consumed, you can actually use the same amount of electricity over the course of the month but pay a smaller electric bill. The key is ensuring that you don't turn on too many appliances all at once (to ensure a lower maximum monthly demand) or to shift power-intensive processes - like washing dishes or clothes - to off-peak periods when demand charges are lower or non-existent.

First and foremost, check to see if your utility offers or has proposed a demand charge rate for residential customers and particularly residential customers with solar. If, after reading this and other pieces, you are feeling informed and up to the challenge of reducing your peak demand, then think about a demand charge rate as a potential cost-saving opportunity.

That said, if you know that your primary electricity usage occurs all at once, then a demand charge rate may not be for you. And if you have net-metered solar, check to be sure the rate that your panels' production will be compensated before making the switch.

The best way to take control of your energy bill is to install solar panels. Pre-screened local installers on the EnergySage Solar Marketplace account for rebates and incentives available in your area, and our team of experts can help determine the best options, given your specific utility bill. To start your solar research with a quick estimate of what solar can save you, try our Solar Calculator.