What Are Capacity Charges and How Can You Manage Them?
Capacity charges have become a growing topic of discussion in recent years, but what are capacity charges? And how can
Capacity charges have become a growing topic of discussion in recent years, but what are capacity charges? And how can
Capacity charges have become a growing topic of discussion in recent years, but what are capacity charges? And how can businesses manage capacity charges to lower their electric bills?
Over the past year or two, there’s been a lot more talk about electric capacity charges, especially as they’ve started to increase and make up a bigger portion of electricity costs.
However, for many business owners, capacity charges remain a bit of a question mark.
I get it! All the line items on an electric bill—tariffs, fees, and miscellaneous charges—can often seem confusing or downright mysterious.
As much as I’d love to break down every single line item on your electric bill, the truth is, it’s nearly impossible because every utility structures its charges differently.
What I can explain is one of the biggest components of an electric bill, second only to the actual electricity used: capacity charges!
Capacity charges can account for 15% to 30% of a bill’s total electricity charges.
Understanding what capacity charges are and how to manage them can be a surprisingly simple way to lower the amount businesses pay each month.
What are capacity charges?
Capacity charges are the fees you pay to make sure there’s enough electricity available on the grid when electricity demand is at its highest.
But the above explanation doesn’t help explain how to manage capacity charges or lower your electric bill.
To help make sense of capacity charges and better understand how to manage them, it’s essential first to understand a few basic concepts, such as peak demand and how capacity charges are determined.
Peak demand refers to the times when electricity usage (or demand on the grid) is at its absolute highest.
Think of a hot summer day at 4:00 pm, when most businesses and residence are blasting their air conditioner to keep things cool.
During these moments, the strain on the electric grid is greatest because many people are drawing power simultaneously.
We call these “peak demand periods.”
On a typical day, when electricity demand is normal, utilities supply power as usual. But on that super hot summer day when the sun is scorching and everyone is blasting their air conditioners, the utility has to be able to provide enough power instantly, or there’s a power outage.
To ensure there’s always enough power when it’s needed the most, utilities track these high-demand periods very closely.
The more power a business uses during these peak demand periods, the more it contributes to that overall strain, which is where capacity charges come into play.
Capacity charges are the cost that each electric customer (business and residential) pays to their utility to ensure there is always enough electricity available to meet those specific moments of extreme electricity usage across the grid.
However, not every customer pays the same capacity charge.
Below, you can see an AI-created model of estimated capacity charges by customer type:
As you can see, not all customers are treated the same.
The portion of an electricity bill that goes toward capacity depends largely on how much power each home or business uses and when they use it.
Residential customers typically see capacity charges make up around 10% of their total bill.
For small businesses, that number often rises to 15–25% and sometimes 30% if they don’t use their electricity efficiently.
For medium-sized businesses, which have more equipment and varied energy usage throughout the day, the cost may be around 25%-35 %.
For industrial customers operating large-scale operations and utilizing heavy machinery, capacity charges can account for a significant 30–50% of their total energy costs.
So, why the difference?
It mostly comes down to how much stress each type of customer puts on the grid.
Larger users often consume more electricity during peak demand times, which pushes up their capacity tags.
So, how does a utility decide how much to charge each customer?
Let’s break that down next by understanding capacity tags and how they’re calculated.
Let’s go back to the example of the hottest summer day of the year, when every business and residence is using their air conditioner to keep cool – that moment when there’s a much higher than usual demand for electricity on the grid.
Utilities companies track how much electricity each customer uses during that high-demand moment (peak period) and assign each customer a “capacity tag.”
A capacity tag is similar to a label or grade that a utility assigns to each customer based on the amount of electricity they use during a peak period.
And here’s the thing: that “tag” helps determine how much each customer will pay in capacity charges each month for the following year.
Think of a capacity tag as a score that shows how much stress your business puts on the grid during a moment of peak demand. The higher your usage during that moment, the higher your tag. The higher your tag, the more you pay, and once your tag is set, that’s the cost you pay each month for the following year.
