What Is a Demand Ratchet? How It Locks You Into High Charges
Your commercial utility bill shows a demand charge of $1,200 for last month. But when you check your actual peak power usage for that month, it was only 50 kW. The bill shows a 80 kW charge. This gap exists because of a "demand ratchet"—a clause that locks you into a minimum demand charge based on your annual peak, not your current monthly usage. One hot summer day when your AC peaked at 80 kW determines your demand charge for the next 12 months, even during winter when peak demand drops to 30 kW.
Demand ratchets are particularly common in natural gas and commercial electric contracts. Understanding how they work and negotiating them down can save $500-2,000+ annually.
How Demand Ratchets Work
A demand ratchet is a clause that sets your monthly minimum demand charge based on a percentage (typically 75-90%) of your peak demand from the entire prior 12-month period. It prevents your monthly demand charge from falling below this threshold, regardless of actual usage that month.
Monthly Demand Charge = MAX(Actual Current Month Peak, Annual Peak × Ratchet %)
Real Example: How Ratchets Lock You In
Contract terms: Demand rate = $15/kW, Ratchet = 80% of annual peak
Annual usage pattern:
- January (winter, heating peak): 45 kW
- June (summer, AC peak): 95 kW ← ANNUAL PEAK OCCURS
- July (continued summer): 90 kW
- December (winter): 35 kW
Ratchet is set to 80% of 95 kW = 76 kW minimum
December billing (actual peak = 35 kW):
- Actual demand charge: 35 kW × $15 = $525
- Ratchet demand charge: 76 kW × $15 = $1,140
- You pay: $1,140 (ratchet applies)
- Extra cost due to ratchet: $615 for one month
Over a year with 8 low-demand months, this facility overpays approximately $4,920 annually ($615 × 8) due to the ratchet clause.
Types of Demand Ratchets
1. Annual Peak Ratchet (Most Common)
Your minimum demand is set to a percentage of your highest 15-minute demand from the previous 12 months.
Typical formula: Minimum demand = 80% of peak demand from prior 12 months
Who uses it: Most gas utilities, some commercial electric suppliers
Impact: One spike in one month affects your charge for the entire next year
2. Seasonal Peak Ratchet (Better)
Minimum demand resets seasonally based on the peak from that season only.
Example formula:
- Winter (Nov-Feb): 85% of highest demand in winter months
- Summer (Jun-Aug): 85% of highest demand in summer months
- Shoulder (Mar-May, Sep-Oct): 70% of highest demand in shoulder months
Why it's better: Recognizes natural demand swings. A summer AC spike doesn't punish you in winter heating.
3. No Ratchet (Rare)
Monthly demand charge is based only on that month's actual peak. No minimum applied.
Who offers it: Some competitive suppliers in deregulated markets (Pennsylvania, Ohio, Illinois); hard to find in utility contracts
Cost advantage: Significant for seasonal businesses (savings of 20-50% compared to 80% annual ratchet)
Who Is Most Affected by Demand Ratchets?
| Business Type | Typical Usage Pattern | Ratchet Impact | Annual Cost Increase |
|---|---|---|---|
| Office (constant HVAC) | Relatively stable year-round | Moderate (10-15% overage) | $300-800 |
| Retail (seasonal) | High summer AC, low winter | High (30-40% overage) | $2,000-5,000 |
| Restaurant (small load) | Flat usage, occasional spikes | Moderate (15-25% overage) | $400-1,200 |
| Manufacturing (variable production) | High variation month-to-month | Very High (40-60% overage) | $5,000-15,000+ |
Why Utilities and Suppliers Use Ratchets
The Utility's Argument
- Infrastructure sizing: If your peak is 95 kW one month, the utility must maintain capacity for that level year-round
- Cost recovery: The ratchet ensures the utility collects revenue for that infrastructure even in low-demand months
- Peak management incentive: Ratchets penalize usage spikes, encouraging customers to invest in load management
The Reality
Ratchets also provide revenue stability for utilities. A building that peaks at 95 kW in summer might use only 35 kW in winter, reducing demand charges naturally. The ratchet prevents that seasonal revenue drop, guaranteeing income across all months regardless of actual usage.
