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HomeMy WebLinkAboutStaff Report 2508-5116CITY OF PALO ALTO Climate Action and Sustainability Committee Friday, September 05, 2025   Agenda Item     2.Consideration of Alternatives for City's Role in Facilitating Compliance with Air District Zero NOx Requirements for Water Heaters; CEQA Status: Under CEQA Guidelines Section 15183, Projects Consistent with an Existing General or Comprehensive Plan to not Require Additional CEQA Review Presentation, Late Packet Report Added Climate Action and Sustainability Committee Staff Report Report Type: ACTION ITEMS Lead Department: City Clerk Meeting Date: September 5, 2025 Report #:2508-5116 TITLE Consideration of Alternatives for City's Role in Facilitating Compliance with Air District Zero NOx Requirements for Water Heaters; CEQA Status: Under CEQA Guidelines Section 15183, Projects Consistent with an Existing General or Comprehensive Plan to not Require Additional CEQA Review This will be a late packet report published on August 28, 2025. Climate Action and Sustainability Committee Staff Report From: City Manager Report Type: ACTION ITEMS Lead Department: Public Works Meeting Date: September 5, 2025 Report #:2507-5016 TITLE Consideration of Alternatives for City’s Role in Facilitating Compliance with Air District Zero NOx Requirements for Water Heaters; CEQA Status - Not a Project RECOMMENDATION This is a discussion item and no recommendation is requested. Staff is developing a proposed 2026-2027 S/CAP Work Plan and will incorporate the Climate Action and Sustainability Committee’s feedback on potential assistance programs to help residents comply with Bay Area Air District’s building appliance requirements for water heaters taking effect in 2027 that prohibit sale of water heaters that produce oxides of nitrogen (Zero NOx rules). EXECUTIVE SUMMARY Bay Area Air District (Air District) rules are taking effect January 1, 2027 prohibiting sale of water heaters that produce oxides of nitrogen (the Zero NOx rules).1 Community members needing to replace a water heater will almost certainly need to install electric water heaters to comply (many may choose not to comply, procuring gas water heaters from outside the region). While the City does not have a role in enforcing these regulations, the City could play a role in providing information, technical assistance, and potentially financial incentives or financing options to assist community members to comply with the updated Air District rules. Current options for building water heaters include legacy gas-fueled heaters, electric resistance tank and tankless water heaters, or heat pump water heaters. Electric resistance tank and tankless water heaters have low upfront costs, but high lifecycle costs, and tankless electric water heaters can have significant grid impacts. It is, however, difficult for electric resistance water heaters to comply with current Energy Codes. Heat pump water heaters have the lowest lifecycle cost, the least grid impacts, and can easily meet code requirements; however, they are more expensive to install. 1 Bay Area Air District Rule 9-6 (Nitrogen Oxides Emissions from Natural Gas-Fired Boilers and Water Heaters) https://www.baaqmd.gov/en/community-health/building-appliances-rule-implementation Staff is seeking Climate Action and Sustainability Committee (CASC) feedback on potential approaches for City engagement with ongoing regional discussions on Zero NOx and Energy Code compliance assistance, and making it as easy as possible for residents seeking to comply to adopt heat pump water heaters. Potential forms of assistance under consideration by staff and regionally include contractor training, permit streamlining, incentives, and financing. Potential incentive and financing alternatives include: • Providing information to community members seeking to comply, but not incentives or financing. • Providing financing, but not incentives, and/or limited income-qualified incentives. • Providing a full range of incentives and financing accommodated by available funding. Incentives and financing could be aligned with regionally common levels of financial support offered through other similar agencies or could be provided at a greater or lesser level. Based on CASC feedback, staff would design a potential assistance program in coordination with other regional agencies for Council approval. Staff would also include any relevant work items in the proposed 2026-2027 S/CAP Work Plan for CASC review, and would consider funding needs in its development of the FY 2027 budget and long-term S/CAP financial modeling efforts. Staff is requesting CASC feedback on the following questions: • Should staff be considering incentives and/or financing to promote heat pump water heaters to assist residents to comply with Air District Zero NOx requirements? • Should staff bring forward residential assistance alternatives for consideration at higher levels than are available regionally, or seek to align with the regional standard? • Should staff consider ways to accommodate electric tank