Every year on June 1st, the cycle resets. Your capacity tag is updated based on the previous summer’s peak usage. If you used a lot of energy during the five highest-demand hours, your capacity tag (and your costs) go up. If not, it could go down.
The way your capacity charge is calculated depends on where you are; every utility may have its own way of calculating it, but it usually comes down to one of three things:
How much electricity you used during the busiest hours of the year
Your share of the total demand in your area
Your highest usage in a single month
Your utility tracks this information and sends it to your electricity supplier, who then adds a capacity charge to your monthly bill based on local market prices.
That money is passed along to grid operators—like ISOs or RTOs—who make sure the grid stays reliable, especially during high-demand periods.
Ok, one last concept to explain:
Each year, each electric grid runs what’s called a capacity auction.
In simple terms, they try to forecast how much electricity will be needed in the year ahead, especially during peak demand times, and then set a price to ensure enough power will be available when it’s needed most.
That price becomes the capacity charge, which is then applied to each customer based on their capacity tag – your personal “score” based on how much energy you used during the grid’s busiest hours the previous year.
Here is a simplified chart that provides an overview of how capacity charges are determined, based on a customer’s usage during a peak demand period:
Why does all this matter?
Because capacity charges are going up, and they’re playing a bigger role in rising electricity bills. That’s why it’s worth taking a closer look at what’s driving these increases, and why it matters to your bottom line.
Here are three key factors behind increasing costs and why every business owner should understand how capacity charges work:
For the past two decades or so, electric demand on the grid has been relatively stable.
However, due to:
U.S. electricity demand is starting to surge, and current predictions show there is no sign of stopping, at least through 2050.
Click here to download our U.S. electric demand and price references and charts.
Something unusual is happening in America. Demand for electricity, which has stayed largely flat for two decades, has begun to surge.
Over the past year, electric utilities have nearly doubled their forecasts of how much additional power they’ll need by 2028 as they confront an unexpected explosion in the number of data centers, an abrupt resurgence in manufacturing driven by new federal laws, and millions of electric vehicles being plugged in.
While it’s normal for electricity prices to rise and fall each year with market conditions and supply and demand, what we’re seeing now is different.
A sudden surge in demand has created a widening gap between the amount of power needed and the amount the grid can supply, and electric grid providers are struggling to keep up.
As a result, electricity prices have risen faster in the last five years than ever before.
Since 2020, the average U.S. electricity rate has increased by 6.8% annually, which is faster than inflation over the same period.
Below is an AI-generated estimate illustrating the projected increase in U.S. electricity demand through 2050, alongside a modeled forecast of electricity prices.
The electricity price projection is based on the current average U.S. electricity price of $0.1299 per kWh*, and illustrates how prices could rise year over year through 2050, assuming no significant actions are taken to slow the rate of increase.
* According to the Energy Information Administration (EIA), the average price for electricity across all sectors (residential, commercial, and industrial) is 12.99¢ per kWh for 2024. While residential customers are paying a slightly higher average of 0.1615 to 0.1644 cents per kWh as of June 2025.
There are two major reasons the electric grid and power providers are having a hard time keeping up with rising demand:
Much of the U.S. power grid is decades old and was never designed to handle today’s growing electricity needs, let alone the demand we’re expecting in the coming decades.
Power outages are already becoming more frequent each year, and experts estimate that upgrading and modernizing the grid will cost billions of dollars.
Unfortunately, those costs are being – and will continue to be – passed on to customers through higher electric bills.
At the same time, many older fossil fuel power plants are being retired.
While this shift is necessary for long-term sustainability, the problem is that new power plants and renewable energy projects aren’t being built fast enough.
Delays in construction and permitting are slowing the rollout of replacements, leaving a growing gap between what is needed and what is available.
Together, these two challenges are creating a perfect storm of supply pressure, driving up costs and increasing the likelihood of capacity charges continuing to rise.
