The City of Chicago, which runs an opt-out municipal electric aggregation, recently announced some high-profile changes to the aggregation's electric rate structure. The changes show why municipal aggregations, and their one-size-fits-all approach, are not the best way to save on your electric bill.

In short, as noted by Crain's Chicago Business, Chicago is introducing several "tiers" for a flat monthly charge that all aggregation customers must pay each month as part of their electric bill. This is in response to customer dissatisfaction with the aggregation's original flat monthly charge.

This flat monthly charge for electricity supply on top of volumetric (per kWh) charges is unique, and is not typically found in residential electric rates when you shop for an alternative electric supplier on your own.

Why institute a flat rate?

To understand why Chicago elected to institute, and then modify, the flat monthly charge, we need to talk about the electric grid, and specifically electric capacity. Federal regulators require each electric supplier operating in the ComEd service area to purchase an administratively determined amount of "capacity" to ensure that the grid has enough power plants, and other sources of capacity, to meet peak demand.

Capacity is measured on a "demand" basis, in megawatts (MW), or kilowatts (kW). These demands represent the electric production that a power plant can contribute to the electric grid at any instant (or on the flip side, how much demand a customer is pulling from the grid at any instant). These demand measures have no time horizon. Electric suppliers must pay capacity charges based on their demand (kW).

In contrast, when you consume electricity, the consumption is measured over a period of time, typically a kilowatt-hour (kWh). This creates a mismatch between how suppliers are charged for capacity (on a kW demand basis), and how electric use is measured for residential customers (on a kWh usage basis). Further complicating matters is the fact that residential electric meters do not measure a customer's demand (or their pull from the grid at any one instant), and instead simply measure aggregate electric usage on a kWh basis.

This makes it impossible for electric suppliers to properly assign capacity demand charges to residential customers on a pure cost causation basis. Indeed, all residential customers are assumed to have the exact same demand, under a mechanism known as a "load profile," which is a proxy for the demand of an average residential customer.

What do electric suppliers do?

Traditionally, utilities and electric suppliers have simply included residential capacity demand charges in their volumetric per kWh rates.

However, this creates cross-subsidization. Since electric suppliers incur the same exact capacity demand charge for all residential customers (under the load profile mechanism discussed above), when you then recover these costs from customers on a volumetric (kWh) basis, customers who use more kilowatt-hours end up paying more in capacity charges, relieving lower-usage customers from paying the full amount. While higher-usage customers do use more electricity, they don't necessarily place higher demand on the grid (again, as assumed under the load profile mechanism), and arguably, should not be paying higher capacity charges versus other customers.

One approach to this cross-subsidization problem is imposing a flat charge, equal for all customers, to recover capacity charges. However, this has its own problems.

The first is that it relies on an inherently flawed model, the load profile proxy, which itself is inequitable. In other words, under this flat charge model, customers who have low demands are being charged a high flat charge simply due to the use of an average load profile. This flat charge can represent a significant portion of the overall bill for a low-usage customer.

Second, the use of a flat charge sends disincentives to customers to conserve energy, since they will see less of a reduction in their bill (due to the fixed flat charge) from using electricity wisely. Critics therefore argue that although a volumetric recovery of capacity costs is not perfect, equity demands such cost allocation versus a flat charge model.

Who's right?

The truth is: nobody.

The reality is that a volumetric collection of capacity charges will be better for some customers (namely low-usage customers). In contrast, high-usage customers will benefit if capacity costs are allocated on a flat, per-customer basis.

The changes to Chicago's municipal aggregation rate design are meant to reconcile these competing tensions, but the changes introduce an overly complex set of pricing tiers based on usage.

The solution is much simpler. Customers should simply negotiate their own electric rate that suits their individual needs, demands, and usage patterns. That's one of the biggest benefits unlocked from the introduction of choice into the electric market: Customers can get the best electric rate designed for their individual circumstances.

Municipal aggregation essentially eliminates this custom pricing, and re-introduces cross-subsidization into electric rates under the aggregation's one-size-fits-all rate structure. The Chicago aggregation flat charge, and its inevitable redesign, is only the latest manifestation of this reality.

Crain's summarized that with the government aggregation rate design, Chicago, "has created losers as well as winners among the more than 700,000 households buying power through the contract negotiated by the city."

When you make your own choice for an electric rate, instead of relying on a government aggregation, you can ensure that you're not one of these losers.