and tankless water heaters, developing programs to address the lifecycle costs to customers and the impacts to the electric system? Staff’s recommended approach is to: • Continue to track regional discussions and collaborate with Community Choice Aggregators (CCAs) • Bring forward proposals to provide financial assistance (incentives and/or financing, including 0% financing) for residents to comply with Air District rules, including alternatives that may exceed the baseline level of assistance being provided regionally, and include them as an alternative for consideration during S/CAP financial planning • Evaluate steps to participate in any regional efforts that provide contractor support, incentive delivery, financing, or permitting alignment • Explore the feasibility and potential benefits and impacts of programs enabling electric resistance tank and tankless water heaters • Include a work item in the 2026-2027 S/CAP Work Plan on helping residents comply with Air District Zero NOx rules. BACKGROUND The City currently operates a voluntary program to help people convert their gas water heaters to heat pump water heaters. In 2027, mandates will start to take effect. The Air District regulates emissions from small water and space heaters typically used in homes and small businesses (Rules 9-4 and 9-6).2 In March 2023, the Air District required that all new water heaters manufactured after January 1, 2027 and installed in the Bay Area must be zero-NOx. This applies to small water heaters (less than 75,000 British thermal units (BTU) per hour), which are common in homes and small commercial buildings. The prohibition covers all of District territory (Alameda, Contra Costa, Marin, San Francisco, San Mateo, Santa Clara, southwestern Solano, and southern Sonoma counties). Staff anticipates that by 2027-2028, most available water heaters will be heat pump or electric tank/tankless heaters. Electric tank and tankless water heaters have lower up-front costs but use far more energy than heat pump water heaters, and so are more costly long-term and have greater impacts on the electric grid. These units also face challenges in meeting current Energy Code requirements and are likely to be installed without permits. Heat pump water heaters are therefore preferable, despite higher initial costs, larger size, and potential construction upgrades such as the need for new electrical conduit, proper ventilation, and condensate drainage. Staff's Advanced Heat Pump Water Heater Pilot Program has identified solutions to these barriers, but substantial funding and assistance are often necessary. Other agencies are also addressing these issues. In April 2025, the Air District Stationary Source Committee reviewed strategies for situations where installing heat pump water heaters is challenging, with recommendations due later this year. Staff is coordinating with CCAs on potential support measures, such as incentives, financing, contractor training, and streamlined permitting. ANALYSIS Various forms of assistance are under consideration both locally and regionally. Permit streamlining and contractor support are the lowest-cost options. The City has already streamlined permitting for heat pump water heaters through its pilot program but could further align with regional processes. Contractor training requires more effort, but robust programs are available through Silicon Valley Clean Energy,3 Marin Clean Energy,4 Pacific Gas and Electric,5 2 Bay Area Air District Rule 9-6 (Nitrogen Oxides Emissions from Natural Gas-Fired Boilers and Water Heaters) https://www.baaqmd.gov/en/community-health/building-appliances-rule-implementation 3 https://svcleanenergy.org/contractor-training/ 4 https://mcecleanenergy.org/contractor-resources/ 5 https://www.pge.com/en/business-resources/business-education-and-tools.html BayRen,6 and Build it Green.7 Regional workforce development efforts also exist. Utilizing these regional resources would allow the City to support compliance using current staff and budget. Incentives and financing generally require more resources. Typically, utilities discontinue incentives once mandates are in effect, but the Air District’s Zero NOx Rule may justify ongoing incentives and financing since complying could raise household costs. While the Rule may be cost-effective societally based on long-term health benefits from improved air quality, in many or most cases the available pathways to compliance will raise ongoing household expenses for the individual homeowner. As gas water heater availability in the Bay Area declines under the Zero NOx Rule, residents seeking to comply will likely pursue one of the following approaches: • Installing heat pump water heaters. • Replacing gas water heaters early with pre-2027 gas models. • Installing lower-cost electric resistance water heaters, often without permits.8 These units consume 3 to 4 times more energy than heat pump water heaters, resulting in higher long-term operating costs. If installed as tankless models, they can also place additional strain on the electric grid. Noncompliance with