Capacity Markets (Part II): How to minimize your exposure to capacity costs

In Part I of this blog series we explained how rising capacity prices increase revenue for demand response (and generation) and how you can cash in on demand response. But that’s only one side of the coin; the other side is that someone has to pay for that capacity. It probably comes as little surprise to hear: that someone is you, the electricity consumer.

In this post we will explain how capacity charges are determined, and what you can do to minimize your exposure.

What is a capacity charge?


Energy represents a large expense for most businesses. Capacity costs—determined by electricity consumption during just a limited number of peak demand hours in the year—are a key driver of annual utility costs.

Electricity consumers pay a fixed monthly payment called the capacity charge. This charge mirrors the price paid to electricity generators in the capacity markets for ensuring the grid can meet peak demand.

Depending on the operating rules of the local utility and regional transmission organization (RTO), capacity and other demand-based charges often range from 10-40 percent of a customer’s total electricity costs.

What comprises your capacity charge?

Your capacity charge is effectively comprised of two elements—the size of the capacity market and your usage during peak demand.

The size of the capacity market

For various reasons discussed in Part I of this blog series, capacity prices in the Northeast are undergoing an unprecedented increase. While capacity prices have been relatively low and stable for the past seven years, recent forward capacity auctions have closed at prices reaching five times higher than historic rates in some zones.

The increasing size of the capacity market (in both absolute terms and as a percentage of the wholesale electricity markets) will result in a commensurate increase in capacity charges for energy consumers unless they actively manage that risk.

Your usage during peak demand

Each year during peak demand on the electricity grid (usually during the afternoon on one of the year’s hottest days), the market operator tags each customer’s energy consumption, tracking their usage during the peak. This “capacity tag” determines your share of the capacity market for the following commitment period (see timeline grapic).


Hypothetically, a customer who reduces consumption to zero during the system peak could avoid paying for capacity all together.

How to minimize your exposure to capacity costs

While you cannot control the capacity market, you may have considerable control over your usage during the system peak when “capacity tags” are set. Therein lies the opportunity for savings. And as the capacity market grows, so does the incentive to minimize your exposure to capacity costs.

Here are some steps you can take to reduce your electricity usage during peak demand:

  • Energy Efficiency Measures – The most reliable way to mitigate capacity costs is to install energy efficiency measures to lower your capacity tag prior to the summer when they are set. For example: replace inefficient lighting and motors, modernize HVAC equipment, etc. Consider conducting an energy audit to identify any deficiencies and maximize your savings.
  • Engage in Demand Response – As discussed, demand response—a commitment to reduce electricity demand when called upon—can be a source of revenue, but it can also reduce your capacity charge by decreasing your electricity consumption during system peaks.
  • Capacity Tag Management – Customers can take action to voluntarily reduce consumption during predicted peak hours. As with demand response, some preparatory work can help you make the most of this opportunity. A qualified energy consultant can help you:
    ---Sign up for alerts that notify you of the days when capacity tags are likely to be set
    ---Execute demand reduction strategies, such as lowering air conditioners, shifting production, scheduling maintenance or even shutting down a factory for a brief period
    ---Install a smart control system to facilitate demand reduction
    ---Evaluate whether back-up generation is an appropriate solution for your facility

Combined together, these strategies can help businesses save up to 30 percent on annual electricity costs, just by taking action during a few hours of the year. 

Want to learn more? Contact SourceOne at 800.510.4485 to speak to an energy expert.