Published in Learning Center • Advanced Rates

Understanding Peak Demand Charges: The Hidden Cost of Your Highest Hour

You notice a surprising charge on your electricity bill labeled "demand charge" or "peak demand." You used the same kilowatt-hours as last month, but this bill is $30 higher. What happened? The difference: for one hour this month, you ran your AC and water heater simultaneously—your peak demand moment—and the utility is charging you $30 for that single hour of high power usage.

This guide explains what peak demand charges are, why utilities use them, which customers face them, and how to reduce them through strategic load management.

What Are Peak Demand Charges?

A peak demand charge is a monthly fee based on your highest power usage during a specific period (usually a 15-minute or 30-minute interval). It's separate from your kWh (energy) charges and is calculated on your peak power draw, not total energy consumed.

Peak Demand Charge = (Your peak power usage in kW) × (Demand rate per kW)

Key Distinction: kWh vs. kW

  • kWh (kilowatt-hours) = energy over time (how much you used)
    Example: Run a 5 kW AC for 4 hours = 20 kWh
  • kW (kilowatts) = instantaneous power demand (how much at one moment)
    Example: At 2 PM, you're drawing 5 kW from the grid

Demand charges penalize the moment of highest power draw in a month, not total consumption.

How Peak Demand Charges Are Calculated

Utilities record your power usage in 15-minute or 30-minute intervals throughout the month. The interval with the highest usage becomes your "peak demand" for the month. You're then charged a rate per kW for that peak.

Real Example

Your demand charge rate: $12/kW per month

Your usage throughout the month:

  • Most hours: 2-3 kW (normal usage)
  • Afternoon hours: 4-5 kW (AC running)
  • One day at 2 PM: 8 kW peak (AC + water heater + clothes dryer all running)

Your peak demand charge: 8 kW × $12 = $96/month

That single hour of high usage (8 kW) costs you $96 for the entire month.**

Who Has Peak Demand Charges?

Residential Customers

Most residential customers DO NOT have demand charges. Traditional residential rates use only kWh (energy) charges. However, some customers are subject to demand charges if:

  • Demand response programs: You voluntarily enrolled in a time-of-use plan with demand charges
  • Net metering customers with high usage: Some utilities are adding demand charges to reduce solar/rooftop PV subsidies
  • Commercial customers in residential areas: You have a business at your home address
  • Certain utility jurisdictions: A few utilities (Hawaii, some California utilities) are rolling out residential demand charges

Small Business and Commercial

Most small businesses HAVE demand charges. This is standard for any commercial account above ~20 kW peak usage. Examples:

  • Retail stores: $15-25/kW
  • Offices: $12-20/kW
  • Manufacturing: $10-30/kW (varies by region)

A small office with a peak demand of 25 kW at $15/kW pays $375 just in demand charges every month, before any energy charges.

Industrial and Large Users

All industrial customers have demand charges. These often also include:

  • Ratchet clauses: Peak demand is "ratcheted" to 80-90% of your annual peak (you pay for high demand even in low-usage months)
  • Time-of-use demand: Higher demand rates during peak hours (2-8 PM)
  • Power factor penalties: Additional charges if your equipment isn't efficient

Why Do Utilities Charge Demand?

Utilities argue demand charges reflect real costs:

The Utility's Argument

  • Infrastructure capacity: A customer using 8 kW requires utility infrastructure (transformers, wires, substations) sized for 8 kW, even if they only use it for one hour per month
  • Peak grid stress: When everyone's AC runs simultaneously (hot summer afternoons), the grid reaches maximum capacity. Demand charges incentivize customers to avoid peak usage.
  • Fair cost allocation: Without demand charges, low-usage customers subsidize high-demand customers

The Reality

Utilities also use demand charges for revenue stability. A customer might reduce energy usage via efficiency, but demand charges still apply to any customer with a working AC unit. This guarantees revenue regardless of conservation efforts.

How to Reduce Peak Demand Charges

1. Shift Major Loads Off-Peak

Strategy: Run high-power devices during off-peak hours (evening/night) instead of afternoon.

Examples:

  • Run clothes dryer at 8 PM instead of 2 PM
  • Run dishwasher and laundry in evening
  • Pre-cool your home at night (set AC to 68°F at night, then 74°F during hot afternoon)
  • Charge EV overnight instead of during peak afternoon hours

Potential savings: $20-100+/month depending on what you shift and your demand rate

2. Install Energy Storage or Smart Scheduling

Technology: Battery systems or smart thermostats that manage peak demand.

How it works: Battery charges during off-peak (cheap) hours, then powers your home during peak (expensive) hours. Smart thermostat pre-cools the home when demand rates are low.

Cost: $5,000-15,000+ for battery systems (eligible for tax credits in some states)

ROI: 5-10 years depending on your demand charge rate

3. Stagger Appliance Use

Strategy: Don't run multiple high-power devices simultaneously.

Simple example:

  • Before: 3 PM: AC (5 kW) + Water Heater (4 kW) + Dryer (5 kW) = 14 kW peak
  • After: Stagger so only AC + Water Heater at same time = 9 kW peak
  • Savings: 5 kW reduction × $12/kW = $60/month

4. Upgrade to Efficient Equipment

High-efficiency units draw less peak power:

  • Heat pump AC (vs. traditional): 20-30% less peak power
  • On-demand water heater (vs. tank): Eliminates heating standby power
  • Energy-efficient HVAC: Smaller units with better efficiency

Potential savings: $30-80/month if you reduce peak from 8 kW to 6 kW

5. Negotiate Demand Response Programs

For commercial customers: Participate in utility demand response programs where you agree to reduce usage during peak hours.

Incentive: Lower demand charges or direct payments for participating

What's required: Ability to quickly reduce loads (smart controls, flexible operations)

Peak Demand Charges vs. Time-of-Use Rates: Which Is Better?

Some utilities offer a choice between demand charges and time-of-use (TOU) rates.

Demand Charges (Current Month Only)

  • Charged on your single highest hour in the month
  • Punishes one moment, ignores overall usage
  • Example: $12/kW if your peak is 8 kW

Time-of-Use Rates (All Peak Hours)

  • Higher rate for all hours during peak period (usually 2-8 PM)
  • Charges based on when you use, not just your peak
  • Example: 25¢/kWh during peak hours, 10¢/kWh off-peak

Which Is Cheaper?

Scenario: Commercial customer using 3,000 kWh/month with 8 kW peak

  • Demand charges: (8 kW × $12/kW) + (3,000 kWh × $0.10/kWh) = $396/month
  • TOU rates: (500 kWh × $0.25) + (2,500 kWh × $0.10) = $375/month
  • Winner: TOU rates by $21/month IF you can shift usage off-peak

TOU is better if you can shift loads. Demand charges are worse if you have any peak usage at all.

Key Takeaway

Peak demand charges charge for your highest power draw hour, not total energy. Residential customers rarely have them, but commercial customers always do. Reduce demand by shifting loads to off-peak hours, staggering appliance use, or upgrading to efficient equipment. Even 1-2 kW reduction can save $12-24/month.

Next Steps

  • Check your bill: Look for "demand charge" or "peak kW" line items. If present, note the $/kW rate and your peak kW.
  • Identify your peak hour: Ask your utility which 15-minute interval had the highest usage. Plan to avoid that time.
  • Ready to shop? Check How to Choose an Electricity Supplier and ask about demand charge options.
  • Want battery storage info? Battery systems can help reduce peak demand; explore alternatives to peak charges.