the regulation will also likely occur, with installers buying water heaters outside the area. Staff is unsure what degree of compliance may occur, but given that many gas water heaters (likely a majority) are installed without permits, some degree of noncompliance should be expected. Given the City’s emission goals, encouraging heat pump water heaters is desirable, though initial costs and installation complexity are barriers for many customers. While first installations might be costly, subsequent replacements would be more affordable because one-time improvements such as electrical conduits and drainage would already be done. Heat pump water heaters may be cost-effective for households of 3-4 people with straightforward installations. Medium complexity installations might not recover initial costs immediately but could pay off within the life of the second heat pump water heater installed (since the one-time improvements like electrical upgrades and drainage are only installed the 6 https://docs.google.com/forms/d/e/1FAIpQLScGQlhZVFl7GPiUMoCw2cENHiSpE16qLp2UC8BsLaj7PuhRkA/viewfo rm 7 https://www.builditgreen.org/training/, https://www.builditgreen.org/power 8 In practice it would be difficult for a homeowner to switch from a gas water heater to an electric tank or tankless water heater while complying with Energy Code requirements. Although it may be technically feasible with the addition of solar panels and/or solar hot water to offset the increased energy usage, few homeowners are likely to take this approach. Instead, many are expected to proceed without permits – consistent with current trends, where staff estimates that approximately 2/3 to 3/4 of water heaters are already replaced without permits. Electric tankless water heaters are challenging to install due to their high electrical demand, which often require a service panel upgrade. As a result, most unpermitted electric replacements would likely be electric tank water heaters, which have lower electrical capacity requirements first time). More complex projects may take longer to recover costs, and the Air District is considering exemptions for these scenarios. Incentives or financing with long payback periods can help residents achieve long-term economic and health benefits. Alternatively, limiting incentives and financing would have lower costs to the City, and funding sources that might be used for these programs could be used for other programs or to moderate utility rate increases. Without City-provided financial incentives, adoption of heat pump water heaters would likely be lower, and more electric tank and tankless water heaters and more gas water heaters would likely be installed. If the City proceeds with customer incentives and financing, however, the City could align these with regional efforts. Current regional discussions include low-cost or zero-percent financing, potentially prioritizing low- and middle-income households, since up-front incentives for all community members would likely be costly. Staff has developed very preliminary cost and bill impact estimates for several sample scenarios. These do not represent formal proposals and the actual cost of any of these proposals may be higher or lower than estimated. The scenarios modeled include: • Preliminary Example 1 – 0% financing available to all customers • Preliminary Example 2 – Low-income (LI) $4500 incentives + 0% Financing • Preliminary Example 3 – LI $4500 incentives + Middle-income (MI) $2500 incentives + Lower-interest (5%) financing • Preliminary Example 4 – LI $4500 incentives + MI $2500 incentives + 0% financing Staff made preliminary cost and bill impact estimates for each program assuming the program runs for 13 years from 2027 through 2039. This is about the expected life of a tank water heater, so even people who put in gas water heaters in 2026 would be able to take advantage. Various other assumptions (average heat pump water heater cost, gas water heater cost) were drawn from the S/CAP Funding Model, which in turn drew from the best available regional data sources. The cost of interest rate buydowns were based on a quote from the GoGreen program. Net bill calculations are based on 0% financing over 20 years of the incremental cost of a heat pump water heater (the amount by which the cost of a heat pump water heater replacement exceeds the cost of a gas water heater like for like replacement). Table 1 shows the results of the preliminary analysis. Table 1: Preliminary Results from Four Preliminary Example Program Designs Preliminary Example Estimated Annual City Program Cost Customer first year net monthly bill impact, assuming average bill savings from HPWH and assuming financing is repaid on bill ($/month) Low-income Middle-income All others 1 (0% financing) $0.91 million +$7 +$7 +$7 2 (LI incentives + 0% financing) $1.18 million -$12 (savings) +$7 +$7 3 (LI + MI incentives + 5% financing) $1.21 million -$12 (savings) Minimal or no change +$18 4 (LI + MI incentives + 0% financing) $1.63 million -$12 (savings) -$4 (savings) +$7 The scenarios above do assume an up-front