Calculating the Cost Impact of Different Ratchet Percentages
Scenario: Retail store with 100 kW summer peak, 40 kW winter low
Demand rate: $18/kW
| Ratchet % | Minimum (kW) | Winter Month Bill | Annual Overage |
|---|---|---|---|
| No Ratchet | 40 kW (actual) | $720 | $0 |
| 60% | 60 kW | $1,080 | $4,320 |
| 80% | 80 kW | $1,440 | $7,200 |
| 90% | 90 kW | $1,620 | $8,100 |
Note: Annual overage assumes 6 months at 40 kW actual peak (winter/shoulder months) + 6 months at or near 100 kW (summer months)
Negotiating Demand Ratchets
For Commercial Electric Customers (Deregulated Markets)
If you're in PA, OH, IL, TX, or other deregulated states, you can shop suppliers. Many competitive suppliers offer:
- No ratchet: Monthly demand based only on actual peak (rare but available)
- Lower ratchet percentage: 70% instead of 80% can save 10% on demand charges
- Seasonal ratchet: Request summer/winter split instead of annual
Negotiation approach: "We have seasonal demand variation. Can you offer a 60% ratchet or seasonal ratchets instead of 80% annual?"
For Gas Customers and Utility Tariffs (Regulated)
Ratchets on utility tariffs are harder to negotiate but not impossible:
- Request exemption for one-time events: "Our summer peak was unusually high due to equipment failure. Can that month be excluded from the ratchet calculation?"
- Request seasonal reset: "Can we use summer peaks for summer ratchets and winter peaks for winter ratchets?" (Some utilities allow this)
- Load management investment: "If we install battery storage to reduce summer peak, will the ratchet reset?" (Incentive for conservation)
Four Steps to Reduce Ratchet Impact
Step 1: Identify your peak and ratchet percentage
Your bill or tariff should show: "Minimum demand = 80% of annual peak demand." Calculate what that percentage applies to.
Step 2: Calculate annual cost impact
Use the table above with your actual peak and seasonal variation to see the overage.
Step 3: Invest in load management if cost-justified
- Example: Ratchet costs you $7,200/year. Battery system costs $15,000 and reduces peak by 20 kW = $3,600/year savings. ROI = 4.2 years
- Pre-cooling HVAC during off-peak: Low-cost (~$2,000 smart thermostat) can reduce peak 10-15 kW = $1,800-2,700 annual savings. ROI = <1 year
Step 4: Renew contracts without ratchets when possible
When your supply contract renews (common every 12-36 months), shop for suppliers offering no ratchet or lower percentage.
Key Takeaway
Demand ratchets lock you into paying for peak demand from your highest-usage month, even during low-demand months. A 80% ratchet can cost seasonal businesses $4,000-8,000+ annually. The impact varies dramatically by business type: offices see 10-15% overage, retail faces 30-40%, manufacturing can exceed 50%. If you're a commercial customer, verify your ratchet percentage, calculate the annual cost impact, and negotiate lower percentages (60% or seasonal splits) when renewing supply contracts.
Next Steps
- Review your bills: Look for "ratchet," "minimum demand," or "demand percentage" language. Most utility bills have a line explaining the ratchet.
- Calculate annual impact: Use the formula above with your actual peak demand and seasonal usage to quantify overpayment.
- Check your contract renewal date: Ratchets are often non-negotiable with utilities but highly negotiable with competitive suppliers when your contract renews.
- Explore load shifting: Review Understanding Peak Demand Charges for load management strategies that reduce your annual peak.
- For commercial: Use Decoding Energy Contract Terms to understand all clauses when comparing supplier contracts.