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2.2 Demand Charges, Ratchets, Peak Shaving, and Power Factor Penalties

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AEE Certified Energy Manager CEM

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1 Chapter 1: Energy and Sustainability Policies, Codes, and Standards

1.1 Federal and State Energy Policies, Decarbonization Targets, and ESG Reporting 1.2 Building Energy Codes: ASHRAE Standard 90.1, IECC, and Compliance Paths 1.3 Energy Management Systems: ISO 50001, ENERGY STAR Benchmarking, and Portfolio Manager

2 Chapter 2: Energy Rates, Tariffs, and Supply Options

2.1 Utility Rate Structures: Volumetric vs. Demand Charges, Time-of-Use (TOU), and Real-Time Pricing 2.2 Demand Charges, Ratchets, Peak Shaving, and Power Factor Penalties 2.3 Energy Procurement, Deregulated Markets, Supply Contracts, and Green Tariffs 2.4 Demand-Side Management, Load Curtailment, and Transportation Energy Efficiency

3 Chapter 3: Energy Audits and Instrumentation

3.1 Energy Audit Methodologies: ASHRAE Level I, II, and III Audit Scopes 3.2 Audit Instrumentation, Data Loggers, Metering Accuracy, and Safety (PPE) 3.3 Baseline Energy Data, Utility Bill Disaggregation, and ECM Identification 3.4 Energy Modeling, Simulation, Digital Tools, and Performance Indicators

4 Chapter 4: Energy Accounting and Economics

4.1 Energy & Power Units (kWh, kW, Therms, MMBtu, Joules) and Conversion Calculations 4.2 Financial Metrics: Simple Payback Period, Return on Investment (ROI), and LCCA 4.3 Time Value of Money: Net Present Value (NPV), Internal Rate of Return (IRR), and Escalation 4.4 Advanced Financial Evaluation: Annual Worth, SIR, Depreciation, and Interest Formulas

5 Chapter 5: Electrical Power Systems and Motors

5.1 Electrical Fundamentals: Single/Three-Phase Power, Apparent/Real/Reactive Power, and Power Factor 5.2 Electric Motors: Efficiency Classes, Loading Calculations, NEMA Premium, and Losses 5.3 Variable Frequency Drives (VFDs), Affinity Laws, and Electrical Harmonics

6 Chapter 6: Lighting Systems

6.1 Lighting Fundamentals: Photometric Quantities (Lumens, Lux, Foot-Candles, CRI, CCT) and Efficacy 6.2 Lighting Technologies & Retrofits: LED Systems, Fluorescent/HID Replacement, and LPD 6.3 Lighting Controls: Occupancy/Vacancy Sensors, Daylight Harvesting, Dimming, and Task Tuning

7 Chapter 7: HVAC Systems and Building Envelope

7.1 HVAC Fundamentals & Psychrometrics: Dry-Bulb, Wet-Bulb, Dew Point, Relative Humidity, and Enthalpy 7.2 Cooling and Heating Equipment: Chillers (COP, kW/ton, EER, SEER), Heat Pumps, and Boilers 7.3 Air and Water Distribution: AHUs, VAV vs. CAV, Pumping Systems, Fans, and Economizers 7.4 Building Envelope: Heat Transfer (U-factor, R-value, SHGC), Infiltration, and Thermal Insulation 7.5 Building Envelope Calculations: Degree-Days, Solar Heat Gain, and Passive Design 7.6 Refrigerants, Cooling Towers, and Specialized HVAC Technologies (Absorption, VRF, Chilled Beams)

8 Chapter 8: Building Automation, Controls, and Artificial Intelligence Systems

8.1 Building Automation Systems (BAS) Architecture, BACnet, Modbus, and DDC Loops 8.2 Energy Control Strategies: Temperature/Pressure Resets, Night Setback, and Deadbands 8.3 Fault Detection & Diagnostics (FDD), Energy Analytics, and AI Optimization 8.4 IoT, Cloud-Based BAS, Expert Systems, and Cyber-Security

9 Chapter 9: Energy Storage Systems

9.1 Battery Energy Storage Systems (BESS): Technologies, Capacity, Efficiency, and Safety 9.2 Thermal Energy Storage (TES): Chilled Water, Ice Storage, and Phase Change Materials 9.3 Storage Dispatch Strategies, Tariff Integration, Peak Shaving, and Microgrid Integration

10 Chapter 10: Boiler and Steam Systems

10.1 Boiler Fundamentals & Efficiency: Combustion Efficiency, Excess Air, and Stack Losses 10.2 Steam Distribution & Traps: Steam Trap Types, Failure Modes, Testing, and Insulation 10.3 Condensate Recovery, Boiler Blowdown Control, and Waste Heat Recovery

