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The Rational Economic Man’s take on Chicago Municipal Aggregation #Chicagomuniagg

With all this talk of Chicago Municipal Aggregation lately, I’ve been thinking about what would be the best way to tackle this decision. On one side you have the tried and true ComEd, on the other side you have the new Integrys Energy providing a new supply rate of 5.42 c/kWh, and as a third option you have all the other retail electric suppliers with various rates and their various contracts stipulations.  I figured at the end of the day, the “best” decision is based on the one that will provide me the most utility. A good proxy for utility is dollars ($). So, if I apply the economic principle of Rational Economic Man to the options surrounding Chicago Municipal Aggregation, I should be able to do the math and determine which option will provide me with the most utility. (My U of Chicago professors are so proud and smiling right now!)

Problem Set-up

The best way to begin this problem is to figure out what we already know. (This is a trip down memory lane back to my undergrad days. Now if I could only find my TI-85.)

Let’s start with option 1 – ComEd.  ComEd’s current supply rate is 8.32 c/kWh. There are very few stipulations in the ComEd contract, except that if I choose a retail electric supplier and subsequently go back to ComEd for more than 2 months, I have to stay on the ComEd rate for at least 12 months. Also, I know that ComEd’s contracts for electricity supply are coming due in June, and it’s expected at that time that the IPA will be able to get new supply contracts for a lower electricity supply cost than we currently have. (check out this article I wrote about How the IPA purchases electricity for ComEd and Ameren.) But, no one is sure how much the electricity supply charge will go down, and no one know that ComEd’s rates won’t go up between now and June. These are known as “variables”.

Option 2 is to go with Integrys and the Chicago municipal aggregation rate. Their supply rate is 5.42 c/kWh. The contract with Integrys is for two years (24 months). It also includes a $0 ETF (early termination fee), which allows me to change suppliers at any time within those two years without having to pay a penalty. But, the timing of Chicago Municipal Aggregation means that I won’t actually be switched until March at the earliest, so my December, January, February, and possibly March electricity bills will still be on the current ComEd rates.

Option 3 is a little more complicated since it’s technically dozens of options. I can choose the rate, the length of the supply contract, the ETF fee, and the amount of green energy I want to purchase. The “democratization of electricity” means that I can choose, but it also means that I have many options to evaluate. For the sake of simplicity and brevity, I’m going to make-up an option 3 that is representative of an “average” supply contract. So, option 3 will be from Supplier X, have a rate of 5.7 c/kWh, a length of 12 months, and an ETF of $50.

The next step is to determine what will be our average electricity usage for each month. I’m going to use ComEd’s Settlement Load Profile (https://www.comed.com/customer-service/rates-pricing/retail-electricity-metering/Pages/res-settlement-profiles.aspx) for the “Residential Multi Family Without Electric Space Heat” customer class (Customer Class 23). This data is an average electricity usage by hour for all users in this customer class.  Using the most current month data as a proxy, here’s what we get:

January 2012                                                         744.7 kWh

February 2012                                                       675.9 kWh

March 2012                                                            630.7 kWh

April 2012                                                               610.2 kWh

May 2012                                                                639.5 kWh

June 2012                                                               863.8 kWh

July 2012                                                              1,128.4 kWh

August 2012                                                        1,008.2 kWh

September 2012                                                     791.7 kWh

October 2012                                                          772.1 kWh

November 2012                                                     353.1 kWh

December 2011                                                     366.2 kWh

The problem we’re trying to solve is to figure out which of the 3 options we’ve laid out is going to be the best for us. Clear as mud, right?

The Math

It’s time to crunch the numbers. We’re going to make it a little easier on ourselves and make a few simplifying assumptions to make the math easier. First, we’re going to assume that your electrical bill is only the electricity supply charge. In reality, your electrical bill includes many more line items which all have an impact on your cost of electricity. But, since we’re comparing supply rates from different suppliers, this simplifying assumption will make the math much easier, and only have a small impact on our results. The dollar value savings will be correct for all 3 options, but the calculated percent savings will be larger than reality (because we’re not including all the costs). Second, we’re going to assume that the ComEd electricity supply rate will remain the same until June. The electricity supply rate will most likely change between now and June, but we have no insight into how and when it could change, so we’re just going to assume it remains the same.

So, if we value our 3 options for the next year, here’s what the table looks like:

But, we run into a problem to compare the options after June because we don’t know what the ComEd rate is going to be after that. Most experts are pointing to the fact that the ComEd rate will be lower than it is now, but no one has ventured a guess as to what is going to be the rate. So, there’s one challenge to determining which option provides the most utility in the next 12 months. Plus, if my contract has an ETF, I have to make sure that the addition value of my new supply rate over my old one exceeds the cost of the ETF.

Evaluating the Options

The other piece that we haven’t discussed is that it is not a single decision that must be made today, and we must live with the consequences. We can choose to make a choice at some point in the future.

Let’s start with a simple choice, and see how complicated it could become. Let’s choose to do nothing, meaning that we’re going to be with ComEd for 2 months, and then be switched to Integrys.  We’ll spend $118.19 for the 2 months we’re on ComEd, and  $101.92 between March and June for Integrys. But in June, after I know the new ComEd rate, I can make the choice to return to ComEd. How to I value that “option” and determine how much utility I can get from making that choice? Luckily, one of the professors at the U of Chicago, Myron Scholes, determined how to value an option in 1973. The Black-Scholes Equation is below. (All my U of Chicago professors are now grinning from ear to ear.)

Let’s do the math…

Actually, let’s not and say we did. I’ve used this equation in the past, and it was difficult then when my calculus was a more fresh. I’m a little rusty these days, so it would take a while to get it to work out right. Plus, we’d have to run it for every option. (At first glance, there are at least three, and I’m sure we’d find more as we dug into the problem.)

The Gist

This problem quickly gets out of hand once you start figuring in all the possibilities and different options that you have in front of you. Part of the issue is that we’re not all Rational Economic Man. We don’t seek to maximize our economic utility with every decision. We have imperfect and incomplete information (as was demonstrated above), which makes fully rational decisions nearly impossible. And, if we waited for all the information to be available, we wouldn’t be able to make any decisions. (Hence the rise in the study of Behavioral Economics as a field of economic study. And, the U of Chicago professors go wild!) Regardless, “utility” is an extremely nebulous concept, and who’s to say that I don’t get more “utility” from choosing a green power rate than from saving an extra $2 per month.

At the end of the day, understand your options and choose the one that works for you. It’s the democratization of electricity – know your options and make a choice.

Man, trying to be a Rational Economic Man is really hard…  My brain is fried… I need a beer…

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  1. Mark Pruitt says:

    Your model is quite good. However, the City’s plan starts delivering electricity in February 2013, not March 2013. So savings should be elevated for the City option.

    Additionally, the model fails to place a value on the rational man’s time to effect option 3. This is not an insignificant issue based on the fact that the real (or perceived) cost of making a transition to a third party supplier has been and continues to be the primary barrier to customer migration away from the default rate offered by ComEd. If this were not the case, would we not see 85% migration as opposed to only 15% migration. So the City offering should be factored in a manner that monetizes the time and effort an average consumer would need to invest to research, evaluate and decide to change to a lower price.

    Best regards.