:Demand charges cover electric utilities’ fixed costs of providing a certain level of energy to their customers. Energy costs are the variable-costs portion (charges by kWh). The challenge is that utilities have to maintain enough capacity to satisfy all their customers’ energy needs at once (e.g., a hot day in July when every customer runs their AC). Utilities have to maintain enough power capacity to supply all that energy at once, and this requires them to keep a vast array of expensive equipment on constant standby, including transformers, wires, substations, and generating stations. This capacity is extremely expensive to build, and demand charges help pay those costs.
Demand charges are also a means of encouraging customers to:
1) reduce power usage during peak hours.
2) shift their usage from peak to non-peak hours.
This way, utilities can levy higher charges on customers with more variable loads and pass the savings on to customers with more consistent loads.