11 Chapter 11: Distributed Generation and Renewable Energy Systems

11.1 Solar Photovoltaic (PV) and Wind Energy Systems: Design, Inverters, and Capacity Factor 11.2 Combined Heat and Power (CHP) / Cogeneration: Thermal Efficiency and System Sizing 11.3 Grid Interconnection, Net Metering, Islanding, and Microgrid Resilience 11.4 Biomass, Geothermal, Hydropower, Solar Thermal, and Waste-to-Energy Systems

12 Chapter 12: Industrial Systems

12.1 Compressed Air Systems: Efficiency, Pressure Drop, Leak Management, and Receiver Storage 12.2 Industrial Process Heating, Cooling Towers, and Industrial Refrigeration 12.3 Production-Normalized Energy Metrics, Pumping System Optimization, and Process Integration

13 Chapter 13: Operations, Maintenance, and Commissioning

13.1 Preventive, Predictive, and Reliability-Centered Maintenance Strategies 13.2 Building Commissioning: Existing Building Commissioning (EBCx) & Retro-Commissioning (RCx) 13.3 Savings Persistence, Continuous Commissioning, Sensor Calibration, and Alarms 13.4 Quantifying O&M Losses: Compressed Air Leaks, Steam Traps, Boiler Scale, and Group Relamping 13.5 CMMS, Water Treatment, and Human Behavior in Energy Management

14 Chapter 14: Energy Savings Performance Contracting and Measurement & Verification

14.1 Energy Savings Performance Contracting (ESPC), ESCO Roles, and Financing Models 14.2 Measurement and Verification (M&V): IPMVP Options A, B, C, and D 14.3 Baselines, Weather Normalization, Non-Routine Adjustments, and M&V Reporting

2.2 Demand Charges, Ratchets, Peak Shaving, and Power Factor Penalties

Key Takeaways Explain This Topic AI

Billing demand can exceed actual demand due to ratchet clauses, which enforce a minimum charge based on a percentage of the highest historical peak over a previous period.

Peak shaving strategies, such as load shedding, thermal energy storage, or battery discharge, aim to flatten the load profile and reduce demand charges.

Low power factor (typically below 0.85-0.90), caused by inductive loads like motors, forces utilities to supply excess apparent power (kVA).

Utilities penalize low power factor by inflating the billing demand, a cost that can often be mitigated by installing local capacitor banks to supply reactive power (kVAR).

Last updated: July 2026

  • 2.2 Demand Charges, Ratchets, Peak Shaving, and Power Factor Penalties
  • Introduction

Building on the foundational understanding of energy versus demand, this section delves deeper into the mechanical and financial aspects of demand charges. For many industrial and large commercial facilities, demand charges account for 30% to 60% of the total electricity bill. Consequently, managing and mitigating peak demand is often the most lucrative strategy for an Energy Manager. Here we will explore how utilities calculate billing demand, the punitive nature of ratchet clauses, strategies for peak shaving, and the calculations behind power factor penalties.

Billing Demand vs. Actual Demand

It is crucial to distinguish between a facility's actual measured peak demand and its "billing demand." The actual demand is the highest average kW registered by the utility meter over a specific interval (e.g., 15 minutes) during the current billing cycle. The billing demand, however, is the value the utility actually multiplies by the demand rate ($/kW) to calculate the charge. While billing demand is often equal to actual demand, various tariff rules can cause billing demand to be significantly higher.

Ratchet Clauses

The most common mechanism that causes billing demand to exceed actual demand is the ratchet clause (or demand ratchet). Utilities must maintain infrastructure to meet a facility's highest historical demand, even if that peak only occurs during one month of the year (e.g., air conditioning load in July). To ensure they recover these year-round infrastructure costs, utilities implement a ratchet clause, which sets a minimum floor for billing demand based on a percentage of the highest peak demand recorded over a previous rolling period (typically 11 or 12 months).

The formula for determining billing demand under a ratchet clause is generally:

  • Billing Demand = Math.max(Actual Current Demand, Ratchet Percentage * Max Historical Demand)
  • Worked Example: Ratchet Clause Calculation

A facility is on a tariff with a demand charge of $15.00/kW and an 80% 12-month ratchet clause.

In July (the peak summer month), the facility recorded an actual peak demand of 2,000 kW.

In December (a low-usage month), the facility's actual peak demand was only 1,200 kW.

Let's calculate the demand charge for December.

Step 1: Determine the ratchet minimum based on the historical peak.

  • Historical Peak = 2,000 kW (from July)
  • Ratchet Minimum = 0.80 * 2,000 kW = 1,600 kW

Step 2: Compare the actual current demand to the ratchet minimum.

Actual Demand in December = 1,200 kW

Since 1,200 kW < 1,600 kW, the billing demand is set to the ratchet minimum of 1,600 kW.

Step 3: Calculate the demand charge.