participant payment about equal to the cost of a gas water heater. In the City’s experience, even this copayment can be challenging for many income-qualified program participants. If the City were to allow 0% financing for the copayment for income-qualified participants for Scenario 2, 3, and 4, along with the low-income incentive, their utility bill would show little or no net change rather than a $12/month savings in the first year. This could be an alternative to consider for a future program. It would add about $80,000 per year in costs. The scenarios above are based on average costs for heat pump water heater and gas water heater installations based on regional data (about $7400 for a heat pump water heater and $2850 for a gas water heater). Staff intends to perform a more in-depth cost analysis using the full range of available heat pump water heater cost data from the Advanced Heat Pump Water Heater Pilot Program when developing final program proposals for Council adoption. FISCAL/RESOURCE IMPACT The fiscal impact of a Zero NOx compliance customer assistance program would vary depending on the approach considered, as noted in the Analysis section above. The funding sources for financing and incentives for such a program could include, at minimum, the following: • Public Benefits • Electric Cap and Trade • Gas Cap and Trade A thorough overview of these funding sources and the range of potential City priorities they could support, including S/CAP climate goals, was provided to Council at its May 12, 2025 study session. The staff report for that meeting provides information on the funding sources generally, including projected revenues and expenses.9 9 City Council, May 12, 2025, Discussion of Strategies for the Use of Low Carbon Fuel Standard, Electric and Gas Cap and Trade, and Electric and Gas Public Benefits Revenues https://cityofpaloalto.primegov.com/meetings/ItemWith TemplateType?id=7996&meetingTemplateType=2&compiledMeetingDocumentId=14601 Based on feedback from the CASC, staff will evaluate potential funding sources for this program in the context of other long-term S/CAP financial planning efforts and the FY 2027 Budget. STAKEHOLDER ENGAGEMENT Staff is meeting with the Climate Action Working Group prior to the September 5 meeting and will provide a verbal update on feedback received. In addition, staff has been discussing potential alternatives with neighboring community choice energy providers to ensure regional alignment and is tracking regional progress on consideration of this issue. Staff is considering what additional outreach could be helpful in consideration of a program this broad, such as engagement with low-income service providers, contractors, and the public more broadly. Staff also intends to coordinate with regional agencies on outreach and may use surveys (Palo Alto specific or regionally coordinated) as needed to support program design. ENVIRONMENTAL REVIEW The Committee’s discussion of potential customer assistance and incentive programs for water heater replacements to comply with the Air District Zero NOx Rule does not meet the definition of a project under the California Environmental Quality Act (CEQA), pursuant to the California Public Resources Code Section 21065, because it is not an activity that will cause a direct physical change in the environment. In the alternative, the discussion is exempt from review under CEQA Guidelines Section 15302, since it involves the replacement of existing facilities. ATTACHMENTS None APPROVED BY: Brad Eggleston, Director Public Works/City Engineer Agenda Item 2: Zero NOx Regulations Compliance Assistance Climate Action and Sustainability Committee September 5, 2025 www.paloalto.gov Background 2 •Air District regulates water heating and space heating emissions (Rules 9-4 and 9-6) •Small water heaters manufactured after January 1, 2027 must be Zero NOx to be sold or installed in Bay Area •Heat pump water heaters are the most cost-effective approach on a lifecycle basis •More expensive up-front due to one-time home modification •Various agencies discussing assistance programs paloalto.gov/ClimateAction Potential Forms of Assistance 3 •Incentives •Financing •Contractor Training •Streamlined Permitting paloalto.gov/ClimateAction 4 4Acting Now for A Resilient Future paloalto.gov/ClimateAction Preliminary Cost Estimates – Incentive/Financing 5 5Acting Now for A Resilient Future paloalto.gov/ClimateAction Staff Recommended Approach / Next Steps •Continue discussions with CCAs and other Bay Area agencies –Evaluate steps to participate in any regional programs •Add work item (incorporating Committee feedback) into 2026 -2027 S/CAP Work Plan –Coordinate with other 2026-2027 strategies for residential electrification •Develop proposals for Council consideration in early 2026 –Include a range of alternatives, including those that exceed what other agencies are providing regionally •Explore the feasibility, benefits, and impacts of electric resistance water heaters for compliance Thank You! Please submit questions or comments to Sustainability@paloalto.gov