By: Ralph Zarumba, Vice President and Tom O’Neill, Jr., Consultant
This article is the second in a series addressing the changing environment for regulated utility pricing given advances in Distributed Energy Resource technology, data availability, and customer preferences. Part One addressed the issue of Net Energy Metering.
Demand charges have been a component of electric utility pricing design for many decades. The original arguments for demand charges were developed by John Hopkinson and further summarized by James Bonbright:
“The full rationale of this Hopkinson, two-part rate is far from simple. But the rationale usually given (although it will serve only as a first approximation) is that the two-part rate distinguishes between the two most important cost functions of an electric-utility system: between those costs that vary with changes in the system’s output of energy, and those costs that vary with plant capacity and hence with the maximum demands on the system (and subsystems) that the company must be prepared to meet in planning its construction program.”
However, industry experts are now debating whether demand charges are an appropriate pricing mechanism, in particular for smaller customers (e.g., residential customers). Some compelling arguments against demand charges to consider:
- Demand charges do not send proper price signals to customers.
- Demand charges are expensive to implement.
- Customers do not understand demand charges.
- Customers cannot react and/or respond to demand charges.
- No cost support exists for demand charges; they do not reflect the incremental cost to use the distribution system.
- Distribution investments should be recovered by some form of energy charge.
In this article, we limit the debate to electric distribution systems. We will assess the arguments for and against demand charges and determine if demand charges are an appropriate mechanism in an electricity pricing design.