December Demand Charge = 1,600 kW * $15.00/kW = $24,000

Notice the severe financial penalty: the facility only used 1,200 kW of peak capacity in December, but they paid for 1,600 kW. They paid an "invisible" penalty of 400 kW * $15.00 = $6,000 just because of a high peak set five months earlier. This illustrates why preventing a new historical peak is a paramount operational priority.

Peak Shaving Strategies

Because demand charges and ratchets are so punitive, energy managers employ "peak shaving" to flatten the load profile. Peak shaving is conceptually straightforward but operationally complex. The goal is to clip the highest points off the facility's load profile graph without disrupting core business operations.

Common peak shaving strategies include:

Load Shedding : Temporarily turning off non-essential equipment when demand approaches a predetermined threshold. This requires a robust energy management system (EMS) programmed with strict load priority tiers. For example, decorative fountains, secondary ventilation fans, and domestic hot water heaters might be shed first.

Load Shifting : Moving flexible processes to off-peak hours. In manufacturing, this might mean running heavy grinders only on the third shift. In commercial buildings, a common strategy is thermal energy storage (TES)—running chillers at night to freeze large tanks of water, and then using that ice during the afternoon to cool the building while the chillers are turned off.

On-Site Generation : Starting up a backup diesel, natural gas, or combined heat and power (CHP) generator to carry part of the facility's load during peak hours. Note that environmental regulations often limit the run-time of backup generators for non-emergency purposes.

Battery Energy Storage Systems (BESS) : Rapidly becoming the preferred peak shaving tool, BESS involves discharging a large lithium-ion battery during peak intervals to reduce grid reliance, then recharging the battery at night when grid demand and energy prices are low. Because batteries respond instantaneously, they are highly effective at neutralizing sudden demand spikes caused by motor startups.

Power Factor (PF) and Penalties

Another major component of utility billing that affects demand charges is Power Factor. In alternating current (AC) systems, especially those with significant inductive loads like large electric motors, transformers, and fluorescent lighting ballasts, the total power supplied by the utility is not entirely converted into useful work.

The physical cause of low power factor is the presence of magnetic fields required to operate inductive loads. Motors, transformers, and high-intensity discharge (HID) lighting ballasts require reactive power (kVAR) to sustain their magnetic fields. While this reactive power doesn't perform mechanical work, it oscillates back and forth between the utility generator and the facility's equipment, drawing additional current through the distribution lines and causing thermal losses.

Total power is measured in kilovolt-amperes (kVA), known as Apparent Power .

Useful power is measured in kilowatts (kW), known as Real Power .

Wasted or reactive power is measured in kilovolt-amperes reactive (kVAR), known as Reactive Power .

Power Factor is the ratio of Real Power to Apparent Power:

PF = kW / kVA

Ideally, PF = 1.0 (100%), meaning all supplied power is performing useful work. However, inductive loads cause the current waveform to lag behind the voltage waveform, resulting in a lower power factor (e.g., 0.75). A low PF forces the utility to generate and transmit more apparent power (kVA) to deliver the required real power (kW). To penalize facilities causing this inefficiency, utilities levy power factor penalties.

Most utilities require a minimum PF of 0.85 to 0.95. If the PF drops below this threshold, the utility will adjust the billing demand upward.

A common penalty adjustment formula used by utilities is:

Adjusted Billing Demand (kW) = Actual Demand (kW) * (Required PF / Actual PF)

Another formula often seen on utility bills involves charging a direct fee per kVAR of reactive power that exceeds a certain percentage of the real power. For example, a utility might charge $0.50 per kVAR for any kVAR consumption exceeding 33% of the kW demand. The relationship between kW, kVA, and kVAR forms a right triangle (the power triangle), where kVA is the hypotenuse. The formula tying them together is: kVA = sqrt(kW^2 + kVAR^2). You can also find the reactive power if you know the power factor angle: kVAR / kW = tan(arccos(PF)).

Worked Example: Power Factor Penalty

A facility has an actual peak demand of 1,000 kW. The utility requires a minimum PF of 0.90, but the facility's measured PF is 0.75. The demand charge is $12.00/kW.

Step 1: Calculate the adjusted billing demand.

  • Adjusted Demand = 1,000 kW * (0.90 / 0.75)
  • Adjusted Demand = 1,000 * 1.2 = 1,200 kW

Step 2: Calculate the financial impact.

  • Normal Charge without penalty = 1,000 kW * $12.00 = $12,000
  • Charge with PF penalty = 1,200 kW * $12.00 = $14,400

The facility is paying a $2,400 monthly penalty due to poor power factor.

To correct low power factor and avoid these penalties, energy managers typically install capacitor banks. Capacitors supply reactive power (kVAR) locally, reducing the kVAR that must be drawn from the utility grid, thereby bringing the facility's overall Power Factor closer to 1.0 and virtually eliminating the financial penalties.