Alright, now that I’ve talked your ear off about capacity charges, what they are, why they exist, and how they’re calculated, let’s get to the good news:
There are many ways a business can actively reduce capacity charges and thereby lower its electric bill!
Since capacity tags are based on how much electricity a home or businesses uses during a specific peak demand period, the smartest thing to do is to use less energy during those peak periods.
And you don’t have to guess when those moments happen.
In many areas, energy consulting companies, like us here at Energy Professionals, offer programs, called demand side management programs, that actually send out alerts a day in advance, warning you that a peak demand period or day is coming.
These alerts give you time to prepare, allowing you to reduce usage when it matters most.
A good consultant can help you identify simple, low-impact ways to reduce electricity usage during peak demand periods, without disrupting your day-to-day operations.
In other words, you don’t have to shut down your business or stop what you’re doing.
You can keep running as usual, while following a tailored strategy that targets just the right areas to lower demand when it matters most.
Participating in a demand-side management program not only helps lower your capacity tag for the next year, but in some cases, you may even qualify for credits or rebates on your electric bill just for reducing demand during those high-stress grid moments.
For medium-sized businesses, extensive facilities, manufacturers, and industrial customers, there are many effective ways to significantly reduce electricity demand during peak periods, without interrupting operations.
As professional energy consultants, we specialize in designing custom strategies based on how and when your facility uses energy.
This includes analyzing your equipment, HVAC systems, production schedules, and overall consumption patterns. In many cases, we can even automate demand reduction, so that during peak demand events, your facility responds with the flip of a switch—seamlessly and without disruption.
Additionally, we can implement on-site generation solutions that activate during peak times, helping to offset grid usage and further lower your capacity charges. It’s all about building a plan that works specifically for your operations—smart, efficient, and cost-saving.
Lowering your overall energy usage doesn’t just shrink your monthly electric bill; it can also help reduce your capacity charges.
When you use less electricity, especially during peak demand hours, you’re not only paying for fewer kilowatt-hours, but you’re also lowering the stress your business puts on the grid.
That means a smaller capacity tag, which leads to lower capacity charges in the year ahead.
So, improving your energy efficiency has a double benefit: it reduces your immediate costs and helps manage long-term charges associated with peak usage.
In addition to managing your capacity charges, businesses located in states with energy choice (also known as energy deregulation) have another powerful tool: the ability to shop for competitive, fixed-rate electricity plans from retail energy suppliers.
By locking in a fixed rate, you can protect your business from future price spikes and avoid surprise increases when the broader market shifts. It’s a smart way to bring stability to your energy costs, especially in a time when rates are rising.
Thanks to deregulation, you’re not stuck with a single utility. You have the freedom to choose a supplier that offers better pricing or plans tailored to your business’s unique needs.
Many of these suppliers also offer advanced tools and services to help manage your capacity tag, monitor energy usage, and enhance overall efficiency, providing you with even greater control over your energy costs.
As one of the top energy consulting companies in the U.S., Energy Professionals has helped thousands of businesses save millions of dollars on energy costs over the past 25 years. From negotiating fixed-rate plans to designing custom energy strategies, we’re here to help you take full advantage of every opportunity to reduce your costs.
Click here to watch a short video that explains the Energy Choice Program
At Energy Professionals, we help businesses across the U.S. manage and reduce their energy costs, especially when it comes to electricity prices and capacity charges.
Whether you’re running a small operation or a large commercial facility, we’ll build a custom energy strategy that fits your goals and reduces risk.
With over 25 years of experience, we’ve helped thousands of companies save money through:
To support small businesses, we’re offering a free energy analysis and custom strategy session to help you identify ways to manage and reduce your energy costs, with no obligation to hire us.
Whether you partner with us or simply want guidance, we’re here to help.
Don’t hesitate to reach out—let’s start building your savings strategy today.
James Lightning
Senior Editor, Energy Professionals
(844) 674-5465
info@energyprofessionals.com
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