Deregulation in the electric utility industry is forcing utilities to identify ways to maintain revenues and maximize profits (Elleson (2000)). This is also having an impact on the industrial plant that must purchase power. In the regulated environment, the price for electricity is equal to the cost to produce and distribute power plus the profit as guaranteed by regulators. In the new, deregulated, marketplace profit is equal to price minus the cost to produce and distribute the electricity.
Currently, there are two main types of pricing for industrial consumers, namely, Demand and Time of Use (TOU). With demand pricing the energy cost is comprised of two components: a demand charge based on the amount of electrical capacity the industrial plant wants to be guaranteed of having in case it needs it, and a energy charge for the actual amount of power that is used. With a demand pricing contract the customer gets the energy when he wants at a price based on the amount of power required. Under the Time of Use pricing option, the price of electricity depends on the time and day and season of the year. This is similar to the way airlines adjust fares during peak travel times. TOU contracts benefits customers that have the flexibility to shift usage to off-periods when the price of electricity is less.
A utility that offers demand pricing must determine an appropriate price that will cover the average cost of supplying power. The utility runs the risk that during times when the power cost is high, its customers' total demand will be greater than was estimated when the rate was established; thereby, lowering profits. Time-of-use rates represent a step toward matching the price of electricity to the cost of providing it. However, the utility still bears some risk that its cost of production and distribution will not be covered.